Thursday, June 30, 2011

Some Links

Lest you think this blog has fully transformed from one which started as a travelogue of sorts interspersed with thoughts (an accident of its birth, I assure you) to one with just random economic thoughts that may bore you (there is a rule about economists only being invited once to cocktail parties), I was on vacation recently. And by recently, I suppose I mean May. And at some point I'll probably put up pictures from Edinburgh, which will be a fun post.

But for now, some links that caught my eye:

1) Quantifying History: Two Thousand Years in One Chart

Or, as Don Boudreaux at Cafe Hayek wrote:

Lest we forget, amidst the daily/weekly/monthy/yearly ups and downs of the market, the market is an historically off-the-charts (almost literally) innovation machine.

Absolutely agreed. A chart, in this case, makes me very optimistic, provided we continue to bolster our economic freedom. Which leads us to...

2) Economic Freedom vs Income (and a whole host of other metrics lest you make the standard accusation that economists care only about economic growth)

Yes, the last bit is a political statement. I would argue this is an ideological statement. It's the argument that a government that stays small and lives within its means is one that promotes the most growth in all quality of life aspects. It's the argument that a country with secure property rights (as our Declaration of Independence put it, "Life, Liberty, and the Pursuit of Happiness", borrowing from John Locke's "Life, Liberty, and Property") best promotes economic growth (for example, how secure would you feel about investing if tomorrow the government seized your pensions to pay its bills, as happened in Argentina, or maybe not seize your pension, but borrow from it and give IOUs to say that you'll pay it back, as occurred with U.S. government workers recently). It's the ideological statement that a laissez faire system is the one that's best, never mind what our history books from 4th grade on teach us. At least, I remember being taught that in school, but maybe that's because going to private school is better than....

3) California Public Schools Considering De-Emphasizing Homework

I remember learning via doing homework. How else was I to learn how to read, write, critically argue (well, maybe you readers think differently) a point, do simple and advanced math (including statistics), and later understand more complex topics like economics, politics, investing, and so on? By magic? Or just staring at a chalkboard and listening to a teacher all day? Without practice, without something to make a skill a habit, how do you really learn?

I've lost most of my Spanish skills, for the simple reason that after passing the required proficiency level at Georgetown, I ceased to use it. If with that, then why not with anything you learn? Especially if it happens to be something important, like being able to read. Surely reading should be assigned as homework?

Maybe I'm just reacting with anecdotes to illustrate my thinking, and the statistics say that homework is not meaningful for learning.

Or maybe we're just trying to dumb our (public) schools down even more than they are right now. If I have kids, I definitely will do my best not to send them to a public school.

Well, I hope I've left on a controversial note!

Tuesday, June 28, 2011

Why is everyone afraid of default?

Far be it from me to say that default is jolly good, but honestly, if anyone had ever read This Time is Different, they would realize that the fast decade with a lack of sovereign defaults is the exception to the rule. And if it is the exception, then really, why is everyone in a tizzy over the prospect of a nation or four in Europe potentially on the verge of default because they can not get their fiscal house(s) in order? We've been able to handle it before.

And if we're not able to now, whose fault is that? Those bankers? Or those regulators? Mayhaps our regulatory institutions are not robust enough to handle failures - that certainly seems to be my opinion, given how Basel II, a creation of regulators, stated that for European banks, they could treat any EU government bond as gilt bonds and hence hold practically no capital against them. So what do you think happened? Of course they loaded up on bonds from Greece, Ireland, Spain, Italy and Portugal.

But what about if there was no such regulation incentivizing those banks to hold those bonds? They would have had to judge, on their own, how much capital to hold against the prospect of default of those assets (rather than not needing to hold any against those bonds), which would have A) reduced the amount they would hold in the first place because it would be a hit against their capital base (less capital would be available for holding against lending for other assets); and B) forced them to consider the prospects of default for nations with weaker finances, and judge whether to hold those assets at all (which would have resulted in the market better pricing those assets based on risk and perhaps keeping those profligate countries from actually becoming too profligate because they couldn't get as good an interest rate as Germany).

In other words, which institution is the more robust given limited information? Regulators? Or the market? If in past decades we had plenty of sovereign defaults and ultimately handled them, and there was less regulation then; and today we're in a panic and not sure we can handle a default, mayhaps more regulation makes our system weaker? And mayhaps the market, with incentives less skewed by regulators (it really is an important point how the skewed incentives of Basel II probably will cause a lot of havoc on European bank balance sheets by weighting them much more towards risky government bonds than they likely would have held) would have been more robust and capable of handling such a situation, even limiting the extent of it since less asset buying of those governments' bonds would have occurred and hence less damage could be inflicted in the case of default.

Sadly, most people have an anti-market bias, so this rumination is likely to convince no one.

In any case, I'll leave you with this interview with Jamie Dimon (H/T Devon Shire).

Sunday, June 19, 2011

Inflation Essential for Transition to Industrial Economy?

Far be it from me to say that I have odd dinner discussions...

Anyway, I hosted a dinner tonight, which I am still reeling from. I made sangria (red wine, brandy, triple sec, blackberries, pomegranate juice, lemon juice, orange juice and club soda). Additionally, one of my guests kindly brought some American whisky as a contribution to my liquor collection. Which I appreciate. The majority of my collection is Scotch (Glenfiddich, Glenmorangie, Laphroig, and another one), though I also have a Rip van Winkle bourbon and a High West rye, courtesy of my friend Jeff.

But to get back to the point, at my dinner tonight, we discussed the essentiality of inflation for a transition from an agrarian to an industrial economy. Which, if you follow this blog, you will not be surprised at the fact that it came up in conversation. But you'll probably be glad that you weren't at the dinner table for it! Though maybe not - the food we had tonight was stuffed tomatoes (panko, tomato pulp, basil, almonds, olive oil, salt, and buffalo mozzarella for the stuffing), tortilla espanola, a grain and zucchini salad, a mango and fruit salad, and espresso. In my opinion, the food may have compensated for the discussion. And if it didn't, I would certainly have provided ample libations to assist in ignoring an argument among economists.

Anyway, why is it that an agrarian economy is fine sans inflation, but an industrial economy requires it? For that was the implicit point that my friend was making when he argued that the Federal Reserve was created to help stabilize the banking system (though, if any of us remember 2008, we have to doubt that it truly stabilized it!). Does anyone realize that computers are deflationary in pricing? You get more computing power each year without paying more, which is deflationary. And yet, the computer industry is not suffering. The computer industry is competing, and competing quite vigorously, aiming to deliver products to us at lower prices than the prior year when considering computing power. As a consumer, this is great! We consider this to be fine!

So why do we consider deflation to be evil? Clearly, price deflation is good for consumers with savings, since their savings increase in purchasing power during that period. Also, during one of the most robust periods in U.S. economic history, where average GDP doubled, the CPI decreased from 138 in 1869 to 93 in 1889 (The period of 1910 to 1914 is 100 here, The Case for Gold, p. 164 and 167). This is price deflation, which is evil according to people like Bernanke. But think for a moment: is it evil that 20 years later, I can buy the basket of essential goods for my survival at 32.6% less? I would think this a blessing. And yet, central bankers today consider deflation, such as this, to be bad. Never mind the fact that the economy grew during this period, proving that price deflation does not equate to economic downfall.

Maybe central bankers consider deflation evil because government debt becomes more expensive during deflation. On the contrary, with inflation, a dollar is debased and is worth less, so the debt burden is lightened. So maybe central bankers are subject to a very primitive bias: "Whose bread I eat, his song I sing."

To circle back to the headline of the blog post, if during the period of 1869 to 1888, when we were certainly experiencing economic growth sans inflation while going towards a more industrial economy, shouldn't that prove that we don't need inflation for an industrial economy? Or, to put it another way, why is it essential that the US dollar inflated to be worth so much less today than in 1913 in order to grow our economy? Why is it essential that people who saved money were penalized by inflation to grow the economy, when in prior periods this was not necessarily the case? If during the late 1800s we grew our economy with price deflation, why can't we grow our economy now with price deflation?

I'm unconvinced of certain people's arguments that inflation, created via the Federal Reserve, is essential for economic growth. To me, it seems essential to avoid a crippling debt burden from bad fiscal policy (inflate our money away, and the debt will not be as much of a burden!). In other words, we are paying for the sins of the politicians via inflation. If we grew our economy via price deflation during 1869 to 1888, then there is no reason why that can't occur now, except for government intervention. The switch from agrarian to industrial does not convince me either. If anything, an industrialist would want to know that the money he receives is sound (since he may be doing contracts from far places), and hence would prefer a money that is not debased in value.

In sum, I am unconvinced of my friend the government economist. Quite frankly, I view it as a case of A) "Whose bread I eat, his song I sing"; and B) mainstream economics thinking, which embraces the "euthanasia of the rentier" and forgets that the rentier is the one who provides the capital that allows new businesses to be created, through bonds he buys, IPOs he participates in, seed capital he provides to startups, deposits that he makes at banks which are lent out to small businesses, and so on. Maybe in government land, inflation is good, but from where I stand, my savings are being degraded each year unless they keep up with inflation, which can be hard in certain years (for example, during a period of hyperinflation, or a year where a stock market bubble bursts and takes down all stocks).
N.B. Sadly, I am convinced that most people don't realize that a primary factor in inflation is the Federal Reserve. "Power tends to corrupt, and absolute power corrupts absolutely."