Scott Sumner’s Mind Is a Terrible Thing to Waste
Milton Friedman gave us many gifts, but among his undesirable ones was income tax withholding. He also gave an erroneous explanation of the Great Depression, namely that the timid Fed didn’t pump in enough monetary base to prevent disaster. In addition to giving Bernanke the intellectual justification to destroy the dollar, Friedman’s theory has body-snatched Scott Sumner.
Scott is one of my favorite bloggers, and yet I fear his one main idea–the thing everybody knows him for–is terribly mistaken. If and when the dollar collapses, Scott will be too intellectually honest just to shrug it off, blame deregulation and greedy speculators, and move on. No, Scott will probably abandon economics entirely, and finish his days preparing pounds of Beef & Broccoli in a Chinese restaurant down the street from GMU. (I shudder to think of it.)
For a great example of the terrible waste of a perfectly good economics blogger, consider Scott’s most recent post, “We don’t expect inflation, but we expect to expect it soon.” Now anyone who has been through a grad program in economics can remember the fun with nested expectation operators! Ah, good times, good times. But rather than reminisce, let’s get down to business.
Scott is upset that the “market’s expectation” of inflation–whether gauged by CPI futures or TIPS/nominal bond spreads–is less than 2%, while the ostensible Fed target for inflation is 2%. So what gives? Scott suggests:
It seems to me that the Fed is for some strange reason assuming that there is a logical distinction between inflation expectations and expectations of inflation expectations. In other words, they see that inflation expectations aren’t a problem right now, but they expect them to be a problem in the near future unless they tamp them down with some hawkish talk. But that commits a fundamental logical error; the Fed is ignoring the fact that those inflation expectations (both market and private forecasters) are formed with knowledge of current and expected future Fed policy, including the 0.25% target rate and the massively bloated monetary base that everyone seems worried about.
I think Scott is overlooking a pretty obvious point here. What if the market is forecasting low inflation because Fed officials are assuring them that they will suck out all that extra liquidity when the time is right?
Imagine Scott’s in an airplane, coming back from a pleasant few days at GMU. He wanders into the cockpit and asks the pilot why he doesn’t take a nap. “Well, if I took a nap, the plane would eventually crash and we’d all die.”
“You really think so?” challenges Scott. “Give me the mic. ‘Attention everyone! I’m conducting a survey. How many people aboard the plane think we are all going to die within the next hour? Show of hands? OK, just one of you, the guy with the Ron Paul shirt in the seat 13A, who’s been talking about a green monster on the wing for the last hour. OK thanks everyone.'”
Scott puts the mic back. “See, Mr. Pilot? You’re worried about nothing. Everyone has confidence that we won’t crash. Go ahead and catch a few winks.”
OK let’s move on to another gem in Scott’s analysis:
Here’s what the Fed doesn’t seem to realize. If the market thinks inflation will be too low under current and expected future Fed policy, then the Fed needs to send out more dovish signals not hawkish signals. They need to get 2-year inflation expectations up to around 2% or 3%. And that would require a much more expansionary monetary policy. Yes that’s right, I’m suggesting we go back to how things used to be in 1958 and 1983, when very steep recessions were followed by very rapid recoveries. Why not? Instead, everyone is estimating really high unemployment for years to come. Correct me if I am wrong, but I don’t recall the 1958 and 1983 recoveries leading to double digit inflation. Sure we’ve got some structural problems, but in 1983 we were in the midst of a painful downsizing of the so-called rustbelt’s manufacturing capacity as a result of technology and foreign competition. That was a huge structural problem, similar to our overbuilt housing stock. Indeed, because of population growth the housing overhang may be solved more quickly than that earlier structural adjustment. And yet RGDP grew very fast in 1983-84.
Hmm let’s go to the tape:
So Scott looks at that chart and says: “The reason we had a rapid recoveries in 1958 and 1983, while we have a sluggish recovery right now, is that the Fed obviously hasn’t pumped in enough monetary stimulus this time around. And for those critics who think we are risking (price) inflation, all I have to ask is: Why weren’t your fears borne out in 1958 or 1983? Morons.”
Shall I stoop to another analogy? Sure why not; it’s the Internet:
Scott’s buddy has the flu. Scott starts subjecting the guy to massive doses of radiation. “Whoa whoa whoa, what are you doing?!” Gary North says.
“I’m helping him get better!” Scott explains. “Many doctors think radiation is a good way to make people well.”
“Any doctor who tells you radiation fixes the flu is an idiot,” North declares. “You’re going to kill him if you keep that up!”
“Oh please!” Scott rolls his eyes. “My cousin and my brother-in-law both had really bad cases of the flu when they were growing up, and correct me if I’m wrong, but they didn’t die of radiation poisoning. Jeez. OK sir, for some inexplicable reason, the radiation therapy isn’t taking. I’m gonna put your head into my microwave for 30 seconds. Ready? I want to make sure you expect what I’m about to do to you.”
Last few points for Scott, in case he reads this:
(1) If the whole justification for money-pumping is nominal price rigidities, shouldn’t those fade away after a year or two? In other words, how can you warn us about a decade of Japanese stagnation, if the ultimate cause is that it takes nominal prices a while to adjust downward? It really takes ten years for people to stop resisting a wage cut?
(2) If the Fed is so tight, and the market is expecting (price) deflation / stagnation, why has gold risen about 19% year-to-date? Again I ask, are bond traders smart but commodity traders stupid? Is it possible that the ginormous central bank purchases of debt instruments has something to do with it?
(3) In the late 1990s there was a bubble in Internet stocks, and as time passed more and more people knew it. A few years later there was a bubble in real estate, and as time passed more and more people knew it. Weren’t those cases where people “expected prices to rise, but expected to expect them to fall”? If we’ve had two huge bubbles in the last 10 years, why is it so inconceivable that there is a bubble right now in US Treasurys?
Gold Sets Record High; EPJ Explains Plot Against Dollar
Gold hit a record high today, trading at $1,040.15 / ounce. I’m not being a wiseguy; has Mish or another prominent deflationist explained this?
If you want to read up on the international conspiracy against the greenback, EPJ has the latest. Is that the out that Mish et al. will take? “Yes, the dollar should have appreciated 10% annually for three years in a row, while the credit overhang was worked off. But the Saudis and Russians were idiots and dropped the dollar, fearing inflation, and thus set in motion a self-fulfilling prophecy.” ?
Kling’s Critics
I’m sorry kids but I just don’t have the energy to do this justice. So let me give you the quick rundown:
* Arnold Kling has been pushing his “recalculation argument” concerning the recession and fiscal stimulus. (Here’s an early, though not the first, post on the topic.) The idea is that we need a temporary period where “the economy” decides where the excess resources in housing, finance, etc. need to go. Massive government deficit spending simply postpones the needed adjustments. Yes, this is exactly what Austrian business cycle theory says, once the bust ensues. (Kling acknowledged the affinity between his story and ABCT early on, btw.)
* Tyler Cowen rushes to defend Kling from some punks. (And no I’m not using that term as a generic insult. They are truly punks.)
* Paul Krugman rushes to defend the punks from the snide Tyler Cowen. In a post entitled “Reinventing 1934 macro,” Krugman rips Kling for repeating the same tired arguments that Schumpeter advanced way back in 1934. Krugman offers a single objection, namely that if the current recession is just a reflection of the need to reallocate resources, then why didn’t unemployment go way up during the housing boom?
It’s times like these when I think I should have pursued a career in interpretive dance. My three observations:
(1) I dealt with Krugman’s silly objection back in March.
(2) Only the nuanced Tyler Cowen could defend Kling’s recalculation theory from Krugman (or his allies, technically) while siding with Krugman in his critique of Austrian business cycle theory. (Krugman’s attack is the same in both cases. You ask, “Does Tyler literally contradict himself?” Of course not, we’re talking about Tyler Cowen.)
(3) Suppose Schumpeter had written the passages Krugman cited two years later. Would even Paul Krugman have had the audacity to criticize Kling for “reinventing 1936 macro“?
BTW Lucas Engelhardt brought Krugman’s post to my attention. Lucas offers his own thoughts here.
Stay on Robert Wenzel’s Good Side
A lot of people email me and ask, “Bob, since you are one of the greatest living economists, why do you tolerate such disrespect [1 and 2] from a lowly financial blogger like Robert Wenzel?” (I am paraphrasing, but that’s basically what they are asking me.)
Well the answer is, Wenzel is not picking on me in those posts; it’s like a pitbull having some good clean fun. If you want to see what happens when Wenzel clears out his calendar and devotes himself to really chafing somebody, check out his post on Dr. “Oh Mandy” Krauthamer, or the overreaching Matt Taibbi.
"America Needs a New Enemy"
Somebody came just-shy of pining for another 9/11 during the Bush years–I don’t remember who–and now an Obama supporter is doing the same:
Where is Osama bin Laden when we need him? Don’t get me wrong; in no way do I wish death and destruction on our country. But as I listen to the increasingly vitriolic and even seditious rhetoric coming from the political right, I can’t help thinking that we need a threatening external enemy to help us cohere as a nation — a more looming threat than the almost vanished Al Qaeda leader or even his recently arrested alleged minion from Denver.
Oh please, don’t be so shocked. From time immemorial, collections of people have leveraged the fear of an enemy to keep their clans, groups and, later, nations from coming undone…
It’s not pretty, but it’s true. Both individual and collective identities are forged as much by declaring what and who you’re against as what and who you are for. Although we certainly don’t wish for violence on the group we identify with, there are times when we can acknowledge the social value of circling the wagons…
…Think back to 9/11 and how extraordinarily unified the United States was for that moment. In predictable fashion, the vast majority of Americans rallied around President George W. Bush.
It was a noticeable change. Before 9/11, the country was deeply polarized (though not as deeply as we are now), and, as important, we were in the midst of an existential crisis. The fall of the Soviet Union had sent policy wonks grasping for new ways to view the world and politicians casting about for new enemies. So geared were we to see ourselves in contra- distinction with the U.S.S.R., we had to wonder who we were without it. As John Updike’s character, Rabbit Angstrom, exclaimed, “Without the Cold War, what’s the point of being an American?”
…
Compared with other modern nations whose identities are rooted in ethnicity or history, ours is decidedly more ephemeral and difficult to grasp. Throughout our history, crises — particularly wars — have played a crucial role in making this country’s disparate parts cohere. During World War II, shared patriotism and “one for all, all for one” bravura made many groups — including Chinese Americans and Mexican Americans — feel like more integral parts of America. It was during WWII (in the military) that African Americans first saw the beginnings of integration, a process that only gained momentum in the postwar years.
…
While the Cold War helped focus our national interests in domestic as well as foreign affairs (the 1956 federal legislation that led to the construction of a modern national highway system was called the National Interstate and Defense Highways Act), anti-communism also ate at us internally. More recently, Huntington’s search for an external enemy to unify us led him to try to identify Latin American immigrants as evil culprits (they threatened “to divide the United States into two peoples, two cultures and two languages”). He didn’t think the loose-knit and hidden nature of Al Qaeda, our real enemy, was vast enough to make us huddle together and make common cause.
…
In the meantime, we all but ignored Bin Laden’s most recent tape, and attention to the arrest and indictment of Afghan Denverite Najibullah Zazi on WMD conspiracy charges has been surprisingly low-key. Such blase responses to our true enemies set us up for self-destruction, until we once again find out the hard way that we’re all Americans.
Don’t worry, Mr. Rodriguez. I am pretty confident the Obama administration is just waiting for the right time to take advantage of the rally-round-the-flag generated by a domestic terrorist incident. You weren’t the only one to notice how much it helped the Bush administration push through all sorts of things.
More Fed Charts as Fine Art
I am going to hang this in my office so visitors can ponder.
I don’t have the time to get into the data and see which components are responsible for the decidedly different trends. Just be careful when you start talking about what Bernanke is doing with “the” money supply. If you use M2, then it’s been flat for several months and is arguably back in line with the long-term trend. But if you use the narrower M1, then things are much different. (I am guessing a lot of the above graph has to do with people shifting into more liquid assets, but I haven’t actually looked at the components.)
One thing is clear: Those who are talking about the great “deflationary forces” upon us, need to realize that thus far Bernanke has entirely offset them. Yes, it’s true that the fractional reserve banking system has a harder time creating money out of thin air, when loans are decreasing. But as the chart above shows, the standard monetary aggregates have thus far stood up against this pressure.
Mind Control From DC
A ridiculous FTC announcement reported by Yahoo! Tech:
FTC: Bloggers must disclose payments for reviews
PHILADELPHIA –The Federal Trade Commission will require bloggers to clearly disclose any freebies or payments they get from companies for reviewing their products.
It is the first time since 1980 that the commission has revised its guidelines on endorsements and testimonials, and the first time the rules have covered bloggers.
But the commission stopped short Monday of specifying how bloggers must disclose any conflicts of interest.
The FTC said its commissioners voted 4-0 to approve the final guidelines, which had been expected. Penalties include up to $11,000 in fines per violation.
The rules take effect Dec. 1.
There are so many things wrong with that, I don’t know where to begin. But gee whiz–a fine up to $11,000, and no clear guidance on what a blogger needs to do to avoid that fine?!
I should disclose that I do a lot of work for the Ludwig von Mises Institute, and I’m sure my sugar daddies there would appreciate the present blog post.
King Solomon Is Wiser Than John Nash
Solomon was a son of King David (of Goliath fame). After outmaneuvering challengers to the throne (which is fairly page-turning, for the Old Testament), Solomon takes his position as the new king. The Bible explains Solomon’s legendary wisdom:
1 Now Solomon made a treaty with Pharaoh king of Egypt, and married Pharaoh’s daughter; then he brought her to the City of David until he had finished building his own house, and the house of the LORD, and the wall all around Jerusalem. 2 Meanwhile the people sacrificed at the high places, because there was no house built for the name of the LORD until those days. 3 And Solomon loved the LORD, walking in the statutes of his father David, except that he sacrificed and burned incense at the high places.
4 Now the king went to Gibeon to sacrifice there, for that was the great high place: Solomon offered a thousand burnt offerings on that altar. 5 At Gibeon the LORD appeared to Solomon in a dream by night; and God said, “Ask! What shall I give you?”
6 And Solomon said: “You have shown great mercy to Your servant David my father, because he walked before You in truth, in righteousness, and in uprightness of heart with You; You have continued this great kindness for him, and You have given him a son to sit on his throne, as it is this day. 7 Now, O LORD my God, You have made Your servant king instead of my father David, but I am a little child; I do not know how to go out or come in. 8 And Your servant is in the midst of Your people whom You have chosen, a great people, too numerous to be numbered or counted. 9 Therefore give to Your servant an understanding heart to judge Your people, that I may discern between good and evil. For who is able to judge this great people of Yours?”
10 The speech pleased the Lord, that Solomon had asked this thing. 11 Then God said to him: “Because you have asked this thing, and have not asked long life for yourself, nor have asked riches for yourself, nor have asked the life of your enemies, but have asked for yourself understanding to discern justice, 12 behold, I have done according to your words; see, I have given you a wise and understanding heart, so that there has not been anyone like you before you, nor shall any like you arise after you. 13 And I have also given you what you have not asked: both riches and honor, so that there shall not be anyone like you among the kings all your days. 14 So if you walk in My ways, to keep My statutes and My commandments, as your father David walked, then I will lengthen your days.”
15 Then Solomon awoke; and indeed it had been a dream. And he came to Jerusalem and stood before the ark of the covenant of the LORD, offered up burnt offerings, offered peace offerings, and made a feast for all his servants. (1 Kings 3:1-15, New King James Version)
So that’s pretty neat. You could say that Solomon’s true wisdom consisted in his asking for wisdom.
OK it’s one thing to just say, “This guy in our story was wise.” But the Bible then gives a specific example, and I think all will admit that this is pretty neat as well:
16 Now two women who were harlots came to the king, and stood before him. 17 And one woman said, “O my lord, this woman and I dwell in the same house; and I gave birth while she was in the house. 18 Then it happened, the third day after I had given birth, that this woman also gave birth. And we were together; no one was with us in the house, except the two of us in the house. 19 And this woman’s son died in the night, because she lay on him. 20 So she arose in the middle of the night and took my son from my side, while your maidservant slept, and laid him in her bosom, and laid her dead child in my bosom. 21 And when I rose in the morning to nurse my son, there he was, dead. But when I had examined him in the morning, indeed, he was not my son whom I had borne.”
22 Then the other woman said, “No! But the living one is my son, and the dead one is your son.”
And the first woman said, “No! But the dead one is your son, and the living one is my son.”
Thus they spoke before the king.
23 And the king said, “The one says, ‘This is my son, who lives, and your son is the dead one’; and the other says, ‘No! But your son is the dead one, and my son is the living one.’|” 24 Then the king said, “Bring me a sword.” So they brought a sword before the king. 25 And the king said, “Divide the living child in two, and give half to one, and half to the other.”
26 Then the woman whose son was living spoke to the king, for she yearned with compassion for her son; and she said, “O my lord, give her the living child, and by no means kill him!”
But the other said, “Let him be neither mine nor yours, but divide him.”
27 So the king answered and said, “Give the first woman the living child, and by no means kill him; she is his mother.”
28 And all Israel heard of the judgment which the king had rendered; and they feared the king, for they saw that the wisdom of God was in him to administer justice. (1 Kings 3:16-28, New King James Version)
Now note that even though Solomon relied on (what game theorists would call) the self-revelation principle, it actually doesn’t constitute a Nash equilibrium. In other words, if two different harlots (who had heard of the first encounter) approached Solomon with the same problem, then the liar would know to say, “Don’t kill the baby! Give him to her!”
But so what? Only tenured game theorists prefer to study (subgame perfect) equilibria, rather than concentrate on what actual people do when they have to play a game. And note, I’m not talking endorsing “experimental economics” here; you can go ahead and theorize in an ivory tower. My point is, don’t restrict your theorizing to equilibrium cases, when (say) every chess game that has ever been played has been in “disequilibrium.”
BTW, if you want an example of someone using the self-revelation principle where it’s also self-enforcing, try this story (which I think I got from either Steve Landsburg or David Friedman): There is a bad storm tossing a ship to and fro. A safe containing the personal savings of the crew gets bounced around, so that all the gold and silver coins in the safe fall out of their bins. The captain also loses the piece of paper that recorded how much each sailor had deposited.
So the captain makes an announcement: “I want each man to write on a piece of paper which coins are his. After I get all the slips of paper, I will tally up the numbers. If the total you indicate is either too high or too low, I will throw the whole chest overboard.”
Extra credit for the geeks in the crowd: Imagine that the captain will only throw the chest overboard if there are more coins claimed than exist. If there are fewer coins claimed, then the captain distributes them as claimed, and pockets the remainder. What happens then to the optimal bid?
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