25 Aug 2008

A Classical Mechanics Question to Break Up the Monotony

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A quick puzzle before plunging back into the dreary financial news…

So I’m sitting in the left turn lane, the first car in line waiting on the turn signal. A school bus is turning left, coming from my right; i.e. it is making its turn in front of me. At first the driver is cutting it too hard, so that the bus (for a few moments) is literally heading right for me.

Question: If I really thought the driver wasn’t going to correct, should I have put my foot on the brake as hard as I could? (If so, should I also have applied the emergency brake?) I’m thinking yes, because then some of the bus’s kinetic energy would get transferred to my brake pads (as heat), meaning my car has to accelerate less, meaning the seat belt has to press against my chest with less force to get my overweight body moving at the same velocity as the drunk bus driver.

Does your answer depend on whether there is a vehicle behind me in the turn lane?

25 Aug 2008

Anonymous Surveys Worse than Free Advice

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“The U.S. economy may have avoided a recession but will grow below trend for some time as firms face higher prices for a range of goods that will cut into profits, according to a panel of economists surveyed,” we learn in a CNBC article this morning. As Nassim Taleb demonstrates in his book The Black Swan, the record of “professional forecasters” in these matters indicates a dismal science indeed.

What really bugs me about these forecasts–which never really give you new information, they’re always adjusting the forecasts in light of news that everyone in the market already knows about–is that we have no quality control on the survey respondents. For example, this particular news story is referring to “101 NABE members.” Well how accurate have these 101 people been in the past? Just because they have a PhD–do we even know if they all have PhDs to be called “economists”?–doesn’t mean they are good at predicting economic growth six months from now. I would much rather hear the forecasts from, say, “10 economists who predicted the financial sector was in real trouble by late 2006.”

25 Aug 2008

Plug for Schiff’s Book Crash Proof

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As part of my atonement for mocking Schiff back in early 2007, I always plug his book whenever appropriate.

I don’t recommend it as a place to learn international trade theory, but if you accept his conclusions about the direction of the dollar and US assets in general, then you should read his recommendations for how to protect your wealth. For example, he doesn’t recommend shorting the US stock market, because you are still tied to US dollars. Instead, he makes the initially surprising recommendation to take out home equity loans and use the proceeds to buy foreign assets. My full book review is here.

24 Aug 2008

Schiff versus the Establishment

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Peter Schiff is a very interesting guy. He has been basically spot-on for the last few years with his warnings about the US economy. Are you surprised to learn that many big gun finance gurus mocked him along the way? Below are three good examples:

(1) Schiff versus Arthur Laffer (8/28/06)

(2) Schiff versus Steve Forbes (June 2008, I believe)

(3) Schiff versus Bob Murphy (!?!)

Yes, I didn’t care for Schiff’s explanations on why trade deficits are bad. (I still think his analogies are a bit misleading.) However, in the grand scheme he was obviously right, and I should have realized it much sooner. I don’t claim to be omniscient folks, but when I make a mistake I admit it quickly and try not to repeat it.

24 Aug 2008

Is the Fed Inflating or Deflating?

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At first you would think this should be an easy question for economists to answer–much like asking a doctor, “Is the patient’s fever getting worse?” However, there is actually healthy disagreement on the point even within the narrow group of very-free-market economists. Hard money guys like Peter Schiff have been warning that the US dollar is dead as a doornail, while Gary North (pdf) has actually been warning of deflation for over a year. (Note on nomenclature: For North, “deflation” means a falling money supply, which should tend to lead to lower prices. But the price movements are not the definition of inflation/deflation for him.)

Part of the problem is that some things are zigging instead of zagging, and we economists don’t like change. As I explain in this piece, normally when the Fed cuts its target rate, this goes hand in hand with an increase in the money supply (however you want to define it). But since the credit crunch, the Fed has slashed interest rates even while the rate of growth in aggregates such as the base and M1 is very tame, by historical standards. Hence, some economists are aghast at the “easy money” Fed policy, while others are screaming that Bernanke is insane for putting on the brakes while the credit markets are frozen.

Below is a chart (reproduced from my article linked above) showing that the textbook relationship hasn’t held during the credit crunch. Note that by Feb 2008, total bank reserves had fallen more than $1 billion since the previous summer, even though the Fed had cut the target rate 225 bp by that time. That’s not how things used to work on the blackboard when I taught at Hillsdale College, I can tell you that!

As always, the explanation for all this is that in economics, its laws are only true when you hold “everything else equal.” In September 2007 and beyond, certain key interest rates (apparently) were falling on their own because of the new conditions. In that context, it’s hard to say whether the Fed was “contracting” or “expanding.” Part of the problem is that the very presence of the Fed distorts market behavior; it is impossible for the Fed to truly “follow the market” and “not intervene,” as some economists recommend. That’s like telling the Soviet planners to mimic what the market would have done.

We will return to these issues often in future posts. The lesson is that we need to be careful before applying rules of thumb that are inapplicable because conditions are different from previous downturns.

24 Aug 2008

Time Says Oil Prices Rigged

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In a piece that starts out harmlessly enough and then descends into absurdity, Time argues that oil producers themselves are probably buying futures contracts in order to fatten their earnings. You might think manipulating the world oil market would be risky and expensive, but you (apparently) would be wrong, according to these writers:

The point is, it would only take about $9 billion to control the entire long position in oil. That sounds like an enormous amount of money, but some of the major individual players in oil are bigger than the market itself: Sultan Hassanal Bolkiah Muizzaddin, of Brunei Shell Petroleum, is worth about $23 billion; Saudi Prince Alwaleed Bin Talal Alsaud is worth about $21 billion; Russian Vagit Alekperov of LUKoil is worth about $13 billion…

All an oil supplier would have to do to raise prices is buy up futures contracts.

It’s not even that risky. Either the suppliers/investors risk an insignificant fraction of their gargantuan fortune, or they entice other investors to share the risk. With virtually unlimited resources and an actual tie to the underlying commodity, oil suppliers are in a far better position to accomplish this manipulation than, say, the Hunt brothers were during their attempt to corner the silver market in the 1970s.

There are lots of holes in the overall piece, and I will dissect them in an upcoming issue of The Freeman. For now, those readers who are dying to know why speculation in the futures markets isn’t causing record oil prices, should refer to my report for IER, or the geekier discussion at EconLib.

24 Aug 2008

"Is My Bank Safe?"

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Robert Wenzel over at EconomicPolicyJournal gives us his thoughts on protecting yourself from bank runs.* On a related note, in years past my wife and I had used Emigrant Direct as a way to take money out of our checking account (where we might spend it) and get it earning interest but in a very accessible place. It paid much better rates than what our bank’s saving accounts offered, and it was all online.

Well, I’m not sure we want to continue using Emigrant Direct for our alternative savings account anymore, because its business is basically home loans, which (so I hear) isn’t the best bet at the moment. Anyone have any thoughts on ED (not to be confused with a disappointing condition)? ED’s accounts are FDIC insured, but still, if the point is to have a place to store your months’ worth of savings in case you get laid off, you don’t want the hassle of a bank closure.

* Did you know that bank runs are not a fact of life, but rather the result of government-sanctioned fractional reserve banking? Read Murray Rothbard’s The Case Against the Fed (free pdf) for the juicy details.

24 Aug 2008

Recession Does Not Mean Low Inflation!

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There is a myth that during an economic downturn, the one silver lining is that pressure is taken off prices and so inflation rates come down. This mentality oozes from the financial press, and even Ben Bernanke endorsed it Friday during the Group Think session in Jackson Hole, Wyoming. Even though the PPI just hit a 27-year high, the Chairman isn’t worried. From the above NYT article:

Mr. Bernanke, while acknowledging “an increase in inflationary pressure,” reasserted his view that in the near future, the upswing in inflation from the oil and food shocks was likely to moderate.

“The recent decline in commodity prices as well as the increased stability of the dollar has been encouraging,” he said. “If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.”

Now folks, I realize this is going to sound crazy at first, but Bernanke’s view is exactly backwards. Other things equal, if you tell me that economic growth is going to slow, then that tends to make prices go up, not down. What is the lay explanation for inflation? “Too much money chasing too few goods.” So during a recession, there are fewer physical units of products and services getting cranked out, while the number of dollar bills (and checking account balances, etc.) hasn’t dropped.

For a fuller analysis, see my previous LRC article on why central banks–the Fed in the US–are to blame for rising prices, not “robust economic growth.” (Incidentally, Ron Paul backed Bernanke into a corner one time, and got Big Ben to basically admit that an increase in real output actually tends to lower prices–because the same stock of money is chasing more goods. Unfortunately, I can’t remember enough about their exchange to find it for you.)

If I’ve got you wavering with my verbal arguments, click on the graph below, constructed with the Fed’s own data. It shows quite clearly that inflation often spikes during recessions.