Friday, January 18, 2013 can you discuss policy if you can't count?...
Some comics are simply too good to pass up. I've seen jokes using the 110% quip, but this is a nice collage. I've linked this to the Dilbert web site via; if the link disappears you'll need to look for the Jan 18th strip elsewhere. I'll see if I can find the text of (today's) Founders Day lecture at W&L. I don't want to try to paraphrase without links if I can find the real thing and cite, or at least paraphrase with a link to the original. If I manage, you'll see the connection.

Thursday, January 17, 2013

Ron Paul at Washington and Lee: Does gold shine?

...based on discussions following Ron Paul's Wednesday January 15, 2013 talk at W&L...
There's a certain fascination with gold; it seems to offer a way to constrain central bankers, at one end of the rules versus discretion debate. Mind you, central banks don't have a stellar track record. The Federal Reserve raised interest rates during the onset of the Great Depression, surely worsening matters. That's a core criticism of Milton Friedman and Anna Schwartz in their Monetary History of the United States. So it's sensible to ask if there's a viable alternative.
Drawing upon Irving Fisher, Milton Friedman played around with rules that focused on the growth of the monetary base. Empirically, the first pass seemed to be OK. However, that turned out to be an artifact of his particular dataset, drawn from the early post-WWII period in which financial institutions in the US were tightly regulated. By 1980-81, when the Fed briefly tried to use such a rule under Paul Volcker's chairmanship, it was clear that there was no stability of the link between creating additional reserves and banks' creation of money. So if not reserves, then let's try targeting monetary aggregates, first M1 then M2. When those proved unreliable, then let's try an inflation target, now part of the legal mandate for the Bank of England. That, too, has problems; the latest iteration is to focus on holding the constant the growth of nominal gross domestic product. As to Friedman, he eventually concluded that none of the rules he proposed would work. But that was in his academic publications, and in talks before economists. He never went back to emend his popular writings that propounded what has been labeled "monetarism." Nor did he support the gold standard; to reiterate, in his analysis it was the US attempt to adhere to the gold standard that turned a recession into the precipitous decline of the Great Depression.
So what's wrong with gold? For one thing, any claim that it provides a stable source of value fails to pass the laugh test. Jewelry fashions come and go; central banks buy gold and then don't; mines dry up; the global economy booms. All affect the price of gold. Over the past 4 decades (setting 1970 = 100) the price rose to 950 circa 1980, then fell to 150 by the 1990s, and has risen again to 750. Traders in shopping malls booths wouldn't have a business scamming people out of their grandparents jewelry and selling overpriced coins if the price of gold was stable. One of the largest sources of gold is Russia; do we want to give Vladimir Putin the ability to thrust us into a recession if somehow Congress were able to forge a direct link between gold and the US macroeconomy? I suspect not.
Now it's unclear why Rand Paul latched onto gold; I suspect it was that he really wasn't "into" economic policy and never did his homework. Then, too, there is the residual impact of the writings Hayek and other "Austrians" that go back to the days when it looked like monetary policy rules might work. That is compounded by the Austrian school's loss of focus once high socialism was no longer a real threat. Hayek and others engaged in broad-brush arguments against socialism, with the Soviet system as their implicit target. It's hard for young people to fathom, but at one time that model seemed a real threat, both with the Red Army's continued occupation of eastern Europe, and the attraction of Stalin and the meteoric rise of of Russia from a backward peasant society to a military and scientific power that could provide many of the appurtenances of middle class life to its core population. In contrast, England's economy didn't do very well after 1914, and did horribly after 1929. In newly independent colonies, the political model also seemed attractive; bedeviled by unnatural geographies and ethnic tensions, democracy didn't look workable in the short run, and presidents who developed a fondness for the trappings of office found Stalin's example of how to hold onto power more useful than trying to learn lessons from Churchill's electoral failures. But in 1989, the collapse of the Soviet Union, and within a few years of Tiananmen, the success of market-oriented reforms in China. No one now views socialism as a threat.
...he had a store of one-liners, but no coherent story...
Unfortunately, the Austrian school has nothing to say to this new world; its raison d'ĂȘtre vanished in 1989. Yes, government is bad. But we're no longer talking about the heavy hand of the central planners in Moscow and their cruder counterparts in Romania or Beijing. The Austrian's broad-brushed treatment is not amenable to empirical exploration; ironically, unlike the teachings of Marx, it is more political philosophy than economics. (Marx's theories, of course, have been found wanting.) So the Austrians have nothing to offer policymakers, they have no ability to provide a nuanced picture of an economy. Another irony is that without the foil of the Soviet Union, those enthralled by the writings of von Mises and Hayek have become doctrinaire, arguing over fine points, hostile to any who are not true believers. I had hoped that mindset died out with the last generation of Marxists, only to find that today it characterizes the Right rather than the Left [both capitalized – after all, they are/were proud of the label].
Now Ron Paul is an engaging speaker; I've heard him. He makes enough sense here and there to encourage people to listen. But he ranges too far and wide. When it comes to economics, he may have a store of one-liners, but they don't add up to a coherent story.
...mike smitka...

Monday, January 7, 2013

Debt Ceiling Dynamics

...chaos, painful chaos...
What would happen if Congress refuses to raise the debt ceiling? The answer is chaos, painful chaos that would have horrific short-term implications for not just the US but the global economy. Here's why.
Refusing to raise the debt ceiling of course could mean that the government is unable to send out social security checks in a timely manner, or otherwise pay its bills. Mind you, these are all programs duly legislated with expenditures authorized by Congress. So the proper way to do things is to change the law. If members of Congress don't think they can get re-elected if they do that, then ... but let me stick to the economics.
The real nightmare is the uncertainty this would throw into credit markets. The impact would be concentrated in short-term markets, because that's the debt that (by definition!) falls due. An awful lot of our economy is tied to those markets – money market funds, the prime rate that affects small business loans, car loans and credit card interest rates, and of course that also affects the holding cost of financial institutions with short-term funding needs. The Federal Reserve can work to keep the Federal Funds rate low, but that's an arm's length removed, and at best helps out banks. As we've seen, however, the straight banking portion of our financial system is a shadow of its former self, while the shadow banks have taken over.
Normally there's virtually no capital gains risk, upside or downside, in short-term markets – one reason that interest rates are typically much lower. But what if you have a Treaury maturing 5 days from now, and you're not sure it will be good. Now you will get your money, sooner rather than later, but the certainty is gone. Suddenly you're in a seller's market, and face a loss if you try to sell it -- but the possibility of no money on day 5 if you don't.
Now at today's interest rates – let's say 0.04% pa, the rate on a one-month bond at the end of December 2012 – well, a $1 million bond earns roughly $1 a day. But if you're a corporate treasurer that really needs the money to make payroll, you may well prefer to take a $100 loss on your $1 million – that is, get $999,900 today – than have a bunch of workers seeking to lynch you because their car payment check bounced. But that means a 4% interest rate – and if we look at what happened when Lehman failed, rates could go much higher.
That doesn't sound like much, but it would put money market mutual funds at risk, as many have committed to holding short-term Treasuries to minimize risk. Ditto foreign exchange trader from around the globe. With trillions of dollars traded every day, a jump in interest rates of that magnitude would throw a monkey wrench in the economy that would make the fiscal cliff look as flat as a bowling alley.

So I think that an administration pushed into a corner would in fact be willing to do almost anything, even delay social security payments, to avoid a bond default. But market managers won't want to place their careers at risk of politicians, most of whom are lawyers, failing to get their priorities straight. Unlike with the fiscal cliff, a last-minute compromise will thus still cause chaos.

I try to avoid hyperbole, but to me it would be treason – far more dangerous to the US than spilling top secrets – for Congress to use the debt ceiling as a political tool.

...mike smitka...