10 Jan 2010

"Those Guys Are Really Smart, Except For That God Stuff"

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I don’t remember the exact quote, but in C.S. Lewis’ Surprised By Joy he was explaining his conversion from atheism. He said that the writers/thinkers he respected the most just happened to be Christian, and of course Lewis (when he was still an atheist) thought they were fantastic “except for their Christianity.” Naturally this struck Lewis as ironic/funny when he was looking back on the period, after he himself had become Christian.

I had a similar experience. Even though I referred to myself as a “devout atheist” for a certain period in my life (which included undergrad, I can’t remember how early it started), the people/art I respected the most were Christian. (Two give two examples, I was incredibly impressed by the physical pipsqueak of a pastor of the church at the school where my mom taught, who would peacefully protest at abortion clinics and kept getting arrested. He was such a nuisance that the bishop had him relocated to a predominantly black church in an area of town where [I think?] I normally would have been afraid to visit. The other example was the subplot of Valjean’s redemption in Les Miserables, which is blatantly Christian though read this for nuances.)

Anyway it is with this background that I am amused to see atheists explaining the “ironic” success of apparently superstitious mumbo jumbo (my words). Here are three examples in the last month:

* David Friedman has a fascinating series of posts at his blog discussing Jewish law. For example in this one, he gives a theory for the purpose of onerous Jewish customs. Only a true believer would go through all the rigamarole that orthodox Jews are expected to obey, but then when there are legal disputes the other religious Jews will be impressed if you take on oath affirming your testimony. (If you are a true believer then you would fear God’s wrath for taking an oath falsely.) I suspect that if modern scientists went back and understood the exact conditions the ancient Israelites faced, then all of the “crazy rules” in Deuteronomy etc. would make sense.

* In his new book The Big Questions, Steve Landsburg spends a good portion bashing theism (and “bashing” is a completely accurate term) before explaining the incredible discoveries of the Jewish legal theorists. I don’t have the book in front of me so I don’t want to batch the details, but it has to do with things like how to divide an estate among various creditors. Landsburg refers to some recent papers by game theory whizzes in Israel who show that these ancient scholars somehow hit upon very elegant solutions, although of course in their expositions they didn’t give a proof showing existence and uniqueness theorems, they just said, “This is how you would divide the estate in this situation.”

* In this fascinating paper [.pdf] Pete Leeson analyzes the medieval practice of settling certain legal questions by ordeals, where (e.g.) you would dunk your hand into a cauldron of boiling water to fetch a ring, or the priest would dunk the accused in a pool and determine his guilt or innocence by whether he floated. Leeson argues that these practices–which seem unbelievably barbaric and superstitious to us–were actually effective in determining guilt. (Note that I have no idea about Leeson’s religious views, but the above link was from Tyler Cowen and I’m pretty sure he is a modern free thinker.)

So anyway I think these modern reconstructions of how faith “works” are very interesting. From my perspective, it’s obviously not surprising at all that, say, old-school Jewish legal scholars would “happen” to stumble upon a very deep and elegant way to settle disputes; they were in daily meditation with the author of mathematics and justice.

If you are openminded and truly a free thinker, you just may find that a lot of the “stupid” beliefs of religious people are actually quite pragmatic. Yet rather than merely saying, “Ah, so that explains their persistence in evolutionary-meme terms,” I would go farther and say, “Right, this is yet another piece of evidence that there is a God who wants to help His children navigate through the world He designed.”

10 Jan 2010

Gary North Tackles the Deflationists

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Today LRC ran a Gary North article in which he took on the deflationist camp. Although his official target is a guy named John Exter, the apparent grand-daddy of the viewpoint, North’s critique applies perfectly to someone like Mish who claims that there will be a general deflation yet a constant / rising gold price because “gold is money.” (I am pretty sure that’s what Mish’s view is, but please correct me if I’m off.)

Some great excerpts from North’s column (emphasis mine):

Anyone who really believes in Exter’s scenario should recommend paper money rather than gold for investors with less than $10,000 to invest. The investors with more money should buy T-bills. Why? You don’t have to pay taxes on your capital gains with paper money and T-bills. Legally, there are no capital gains. In fact, there are: everything costs less, and you have cash to spend.

Any investment advisor who predicts inevitable price deflation who does not recommend T-bills and paper money is faking it. He doesn’t really believe his position.

According to Exter, gold is more liquid than anything else. This is wrong conceptually. Gold is not money today. Therefore, you must pay a commission to buy or sell it. If you pay a commission, the asset is not truly liquid. One of the three characteristics of liquidity is the absence of any commission. This means money. Any asset that can be exchanged only by paying a commission is not money.

Gold’s price will fall in a time of deflation. It will fall because gold is not money except for central banks, and they hold it mainly for show, as I shall explain. It is a mass inflation hedge. It is not a deflation hedge.


We have never had an opportunity to test Exter’s theory of gold as a hedge against price deflation, because there has yet to be a single year in which the CPI has fallen.

Say that you buy a share of stock at the market price. Let us call the company Madoff, Inc. You buy it for $100. You write a check for $100 to your broker. The $100 goes from your bank account to the broker’s bank account, and most of that money then goes to the bank account of the person who sold you the share.

Then bad news hits regarding your stock. The company has cooked the books. It turns out that the company is an empty shell of debt. The share price immediately falls to zero. You take a 100% loss.

You are a big loser. The person who sold you the share is a big winner: he got out in time.

The money supply has not changed.

What is the effect of the collapse of Madoff, Inc. on consumer prices? Nothing.

Why not? Because the price of Madoff, Inc. was an imputed price based on a few sales. Until the bad news hit, not many people bought or sold Madoff, Inc. There were millions of shares outstanding, but only a few thousand traded on any day. The price at which the latest share traded was imputed by the market to all the others. The money involved was limited to the handful of actual trades.

You lost the $100 on the day you wrote the check. You received an asset that you thought was worth $100, which it was, very briefly. Then it wasn’t.

You say “I lost $100 when the stock fell to zero,” but this is a mistake conceptually. You are applying the loss to the value of the share. You lost your expected future value on the share.

Yes, you lost money. You lost your money on the day you bought the share. You gave up money for a dream. The market value of your dream then collapsed. You did not lose money at that point. You lost it when you wrote the check. What you lost when the stock’s price collapsed was value. You did not lose money. The asset was not money.

09 Jan 2010

Epiphany or Brain Fart? Government Debt and Inflation

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As I think I have mentioned, I’m working on a textbook for junior high / early high school kids. (It’s a textbook on economics, not yoga, in case you are wondering.) I was being really anal about the precise connection between government deficits and price inflation, explaining that a budget deficit per se doesn’t create new dollars, and so by itself doesn’t push up U.S. prices.

But of course in practice there is a connection, since government debt gives the Fed an incentive to create new money. I mentioned that if we just thought about a printing press, there would always be the temptation for the government to pay its bills by simply creating the necessary number of $100 bills.

Finally I dealt with the complication of the Federal Reserve buying Treasury debt from the public, etc. etc. In our system, the government can’t literally just print up new money to cover a shortfall in revenue, and call it good.

But I wanted to show that things were actually quite close to the straight-up “counterfeiting” operation, where the Fed is literally just printing new money so the government can close its budget deficit. In doing so, I had an epiphany; the connection was even closer than I had realized before working on this section of the book. Here’s the footnote, and please tell me if this is basically right or if my black helicopter worldview has misled me:

If you are a sharp reader you might think that this isn’t truly printing up new money just to close a budget shortfall, because the federal government still owes interest and the return of principal to the holder of the bonds it issued. But guess what? The Federal Reserve is the recipient of these payments (since the Federal Reserve bought the bonds from the private dealers), and as standard operating procedure the Federal Reserve remits all of its excess earnings back to the Treasury. In other words, after the Federal Reserve pays it electric bill, employees, and so forth, any extra money it has, it sends back to the Treasury. Thus in the modern American financial system, things really can be quite similar to the operations of an outright counterfeiting operation!

09 Jan 2010

Legalizing Poker and Blackjack Today, Marijuana Tomorrow?

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CNBC reports:

HARRISBURG, Pa. – Pennsylvania legalized poker, blackjack and other table games at slots casinos Thursday, upping the ante in the increasingly fierce competition among states for gamblers’ money.

It may be more than six months before the first cards are dealt, but millions in license fees are expected to begin pouring into the state treasury much sooner.

The table games bill was a critical component of the October deal that ended Pennsylvania’s 101-day budget stalemate, and came about largely because other means of raising tax revenues proved politically unpalatable.

The new law is the latest attempt by recession-slammed state governments to fill budgetary holes with gambling revenue.

Indiana is considering allowing riverboat casinos on Lake Michigan and the Ohio River. In November, Ohio voters passed a ballot measure to put casinos in four cities. Kentucky’s governor wants slots or table games at racetracks and Chicago plans a new casino.

Closer to Pennsylvania, Delaware recently began allowing parlay betting on sports at its racetrack casinos, and a new report says it may have to add two casinos to keep pace with neighboring states.

Last month, voters approved table games for a horse track in Charles Town, W.Va.

And Maryland voters have approved up to 15,000 slot machines in five areas, although progress on implementing gambling there has so far been slow.

“I see it as a border war more than a national picture,” said University of Nevada-Las Vegas professor Bill Thompson, an expert on the gambling industry. “It is the gambling war of today — three years from now it might be something else.”

I wonder what that could be? Hmm what if people are really really mad in about 3 years, the economy is still awful, states are all up to their eyeballs in deficits, and young people–for whom the unemployment rate might be 50% or higher in some demographics–are getting ready to riot?

Is there some way the people in charge could get everyone to chill out?

I’m drawing a blank.

09 Jan 2010

How (Falsely) Low Interest Rates Screw Up the Economy

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I just made a fairly long and technical post, which I’m sure half of my readers will skip. Let me say it in plainer English:

Loosely speaking, the market interest rate allocates the available financial capital among various possible investment projects. The equilibrium interest rate is j-u-u-s-t right so that people save exactly the amount of money that other people want to borrow.

Although we think of it in terms of money, there is a corresponding physical reality to all this, too. If entrepreneurs see hot new investment projects and want to start hiring workers and buying raw materials to get started, those workers and resources have to be redirected away from other things.

Ideally, if everyone in the community wanted to cut back on eating out once a month, in order to save up for a summer cruise in 3 years, what would happen is that their spending and saving decisions would (a) cause layoffs in the restaurant industry, and (b) lower interest rates enough to make it profitable for the people in the cruise industry to borrow money to start building more ships and training more crew members. Obviously in the real world things would be messier, but the point is that market prices–especially interest rates of various maturities–would help with this transition.

Now what happens if the government comes in, prints up a bunch of $100 bills, and starts lending them out to borrowers at lower rates than what the original market interest rate was? Obviously that will totally screw things up.

Even if people are fully aware that there’s a guy throwing funny money into the works, they can’t not borrow at the lower rates. That would only work if they could trust every single person in the whole economy to not take the crisp new $100 bills from the Fed official, even though he was offering to lend them at lower terms than the other people offering equally-legal $100 bills.

The point is that it can’t be the case that this handing out of new money is benign. People end up borrowing more money than they otherwise would have been able to get. Even a particular entrepreneur who knows there is a bubble, and knows interest rates will eventually shoot up, and who gets out in time, has still screwed things up. In other words the damage caused by the Fed guy handing out $100 bills is not simply the borrowers who get caught with their pants down when rates shoot up earlier than they thought.

No, from DAY ONE, when people borrow more money at the artificially low interest rate than they should have been able to borrow, the structure of the market starts diverging from what it should have been. If you think “rational expectations” should allow people to offset everything, then you are really saying the market interest rate serves no function.

If you admit the market interest rate means something–that a businessperson needs to know, for example, whether the one-year rate is 3 percent versus 2 percent–then you have to admit that it screws things up if the government pushes down the original 3 percent rate to 2 percent.

09 Jan 2010

How (Falsely!) Low Interest Rates Contributed to the Housing Boom

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In my battles with Greenspan defenders, things often come down to examination of what the Federal Reserve did with the money supply (however defined) after the dot-com crash. The idea is that interest rates per se are irrelevant, since the (typical) way the Fed moves interest rates is by shrinking or enlarging the total amount of bank reserves through open market operations.

The reason we are supposed to focus on money, not nominal interest rates, is that the market interest rate could be changing for “fundamental” reasons. For example, if the free market interest rate should be rising, then the mere fact that the Fed raises its target rate too doesn’t prove that the Fed is “tightening.” Indeed, if the Fed’s hikes lag behind the increase in what the free-market interest rate would be (however we define it), then arguably the situation would represent one of “easier money.”

This is a very important point, and failure to heed it led certain Keynesians astray when they thought the German central bank in the Weimar Republic was engaged in tight money because nominal interest rates were so much higher than normal. (!!) This despite the wheelbarrows of cash.

Notwithstanding all of the above, I think there is a similar danger in throwing nominal interest rates out the window. For example, I have a gut feeling that interest rates are too low right now, simply because…I can’t believe free market interest rates would ever be virtually zero–let alone negative for brief periods!–in a modern economy not threatened by roving marauders. (Even if Geithner et al. are marauders, they are not roving. They are here for at least another three years, so suck it up.)

When it comes to the housing boom, suppose (for whatever reason) that interest rates in the early 2000s responded very strongly to modest injections of money from the Fed. In other words, nobody has ever shown me that, say, a 1% increase in the growth of some monetary aggregate could only cause a proportionally small distortion in market interest rates. And because interest rates are prices that mean something about intertemporal tradeoffs, that can in theory really screw up the whole economy.

To reiterate a basic point that even many free market economists overlook: INTEREST AND MONEY ARE NOT THE SAME THING. The problem with government intervention in the banking system is not merely that “it will eventually lead to price inflation.” No, when the government distorts the interest rate, it messes up the intertemporal coordination of the economy. People’s long-term plans don’t mesh as well as they would in the absence of a central bank.

With the above as background, I was very pleased to read this post by David Beckworth (HT2 Arnold Kling). He quotes from various academic papers and blog posts showing plausible ways that low nominal interest rates could have fueled the housing boom. Here’s a good excerpt, and note that the first paragraph is from Beckworth, while the remainder is his quoting in turn of Barry Ritholtz:

Both papers above empirically show the low federal funds rates were very important to the excessive leverage and big bets made by financial institutions during this time. Barry Ritholtz provides a nice summary of this channel in a recent post:
What Bernanake seems to be overlooking in his exoneration of ultra-low rates was the impact they had on the world’s Bond managers — especially pension funds, large trusts and foundations. Subsequently, there was an enormous cascading effect of 1% Fed Funds rate on the demand for higher yielding instruments, like securitized mortgages…

An honest assessment of the crisis’ causation (and timeline) would look something like the following:

1. Ultra low interest rates led to a scramble for yield by fund managers;

2. Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;

3. Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;

4. These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers….

And then the list goes on to describe the events we all know.

Let me add one point here: Tyler Cowen (I think?) had a post a while back ridiculing or at least seriously questioning this line of argument. He said something like (and this is a paraphrase), “Suppose the government started paying people to store bananas on their roofs. After a while, if a bunch of roofs started caving in, would that be a sign of irrational homeowners or bad government policies? Surely the people who believe in the free market should be troubled that homeowners would respond so stupidly to a government incentive that they had the option of refusing.”

With that skepticism in mind, I imagine someone could dismiss the excerpt I’ve placed above by saying, “Well gee whiz, suppose that the Fed didn’t exist, and that the analogous free market interest rate fell to 1% from 2003 – 2004. Are you saying that the dumb investment banks would have blown up a few years later because of their insatiable need for higher yields?”

But hang on: If I’m right that it was Greenspan (and other central bankers) who pushed down nominal interest rates well below what they should have been, in an attempt to have a “soft landing” after the dot-com crash, then it’s not true that the free market interest rate would have been anywhere near those low levels. Things like investors’ preferences regarding risk and yield help determine what the structure of free market interest rates would be.

In that respect, I think Cowen’s banana analogy (if I have correctly represented it above, which I may not have) would be similar to someone saying, “What’s the big deal with setting Manhattan rents at $400 a month? Suppose there were a new invention that made building apartments easier, and the supply curve shifted way out so that the market price was $400. Do the free marketeers think this would all of a sudden cause a massive shortage of apartments? Of course not. So why do they get their undies in a bunch when I suggest that the government set a price cap at $400?”

09 Jan 2010

Bob Murphy, Neo-Confederate?

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Steve Landsburg has the distinction of (possibly) being a more narcissistic economics blogger than me. (As Vader would say, “Impressive.”) Not only did Steve decide his readers should see his personal list of heroes, but he broke it up over three posts, making them guess at the identity of the people who were pictured.

Anyway, one of the people on Landsburg’s list was Abraham Lincoln. (Everyone identified that portrait in round one.) During the post-game show, one of the commenters was horrified at the inclusion of “The Great Murderer” but I tried a friendlier approach:

Steve,

If you’re still reading, I would love to hear your reasons for including Lincoln. I have the same misgivings as the other commenter above, though I was going to introduce them with levity. (E.g. “I know you like math, Steve, so is that why you included the guy who maximized the wartime deaths of Americans?”)

Don’t get me wrong, I grew up thinking Lincoln was great, just as I thought FDR was great. But when I actually started thinking about things (a la your bathtub drain), I realized: “Wait a second, doesn’t ‘he saved the Union’ describe the same behavior that King George engaged in when the colonists decided to split?”

I’m being dead serious here. If you’re new to my blog, and had never really thought much about it, I’m curious to know: Do you think Abraham Lincoln is great, and if so, why? Isn’t the whole point of our “way of life” that we allow people to choose their own forms of government?

Let me deal with the obvious rejoinder: The U.S. colonies had slavery when they seceded from Great Britain. If King George had promised to free the American slaves, would you have rooted for the colonists to lose the American Revolution?

08 Jan 2010

Ludwig von Mises On the Health Insurance Bill

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[UPDATE below.]

Ever since I finished the Study Guide to Mises’ magnus opus, he has been communicating with me from beyond the grave. I asked him what he thought of the pending health insurance legislation, and he reminded me of his general principles of the dynamics of interventionism. Once the government interferes with one aspect of the market, it can’t stop there. Things would be even worse than before the initial intervention. So the government has to do a second, third, fourth…interventions, until you either stop–amidst a completely muddled system that everyone recognizes is awful–or go full-bore until you hit socialism.

I understood the general principle, but I asked Dr. Mises to apply it to this particular case. So he said:

Start with the proposition that we don’t want our fellow citizens denied coverage because of preexisting conditions — which is a very popular position, so much so that even conservatives generally share it, or at least pretend to.

So why not just impose community rating — no discrimination based on medical history?

Well, the answer, backed up by lots of real-world experience, is that this leads to an adverse-selection death spiral: healthy people choose to go uninsured until they get sick, leading to a poor risk pool, leading to high premiums, leading even more healthy people dropping out.

So you have to back community rating up with an individual mandate: people must be required to purchase insurance even if they don’t currently think they need it.

But what if they can’t afford insurance? Well, you have to have subsidies that cover part of premiums for lower-income Americans.

In short, you end up with the health care bill that’s about to get enacted. There’s hardly anything arbitrary about the structure: once the decision was made to rely on private insurers rather than a single-payer system — and look, single-payer wasn’t going to happen — it had to be more or less what we’re getting. It wasn’t about ideology, or greediness, it was about making the thing work.

I see that in the afterlife Mises is following Hayek’s example and trying to convert socialists.

UPDATE: Lew Rockwell emails with an actual quote from Mises’ Socialism:

“To the intellectual champions of social insurance, and to the politicians and statesmen who enacted it, illness and health appeared as two conditions of the human body sharply separated from each other and always recognizable without difficulty or doubt. Any doctor could diagnose the characteristics of ‘health.’ ‘Illness’ was a bodily phenomenon which showed itself independently of human will, and was not susceptible to influence by will. There were people who for some reason or other simulated illness, but a doctor could expose the pretense. Only the healthy person was fully efficient. The efficiency of the sick person was lowered according to the gravity and nature of his illness, and the doctor was able, by means of objectively ascertainable physiological tests, to indicate the degree of the reduction of efficiency.

“Now every statement in this theory is false. There is no clearly defined frontier between health and illness. Being ill is not a phenomenon independent of conscious will and of psychic forces working in the subconscious. A man’s efficiency is not merely the result of his physical condition; it depends largely on his mind and will. Thus the whole idea of being able to separate, by medical examination, the unfit from the fit and from the malingerers, and those able to work from those unable to work, proves to be untenable. Those who believed that accident and medical insurance could be based on completely effective means of ascertaining illnesses and injuries and their consequences were very much mistaken. The destructionist aspect of accident and health insurance lies above all in the fact that such institutions promote accidents and illness, hinder recovery, and very often create, or at any rate intensify and lengthen, the functional disorders which follow illness or accident.

“Feeling healthy is quite different from being healthy in the medical sense, and a man’s ability to work is largely independent of the physiologically ascertainable and measurable performances of his individual organs. The man who does not want to be healthy is not merely a malingerer. He is a sick person. If the will to be well and efficient is weakened, illness and inability to work is caused. By weakening or completely destroying the will to be well and able to work, social insurance creates illness and inability to work; it produces the habit of complaining – which is in itself a neurosis – and neuroses of other kinds. In short, it is an institution which tends to encourage disease, not to say accidents, and to intensify considerably the physical and psychic results of accidents and illnesses. As a social institution it makes a people sick bodily and mentally or at least helps to multiply, lengthen, and intensify disease.”

I’m going to go out on a limb and say that Mises would not endorse the present bill.