Consulting by RPM || Free Advice Blog

I Offer Constructive Advice at MarginalRevolution

Over at MR, Tyler Cowen refers to the latest issue of Cato Unbound, where Matt Yglesias chides libertarians for claiming to oppose corporatism while not taking real practical steps to limit it. Tyler says:

In my view at the margin it would be better to have both less corporate privilege and less labor union privilege. Maybe we have no good theory (much less a strategy) for how to get there, but surely some marginal improvements are possible and who knows maybe more.

In the comments I offered this helpful remark:

Here’s a suggestion on strategy: When the former CEO of Goldman Sachs asks for $700 billion to dish out as he pleases, in light of an alleged disaster that he had no idea was coming just two months prior to the request, then all libertarians say “HECK NO!”

Seriously, I guess I can understand why some libertarians–especially those with “respectable” positions where they can’t come off as cranks–didn’t raise a ruckus when Paulson first asked for the money. But now that he has almost literally admitted he was lying through his teeth at the time, what’s the holdup, fellas? At the very least, please spare us all this faux hand-wringing over ‘how oh how can we limit corporatism?’

The New Deal Made the Great Depression; and What’s the Trade Fallacy? Quick!

This will be a post in two parts. First, let’s celebrate historian David Beito’s great column on LRC today, where he makes a basic point I’ve been pounding away at. Namely, even if you knew little about economics, if I told you that the worst economic downturn in US history occurred when the government applied the most “stimulus” in US history, what would you conclude? Then if I added that basic economic theory teaches that the “stimulus” efforts would be expected to increase unemployment and delay recovery, what would that do to your confidence in your original answer? And yet, our most recent Nobel laureate concludes from all this that the New Deal spared the US from what would have been an even bigger disaster. Here’s Beito’s take on this:

I don’t know for sure that that the old anti-depression policy would have made for a shorter downturn but, then, Krugman doesn’t know that the reverse is true. I point to the historical evidence from previous depressions that were fought by using the old anti-depression policy. These were mostly over in two or three years.

If Krugman believes that the decade-long Great Depression was exceptional in nature compared to previous depressions and could only be fought with a new Keynesian approach, he needs to give some evidence for that claim. As far as I can tell, however, he doesn’t try. Pending such an attempt, the main burden of proof is on him, not me.
…
It is not ridiculous at all [to compare the 1921-1922 depression with the Great one], that is if the goal is to understand why we had an unprecedented decade long depression. The comparison becomes especially instructive if we limit the analysis to the first year of both downturns. Between 1921 and 1922, there was a significantly faster drop in prices and GDP and a greater rise in unemployment than between 1929 and 1930. From 1921 to 1922, Unemployment advanced from 4 percent to twelve percent, the gross national product fell by a staggering 17 percent. All this was in one year. By contrast, unemployment was still well under 10 percent at the end of 1930.

I have not verified Beito’s claims, but the guy has a PhD in history and blogs at HNN; he doesn’t sound obviously crazy or shady. I had no idea that unemployment was so high or that output fell so much in the previous downturn. Beito’s right: this is a great case study in the effectiveness of two different approaches. (I am sure Rothbard went over all of this, and that I have just forgotten the numbers relating to the earlier depression.)

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Anyway, I went to Beito’s original blog post and was reading the comments. I came across this:

Basically I am wondering if anyone in the world is actually an economist. Or is everyone a bunch of stupid idiots with big titles and completely no sense. I am not an economist but I do know a few things. 1. To improve an economy you have to be able to produce more with less input. 2. Any policies that help this will help everyone. 3. Any policies that hurt this will hurt everyone. So with that simple definition what do wars do that will increase economic output. Almost nothing…Trade agreements that move jobs from highly automated equipment to highly unskilled labor, ie more workers less equipment is bad for the economy. Why, because you are producing less with more people, dumb (*&^!! So all this stuff we buy from China and Indian and Mexico is a complete bunch of baloney that ruins the economy. So you get really three simple ways to fix the economy in about 2 months. 1. End the war and slash military spending. 2. End any trading with countries who do not have the same minimum wage laws we have. 3. Loan any money to business’s who are very likely to become highly automated, ie less people more output.

Now in the spirit of this guy’s comment, I will refrain from pointing out what I perceive to be its glaring flaw. (First, I could very well be an idiot with a big title, and second, I want to produce my blog posts with the least amount of labor as possible.) Can anyone quickly come up with it? If this guy said the above at a dinner party, would you be able to explain in 30 seconds to everyone’s satisfaction why he’s a buffoon?

Ron Paul on the G20 Meeting: Bretton Woods II or III?

Ron Paul is probably the best person in the world to comment on this stuff, because he understands the economics better than 95% of professional economists, and he of course understands politicians better than 100% of professional economists. (HT2LRC)

Bubble, Schmubble: Mexico Shows Why Derivatives Are Still Cool

The WSJ reports (HT2 Dan Simmons) that the Mexican government is worried that oil could really collapse, so it is hedging its exposure:

Mexico said it has hedged all of its oil exports for next year against a price of oil below $70 a barrel, in a sign of how some resource-rich nations are trying to protect themselves against slumping commodity prices amid a global economic slowdown.

Mexico’s Finance Ministry said Thursday that it bought $1.5 billion of put options that guarantee Mexico will get at least $70 a barrel for some 330 million barrels.

If the price is above $70, then Mexico can choose not to exercise the option and sell for the market price.

Mexico has been hedging against the price of oil for years, but normally the country covers only a fraction of total exports. But the steep fall in the price of oil from last year’s highs alarmed Mexican officials. The price corresponds to Mexico’s expectations of oil income for next year’s budget.

“We started this back in July, doing it very slowly to avoid affecting the market,” said Rodrigo Brand, a Finance Ministry spokesman.

With oil at Wednesday’s closing price, Mexico would have made $9.55 billion on the hedges, the Finance Ministry said.

Just to clarify a few things, because I’ve heard even some energy insiders misinterpreting the above:

(1) The Mexican government did not lock itself into $70 oil for 2009. That would have occurred if Mexico sold 330 million barrels worth of futures contracts, with a futures price of $70 per barrel. This move would not have cost anything upfront; no money changes hands when a producer issues (i.e. goes short) a futures contract to a party going long.

(2) The Mexican government is not “betting” that oil will average below $70 for 2009. They might think that, but strictly speaking they are buying insurance against this possibility. If you buy fire insurance for your house, it’s not because you are predicting it will burn down.

(3) The Mexican government will make more money if oil shoots up again. The last line about “making money” on the hedges is correct, but misleading. The $1.5 billion that the government spent on the put options is a sunk cost; that money is gone at this point. Now if oil is $70 or below, that’s how much the government makes on it per barrel. The difference between the actual price and the strike price of $70 shows up in the market value of the put options; the Mexican government “makes money” on them only because it is making less money from selling its oil. (If oil is at $50, then the puts are worth $20 per barrel; if oil is $40, then the puts rise in market value because they are worth $30 per notional barrel, etc.) If oil sells for above $70, then the put options are worthless, but the Mexican government is still better off.

All the put options do is allow the government to limit the downside to $70 per barrel; the government now has the ability to sell its oil for $70 or the market price, whichever is greater. And for that option, the government spent $1.5 billion in the present. Once you frame it like that, it is obvious the government is hoping for a high oil price. It’s true, the options would be worthless, and in retrospect they could have saved themselves the $1.5 billion expense. But given that that money is now a sunk cost, the government certainly doesn’t want to “make money” on the hedge. (Of course, if some policy makers fought hard for the purchases, while others said it was too much, then clearly group A might be hoping for $50 oil next year so they don’t look like idiots.)

Deep Thoughts: Saving vs. Consumption

Back in October, I posted a link to my article “The Importance of Capital Theory.” In the comments, reader randallsquared (RS) was confused by this passage from the article:

As for Cowen, he seems to be assuming that “real income” is equivalent to “real consumption.” I don’t know what to say except, “No it isn’t.” If a worker gets a job in a silver mine and gets paid in ounces of silver that he stores in his basement, he can have very high “real wages” even if his consumption is very low.

So RS was confused by this, and asked why that wasn’t an example of the worker consuming silver. I replied by asking (paraphrasing here), “What if he had been paid in dollar bills and stuck them in his piggy bank? Would you agree with me that that was saving? So how is it different if he gets paid in silver ounces and stores them in his basement?”

RS could see the logic in that, but was still uncomfortable. He then gave me a different example, where a person buys gems and places them all over his house as decorations. This is similar–physically–to my example of a worker taking ounces of silver and putting them in his basement, but clearly we will call the gem story an example of consumption. To explain the difference, I explained in my reply:

The criterion is your subjective intention. If you are buying something with the intention of using it down the road to get something else, then it is saving. (E.g. the guy is holding the silver in his basement, planning to sell it later on and buy cars or whatever.)

[Now] if I fear roving looting bands, and turn my cash into gems, and then strategically hide the gems in the walls etc. around my house, then that is [also] savings. It’s not the physical act per se, it is the intention behind it. If you are deriving direct pleasure from it, [like putting the gems around your house because they look pretty, then it] is consumption. But if you are doing it as a means to consumption in the future, then it is saving.

So then RS finally asked the big question in reply to all of this:

See, this is what I don’t understand. How can my subjective intention (assuming exactly the same outward actions) make any difference to the economy? If it’s the inner life of the actor that makes the difference between consuming and saving, then how can they be different in terms of their effects (given the same action)?

Now this is a great question. I was totally confident in my answers to the hypothetical scenarios of the worker getting paid in silver or dollar bills, or the homeowner placing gems around his house. But RS’s question tries to link these definitive “micro” answers to how economists talk about “macro” things. In other words, economists–especially classical or Austrian types, as opposed to Keynesian nuts like Krugman–often stress how important savings are to economic growth. It certainly seems like there is a physical difference between the two activities (saving vs. consumption). So how can it all just be “in your head”?

Now this is really an interesting issue, and I bet even many professional Austrian economists (all 16 of us) haven’t considered before. I think in order to reconcile the two seemingly obvious positions–namely, that (1) subjective preferences determine the difference between saving and consumption, and (2) others can be affected by one’s decision to save vs. consume–some weird things need to happen to make everything “balance.” It’s sort of like pushing the implications of special relativity onto unusual thought experiments; you get surprising results but if you still believe in the axioms (e.g. speed of light is the same measured by all observers) then you have to endorse the conclusions (e.g. length depends on the observer).

OK the “trick” I suggest, in order to resolve these apparent paradoxes, is that real output increases based on the switch in someone’s subjective preferences. This seems weird at first, because you want to say that “real output is real output,” regardless of how much utility people get from things. E.g. if all of a sudden I decide that I really love my Barry Manilow collection, whereas yesterday I only enjoyed it, I’m not really wealthier. I’m just happier. But despite this observation, I think we have to conclude that real output increases in at least some of these weird cases.

Let’s switch away from silver and into fiat currency, because I think my position will be clearer. OK in scenario one, a worker gets paid $1000 per week in cash at his job in the factory assembling cars. He spends $900 of it on consumption goods (including his rent to his landlord), and every week he puts $100 under his mattress. At the end of 2 months, he spends the $900 on a fancy new TV. The analysis here is straightforward: he was basically selling some of his current labor for a future TV. By saving during the two months, he freed up factors of production that could have gone into more immediate consumption goods, and allowed them instead to be devoted to the production of an additional TV set available in two months’ time. (Naturally we are assuming entrepreneurs correctly forecast everything.)

OK now scenario two: Here, a worker at the same factory gets paid $1000 per week in cash for the same type of labor that the other guy does. This second worker also spends $900 in the community every week on consumption goods, including his rental payments. But every week, he takes a crisp $100 bill, puts it on his garage floor, douses it with lighter fluid, and burns it. Nobody knows why he does it; the guy’s kind of a nutjob. But there is no doubt that he enjoys doing this, and never regrets it. He is quite literally consuming this portion of his income, there’s no doubt about that.

Now this is odd. The first guy every week put the $100 bill under his mattress, and economists classified that as savings. By refraining from potential consumption, his farsighted behavior freed up physical resources and allowed for the production of an additional TV in two months time.

But with the second guy, he is not saving at all. He consumes his whole paycheck week after week. And yet, he is drawing on the community’s output of consumption goods no more than the first guy, and on top of that, he has no cash with which to purchase a TV in two months. So it would seem that the community is richer in the second scenario, even though there was less saving occurring!

OK first thing: There was actually no net saving in the first example, over the whole period. What the guy accumulated in his mattress, he ultimately spent on the TV. (Even if he deposits the money at a bank earning interest, so long as he blows the whole balance when he buys the TV, there is no net saving.) So in both scenarios, there is zero saving over the whole period in question. The issue is really, how can the community be richer in the second scenario?

And I think the answer is obvious: There is more real production in the second scenario; real output is higher. Not only is the factory producing cars, but in addition that guy is getting $100 per week in cash-burning entertainment. If he paid $100 to a juggler to come perform every week in his garage, that would clearly be an example of real output. So if he “pays himself” $100 to put on a show of burning cash, he is enjoying real output (of a service). It just so happens that in his capacity as producer of that service, his wages are zero. His cost of production (ignoring the lighter fluid and match) is just equal to his revenue.

Of course you can tweak these examples all you want. The reason I had the guy burn the money, instead of (say) framing the bills and putting them up on his wall as fine art, is that I wanted to make sure he couldn’t change his mind down the road and try to exchange them for other goods and services.

My overall point is that in these odd cases, where savings can rise or fall apparently at whim with someone’s change in subjective preferences or intentions, I think the way you balance the accounts is that total output (and hence real income) changes too.

Hank Paulson Is a Bald (-Faced) Liar: I Have Proof

Here is an ABC story (HT2EPJ) reporting on Paulson’s sudden change of heart regarding how his requested $700 billion “Troubled Asset Relief Program” (TARP) would now not involve any troubled assets:

So, is this the biggest bait and switch in American history? There will certainly be critics who say that Paulson and the Bush Administration were disingenuous when they were selling Congress and the American public on the program back in September. And they’d probably be right. Paulson said today, he knew when the bill was signed the purchase of trouble assets wasn’t the right solution to the problem.

(Incidentally, if someone can point me to a direct quote from Paulson–preferably from an official transcript–that would be great. Paulson’s defenders could argue that the ABC reporter is fudging what he actually said.)

Assuming the statement above is true, and that Paulson really did just admit that he knew purchasing “toxic” mortgage derivatives wasn’t the solution when the bill was signed, then the following clip casts our Treasury Secretary in a less than ideal light, wouldn’t you say?

Peter Schiff’s Critics: Who’s Laughing Now?

I felt terrible for my smug treatment of Peter Schiff in a few articles in 2006 and early 2007–though in my defense, strictly speaking the arguments in his articles that I read were invalid, and so 99% of my critiques were “good.” But since he was warning everyone the US economy was on the edge of a cliff, and most others (including me) were saying, “Watchou talkin bout, Peter?” I think he should feel vindicated.

But OK, I was a little unfair to him, and since then I have made up for it (I hope) through a few official recognitions of my mistake; here is the mea culpa (with links to some of my harshest Schiff critiques if you feel like taking a trip down memory lane). But MAN check out the video below, which an anonymous commenter put in an earlier post at this blog. You’ve probably seen the first one several times by now, but make sure you watch the second exchange. These two guys literally laugh out loud at Schiff, when–with the benefit of hindsight–we can see that Schiff is 100% accurate in his predictions. Seriously, you have to watch at least the second example in the clip below. I can’t believe what jerks these guys were, with the cameras rolling. They might as well have waved their hands in a circle next to their heads and said, “Coo coo, coo coo.”

Should the Government Close the Money Hole?

(HT2LRC.) This is pretty good; it sustains the joke for the entire clip. Warning, there is one naughty word in the beginning, so be careful if you are playing this at work or your parents’ house.