David Robertus's Open Salon Blog

Push on a string or pull on a rope

Fri, 26 Aug 2011 13:08:14 -0400

The Fed is not going to save us from this economic contraction. It can't. It has done everything conceivable to prevent things from getting worse by buying government debt and at one point backing essentially the entire commercial paper market (might still be for all we know). If the economy was going to spring to life from monetary action it would be sprinting and tap dancing.

UNLESS...

the economy is in a different mode from what it has been in since the end of World War II. Which it is. An economy operates in two different modes. Normally, when things are going well, the intent is to maximize profits (if you are a company) by expanding production or utility (if you are a consumer) by buying and taking on consumer debt in the form of credit and loans.

But there is another mode- instead of maximizing profit/utility the current mode (again, not seen in the US since the Great Depression) is to minimize debt. This insight, made by Richard Koo from his analysis of the Japanese economy and the Great Depression, aligns perfectly with the behavior we are seeing now. The Fed, now as in the 30's is in a position where it can make the situation worse by forcing further contraction, but cannot drive expansion. like a string, you can pull on it, but can not push against it.

The reason is simple- if you are leveraged to the hilt as a consumer, and someone offers you another loan the only reason you would take it (sensibly) is if you could refinance an existing loan at a lower interest rate. And if you are unemployed then your options are even more limited. Businesses are in the same boat, particularly in the banking sector. Bank of America is hesitant to make loans because it needs all the cash it can hold on to, after all, the bad loans it made (or Countrywide made) need to be written down, and the last thing it needs on its books is more risk. So companies and households hoard cash.

What sector is left to push the economy forward? You guessed it- government. And here's the most infuriating part of that- all through the '00s the government should have been battening down the hatches against debt and instead it fanned the flames with regressive tax cuts, two wars, and deregulating the finance industry to allow it to expand leverage (debt) by using peoples savings as collateral.

Its no wonder that trust in government is so low, but here is another grain of salt to rub into the mood. In this day and age if you don't have the backing and protection of a strong central government then you are going to lose on the global stage. If you think small government is better and no government is best, then take a look at Somalia. If you think bigger stronger government is worse then look at China.

I know, I know- every Tea Party whiner will cry about "government spending" and "wasteful spending". You think the private sector isn't wasteful? I think HP just blew billions of dollars on its WebOS investment. I've worked at firms where rivers of money flow off cliffs, so it is foolish to pretend that governments are always wasteful and the private sector isn't.

Finally, there is a difference, and a crucial difference, between spending and INVESTING. Instead of an economy where people buy trinkets and cheap imported shoes and too much sugary snacks at the level of the retail environment (buying imported crap) there is an alternative. Is is perfectly viable to have an economy driven by spending on infrastructure investment that promotes a virtuous cycle of domestic spending on steel and concrete to repair and replace our crumbling highways and bridges, make trains and rail lines, high density housing and water and sewage systems, fiber optic cable for improved telecom, and the jobs and worker skills needed for all of that.

Its our collective choice, America- a third world lifestyle buying someone else's cheesy exports or get a decent tax structure in place, control the waste in our healthcare system (socialize it) and rebuild the country our grandparents built that made this country great. And if you DO need a new BluRay player you might pay a little more, but at least you are more likely to have a job to pay for it in the first place.

The Libertarian "Blind-spot"

Mon, 21 Feb 2011 10:02:43 -0500

I know quite a few Libertarians. A disproportionate number of them are small business owners, savvy, or at least more entrepreneurial than most people I know. I have come to recognize what seems to be a blind spot, of sorts, in their economic view point that I was at a loss to understand. Recently, though, I read an article which has really helped me gain in insight into their perspective.

First, let me describe the blind spot. On a micro-economic level, basically the ability to run a business, Libertarians generally come across as being just about spot on. They know the tax code, how to benefit from it, how to pick a good locale for a business, inventory management, marketing, you name it. But at the macro-economic scale, anything above the scale of a business, their logic seems to break down. One example seems to be economy of scale. In a southwestern city there was a single contractor for garbage collection, and, the Libertarian argument went, this led to higher costs due to lack of competition. Now if you follow the pure, free market assumption, this must be true. But it makes a simple error by over looking fixed costs. In order to get the lowest cost for city-wide garbage collection, you need to have the lowest per unit cost of collecting it. IF you have one agency (public or private doing the work) then you can minimize the amount of machinery, management, facilities for parking, logistics, and so on. Assuming that the costs for these fixed expenses are kept minimal, then the cost will certainly be lower than having multiple agencies, each needing to separately perform these tasks. TO extend the nature of the blind-spot the Libertarian proposal would not have sectioned up the city but allowed individual households to select their collector. This would introduce inefficient variable costs as well since you would certainly have different agencies running vehicles down the same general routes, each vehicle burning fuel and each vehicle being driven by a worker who is paid hourly.

Given how obvious it is that the free-market approach can not possibly produce the lowest overall cost as the regulated monopoly approach, why then would intelligent people make the assessment to the contrary? Here I think the nature of the blind-spot reveals itself. It is ideological, in a manner of speaking, but is mostly driven from a point of view. If you are an entrepreneur or small business owner, then allowing every household to select their service levels the playing field and allows entry into markets rather than selecting a single provider.

The Libertarian mindset mindset wants lower ease of entry into these closed markets AND fears that corruption (and hence inefficiency) inevitably emerge from having a locked-in provider. And there is ample evidence of the this unfairness in many cases. You see this evidenced in the number of government employees who have retirement benefits that are simply unjustifiable. All in all I think that many civil servants are underpaid- teachers, policemen, and so on (although their pension plans, supposedly to make up for being underpaid, are certainly far too generous in many cases). I think it is these examples of corruption (for lack of a better word) that Libertarians are effectively coming out against. The economic argument of efficiency clearly falls flat. But when you translate it to an ideological outcry against corruption, the nature of the Libertarian "blind-spot" becomes very much clearer and very much more understandable.

The fact that this perspective has emerged (articulated or otherwise) is a sad commentary on the level of trust that government has amongst a large fraction of the population.

Books Revisited Review

Wed, 21 Apr 2010 18:04:54 -0400

I have always found the value of book reviews to be limited to the kind of book being reviewed. A review of fiction is probably as good one day as the next. Nonfiction, and in this case economics, is another matter. I've decided to read books from years ago and see if they stand the test of time. I picked "Everything for Sale" by Robert Kuttner from 1996, and "Generational Accounting" from 1993 by Laurence Kotlikoff. As I am not the best at this kind of thing, I've broken the reviews into four sections- the good, the bad, the ugly, and the memorable. I think you can guess the nature of the first three, but the fourth is specific to the things that stuck out and make it stand the test of time in some way (or not).

Everything For Sale: The Virtues and Limits of Markets by Robert Kuttner

The Good

No matter your view of Kutters philosophical orientation, the guy can write. This is an excellent work that with 20/20 hindsight provided by 14+ years of history hits the nail on the head at almost every turn. He starts with an over view of what it means to be economically efficient, and gives the three measures- Smithian, Keynsian, and Shumpterian (allocative/micro-economic, distributive/macro-economic, and innovative/monopolistic). He focuses on three markets- labor, health care, and financial markets. The second two REALLY stand out, perhaps because labor markets have not exploded and dragged the nation into the worst recession since the 1930's. He examines in detail the reasons that a free-market approach can not provide a coherent efficient health care system. If he thought the health care situation was bad in '96 then he must have been nauseas by February 2010. His section on financial markets was written at a very telling time- it was just before the repeal of Glass-Steagel, which he described as the last remaining pillar of financial regulation.

The Bad

This is actaully the hardest part of this entire review to write. Read it yourself and if you find something that deserves mention here, let me know and I'll post it, 'cause I'm essentially at a loss. Oh, here's one- could be shorter. I have two kids and no time, so help me out here, Rob!

The Ugly

Dust jacket was marred with chewing gum- damn kids!

The Memorable

Basically everything he predicted would happen in the financial markets came to pass so for those of you saying the economic crisis of the recent past was not forseeable should read this and let it sink in.

If you were lost in the health care debate and wonder why over haul is really necessary, just know this- public health is an "indivisible public good". And competitive markets don't function well in those areas. Regulated oligopolies/monopolies, ideally at a national/societal level are most efficient.

The section on government intervention in R&D should be mandatory reading for all members of Congress. Those who disagree with the conclusions should be impeached as they are too ideologically stubborn to assist the nation in any meaningful way.

Generational Accounting: Knowing Who Pays, and When, for What We Spend by Laurence Kotlikoff.

The Good
There is an excellent chart showing what age cohort can (as of the time of writing and under the expected policies at that time) expect to pay out, or receive in surplus benefits, over their expected life times. This is an immense achievement. There should be an updated version of this chart made after every congressional session that is posted online and mailed with your Social Security Benefits each year. And a big version of it should be posted outside the House and Senate that the member walk by when they enter and leave chambers.

The Bad

Kotlikoff is a heck of an accountant. But his writing style leaves much to be desired- he says up front that his editor was invaluable but I think another over hal was necessary. Typos, misstatements abound. The worst part is that he will often write out a long stretch of what current deficit measures fail to do, but waits until much much later to say what they DO show and offers an alternative view. He spends too little time on the mechanics of his results, so his chart is not reproducible. No algorithms or techniques are laid out, which is a shame, as such a section could be an excellent textbook.

The Ugly

Quite a bit- Kotlikoff fails to leave his emotions a the door for his writing. He obviously has (or had) contempt for the accounting techniques of Washington and the emotions clearly take over part of his writing. He forgets that his audience is trying to learn how generational accounting works, not that the existing approach has negative consequences. His anger is quite understandable when you get to the chart about net payments/receipts, and I'll bet hasn't been mitigated given that over the last 17 years the chart probably doesn't show an improving prospect for his cohort (or anyone else's for that matter).

The Memorable

At one point Kotlikoff writes "...later this decade [meaning the 90's] we will have a large budget surplus... the difficulty will be preventing politicians from spending it." So, later in the 90's we get the substantial budget surplus and then in 2001 Bush spends the whole schmeer on tax cuts for the rich.

The best part of this book is how he shows that the stated deficit is a useless number to measure as it is skewed by simple naming convention. His example is quite brilliant- Social Security. If one country says "we tax our workers and pay retirees" and another says "we take out loans for each worker and pay that loan back with interest to each worker" both have exactly the same effect, but they show radically different deficits. The book is worth it just for learning this.

Why the Health Care Bill Will Make the Market Work

Mon, 22 Mar 2010 11:03:35 -0400

The health care bill passed last night, and I have to admit I was initially indifferent, the main reason being that I honestly didn't expect it to pass so I had largely ignored it. Last night I delved into the thing. All crying in the beer aside, this bill is (probably) going to take a huge step towards making health care reasonably efficient for two reasons- 1) it makes a open system into a closed one, and 2) it will push insurers to follow the old maxim of "an ounce of prevention is worth a pound of cure" as a result of the switch to a closed system.

A closed system HAS to be efficient. Basically a closed system says that you will eat what you... ummm... excrete. In an open system if your company or activities produce waste you just drop it into a stream call it a day. In a closed system you live downstream from that plant and your wife will beat you senseless if you ruin her laundry with your mine tailings. How does this translate to health care? Well, we have a marvelous example in place in the US system (or did until Sunday). Let's say you are a health insurer. You're motivation as a private firm is to maximize profits. To do this you minimize costs and maximize income. A person with a pre-existing condition (let's say blood pressure issues) buys health insurance from your firm but you don't want to cover the cost of the blood-pressure meds they needs. This person can't afford the meds without the coverage, so they go without it. As a result they have a little incident followed by a pricey ambulance ride and a trip to the even pricier Emergency Room. Well, that's a BIG expense if you are an insurer, and it was caused by a pre-existing condition. What do you do? Well, better drop their coverage! Whew- problem solved and profits maximized. Except for one thing- the problem has just been shifted from your part of the health care system into a larger arena. Your former client goes bankrupt since they can't work, the hospital that treated her takes on a ton of debt since it can't recoup the expenses in treating her and now she's on Medicaid and a problem for the taxpayers, not you, the private insurer.

Now lets look at a closed system. You are the same health insurer, but you can't preclude a customer for a pre-existing condition nor can you drop them if they have an actual health care problem. Compared to the first scenario you might say "Whoa! I'm not going to make any money!". However, all your competitors face the same constraints, so the playing field is still level. The difference is that now I have to find a way to actually provide health care to this person that will minimize costs. The same customer comes to me and buys my health insurance. Hmmm- if this person doesn't take blood pressure medicine then I'm going to be on the hook for an ambulance ride, plus an ER visit. So, if I want to maximize my profits and reduce my risks I should make sure this person gets some decent medication that will deal with her blood pressure issues in the short and long run , and see if there is some kind of wellness program I can recommend to her to reduce her need for those meds and overall risk of related ailments.

By making the health care system closed rather than open the health care bill has created an incentive for insurers to try and provide the best possible service at the lowest possible cost, which is exactly how the free market system should work. The old system was so broken because it was an open system; it was a mix of private and public efforts with the private trying to absorb the income and pass on the expenses to the public.

I understand the beef the conservatives have with this law- it doesn't address costs, right? Not directly, but it does something even better- it creates an incentive for private companies rather that the government to address costs.

Inefficient Statistics: Inflation, the Fed, and the Bubbles

Thu, 9 Jul 2009 12:07:07 -0400

The Efficient Economist

Inefficient Statistics: Inflation, the Fed, and the Bubble Economy

Asset bubbles have been familiar in the American economy for over a century, but over the last several decades they have gained new prominence. During these years inflation has also been near a historic low, and the Fed, especially under Allen Greenspan, took the credit, at least until the bubbles burst, notably after the "dot-com" stock market bubble and particularly after the bursting of the housing bubble. But this raises an interesting question- how could inflation be so low during times of rapidly rising prices? Housing, which represents a quarter of the Consumer Price Index (a third if all components of housing are included) saw prices nearly double on a national level, and yet tis huge increase was never reflected in the inflation rate, and money was kept cheap and poured into the sector.

An asset bubble is supposedly an abomination to a perfectly efficient market- it means that people are investing resources into assets that are over priced. Proponents of the idea that markets are optimally efficient usually find a way to skirt around this point, but the simple fact is that people drive bubbles and people are driven by emotion, greed, and irrational expectations. The efficient economist wants to find a way to prevent these irrational bubbles without expensive (and often easily bypassed) regulation that can impede other market mechanisms that ARE efficient. To do that we have to see what it is our economic system that allows these bubbles to form in the first place. So lets start with the Fed.

The Federal Reserve is the national (in many regards the global) central bank. Among its jobs are setting the over night lending rate and defending the value of the currency. Setting the over night rate is key- most longer term rates are tied directly or indirectly to this rate. The rate is also an aspect of defending the currency- a higher rate means a higher rate of return for lending money to the US financial system (or paying more for borrowing dollars). Fighting or preventing a high rate of inflation is the first job of the Fed in defending the dollar. When prices start to rise the response of a currency defending Fed should be interest rate hikes.

But what if prices can rise that are invisible to the Fed? The Fed has a range of tools and measures to calculate inflation which it uses to set interest rate policy. Here is a simple fact of economics- it is not as hard a science as economists would like it to be (particularly quantitative economists) and the tools and measurements used to calculate inflation have aspects to them that are quite subjective. This subjectivity takes several forms- what prices are included in the index and what are left out and how much a price is "weighed" in the overall calculation, and finally how a price is actually measured.

Over the years these tools and measures have been tweaked and modified as the central bank has attempted to get a grip on how best to measure inflation in an economy that has a constant churn of products, technologies, consumer behaviors and preferences, and economic structures. Health care, for example, is under weighed in the measure of inflation. It accounts for only 6% of the weight of the CPI even though it accounts for nearly a fifth of GDP. There is no measure of inflation is the stock market, even though a large fraction of consumers buy stocks and other equities through mutual funds and retirement accounts with every paycheck. And housing. Housing is measured by what is called "Owner equivalent rent". What this means is that the monthly cost of housing is not measured by the mortgage payments, but what price comparable housing would cost to rent. This belies a simple fact- buyers and renters do not compete in the same market. The inefficiency of the measure is, over the past few years, quite apparent- housing prices can double, but if rental rates do not follow suit the resulting measure of inflation in the housing market (or "shelter" as it is referred to in the CPI) is flat. (On another note, the use of "substitution" in computing inflation, ie- switching from the cost of beef to the cost of chicken, is not a real measure of inflation in any meaningful way. It is essentially a way to say that so long as the American consumer will continually allow for a diminishing quality of life he or she will not have to read that inflation is higher than might be politically comfortable).

So here we have the Federal Reserve, defender of the American currency and inflation watchdog, keeping guard with what are some rather large blind spots. In these blind spots inflationary pressures can rise up in the form of price (or asset) bubbles that for a while give a positive economic spin to what is in fact an underlying econometric weakness. When these bubbles burst the result is lost investment capital, an a re-allocation of economic resources to more efficient and productive uses that must try and make up for the capital lost to the bubble and earn a decent return on top of it (lately though, money has gone into anther bubble, there by exacerbating the process). This is not only inefficient but expensive, wasteful and destructive.

So, the efficient economist would like a solution that can kill as many birds with as few stones as possible. In this scenario, the solution is obvious.

The measure of inflation must be expanded to include those aspects of the economy that have seen inflationary price bubbles. Housing prices must be accommodated more robustly to move beyond the easy to measure "owner equivalent rent" to include purchase costs. A new component should be added (or a separate index created) to measure inflation in the stock market.

This, though, is still a less than efficient solution to preventing bubbles in the economy. The efficient economist would ideally like to see interest rates tied to the rate of inflation that is present in a particular market rather than to the inflation rate of the whole economy. If housing prices are booming in Maine then interest rates on home loans in Maine should ratchet up while those else where reflect their own local scenarios.

The case for a more flexible interest rates runs into a number of legal issues. Speculators, as well as legitimate suppliers and developers, will argue that such an arrangement runs against their legal rights to profit. The best counter I can see to this complaint would be along these lines: If you were sharing a boat with another person, would you want to protect their right to profit by selling the the planks? At some point the protection of the greater good must outweigh that of individual benefit, and those involved in speculation as opposed to actual development and value-added economic activity should be kept on a shorter financial leash, if not for their own sake than for that of their clients.

resources: http://www.bls.gov/cpi