Happy New Year!

Remarkable article by Mark Ames on why the New York Times' coverage of the Georgian invasion of South Ossetia was ultimately retracted.

State of the Union

This post by Mark Thoma (econ, U Oregon) reflects the typical thinking in academic econ:

Keeping the budget in balance while the economy is struggling is not good policy. If the goal is to stimulate the economy and to create new jobs, then the "clear" lesson - the advice to pay for the spending on infrastructure by raising taxes - is wrong. The new infrastructure does need to be paid for, but the time to do that is when the economy is healthy, not when it is under performing.

The "clear" lesson is, when the private sector deleverages, to maintain money supply, the Federal Government has to leverage up by running a larger deficit. In some ways, you can think of this as reversing the disintermediation between money creation (Fed) and money allocation (banks). You only want to run down the deficit if you have inflation which you want to reduce.

Note that the goal here is to increase the Federal deficit to increase money supply. Picking winners and losers via how that new money is allocated is an entirely different lesson. If you use it to prop up zombie industries (AIG, Bear Stearns, Citi, the entire financial sector, GM, Chrysler etc.) then you get no new productive capacity for this allocation. If you spend it on uselessness (infrastructure in 2008 means bridges to nowhere) then construction workers get rich, but no one else). The best, fastest way to distribute this money into the economy is to announce a payroll tax holiday that will continue until CPI starts to tick up.

Paul Krugman 12/23/08 vs Paul Krugman 12/24/08

Paul Krugman, NYTimes, 12/23/08:

...why so few economists saw the crisis coming. I think it’s a two part question.

I think it’s understandable, though not entirely forgivable, that economists didn’t see the risks of a broad financial breakdown...

The big mystery is the failure to see the housing bubble. The data screamed “bubble”, even in real time. And there was no excuse for believing that such things don’t happen in efficient markets, not with the dead body of the dot-com bubble still warm.

So why did so few people point out the obvious? ...the failure to see the most obvious bubble of my lifetime remains a puzzle.

Paul Krugman, NYTimes, 12/24/08

Keynes’s genius – a very English one – was to insist we should approach an economic system not as a morality play but as a technical challenge.

That’s the point of my favorite Keynes quote, where he declared of the Great Depression, “we have magneto trouble.”

Which Krugman is right? Do we have a bunch of shaman who have no idea what they are doing? Or a bunch of skilled engineers who are working on a well understood, technical system? Paul -- present evidence aside -- are economists shaman or engineers? Is macroeconomics and academic finance phrenology, or a science? Do we have magneto trouble, or are we trying to drive a horse?

A Player, not a Referee

An excellent post by Wretchard on how the official press is used by factions within the Government to attack each other.

Absent any widespread reconsideration of the Post’s actions during Watergate in the three years since Felt’s identity became known, the press in Washington continues to serve as a conduit for leaks of secret information. They publish this information while protecting the leakers, and therefore the leakers’ motives. Rather than being a venue for the neutral reporting of events, journalism thus becomes the arena in which political power plays are executed. What appears to be enterprising journalism is in fact a symbiotic relationship between journalists and government factions.

Remember, everything you read has been put there for a reason.

It ain't over

I had to reprint this remarkable chart (ht Barry Ritholtz)



Many remarkable things about it. Note, that from 1906 to 1940, stocks were essentially flat (with high volatility). That is Japan level abysmal-ness. The slump in the 80s also lasted about 12 years, with two sharp shocks in the middle.

The US has had a high volatility, but flat 13 years, with the near and medium term outlook decidedly gloomy. Will we have 20 years of flat, but high vol, equity prices?

The Rehabilitation of Henry Blodget

Although the Atlantic is no New York Times, this article by Henry Blodget has some really interesting quotes.

First things first: for better and worse, I have had more professional experience with financial bubbles than I would ever wish on anyone. During the dot-com episode, as you may unfortunately recall, I was a famous tech-stock analyst at Merrill Lynch. I was famous because I was on the right side of the boom through the late 1990s, when stocks were storming to record-high prices every year—Internet stocks, especially. By late 1998, I was cautioning clients that “what looks like a bubble probably is,” but this didn’t save me. Fifteen months later, I missed the top and drove my clients right over the cliff.

Later, in the smoldering aftermath, as you may also unfortunately recall, I was accused by Eliot Spitzer, then New York’s attorney general, of having hung on too long in order to curry favor with the companies I was analyzing, some of which were also Merrill banking clients. This allegation led to my banishment from the industry, though it didn’t explain why I had followed my own advice and blown my own portfolio to smithereens (more on this later).

I experienced the next bubble differently—as a journalist and homeowner. Having already learned the most obvious lesson about bubbles, which is that you don’t want to get out too late, I now discovered something nearly as obvious: you don’t want to get out too early. Figuring that the roaring housing market was just another tech-stock bubble in the making, I rushed to sell my house in 2003—only to watch its price nearly double over the next three years. I also predicted the demise of the Manhattan real-estate market on the cover of New York magazine in 2005. Prices are finally falling now, in 2008, but they’re still well above where they were then.

Housing prices are still well above their pre-bubble levels, and already the US Government is shifting huge amounts of money from those who have some, to those who spent it on houses, leaving those who stayed out of housing when the bubble was forming completely high and dry. Yes, they are being "priced out forever" but the culprit is not "all of us".

Ponzi Economy

While Bernie Madoff was wrong to break the law and cheat wealthy, gullible people out of their money (and should be thrown in prison), Krugman's analogy between Madoff and the American Economy is Grade A CYA.

Yet surely I’m not the only person to ask the obvious question: How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?

The financial services industry has claimed an ever-growing share of the nation’s income over the past generation, making the people who run the industry incredibly rich. Yet, at this point, it looks as if much of the industry has been destroying value, not creating it. And it’s not just a matter of money: the vast riches achieved by those who managed other people’s money have had a corrupting effect on our society as a whole.

The same could be said for the trades of academic finance and macroeconomics, graduates of which fill the nation's universities, government departments, and yes, banks. Bernie's fraud was of the straightforward kind, and while $50B is no small sum, it is still a trifle compared to the $6T or so (and counting) in real wealth destroyed by the fraud that is Academic Finance and Macroeconomics.

The $6T loss was not caused by anyone breaking the law, it was caused by a system which is fundamentally, structurally unsound. And the people in charge with studying and designing this system had no clue. But the same individuals who had no idea what was going on pontificate at length -- after the fact -- about what went wrong, how to fix it, and who the winners and losers should be. It makes me nostalgic for Bernie.

Ford SmartGauge Instument Panel

For those who like cars and customer experience, it's worth checking out this demo on the new Ford SmartGauge Instrument Panel. Essentially, two high-def LCD panels make up the core part of the dash where the speedo and other instruments sit. The video has a nice walkthrough.

Some comments.

The initial experience is nice -- you unlock the car from your remote keyfob, and the interior is bathed in blue light. Makes it easy to find your car in a dark parking lot, and is also simply cool.


Once you are in the car, but have not put in the key, the blue panels are replaced with a cheesy grass and blue sky image. This looks too much like Windows booting up to me, but I don't think it's a big negative.


The nicest moment is when you turn the car on. The instrument panel visually unfolds, and the red speedo needle cranks all the way clockwise, before returning to zero. The effect is quite beautiful, and for those into performance cars, having the needles in the gauges crank over and settle back is a really nice touch. This is my favorite part.



As for the instrument panel itself, I'm mixed. I think that things like the temp readout should be hidden. Most people do not care what temp their car is, they only want to know if it's overheating, and whether or not the heater will work. There are much better ways to do both of these. Also, the warning lights are the same tiny, incomprehensible icons. Again, given the flexibility of the new display, Ford could do better.

I like how there are both a fuel and battery level indicators, and while there are elements of the graphic design I don't love, I think they work well. The charging/discharging affordance on the battery indicator is discrete and efficient, as is the amber/yellow/red low fuel light warning system on the fuel gauge.

The immediate feedback you get on your economy will motivate people to hypermile, which I think is a good thing, and so I would make this even clearer. I understand what they were trying to do with the long term fuel economy reading (the plant on the right) but I'm not sure I love the final executive. That said, I'm sure this was something that design fought long and hard for, so we'll have to see how it works in the real world.

Austrians vs Keynes

A little bit of cognitive dissonance for me at Marginal Revolution. Tyler Cowen, who is plugging through GT, says:

Keynes admits that with economic development labor gets very specialized, or very closely connected to particular capital goods, so yes there are capital complementarities of the Austrian kind. But Keynes thinks such fragilities will only help his argument, while rendering the analytics too messy. He declares his intention to proceed with homogeneous magnitudes of capital and labor.

This chapter often fails to receive its proper due; it is very important for understanding the location of Keynes in the history of economic thought.

With this one chapter, Austrian capital theory falls off the map.

Austrian capital theory certainly did fall off the map, but there is clearly nothing in Keynes GT that pushed it. If you can find an actual argument for why capital complementarities with labor can be brushed over, please also tell me how the Government giving money to ditch diggers will help unemployed investment bankers.

For another perspective on why Austrian capital theory "fell" off the map, you can check out Rothbard's biography of Keynes (pdf). If the crappy models aren't bad enough for you, then you can always read about the person himself.

Zombie infrastructure

If John Maynard Keynes had lived during a period of high labor specialization, and high Federal taxes on labor, he would not have recommended "digging a ditch and filling it up again" as a useful target of deficit spending during a recession. Under Keynes' GT, the goal is to increase aggregate demand by increasing the Federal deficit, and this can be done through lower taxes, higher spending, or both. The key is to raise the deficit as quickly as possible in ways that also increase real goods and services available to the economy. In Keynes times, this was hiring men to work the land with shovels.

Fast forward to 2008, aggregate demand is falling, and the Government wants to run deficits to boost it. So, academic economists, who have never had to make a payroll never mind handle a shovel, dust off their old copies of the General Theory, and parrot back "infrastructure spending". "Infrastructure spending" has become this talismanic utterance, bested only by the more potent phrase "shovel-ready infrastructure spending", that if repeated often enough will result in magical economic growth.

Japan has tried this for the past 20 years, and failed. The US is going down the same path as Japan by propping up zombie firms, and expanding the monetary base in half hearted ways which do not, net, increase aggregate demand or increase the amount of real goods and services available in the economy.

If Keynes was alive today he would not call for "infrastructure spending", he would call for the Government to pick up the tab for FICA taxes, and to keep picking this up until CPI began to tick up in a serious way.

Not so NICE

Fantastic article on NICE, the UK agency that determines whether a given medical treatment is worth its price or not.

A clinical trial showed that the pill, called Sutent, delays cancer progression for six months at an estimated treatment cost of $54,000.

But at that price, Mr. Hardy’s life is not worth prolonging, according to a British government agency, the National Institute for Health and Clinical Excellence. The institute, known as NICE, has decided that Britain, except in rare cases, can afford only £15,000, or about $22,750, to save six months of a citizen’s life.

But this makes no sense:

Britain’s National Health Service provides 95 percent of the nation’s care from an annual budget, so paying for costly treatments means less money for, say, sick children. Before NICE, hospitals and clinics often came to different decisions about which drugs to buy, creating geographic disparities in care that led to outrage. (Such disparities are common in the United States, even for federal Medicare patients.)

Sick children provide excellent return on investment for treatments. A positive intervention in a child can yield years of benefits. Why don't children always win?

After consulting a citizens group, the institute decided that the nation should spend the same amount saving or improving the life of a 75-year-old smoker as it would a 5-year-old.

Ah, that makes sense. It is also highly informative about the value of consulting citizens' groups.

Does not understand Federal Reserve Banking

Brad DeLong, like all macroeconomists I've ever met, has no understanding of Federal Reserve banking, fiat money economics, or Mises. Mises was thrown under the bus a long time ago, but not getting 1) and 2) is like a physician not knowing about bacteria and viruses. Check out this reaction to Mises

Mises says:

"[T]he gold standard appears as an indispensible element of the body of constitutional guarantees that make the system of representative government function.... What the foes of the gold standard are asking for is... to intensify very considerably the already-prevailing upward trend of prices and wages.... Such a policy of radical inflationism is, of course, extremely popular.... How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's treasury department! The government, professors tell us, 'can raise all the money it needs by printing it'[1]. Taxes for revenue, announced a chairman of the Federal Reserve Bank of New York, are 'obsolete'[2]. How wonderful!... Eventually... the cleverly-concocted plans of inflation collapse. Whatever compliant government economists may have said, inflationism is not a monetary policy that can be considered as an alternative to a sound-money policy...."

DeLong responds:

this citation to Beardsley Ruml's "Taxes for Revenue Are Obsolete" is a gross and illegitimate distortion.

Ruml writes that while state and local governments must ultimately raise all the money to finance their spending through taxation, the federal government has extra freedom of action because of "the elimination, for domestic purposes, of the convertibility of the currency into gold." How should the government use this freedom of action? The first of the policy considerations it should have in mind, Beardsley Ruml says, is: "Do we want a dollar with reasonably stable purchasing power over the years?... [T]he most important single purpose ot be served by the imposition of federal taxes is the maintenance of a dollar which has stable purchasing power.... [W]ithout the use of federal taxation all other means of [price] stabilization... monetary policy... price controls... subsidies, are unavailing..." That is the opposite of what von Mises wants his readers to think Ruml's meaning is.

But both Ruml and Mises are right, DeLong is wrong. State and local governments are currency users, not currency issuers, so they must raise all their money to finance spending through taxation. The Federal Government is unique in that it is a currency issuer, and so does not need to finance spending through taxation, it can simply create the money ex nihilo. So why tax at all? Most importantly, the Federal Government must tax to create demand for the fiat currency it, and it alone, can create. There is one simple reason why my region of NorCal does not run on winterspeakBucks, and it has everything to do with the size of my standing army, and nothing to do with my ability to print out little pieces of paper with "N winterspeakBucks" written on them.

The secondary reason to tax is to reduce aggregate demand, and so keep the money supply from growing too much faster than the real quantity of goods and services in the economy (which would show up in the CPI as inflation). I cite this as a secondary reason because there are many ways to control money supply, including interest rates, deficit spending, etc. But please note, at no point does the Federal Government need to tax in order to spend. The Fed spends first, and then taxes to sterilize that increase in money supply.

So, Ruml is saying that the Fed needs to tax to create demand for fiat money, and then tax again to reduce aggregate demand and take the quantity of fiat money available in excess of that required for private saving, out of the system. Only in a fiat money system can the Fed control money supply. Compare and contrast this with third world countries who are unable to tax, and unable to have all the economic activity in their country be in their local currencies.

Mises is saying that politics, being what it is, will not control money supply wisely or well, that the incentive to create extra money and give it to favored interests is too great, and it will all end in hyperinflation which debases the currency entirely. Best to take it out of Government hands and have a fixed money supply, which in a world of rising productivity would result in an environment of mild and continuos deflation.

They are both exactly right. Taxation is central to generating fiat currency, and controlling inflation. And government has been unable to resist ultimately hyper-inflating fiat currency. The US$ has lost well over 90% of its value over three generations, which is not hyperinflation but it's certainly not a "stable source of value" either. Harvard economists are calling for 6% inflation for two years as if inflation can be turned on, and then turned off so easily. Volker raised interest rates to 20% to stop inflation in the 70s, a feat that seems impossible in the 21st century's political climate where even millionaire investment bankers cannot be allowed to become redundant, even for a few weeks.

Brad DeLong, however, Macroeconomist, writer for the NYTimes, Obama cabinet hopeful, clearly does not understand Austrian economics, which is forgivable given they were excommunicated from the Temple long before DeLong went to grad school, but sad since some of their ideas are not only brilliant, but also correct. What is not forgivable is that DeLong also does not understand Federal Reserve Banking, which is an indictment of him, and his profession.