Tyler Cowen Comes to His Senses
Cowen has been on fire lately at MR. Maybe he is countercyclical in his musings; when a “free market” Administration is in power, Cowen says all sorts of things that annoy me, but now that a pump-priming Democrat is about to assume power, Cowen is writing all sorts of critiques of Keynesianism.
Whatever the reason, here are some great recent posts on how crazy the “stimulus” analysis is: boom, boom, boom.
Proponents of "Green Jobs" Need to Read Bastiat
At IER we are preparing a critique of some of the leading “green jobs” studies. Perhaps the most important was put out by the Center for American Progress. A colleague sent me this response they gave to a Heritage Foundation / WSJ critique of their study. They don’t even acknowledge that their plan costs anything; this isn’t surprising, since they don’t acknowledge any tradeoff in their actual study either. (They say it will be funded with revenues from carbon allowances, and don’t even mention that this program will have any negative effects.)
But what is just fan-diddly-tastic in this latest piece is the opening where they declare:
Eight years of neglect, deregulation, and rampant speculation have left our economy a shambles. The world’s scientists have at the same time concluded with certainty that we have less than a decade to fundamentally change the way we produce and consume energy, or we will face a global environmental catastrophe with devastating social, economic, and national security consequences.
Note that the “certainty” includes observations regarding economic impacts. That’s funny, I wasn’t aware that the economics profession had endorsed any such predictions about what will happen if fundamental action isn’t taken by 2018. And the (natural) scientists now don’t just have a consensus, but they are certain? Wow.
Brad DeLong Doesn’t Even Know Who He’s Dealing With
UPDATE below.
In this well-reasoned post, Brad DeLong says Mises’ Theory of Money and Credit is “readable in a rhetorical-excess-train-wreck mode, for it is also totally bats— insane.” (BTW, because of my charming innocence, upon my first reading I didn’t even catch the “bats—” adverb. [You want to say batsh*t is a noun, but I’m pretty sure it functions as an adverb here. Insane is an adjective, and what kind of insane is the book? Why it’s batsh*t insane.])
Needless to say, DeLong literally does not offer a single example of why he levels such a strong claim against one of the most important thinkers of the 20th century. (I understand DeLong doesn’t consider Mises to be such, but DeLong is wrong on all kinds of stuff. His ignorance is no excuse.) The only work he actually does, besides providing lengthy quotes of Mises, is to claim that Mises misrepresents two of the authors he quotes. (I am not familiar with the passages so I can’t say.)
Here is my comment:
Professor DeLong,
Like some of the other readers, I do not see that batsh*ttiness in the quotations you provide above. I am not familiar with the two authors you claim Mises is misrepresenting, but I have never caught Mises quoting people out of context before with writers I know. (In contrast, I think Rothbard was unfair with his enemies on a few occasions so I would be more disposed to believe your interpretation if you had leveled your charge against him.)
The only demonstrable “mistake” in what you quoted is that Mises seems to be saying representative government can’t last without the gold standard, and presumably we still have democracy. OK fine, Mises may have overstepped there, just like Hayek in _The Road to Serfdom_ if you take him strictly. But Nazi Germany certainly wouldn’t have occurred without the hyperinflation of the Weimar Republic, and that wouldn’t have happened if the mark had been strictly tied to gold.
Last thing: This book was amazing in what it accomplished. Mises literally integrated micro and macro. His regression theorem solved the “infinite regress” problem and allowed the deployment of subjectivist price theory to units of money. He also provided a theory of the business cycle that, in my opinion, explains what the heck happened with the housing crisis. Not too shabby.
To blow off this book the way you did above would be analogous to me calling Arrow a two-bit math jock who wrote a crazy paper about voting.
One of my former students, Shannon P. (who posts here occasionally), won an award for her paper on this book. Maybe she has something to say?
Oh, if you check out the MR thread that spawned DeLong’s ill-advised remarks, you’ll see I threw down with some punks there too. It’s a wonder I get anything done. “I’m sorry sir, I know I promised you the analysis by 3, but there are so many idiots on the Internet!!”
UPDATE: Someone notified me that my comment had been deleted from DeLong’s thread, and lo and behold, he’s right. DeLong has a comment near the bottom that says: “OK time to cut this off and prune it down to something useful…” and then after one other guy’s (non-useful) comment, it says comments on the thread are closed.
Since there are still plenty of potty jokes (literally) still in the thread, I was initially stunned that he deleted my comment (above). But then I thought, “Well, maybe he just truncated the thread after a certain point, and so it’s not that he was picking on me per se. I.e. maybe there are 14 of us whose posts got booted, and I’m only noticing the absence of mine, rather than those of the 13 guys making puns about toilets.”
Eh, I’m still suspicious. If you look at the time stamps of DeLong’s “OK time to cut this off” (6:34pm PST) and my original post here on Free Advice (which was 8:32 pm EST), there was about an hour gap. Now it’s possible that what happened is a bunch of Austrians flooded his thread with negative remarks, because I tipped off a Listserv about it right before I posted my own response.
In any event, my opinion of DeLong has sunk even further. I can’t even imagine posting a thread here at Free Advice saying, “Krugman is batsh** insane” and then just quoting him, and then deleting the comments halfway through when angry Krugmanites show up to defend his honor. In particular, look at how polite my comment above was! I bent over backwards to show I wasn’t giving a knee jerk “well shut up you socialist!!” response.
C’mon Professor DeLong, even Bill O’Reilly ends his show by reading hostile viewer mail. If you’re going to title a post, “When Reactionary Goldbug Austrian Plumber-Economists Attack!!” common blogosphere ethics demand that you allow the reactionary goldbug Austrians their say in the comments, particularly if, after your pruning, you are going to retain such “useful” comments as “Even an Austrian might wonder about a list in which _Theory of Money and Credit_ follows three books about shit.” and “A favorite fun fact: the von Mises Institute is a non-profit organization. Apparently, Austrian economics cannot compete in the commercial free market.” (Those comments occur in the thread about 3 from the top.)
The Predictive Power of Austrian Business Cycle Theory (in the right hands)
In a previous post, I asked (partially in jest) if I had gone into the wrong profession, because the performance of economists before and during this financial crisis has been so abysmal. It’s not even that we disagree on how to fix things; we can’t even agree on what’s wrong. (For example, Tyler Cowen and Alex Tabarrok are having serious disagreements over whether there even is a “credit crunch,” and Alex Tabarrok and I are having serious disagreements over whether there even is serious liquidity injection occurring.) The icing on the cake was the recent announcement by the NBER that the US has been in recession for the last twelve months. And as the news story explained, in the prior two recessions, the NBER couldn’t make up its mind until after the recession was over.
However, sometimes my self-deprecating humor backfires. From the comments, it appeared some readers thought that I was beating myself up over this. Au contraire. I have known we were in a recession–whether “official” or not–for quite some time. In fact, I have been amused that when I write op eds for various outlets, my editors would strike out comments where I say “especially in the midst of a recession” or such. (BTW, they stopped doing that months ago. They are more attuned to reality than the NBER.)
And, as a token for those who cherish falsifiable predictions, I want to remind everyone of my October 2007 article entitled, “The Worst Recession in 25 Years?” which itself was based on my July 2007 forecast (pdf) in which I wrote:
From 2001 – 2004, the Federal Reserve enacted a cheap credit policy, resulting in a negative inflation-adjusted fed funds rate throughout the period. This artificial monetary stimulus—not seen since the Carter Administration—has sown the seeds of a contraction that will hit by 2Q 2008. The concerns of an asset bubble in real estate and (to a lesser extent) the stock market are entirely justified. Though not always a harbinger of bad times, the recent current account deficits also provide a clear warning.
Since I have been so apologetic on this blog for my early teasing of Peter Schiff’s views on international trade, I thought I should at least balance it out by pointing out when I was dead-on.
Did I Pick the Wrong Profession?
Over at MR, wiseguy meter wrote:
I have to say, this is like watching a bunch of chickens with their heads cut off.
‘The Economy’ is surely large and complex, but it is surprising (to me, and other laypeople I’m sure) that economists can’t come to a consensus on even the theoretical prescriptions & proscriptions – much less the mechanics to carry out those policies.
I’m wondering if any of you are suffering a private loss of confidence in your field of study/practice.
I, being even wiser and more manly, responded:
Meter, right now I am hoping Paulson offers an econ PhD buyback program. You are actually being too kind to us. Forget the prescriptions; we can’t even agree on the patient’s temperature. Did you catch how Alex Tabarrok and I–who are fairly close on the ideological spectrum–can’t even agree if the Fed is injecting liquidity?
This would be like a doctor giving a morphine drip, then the other doctor says, “Whoa that might make things worse!” and the first doctor saying, “What morphine drip? I passed a magnet over it so it’s equivalent to saline.”
(Yes Alex ends up being the bad doctor in my analogy.)
No worries, folks. In twelve months we’ll know whether Alex or I am right.
Fractional Reserve Banking Explained
Loren Howe runs a vlog and asked the Mises Institute for help in understanding how modern banking systems create money. I thought his email raised some interesting questions, so (with his permission) I reproduce it here and hopefully provide decent answers.
I run an online vlog with around 20,000 viewers who would be very grateful for a layman’s explanation to this question. What is the fundamental method by which the currency supply inflates? Here is my current understanding:
I understand the standard explanation that under fractional reserve lending the banks lend out say 90% of the money on deposit. However, any investment entity – say a REIT, a mutual fund, a private money manager, etc. – can do exactly the same thing. In fact any other investment entity can and does lend out nearly 100% of deposits. Then that money can eventually be deposited back with say the private money manager and 100% can be lent out again over and over.
What I don’t understand is that this action does not appear to create any new money. If you start with 1,000 one dollar bills. It can be given to a private investor, lent out to people, re-deposited with the private investor, and on and on – it is still only 1,000 one dollar bills regardless of what percent the investor holds as reserves during each loan cycle. There does not appear to be any “new” currency in the overall economy and ultimately no new inflation (beyond the initial creation of $1,000 by the Federal Reserve). However, the “money multiplier formula” used by economists and the M 1, 2, & 3 data show that under current banking practices “new” money is being created beyond what the Federal Reserve initially creates. There are two explanations I hear for this in the online community.
The first explanation I hear is that a bank (unlike a private investor or other investment entity) can call its loans “deposits” or “reserves” and then, in effect, type new money into its accounts to lend out. This would explain inflation, whereas fractional lending (as practiced by any investment entity) does not appear to. For example (at 10 to 1 fractional lending) you start with the 1,000 one dollar bills and you lend out 900 and then call that loan a “deposit” or asset. Based on that “asset/deposit” you then type into your account what amounts to 810 new pieces of paper to lend out again. After just one iteration there are no longer 1,000 dollar bills in existence, but instead 1,810 dollar bills (100 in the bank vault, 900 given to the first borrower and 810 given to the second borrower).
The second explanation I hear for inflation is that (at a 10 to 1 fractional ratio) banks take in the original deposit, hold that deposit and then self-create 90% of the value of the deposit to lend out. Then the original depositor is allowed to withdraw 90% of the original deposit and the bank only keeps 10% as reserves. When starting with $1,000 – after one iteration there would then be $1,900 in existence ($100 held by the bank, $900 taken back by the original depositor, and $900 given to the borrower). In effect this would be a convoluted way of allowing banks to self-create 9 times as much money as they hold on deposit.
I tend to believe one of these examples is the case since it would explain inflation and the “principal” I hear banks “extinguish” as a loan is repaid. This type of lending seems fundamentally different from the standard economics description I hear of banks only lending 90% of “true” deposits. To my knowledge, no other investment entity (REIT, mutual fund, private investor, etc.) is allowed to self-create loan money in this way.
Sorry for the long email and I really appreciate your time in clearing up this issue. My questions boils down to: Are banks allowed to call a loan an asset/deposit and then self-create new money to lend based on that “deposit” or is the second method used where banks in effect self-create 10 times what they hold on deposit? If neither method is true, then I’m wondering why there is inflation of M 1, 2, & 3 beyond the initial money created by the Federal Reserve and what “principal” banks are supposedly “extinguishing” when loans are paid off.
If you can clear up this question in layman’s terms, I and many thousand viewers would be greatly appreciative and better informed.
I’m not so sure about the distinction between his two proferred explanations, but at the very least I can explain why banks are said to “create money out of thin air” while a hedge fund can’t.
The fundamental reason has to do with our definition of money, and this gets into the differences between monetary base, M1, M2, M3, MZM, etc. Note that I’m not going to go into a big description of these definitions; I just want to make the basic point here.
It’s true that only the Treasury (not the Fed, mind you) can create additional pieces of paper with numbers and US presidents printed on them, i.e. currency. But in a modern economy, it doesn’t make much sense to confine the definition of money to currency. Since presumably the whole point of the analysis is to gauge the impact on prices, and also to accord with common usage, most economists would say that demand deposits (i.e. checking accounts) are part of the total quantity of money. From an individual’s point of view, whether he has a $20 bill in his wallet, or a $20 balance in his checking account at his local bank, he has $20 in “money” that he can go spend. It’s true we can come up with scenarios where the currency is more liquid, and hence more money-ish; e.g. maybe he wants to buy some black market items or he wants to tip the bellman, and checks or debit cards are fairly cumbersome in these situations. But in the grand scheme, it makes sense to count demand deposits as part of the total quantity of money. All of the aggregates besides monetary base–namely M1, M2, M3, and MZM–include demand deposits.
So quickly let’s review why, in a fractional reserve system, banks can “create money” (if we define demand deposit balances as part of the total quantity of money). Someone has $1000 in crisp bills that he finds in his grandpa’s attic after the old guy knocks off. He deposits them into his checking account. His balance goes up by $1000; he walks around town, writing checks and pushing up prices. He thinks he has $1000 more than he had the day before.
But because of FRB, his bank only needs to keep $100 of the currency in its vaults as reserve against the $1000 in its customer’s checking account. So a guy who wants to buy a used motorcycle walks in and applies for a loan for $900, and the bank gives him the currency. So already, the quantity of money has shot up $900. The guy who found the money still thinks he has $1000 extra in his checking account, and the guy who got the loan to buy a motorcycle thinks he has an extra $900.
The seller of the motorcycle now has an extra $900 in currency, and deposits it at his local bank into his checking account. But because of FRB, his bank only needs to set aside $90 of the cash in its vault, and can lend out the remaining $810.
When all is said and done, if ultimately all of the newly discovered currency ends up in bank vaults as reserves and the banks are “loaned up,” then the $1,000 discovery will translate into an increase of $10,000 more money in the economy. I.e. the $1000 in currency sitting in bank vaults will support $10,000 in higher checking account balances.
Last, we need to ask why a similar process doesn’t occur with, say, a hedge fund. The answer is that claims on institutions other than banks, are not as liquid as demand deposits, and hence are less money-ish. This is why economists have broader and broader measures of money. Money market accounts and other very liquid assets are included in higher measures, but not in M1.
Think of it this way. When I deposit $1,000 in currency with my bank, it in effect gives me $1,000 in bank notes. (Yes we write checks and merchants have to hope the checks don’t bounce, but that’s just a detail.) You can go to the grocery store and write a check on your local bank, and they will hand over groceries, at par. (I.e. a $100 check gets you the same amount of food as $100 in currency.)
In contrast, if you lend $1,000 to a hedge fund, what you get in exchange is not nearly as liquid as a checking account balance. You can’t take your bonds to the grocery store and buy steak and milk with them.
So this is why banks in a fractional reserve system can “create money” while other institutions can’t. It is ultimately because we include bank liabilities as part of the definition of money, while only broader notions of money include things that can be created out of thin air by non-bank institutions.
Why No One Takes Economists Seriously
In a recent post, I tried to explain the undeniable fact that many laypeople act as if they are entitled to their views on the economy, in a way they would never dream of doing with regard to, say, quantum physics or heart surgery. A CNBC news story from today sheds light on this phenomenon:
The US economy slipped into recession in December 2007 [one year ago!!–RPM], the National Bureau of Economic Research announced Monday, marking the official begining [sic] of the economic downturn.
The NBER—a private, nonprofit research organization—said its group of academic economists who determine business cycles met and decided that the US recession began last December.
By one benchmark, a recession occurs whenever the gross domestic product, the total output of goods and services, declines for two consecutive quarters. The GDP turned negative in the July-September quarter of this year, and many economists believe it is falling in the current quarter at an even sharper rate.
But the NBER’s dating committee uses broader and more precise measures, including employment data. In a news release, the group said its cycle dating committee held a telephone conference call on Friday and concluded that the 73-month economic expansion had ended. The previous expansion of the 1990s lasted 120 months.
Many Wall Street financial institutions already had declared that the US recession began in December 2007, when there was a sharp increase in the US unemployment rate.
The last two recessions have been so short—about eight months—that the NBER’s official prenouncement [sic] came after the downturn had actually ended.
In November 2001, for instance, the group said the recession had begun in March of that year. History would later show the recession ended in November of 2001.
What’s been confusing for economists this time around is that a contraction in gross domestic product—what laymen consider a key recession indicator—did not happen until the third quarter of this year.
I guess I should give the climate scientists a break…
Hayek on Meet the Press in 1975
Jeff Tucker (editor of Mises.org) posted this last week, but I just got around to listening to it today. Here is the mp3 of Hayek on Meet the Press in 1975. It’s pretty amazing to hear someone like Hayek being thrust into the media circus, and it’s also interesting how “modern” it all sounds. My two favorite parts:
(1) Early on, George Will describes Richard Nixon as a conservative in economic matters. This was in 1975, well after Nixon had run up massive budget deficits, closed the gold window and imposed wage and price controls.
(2) Later on, the woman (I didn’t recognize her name) [UPDATE it was Eileen Shanahan of the NYT, thanks to Bob Roddis] asks Hayek something like, “But what do we do about the immediate suffering of the unemployed?” It is hilarious; Hayek says something like “Some things can’t be helped” and she just repeats, “But what do we do about the immediate suffering of the unemployed?”
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