Excuse the paucity of posts; on Saturday I went to Dick Clark (the younger)’s wedding to Justina White and then I went straight from there to Mises University. For those who know him, let me mention that Dick’s wedding was great; we had the best karaoke ever for the afterparty. I know that might sound lame but really, it was a small group in a dive bar in Decatur AL, but there were several musicians in the group and it was freakin’ sweet.
In the meantime, here is my critique of a PIMCO guy talking about how awesome Bernanke is, and why paying interest on reserves will contain the inflation genie. An excerpt:
Recall that Bernanke’s extreme money pumping — necessary to avoid the “mistakes of the Great Depression” — began in September 2008. That means almost two-and-a-half years will have passed, before these wonderful remedies work their magic.
Am I the only one who wants a refund? Back when Bernanke and Henry Paulson were bailing out AIG et al. with hundreds of billions of dollars, they told us it was necessary to avert a global economic catastrophe. Did everyone realize that the lesser of two evils involved two-and-a-half years (at least) of stagnation and interest rates at 0 percent?
In light of our recent wrestling match, I decided to look up the terms of the wager I had made with Robert Wenzel (see here and here). Back in January we agreed that the winner (someone who gets 2/3 or 3/3 out of the following) would get a dinner of up to $350 from the loser in the winner’s city of residence. The 3 conditions were:
* Murphy says CPI (not the “core” number) will rise by at least 8% during 2009; Wenzel says it won’t.
* Murphy says unemployment will be higher at end of 2009 than at start; Wenzel says no.
* Murphy says real GDP growth will be flat or negative for 2009; Wenzel says it will be positive.
I’m feeling great about the unemployment call, I’m optimistic about the CPI call, and I’m not at all confident about the real GDP call, especially because suppressed inflation numbers would artificially boost the official real GDP figures (which we have no choice but to use for our bet).
But here’s the problem: If you follow the links, and especially if you read other Wenzel posts from January, you’ll see that the reason he made the case for optimism (which prompted me to disagree and then our bet) was that M2 was growing at double-digit rates. Nowhere in our bet did we say “assuming Bernanke keeps up the money printing.”
So what do the judicious readers of Free Advice (both of you*) think? Do I give Wenzel the opportunity to cancel the wager since the basis for his views has now collapsed?
* I mean that only two readers are judicious; I have way more than two readers.
Last week, I dazzled you all with my computer analogy that I thought neatly solved the philosophical mind-body problem as well as the theological problem of God’s sovereignty and free will. In the comments, KSralla argued that my approach wasn’t consistent with the Christian conception of God:
Unless God violates his own rules (becoming a lawbreaker), then he must (according to his nature) allow the physical universe to expand and evolve according to these rules, and has in effect banned himself from pervading his physical creation at t=X. That might be an acceptable model if it were consistent with the image of the Judeo-Christian God portrayed in scripture. It is not.
Several Christians have recoiled from my “solution” in this fashion in the past, and so I want to spend today’s post trying to defuse the hostility. (Note that to make sense of today’s post, you should first read last week’s, though you don’t need to read any of the comments to get up to speed.)
First, let me spend a minute explaining that by definition, God can’t break the laws of physics, any more than He can make 2+2=5. What are the “laws of physics”? As Richard Feynman explained in an essay called “The Character of Physical Law,” they are simply the rules that describe the behavior of the objects of our natural investigations. Now because we are fallible, if we ever discover a violation of one of these “rules”–and we’re sure it’s a legit violation, not due to experimental error–then we must conclude, “The rules aren’t what we thought they were yesterday.” Einstein overturned Newtonian physics, but the universe itself didn’t change because of his work.
Now the average Christian, I think, believes that scientists have come up with the “normal” laws of physics and of biology. Further, the average Christian believes that when Jesus walked on water, or raised Lazarus from the dead, that these miracles were violations of those rules. Maybe they were, and maybe they weren’t (I think not–it would make God’s design that much more impressive), but either way, it is nonsensical to say that the atoms in Lazarus’ body broke the laws of physics that day in the tomb. Whatever behavior his atoms did display, must have been consistent with a generalized body of laws that would be the new and improved “laws of physics.”
(In case this sounds too tautologous, note that unless the rules are fairly economical, the study of physics is pointless. The reason it’s so helpful for us to learn “the laws of physics” is that it gives us predictive power; we really do gain insight into how nature operates. But we could imagine a world in which the laws were so broad that onlookers with our degree of mental powers would discern no obvious patterns, and the world would be a chaotic muddle. So part of God’s design is that all of the wonders of the universe have their physical instantiations–apparently!–composed of a small group of elementary building blocks, which obey a fairly sparse set of rules.)
So we see that KSralla’s objection doesn’t make any sense. The standard Deistic image of God–against which KSralla is reacting–doesn’t really work if you think that God created not only space but also time. It’s wrong to think that God created Adam and Eve and everything else, then sat back and waited for His wound-up clock to spin out His design. From God’s point of view, it is all simultaneous; He creates Adam and Eve just as He descends to Earth with a flaming sword in His mouth. (Note that this is also how I deal with Mises’ praxelogical critique of the Western idea of God. Mises asked, why wouldn’t an omnipotent and omniscient being remove all of its felt uneasiness in one action? He does.)
In my view, it’s wrong to picture God as only jumping in once in a while to help out nature to fulfill His plans. “Whoa, those whiny Israelites will be in bondage forever if I don’t do something. I’ll temporarily make bushes impervious to fire and talk to Moses. Then I’ll hang out back in heaven for a while until they need Me to swoop in again and change the charge on electrons in the Nile to turn the water into blood.”
No, that’s not how I picture it at all. Every instant of the history of the universe is intimately infused with God’s presence and action; He is always “intervening.” But in order to allow us to make sense of things, 99.999999% of the time it seems as if nature obeys its “lifeless” rules, and then once in a great while an apparent “miracle” takes place. There couldn’t be apparent violations of the ordinary rules all the time, lest those “rules” would never be perceived in the first place. (Just to clarify, I am not saying that what we call the laws of physics were actually violated during the plagues and so forth. I think those were just unexpected and rare outcomes of the standard rules, given the earlier conditions of the physical universe.)
OK so on to the new analogy, to help make this point: Let’s say I have a stack of blank index cards. With my pencil I start doodling shapes on the cards. Also, I don’t do the first card, and then the second. Rather, I do part of the doodles on, say, the 87th card in the stack, then I do part of the doodles on the 13th card, and so forth.
Finally, when I’m all done doodling, I call my buddy over. I tell him, “I am going to show you a new world in which your body is that of a frog. Your objective is to get from one side of the street to the other, without getting hit by any of the traffic.”
I start flipping through the stack of cards, on which I have drawn the scenes from a game of Frogger. But because I perfectly anticipated what my buddy would will with his mind, I have drawn the scenes such that the frog moves in exactly the way my buddy wants it to. After a few minutes, the novelty wears off and my buddy is dead certain that he is controlling his frog body with his mental desires.
Now, if I stop the demonstration and ask my buddy, “Describe how the cars move?” he will be able to do it. Some cars move really fast, others move slow. But at no time does a car that’s on the top right of the xth index card suddenly teleport to the lower left of the (x+1)th index card.
I hope it is clear that in order for my buddy to be able to play the game at all, I had to build in some patterns for the objects in the alternate world to obey. Did these rules constrain me? Not really; I was free to do whatever I wanted with the pencil and the blank cards. But part of what I wanted was for my friend to be able to test his frogging skills, and he couldn’t have done that if the cars appeared in and out of existence at apparently random spots on the cards. Moreover, it’s clear that the “time” in the frogger world has nothing to do with me; I didn’t even create the cards in order.
This is what I think the actual, physical universe must be like. It’s true, the replacement of a deterministic, Newtonian universe with quantum uncertainty makes the analogy less compelling. But in any event I think it disposes of the claim that my approach somehow limits God’s sovereignty, or limits His creative work to the first week of Genesis.
* Jason Clemens and I have a piece in Human Events on California’s predicament. (The comments are more entertaining than our dry analysis.)
* Marlo Lewis challenges the claim that the “science is settled” regarding global warming. Does anyone know if RealClimate has addressed Watts’ claims about thermometers being put next to exhaust fans, etc.? If his work is right (as Lewis summarizes in the linked post), it’s pretty serious.
* Scott Sumner continues to unwittingly support my new book’s thesis. After quoting Bernanke’s recent WSJ op ed, in which Big Ben listed all the ways he had expertly steered the economy through this storm, Scott asks:
Isn’t this basically what Herbert Hoover’s Fed did? Didn’t they also cut rates to near zero levels? Didn’t they also massively expand the Fed’s balance sheet, causing rapid growth in the monetary base? Didn’t Hoover also bail out the banking system with taxpayer money through his Reconstruction Finance Corporation? So does that mean the Fed was also “accommodative” in the early 1930s? And if so, what’s the difference between ‘accommodative’ and ‘expansionary.’
Am I being too hard on Bernanke? After all, the Fed has done a lot. But so did Hoover’s Fed, the question is whether the Fed is doing anything effective. The only difference I can see is that the base rose even more under Bernanke than under Hoover, but that was fully neutralized by the policy of bribing banks to hoard excess reserves.
Yes Scott, that is what happened under Hoover. The government has implemented the exact policies that it implemented the last time it caused a decade-long depression. And since Bernanke was appointed before it was apparent that we were in for Depression 2.0, and since he was an academic expert on what has caused the Great Depression…that’s why I got suspicious.
* In the post calling for celebrity quotes, someone posted the following video. Hilarious. (Make sure you watch the finale.)
Here is the audio [.mp3]. (Note that that’s not me singing in the beginning.)
I am working on a project where I need to collect a bunch of economically ignorant quotes from famous people. So for example, I know Bono has pontificated about Third World debt, Leonardo DeCaprio has jumped on the global warming bandwagon, etc. In the comments I’d like any links you could provide to examples.
Von Pepe sent me this fascinating video that I just had to stop. (I can’t spend an hour at the office watching it right now, and if I go for 10 minutes I won’t have the willpower to turn it off.) In fact, it looks like this MIT video series has a bunch of really interesting lectures.
I had read Mandelbrot’s The (Mis)Behavior of Markets when making the jump from academia to the financial sector, and it was amazing. Also, if you are curious about chaos theory but don’t know where to start, James Gleick’s book is awesome. (Fractals and chaos theory aren’t the same thing, but Gleick discusses Mandlebrot’s connection to finance.)
Now don’t get all tribal on me, Austrian purists. I’m not saying Mandelbrot’s “non-Gaussian” models of the stock market are right. Rather, I’m taking Rothbard’s approach when he argued that the chaos theorists are showing just how baseless the neoclassical economists are when they try to play the “we’re real scientists” card on Austrians.
EXTRA CREDIT: What’s the special connection between the blog Free Advice and the work of Benoit Mandelbrot?
Every now and again it’s fun to disrupt the blogospherical equilibrium by picking a fight with your allies. Hence today I will point out my serious reservations with Robert Wenzel’s analysis of stock prices and his preferred monetary aggregate, non-seasonally adjusted M2.
Back on June 12 Wenzel announced (CAPS in original):
MAJOR ALERT: Another Major Switch in Fed Policy?
After unprecedented money growth, in recent weeks I have hinted that Fed money growth was slowing. The latest data now show that money supply is now in a nosedive.
The whipsaws in Fed monetary policy under Fed chairman Ben Bernanke are unprecedented.
In early 2008, money supply (M2 not seasonally-adjusted) grew at rate of around 12%. During the summer of 2008, Bernanke reversed engines and completely slammed on the breaks and slowed money supply growth to 1.2% annualized. This last money slow down is what I believe intensified the downturn.
In late September 2008, in panic, Bernanke opened the money spigot, again, For approximately 6 months we had money growth of near 15% on an annualized basis. An unprecedented amount of Fed money growth. This is what I believe is fueling the current rebound in stocks and commodities.
However, it appears that Bernanke may now be reversing policy, again. The latest numbers from the Fed show that over the last three months the money supply has actually declined. On March 9, 2009 M2 non-seasonally adjusted stood at 8363.7 billion. Yesterday, the Fed reported that as of June 1, 2009 the money supply stood at 8335.1 billion. This is an annualized decline of of 1.4% in the money supply.
Needless to say, this stock market climb is pretty much over, if Bernanke keeps this money shrinkage act up.
Just to make sure that he is still sticking to this story, yesterday Wenzel wrote:
[A]s I have warned many times, the Fed is not printing any money at the current time. Couple this with the fact that August begins the start of seasonal down trend in the market and we [could] be in for a lot of trouble.
If Bernanke keeps up his no money printing stance, there is a huge market break coming. Don’t be sucked in by any short term rallies. The money isn’t there to support them long term.
I have several problems with all of this. First and most serious: How can you possibly argue that stock prices respond to money supply numbers with a 3-month (or greater) lag? I understand if you want to argue that measured CPI responds only slowly to injections of new money; fair enough. But surely it shouldn’t take forward-looking investors three months to digest the implications of a change in Fed policy. Imagine if oil prices crashed one day. Would anybody say, “It was because the Saudis cut production two months ago”?
Yes, there is certainly a connection between Fed policy and nominal stock prices, but it can’t be backward-looking and with a lag (let alone a variable lag!). That is impossible to reconcile with any type of sensible expectations theory. I’m not claiming that the efficient markets hypothesis is correct; I’m just saying that it can’t possibly take speculators months to react to unexpected changes in Fed policy.
But let’s put aside all of the theoretical issues. In practice, how useful is Wenzel’s approach? Mostly because of the huge upswing today, the S&P 500 right now is up more than 3% from when Wenzel first warned us (on June 12) that the market rally was kaput. That’s more than a 20% annualized rate of appreciation, which isn’t a bad return in the present environment.
Yes yes, of COURSE the stock market is bouncing around like crazy; for all I know it might fall 3% tomorrow. And just because it rose at 3% in less than two months, it doesn’t mean it will continue to do so for the next year.
But my point is, if Wenzel’s theory is driven by 3-month changes in (nsa) M2. This variable was almost perfectly flat from the week of March 23 to the week of July 6. If the market were much lower today than it was at some point in the interval, I am quite sure Wenzel would have pointed to that as vindication of his analysis.
This is the supreme problem with monetary theories that rely on “long and variable lags.” They are non-falsifiable, because no matter what happens, you can always pore over the last two years of data and find some monetary trend to point to as “causing” whatever is happening today.
Of course, pure economic theory is a priori; Mises argued (and I agree with him–and so does Wenzel I believe) that you come to the table already armed with theories about how the economy works. It is precisely this antecedent framework that allows you to interpret the vast reams of data pouring in by the hour.
But on either count–theoretical or empirical–I don’t see how looking at lagged changes in M2 explains stock movements.
A final note: I am sure that Wenzel is much more attuned to market movements than I am. If you had $1000 to entrust to either of our calls on market timing, you would do better to give it to Wenzel. What I am saying though is that when he steps back and tries to formalize why he thinks the market will do such-and-such, he is not accurately crystallizing his tacit knowledge. But because his theory is so open-ended, I don’t think he even sees when it is being contradicted by actual events.