For some inscrutable reason, I've been reading "The Gathering Storm" recently. Not the 11th volume of the Wheel of Time. Rather, I've been reading the first volume of six by Winston Churchill on the second World War.
While I have not completed reading it yet (nor have I made any progress on This Time is Different, which if I recall correctly has some interesting statistics for that period of time), one very common theme in that volume is that the war was preventable. That was Churchill's view. Geopolitically, Germany rising again was not preventable. However, the war could have been prevented.
Another way to put it would be that Germany rebuilding itself as a powerhouse was geopolitically inevitable. Whether it would be a military powerhouse desiring war or an economic powerhouse was what could have been influenced by the UK and France, but unfortunately was not.
Keeping in mind the bias that "to understand is to believe," I think I could subscribe to Churchill's view.
I'll let some of his words speak for themselves on the preventability of that war, or if not preventability, at least being able to avoid the disastrous need to be evacuated from Dunkirk for inadequate training of the BEF and statistical inferiority of the RAF to the Luftwaffe:
While remaining sufficiently armed themselves, they must enforce with tireless vigilance and authority the clauses of the treaty which forbid the revival of their late antagonist's military power. Secondly, they should do all that is possible to reconcile the defeated nation to its lot by acts of benevolence designed to procure the greatest amount of prosperity in the beaten country, and labour by every means to create a basis of true friendship and of common interests, so that the incentive to appeal again to arms will be continually diminished. In these years I coined the maxim, "The redress of the grievances of the vanquished should precede the disarmament of the victors." As will be seen, the reverse process was, to a large extent, followed by Britain, the United States, and France. And thereby hangs the tale. [Location 798-801 in Kindle edition]
On March, 16, 1933, the MacDonald Plan was introduced, suggesting that the French army be reduced from 500,000 to 200,000 men and the German army allowed to reach parity with the French one. Churchill commented:
The Germans demand equality in weapons and equality in the organisation of armies and fleets, and we have been told, "You cannot keep so great a nation in an inferior position. What others have, they must have." I have never agreed. It is a most dangerous demand to make. Nothing in life is eternal, but as surely as Germany acquires full military equality with her neighbours while her own grievances are still unredressed and while she is in the temper which we have unhappily seen, so surely shall we see ourselves within a measurable distance of the renewal of general European war.
... One of the things which we were told after the Great War would be a security to us was that Germany would be a democracy with Parliamentary institutions. All that has been swept away. You have the most grim dictatorship. You have militarism and appeals to every form of fighting spirit, from the reintroduction of duelling in the colleges to the Minister of Education advising the plentiful use of the cane in elementary schools. You have these martial or pugnacious manifestations, and also the persecution of the Jews of which so many members have spoken.... [Location 1,313-24 Kindle edition]
[Hitler] did not even trouble to accept the quixotic offers pressed upon him. With a gesture of disdain he directed the German Government to withdraw both from the Conference and from the League of Nations. Such was the fate of the MacDonald plan. [Location 1,388 Kindle edition]
All this time [up until 1934] the Allies possessed the strength, and the right, to prevent any visible or tangible German rearmament, and Germany must have obeyed a strong united demand from Britain, France, and Italy to bring her actions into conformity with what the Peace Treaties had prescribed. In reviewing again the history of the eight years from 1930 to 1938 we can see how much time we had. Up till 1934 at least German rearmament could have been prevented without the loss of a single life. It was not time that was lacking. [Location 933 Kindle edition]
On March 14, 1933, a statement of Churchill's:
I regretted to hear the Under-Secretary say that we were only the fifth Air Power, and that the ten-year programme was suspended for another year. I was sorry to hear him boast that the Air Ministry had not laid down a single new unit this year. All these ideas are being increasingly stultified by the march of events, and we should be well advised to concentrate upon our air defences with greater vigour. [Location 1266 in Kindle edition]
Mr. Baldwin, on Nov 28, 1934, refuting a statement by Churchill on German air force rearmament:
It is not the case that Germany is rapidly approaching equality with us. I pointed out that the German figures are total figures, not first-line strength figures [...] Germany is actively engaged in the production of service aircraft, but her real strength is not 50 per cent of our strength in Europe to-day. As for the position this time next year, if she continues to execute her air programme without acceleration, and if we continue to carry out at the present approved rate the expansion announced to Parliament in July, so far from the German military Air Force being at least as strong as, and probably stronger than, our own, we estimate that we shall still have a margin in Europe alone of nearly 50 per cent. [Locations 2,032-42 in Kindle edition]
And yet, either the Air Ministry had poor forecasters or intelligence about Germany (people in general are poor forecasters though), for:
[A]t the end of March the Foreign Secretary and Mr. Eden paid a visit to Herr Hitler in Germany, and in the course of an important conversation, the text of which is on record, they were told personally by him that the German Air Force had already reached parity with Great Britain. [...] We had indeed fallen into an ambush. [Locations 2064-68 in Kindle edition]
Henceforward all the unknown, immeasurable threats which overhung London from air attack would be a definite and compelling factor in all our decisions. Moreover, we could never catch up; or at any rate the Government never did catch up. Credit is due to them and the Air Ministry for the high efficiency of the Royal Air Force. But the pledge that air parity would be maintained was irretrievably broken. [...] Very considerable efforts were made by the British Government in the next four years, and there is no doubt that we excelled in air quality; but quantity was henceforth beyond us. The outbreak of the war found us with barely half the German numbers. [Locations 2,200-6 in Kindle edition]
During the Battle of Britain, the RAF took down three to four enemy planes for one British loss, which is a quantitative statement on quality, but no one in their right mind would want to enter a war against a foe with as good technology as oneself with statistically inferior numbers. And yet the British were forced to do so, in large part because of a policy of disarmament in the MacDonald-Baldwin Government which could not be rectified after 1934. If the RAF had that hit rate, but as good numbers or better than the Germans, it would be a good probability that the shortcomings of the BEF in 1940 could have been overcome.
Or maybe not. For in deployment in Europe in 1939, its commanders had frittered away the months that passed between the declaration of war (over Hitler's invasion of Poland) and the arrival of blitzkrieg close to the Channel and Britain itself. [...] The 3rd Division's commander, Major General Bernard Montgomery, had not been idle, though. His formation had been honed during five major exercises that had emphasized all of the operations it was about to carry out.[...] As events unfolded, Montgomery's staff were struck by his prescience, one reflecting 'Although Monty made no predictions about the course of the battle, it followed almost exactly the way he had anticipated in his exercises.' Unfortunately for the army, the 3rd Division was the only part of the BEF that had rehearsed to this degree. [Mark Urban, Generals, p. 269]
Even if the RAF had statistical parity or superiority to the Luftwaffe, the BEF's apparent lack of professionalism and practice would probably have resulted in a land rout, and hence an overall rout. It just may not have been as hideous and dire as it was during Operation Dynamo, the evacuation of Dunkirk.
What would the world be like if Churchill, instead of being an ignored MP, was listened to and such prevention was effected? Would we never have had a second World War? Would Britain and France have been able to hold their own against Germany, effecting a repeat of the first World War with German advances being halted in France but not pushed back? Would Dunkirk still have happened, but with fewer casualties and little to none of the war materiel abandoned on the beaches because of enough RAF fighters to repel the Luftwaffe's bombing runs and allow the evacuation to occur in a less haphazard manner? Who knows? But we can guess, and at the minimum, "The Gathering Storm" to me is a persuasive account of the tragedy of lack of prevention.
Sunday, December 5, 2010
Tuesday, November 30, 2010
Saturday, November 27, 2010
Coming upon Christmas
With less than a month to go until Christmas, I thought I'd touch, very briefly, on the more materialistic aspect of it - namely, gifts. I used to have the notion that Christmas had become corrupted by the capitalistic urge to make money, with retailers utilizing the holidays as an excuse to sell you many things you didn't necessarily need, for yourself and others. Those people would be influenced by all those advertisements, like puppets on strings, giving their dollars to whoever pulled their strings the best. And then to alleviate their buying binge, they'd give some of the purchases to friends and family, expecting them to do likewise so they'd feel somewhat better (reciprocity bias). Then I realized that I am a capitalist, and my viewpoint changed.
Well, it didn't really change, per se. At least, not my cynical view that people might purchase things they didn't need. However, I no longer thought of the holiday as "corrupted" and people being played like puppets on strings. And so, I felt no guilt at retailers and everyone using the holidays as an excuse to sell things. If people wanted to buy things (choosing to enter into a transaction as responsible adults), regardless of need or not, then who was I to judge them for buying them, and who was I to judge retailers for taking advantage of that desire and discounting merchandise in competition for those people's dollars/pounds/euros/whatever? After all, if they didn't want to participate in Christmas from a gift-giving view, they did not need to. Sure, there is the social proof bias that everyone else in your family is doing it, and so you should too. Then there's the reciprocity bias that everyone will give you a gift, and so you should return the favor too (even if the gift given is not the same dollar value as the gift received). So opting out of the holiday could be hard. But people didn't seem to want to opt out - why opt out of receiving gifts, even if it means you have to buy gifts yourself?
The view in the first paragraph is a Galbraithian inspired view, incidentally. The view in the second paragraph is more Hayekian in influence. My viewpoint has shifted in general from a Galbraithian viewpoint to a Hayekian one, and I thought the example above might be a nice illustration of how those two economic schools of thoughts see the world. We are puppets on strings in a Galbraithian world, and the person who understands our bias can easily manipulate us into doing whatever they want, via advertisements, speeches, or whatever. There is some truth in this, I think.
However, there is also truth in a Hayekian point of view that we are not mere computers who will do things if the proper line of code is written. To extend the metaphor, we are computers who can reject the line of code no matter how it is written. We can be influenced, but we can choose what to be influenced by. There are many lines of code written by different programmers, but we can choose which one to accept. And we often do. This is very easy to do for a person aware of the psychological biases in our mind, but I think that any person can do this, and people do this more often than we realize. So I think there is some truth in this too.
My perspective, ultimately? I think the truth lies somewhere in between. We are rational creatures who can be manipulated some of the time, but other times we pause to reflect and make the choice to transact or not, to listen or not. We are Galbraithian and Hayekian in our behaviour.
(Greg Mankiw does a much better job of explaining this than I do. To see his little summary, go here where he discusses the little box of information he put into his Economics textbook on Galbraith and Hayek.)
One more thing. After 24 years of opting out of Christmas each year, I've decided that I might as well opt in this year. I partially opted in last year, but copped out by getting boxes of chocolate for people. This year I've decided to have some fun by thinking of what book or object a friend of mine would like. Of course, a wishlist by that person would also be good, though part of the pleasure of giving a gift finding something that the person doesn't know about but would want it if he or she knew about it. As I've signalled over the majority of my life that I do not participate in Christmas though, I am curious if this contradictory signal will be properly interpreted by friends and colleagues. In other words, I wonder if reciprocity bias will assert itself in time. I don't think so if people receive their presents on Christmas day. But before, giving ample warning? I think that would give enough time for reciprocity bias to do its work (I have a wishlist, incidentally, but I think anyone reading this is smart enough to figure out where to look if they happen to receive a gift from me and choose to listen to their reciprocity bias). Though I might end up with a bunch of chocolate as a result, which would be a hilarious turn. (If so, I'll have to host loads of wine and champagne tasting parties to get rid of them, which some people no doubt would like.)
Why books, by the way? Because I consider my friends erudite enough that I think each of them would enjoy a book that broadens his or her horizons. Though I may give wine or champagne/sparkling wine (to satisfy the aparatchiks of the EU) to some in lieu of books.
Well, it didn't really change, per se. At least, not my cynical view that people might purchase things they didn't need. However, I no longer thought of the holiday as "corrupted" and people being played like puppets on strings. And so, I felt no guilt at retailers and everyone using the holidays as an excuse to sell things. If people wanted to buy things (choosing to enter into a transaction as responsible adults), regardless of need or not, then who was I to judge them for buying them, and who was I to judge retailers for taking advantage of that desire and discounting merchandise in competition for those people's dollars/pounds/euros/whatever? After all, if they didn't want to participate in Christmas from a gift-giving view, they did not need to. Sure, there is the social proof bias that everyone else in your family is doing it, and so you should too. Then there's the reciprocity bias that everyone will give you a gift, and so you should return the favor too (even if the gift given is not the same dollar value as the gift received). So opting out of the holiday could be hard. But people didn't seem to want to opt out - why opt out of receiving gifts, even if it means you have to buy gifts yourself?
The view in the first paragraph is a Galbraithian inspired view, incidentally. The view in the second paragraph is more Hayekian in influence. My viewpoint has shifted in general from a Galbraithian viewpoint to a Hayekian one, and I thought the example above might be a nice illustration of how those two economic schools of thoughts see the world. We are puppets on strings in a Galbraithian world, and the person who understands our bias can easily manipulate us into doing whatever they want, via advertisements, speeches, or whatever. There is some truth in this, I think.
However, there is also truth in a Hayekian point of view that we are not mere computers who will do things if the proper line of code is written. To extend the metaphor, we are computers who can reject the line of code no matter how it is written. We can be influenced, but we can choose what to be influenced by. There are many lines of code written by different programmers, but we can choose which one to accept. And we often do. This is very easy to do for a person aware of the psychological biases in our mind, but I think that any person can do this, and people do this more often than we realize. So I think there is some truth in this too.
My perspective, ultimately? I think the truth lies somewhere in between. We are rational creatures who can be manipulated some of the time, but other times we pause to reflect and make the choice to transact or not, to listen or not. We are Galbraithian and Hayekian in our behaviour.
(Greg Mankiw does a much better job of explaining this than I do. To see his little summary, go here where he discusses the little box of information he put into his Economics textbook on Galbraith and Hayek.)
One more thing. After 24 years of opting out of Christmas each year, I've decided that I might as well opt in this year. I partially opted in last year, but copped out by getting boxes of chocolate for people. This year I've decided to have some fun by thinking of what book or object a friend of mine would like. Of course, a wishlist by that person would also be good, though part of the pleasure of giving a gift finding something that the person doesn't know about but would want it if he or she knew about it. As I've signalled over the majority of my life that I do not participate in Christmas though, I am curious if this contradictory signal will be properly interpreted by friends and colleagues. In other words, I wonder if reciprocity bias will assert itself in time. I don't think so if people receive their presents on Christmas day. But before, giving ample warning? I think that would give enough time for reciprocity bias to do its work (I have a wishlist, incidentally, but I think anyone reading this is smart enough to figure out where to look if they happen to receive a gift from me and choose to listen to their reciprocity bias). Though I might end up with a bunch of chocolate as a result, which would be a hilarious turn. (If so, I'll have to host loads of wine and champagne tasting parties to get rid of them, which some people no doubt would like.)
Why books, by the way? Because I consider my friends erudite enough that I think each of them would enjoy a book that broadens his or her horizons. Though I may give wine or champagne/sparkling wine (to satisfy the aparatchiks of the EU) to some in lieu of books.
Sunday, November 14, 2010
While I'm in London...
I'm going on holiday in London for about a week, from tomorrow to the 23rd. I'm quite excited about it, because I don't know quite what I'm going to do. Oh, I know that in the first hour of my trip, after customs, after dropping my luggage off at my flat, I'll get on the Underground (Bakerloo line, I believe), get off at Trafalgar Square, walk to the National Gallery and go up a flight of stairs to the room with two Turner paintings, and stare at them, allowing the matrix of what those paintings mean to me to come to my mind. That's a whole other post, what I see when I look at certain art, because I like to think of a piece of art from the point of where it is in history - what was occurring in the era in which it was painted, does it reference anything in that era, etc. One of Turner's paintings, Rain, Steam and Speed, is particularly evocative to me because of its historical context, Industrial Revolution era Britain. But again, a post for another time.
No doubt I'll go to some other museums while in London, such as the V&A. I'll try to go to a play, concert or the opera too. And I'll be running outside a lot too - I bought some Vibram Five Fingers specifically for the purpose. I'll also be enjoying coffee shops too - I found this insight about coffee houses to be rather delightful, so while I will probably not notice it (and how applicable would it be to Britain?), I thought it would be fun to attempt it:
In the cafes where men meet, are they older men, retired? Or are they young men? Are the cafes crowded with men in their forties drinking tea or coffee, going nowhere? Are they laughing and talking or sitting quietly as if they have nothing left to say? Official figures on unemployment can be off a number of ways. But when large numbers of 40-year-old men have nothing to do, then the black economy — the one that pays no taxes and isn’t counted by the government but is always there and important — isn’t pulling the train. (George Friedman, Stratfor, A Geopolitical Journey, Part 1: The Traveler).
I'll also write a decent amount if I am bored or having such a good time thinking and debating that I simply must write down my thoughts. For example I had a brilliant debate with my sister regarding the merits of consumer choice in the area of obstretics, specifically the delivery method. (I have some sensitive readers, I think, otherwise I would write like I would talk at a party about this.) I was of the notion that if the patient is informed of the risks, and wants to go with the surgical method even though it is riskier and an invasive abnominal surgery, rather than waiting and waiting, then damn the torpedos. The patient's choice should be respected. The doctor has fulfilled his/her ethical obligation to inform the patient of the risks, and now the doctor, in my mind, has an ethical obligation to fulfill the patient's choice or direct the patient to a doctor who will. (I realize I must have made some lawyer happy with those words too.)
My sister was of the other opinion, that if the patient is told the risks but wants the surgery anyway versus waiting (if after a week you're still waiting, surgery is appropriate, apparently, but not before then), the patient is making ill-judged decision and the doctor ethically should refuse to provide the surgery. (She also was offended by my comment then that the patient would then shop around for a doctor who would respect her choice.) If the doctor decides to not be a supplier then, fine by me, but to say that the patient should not make that choice for surgery unless nature has been given time and is too tardy is to fundamentally ignore the fact that the patient is a consumer and making a choice. (Of course, if the system is not a free market, consumer choice driven system, but a nationalized single payer system, then such bias that are anti-consumer while purporting to serve the consumer are incorporated into the system, usually for the worse in my opinion. We're adults, thank you very much.) A choice that is informed by the risks.
I was coming at the argument from one mental model, that of economics and choice, and my sister was coming at it with another. I shall be quite amused to see if I can understand her mental model and then see if her point of view is the right one. I don't quite think it is. But nevertheless, I shall enjoy stretching my mind with a different mental model of my sister's. After all, if I bemoan the fact that people do not utilize the mental models that economics offers, then I should take the opportunity to understand a non-economics mental model and incorporate it into my referential frameworks to use in conjunction with my other mental models as necessary.
Whoever thought that vacation would be so taxing on the mind? :)
No doubt I'll go to some other museums while in London, such as the V&A. I'll try to go to a play, concert or the opera too. And I'll be running outside a lot too - I bought some Vibram Five Fingers specifically for the purpose. I'll also be enjoying coffee shops too - I found this insight about coffee houses to be rather delightful, so while I will probably not notice it (and how applicable would it be to Britain?), I thought it would be fun to attempt it:
In the cafes where men meet, are they older men, retired? Or are they young men? Are the cafes crowded with men in their forties drinking tea or coffee, going nowhere? Are they laughing and talking or sitting quietly as if they have nothing left to say? Official figures on unemployment can be off a number of ways. But when large numbers of 40-year-old men have nothing to do, then the black economy — the one that pays no taxes and isn’t counted by the government but is always there and important — isn’t pulling the train. (George Friedman, Stratfor, A Geopolitical Journey, Part 1: The Traveler).
I'll also write a decent amount if I am bored or having such a good time thinking and debating that I simply must write down my thoughts. For example I had a brilliant debate with my sister regarding the merits of consumer choice in the area of obstretics, specifically the delivery method. (I have some sensitive readers, I think, otherwise I would write like I would talk at a party about this.) I was of the notion that if the patient is informed of the risks, and wants to go with the surgical method even though it is riskier and an invasive abnominal surgery, rather than waiting and waiting, then damn the torpedos. The patient's choice should be respected. The doctor has fulfilled his/her ethical obligation to inform the patient of the risks, and now the doctor, in my mind, has an ethical obligation to fulfill the patient's choice or direct the patient to a doctor who will. (I realize I must have made some lawyer happy with those words too.)
My sister was of the other opinion, that if the patient is told the risks but wants the surgery anyway versus waiting (if after a week you're still waiting, surgery is appropriate, apparently, but not before then), the patient is making ill-judged decision and the doctor ethically should refuse to provide the surgery. (She also was offended by my comment then that the patient would then shop around for a doctor who would respect her choice.) If the doctor decides to not be a supplier then, fine by me, but to say that the patient should not make that choice for surgery unless nature has been given time and is too tardy is to fundamentally ignore the fact that the patient is a consumer and making a choice. (Of course, if the system is not a free market, consumer choice driven system, but a nationalized single payer system, then such bias that are anti-consumer while purporting to serve the consumer are incorporated into the system, usually for the worse in my opinion. We're adults, thank you very much.) A choice that is informed by the risks.
I was coming at the argument from one mental model, that of economics and choice, and my sister was coming at it with another. I shall be quite amused to see if I can understand her mental model and then see if her point of view is the right one. I don't quite think it is. But nevertheless, I shall enjoy stretching my mind with a different mental model of my sister's. After all, if I bemoan the fact that people do not utilize the mental models that economics offers, then I should take the opportunity to understand a non-economics mental model and incorporate it into my referential frameworks to use in conjunction with my other mental models as necessary.
Whoever thought that vacation would be so taxing on the mind? :)
Monday, November 1, 2010
Classical Music...
All I can say is that I'm rediscovering my love for classical music. I used to listen to Beethoven's 2nd, 5th and 7th symphonies often on my drives to and from Richmond. Or the 8th symphony, with the 2nd movement of the 2nd symphony replacing the 2nd movement of the 8th.
Classical Music that I've enjoyed recently:
Classical Music that I've enjoyed recently:
- Sinfonia in D Minor (W.F. Bach)
- The Planets - Mars (Holst)
- Short Ride in a Fast Machine (John Adams)
- Overture 'Coriolan', and Piano Concertos 1 through 5 (Beethoven)
And since the Phillips Collection in DC has Sunday classical music concerts, I'll probably make time for a few of them, particularly one on Dec 12 featuring Brahm's Variations on a Theme by Paganini. I've heard Rachmaninov's Rhapsody on a Theme by Paganini, so I'm curious about Brahm's piece.
Monday, October 11, 2010
Quick Thought on the 11th October
I mentioned in a prior post my suspicion that we are becoming lazier in research, probably on average. Anyone willing and able to fight this will probably be at an informational advantage in whatever field he or she chooses, unless that field disproportionately has people who have avoided that laziness (hard to believe given the prevalence of Google and the like) or that field has practically all information available online and easily findable.
I have a suspicion that in one of the fields I follow that the majority of the people do not reading the filings available for free online at a government commission's website; and furthermore, that those who do mostly focus on certain bits, not all of the reporting and therefore may miss something utterly relevant tucked into a footnote towards the end of a 200 page document. So while those people are at an informational advantage compared to the majority, they themselves are at an informational disadvantage compared to the people who read all of the reporting (though only if those people reading all of the reporting are able to interpret it).
Right now I am slogging through This Time is Different. Unfortunately, this means that I do not have the time to read Christina Romer's paper "The Macroeconomic Changes of Tax Changes" where purportly the argument is that tax cuts result in increases in GDP.
Funnily though, or maybe displaying a case of "whose bread I eat, his song I sing," in a blog post on the White House's site and a farewell speech given upon her resigning from Obama's economic team, she makes the case that extending the high-income tax cuts will provide very little in terms of short term job creation. (This blog entry was from July 28, 2010, so as you can see, I am rather late in my criticism. Then again, since I'm not a blogger for a conservative, libertarian or liberal institution, I have the liberty of writing about what I want when I want. And my small readership hasn't complained...yet.) Romer also notes that:
"Since most postwar tax changes have been broad-based, our evidence indicates that broad-based tax cuts have large effects. But it’s important to note that our study did not distinguish among tax cuts for different groups and did not focus on high-income earners. Thus, it provides no basis for doubting the compelling evidence that tax cuts for high-income earners are less effective than broad-based tax cuts focused on the middle class."
Now, here's where the laziness mentioned above comes in play, for me at least. If I read those remarks correctly, Romer says that the paper does not focus on high-income tax cuts. However, since she looks at broad-based tax cuts, presumably the effects include tax cuts for the rich since she did not focus on tax cuts for any one socioeconomic class but any tax cut package. Since I have not had the chance to read Romer's paper, I can only make that remark based on my reading of her blog post, not the primary source, her paper. That, my friends, is intellectual laziness on my part.
May I note this though? If her paper included effects of the tax cuts on the rich, not separating them on, then Romer has no basis to say that tax cuts to the rich will have little effect. Her paper focused on broad tax cuts, which included tax cuts for the rich. It did not do an analysis of which tax cut to which group had the most effect, so how does she have a basis to say that tax cuts for the rich will provide little benefit when her research did not disaggregate the effects? (She quotes the CBO and a Goldman Sachs study, Goldman Sachs Global ECS US Research, “US Daily: Extending the Expiring Tax Cuts: What, How, When and Why (Phillips),” July 26, 2010.) Dare I say that this could be intellectual laziness on her part? Or a case of "whose bread I eat, his song I sing," since this administration seems to love to target the rich whenever possible? I'm not sure if it is a case of laziness, but unless that Goldman study is econometrically rigorous (again, laziness on my part for not reading it), I think it's more a case of "whose bread I eat, his song I sing."
Continuing on the theme of "whose bread I eat, his song I sing," let's run a thought experiment about the CBO. The CBO is a part of the government. In my skeptical mind, that means that it is biased towards anything that increases government revenues (and size), since those revenues form the basis of what can be spent and help fund the CBO's existence. (Sorry, not going to discuss the deficit.) So, while the CBO may not be biased towards either political party, it probably is biased towards government, since that is the system it is part of. And rationally, it would want to increase its revenues wherever possible. Hence, why they think high-income bracket tax cuts will be ineffective. Or maybe it's just that they want that additional revenue, eh?
Finally, let me level another criticism at Romer, again from her lovely blog post:
"Likewise, estimates by the Council of Economic Advisers suggest that spending $10 billion to prevent the layoffs of teachers, firefighters, and police would lead to nearly twice as many jobs as the estimated $30 billion of high-income tax cuts—that’s twice as many jobs for one-third the cost."
While I have nothing to say on the police, I must note that a paragraph like this seems to be terribly short-run biased. Actually, all economic discussions seem to be very short-term biased, not medium-term biased on the necessary structural reforms to government spending to prevent the day when my generation pays the bill for the excesses and irresponsibility of prior generations if we continue on this path. In this case, Romer's assumption is that it is good to preserve any job possible, the kind of logic that leads to a bailout of GM rather than asking the hard question of if those jobs are truly necessary, if it is good resource allocation to bailout an ailing motor company with structural woes (labor unions) rather than cyclical woes.
That same question applies to teachers and firefighters (and probably police). The unfortunate thing about teachers is that seniority overrules performance, the exact opposite of a rational employment system. And so when cuts need to be made, the teachers fired are likely the ones you want to keep, probably being young, ununionized, and not disenchanted with education yet; the ones retained are the ones you want to fire. So is it the right thing to spend money to save teacher jobs who would otherwise be fired? Keeping the teachers who would otherwise be fired, as long as they are the outperformers, is not bad; except that patches like that delay any necessary structural reform. Better would be to demand structural reform before handing out some money to teachers. But instead such $10 billion (part for the teachers) inefficiently allocates scarce government resources inefficiently by supporting a system that needs to be revamped if it is to actually serve the customers it purports to serve - the students. Shame on an economist for not thinking about that - or again, is it a case of "whose bread I eat, his song I sing?"
And while I have not seen anything statistical on firefighters, let me provide an anecdote from Merseyside (read it in The Economist), with a sentiment from the fire chief there that reflects part of my gloomy opinion about government in general - "the trouble with the public sector is bone-idle staff":
In 1999-2000 there were 2,140 fires in the Merseyside area and 15 fire-related deaths; last year (2009-10), there were 1,299 and 8. Meanwhile, the number of traditional fire officers has fallen from 1,400 to 850, saving money. [Better results with less staff and money - what's not to like?]
Mr McGuirk saw that speedy response wasn’t enough: prevention was the key.[...]
All this involved cutting the number of fire officers, who, Mr McGuirk realised, were underemployed for long periods during their shifts. Anyway, fewer fires required fewer rescuers. Although no one was made redundant involuntarily, in 2006 the fire-brigade union called a strike. Protesters dubbed the fire chief “McJerk”; 2,000 of them walked through Liverpool carrying banners with slogans such as “I hate McGuirk”. [When you're part of a system, even if that system is part of a problem, the fact that you're in that system and that it puts the bread on your table means that you will fight for it no matter that it may need reform to fix the problem.]
Ironically, it was soon clear that the 200 officers who stayed at work could run the service at full capacity. [Emphasis mine]“I told the local press they would never notice there was a strike,” says Mr McGuirk. “It’s not my job to be popular, it’s to deliver.” The strike was defeated in a month.
Dare I say that the $10 billion comment from Romer represents intellectual laziness? A distressingly short-sighted viewpoint from an economist, who should look longer term than the next year, two or three? Someone failing to realize that preservation of a job is not the same thing as efficiently allocating resources where needed for the most return? Someone failing to question whether those jobs are truly needed, or whether those departments can run more efficiently with less or whether something structural, such as teachers unions, are the problem with dealing with budget shortfalls for education (if you could fire your worst performers during a cyclical downturn, instead of having to retain them and fire your best performers who are not unionised, wouldn't that make more budgetary sense than just doling out money to keep all the jobs and perpetuate a system in need of reform)?
My ending conclusion is that a constant focus on the short term means that you will always be in the short term, losing sight of the long view and avoiding problems that will come in the medium term until it is too late. Short term pain seems like it will be long term gain, in this case; or as Ben Franklin put it, "An ounce of prevention is worth a pound of cure." But a focus on the short term at the cost of the medium and long term means that we will continue to emphasis that pound of cure (and therefore waste resources) over that ounce of prevention.
N.B. Politics is something that is quite incendiary. Economics is something that can bore many people. While I have a small readership, no doubt I have said something that may have incensed or bored you. Please bear in mind that these are my opinions, and that I can be quite arrogant. If you disagree with me, either politely comment or impolitely send me an angry email - I would rather have any comments with inflamatory remarks, including any four letter words, to be in my mailbox. Besides, you'll have a higher chance of me reading it than if you put it in a comment. And if you're commenting, didn't you want me to read it in the first place? Hence why it is logical for you to send inflamatory remarks (and maybe all of them) to my inbox rather than posting a comment.
N.B. #2 Psychologically speaking, confirmation bias exists. And most people are susceptible to it. Broadly speaking, once I've come to a conclusion about it, I will tend to seek out data that confirms my view rather than data that disagrees with my view. This is probably one of the reasons for the joke "Science advances by the funeral." Replace science with "society" and you probably still are accurate in describing societal mores. (Another post for another day, about J.S. Mill's quote about conservatives.) Anyway, I know I am susceptible to confirmation bias (I also suspect that to be true of writers for think tanks and newspaper blogs of all political stripes). And hence, I promise myself and anyone reading this that I will not let this post lie like this. I've noted above that I've not had a chance to read Romer's paper, the Goldman Sachs or CBO studies. Since those potentially contain views and data disagreeing with my opinion, it is intellectually incumbent upon me to read those when I can and further decide if I am wrong or if the opposition's arguments have enough flaws to render their conclusions suspect. So once I'm done with This Time is Different, I shall read the literature mentioned above and revisit this post (though I'll probably preserve this post as is for my own humor in seeing the potential evolution of the argument).
I have a suspicion that in one of the fields I follow that the majority of the people do not reading the filings available for free online at a government commission's website; and furthermore, that those who do mostly focus on certain bits, not all of the reporting and therefore may miss something utterly relevant tucked into a footnote towards the end of a 200 page document. So while those people are at an informational advantage compared to the majority, they themselves are at an informational disadvantage compared to the people who read all of the reporting (though only if those people reading all of the reporting are able to interpret it).
Right now I am slogging through This Time is Different. Unfortunately, this means that I do not have the time to read Christina Romer's paper "The Macroeconomic Changes of Tax Changes" where purportly the argument is that tax cuts result in increases in GDP.
Funnily though, or maybe displaying a case of "whose bread I eat, his song I sing," in a blog post on the White House's site and a farewell speech given upon her resigning from Obama's economic team, she makes the case that extending the high-income tax cuts will provide very little in terms of short term job creation. (This blog entry was from July 28, 2010, so as you can see, I am rather late in my criticism. Then again, since I'm not a blogger for a conservative, libertarian or liberal institution, I have the liberty of writing about what I want when I want. And my small readership hasn't complained...yet.) Romer also notes that:
"Since most postwar tax changes have been broad-based, our evidence indicates that broad-based tax cuts have large effects. But it’s important to note that our study did not distinguish among tax cuts for different groups and did not focus on high-income earners. Thus, it provides no basis for doubting the compelling evidence that tax cuts for high-income earners are less effective than broad-based tax cuts focused on the middle class."
Now, here's where the laziness mentioned above comes in play, for me at least. If I read those remarks correctly, Romer says that the paper does not focus on high-income tax cuts. However, since she looks at broad-based tax cuts, presumably the effects include tax cuts for the rich since she did not focus on tax cuts for any one socioeconomic class but any tax cut package. Since I have not had the chance to read Romer's paper, I can only make that remark based on my reading of her blog post, not the primary source, her paper. That, my friends, is intellectual laziness on my part.
May I note this though? If her paper included effects of the tax cuts on the rich, not separating them on, then Romer has no basis to say that tax cuts to the rich will have little effect. Her paper focused on broad tax cuts, which included tax cuts for the rich. It did not do an analysis of which tax cut to which group had the most effect, so how does she have a basis to say that tax cuts for the rich will provide little benefit when her research did not disaggregate the effects? (She quotes the CBO and a Goldman Sachs study, Goldman Sachs Global ECS US Research, “US Daily: Extending the Expiring Tax Cuts: What, How, When and Why (Phillips),” July 26, 2010.) Dare I say that this could be intellectual laziness on her part? Or a case of "whose bread I eat, his song I sing," since this administration seems to love to target the rich whenever possible? I'm not sure if it is a case of laziness, but unless that Goldman study is econometrically rigorous (again, laziness on my part for not reading it), I think it's more a case of "whose bread I eat, his song I sing."
Continuing on the theme of "whose bread I eat, his song I sing," let's run a thought experiment about the CBO. The CBO is a part of the government. In my skeptical mind, that means that it is biased towards anything that increases government revenues (and size), since those revenues form the basis of what can be spent and help fund the CBO's existence. (Sorry, not going to discuss the deficit.) So, while the CBO may not be biased towards either political party, it probably is biased towards government, since that is the system it is part of. And rationally, it would want to increase its revenues wherever possible. Hence, why they think high-income bracket tax cuts will be ineffective. Or maybe it's just that they want that additional revenue, eh?
Finally, let me level another criticism at Romer, again from her lovely blog post:
"Likewise, estimates by the Council of Economic Advisers suggest that spending $10 billion to prevent the layoffs of teachers, firefighters, and police would lead to nearly twice as many jobs as the estimated $30 billion of high-income tax cuts—that’s twice as many jobs for one-third the cost."
While I have nothing to say on the police, I must note that a paragraph like this seems to be terribly short-run biased. Actually, all economic discussions seem to be very short-term biased, not medium-term biased on the necessary structural reforms to government spending to prevent the day when my generation pays the bill for the excesses and irresponsibility of prior generations if we continue on this path. In this case, Romer's assumption is that it is good to preserve any job possible, the kind of logic that leads to a bailout of GM rather than asking the hard question of if those jobs are truly necessary, if it is good resource allocation to bailout an ailing motor company with structural woes (labor unions) rather than cyclical woes.
That same question applies to teachers and firefighters (and probably police). The unfortunate thing about teachers is that seniority overrules performance, the exact opposite of a rational employment system. And so when cuts need to be made, the teachers fired are likely the ones you want to keep, probably being young, ununionized, and not disenchanted with education yet; the ones retained are the ones you want to fire. So is it the right thing to spend money to save teacher jobs who would otherwise be fired? Keeping the teachers who would otherwise be fired, as long as they are the outperformers, is not bad; except that patches like that delay any necessary structural reform. Better would be to demand structural reform before handing out some money to teachers. But instead such $10 billion (part for the teachers) inefficiently allocates scarce government resources inefficiently by supporting a system that needs to be revamped if it is to actually serve the customers it purports to serve - the students. Shame on an economist for not thinking about that - or again, is it a case of "whose bread I eat, his song I sing?"
And while I have not seen anything statistical on firefighters, let me provide an anecdote from Merseyside (read it in The Economist), with a sentiment from the fire chief there that reflects part of my gloomy opinion about government in general - "the trouble with the public sector is bone-idle staff":
In 1999-2000 there were 2,140 fires in the Merseyside area and 15 fire-related deaths; last year (2009-10), there were 1,299 and 8. Meanwhile, the number of traditional fire officers has fallen from 1,400 to 850, saving money. [Better results with less staff and money - what's not to like?]
Mr McGuirk saw that speedy response wasn’t enough: prevention was the key.[...]
All this involved cutting the number of fire officers, who, Mr McGuirk realised, were underemployed for long periods during their shifts. Anyway, fewer fires required fewer rescuers. Although no one was made redundant involuntarily, in 2006 the fire-brigade union called a strike. Protesters dubbed the fire chief “McJerk”; 2,000 of them walked through Liverpool carrying banners with slogans such as “I hate McGuirk”. [When you're part of a system, even if that system is part of a problem, the fact that you're in that system and that it puts the bread on your table means that you will fight for it no matter that it may need reform to fix the problem.]
Ironically, it was soon clear that the 200 officers who stayed at work could run the service at full capacity. [Emphasis mine]“I told the local press they would never notice there was a strike,” says Mr McGuirk. “It’s not my job to be popular, it’s to deliver.” The strike was defeated in a month.
Dare I say that the $10 billion comment from Romer represents intellectual laziness? A distressingly short-sighted viewpoint from an economist, who should look longer term than the next year, two or three? Someone failing to realize that preservation of a job is not the same thing as efficiently allocating resources where needed for the most return? Someone failing to question whether those jobs are truly needed, or whether those departments can run more efficiently with less or whether something structural, such as teachers unions, are the problem with dealing with budget shortfalls for education (if you could fire your worst performers during a cyclical downturn, instead of having to retain them and fire your best performers who are not unionised, wouldn't that make more budgetary sense than just doling out money to keep all the jobs and perpetuate a system in need of reform)?
My ending conclusion is that a constant focus on the short term means that you will always be in the short term, losing sight of the long view and avoiding problems that will come in the medium term until it is too late. Short term pain seems like it will be long term gain, in this case; or as Ben Franklin put it, "An ounce of prevention is worth a pound of cure." But a focus on the short term at the cost of the medium and long term means that we will continue to emphasis that pound of cure (and therefore waste resources) over that ounce of prevention.
N.B. Politics is something that is quite incendiary. Economics is something that can bore many people. While I have a small readership, no doubt I have said something that may have incensed or bored you. Please bear in mind that these are my opinions, and that I can be quite arrogant. If you disagree with me, either politely comment or impolitely send me an angry email - I would rather have any comments with inflamatory remarks, including any four letter words, to be in my mailbox. Besides, you'll have a higher chance of me reading it than if you put it in a comment. And if you're commenting, didn't you want me to read it in the first place? Hence why it is logical for you to send inflamatory remarks (and maybe all of them) to my inbox rather than posting a comment.
N.B. #2 Psychologically speaking, confirmation bias exists. And most people are susceptible to it. Broadly speaking, once I've come to a conclusion about it, I will tend to seek out data that confirms my view rather than data that disagrees with my view. This is probably one of the reasons for the joke "Science advances by the funeral." Replace science with "society" and you probably still are accurate in describing societal mores. (Another post for another day, about J.S. Mill's quote about conservatives.) Anyway, I know I am susceptible to confirmation bias (I also suspect that to be true of writers for think tanks and newspaper blogs of all political stripes). And hence, I promise myself and anyone reading this that I will not let this post lie like this. I've noted above that I've not had a chance to read Romer's paper, the Goldman Sachs or CBO studies. Since those potentially contain views and data disagreeing with my opinion, it is intellectually incumbent upon me to read those when I can and further decide if I am wrong or if the opposition's arguments have enough flaws to render their conclusions suspect. So once I'm done with This Time is Different, I shall read the literature mentioned above and revisit this post (though I'll probably preserve this post as is for my own humor in seeing the potential evolution of the argument).
Sunday, October 10, 2010
Thoughts so far on "This Time is Different"
There are two financial history/economics books which I have found very rewarding to read, even if a tiring slog to get through. One is Kindleberger's Manias, Panics and Crashes, particularly the discussion of credit creation and contraction with the Minsky model (the financial instability hypothesis).
The other, though I'm still working through it, is This Time is Different. Part of the reason it is a slog is the very reason is it so rewarding - the loads of quantitative data and segways discovered, such as India's share of world GDP declining between 1913 and 1990 (though why that table didn't have 2007 figures is unknown to me). Debt intolerance though seems to be a main part of the book, the notion that certain governments have higher debt intolerance than others, and hence while one government can withstand a certain amount of debt to GDP, another can not withstand that same amount. Mental-model wise, it is very interesting to discover this in the quantitative data; and even more interesting to connect it qualitatively to the narrative of history in Walter Russell Mead's God and Gold, which offers a pretty good explanation of the rise of Anglo-Saxon institutions that have resulted in those countries having very strong financial systems that are debt tolerant (it may not seem like we have a strong financial system, on an absolute basis, based on the past crisis, but relatively speaking we do compared to non Anglo-Saxon countries). One of Reinhart and Rogoff's tables show that none of the colonial (as opposed to imperialist era holdings like India, South Africa and Zimbabwe) Anglo-Saxon spinoffs (Canada, Australia, New Zealand, and the United States) have explicitly defaulted on debt - we're very debt tolerant, a blessing for people needing to buy fixed income securities. (Covert defaults, including inflation, is another story, though we still fare pretty well on a relative basis.) Mead's analysis provides a good explanation of that quantitative anomaly revealed on Reinhart and Rogoff's analysis.
From a research perspective, This Time is Different reveals another curiosity - due to the lack of transparency regarding domestic debt of countries, most economic analysis of default and inflation episodes do not incorporate a discussion of domestic debt. As a result, Reinhart and Rogoff find that most analysis is seriously deficient in explanatory power of why a government would choose to default or inflate because most researchers are looking at a very incomplete picture (only external debt, which usually is less than half of the total debt of the average nation) with incorrect assumptions (that domestic debt is usually paid off in full, at face value, with no overt or covert defaults). The simple reason for this deficiency is partially that governments do not want to reveal their knickers (unfortunate because government ultimately should be accountable to their citizens) and partially that researchers might be becoming lazier. (For more on this, see Farnam Street's blog article: Does the Internet Make You Smarter or Dumber?)
And if we take a moment to engage in a thought experiment, we may be becoming even lazier as we become used to instantaneous access to information via our computers, mobile search and more. If that is the case, then any information that is not easy to find via online sources at all or online only if digging deeply (i.e page 200 of a 201 page document) will progressively become more and more ignored. Any decisions we make then will be based on even more incomplete and erroneous analysis. This is important - for example, if I remember correctly (key because I do not have the book in front of me at the moment), Reinhart and Rogoff go so far as to say that institutions advising on debt restructuring for nations are giving inadequate recommendations because of the propensity of research to improperly ignore domestic debt levels and the lack of transparency around a nation's domestic debt.
Combining the two books, I distinctly remember Kindleberger talking about capital levels throughout the 19th and 20th century at banks in the United States. Reinhart and Rogoff have a time-series analysis, I believe, of banking crises in the U.S. I think it would be quite interesting to overlay that analysis with the trend of bank capital levels from the 1800s to the present. I think it would make the case that whatever reform we're getting through Dodd-Frank and Basel III, it will only mitigate (at best ) future crises, not prevent them.
I'm including systemic risk in that assumption, by the way - I highly doubt that systemic risk buildup will be prevented by the regulators created and empowered in the legislation, since I wonder if they (or anyone) will know what the next systemic risk is. They might be fighting the last war when the next crisis comes. I'm not asserting that the systemic risk of the prior crisis was hard to discern, since investors like Jeremy Grantham, Mike Burry and others happened upon that risk, analysed it, and profited from it; I'm asserting that I find it hard to believe that the regulators will notice the systemic risk, given the prior track record, such as this remark from Bernanke in Oct 2005: "House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals."
After all, if you recall, the Bank of Scotland (now part of Lloyds Banking Group) on average had an equity capital ratio of 25% during the 1700s (i.e. every $4 of loans made by the Bank of Scotland were fund by $3 of deposits or bonds sold to investors and $1 of the Bank of Scotland's money). This, shall we say, is a rather high common equity ratio, especially compared to banks today where you may see 3% common equity ratios (a lot of European banks back in 2008). And yet, when the Royal Bank of Scotland was competing against the Bank of Scotland in the early 1700s, it pretty much caused a liquidity crisis for the Bank of Scotland by buying Bank of Scotland notes and then marching into a Bank of Scotland branch to redeem those notes for payment (in gold or coinage, I think). The Bank of Scotland was forced to call loans early and suspend payments in coinage from March 1728 to September 1728. Bear in mind that there was nothing wrong with the Bank of Scotland's book of loans. They just had an inadequate supply of coinage to cover redemption of all of their currency notes in circulation (a situation the Royal Bank of Scotland probably was in too). A high equity capital ratio did not prevent a liquidity crisis, a crisis of confidence. Even a 100% equity capital ratio (meaning that the bank is not a bank, but an investment vehicle) would not prevent a liquidity crisis if the assets are not easily salable. And legislation would probably not prevent a liquidity crisis in the future. (I realize that such a liquidity crisis for a bank, as opposed to a capital markets dependent financial company, would not happen now because of the Federal Reserve, the Bank of England, and the European Central Bank each offering banks access to liquidity at need, but I think the example still relevant if only to illustrate that there are more to financial crises than just bad loans eating away at a bank's capital. Also, I felt like bragging about what I learned when touring the old Bank of Scotland headquarters in Edinburgh last summer.)
As for a quality crisis (while I do not remember the exact nomenclature, what I mean by this is that the quality of assets/loans on the bank's books are a lot more suspect than stated), a higher capital ratio means that there is more of a buffer provided by the bank's money to absorb losses on loan writedowns before impacting depositors. But if a bank is stupidly underwriting, no capital ratio will ultimately prevent it from going under. Legislation does not prevent stupidity, herding, or a race to the lowest common denominator (and lowest quality) in lending. And when banks did not have federal backstops, there were still banking crises despite the incentive of the bank owners to ensure that the bank underwrote well because if it made a bad decision, they lost their net worth. So why does anyone think that the current legislation will prevent a future crisis? Any rational person willing to take the time (i.e. not be lazy) and look at the historical record will find that to be a delusion.
I realize this post is a bit incoherent - I hope not only to come back and edit it, but to provide some data, such as that time-series analysis of banking crises with capital levels if only to underscore that Basel III capital levels will not prevent a future crisis. In the mean time, I hope you enjoy these off the cuff thoughts (and email me with any thoughts on the deficiencies).
The other, though I'm still working through it, is This Time is Different. Part of the reason it is a slog is the very reason is it so rewarding - the loads of quantitative data and segways discovered, such as India's share of world GDP declining between 1913 and 1990 (though why that table didn't have 2007 figures is unknown to me). Debt intolerance though seems to be a main part of the book, the notion that certain governments have higher debt intolerance than others, and hence while one government can withstand a certain amount of debt to GDP, another can not withstand that same amount. Mental-model wise, it is very interesting to discover this in the quantitative data; and even more interesting to connect it qualitatively to the narrative of history in Walter Russell Mead's God and Gold, which offers a pretty good explanation of the rise of Anglo-Saxon institutions that have resulted in those countries having very strong financial systems that are debt tolerant (it may not seem like we have a strong financial system, on an absolute basis, based on the past crisis, but relatively speaking we do compared to non Anglo-Saxon countries). One of Reinhart and Rogoff's tables show that none of the colonial (as opposed to imperialist era holdings like India, South Africa and Zimbabwe) Anglo-Saxon spinoffs (Canada, Australia, New Zealand, and the United States) have explicitly defaulted on debt - we're very debt tolerant, a blessing for people needing to buy fixed income securities. (Covert defaults, including inflation, is another story, though we still fare pretty well on a relative basis.) Mead's analysis provides a good explanation of that quantitative anomaly revealed on Reinhart and Rogoff's analysis.
From a research perspective, This Time is Different reveals another curiosity - due to the lack of transparency regarding domestic debt of countries, most economic analysis of default and inflation episodes do not incorporate a discussion of domestic debt. As a result, Reinhart and Rogoff find that most analysis is seriously deficient in explanatory power of why a government would choose to default or inflate because most researchers are looking at a very incomplete picture (only external debt, which usually is less than half of the total debt of the average nation) with incorrect assumptions (that domestic debt is usually paid off in full, at face value, with no overt or covert defaults). The simple reason for this deficiency is partially that governments do not want to reveal their knickers (unfortunate because government ultimately should be accountable to their citizens) and partially that researchers might be becoming lazier. (For more on this, see Farnam Street's blog article: Does the Internet Make You Smarter or Dumber?)
And if we take a moment to engage in a thought experiment, we may be becoming even lazier as we become used to instantaneous access to information via our computers, mobile search and more. If that is the case, then any information that is not easy to find via online sources at all or online only if digging deeply (i.e page 200 of a 201 page document) will progressively become more and more ignored. Any decisions we make then will be based on even more incomplete and erroneous analysis. This is important - for example, if I remember correctly (key because I do not have the book in front of me at the moment), Reinhart and Rogoff go so far as to say that institutions advising on debt restructuring for nations are giving inadequate recommendations because of the propensity of research to improperly ignore domestic debt levels and the lack of transparency around a nation's domestic debt.
Combining the two books, I distinctly remember Kindleberger talking about capital levels throughout the 19th and 20th century at banks in the United States. Reinhart and Rogoff have a time-series analysis, I believe, of banking crises in the U.S. I think it would be quite interesting to overlay that analysis with the trend of bank capital levels from the 1800s to the present. I think it would make the case that whatever reform we're getting through Dodd-Frank and Basel III, it will only mitigate (at best ) future crises, not prevent them.
I'm including systemic risk in that assumption, by the way - I highly doubt that systemic risk buildup will be prevented by the regulators created and empowered in the legislation, since I wonder if they (or anyone) will know what the next systemic risk is. They might be fighting the last war when the next crisis comes. I'm not asserting that the systemic risk of the prior crisis was hard to discern, since investors like Jeremy Grantham, Mike Burry and others happened upon that risk, analysed it, and profited from it; I'm asserting that I find it hard to believe that the regulators will notice the systemic risk, given the prior track record, such as this remark from Bernanke in Oct 2005: "House prices have risen by nearly 25 percent over the past two years. Although speculative activity has increased in some areas, at a national level these price increases largely reflect strong economic fundamentals."
After all, if you recall, the Bank of Scotland (now part of Lloyds Banking Group) on average had an equity capital ratio of 25% during the 1700s (i.e. every $4 of loans made by the Bank of Scotland were fund by $3 of deposits or bonds sold to investors and $1 of the Bank of Scotland's money). This, shall we say, is a rather high common equity ratio, especially compared to banks today where you may see 3% common equity ratios (a lot of European banks back in 2008). And yet, when the Royal Bank of Scotland was competing against the Bank of Scotland in the early 1700s, it pretty much caused a liquidity crisis for the Bank of Scotland by buying Bank of Scotland notes and then marching into a Bank of Scotland branch to redeem those notes for payment (in gold or coinage, I think). The Bank of Scotland was forced to call loans early and suspend payments in coinage from March 1728 to September 1728. Bear in mind that there was nothing wrong with the Bank of Scotland's book of loans. They just had an inadequate supply of coinage to cover redemption of all of their currency notes in circulation (a situation the Royal Bank of Scotland probably was in too). A high equity capital ratio did not prevent a liquidity crisis, a crisis of confidence. Even a 100% equity capital ratio (meaning that the bank is not a bank, but an investment vehicle) would not prevent a liquidity crisis if the assets are not easily salable. And legislation would probably not prevent a liquidity crisis in the future. (I realize that such a liquidity crisis for a bank, as opposed to a capital markets dependent financial company, would not happen now because of the Federal Reserve, the Bank of England, and the European Central Bank each offering banks access to liquidity at need, but I think the example still relevant if only to illustrate that there are more to financial crises than just bad loans eating away at a bank's capital. Also, I felt like bragging about what I learned when touring the old Bank of Scotland headquarters in Edinburgh last summer.)
As for a quality crisis (while I do not remember the exact nomenclature, what I mean by this is that the quality of assets/loans on the bank's books are a lot more suspect than stated), a higher capital ratio means that there is more of a buffer provided by the bank's money to absorb losses on loan writedowns before impacting depositors. But if a bank is stupidly underwriting, no capital ratio will ultimately prevent it from going under. Legislation does not prevent stupidity, herding, or a race to the lowest common denominator (and lowest quality) in lending. And when banks did not have federal backstops, there were still banking crises despite the incentive of the bank owners to ensure that the bank underwrote well because if it made a bad decision, they lost their net worth. So why does anyone think that the current legislation will prevent a future crisis? Any rational person willing to take the time (i.e. not be lazy) and look at the historical record will find that to be a delusion.
I realize this post is a bit incoherent - I hope not only to come back and edit it, but to provide some data, such as that time-series analysis of banking crises with capital levels if only to underscore that Basel III capital levels will not prevent a future crisis. In the mean time, I hope you enjoy these off the cuff thoughts (and email me with any thoughts on the deficiencies).
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