Thursday, September 30, 2010

Public Choice

The speaker for this podcast seemed to touch very little on economics as a subject. Rather, he seemed to point out what he perceived as problems with the current system. In fact, he seemed to point out the basics of what someone would learn on a Saturday morning political strategy workshop. For instance, he pointed out that there are a number of different reasons for why people vote the way they do. I will begin by pointing out the most familiar one. He mentioned that people who have a "baby face" are less likely to be elected. Fine, if the statistics demonstrate this, I will take his word for it. He then created some sort of a sociology experiment in which people had to express their views, first through a forced mechanism, then through their free will. Again, alright, I will recognize that this is a legitimate way to carry out a social experiment. What was bothersome about his overall talk, however, was that he really didn't provide any sort of a convincing argument. Sure, people will vote for people for their own moral conscience, because they want to express some sort of off-the-wall view, or maybe they even buy into a popular campaign slogan. I get it. However, he didn't cite any studies to demonstrate this. Granted, it would be very hard to conduct such a study, but it seemed to be more speculation than anything else.

Wednesday, September 29, 2010

Carl Menger's Beard vs. Keyne's Mustache

So The Question of the week is a battle of facial hair rather than ideas (pun on the Commanding Heights for Sherri)

If Carl Menger's beard got in a brawl with John Maynards Keyne's mustache which side would be victorious?

Please vote below through commenting action but note that due to public choice this results in intransitivity which makes this whole process irrational (Who knew?)

Examples for know why! Menger is the sporting the Austrian look. While JMK is presenting the latest fall Keynesian number.

Are the SWEET Scholars trying to make me an irrational Nihilist?

Collective action is sloppy and imprecise. To look at each individual and make value judgements as to whether they are acting rationally or irrationally is an utter impossibility by the very fact that the model would collapse under its own weight. So the proposal squeaked out by Matt Mitchell is that we instead focus on how other people’s institutions function to give us clues as to why or why not their society prospers or fails. It is difficult to test this theory, but it does carry value, particularly when we consider how these institution impose limits and interact with their society. And as people we should probably consider ourselves equally rational (or irrational) in spite of widely differing views and opinions.
So the institutions (governments) place a series of choices in front of a given people, with absolute control over the options, the number of options, the order of the options, the level at which people can interact with those options, everything. The people get to make an uninformed decision on which options suit them best given massively imperfect information, and then hand the poor choice back to the institution for interpretation of the meaning of the chosen option. Furthermore, there is a statistical inevitability that your vote will not matter, especially if your institution has strange and complicated processes of arbitrage (like an electoral college). Amazingly, people continue coming back to the polls to repeat the process, again and again, while institutions continue to provide the opportunity.
So in spite of democratic appearances it would seem that institutions wield nearly absolute power. However, there is one caveat that Matt Mitchell failed to address, perhaps institutions are as irrational and as uninformed as society. Institutions and society are made up of the same material (idiots) and are subject to the very same cycles of rationality and irrationality. The assumption that institutions are acting rationally at all times is absurd, in fact it my be the case that institutions are in fact more irrational in their behavior then society at large: it may be that institutions are quite consciously irrational. They undoubtedly want to create prosperity for their society, and their very existence depends on the increasing prosperity of their societies, yet at nearly every opportunity they make the possibility of actually obtaining prosperity that much more unattainable. This is probably done with the best of intentions, and unintentionally at worst; sure there may be a clever weasel of a bureaucrat pulling the strings of a public figure, manipulating the system in their favor. Yet for all their brilliance and strategy, they are still surrounded by the very same people that make up the imbecile hive mind of a nation, the deeply uninformed and the perpetual irrational.

Tuesday, September 28, 2010

Woes of the Aggregated Demographic

Once again I will have to bring up prudence as an explanation for "desirable" rational behavior. When considering rationality and prudence time preference has a major part to play. I'm apathetic about something; this will either be due to a scarcity of time or a prudent decision to have willful ignorance.

Despite problems of cohesion Mitchel does a good job of explaining low participation rates in open democracies. Most modern political scientists understand that low participation is common due to general apathy rather than situational disillusionment. Despite what various "rock the vote" ads and Ralph Nader will say this is not an issue.

The micro-economics that can be applied to the sociology of public choice are quite useful as basic logical constructions but start to fall apart when extended beyond core situations. In Mitchel's troop voting example he pointed out that transitional preferences are very useful at their core but become irrational when measured in th aggregate. In most applied settings aggregate measurement is all that is going to matter. Whether it is a government official trying to cater to various interest groups or businesses trying to set up an advertising scheme. When doing this results are inconsistent, even random and might as well be associated to an expensive and costly game of pin the tail on the donkey.

Any economist worth his salt will be able to tell you tomorrow why yesterday's plan worked. They will look at individual logic constructions to explain the rational behavior. This fails with speculation do to unforeseen forces. Oddly enough the most value I see from the theories of public choice is that it might tell people that pandering and catering to aggregate groups such as political parties or demographics is pointless. Despite loving the old spice ads I wont but their "not ladies scented body washes" due to simple preference. It seems that I can only ever half agree with a politician due to the aggregation caused by the system.

I will close with a story to explain the post title.
I recently attended the Fredmeyer's student late night shopping extravaganza! (paraphrased title) And during the evening I would complain to my friend Levi that I hadn't heard a single song that I liked on the loudspeakers and Fredmeyer's was doing a bad job trying to please me as a shopper. He contended that I was a minority listener and they would target the majority with the pop songs that were playing. He even went as far as to point out my arrogance in making such a notion. I simply refused to believe that I was the only one who felt displeased with the music but let it go. This changed however around ten minutes late when in the checkout line the Journey song "Don't Stop Believin'" started playing and most of the very packed store started singing along. Not only was this one of the most surreal grocery moments of my life but in my opinion it caused me to "win" the demographic argument from now until the end of time.

Well Armed Sheep

A man struts into a bar and declares it is in his best interest to leave without picking up the tab. The bartender disagrees. The other patrons also disagree. Naturally, this bartender would absorb the cost of the unpaid tab, and the regular patrons would eventually pay some small amount more. Of course they would rise, and perhaps in the name of fairness.

It is easy to convince people to accept a benefit. Pork-barreling politicians are adored in their districts for a steady stream of projects and endowments. It is clear that the funding for these projects comes from the income taxes of these same constituents, but an adapt politician manages to transfer the expenses to others. The actual costs are borne by outside groups. The politicians have satisfied their constituents by negatively impacting the voters from other districts.

The obvious goal for an economically aware citizen is to make sure the large system is fair to the people who pay for these project. The two possibilities are to cut the funding by limiting government or increase the size of the system by adding special interests. It seems to me that either side can be related to a particular Benjamin Franklin adage:

"Democracy is two wolves and a sheep voting on what is for dinner. Liberty is a well armed sheep contesting the vote."

If one strives to protect their liberties by collecting into groups of mutual interest, or if one seeks to reduce the size of government, they would see a more fair decision being made in respect to their personal wealth. Now, of course, the interest group could fly a state legislator over the Grand Canyon and likely assure greater-than-fair benefits for their group, but given the likelihood that other interest groups would do the same it is quite difficult to justify sitting out of the race.

Interestingly enough, the global fisheries industries offer another example of irrational group actions. The increasing pressure from more technologically and financially equipped fishermen has driven about a dozen formerly productive fisheries to shortages, resulting in overall losses for everyone involved. The best option is a system that balances the resources against the demands on the resources; the Alaskan fisheries management is among the most successful models of such a regulatory system. If one were considering the Western coast of Africa, where no such regulation existed, it would be easy to imagine the motivations of the individuals that destroyed the formerly productive fishery. As overfishing begins to take a toll, the individual could stop fishing while their competitors went ahead and overfished anyway, or they could gradually go bankrupt.

I am curious if the voter theories proposed by Mitchell would still hold in smaller elections. Would the same balance of motivation and impact hold in a local House election, or school board decisions?

I Have a Dream...Of a World Where Voting is Just as Simple as Buying a Soda.

During Matthew Mictchell's presentation he juxtaposes the transaction of buying a soda from a vending machine to that of the transaction a voter makes when they step into a polling booth with their ballot. In this example there is an essence of beauty present in buying a soda that is absent in the voting process.

This presence of beauty occurs when you use your own personal preferences and have the full realization that the button you chose to push will result in that particular kind of soda falling down to fulfill your utmost desire for a high fructose corn syrup beverage. However, this is not true when you vote as the way you vote doesn't result in the outcome of the ballot measures or candidates selected, as this is determined by the aggregate majority. Because of this we have this whole notion of Public Choice theory.

Why do people vote when their vote makes so little impact? Infact their vote can result in irrationality due to intransitive preferences. Now it becomes a game of rock-paper-scissors between whatever these interfaces are. For example the doves-hawks-pragmatists or the McMillerskis and they result in the same thing. A system where your vote doesn't fully count in the way that your dollar can. Mitchell states, that it is this process which results in cycling and if the institution is not changed and we only change the people we will find ourselves facing the same dilemmas that our political economy is built on.

According to Mitchell's argument the reverse should be true. If we purchased a soda in a machine that would spit something else out then we would care less about which button we push. Using these explanations as to why people choose to be rationally ignorant or to develop their vote based on an internal basis or consideration of the candidate's personal level of attractiveness is nothing shocking.

What would be shocking would be a world where this essence of buying a soda with its of importance of personal choice and the tangible cause and effect relationship was present in a system's legal and political institutions. In this world we as individuals would be empowered by the fact that their votes count and make a difference, in result we would have the incentive to stray away from being an idiot voter (I personally know some one who votes like a test on how everyone else votes and always anxiously awaits for results to see if his voting is "right".... Ridiculous, I know). This world however as cynical as it sounds just a dream...How can we ever aspect ever to live in a system were personal choice could be reflected in public choice without the conflict of equity problem (the problem of our choice crowding out the choices of others)?

Blame my ex for the Adultery...

Public Choice:

It solves the age old question of why different people live in different ways. Why is the murder rate in Colombia higher than in Costa Rica? Why were you more likely to die a violent death in 13th century England than in 20th century England. Why do South Koreans have more money than North Koreans? Why won't those damn kids stay off my lawn.

Basically it boils down to three things, it's either that the people are different, the institutions are different, or the place is different. (I'm having a hard time nailing down what that last one means. The landscape? The realm of possibilities?) The speaker used the example of craving beer. Why do some people have beer while other people don't have it? (I think this is a bad example, but it's his so I'll use it.) Well, it's either that some people want beer and other people don't, or there are some institutions that are pro-beer (Germany anyone?) and others that aren't, (You don't see many Yemeni Lagers or Iranian Pale Ales on the market.) or it could be that some places have grain, water, yeast, and hops, and others don't. It might even be a combination of all three.

The primary focus of the speaker was on institutions: government specifically. He started with a list of things that governments do that a vast majority of economists agree are 'bad'. He then asked the questions: Why does the government continue to do these things? Why don't they listen to the economists? This point of the show seemed to be a little circular. Things are they way they are (different in different places) because of the institutions, and the institutions are the way they are because of the institutions? Meh - whatever.

People respond to incentives, unless they don't. Personal preferences determine how people act, unless they are overridden by the institutions. My ex wife didn't cheat on me because she is a morally bad (bad bad bad) individual, she soiled the nuptial sheets because she is surrounded by institutions that incentivize acting like a strumpet. The good news is that I'm not bitter, not because that's my personal preference, but because I'm surrounded by institutions that encourage low self-esteem, apathy, passive aggression, and not throwing a woman down a flight of stairs.

It sounds like I'm joking, and I probably am, but think about how things would have been different if I were able to avail myself of some good old Wahhabi institutions. The community would have introduced my ex to some high velocity geology.

The take home message for me was as follows: Not only are people "rationally ignorant", but they are most likely "rationally irrational" as well. Not only does the combination of personal preference, institutional climate and physical environment, not incentivize the act of information collection, those things also remove the incentives for me to rationally think about the things about which I'm rationally ignorant. Say that last sentence out loud.

At our meeting this week, ask me about rational dishonesty. I might tell you some lies about it.

What choice?

I don’t know a whole lot about public choice theory, but I have heard most of the arguments in this podcast from other contexts. I was a little disappointed with the presentation. If his point was simply that politicians have individual incentives, fine. Say that in one line. If the point was that aggregation of choices can be non-transitive, ok we get it. The problem I have is that there was an extraordinary case of diarrhea from the mouth here that never led to any sort of conclusion or solution. Seriously, we already know from Ken Arrow’s impossibility theorem that sequential voting while eliminating alternatives can be non-transitive. We know from Black’s theorem that voters tend to move toward the center in two party elections, and that the voters nearest the poles are least likely to be represented. We have all heard that each individual vote counts for very little, again from Arrow. And we know that a three party option leaves all parties with no best response function (Hoteling). We have also already solved the dollar auction problem by avoiding such bidding processes. Just bid $0.99 from the start and avoid the war. But what does that even matter in public choice. I ended the podcast with the feeling that the lecturer had a grim view of politics, feels they are a waste of time and money and that since we are rationally ignorant, nothing will change. Can I have my hour back?

Thursday, September 23, 2010

ABCT and the Madness of Crowds

As far as an introduction to ABCT, this presentation+podcast was superb.

That liquidation and the formation of real savings are required for the economy to return to real growth is fundamental, but of course not an expedient policy for a bureaucrat or elected official.

How can liquidation be avoided? Mr. Bernanke knows! During TARP mania, the Federal Reserve purchased a major portion of the toxic assets from the six megabanks in order to save the financial system. Of course they refer to these assets as "illiquid assets" ... and of course they purchased them at their "full" value. This was not expansionary monetary policy because they would simply sell the assets back once the market had recovered, thus removing the temporary injection of liquidity. But of course, an asset that has already gone to zero, a mortgage that has already defaulted (some sold on 100:1 leverage no less) is not illiquid in the sense that it has low value due to uncertainty. It is straight up worthless and can never be sold.

By swapping dollars for worthless assets, they have not avoided the liquidation phase of the business cycle, they have simply kicked the can down the road ... avoiding what should have been a short lived but very sharp correction in real estate, and turning it into a future currency crisis. Liquidation still must happen, it will simply happen in a different (and much more widely felt) sector.

This is what gold is telling us. Mr. Greenspan admitted as much in his speech before the CFR last week. He called the gold price rise "a canary in the coal mine." Liquidation of worthless assets is being avoided in the short term at the cost of a currency crisis. Gold has been telling the market this for ten years. Those who are apologists for Keynsian policy missed out on the best performing asset class of the last decade. They said not to buy gold at 250, 300, 400, 600, 800, 1000, and definitely not now. They see the canary die (gold prices rising 20% year over year). They blame the canary for dying. "The air is fine, who needs the canary anyway!" Recovery is just around the corner! But those who ascribe to the ABCT know that recovery cannot and will not happen until there is liquidation and a return to savings as the modus operandi of the public.

One thing about the ABCT that I was initially reluctant to buy into and some have blogged about, is the idea that investors are stupid enough not to realize what artificially low interest rates mean in the long run. Of course, this is where the madness of crowds comes into play. Most investors do not have the time or motivation to look at market fundamentals day in and day out. They use market signals like interest rates to make quick decisions. In the U.S. in particular, it's a mess. Market analysts in the media boiled investment trends down to statements like "markets go up 5-10% per year in a normal environment" ... and "housing growth is unsustainable now, but will probably settle into to a normal 10% annual growth rate in the near future." Market cap? P/E? Dividend yield? Who cares! Markets "go up" 5-10% (stock price appreciation) and interest rates are lower than that. You'd be stupid not to "be in the market!" Hell, buy financials that are leveraged 10:1 to 100:1 and make 50-500% annually!

As to investors not identifying low interest rates as temporary (thus borrowing cheap money and using it with little discretion)...

Exhibit B: (3:14 till the end)

"As a general rule, the most successful man in life is the man who has the best information."
Gold is talking. Keynsians and Monetarists are losing their shirts in the market. Those investing based on an understanding of ABCT are preserving their wealth ... and even growing it. What did it take to bury Marxism? Massive poverty and wealth destruction. What will it take to bury Keynsianism? Probably 5-10 more years.

Wednesday, September 22, 2010

Over Consumption and Prudence

The podcast had an underlying theme of the Keynesian value of consumption and the reality of sustainability. Sustainability in the economic output sense that is.

Many people believe that people should work to have money to spend; this is typically touted as what fuels the economy. My question to people that believe this is "To what end?" what is the goal of a system like this? I see all around me the effects of overconsumption; sedentary lifestyles, poor quality in goods and services and a general disregard for mounting debt.

The lecture talked about sustainable economic output, the simple idea that scarcity limits an economy's ability to create. This is where I believe the issue lies. There is a severe limit to the amount of frivolous goods and services that can fit into a sustainable system. Whenever we see these bubbles burst they are on intangible and impractical ideas. I would like to believe that if the general growth of the economy was slow and had large amounts of risk an atmosphere of prudence rather than overconsumption would be created.

With such risk people would be forced to learn. This is the difference between what some of my peers have referred to as the Austrian "You’ve just got to let it cure itself" mentality and the reality that Austrians have learned that intervention will only perverse the system. In prudence individuals will have to think before they act. Hopefully looking to past failures for guidance.

Hooray for Foreclosure!

My Mother is going through a foreclosure on her mortgage. At some later date, after several forests worth of paperwork are pushed around a few government offices, she will be given a date to leave and the house will be auctioned. We will return to my Mother's situation an a short while.

I spent many years poorly arguing that the economic theories I knew were unsatisfactory. Microeconomics was never the focus of my debate, as it seemed rational enough that individuals and small groups would pursue their self interests. My trouble was with the absurd propositions directed towards the macroeconomic scale. I wondered aloud how we could expect to cure the monetary ailments of a society; I argued the futility of halting an economic downturn. Eventually all systems must balance.

What causes people to desire control? Why do we believe we can have perfect lawns and an economy that never fails to grow? What is this flaw that causes people to demand natural systems to yield to our desires?

Humans seek to manipulate and tame their surroundings. Keynesian theory supposes that we can tweak an interest rate every now and again, and perhaps if we get out facts laid out our efforts to save the economy would be a success. The economy can be impacted in this way; by the intervention of government we are able to pull the system away from its natural balance for some time. As false security builds the system becomes more stressed, and it is only natural that it should painfully drop to levels which restore the balance.

I don't know why my Mother surprised me with her response to the pending foreclosure. While I expected complaints about the fairness of such an act, I heard relief instead. "I can't afford this house, and I don't want another scheme to fudge numbers so I can stay here. I want a simple apartment that I can easily afford, and I think it would be nice if I could go out for coffee sometimes." My mother knows she took risks and manipulated the natural market. She knows it is best to liquidate and start fresh. Maybe some well articulated economist can convince government to return to this proven system.

Can I trust something I cannot see?

Whenever I have the opportunity to look at systems like economics, or any situation that shows the characteristics of a spontaneously, organically formed system, a reoccurring theme always emerges; a system cannot anticipate a problem, it can only react with the mechanisms available to it. I know that hardly resonates with profundity, but it should be noted that every complex system has within it, the tools available to react quickly, exactly and effectively. This reaction capacity is the defining characteristic of a viable, sustainable complex system, opposed to something that is simply complicated. Furthermore, being unable to anticipate problems may sound like a crippling limitation, yet the reaction is so rapid and on such a localized scale the that the vast majority of disturbances remain localized.

To apply this to the province of macroeconomics, occasionally a systemic disturbance may propagate throughout the entire economy, yet the simple underlying rules and the decentralized nature allow for a rapid and proportional response to any shock that does not completely destroy the system. It is the beauty and the precision of that response that I believe most interests the Austrian Economists, regardless of where it falls on the business cycle. When economies are in difficult or transitional times, their true functioning nature as a self-sustaining complex system emerges. In fact it is the hardships that keep the system healthy and nimble. In contrast, the Keynesians are completely obsessed with arresting complex systems right in the middle of their moment of self-healing glory, they stop the massage before one can really relax, and well before the happy ending. Keynesians cannot predict business cycles, nor can they react as effectively as the natural economy, yet they will bet the wealth of an entire nation on premise that they most certainly can. And as our lecturer mentioned, set off an entirely new cycle of artificial growth with an accompanying (and entirely natural) economic crash.

So it’s a mutually exclusive choice being offered: being unable to predict a business cycle but being confident that it will simply take care of itself (try that line on your constituents); or being unable to predict a business cycle and being able to react only like an idiot, yet setting up your response to ensure that idiots now have a very necessary role to play in future decision making.

Austrian Business Cycle

I have to say, after listening to the podcast and reading through the power point presentation on the Austrian Business Cycle, I was very happy with the fact that numerous statistics by credible sources were listed. I have often been a critic of the Austrian school of thought because it seems that generally Austrian economists focus on a more theoretical school of thought than one, which is empirical. Empirical evidence, whether it is skewed or not, is for more convincing than any theoretical concept offered. That being said, I was not surprised to discover that the Austrian school of economics is the only one that embraces the concept of liquidation. It was mentioned that "only through the process of converting the malinvestments into productive capital can the foundation for growth be achieved." Hayek himself stated that "The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production." In other words, government creates what the Austrian thinkers call an "artificial boom." The question, however, is does this artificial boom allow for long-term stability in economic periods of growth and downturns? I realize it was the last discussion where we talked about the New Deal, but I think it is important to point out that whether it was a "raw" deal or not, did the idea of government intervening into this bussiness cycle create long-term stability. I would have to argue that it did. Let's look at an example of China where the unemployment we have seen in the United States has also gone overseas. Now, due to the influx of jobs being created in China, many were able to afford goods they once could not. However, when unemployment rose due to the recession in the United States, China has decided to invest in its infrastructure, paying relatively the same wages that unemployed workers had before. A return to a better life for these workers would not have occured under the Austrian bussiness cycle, at least not quickly. After all, "in the long run, we're all dead. Let's look at an example in the United States. From the 1820s onward, there was a recession of drastic measures nearly every eight to ten years. Following the New Deal and World war two, there was great consistency in the economy for the next thirty years. With the economy have to adjust so quickly to new forms, under the Austrian Business Cycle, people are constantly losing out.

Tuesday, September 21, 2010

Not As Easy As ABCT

One of the most interesting aspects about the Austrian Business Cycle (ABCT)is how many people think that the ABCT is how the economy generally works in an overall sense. Many who know very little about Austrian economics seem to have heard about the ABCT. Like Richard who I know thinks that the ABCT is "bunk". I also am skeptical of the theory. To me the ABCT seems like an over simplification that does necessary seem to explain quirks in the economy(a vast system with billions of human personal decisions occurring synonymously impacting markets in ways that are both diverse and complex).

I thought it was interesting that in the podcast the speaker groups the those that don't agree with the Austrian business cycle as the Non-Monetary theorists and the Keynesians and those that support the ABCT are the monetary theorists, the Austrians, and the Neoclassical Economists. I though this was an over simplification as there are ton of well known economists in each of these groups that don't view the ABC as he presented them. I did a little research and one of these economists is one of the most well known American economists of the twentieth century. Funny enough he is the father of the Monetarists, Milton Friedman.

What does Milton have to say?

When interviewed about the Austrian business cycle in 1998 Friedman states the following:

"I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and in the United States, they did harm."

PS-"More Caffeine" bad example I like the coffee :-) If anything this make this me say yay this is fun lets yes lower the discount rate :-( to me these are very different I'm not a fan of this commonly used example.

Here We Go Again...

Long-time SWEET members probably remember that I have something of a love-hate relationship with the Austrian Business Cycle Theory. The Austrians had a lot of good ideas, but I'm not convinced the ABCT was one of them.

On one hand, the Austrian's have an intuitively satisfying theory about how the business cycle fluctuates. State manipulation of the interest rate distorts the capital structure, creates malinvestments and causes recessions, and more State intervention will only exacerbate the problem. It's easy to grasp and provides an appealing explanation about how we got into our current mess. On the other hand the ABCT suffers from some odd theoretical assumptions about the behavior of entrepreneurs and investors, and largely lacks the empirical validation necessary to stand as a respectable alternative to neoclassical business cycle theories.

Any economist would agree that expansionary monetary policy decreases the short term rate of interest, stimulating investment in more roundabout projects. The question ABCT doesn't explain very well is why these investments tend to become malinvestments. Bryan Caplan made this observation over a decade ago. Obviously the lower rate of interest will cause people to reevaluate the profitability of current investment projects, and some projects that wouldn't otherwise be undertaken now will be. However when the Fed announces that they're targeting lower interest rates you can't seriously expect those artificially low rates to deviate from the natural rate forever. What any sensible entrepreneur will do is invest in projects that they expect to be profitable within the expected time frame between the credit expansion and the subsequent readjustment. To assume otherwise is to assume that entrepreneurs consider only current interest rates in their investment calculations and ignore other variables like long term interest rate trends, expectations of future tax rates, expectations of government policies, etc.

H.L. Mencken once said that "For every problem, there is a solution that is simple, elegant and wrong". So too for theories of the business cycle I guess.

The Austrian Business Cycle

I have to admit that this was probably one of my favorite readings/ listenings of all time primarily because it had graphs involved! In general I followed through pretty easily with what Dr Cwik was talking about. I especially enjoyed listening to the explanations to the graphs that he presented. I had one issue with the graphs, and it stems from what Cwik himself said. Cwik stated that the graphs are accurate, however the market is always changing and therefore this is just a snap shot of what actually occurs in the economy. Well, if that is true, which is absolutely accurate, because otherwise economists would actually be able to predict the future of the economy accurately, then the fact remains that the graphs do not have as much meaning. I understand that they are essential to the understanding of the fundamentals of the business cycle, but when it comes to how applications may be used it seems very inaccurate. There are obviously too many variables to take into account in order to make a graph. For example in the case of the graph which shows what occurs when more people become impatient, well is everyone becoming impatient at the same time? Probably not! Infact Im pretty sure that even if this were true, everyone would have different levels of impatience. Then the problem that comes to my mind is, how does one measure impatientce? Maybe an economist could help me, but how would an economist measure impatience? What would the units be? In general it seems to me that the way that Cwik shows his graphs makes sense, but what I would further like to read about would be how exactly does one apply the concept of the business cycle accuratley to try to predict or understand the state of the economy.

There is no such thing as the Business Cycle

The concept of the business cycle is a joke. (I'm being serious.) It is an artifact of data collection. I'll bring a quarter to our SWEET scholars meeting and in less than 3 minutes show you what I mean. I don't really want to elaborate on my denial of the existence of "the business cycle", because I don't want everyone to get upset.

So instead, I'll just leave some random brain droppings here: You've probably heard the expression, "if you can measure it, you can manage it." In fact, a search of the US Patent & Trademark Office's web database shows that the phrase "If you can measure it, you can manage it" was registered under trademark protection by the Kinex AHA Corporation in March of 2000. I'd like to sue these guys, not for trademark infringement, but for 'logic infringement'.

It seems more likely to me (assertion without evidence, economics is full of them) that if you CAN'T measure something, you CAN'T manage it. Just because this negative relationship is true, it doesn't automatically make it true the other way around.

One nice thing that economics has given us, and Keynesian economics in particular, is the ability to more accurately measure various facets of the economy. This ability coupled with high self-esteem and ignorance, has led many people to believe that they are able to manage the economy. (Specifically the NON EXISTENT business cycle) I'd be surprised if they are able to even manage their own impulses, much less the entire economy. (Which is, if you think about it, the aggregated impulses of 6.7x10^9 people.)

But seriously, the business cycle doesn't exist.

It's a ghost in the machine.

An artifact of data collection.

A figment of reporting.

A fart in the hallway.

A quarter in my hand at our SWEET scholar's meeting.

Fear the Boom and Bust and Recession and Recovery and...

The first time I saw that rap video of Keynes vs Hayek I felt just like that desk clerk. “And who are you sir?” That’s when I decided to pick up “the road to serfdom” and look into this alternate perspective. You see, as a student of economics at the University of Washington there is no mention of an alternative to Keynes. And as I sat and listened to how borrowing money can be a good thing, I couldn’t help but wonder how we would pay it back in the future. Of course I never voiced my concerns of the limitations of Keynes theories, but they lingered. I think my tipping point was when I heard a professor make this claim: “the reason we are in a recession is because of too much government spending, now to get out of it we need to increase government spending.” Hmmmm, I’m not sure about this.

Alas, having grown up in the Keynesian school of thought, I can’t help but cringe at some of the points attempting to be made in this lecture. And after having heard the Austrian perspective I can now say that I truly have no economic home. Seeing as most of our group appears to be leaning much further right than myself, and having a background in Keynesian thought, I suppose I have a voluntary duty to put my head on the block again this week.

I suppose the first weakness in this argument that I should make is the most potent. The foundation of Austrian economics is that growth is derived from savings whereas Keynes argues that savings is a luxury good and comes as a trade-off to consumption. I have to say there is no winner here. Of course we know that with a zero percent savings rate there is no money for investors to borrow. This is obviously dampening to output as borrowing money for capital can increase productivity immediately and lead to real sustainable growth. One could argue that without investment, there would be no production at all. On the other hand, it should not be hard to imagine that a one-hundred percent savings rate leaves no money for consumption at all. Therefore, it must be true that there exists some maximizing level of savings between the two extremes. And for that reason, blanket statements such as increased savings equal increased production is clearly fallacious. Although true at some points, the same can be said about the opposite case.

I should also point out that the PPF demonstrated in the slides is fundamentally no different than a Keynesian cross. However, there is a huge error in interpretation within the model shown. We can definitely say that consumption and investment are trade-offs. However, the PPF described does not reflect full employment by any stretch of the imagination. To "consume" investment goods does not require the labor inputs that consumption goods do. Unfortunately, that realization unravels most of the argument made later.

Although there is much more to be said, I think I will just touch on one more subject, The Federal Reserve. The thrust of the Austrian argument is that monetary policy creates booms and busts. The zeitgeist that has been created is that the Fed somehow is inherently evil and manipulates some agenda so that artificial growth makes people feel good. In fact, the Federal Reserve was created to stabilize an already chaotic financial system (which faced 27 recessions before the Fed was created) and was made independent of the rest of the government for the purpose that it could not be used to manipulate the money supply in order to make politicians look good by artificial means. The Fed answers to the Congress, its members appointed by the President and its profits belong to the US treasury. It is required to testify to the Congress on its actions and that they fall in line with its legal responsibilities of trying to accomplish three noble goals, for the good of the people.

Those goals are sometimes impossible to achieve simultaneously, but to violate these goals is to face prosecution. The first goal is to attempt to maintain “full employment”, which does not mean that everyone in the country must work. It means that everyone trying to find a job has the opportunity to find one. It is not even 100% of workers working that is the target. It allows for the frictional unemployment created by leaving one job for another, which allows the economy to correct inefficiencies. So this goal is actually what is called “the natural rate of unemployment”. That is a good goal. It means that we don’t want people that are willing and able to work to be starving on the streets. That means that this goal reduces the amount of money that society would feel obligated to pay in welfare to rid itself of the guilt from being lucky while others starve by random chance.

The second goal is price stability. This goal is the most lenient, but still important. Changing prices affect price expectations and prices never change in unison. The chaos in prices would exasperate the problems, that is to say they are a negative feedback loop. Although it may be true that the market clearing adjustments create a better outcome on paper, the real impacts on people’s lives are much more devastating and impossible to quantify.

And finally, the Fed has a legal responsibility to attempt to maximize sustainable economic growth. That is why the Fed moves the money market in counter-cyclical motions, not continuous injections of “caffeine”.

The bottom line is that people respond to the incentives that they face. No economist I know would ever argue with that. To believe that requires a belief in people weighing their expected values from a trade, which is exactly what “Animal Spirits” are; the producer’s confidence in an investment being profitable versus the fear that it won’t and the consumer’s faith in having an income, as well as expectations of future prices. As those expectations change, the economy moves up or down, without any change in the money supply. All I am saying is let’s not be so quick to think we have it all figured out.

PS: Best line ever = "can we ruin the economy? YES WE CAN!"

Thursday, September 16, 2010

Hangovers, George Jetson, and iPods for Kings

After watching this debate, I can see why the UNLV economics department got rid of Hans Hoppe. After having any classes with him, the students were probably tearing up the other faculty. Malamud's concession that basically Roosevelt had no idea what was going on but that "it worked" reminded me of this:

Given that this discussion focused on FDR's policies, there was only brief mention of the fact that the damage is done during the boom. Misallocation of resources, malinvestment, and depletion of savings is the problem. The recession/depression is the result. Thus, any effort to "fix" the depression misses the point. Resources have to be reallocated, bad investments have to be purged, and savings (the basis of credit) has to be restored before there can be recovery. Any policy that retards this process will prolong the depression.

The common analogy is to an alcoholic. Heavy drinking leads to a hangover. Most people accept the hangover as the consequence of too much alcohol and deal with it. They spend Sunday recovering and make it in to work on Monday. The alcoholic on the other hand drowns out the hangover with more booze, playing a perpetual game of "kick the can." He misses work Monday, or worse yet, comes in drunk. He loses his job, destroys his liver, etc etc because he refuses to deal with some short term pain in order to sober up and become functional again. He lives in a high time preference world where the next moment is more important than the next day. Politicians live in this world. Hans Hoppe has demonstrated that high time preference is de-civilizing. This is why we saw a stagnation in the increase of the standard of living from the 20s through the depression. It's also been the case in America from the early 1970s to present (real wages per hour worked).

Another completely nonsensical goal of depression policies was that of job creation and propping up wages. Reed correctly points out that plowing under crops and killing livestock was absurd as it was wealth destruction in the name of propping up nominal prices (a confusion of money with wealth), but he missed an opportunity to take a swipe at every politician's goal (and the Federal Reserve's mission): creating "full employment."

An effective economy produces wealth, not jobs. The reason for having a job is to get stuff, not to work. Humans want to work less and have more. Even those who quit their jobs and move to Africa to do charity work are doing this. They want to minimize time spent on things of low subjective value and maximize time spent on things of high subjective value. This is axiomatic to human action.

Before the industrial revolution, 16 hour work days were the norm. Women worked. Children worked. Everyone except the elite worked (there must have been a glass ceiling for Kings). Abundant food was a rare blessing, not a fact of life. There was full employment. There wasn't enough food.

As the industrial revolution progressed, work days got shorter and wages (wealth per hour) increased (Henry Ford offered Model T assembly line workers high enough wages to buy the car they were producing ... even with an unheard of 8 hour work day).

Women and children no longer had to work, so most didn't. They viewed this as "progress." Relative to centuries past, there was massive unemployment. Despite this terrifying wave of unemployment, people had enough food. Many immigrants to America were shocked to find day old bread in the dumpsters in New York City. Americans stopped eating stale bread while Europeans still dealt with widespread hunger.

Then came the Federal Reserve, Hoover, and Roosevelt.

Government jobs are paid for by the productive economy. Government salaries must necessarily come from taxes, inflation (taxing savings), or borrowing (deferred inflation). All three of these methods destroy wealth by disincentivizing wealth production (taxes by definition). Thus, government work programs tend towards not enough food even if they do create jobs. Aggregate wealth production per hour worked is lower than it would otherwise be. Farms and bakeries were not destroyed during the '29 crash. Potential food production in America was unaffected until the dust bowl (destruction of natural capital), an event which didn't "end" until the 1940s when normal rain patterns returned. Of course by then most farmers had moved to better soil ... having wasted half a decade trying and failing to restore the soil through massive subsidies that were part of Roosevelt's polices. How much sooner would they have moved if there were no subsidies to stay? How much wealth was taken from productive farms in the midwest to subsidize dust bowl areas? How much worse did this make food shortages?

Of course in the future...
George Jetson has a flying car and lives in a space-needle type house. He works 1 hour a day 1 day a week doing the backbreaking work of pushing buttons. He complains about his job. He does not want more hours, he wants less. Presumably Jane does not want to get a 1 hour/week job pushing buttons just to show she can do it to. People prefer not to work. George would prefer to work less. Of course, a central banker would wonder, what is George's wage in nominal terms (as if it matters)? Does he have to deal with the horrors of falling prices (like the terrible trend of computers getting faster AND cheaper every year)?

Malamud referred several times to "Freedom from Want." During my first visit to D.C., I recall being especially disgusted at Roosevelt's temple (monument, as most Americans call them) when I read that phrase, etched in stone. Humans want more and want to work less. Always. Ghandi wanted more peace. Mother Theresa wanted to help more people. Jesus Christ wanted to spread his message to more people. How can the Government promise "Freedom from Want" when people who wanted or needed "nothing" material still had "wants" that were unsatisfied?

Some would say that Roosevelt simply meant physical wants (food, clothing, shelter). Of course, this too is relative. A well fed farmer from the 1500s is a nutritionally deficient person in today's society. Kings lived in drafty stone palaces with no central heat, air conditioning, or electricity. They didn't even have a computer to blog about their low standard of living. Who wants to live like a King anymore? Why drag a bunch of trumpeters around to announce your arrival when you can stuff all the music ever created through the middle ages onto an iPod? Given that iPods didn't exist in the middle ages or in the '30s, but that everyone has one now, is that part of "Freedom from Want" ... or are we stuck with a government issued tube radio? Who wants to live like a well-to-do 1930s aristocrat today?

A government guarantee of a standard of living is a sentence to a fixed or decreasing standard of living due to misallocation/wealth destruction (as Roosevelt gave Americans in the '30s and as Russians endured from 1917 - 1991). It impedes the human pursuit of less work and more stuff by guaranteeing free stuff now. Taken to its logical extreme it is a guarantee of one thing: not enough food.

Bread lines anyone?


Malamute vs Reed

After listening to the “spirited” debate between Bernard Malamute (his parents must love dogs!) and the FEE president, it is certain that the debate between the two professors was quite the joke! There was obviously a better speaker/ debater and it just so happened to be that the video was posted on this person’s website and that the crowd seemed overwhelmingly Austrian! Not that I think this is unfair, because I would probably post videos of myself slaughtering my opponent online too, its just human nature! In any case, I did a little background search of the two men considered in the video and it turns out that one of them had a bachelors and masters in engineering and the other has had an extensive economics experience which includes getting put in prison for spending time with underground Polish anti-communists. Any guesses on which debater had more experience? All in all, it seemed a little unfair, perhaps a rigged debate, or maybe just a show put up for members of the FEE. I feel that there are perhaps better, more accomplished and charismatic Keynesian economists out there.
From the information or the lack there of that Malamute provided the one point that I liked was that about the gold standard. It was probably the best and only point that Malamute actually explained. It was definitely the only point that helped him justify an action that the government took and how it affected the economy in a positive way. His last comment was perhaps the worst in the history of “two old white guys debating about economics.” Malamute actually brought up the fact that the Supreme Court ruled the New Deal unconstitutional as his closing statement! It was like providing his opponent with an AK47 while trying to protect cute bunnies.
Another point that Malamute made really bothered me. He kept stressing about how FDR just walked into this situation, and that aspects of the New Deal were ready for him, the just needed to be put in place. It sounded like Malamute was giving excuses for why some of the policies that were criticized. He never even went into why they shouldn’t be criticized!
The second speaker, Dr Reed, made some very good points. I especially liked how he gave numbers, statistics and quotations to prove his point. I really gave some substance to his views, and it also helped that Malamute justified his viewpoint by saying, “but it worked”. Dr Reed talked largely about the “lunacy” behind FDR’s decision making skills. He spoke about how FDR was a, “man who knew so little about economics.” Firstly, I would like to point out that the President is usually just the person who enforces policy, he/she has advisors who actually do the thinking for them. If most Americans thought that the quantity of knowledge about economics was a priority to voting they would probably vote in an economist as President. The fact is that maybe to Reed FDR was a lunatic, however, some how people reelected FDR. Also Reed did not give reasons why this was lunatic of FDR? Reed thought that progressive tax policies were negative, and the audience was so biased that he did not even have to explain why this was a bad thing.

Wednesday, September 15, 2010

When I was informed that our first discussion would be based on an actual debate regarding the New Deal as "raw" or not, I was looking forward to hearing from two experts in the subject. I do not doubt for a minute their credibility. However, given the fact that the FEE decided to post this ,in which clearly their Austrian white knight was the victor, it seems that those of us who are not as informed about the New Deal policies, like myself, were really not given a well balanced view of these different perspectives. Mr. Malamud seemed to base the vast majority of his arguments on theory more than anything else. Frankly, it seemed as if he didn't put a great deal of thought into preparing. Reed, on the other hand, had his statistics ready, was well versed, and had a few jokes to please a clearly Austrian crowd. Nevertheless, like any series of policy reforms, I am going to assume, though I could be wrong, that the New Deal was not a continuous process of oppressive means to tax the more fortunate in rough times, nor am I going to make the case that it was the savior of the day.
We all learned in our history classes the idea of people withdrawing their money quickly from their banks, thus making the horrible extent of the depression inevitable, etc. However, I would be very interested to see what people's actual viewpoints were regarding the Emerging Banking Act. If I were conducting a study, for instance, I would not just conduct a survey following the passage of the act, but would see how quickly deposits were regained in the banks as well. If I had been so unfortunate to be living during this time, I would have seen it as a major relief. I would be willing to say that this was a likely success of the New Deal.
If I were mIaking the argument that the New Deal solved the primary issue of unemployment, I would lose worse than our poor friend Malamud. The statistics clearly show that the New Deal did not solve this problem, so unless someone wants to make this case, I am going to leave it at that. I will not, however, say the depression was prolonged as a result. I simply do not know. If someone were to tell me that our presiden't stimulus package were prolonging the current recession, I could give them a number of reasons why government interference isn't necessarily the reason for that.

Sophomoric Fear

In a typical debate format one will state their belief on the relevant material and briefly explain their reasoning before allowing for a rebuttal. Malamud only seemed to follow a fairly disorganized set of talking points in a candor that I will kindly refer to as “less than succinct”. He seems to try and fill time by repeating topical information in as many permutations as he can muster. I would not have an issue with this if he was to illustrating examples of the merits of his ideology, but he is not.

What Malamud is actually describing I will term as Historical Pandering. Malamud spends all of his time trying to inform the audience about the great depression while inserting snippets of his own beliefs against fear, deflation and unemployment. This direction does nothing to defend his point and only works to build a house of cards to be scathingly disassembled by Reed.

It seems the weakness at the core of Malamud’s talking points is a clear faith in his ideology. He generally seems to assume the audience will not find issue with what I believe to be his core idea that economics should be used to create wealth rather than efficiency. When Reed speaks he points out the reasoning behind his beliefs and offers several relevant examples to reinforce them. Malamud alludes.

What surprised me most in the end was that Reed did not attack Malamud for his use of fallacies. This is the crux of the issue for me. Creating inefficient or pointless jobs will not help a country grow or operate. Keynesians seem to have a habit of ignoring human action and motivation. People respond to incentives. The idea of a 100% employment rate is ridiculous. If someone does not have a risk of losing their job they will not be an effective worker. Think of a system of gears and motors. If one of many motors in a collection gives way the system will redistribute the energy to push along the broken gear. However the more this happens the less the system works. If a decent portion of the gears stop moving on their own and have to be hurried along the whole system will eventually stop. The “Fear” that Malamud talks about is one of the most important driving forces of humanity. Uncertainty has taught us how to deal with scarcity and all of its effects. A lack of fear is an example of stagnation, or more pointedly the later years of the Great Depression.

Conveniently Neglected

FDR's New Deal imposed nearly a decade of legislation that generated a net improvement for our national economy. These policies, while occasionally flawed, had the general effect of improving our national standing.

In this painfully one-sided debate, one cannot help but to call foul on several conveniently neglected details that could put this discussion into perspective. We are, of course, viewing a debate of economics, but it is unreasonable to exclude these forces from consideration. I felt that the discussion was too focused on textbook economics and disconnected from the diverse interrelationships involved in most New Deal legislation.

The debate gave passing mention to the Tennessee Valley Authority, Hoover Dam, and other infrastructure and public works projects. Mr. Reed is fond of noting the audacity of government creating jobs. Certainly we should not dig and refill holes to create jobs, but it would be prudent to note that the infrastructure commissioned in the New Deal legislation is still with us today. The eastern tributaries of the Mississippi river support agricultural irrigation where unpredictable floods once ravaged towns, and the Las Vegas area is as electrified and hydrated as we have come to expect. The courthouses and schools commissioned during the New Deal are smaller but equally relevant examples of the necessary construction that happened to use cheap labor. I find it interesting that these public works projects are blamed for prolonging the Great Depression while the construction of the Interstate Highway System is applauded as an intelligent allocation of government resources. Perhaps I am mistaken, but I am of the view that improvements which allow a more efficient society are beneficial to the public; the use of inexpensive labor seems to only improve the desirability of these projects.

On a different topic raised in the debate, I feel that Mr. Reed conveniently neglects to define the purpose of the Civilian Conservation Corps while he bashes their mission. It is common knowledge that a forest should be managed if it would be productively used, yet basic environmental history tells us that heavy logging took a tole on the health of our forest systems. It seems exceedingly wise to invest cheap labor to cut erosion and restore the forests, allowing for future economically beneficial use. Mr. Reed also mentions the government slaughter of livestock and waste of crops. It is a basic fact that overuse of agricultural lands contributed to the longevity and severity of the Dust Bowl. Rather than decrying the idiocy of the Roosevelt administration for wasting food, perhaps we should applaud their actions to protect the future production value of the agricultural systems.

In summary, it is easy to ignore the many problems Roosevelt needed to address with his legislation. We cannot know for certain if his methods to address the Great Depression were helpful, if they were necessary, or if they were unnecessary. At the very least, the public buildings, dams, bridges and roads we needed were built, and built with talented workers at a lower cost than was possible around that time. I certainly wish our modern government spending could produce so much lasting benefit for its cost.

Tuesday, September 14, 2010

The Ringer

This debate reminded me of a "friend" of mine. This particular individual has a job where he is paid to argue the opposite side and lose poorly and spectacularly. For example, if "big oil" was sponsoring a debate on campus about off-shore oil drilling, they would hire my buddy and have him show up as a member of the Sierra Club. Now my friend's task isn't easy. He has to look like he is trying, and he has to look like he sincerely cares about the subject being presented, but his arguments have to be crafted in such a way that they make you feel bad about yourself for ever having agreed with him. It's beautiful.

It feels like the Cato institute hired the Pro-FDR guy and paid him to stink it up, big time. He actually got applause from his audience after he gave the line about some of FDR's programs being unconstitutional. His response? Well they may have been unconstitutional, but they WORKED! The great depression was on when FDR became president, and it had ended by the time his administration was over. If I was listening correctly, his entire argument was a correlation = causation fallacy.

I loved the response given by Cato "Russell" Hayek, or whatever the anti-FDR guy's name was: "Of course American agriculture was in deep depression, we wiped out a third of their markets with Smoot-Hawley. You have the Fed contracting the money supply. You've got government all over the place. And so you've got unsold goods, plummeting prices... What do they decide to do? Destroy perfectly good fields of corn, wheat, and cotton, perfectly healthy cattle, sheep and pigs. In an effort to reduce supply and raise the price. Even if it had helped the farmer, it could have done so only at the expense of everybody else. Something like 2/3 or 3/4 of Americans were not farmers, and yet they were the ones who would have to pay the higher prices. The AAA did something else, it levied a new tax on agriculture, millers and refiners and processors in particular. Just what you would expect a devastated economy to need right? Another tax on top of this terrible situation, with the idea that somehow this whole thing is going to create prosperity. It didn't, and it couldn't have. From the very beginning.

He was on fire!

Seriously though, by any standard of historical human health and well-being, the great depression was a non-event. Average life expectancy continued to rise throughout. Times were tough, but they were better in 1930's America, then they were for the vast majority of history. I would have gladly traded World War II for another decade of economic depression. Let's talk about that on Thursday.

Fear and Value Culminations in the Political Economy

I am just curious if I am the only one in the group who had this experience in the realms of their education about the New Deal and World War II. In all of my American History classes in middle and high school I clearly remember sitting in American History courses and hearing the teacher say the same story. The story is this there was a "credit bubble" which popped and resulted in the "Great Depression." At this point in the course there would be some romanticism about the government work acts such as the CCC and WPA "creating jobs" and "priming the pump." I distinctly remember my Advanced Placement American History teacher stating the Depression wasn't ended until World War II occurred as according to him it strengthened production and thus it strengthened the economy. The reason why I would like to know if others share this experience in their American History courses is because it was not until I started studying Econ in college that I was presented that there were two sides to this story. Until this point I had no idea that there was a debate.

Since obviously it is a huge debate and economists will probably always be arguing about whether or not the new deal was a raw deal, I found this podcast particularly interesting. Reed and Malamud have different perspectives but they both use some of the same tools in arguing their points which make me antsy. This is the use of emotion while Malamud spends most of his time on the floor painting the picture of how awful the Depression was and trying to give us a sense as to why the political economy needed to step in. Reed however is guilty of the same approach as he tries to incriminate FDR as just being a really economically stupid president. I am unsure if I like both of these approaches as they weakened my own sense of credibility for the speakers.

For the most part though I felt like on majority of the points I could identify with Reed. Mostly because he understands that you can't create long term jobs by throwing money around.

In this post I would like to direct myself to two particular issues discussed and would like to ask a couple questions about them.

1.) This idea of fear being toxic to an economy. I think this is the best argument that Keynesians have as it makes logic sense. Uncertainty leads to a stagnating economy. Why would you want to invest in a particular industry if you were filled with uncertainly and didn't know about tomorrow? As a politician I would find it hard to respond a huge drop in the economy by saying “ok I am going to do nothing just hold tight ok”. I would want to throw some expansionary policy out there (of course Smoot Hawley act from the FDR administration was contractionary ek!). Do the Ted Stevens thing and nab some pork!!!!  My question is: Can we really expect to have the political economy react to negative or uncertain economic expectations of individuals facing a depression by doing nothing? (I don't know it sounds like alternative universe to me)

2.) The other thing I wanted to touch base on is this "creation on jobs" bit which is thrown around. I understand and really like the principles of the broken window fallacy. However I think as long as there is a United States of America there will be public works projects. I feel though that there is a scale that people don't touch base on when they try to measure the value from these projects. With that strand of logic in mind it is very hard to determine the number of jobs that the private sector loses out on because of the investment in public works programs. There in a problem with empirically determining value of the projects. Reed would like to argue them as being stupid and Malamud would say they put the economy back on track. However, no one really breaks them down like individuals of the noneconomic spectrum. I think that there is a scale of created (or noncreated…I know not a real word) long term value that can come out of these projects. For instance I would like to say the Hoover Damn was a good idea and the current stimulus project in Alaska that is spending $26 million to pave about 26 miles of the Dalton Highway is a bad idea. The value that comes out of these kinds of projects spans various amounts of time. The Dalton Highway is not a useful road after it is no longer economically feasible to drill oil in Prudhoe Bay, but the hydropower produced by the Hoover Damn has a greater longer term value to more individuals. The problem though since most federal projects are the outcome of representatives squabbling for dollars that they are often are not put to any logical use. Some things like money invested in scientific research even create more of the questionable value problem as it is hard to identify which studies will have break troughs and which won't. As well to know which studies will find knowledge that will be important and which find knowledge will be unused in the future. If we had a formula to figure out which of these projects would produce long term value and which would not, it would just be too good, as the private sector could just jump in with certainty and invest in the works projects. My question is: If the democratic decision making of public workings projects was expanded to all American citizens rather than just their elected politicians would we then focus on public works projects of more rather than less value on the scale? (ie cut out the riffraff)

I have a feeling that I have been rambling so I'll stop with the statement that I am unsure if the last paragraph I wrote will may any sense to anyone (sorry guys :-)

Monday, September 13, 2010

World War II and the Broken Window Fallacy

Welcome to a new semester in the SWEET Scholars program everyone. Whether you're a grizzled veteran or a brand new member I'm looking forward to another semester of discussions and debates together.

We probably couldn't have started the Fall program with a more divisive subject to tackle though. How an economist feels about FDR's policies during the Great Depression is an ideological litmus test of sorts. Depending on which side of the political spectrum you lean FDR either saved the economy or destroyed it. From where I stand I can certainly see that there were aspects of the New Deal that hindered recovery, but I can't deny that others seemed to provide at least modest relief. The macroeconomic theories behind the causes and consequences of the Great Depression aren't really my area of expertise though, so I can't pretended to know enough about the New Deal to guess which programs did what for sure.

I will say two things about the debate though:

1) That macro-economists still can't reach a consensus about whether the New Deal ended or prolonged the Great Depression and that the divide between opinions on the matter are, at least in my experience, still divided primarily along ideological lines, hints at a fundemental dysfunction in the way macroeconomic problems are approached. I would like to think that economists could set aside their politics long enough to take a more objective look at what the New Deal did or didn't accomplish. But in a field as dominated by public policy prescriptions and partisan politics as macroeconomics is, I guess that's just asking too much.

2) Differing opinions on proper macro policy aside, Malamud's assertion that most economists would agree that World War II ended the Great Depression repeats what Russ Robert's recently, and rightly called "the biggest and most dangerous economic myth of all time", i.e. the idea that war is somehow good for the economy. That's an idea I think stands as one of the most persistent, and dangerous of all Broken Window Fallacies. Not even Nobel laureates are safe from confusing unprecedented levels of government spending on instruments of death and destruction with productive investment in true economic development and growth.

Did the War achieve full employment? Probably, but of course forced conscription tends to do that. Were those 10 million people that were drafted for military service made better off as a result? Malamud seems to think so, but I would argue that even in the midst of a Depression labor would prefer remain idle than dead. Malamud seems to think that employment is employment, and that stimulus is stimulus, end of story. Whether people are employed manufacturing cars or tanks, or whether the stimulus pays for building hospitals or blowing them up seems to be irrelevant in his crude Keynesian model.

Now I'm probably not so hostile towards the General Theory to deny, as Reed does, that government spending can have no positive stimulative effect. But to praise WWII for achieving full employment is like praising a tsunami for leveling a city that has to be rebuilt.

On the New Deal

I don’t know about you, but every time I hear the phrase “redistribution of wealth”, I get a shiver down my spine. Alas, as with any topic in economics, there are costs and benefits to consider. I suppose our obligation here on the policies of the “New Deal” is to weigh those costs against the benefits and see if we end up with a surplus or loss in social welfare. That’s a tall order.

The good that did come from the new deal took place in the financial sector, namely the creation of the Federal Deposit Insurance Corporation and the movement away from the gold standard. Restoring faith in the banking sector is a tough thing to do when banks are collapsing all around you. With the entire population withdrawing and holding any funds they could (in the form of gold), the government had no control at all over the money supply. The newly formed and well intentioned Federal Reserve was put to the test, which they failed miserably. The general population had no faith in the new economic system involving monetary policy; the very foundations of economics were far from understood. But the bank holiday imposed by FDR and the assurance that the banks that did re-open were backed by the federal government, that was the perfect move to make to restore faith. How else could he validate his claim “there is nothing to fear, but fear itself”? Creating the FDIC drove that point home. The confidence in the system that allows money to circulate was well worth the moral hazard it created. The foundation of the Security Exchange Committee fit perfectly into the correct government position, the enforcer of the rules. Even the Social Security Act was a positive move in its infancy; a forced retirement plan for all those suffering from money illusion and present value bias. But the biggest and boldest move was to remove the currency peg to the value of gold. Only then could the Federal Reserve really meet the conditions for which it was created. A free floating currency, free from the uncertainty of another market, is a prerequisite for controlled stability.

So was the New Deal a good one? I’m afraid not. That is why most of the policies were later removed. Did they work? Well, maybe. Unfortunately it is impossible to say. We can speculate, based on historical evidence that the markets would have corrected in the absence of any government “help”. What we can’t say is if the recovery would have taken longer or not. We also can’t tease out how much of the drawing out of the depression was due to fiscal policy and how much from monetary policy mistakes. The Federal Reserve was still relatively young and inexperienced. They didn’t really understand the impacts of changing the interest rates or the injection of new currency. One thing that is certain is that there was incongruence between the two policies which undoubtedly prolonged the depression beyond its natural life and without the social benefits of reduced unemployment or poverty.