Over at MasterResource I make another guest blog post, this time tackling Robert Bryce's possibly premature concession on whether speculators were driving oil prices. I don't really take a stand but just try to clarify the debate:

In the broadest sense, any price is caused by “supply and demand.” The prices for Las Vegas real estate in 2006, as well as for Dutch tulip bulbs in 1637, balanced the quantity demanded with the quantity supplied. Even at the height of a speculative bubble, sellers can only receive what buyers are willing to pay.

In the present context, however, it is common for people to contrast “the fundamentals” from mere “speculative demand.” In the case of oil, if demand has increased because factories need to run their machines harder or because refiners expect motorists to buy more gasoline, then that is deemed a legitimate, fundamental driver of higher oil prices. On the other hand, if hedge fund managers invest in oil futures contracts not because they forecast higher fundamental demand, but rather because they are simply betting that the market value of the contracts will appreciate, allowing the hedge fund to unload the contract before physical delivery, then that is considered pure speculation.

Incidentally, I knew when I wrote it that that last sentence was a bit long. But man, that last sentence is a bit long.

I'm not making this up. The actual headline is, "Hard-Hit Families Finally Start Saving, Aggravating Nation's Economic Woes." (HT2LRC) Here's some great analysis from the nation's "economically savvy" newspaper:

As layoffs and store closures grip Boise, these two local families hope their newfound frugality will see them through the economic downturn. But this same thriftiness, embraced by families across the U.S., is also a major reason the downturn may not soon end. Americans, fresh off a decadeslong buying spree, are finally saving more and spending less -- just as the economy needs their dollars the most.

Usually, frugality is good for individuals and for the economy. Savings serve as a reservoir of capital that can be used to finance investment, which helps raise a nation's standard of living. But in a recession, increased saving -- or its flip side, decreased spending -- can exacerbate the economy's woes. It's what economists call the "paradox of thrift."

Good for you, American consumers! Too bad the government increased its debt by more than one trillion in 2008 on your behalf. (HT2 Tim Swanson)

If you would like a careful unpacking of the "paradox of thrift," see my earlier article. It's bad enough when the Nobel laureate brings it up, but now the Journal? Oh man.

Our first Speak Out! award goes to Mario Rizzo. Both on his new blog and in the comments section at other sites, Mario has continually pounded home the message that microeconomics is still relevant, even when there is a recession. The second link above is to an Arnold Kling EconLog post. Kling says he's "firmly" against a big stimulus, but would instead "prefer a small stimulus." (Whoa, you should have warned us to sit down before dropping that bombshell, Arnold!) Rizzo says:

Why is there a case for any (fiscal)stimulus at all? If we are simply talking about indulging the public in their fantasies about an easy way out of the economic mess, then I am no expert on this.
However, since so much of the current problem has its roots in the misdirection of resources we must be careful not to frustrate allocative adjustments by renewing the misdirection of resources towards over-expanded sectors. These are not sustainable in terms of the preferences of consumers and investors. The operative resource allocation principle in the political process is toward those areas with the greatest political influence. (BTW, none of this is to be taken as opposing the maintenance of sufficient high powered money to prevent outright deflation.)

Of course, even Rizzo inexplicably thinks that creating more money out of thin air will help with relative price coordination, but that's why you have me.

He still wants to bail out state and local governments, but nobody's perfect. All in all, great stuff Tyler. Perhaps my constant nagging on his site is paying off?

Somebody ages ago mentioned to me that Marianne Sierk, a girl from my high school class, was doing stand up in NYC. For some reason I googled her today, and she's pretty funny. (I didn't really know her in high school, what with her being a girl and all, and me being interested in physics and a fan of Star Trek.) OK Marianne, it's a race to see who gets on Leno first!

Jeff Hummel passed this post along. I haven't read it carefully yet, but it looks promising, with lots of charts and not assuming the reader is an expert. And I was definitely intrigued when I saw this:

And how about the Fed's "free money" from the ballooning excess reserves? If those funds do start to end up as cash held by the public, then the Fed will need to worry again about inflation, in which case it has two options. One is to sell off some of its remaining assets (or fail to roll over some loans). In this case, the consequences for the Treasury are the same as above-- that income from the Fed's earnings is no longer coming back to the Treasury, and it's as if the $800 billion in excess reserves was again replaced by direct Treasury borrowing.

The second option is just allow the inflation.

The bottom line is that Bernanke has made a gamble with something approaching 2 trillion. If the gamble wins, taxpayers owe nothing. If the gamble loses, taxpayers are committed to borrow a sum equal to any losses and start making interest payments on it.

The NYT reviews James Grant's book, Mr. Market Miscalculates, which reflects on his warnings about the financial storm (HT2 von Pepe). The reviewer basically credits Grant for making spot-on predictions, then takes away the compliment through various nitpicks. A representative excerpt:

Mr. Grant’s targets have been many, but none more so than the Federal Reserve. During the height of Alan Greenspan’s maestro acclaim, Mr. Grant made the case against him, then took up the cudgel against his successor, Ben S. Bernanke. He accused them of inflating bubbles and of fighting what Mr. Grant sees as the false bogeyman of deflation.

Beyond the tilting, though, one question begs an answer: Is it possible to have robust growth without the follow-on crises? Essentially, Mr. Grant answers, no.

Capitalism, like invention, is disruptive, he has observed many times, while arguing that past efforts to ensure future safety have only increased long-term instability. That’s because well-meaning protections against “systemic risk” — even government insurance for bank deposits — encourage recklessness. Such was the backdrop to the financial engineering that computers made possible.

IN addition, as Mr. Grant sees it, the world went to hell after 1971, when the United States abandoned the gold standard. “Gold not only collateralized the currency but also tempered the growth in bank credit,” he admonished in 1999 — and, it seems, every year, before and since.

Unhitching economic growth from the vicissitudes of mining freed the Fed to issue endless liquidity to prop American employment and G.D.P. But cheap credit meant that investors, already egged on by Uncle Sam’s implied backstop guarantees, became flush with gambling money.

Mr. Grant is dead right about the long-run tendency of central banks to debase their own paper currencies, but permanently returning the dollar to a gold standard is no more practicable than reducing the government’s size to 19th-century levels. Still, as he warned in 2002, “very low interest rates often ignite booms, but even ultralow interest rates may not fix busts.” Live by the Fed’s pump-priming, die by the Fed’s pump-priming.

Can someone tell me what is up with this "practicable" line? How "practicable" is our current mess? Is the NYT guy really arguing that Grant is right, but the suggestion is impractical, or is he really not even taking Grant seriously?

Eight months ago, how "practicable" would it have been if Paul Krugman suggested that the feds nationalize major portions of the financial sector, and borrow a trillion more dollars for stimulus? Times change quickly.

(Note to new readers: Every Sunday I try to do a post on religious themes, but sometimes it spills over into Monday.)

I am working my way through the Book of Exodus. Last night was chapter 29, which concerned the sacrificial duties of Moses' brother Aaron and the other newly anointed priests:

10 "Bring the bull to the front of the Tent of Meeting, and Aaron and his sons shall lay their hands on its head. 11 Slaughter it in the LORD's presence at the entrance to the Tent of Meeting. 12 Take some of the bull's blood and put it on the horns of the altar with your finger, and pour out the rest of it at the base of the altar. 13 Then take all the fat around the inner parts, the covering of the liver, and both kidneys with the fat on them, and burn them on the altar. 14 But burn the bull's flesh and its hide and its offal outside the camp. It is a sin offering.

Now to an atheist, the above sounds fictitious and/or barbaric. But for a Christian or Jew (not sure whether it applies to Muslims also), it would be odd for the Lord to issue such instructions if they didn't serve some helpful function. For an analogy, a lot of times I tell my own son to do things and he doesn't understand why, but (I hope!) I am not arbitrarily exercising my superior strength; the rules are issued for his own good (or sometimes because I have a headache).

So with the above passage, a few things occurred to me:

(1) The priests would become very adept at learning animal parts, handling blood properly, etc.

(2) This knowledge, in the minds of the most respected members of the community, would be very useful both for dietary and medicinal purposes. On the latter point, for example, Jesus told the former lepers to go present themselves at the temple. So if the priests are going to be in charge of deciding which people are sick (and need to stay outside the camp for x days) and which people can come back in, you want them to know what they're doing.

(3) By instructing them to slaughter the finest animals, the Lord causes them both to take Him seriously but also to practice on the best examples. I.e. it would be both dangerous and less instructive if the priests always slaughtered a sickly goat with a limp, just like high school biology students shouldn't be dissecting frogs that were diseased.

So I claim at mises.org, focusing on the Madoff scandal. An excerpt:

In the private sector, when a firm fails, it ceases operations. The opposite happens in government. There is literally nothing a government agency could do that would make the talking heads on the Sunday shows ask, "Should we just abolish this agency? Is it doing more harm than good?" It's not just Fannie Mae and Freddie Mac: throughout history, virtually every agency created by the federal government has been deemed too important to fail. (I vaguely remember some Republicans in the mid-1990s holding a press conference and declaring that the Department of Commerce was done, and that voters could "stick a fork in it." I guess they found it was still pink inside.)

The pattern plays out perfectly with the SEC and the Madoff bombshell. Suppose a few years ago, I told a group of MBAs to imagine the worst screwup that the SEC could possibly perform, something so monumentally incompetent that members of Congress might openly question whether the agency should continue. I think that at least half of the class would have come up with something far less outrageous than what has happened in fact.

Here is a chart that may surprise you:

Here's a rather silly post about the Great Depression and whether FDR hurt or helped (HT2 Bob Roddis).

To be sure, you can credibly argue that the New Deal had its share of problems. But overall, the numbers prove it helped -- rather than hurt -- the macroeconomy. "Excepting 1937-1938, unemployment fell each year of Roosevelt's first two terms [while] the U.S. economy grew at average annual growth rates of 9 percent to 10 percent," writes University of California historian Eric Rauchway.

This is singularly irrelevant. First of all, note the hilarious "Excepting 1937-1938," when unemployment shot up to 20% in some months (if memory serves). Pretty big asterisk.

But beyond that, the issue is whether FDR prolonged the Depression or not. So to answer that, you have to speculate about what would have happened to unemployment in the absence of the New Deal. E.g. suppose Harding had been in charge?

Well, there was a very severe spike in unemployment (and drop in output) during the 1920-21 depression, but as the title indicates, they were resolved very quickly. As we all know, the only reason we call it the "Great" Depression and spend so much time studying it, is that it was three to four times longer (and more severe to boot) than the typical depression up to that time.

I'm trying to think of a medical analogy, but my ignorance of medicine is making it difficult. Anyway, imagine somebody had the flu, and then Dr. Keynes came in and administered a small amount of poison every day. And so the otherwise healthy person took one month to get better, when normally it might take him 10 days. When inquiring about the poison, imagine an apologist saying, "Look at the charts! The person's temperature started out at 105, then it fell half of a degree every day that the poison was administered, except for the spike 11 days into it when it jumped back up to 104. Clearly the poison helped get rid of the flu."

So said a billboard when I used to run laps on the rooftop of an NYU building in grad school. At the time I was struggling with a 3rd year paper topic. I was trying to do something "bold" like Nash (at least as depicted in the Ron Howard fib fest) but I ended up merely showing that you could get arbitrarily large voter turnout even with rational agents who only care about the outcome. (Granted, you need to give me a bunch of assumptions on the preferences of the voters. But it's not as bad as it first sounds, and in fact one of my professors started out telling me it couldn't be done, and then 15 minutes later said, "OK I buy that" and then said the result wasn't interesting. Grr.)

Anyhow let's stop with my bitter grad school reminiscences and get to longtime reader Zach Kurtz's email:

I devised a new way to play monopoly (originally for fun) and it has since evolved into a way to test the affects of central bank actions on a market (on players who don't know they're being observed). Using electronic banking edition of Monopoly, I would play as the banker. Unlike most monopoly games however, players have the ability to take out loans and make deposits (interest rates being set by the banker). Landing on a property or utility opens up an auction for players to bid (so prices are determined by the market). The winner of the property then has the option (starting the next turn) to put the property up for public offering to sell shares in the 'holding company' of that property.

I want to test how the manipulation of interest rates by the central bank affects market behavior and risk making decisions, as predicted by Austrian economists.

While obviously this isn't a perfect model of real-life economics, how good do you think it is and how could I improve it (without making the game too complex)? What are some other variables that could be important to test?

I told Zach one problem is that he doesn't have long-term projects, so it wasn't clear how to model a cluster of errors a la Austrian business cycle theory.

In general, I don't understand why more Austrians aren't doing simulations. I think you could fairly easily show the effects of Fed distortions, and also show why idle resources should be left alone and gradually reincorporated back into the economy.

Thanks to Ian McDonough who revamped the site's appearance and took the title seriously when we discussed compensation. If any of you own an Arby's chain and are big fans of the site, we should talk.

In the coming days I am going to make some other, minor changes, like adding a Blogroll etc. We have to get this place ready for prime time once my new book hits the NYT bestseller list. Company is coming! Pick up those socks, TokyoTom!

Uh oh, another post on climate change that may stir up the hornet's nest in the comments. Anyway, here I give a guest response to NASA's James Hansen's open letter to Barack Obama. An excerpt:

But there’s the rub. The politicians are not going to [follow Hansen's advice and] impose a simple carbon tax. Instead, they will install a confusing cap & trade program, because it will be easier to hide its impacts (in terms of higher energy prices) from voters, and because it provides the politicians with more opportunity to bestow blessings or punishments on certain sectors. For example, the various cap & trade plans differ in their details over whether the permits should be auctioned or freely disbursed, and which groups (power plants, local governments, etc.) should get the free permits. And we can be quite certain that the politicians will, on net, extract far more revenue from the economy after the imposition of the new carbon scheme.

Ironically, Hansen seems to know all of this, for he writes:

Optimism is fueled by expectation that decisions will be guided by reason and evidence, not ideology. The danger is that special interests will dilute and torque government policies, causing the climate to pass tipping points, with grave consequences for all life on the planet.

The President-elect himself needs to be well-informed about the climate problem and its relation to energy needs and economic policies. He cannot rely on political systems to bring him solutions – the political systems provide too many opportunities for special interests.

And yet, Hansen’s eight-page missive is on what policies the government ought to pursue, since persuasion and argument are obviously inadequate. Professor Hansen is sure that he is right, and he wants the new President to force everyone else into line—immediately.

We can only hope that in his next letter, Dr. Hansen explains how the leader of the U.S. political system will implement these suggestions without recourse to the political system. I don’t consider it too flippant to compare Hansen’s letter to a request that the Pope reform the Catholic mass without involving the Church.

Easy stuff for Free Advice readers, but refreshing nonetheless. Another actor whose intuition is much sounder than that of our most recent Nobel laureate. (HT2 Rob A.)

OK as always, instead of working on whatever it is I'm supposed to be doing right now, I got sidetracked by the related links when I looked up the ending for Episode VI for the previous post. Our theme tonight is Star Wars.

This one is pretty good. It reminds me of an idea I had many years ago: Wouldn't it be funny if you compiled a bunch of clips of Michael Jordon turning the ball over, missing gimme shots, etc.? I bet you could come up with several minutes that made him look terrible. To wit:



This next one is a bit obvious, but funny nevertheless. It is titled Mace Windu uncensored, so don't play it with grandma in the next room:



And to wrap it up, some alternate James Earl Jones lines edited into Episode IV clips. It's not hilarious but funny enough that you end up watching the whole thing.

There's a new face on the EconLog masthead: that of David Henderson. Congrats, David. Seeing you magically appear in between Bryan Caplan and Arnold Kling reminded me of a movie scene.

Intrigued by Lew Rockwell's raised hackles, the TIME econ blogger Justin Fox gives a follow-up post. Now look, I am a relative young pup in the field and have thought all these big schisms in Austrian economics are dumb and counterproductive. But this is just silly. After explaining that Lew Rockwell responded to his earlier piece, the TIME guy quotes from David Gordon's version of the Koch/LvMI feud and then the TIME guy says:

Now I get why citing Tyler Cowen on matters Austrian so raises the hackles of some Austrian true believers. He's an apostate! Notice how Gordon makes no attempt to explain what's wrong with Cowen's critique of Misesian and Rothbardian ideas--it's enough just to point out that he has strayed from orthodoxy. Theirs is the true path, and all others are in error.

This kind of thing happens a lot, so let's be clear, Mr. Fox. The reason LRC posted that response, and the reason some people posted comments on your site, is NOT because you cited Tyler Cowen. There are thousands of blogs that cite Tyler Cowen all the time, and I don't see the LRC blog linking to them with defensive posts. No, the reason your initial post raised hackles was that you said this:

People in the U.S. who self-identify as believers in Austrian economics, though, tend to follow a much narrower path, that of Mises and his American disciple Murray Rothbard. They are extremely libertarian (at the first meeting of the Mont Pelerin Society, a libertarian group organized by Hayek in 1947, Mises stormed out saying "You're a bunch of socialists"). They yearn for a return to the gold standard. Many possess a near-religious conviction that their beliefs are correct and that all other economic theories are pure folly. Some of them--I'm thinking here mainly of the crowd around Lew Rockwell--combine these beliefs with far loopier stuff. Others--such as financial pundits Peter Schiff and Michael Shedlock--often let their rabid Austrian leanings overpower (and, to my taste, ruin) otherwise trenchant economic analyses. Am I going to go to these people for perspective on the business cycle or Austrian economics? No, I don't think so.

So yep, those nutjobs in Auburn take offense when people call them loopy extremists, and don't consider them even worth reading when it comes to Misesian economics. Is that so hard to fathom, Mr. Fox? Do you really think that it was your citation of Tyler Cowen that stirred up resentment, or could it possibly have been the above paragraph instead?

This is hilarious (HT2LRC). If you are new to my blog and are just learning about Austrian economics etc., don't bother clicking the above link. But if you know the ins, outs, whys, and wherefores, just look at how ignorant the TIME blogger is when discussing the factions in Austrian economics. In particular, he implies that Steve Horwitz (!!) is a nutjob Rothbardian taking orders from Lew Rockwell. Also, he implies that Tyler Cowen has a respectable book on Hayekian business cycles whereas Roger Garrison doesn't.

What's really scary is that this TIME guy probably knows more about the Austrian movement than the Bush Administration knew about Iraqi insurgents.

UPDATE: OK in fairness to the TIME guy, at the end of his post he pulls back by saying, "Roger Garrison of Auburn and Steve Horwitz of St. Lawrence University, the two modern Austrian-school economists he recommends, seem on first examination to be more interesting than loopy or strident, so I'll start looking out for their writings." So fine fine, he is more careful than certain members of the Bush Administration.

"Defiant" Governor Blagojevich has named Roland W. Burris as the successor to Obama's senate seat. Plenty of people, including the President-Elect himself, had said that Blagojevich shouldn't name anybody, for obvious reasons. But these people went further: Obama foolishly declared that anyone named by Blagojevich should not fill the vacancy.

Do you see the problem? Obama et al.'s declarations just gave Blagojevich the power to prevent one person from getting the job. I don't know anything about Illinois politics, but we can easily imagine someone behind the scenes bribing Blagojevich to nominate a political enemy, and thus tarnish that person.

The correct thing, for both game theoretic but also meritocratic reasons, would have been for Obama to say, "I think the governor should refrain from naming a successor, due to the unusual circumstances and the pending charges. In the event that he does throw out a name, I think his recommendation should be ignored, and that the process should unfold as it otherwise would have, in order to determine the best person to serve the citizens of Illinois."

One final thought: At this point, it is not clear (at least to those of us reliant on newspaper stories) whether the Senate Democrats really have the power to refuse to seat someone named by Governor Blagojevich. But if so, then they are really dumb, for making an empty threat.

I spent New Year's Eve at my parents' relatively new house in a retirement community in Florida, where new residents must be at least 55 years old. (We had come down for Christmas.) I noticed some huge differences between this party and those that I remember from my youthful days:

* Everybody left before 2.
* There was a lot of talk of medical ailments afflicting those both absent and present.
* Much discussion of finances (though admittedly this was a special year for that).
* The hosts (my parents) cleaned up everything before going to bed.
* The guests brought homemade food that was delicious.
* The hosts ended up with more alcohol than they started the night with.

The most unexpected treat occurred when I was talking with a guy who said he was a ditch digger when I asked him his line of work. Turns out he owns a $300k piece of equipment that lays drainage pipes for farmers in Indiana. (It was fascinating how he explained that it greatly boosted crop yields, but it would be difficult for me to translate it into blog-speak.)

Anyway, we were talking about the economy and I was offering my views in a guarded fashion, since I didn't know the guy's politics. But then with very little prodding from me, he basically out of nowhere announces, "It's these low interest rates making 20-year-olds spend money they don't have. Greenspan really f*cked us all."

At that, for the first time in my life, I was able to raise my glass and say, "I'll drink to that!" with no irony. I almost risked saying, "You read LewRockwell, don't you!" but I first tested him by asking if he held gold. He said no, he just invested in his business. So I chickened out.

Rob Bradley (disclosure: the guy who hired me for IER) has a new energy blog. Some of the big guns who will be posting are still on vacation, but it looks to be great for daily commentary on energy issues.

David Henderson had a great Christmas Eve article discussing the outbreak of peace on the front lines in World War I. Naturally, the commanders nipped it in the bud and made sure their men resumed killing ASAP. If you have no idea what I'm talking about, you should definitely read the article.

As always, I am stunned by Krugman's latest blog post (HT2MR). Check this out, and note that this is his entire post:

Readers have been correcting me for saying “niggling nabobs of negativism” in this post. Yes, I know the original (written by my former colleague William Safire.) But “niggling” is better for the current situation.

Here’s how I see it: the opponents of a strong stimulus plan don’t really have an alternative to offer. They don’t even have a really coherent critique; as Brad DeLong points out, if you believe that a surge in private spending would raise employment — and even the critics agree on that — it’s very hard to explain why a surge of public spending wouldn’t have the same effect.

The critics are instead mainly engaged in a series of minor complaints, aka niggles; FDR didn’t do so well, the statistical evidence ain’t so great, you can’t trust government, etc., etc..

So niggling nabobs it is.

Do you understand how crazy this is? To give context, Tyler Cowen has been repeatedly arguing lately that proponents of stimulus have not made the case that it has ever actually, you know, WORKED. That's what Krugman means by "FDR didn't do so well, the statistical evidence ain't so great, etc."

Notice that the two biggest case histories to "prove" the need for a huge stimulus right now, ARE EXAMPLES WHEN HUGE GOVERNMENT STIMULUS EFFORTS WENT HAND-IN-HAND WITH ECONOMIC DISASTER. Everyone got that? Clearly FDR was more of a Krugmanite than, say, Warren Harding or Calvin Coolidge, and yet the depression under FDR was much much worse than any previous one.

By the same token, what the Japanese tried in the 1990s was far from libertarian liquidationism, and it went hand-in-hand with the "lost decade."

Now Krugman et al. have responses here. E.g. both Hoover and FDR idiotically raised taxes during the 1930s, so it wasn't textbook Keynesian fiscal stimulus. And Japan didn't credibly promise large price inflation (to get adequate negative real interest rates) as Krugman recommended, so his prescriptions weren't fully tried.

But Tyler's point (and I'm paraphrasing) is that Krugman et al. are just excusing apparent FAILURES of pump priming to kickstart the economy out of recession. OK fine, so give us one good example WHERE IT ACTUALLY WORKED.

And to this challenge, Krugman offers the above.

I recently wrote a piece for Mises.org (should run soon) saying something to the effect that what more could the SEC do, than its handling of the Madoff Ponzi scheme, to prove that it's doing an awful job and should be abolished? In other words, if one thinks that all this proves is that some heads need to roll and some priorities need readjustment, then this is an admission that the case for the existence of the SEC is non-falsifiable.

But while chasing my son around, outside the church on Christmas Eve (he was NOT going to sit quietly during the Mass that my parents took us to), it struck me: Those of us who have volunteered to fight the good fight against State power...Um, we screwed up pretty badly the last 6 months. I'm not saying we should quit, but I do think we should seriously think about HOW THE HECK DID THIS HAPPEN, and run the film over and over trying to figure out what we could have done differently.

One huge thing that occurs to me: We should have spent more time debunking the conventional story that the free market (and/or Fed allowing money stock to decline) caused the Great Depression, and then Roosevelt got us out of it. If that's what you "learned," then no kidding you'd fall for Paulson's hysterical threats.

I am being serious with this post. Let's think outside the box if you'll forgive the cliche. (C'mon kids, let's be pro-active and foment some synergy here, to implement some preventive protocols going forward...)

Last point: I am traveling and posts will not resume normal regularity until the new year.

I think it's safe to say that the standard economist take on the Fed paying interest on reserves is that it was a tool to (try to) keep the federal funds rate from sinking. The Fed had flooded the market with tons of new reserves (see my new favorite chart below), and so naturally the interest rate on overnight loans of these reserves would sink. Thus, Bernanke may have thought that he could achieve both of his objectives--(1) buy up dubious assets and (2) peg the federal funds rate--if he started paying interest on reserves.

If that was in fact Bernanke's plan, it obviously didn't work. (Robert Wenzel points out that one problem is that the GSEs are still able to lend reserves in the federal funds market, but they're not allowed to earn interest from the Fed. So they would lend them out.)

Tyler Cowen links to this interesting Interfluidity post that discusses a different aspect I hadn't even considered:

Interest rates are, for the moment, excruciatingly low. But a subsidy to the banking system, once put into place, will be quite hard to dislodge. So, let's imagine that the Fed will pay interest on bank reserves in perpetuity, that it will pay such interest at or near the risk-free short-term interest rate, and that the expansion of the Fed's balance sheet is more or less permanent. How large a subsidy to the banking system do the interest payments on reserves represent? Some problems are arithmetically challenging, but not this one. The present value of a perpetual stream of market-rate interest payments is precisely the amount of the principal. Therefore, the present value of the Fed's de facto commitment to pay interest to banks on $800B of freshly created reserves is $800B. We fought and wailed and gnashed our teeth over potentially overpaying for TARP assets. Meanwhile, we are quietly allowing the Fed give away, as a direct, literal subsidy, more than the entire $700B that Paulson was allowed to play with. Note there is no question about this being an "investment": The interest payments that the Fed is now making to banks on its suddenly expanded balance sheet are not loans. The banks owe taxpayers absolutely nothing in return for this windfall.

Now we can quibble about the calculation. What the guy (?) means is that the higher the interest rate the Fed pays, you'd think the greater the subsidy. But not if we take the interest rate to be "the" interest rate. A dollar the Fed pays to the banks next year isn't the same as a dollar today, and so if you discount future payments at the same rate of interest at which the initial principal is rolling over, then the present value of that entire future stream of interest is exactly equal to the original principal.

For what it's worth, it wouldn't surprise me if the Fed discontinues interest payments once inflation gets out of control. But then again, if the banks are still on a morphine drip (which they will be--just look at housing projects), then maybe it will be too painful to contemplate.

Last point: Even more than the mysterious open market operations, in which the Fed buys an asset (such as a government bond) from a bank and then credits its account with more reserves, here the Fed quite openly is "creating money out of thin air." Perhaps the actual mechanism is more subtle than this, but my understanding right now is that if you are a bank and have $1 million on deposit with the Fed, they pay you interest simply by changing the number in their records. No need to debit this payment from some other fund, no need to get Congressional approval, no need to float bonds to raise the money for it. You need to pay out a million dollars in reserves today? Go right ahead, just change the 1s and 0s in the computer.

I think it's starting to sink in with people, even members of Congress, how powerful the Fed really is. I'm still pretty sure Bernanke is mostly an academic, and he's trying to do what he can in an admittedly impossible situation. The only real deceit I think coming from Bernanke is his acting like he knows what the hell he's doing.

But what happens when a real schemer runs the Fed? Do you realize that the Fed chairman effectively has a printing press at his command? Can you imagine the outcry if one sheik controlled the entire world's supply of oil? Well the Fed chair controls the world's supply of dollars.

This Slate piece tallies them up. In terms of commitments (not actual money going out the door), the government had promised, as of Nov. 25, $5.6 trillion in new handouts, er, measures to revitalize the economy. (I think it starts with the Term Auction Facility from the end of 2007.) To put it in perspective, I heard on the radio that a Bloomberg story had found that this was more than all of the United States major wars (and it included Afghanistan), even when adjusting for inflation.

Now remember back when they first bailed out Fannie and Freddie (and then especially AIG), and all of the bad things that certain economists were predicting? Do you think at that point, if we knew for sure that it would lead to an outpouring of almost $6 trillion in new commitments in just a few months, that they would have said, "Let them go bankrupt and let the chips fall where they may"?

This job creation stuff is really getting absurd. Now the President-Elect and his partner in crime are saying they will create 3 million jobs, not the 2.5 million they promised earlier, because (according to Biden) the economy is in worse shape than they originally realized.

The CNBC article doesn't say how much more it will cost to save 3 million jobs versus 2.5 million; such specificity isn't even appropriate in an announcement like this, because no one actually thinks there are serious calculations involved when politicians throw numbers around. (And wouldn't it stink if you were the 3,000,001st person to get laid off?)

But let's use the numbers that some people are throwing around for the total stimulus package. The article mentions three possible numbers: $600 billion, $700 billion, or "in the trillion-dollar range." Dividing by 3 million, the cost per job saved is:

(A) $200,000.00
(B) $233,333.33
(C) $333,333.33

I think instead of Obama's current plan, what he should do is this: Take the lowball estimate of $600 billion. Next, identify the 10 million Americans who are most in need of immediate assistance. Then, send each of them a tax-free cash payout (split up over twelve months if you doubt their discipline) of $60,000.

I'm guessing that $60 grand after-tax is a lot more than most of these people are used to making, and it's not bad to get that while you are still eligible to go get a job in the private sector. Notice that my plan is the low-ball cost estimate, and saves 4x as many unemployed people as Obama's original plan. Plus, my plan is guaranteed to actually "work," in the sense of saving families who are on the verge of foreclosure etc. (In other words there's no guarantee that Obama's job training plans etc. will get these people a job that pays them $60 grand after taxes, especially not right away.)

Obviously, my plan is stupid. It would simply ensure that the unemployment rate stays high for a year, and then we'd be back to square one. At the same time, it would take $600 billion from taxpayers and hand it out to people who aren't working. (If you want to help such people, charities and churches are happy to take your donations.) But my point is that my plan is better than Obama's, even on his own terms.

Now ask yourself: Have Obama and his team just not realized the above? Or is it just possible that they want to spend a trillion dollars to reward their own pals, just like Paulson & Co. did with their own set of cronies?

Gene Epstein places Gene Callahan's Economics for Real People (book or pdf) at the top of his holiday list. (In the box it's third in the list, but Epstein discusses it first.) It really is the best intro to Austrian economics available; I used it as a textbook in my Austrian I class at Hillsdale.

Sadly, the best economics book ever didn't make the cut this year. What's odd is that Thomas Sowell's book Applied Economics is on there, when--as all who read my Wikipedia page know--in his review of my book and Sowell's previous one, Epstein declared:

I only wish Sowell [in Basic Economics] were as informed about the economics of the Austrian school as author Robert Murphy. While Basic Economics and The Politically Incorrect Guide to Capitalism work well as companion volumes, in the few cases where they seem to disagree—as in the discussion of money and business cycles—Murphy's version is the more trustworthy.

Hmm, something tells me that in this festive time of year, I should rejoice in Gene's success and not pout about the injustices I endure daily. Maybe...

...or is it doppelganger? Anyway, for a while I've been amused by the Robert Murphy who is a left-leaning historian of economic thought in Boston. However, his middle initial is different from mine.

Well today my good friend Google Alerts notified me of a guy who is a "planning consultant" for local government projects. His name? Robert P. Murphy, the same as mine.*

* Admittedly confusing, since Danger is my middle name.

This will no doubt be either irrelevant or old news to many readers, but in the past few years I have a newfound appreciation for the lyrics of Christmas carols. When I was younger, they were just what they were, and I didn't think about them. Then I spent several years being "rational" and didn't think about such things. But now that I am coming back to Christianity as an adult, I am really impressed with some of the lyrics of traditional carols. This is no yummy yummy yummy I got love in my tummy. For example:

Hark the herald angels sing
"Glory to the newborn King!
Peace on earth and mercy mild
God and sinners reconciled"
Joyful, all ye nations rise
Join the triumph of the skies
With the angelic host proclaim:
"Christ is born in Bethlehem"
Hark! The herald angels sing
"Glory to the newborn King!"

Christ by highest heav'n adored
Christ the everlasting Lord!
Late in time behold Him come
Offspring of a Virgin's womb
Veiled in flesh the Godhead see
Hail the incarnate Deity
Pleased as man with man to dwell
Jesus, our Emmanuel
Hark! The herald angels sing
"Glory to the newborn King!"

Hail the heav'n-born Prince of Peace!
Hail the Son of Righteousness!
Light and life to all He brings
Ris'n with healing in His wings
Mild He lays His glory by
Born that man no more may die
Born to raise the sons of earth
Born to give them second birth
Hark! The herald angels sing
"Glory to the newborn King!"

(Ha ha get it? My title has at least two meanings. One of which is mildly amusing.)

My next mises.org piece is going to tackle this whole notion of idle resources and how there is (allegedly) no tradeoff involved when the government directs workers and other resources into public works boondog--I mean investments in infrastructure. But for now, I just loved this confident comment over at Env-Econ where John Whitehead is getting attacked (with the rhetorical equivalent of cardboard tanks) for his claim that "green jobs are bogus":

Sniff, sniff... yes, that's it - I do smell reductionism. And packaged in an overly general assertion to boot - my, my!

Let's apply your point to highway construction. Are you really ready to defend your view that the massive investment the US government made in highways from the 50s onward did not contribute any net jobs to the economy, and that it only shifted the balance of jobs?

Yes yes yes, that IS what John should be saying. (Not sure if John had the courage of his convictions to go that far.) Would the unemployment rate have been 15% up through today, in the absence of federal highway construction? Or, did the construction of federal highways lead Americans to have more unprotected sex? If not, then clearly the federal highway program didn't contribute net jobs to the economy.

The only real way to create net jobs within the country's borders is to allow more immigration. Of course, that just destroys jobs in other countries.

So long as wages are allowed to adjust, unemployment will (certainly in the long run) sink to the "natural" level. Government policies can perhaps affect how high that "natural" level is. Other than that, government policies really affect real wages, not job creation per se, if we are talking about the long run. Even massive tariffs don't (in the long run) "destroy jobs" on net. In an autarkic economy, so long as the labor market is relatively free, everyone can still get a job. The (real) wages will just be a lot lower because of the protectionist barriers.

I'm glad to report that the two (fairly clever) guys over at Environmental Economics have been questioning the green jobs/fiscal stimulus orthodoxy. Now to be clear, they actually agree that there is a huge market failure and that the government should take steps to make greenhouse gas emitters "internalize the externalities." But the point is, the textbook way* you deal with that is you slap a carbon tax on, then sit back and let the market process work. You don't need Barney Frank doling out another trillion dollars on wind turbines and solar panels.

Anyway, try these posts--one, two, and three--to see John and Tim's thoughts. Then here's Mark Thoma giving the "scarcity disappeared in December 2007" counterresponse.

* I disagree strongly with this standard textbook approach, of course. But my point is, this new "consensus" about saving the planet and economy simultaneously doesn't even make sense to serious economists who think the government needs to raise the price of carbon emissions.

I am still in the Dark Ages (an anti-Church misnomer) when it comes to reading blogs. My wife once tried to set up a Bloglines thingie for the sites I like, but it didn't take. So that means I only read a limited number of blogs during a normal session. Consequently, I only read Peter Klein's blog posts when they get linked from another site. Perhaps it's just selection bias, but man Klein always knocks it out of the park... Check out Klein on journalists (HT2 Steve Horwitz):

Bush and Paulson and Greenspan and their clique are “free marketeers” in the same way (to borrow from A. J. Jacobs) that Olive Garden is an Italian restaurant. They adopt the language, and some of the form, of market advocacy without any of the content. The Bush Administration was already, before the “financial crisis,” the most economically interventionist since LBJ; it now ranks with Hoover and FDR as the most aggressively anti-market in US history. Greenspan and Bernanke expanded the money supply like none before; Bush and Cheney borrowed and spent trillions to finance overseas adventures; the Federal Register added pages at a record-setting pace; now the banking and automobile industries have become GSEs. Lassiez-faire, indeed!...

And yet, there was Juan Williams on yesterday’s Diane Rehm show explaining, matter-of-factly, how Bush and Paulson had allowed their “free-market ideology” and “resistance to regulation” to “commitment to the idea that the market works itself” to lead the nation into ruin. Williams may be a good news reporter, but he has the political-economy understanding of a fifth-grader. Does it ever occur to these “watchdogs” to investigate what government officials actually do, rather than simply repeat what they say?

Fight the power, Pete!

Readers know that lately I've come to doubt the evenhandedness of Brad DeLong. (This makes it difficult for him to "grasp reality with both hands," the professed goal of his blog.) My suspicions were further aroused when I saw him make this statement at TPMCafe (HT2 Arnold Kling):

What is going to be the new leading sector? What is going to allow us to maintain full employment without running huge long-term budget deficits that will, eventually, sap our rate of economic growth somewhat?

Now that raised some red flags for me. Catch the two qualifiers that DeLong uses, to make sure the reader doesn't get the wrong idea and think that federal budget deficits have a downside: he says "eventually" and then even has to throw in "somewhat"!! And there's no doubt either about the nature of the beast here. He's explicitly talking about "HUGE LONG-TERM budget deficits" (my emphasis of course).

To check my suspicions, I decided to do a Google search of "bush deficit" at DeLong's blog. Go ahead and click on some of the results. When the huge deficits were George Bush's actual, or John McCain's hypothetical, then DeLong was quite severe in his criticism. This post from from just last August is the best example I found:

It says more about me than I should probably admit, but back in 2000 I found the prospect of paying off the national debt to be very exciting.

To me, the pledge to do that, which Bill Clinton made towards the end of his presidency and George W. Bush made as his years in the White House were just beginning, was absolutely thrilling. Because of the lower annual interest payments that would result, no other change then being seriously talked about had the potential to alter the long-term federal budget outlook as positively and permanently.

That's why I found the mid-session review of the budget released yesterday to be so depressing. It was the official notice that the pledge, and all the good things that would come from it, would not be fullfilled. It was also time to admit that the budget politics, economics, and limits of the past decade would continue...and continue...and continue.

That's just not a happy occasion for anyone but those of us who blog, write, and talk about the budget. Business will be booming.

None of this was a surpise, of course. The prospects for paying down the national debt firmly ended back in the first year of the Bush administration. And the close to $490 billion deficit that OMB projected for 2009 has long been assumed or leaked.

Nevertheless, the release of the midsession review on July 28, 2008 should be noted as the official date when the dream of a very different budget debate and fiscal policy opportunities died.

I'll have more about the following shortly. But other observations:

...

From a budget, deficit, debt, interest rate, and fiscal policy perspective, the Bush administration is leaving the country so much worse off than it found it that it will likely hamstring the next president and Congress in ways that aren't yet fully understood.

Based on what we now know for sure about next year's budget, none of the presidential candidates' promises should be taken seriously. Unless they, the country, and those lending us money are willing to tolerate much higher nominal deficits and a larger debt than has so far been imaginable, the next president's options will be severely limited.

Hmm that tone seems a heck of a lot different from the more recent statement quoted in the very beginning of my post. And to repeat, you can't get DeLong out of this by saying, "C'mon, right now we're in a massive recession that requires deficit pump priming." First of all, we were in a recession back in August, though the NBER didn't know it. Second, to repeat myself, DeLong was referring to LONG-TERM budget deficits and what they would EVENTUALLY do. So even if you think he means all of the new pro-deficit talk in terms of a depression economy, then you're still left with the implication that massive budget deficits won't get us out of the slump even in the long-term.

In conclusion, I think Occam's Razor says that the best explanation is that deficits are awful when they are the fault of George Bush. When the incoming Barack Obama pledges them, and Paul Krugman says any fiscal stimulus number should be doubled to get it right, then DeLong can only bring himself to say that HUGE LONG-TERM deficits would EVENTUALLY slow down economic growth SOMEWHAT.

Here is my Townhall column explaining how the California Air Resources Board (CARB) ignored scathing peer reviews of its economic analysis, and voted unanimously to go forward with the statewide cap-and-trade program (and other goodies) contained in AB 32, aka "The Global Warming Solutions Act of 2006." (So now we can stop worrying about global warming.) Excerpt:

The fallacy in CARB’s reasoning is easy to spot. Right now there is nothing preventing businesses from lowering their emissions, and consumers right now are able to adopt the “efficiency” measures that would allegedly save them so much money. And yet, CARB would have us believe that the private sector is so incredibly shortsighted (or just hates the planet that much), that the California politicians have no choice but to force their constituents to become richer.

Outside experts—some of whom were explicitly invited by CARB itself to provide comments—have agreed with my harsh assessment....[For example, consider] the remarks of Harvard’s Director of Environmental Economics Program, Robert Stavins. Now let’s be clear, this guy is no Rush Limbaugh ditto-head. He has been a lead author for the Intergovernmental Panel on Climate Change (IPCC), and was Chairman of the EPA’s Economic Environmental Advisory Committee—a post to which he was initially appointed during the Clinton years. So this professor is no “denier.” Yet here’s what he had to say about CARB’s rosy predictions:

I have come to the inescapable conclusion that the economic analysis is terribly deficient in critical ways and should not be used by the State government or the public for the purpose of assessing the likely costs of CARB’s plans. I say this with some sadness, because I was hopeful that CARB would produce sensible policy proposals analyzed with sound scientific and economic analysis.

Although readers know my views about cap-and-trade programs, that's not why I wrote about this episode. It is truly shocking how crazy CARB's economic analysis was. If you want to take the IPCC science and make a case for a carbon tax or cap-and-trade, you can certainly do so; William Nordhaus makes a strong case [pdf], for example.

But that's not what CARB did; instead they claimed that setting an aggressive emissions target would boost the California economy. I'm just speculating, but I bet higher-ups told the economists something like, "With the recession and huge budget deficit, there's no way this is going through if we report that it will kill jobs and tax revenue. So you come up with a way that AB 32 boosts the economy."

As longtime Free Advice readers know, my favorite graph lately has been of the monetary base, which consists of currency plus bank reserves on deposit with the Fed. (Note that a broader definition of money, M1, includes total demand deposits, i.e. checking accounts, whereas the monetary base doesn't.) In contrast to the broader measures of money, the Fed can directly control the monetary base through open market operations (and other ways if need be), and that's why most economists look at the behavior of the monetary base to see whether the Fed is tightening or loosening.

Anyway, the graph below illustrates the old "pushing on a string" notion of impotent money-pumping. In the past year the Fed has pumped in a ridiculous amount of bank reserves--meaning that the Fed goes out into the market and buys assets such as government debt or even mortgages from institutions, and then out of thin air increases the electronic entries for their deposit balances with the Fed itself. But as you can see, the increase in reserves is basically just sitting in the (electronic) vaults on the Fed's ledger. Even though banks have the legal ability to make new loans to customers (which would increase M1, M2, MZM, etc. by more than the base itself increased), they aren't doing so. In other words, the total amount of checkbook balances (as well as other very liquid forms of money included in the definition of M1) has gone up sharply, but not nearly as much as the base has increased (an increase itself driven by the spike in one of its constituents, reserves).



Here's another way to view it. "Excess reserves" means those reserves that banks hold on deposit with the Fed, that they don't need to back up their outstanding demand deposits. So when excess reserves rise, that means banks have the legal ability to make more loans but are choosing not to. Now I'm just eyeballing it here, but if you look closely you can see an uptick in recent months...



But back to the serious issue at hand: What happens when the panic in the financial sector subsides, and banks feel comfortable lending again? Well, loosely speaking, it means that the amount of money in the hands of the public (as opposed to reserves that commercial banks have on deposit with the Fed) can increase the same percentage as reserves have increased. So even if Bernanke cut the spigot off Monday, and didn't let reserves increase any more, that would still mean there was enough slack in the system for demand deposits to increase some 1,400%. (Reserves have gone up yr/yr a bit more than that, while demand deposit year/year growth has been around 38% or so.)

Now obviously Bernanke is not going to sit back and let prices go up by a factor of 14. But how does he suck reserves out of the system? Why, he has to sell off the trillions in new assets that the Fed has recently acquired. And of course, this is precisely all of the "troubled" assets that nobody wanted to hold in the first place, and that had caused the major players to seize up.

And even if Bernanke decides to hang on to all of the mortgage derivatives--you know, the ones that are going to make us taxpayers so much profit in the coming years--and he just dumps U.S. Treasurys, guess what that does? It lowers the price of Treasury debt, meaning interest rates rise. Fortunately, the incoming Obama Administration has plans to sharply pay down the federal debt, so at least skyrocketing interest rates won't be so painful. Oh wait.

I hope my advice to acquire physical gold and silver makes more sense now. And I hope you also see why I find all this talk about the market forecasting 30-year average inflation rates of 2 percent (or whatever) to be absurd.