Tag: economics

Swamp Rat is more than a little impatient:

I know you’re not an ordinary boob, but that doesn’t necessarily mean that you’re not a boob. I’m willing to concede the possibility that I don’t understand your criticism. Perhaps you can spell it out for me and those like me more clearly.

The vast majority of people either do not grasp the concept of CA or reject it as counter-intuitive, but all schools of economic thought (save Marxian) embrace it. That doesn’t mean it’s valid of course, but you need to do more than express vague doubts if you want to be taken seriously by anyone outside of your fan club.

Specifically where do these economists go wrong and why do you think so?

It’s true that the vast majority of people don’t understand Comparative Advantage, but that’s mostly because so few people have ever read Ricardo. I have to point out how tiresome and ridiculous it is when people nonsensically assert that relatively simple and straightforward concepts, such as science, evolution by natural selection, or comparative advantage, are somehow beyond the capacity of anyone known to possess both the relevant information and the sufficient intelligence to understand them due to some ineffable magic qualities that no one is ever able to identify. Now, I suppose it is theoretically possible that I don’t understand Ricardo despite having proved my grasp of Smith, Marx, Keynes, Friedman, Mises, and Hayek beyond any reasonable doubt, but I doubt even my most vehement critics would consider it to be likely.

That being said, I don’t expect anyone to take my criticism of Comparative Advantage seriously at this point, due to the fact that I have not yet articulated it in any substantive manner. I know Swamp Rat can’t possibly understand it because he doesn’t know what it is. I am quite confident that he will understand it when I publish it; whether he agrees or not will depend upon how convincing a case I am able to present. The extent of what I have only described as my “increasing skepticism” and “budding criticism” of free trade is a single column in which I described some of growing doubts about a concept I have never seriously questioned in 25 years of reading about economics. (It’s in the archives, written sometime last year.)

In the meantime, there is no shortage of economic data to demonstrate that free trade is not strongly correlated with either economic growth or higher incomes for U.S. workers. (It has clearly benefited Korean, Taiwanese, and Chinese workers, but therein lies one seed of my criticism.) The U.S. indubitably engages in freer trade now than it did in the 1960s, and yet GDP growth rates are lower and average wages have been declining since 1973. There are certainly other factors involved, but the obvious indication is that whatever the positive aspects of CA might be, they are being observably outweighed by these other factors. I had hoped to write a fourth appendix addressing Ricardo’s theory in RGD, but I simply ran out of time. As I’m still in the process of working through some of the problems, it may be a little while before I’m able to post a substantive criticism here. But as many of my critics have learned, the fact that I am not ready to present a case should never be confused with the idea that I don’t have a strong one or notion that what I will eventually present is going to be largely the same as the cases that have been made previously by others.

Speaking of economics, here is a link to yesterday’s interview with Mike McSorley, in which CA may or may not have come up. I’m sorry that I’m not sure, but to be honest, with all these interviews, I’m finding it difficult to keep straight with whom I discussed what. I’m a little disappointed that I didn’t realize the new third-quarter total credit market debt number was released by the Fed yesterday. At $52617.3 billion, it shows that total credit has been essentially flat since Q4 2008; it’s down half a percent in 2009.

This means that the debt-deleveraging process has barely gotten started despite the 8-percent decline in bank credit. This puts total Debt/GDP at 369 percent, as the latest GDP revision has current dollar GDP at $14,266.3 billion

You may recall that I warned you to expect further revisions to the third quarter GDP numbers. Japan’s massive reduction of reported growth won’t be the last:

Japan’s Government today hit the Tokyo market with a “ridiculous” revision of its previous estimates for third-quarter gross domestic product (GDP), effectively admitting that the country’s economic rebound may have been only a mirage. The new figures revealed a misreading of corporate investment, which, it now emerges, shrank rather than grew between July and September. There was a similar confusion over deflation, with new numbers showing that the GDP deflator fell 0.5 per cent in the quarter, rather than rising 0.2 per cent as previously reported.

As a result, GDP rose by 1.3 per cent in the third quarter, compared with the previous estimate of 4.8 per cent.

In fact, I won’t be the least bit surprised if the numbers eventually turn negative over time. Remember, GDP is simply an abstract estimate, and as such, it is less important than unemployment. Although you’d be forgiven for thinking otherwise courtesy of the statistical obsessions of modern Keynesians, Keynes’s master work was not actually the general theory of GDP, CPI, and the targeted discount rate. There has not been any economic growth; since GDP measures government spending, all of the “growth” that has been reported is nothing more than the stimulus spending. In fact, if you compare the amount of the spending to the amount of the reported growth, you’ll soon see that a) the numbers don’t add up, and, b) if they did add up, (i.e. if the entire amount of government spending was included in the GDP equations), then the economy is contracting much faster than would seem possible.

The 0.2% decline in U3 unemployment isn’t necessarily the good thing it is commonly assumed to be:

Mara Proctor used to design limestone hearths and columns for luxury homes near Kansas City, drawing on her college education and six years of training. These days, she’s leading customers around a store that sells sculptured snowmen and Santa figurines. It isn’t by choice. Until a few weeks ago, Proctor was among the record 5.9 million Americans who have been jobless for at least six months. Now she belongs to a subset of that group: Out-of-work professionals and managers, engineers and teachers who have turned, in desperation, to holiday-season jobs as sales clerks.

Retailers report a surge in applications this year from professionals who had never applied for such jobs before.

As Pat Buchanan points out, it is insane to import 1.5 million immigrants when tens of millions of citizens are already out of work. Or rather, it is insane to do so if you have any interest at all in the well-being of the citizenry. On the other hand, since education is deemed to be so important, it’s obviously beneficial to the buyers of sculptured snowmen to have such a highly trained saleswoman at their service.

This is also the result of the higher education bubble. I don’t remember who said it, but he was correct in pointing out that expanding higher education to the masses doesn’t mean that you won’t have sales clerks any more, it simply means that you’ll have sales clerks with PhDs. As always, it’s about the supply and demand, and impoverished immigrants will always win out over middle class Americans for the simple reason that they will accept a lower wage. One thing the Ricardians always fail to recognize is that the benefit to the overall economic system from free trade does NOT accrue to those parties who were previously at an overwhelming advantage.

I expect the fears of a Dubai World default to be the first indication of many debt-deflationary shocks to come. The reason for what would appear to be a big overreaction to what is a relatively small problem is that everyone who is anyone in the financial world is thinking that if the legendary sovereign fund of Dubai can’t afford to service its debts, then who possibly can?

On Wednesday, Dubai World, the government investment company behind some of the emirate’s most ambitious projects, said it was seeking to delay repayment on a tranche of its debt.

The company has $60bn (£35.9bn) of liabilities from its various companies including Nakheel, the property firm behind the Palm Jumeirah, the world’s biggest artificial island, and the Nakheel Tower, the world’s tallest building at 1km high. It also owns DP World, the ports operator that bought P&O Ferries. Nakheel is due to make a $3.52bn Islamic bond repayment, plus charges, on December 14. The company also unveiled a restructuring programme, to be headed by Aidan Birkett, Deloitte’s managing partner for corporate finance.

Traders feared that the request for a six-month standstill was a sign that the Dubai Government was struggling with its other debts – and that the full impact of the financial crisis globally may not yet be over.

As I wrote at the beginning of RGD, it is not over. It has only begun. It may be worthwhile to remember that Austria’s Creditanstalt bank didn’t declare bankruptcy until May 1931, 19 months after Black Tuesday. It has been less than 14 months since the U.S. Congress created the Office of Financial Stability in order to establish the Troubled Asset Relief Program.

Or are they just that predictable?

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.8 percent in the third quarter of 2009, (that is, from the second quarter to the third quarter), according to the “second” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP decreased 0.7 percent. The GDP estimate released today is based on more complete source data than were available for the “advance” estimate issued last month. In the advance estimate, the increase in real GDP was 3.5 percent (see “Revisions” on page 3).

You may recall my warning that the 3.5 percent figure in the Advance report would be revised downward on the day it was published. Now, according to the BEA’s newly revised estimate, only 1.3 percent of GDP growth was NOT provided by Cash for Clunkers. So, if you consider the even larger stimulus provided by the $8k housing credit, which is not separately accounted for, it is quite obvious that economic activity is still contracting even if the GDP statistic is not. This won’t be the last revision for 3Q09… and I’m not talking about the scheduled third report, formerly known as the Final one, either.

UPDATE – And in the “Why I should never be allowed on the radio” category, we have tonight’s performance on a national show. I explained how the economic pain of a contraction shouldn’t be confused with the actual cause of the problem by using the analogy of a sexually transmitted disease. Halfway through, I stopped and said “Okay, that’s probably a terrible analogy.” The host concurred and said that he preferred to compare a contraction to chemo. In retrospect, I don’t think that actually works as well, however, because the salient point is that the damage is actually done during the good times and the resulting pain is merely the natural consequence of the damage.

Paul Krugman loves to use the story of the baby-sitting coop told in an article published by Joan and Richard Sweeney in the Journal of Money, Credit, and Banking in 1978 and has repeatedly recycled it, all the while failing to understand that it is a very poor analogy for the American economy and that the lessons he draws from it are false. I have updated and modified it to explain what is actually going on in the U.S. economy as well as to show why Krugman’s proposed solution – print more money – cannot possibly work:

Twenty years ago I read a story that changed my life. I think about that story often; it helps me to stay calm in the face of crisis, to remain hopeful in times of depression, and to resist the pull of fatalism and pessimism….

A group of people (in this case about 150 young couples with congressional connections) agrees to baby-sit for one another, obviating the need for cash payments to adolescents. It’s a mutually beneficial arrangement: A couple that already has children around may find that watching another couple’s kids for an evening is not that much of an additional burden, certainly compared with the benefit of receiving the same service some other evening. But there must be a system for making sure each couple does its fair share.

The Capitol Hill co-op adopted one fairly natural solution. It issued scrip–pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable–and these young professionals certainly were–what could go wrong?

Well, it turned out that there was a small technical problem. Think about the coupon holdings of a typical couple. During periods when it had few occasions to go out, a couple would probably try to build up a reserve–then run that reserve down when the occasions arose. There would be an averaging out of these demands. One couple would be going out when another was staying at home. But since many couples would be holding reserves of coupons at any given time, the co-op needed to have a fairly large amount of scrip in circulation.

Now what happened in the Sweeneys’ co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple’s decision to go out was another’s chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.

In short, the co-op had fallen into a recession.

Since most of the co-op’s members were lawyers, it was difficult to convince them the problem was monetary. They tried to legislate recovery–passing a rule requiring each couple to go out at least twice a month. But eventually the economists prevailed. More coupons were issued, couples became more willing to go out, opportunities to baby-sit multiplied, and everyone was happy.

Later in the article, Krugman goes on to explain how the coop’s “central bank” can manage the coupon supply to prevent couples intent on staying in from accumulating too many coupons and acquire coupons on loan if they found it necessary to go out more often than they’d planned. But what he fails to anticipate is the situation where the coop board has provided lots and lots of coupons to the various couples in anticipation of their future use for an extended period of time. In short, he fails to account for the possibility that the “recession” is not caused by a coupon shortage, but rather by the limits of babysitting demand.

There are three limits to the demand for babysitting coupons, one physical, one practical, and one psychological. The physical limit is that a couple cannot possibly make use of more than seven evenings-worth of coupons per week since that is the maximum number of evenings they can go out and leave the children home. The practical limit is the financial resources the couple has to spend on going out, and the psychological limit is based on the amount of the couple’s desire to actually spend evenings with their children. If, in a given time period, any of these three limits are exceeded by the amount of the coupons distributed or loaned out to the couple, the couple will not make use of them regardless of how many more coupons they are given. Therefore, it should be obvious that any decline in the amount of going out that is based on one of these three limits of demand cannot be solved by simply distributing more coupons for babysitting.

In fact, for the coop, the correct policy prescription is to do exactly the reverse of what Krugman is recommending. Not only should more coupons not be distributed, but all coupon distribution should stop so that people can use up the coupons they have. Coupons given out on loan should be either repaid or simply cancelled; more coupons can be distributed once people have used up their existing supply and actually require more babysitting.

Note: the fact that babysitting coupons are less fungible and important to the coop than money is to a national economy means that one cannot concoct an example of the Austrian business cycle utilizing this analogy. The coupon supplier is not causing the problems here; they are exogenous to the coupon supply. But, this invocation of the material and immaterial limits of demand should demonstrate that Krugman’s analogy is not necessarily relevant to the present economic situation, and to the extent that it can be shown that the American consumer has exceeded the limits of his demand, it shows that his conclusions are demonstrably inapplicable.