The Importance of Capital Theory: A Reply to Krugman (and Cowen)
OK folks, I know I borrow the Rush Limbaugh cocky narcissism angle a lot in my posts (though he has parlayed it into more $$ than I have, thus far). But honestly, I think today’s article over at Mises.org on “The Importance of Capital Theory” really spells out the nuts and bolts of a boom-bust cycle. It’s more difficult reading than the average article, and for maximum effect you should probably print it out and read it on your lunch break or something, rather than in your cubicle with the guy next to you yelling at his cable provider on the phone.
Strictly speaking, I am writing a response to Tyler Cowen, who resurrected an old Slate column by Paul Krugman after he won the Nobel. Krugman ripped the “Austrian” theory of the business cycle back in 1998, and Cowen was citing this piece as one of his favorites by Krugman. (All links are provided in my article, linked above.)
However, if you’re not an econ geek, you can skip all of the petty infighting. Just scroll down to the section “A Sushi Model of Capital Consumption” in my article and start reading there. If you really give it 10 – 15 minutes, I think you will have a much better understanding of what happens during an artificial boom period, and then why the recession (and unemployment) are necessary afterward.
Anthony Gregory Puts the Smack-Down on Weisberg’s "The End of Libertarianism"
In libertarian circles, Jacob Weisberg’s recent Slate column, which blames the financial mess on free markets, has been ruffling feathers. Really, you need to read it if you haven’t already. (And even if you have read it, it might wake you up this Monday morning to read it again.)
I had toyed with writing a response, but it seemed too difficult. Weisberg doesn’t really have an argument, besides the analogy of Marxists who deny that the fall of the USSR has anything to do with their worldview. In particular, Weisberg doesn’t point to this particular deregulation or that, and explain why these changes caused the housing bubble to occur when it did. No, he just asserts that a sufficiently regulated market wouldn’t have gotten into such a pickle.
As so often happens in these matters, Anthony Gregory has ended my anxiety, by writing a column as good as I would have. (Possibly better, but let’s not explore that possibility.) My favorite part–and what really bothers me so much about this “it’s the fault of the free market” BS:
Anyone under fifty who went to public school probably remembers this lesson: We used to have laissez-faire, and it caused great inequality, poor working conditions and bank panics, so we had the Progressive Era and the creation of the Federal Reserve. But we still had too much economic liberty and it (not the Federal Reserve) brought on a Stock Market bubble that burst in 1929, so we had the New Deal, the FDIC, national economic planning and the like. While that didn’t quite end the Depression then (perhaps World War II did?), it did guarantee that we would never have one again. Thanks to government interventions from Teddy and Franklin Roosevelt to Lyndon Johnson, our modern economy will never have the troubles it did in the 1930s. Central banking and millions of pages of federal regulation keep this economy afloat and comfortably growing.
Now all of a sudden the statists claim we are having the same kinds of troubles, and once again it’s all the free market’s fault – the same free market they said no longer exists, due to decades of intervention. It’s the freedom to buy and sell, to contract with one another, to exchange within a framework of free association, free pricing and property rights that has, once again, brought on economic calamity. Not the century of interventions that they said have guaranteed no such catastrophe would ever again happen. No, the remaining pockets of liberty are at fault.
Anthony really nailed it there. In 2003, if you had proposed abolishing the SEC, Jacob Weisberg would have soiled himself. “Are you nuts?! We can’t have a completely unregulated market!! Imagine how leveraged everybody would be! Don’t you remember, that’s what caused the Great Depression!”
You see the point? We don’t get to have liberty, because it would supposedly usher in a depression. And yet then when the heavily regulated system spits out another depression (we are warned, in any event), this is taken as confirmation that liberty causes depressions.
Incidentally, the above musings haven’t proven that free markets are good. If I were advising the Moscow government back in 1983, and they said, “Let’s abolish money,” I would have said–after putting down my Star Wars toys–“No guys, remember what happened when Lenin tried that? Don’t destroy the last vestiges of freedom or your people will starve!”
And then when the USSR collapsed, a die hard Marxist could have said, “Jeez you capitalist pig, you warned us that pure socialism would lead to collapse, so we compromised. And look what happened!!”
Fortunately, Anthony deals with this matter too, i.e. he explains the primacy of theory when it comes to evaluating social systems.
Robert Wenzel: The Man, The Myth, The Legend
Free Advice readers may wonder who the heck this Robert Wenzel guy is, perhaps the only person mentioned more than 5 times on this blog whom I am not mocking. Well, over at the second best blog in the world, RW and I went head-to-head over some trivial issue. (In retrospect, I think we both lost that argument. And to avoid confusion, he had a slightly altered name, just like David Banner would do in the TV series.)
Eventually RW linked to his own blog, and I took a look. To be honest, I was underwhelmed. In the 8 seconds I devoted to the initial survey, I thought he was just pasting in news about financial markets from other sources. What was worse, he often wouldn’t provide links! Sort of like the guy who hooks his friends up with small doses of heroin but doesn’t ever say who his supplier is.
Well, I am now happy / ashamed to report that I completely underestimated Robert Wenzel in my initial survey. (Sometimes the opposite happens.) Assuming you believe that the following is true–and I’m about 98% there myself–I think you will agree that Wenzel’s site is one to check often, typos notwithstanding.
Last July Wenzel explained that it was ridiculous to expect the Fed to police financial markets going forward, because the smarty-pants Fed economists didn’t even recognize the housing bubble as such before it popped. To prove this, Wenzel points to a 2004 paper [pdf] by Jonathan McCarthy and Richard W. Peach, titled “Is There A Bubble in The Housing Market Now?”
You can guess what their answer was. Their reasoning was that the fundamentals justified the rising price of houses–in particular, interest rates were really low. (!!)
Now what’s really great is that Wenzel wrote a rebuttal at the time, which included this great paragraph:
But does this mean real estate prices will not drop? Our answer is decidedly no. Indeed, McCarthy-Peach report that “since 1995, real home prices have increased about 36 percent, roughly double the increase of previous home price booms in the late 1970’s and late 1980’’s.” We view this increase as largely the result of the Federal Reserve’s lowering of interest rates and the pumping of liquidity into the banking system, thus producing the byproduct of higher housing prices. But by incorporating falling nominal interest rates as a “fundamental factor” that can not be a cause of a bubble, McCarthy-Peach have literally defined the cause of the current bubble from being taken into consideration.
Hang on, the story gets better. Peach read Wenzel’s article and incorporated the money quote into his Power Point, with the slide titled, “A dissenting view”:
The faulty analysis by Federal Reserve economists McCarthy and Peach may go down in financial history as the greatest forecasting error since Irving Fisher declared in 1929, just prior to the stock market crash, that stocks prices looked to be at a permanently high plateau.
As Wenzel says, they probably aren’t using that Power Point slide anymore. (Incidentally, here is their whole presentation, if you’re curious.)
One last thing: If you follow the links above, you’ll see that it’s not “Robert Wenzel” but rather “Raymond Sabat” who penned the prescient critique. Wenzel explains that this is because of his sensitive work commitments at the time.
I can totally empathize. By the same token, during 2006 I became very concerned about the prospects for the dollar, and wrote a book (which came out in early 2007) urging Americans to protect themselves. But at the time I was working in the financial sector, so I couldn’t use my real name.
The Recession Hits the NY Fed
I’m glad to see our quasi-governmental agencies lead the way in belt-tightening. Matt Machaj alerts us to this press release from the NY Fed:
October 16, 2008
The Federal Reserve Bank of New York will cease publication of its weekly Statement of Condition with the October 30, 2008 release. The information will continue to be available on the Board of Governors’ Statistical Release H.4.1 Factors Affecting Reserve Balances, Table 5 Statement of Condition of Each Federal Reserve Bank.
The H.4.1 is released each Thursday, generally at 4:30 p.m. ET.
Contact:
Public Affairs
(212) 720-6130
(646) 720-6130
general.info@ny.frb.org
Some readers may remember a similar episode back in March 2006 when the Fed stopped releasing the M3 monetary aggregate, explaining that:
M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.
In tough times like these, I’m glad to see at least some officials keep a sharp eye on costs. You know, it occurs to me that the whole election process burns a lot of money too. What with the bailout, maybe we should skip it this cycle, and reevaluate in 2012?
Should the Fed Burst Bubbles?
The prevailing wisdom among Fed academics used to be “no,” but now that is changing. (If we’re throwing out private property, we might as well look at some other principles to jettison too.) I summarized my views on the issue in response to Tyler Cowen’s remarks on the WSJ article linked:
Cowen: Should the Fed burst bubbles? Maybe in its role as regulator, if not monetary policy.
Murphy: If one thinks that the Fed created the housing bubble, then the above two sentences are truly scary. It would be akin to Richard Nixon saying, “What’s the story with these rising prices?! We’ll combat them through legislation, if not monetary policy.”
Tyler, I realize you think Greenspan’s negative real interest rates were, at most, necessary but insufficient conditions for the housing boom. Fair enough. But even if you think it really was “market failure” that caused the present mess, I am continually surprised at how easily you throw out the suggestion that maybe regulation X or regulation Y, or a few hundred billion here or a few hundred billion over there, will make things better, going forward.
Do you actually trust the real human beings who are in DC right now, or who will be in there after the election, to implement a Pareto improvement? Did you hear Obama and McCain talk about their, shall we say, nuanced endorsement of free trade in the last debate? (Hint: It doesn’t include cocaine imports for McCain, and it doesn’t include car imports for Obama.) And one of these two clowns is going to correct the flaws in second-best outcomes due to asymmetric information in the financial markets?
Incidentally, if you read the WSJ story, you’ll find this asinine paragraph:
The Fed’s view on bubbles helped fuel what became known as “the Greenspan put” — the conviction among investors that the Fed would let them take excessive risks and step in as custodian if the bets they made went awry. By giving market participants an incentive to assume greater risk than they would have otherwise, the Fed’s laissez-faire position on bubbles may have contributed to the surge in credit that helped push housing prices skyward in the first half of this decade.
Got that, everyone? Now “laissez-faire” includes: A situation in which the central bank will expand the money supply in order to prevent Wall Street investors from being burned by risky bets.
And this is the Wall Street Journal. It would almost be a challenge if this were all a grand conspiracy to undermine the free market, but I think 95% of it is sheer laziness / sloppiness.* Eh, what’s the big deal? Who cares what words “really” mean? Everyone else is talking like that, we all know what we mean. Our article was double-plus-good.
* And yes, technically they said “laissez-faire position on bubbles.” But again, if the bubble is caused by the Fed itself, then this is still a rather odd way to phrase it. To borrow an analogy from Rothbard, it would be like allowing the Post Office to jack up rates on First Class stamps to $1, and then calling that “laissez-faire.” Now that I mention it, I don’t see why Paulson doesn’t hop on board. He’s against price controls, for heaven’s sake!
An Atheist With No Sense of Irony
While googling to find a Bible verse for this post,* I came across an About.com article concerning a portion of Scripture that modern Christians allegedly ignore because it is too uncomfortable. First, the gospel passages in question:
17 And when he was gone forth into the way, there came one running, and kneeled to him, and asked him, Good Master, what shall I do that I may inherit eternal life? 18 And Jesus said unto him, Why callest thou me good? there is none good but one, that is, God.
19 Thou knowest the commandments, Do not commit adultery, Do not kill, Do not steal, Do not bear false witness, Defraud not, Honour thy father and mother. 20 And he answered and said unto him, Master, all these have I observed from my youth. 21 Then Jesus beholding him loved him, and said unto him, One thing thou lackest: go thy way, sell whatsoever thou hast, and give to the poor, and thou shalt have treasure in heaven: and come, take up the cross, and follow me.
22 And he was sad at that saying, and went away grieved: for he had great possessions.
23 And Jesus looked round about, and saith unto his disciples, How hardly shall they that have riches enter into the kingdom of God! 24 And the disciples were astonished at his words. But Jesus answereth again, and saith unto them, Children, how hard is it for them that trust in riches to enter into the kingdom of God! 25 It is easier for a camel to go through the eye of a needle, than for a rich man to enter into the kingdom of God.
So our atheist commentator thinks this is a great “Gotcha!” Let him explain:
This scene with Jesus and a rich young man is probably the most famous biblical passage that tends to be ignored by modern Christians. If this passage were actually heeded today, it is likely that Christianity and Christians would be very different. It is, however, an inconvenient teaching and so tends to be glossed over entirely.
The passage starts out with a young man addressing Jesus as “good,” which Jesus then rebukes him for. Why? Even if as he says “none are good [but] God,” then isn’t he God and therefore also good? Even if he isn’t God, why would he say that he isn’t good? This seems like a very Jewish sentiment which conflicts with the christology of the other gospels in which Jesus is portrayed as a sinless lamb, God incarnate. If Jesus is angry at being called “good,” how might he react if someone were to call him “sinless” or “perfect”?
It’s true, if this were the only place in the gospels where Jesus touched on the issue of His own divinity, then it would be a strong argument against it. However, there are other passages where Jesus clearly says that He is one with God. (I mention that because many sharp people confidently say, “Jesus never said he was God.” Yes He did–if the gospels are true–and that’s partly why the Jewish leaders were so furious with Him.)
Anyway, in the passage it doesn’t say Jesus “rebuked” the guy–at least not in this translation. In light of all the other evidence, what I think is (obviously) happening here is that Jesus is saying in an amused tone, “So, you think I’m good? Hmm, well according to your own belief system, no one but God is good. So…which is it? Am I not good after all, is your Judaic Law wrong, or…is there a third option?”
Everyone see how that works? Our atheist friend thinks Jesus just inconveniently admitted (a) He wasn’t God and (b) Christianity is in conflict with Judaism.
No, what Jesus just proved was (a) He is God and (b) He is the fulfillment of the Law.
I have said this before: There are plenty of very sharp atheists out there (not necessarily this guy). But their arguments against the existence of God are often incredibly silly. (Granted, the same is true of Christianity. For every C.S. Lewis you’ve got people who have McCain bumper stickers.) My favorite all-time atheist argument is, “According to your worldview, we must deduce that God does XYZ. Well I don’t want to believe in a God like that.” Great, and that’s my “proof” against quantum physics. How scientific.
In this post, I’m not going to deal with the more serious problem in the gospel excerpt above, namely Jesus’ discussion of riches. I agree that modern Christians–especially of the free-market variety–sometimes dismiss this aspect of Jesus’ teachings too glibly, along the “Aww, he didn’t really mean that…” lines. For now, if you’re curious at my resolution, you can check out my speech on “The Tension Between Economics and Religion” [mp3] at the Mises Institute a few years back.
* Just to remind everyone, the default setting is that Google pumps in whatever ads it finds appropriate (i.e. most likely people will click on) given the content of the post. It is indeed funny / annoying that when I write about God, the posts are either Scientology or for some DVD that “irreverently lays out the case that Jesus Christ never existed.” (I’m not sure how you would reverently say that Jesus never existed. “I mean this with all due respect, guys, but the apostles were a bunch of liars. And you Catholics, umm, hate to say it, but your first Pope was insane–and I’m saying that as a friend.”) There is a way I can go in and veto certain ads, but frankly that is not worth my time. It’s the same rationale for why I am not going to ban trolls etc. Once I go down that path, then I lose my plausible deniability. So just keep in mind, I am definitely not choosing the particular ads that pop up. Surely you don’t think I keep asking, “Is your bank about to close?!?!”
Pete Boettke Gets Saucy on the Financial Crisis
Although he doesn’t name names, Pete Boettke–head of the GMU Austrian syndicate–laments that many free market economists have endorsed the recent shenanigans as regrettable necessities. Go Pete! Below is the first portion of his lecture at FFF; go to this link to see the rest of his talk. (Note that “Bumper” = Jacob Hornberger.)
A Hedge Fund Manager Takes His Marbles and Goes Home
Andrew Lahde ran a small hedge fund and made 866 percent either in its first or second year (the article is ambiguous), by anticipating the subprime collapse. Then he decided he had reached his magic number and walked away. This article lists his goodbye letter, full of thoughts on idiotic MBAs, a corrupt Congress, and the benefits of legalizing hemp.
Incidentally, the article is titled, “Hedge Fund Manager: Goodbye and F—- You.” But those are too many hyphens for the word you’re thinking. Is that a typo, or did they mean “fatwa you”?
(HT2 J. Robinson for the article.)
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