Wednesday, December 31, 2008

A Gas Tax Salve for Housing Prices

I have previously written my skepticisms on raising the gas tax. Economist Greg Mankiw views it as a Pigovian Tax to help reach environmental social goals. I think that the environmental advantages are overblown as we saw only minor reductions in gasoline consumption when prices went up to $4.00.

However, given my skepticism, there is another social goal that can be achieved without violating my libertarian principals. If states were to increase gas taxes and in exchange lower property taxes this should help increase demand for homes.

I'm not sure what the total property tax revenue for California is, and their rate averages a pretty low 4.77/$1000 of valuation, but if you estimate that the average home is worth $400,000 in the state, then eliminating property taxes would save the average home owner a little over $1,900/year, or $158/month. Assuming 3.5 people per house, this means about 10 million homes, and thus $19 Billion in lost revenue.

On the gas tax revenue side we can again use some approximations. Americans use 390 million gallons of gasoline per day. If we assume California uses 1/8th, since they have about 1/8th of the population this equals 48.75 million gallons per day. Multiply by 365 days and you get around 17.8 billion gallons per year. If California were to charge a new tax of a dollar per gallon this would lead to around $17 Billion in revenue (assuming a slight decrease in driving).

This back of the envelope estimation might not be perfectly accurate, but it looks like the gasoline tax could help eliminate property taxes in the state. Getting rid of property taxes would make homes cheaper, but not lower their face value (sales price). It should help offset some downward pressure on home prices without the moral hazard problems of bailing them out. It also seems politically feasible given the "green" inclinations of the party in power.

Larry Kudlow's Rally for the Cause

I'm not a huge fan of Larry Kudlow. He often used incomplete economic arguments to justify George Bush policies that really weren't great ideas. He also has a love affair with supply side economics that borders on infatuation. That being said, he has a good article today at RealClearMarkets.


In fact, the GOP has a great opportunity to challenge Obama’s Keynesian pump-priming by insisting there be a major tax-cut component in any new fiscal package. Republicans shouldn’t merely push for somewhat less government spending. They have to make a bold case that tax rates matter for economic growth and job creation. They must insist that any recovery package includes this key element. Shift the debate. Say clearly that a reenergized economy cannot occur without lower marginal tax rates.

In particular, the GOP position should include lower tax rates on large and small businesses. Right now the top federal tax rate for C-corps is 35 percent. Small businesses, which pay the individual rate, also are taxed at 35 percent. These rates should be 20 percent for both C-corps and S-corps (including LLCs). This would make a huge difference. It would be a boon for our global competitiveness, since companies in the U.S. (as well as Japan) are taxed way above the rates of other advanced countries. It also would attract job-creating investment flows to the U.S. at a time when capital is on strike in our financial markets and economy. And while businesses collect corporate taxes, it’s really consumers who pay the final cost.
But the congressional Republicans have to step up to the plate right now. Me-too-ism on spending is a big mistake in both political and economic terms. Instead, the GOP should argue that fiscal policy needs a choice -- not an echo (to paraphrase the late conservative stalwart Barry Goldwater).

Tuesday, December 30, 2008

Caroline Baum Rips on Government Intervention

From Bloomberg:

Before you can declare free markets a failure, you have to establish that they exist, says Paul Kasriel, chief economist at the Northern Trust Co. in Chicago.
“We do not have free markets in credit in the U.S. or anywhere else that I know of,” he says. “The price of short- term credit is fixed by central banks. It would only be by accident that a central bank would fix the price of short-term credit” at the precise level that a free market would.

Chosen People

Fixing the price of any other commodity, including labor, has proven to be a failure, an affront to the inviolable invisible hand. Yet when it comes to setting the interest rate that will keep the economy on an even keel, we put our faith in a chosen few to get it right.

All sorts of unintended consequences flow forth from central bankers’ fixing of a short-term rate. Hold the rate too low, and it leads to a misallocation of capital into, say, housing or dot- com stocks. That’s what happened in the late 1990s and again in the early part of this decade.

“We are now experiencing the economic and financial market fallout from (Alan) Greenspan’s interference with the free market,” Kasriel says.

In a true free market, risk-takers are punished for bad bets. Not so in the current crisis, where financial institutions -- with the exception of Lehman Brothers -- are deemed too big to fail and rescued, merged or recapitalized.
No commentary necessary. Read the entire article here.

Are Banks a Relic in Need of Replacement?

Banks serve a very useful function, but they have some unfortunate properties. Should they be replaced and what would the replacement look like?

***This is kind of long, so you can scroll down to the “Punchline” if you don’t want to read it all***

There are two problems with banks. First, they have the occasional tendency to go insolvent. This would not be an extraordinary problem nor unique to banks, as many companies go out of business all the time. The second and unique problem for banks is that so many go insolvent at the same time. A domino effect can arise where one bank’s closure can drag down other banks with it. When too many banks fail, they drag each other down and we get financial panics like the one we have had in recent months.

Where you believe in the Austrian Business Cycle or another explanation, banks have a tendency to go through cycles where the economy is growing nicely and banks start to get careless with their loans. They also loan out money to each other. When they have ample cash on hand, but no worthwhile borrowers they loan the money to other banks. When the economy slows, these careless loans start to default and banks start running low on reserves. As some banks start to approach insolvency, they start calling in loans they have made to other banks. Some of these banks are not in good financial shape either, bringing them closer to insolvency as well. A wave of insolvencies can lead to widespread panic as depositors begin pulling out their money.

A bank normally spends its time taking your deposits and lending them out to entrepreneurs wishing to open or expand a business. Individually we lack the time or experience to decipher good investments for local businesses so we accept a low interest rate. The bank, uses its intelligence, finds good business deals and loans money out at a higher interest rate. The difference between the low interest paid out and the high interest paid in is their revenue stream.

When a panic strikes, the normal functions of a bank are suspended. A bank can’t afford to make many loans because they need to keep cash on hand to prevent a bank run. They are stuck in a Catch-22 where they need to hold cash to prevent insolvency, but they are losing their revenue stream because they are not making enough loans. If the panic lasts too long they will fail.

The kind of banking that we are used to is called fractional reserve banking. The bank is only required to hold a certain portion of deposits as a reserve, say 10%. This is what leaves them susceptible to bank runs. If banks held 100% reserves bank runs would be impossible, and thus financial crises, at least for banks, would be impossible. However, 100% reserve banking would not allow banks to operate with their standard model of interest baring deposits and interest paying borrowers. This is an important cog in the machine of our current economy, which connects capital and productive ideas.

However, there is a form of 100% reserve “banking” that operates without the risk of the domino effects inherent to fractional reserve banking. This form also works very well at connecting capital with productive ideas. This form is known commonly as mutual funds. When T. Rowe Price sells you a mutual fund, T. Rowe is not practicing any leveraging like a bank. That is, they are not putting themselves at financial risk when placing your money with various companies. They merely act as an intermediary between you, the holder of capital, and the entrepreneur, the productive user of capital. T. Rowe Price collects an asset management fee and possibly a few others to cover their costs and make a profit for themselves. They use their special business knowledge to act as a more efficient conduit for the economy. If they perform worse than their peers costumers withdraw their money and assets and place them under someone else’s purview.

When looking at the housing mess and so many of distortions and mistakes made we can see the damage and the domino effects of leveraging. Lending companies borrowed at low rates, and lent at high rates to sub-prime borrowers. When no one wanted to buy their sub-prime loans anymore their business model died and a wave of companies went bankrupt. Banks were lending out as well, assuming that borrowers were more credit worthy than they really were. When defaults rose and the value of their loans fell, their reserves were suddenly insufficient. As we saw, many closed or were bailed out by the government.


The question that this begs in my mind is “Why are there no mortgage mutual funds?” Why can’t I go to T. Rowe Price and say, “I want to put $20,000 into a mortgage fund that lends to people with credit scores between 675 and 700 and 10% down”? If this was the model, we would not have seen massive bankruptcies in the mortgage lending business. We would not have seen massive problems in the banking sector. Sure, I would have taken a hit with the large number of foreclosures, but this would not have created the systemic risk that the traditional fractional reserve banking system creates.

Setting up a system where the intermediary only acts as a steward collecting a service fee eliminates much systemic risk, without sacrificing the efficient capital allocation properties of banking. It may also limit the effects of interest rate manipulations by the Federal Reserve on the housing industry, which would reduce boom-and-bust cycles. Perhaps this is the lesson we should learn from our recent afflictions.

A few months ago I actually read an article about a hedge fund that was planning to do this. Unfortunately, I did not keep the link. If you know of a mutual fund that is doing this, let me know. If I had money, I might even try to start a business on this model.

Monday, December 29, 2008

Staying on the Subject of Africa

This article has little to do with standard economics or politics, but I found it very profound.

From the London Times:

As an atheist, I truly believe Africa needs God

Missionaries, not aid money, are the solution to Africa's biggest problem - the crushing passivity of the people's mindset

Some excerpts:

Now a confirmed atheist, I've become convinced of the enormous contribution that Christian evangelism makes in Africa: sharply distinct from the work of secular NGOs, government projects and international aid efforts. These alone will not do. Education and training alone will not do. In Africa Christianity changes people's hearts. It brings a spiritual transformation. The rebirth is real. The change is good.
Faith does more than support the missionary; it is also transferred to his flock. This is the effect that matters so immensely, and which I cannot help observing.
The Christians were always different. Far from having cowed or confined its converts, their faith appeared to have liberated and relaxed them. There was a liveliness, a curiosity, an engagement with the world - a directness in their dealings with others - that seemed to be missing in traditional African life. They stood tall.
I observe that tribal belief is no more peaceable than ours; and that it suppresses individuality. People think collectively; first in terms of the community, extended family and tribe. This rural-traditional mindset feeds into the “big man” and gangster politics of the African city: the exaggerated respect for a swaggering leader, and the (literal) inability to understand the whole idea of loyal opposition.

Anxiety - fear of evil spirits, of ancestors, of nature and the wild, of a tribal hierarchy, of quite everyday things - strikes deep into the whole structure of rural African thought. Every man has his place and, call it fear or respect, a great weight grinds down the individual spirit, stunting curiosity. People won't take the initiative, won't take things into their own hands or on their own shoulders.
Christianity, post-Reformation and post-Luther, with its teaching of a direct, personal, two-way link between the individual and God, unmediated by the collective, and unsubordinate to any other human being, smashes straight through the philosphical/spiritual framework I've just described. It offers something to hold on to to those anxious to cast off a crushing tribal groupthink. That is why and how it liberates.

Those who want Africa to walk tall amid 21st-century global competition must not kid themselves that providing the material means or even the knowhow that accompanies what we call development will make the change. A whole belief system must first be supplanted.

And I'm afraid it has to be supplanted by another. Removing Christian evangelism from the African equation may leave the continent at the mercy of a malign fusion of Nike, the witch doctor, the mobile phone and the machete.

Should We Recognize Somaliland?

Because of the plague of piracy in Somalia, should we look to recognize the one working government within this failed state?

Somaliland is a small country near the horn of Africa, not to be confused with Somalia. The international community does not recognize Somaliland, but it declared independence in 1991. It was previously a British territory and briefly a separate country until the 1960s when it joined Somalia. Somaliland is today a fledgling democracy. It is vastly more stable and peaceful than Somalia.

A BBC film crew created a short documentary that reveals the differences between Somalia and Somaliland. The three sequential youtube videos can be viewed here, here, and here. In the videos it is clear that traveling anywhere in Somalia requires a small brigade of armed guards, as the journalists routinely run into people pulling out guns. The streets of Mogadishu (Somalia) are filled with armed men. In Hargeisa (the capitol of Somaliland) however, guns on the streets are rare. Even the stop lights are operating and abided by.

The BBC journalist is welcomed into a seemingly clean, modestly modern and operating maternity hospital. They are guided by a woman who runs the hospital and sits in the government. She takes them right into a large room where the government is conducting business. The President of Somaliland, who speaks English, is affable and humble about the role of government there.

Lest you think that this government is conning the journalist, he has made a series of videos on break away regions, including one of Trans-Dneistre, which he clearly makes out to be a scary police state. There are a few other lower grade videos available as well and found this view to be the consensus of journalists who have traveled there. It appears to be a remarkable place that deserves some consideration for international recognition.

Friday, December 26, 2008

Rothbard on The First Great Deflation (1839-1843)

One of my Christmas presents was Murray Rothbard's "A History of Money and Banking in the United States". He writes about a period between 1839 to 1843 where the United States experienced deflation on a massive scale. Prices were estimated to have dropped by 42 percent, or 10.5 percent per year. According to the Keynesians, this should destroy the economy in a liquidity trap. Rothbard writes about what actually happened.

In a fascinating analysis and comparison with the deflation of 1929-1933 a century later, Professor Temin shows that the percentage of deflation over the comparable four years (1839-1843 and 1929-1933) was almost the same. Yet the effect of real production on the two deflations were very different. Whereas in 1929-1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839-1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent. The interesting problem is to account for the enormous fall in production and consumption in the 1930s, as contrasted to the rise in production and consumption in the 1840s. It seems that only the initial months of the contraction worked a hardship on the American public and that most of the earlier deflation was a period of economic growth. Temin properly suggests that the reason can be found in the downward flexibility of prices in the nineteenth century, so that massive monetary contraction would lower prices but not particularly cripple the world of real production on standards of living. In contrast, in the 1930s government placed massive roadblocks on the downward fall of prices and wage rates and hence brought about severe and continuing depression of production and living standards.

The economy went on. Economic calculation was not inhibited by deflation.

Michael Williams, A Video

Recently, I gave my support to Michael Williams in his run for the U.S. Senate in 2010 for my state of Texas. I found a video of the speech I heard him give at The video is below. Note: Skip the first 3 minutes. It's more appropriate to the duties of the office that he was running for re-election at the time. I agree with most everything, and you have to admit that he is quite gregarious.

Thursday, December 25, 2008

A Little Christmas Cheer, or Not

Holman Jenkins has a dreary prognostication for the coming decade on Christmas Eve at the Wall Street Journal entitled "Get Ready for a Lost Decade". Not very "Christmasy", but he has many good thoughts. Normally, I would include some excerpts, but the whole thing is good and not too long. He derides the idea that good policy is possible, and thus massive stimulus will be a mess. Not too surprisingly, I agree with him. Click on this link and read it.

Tuesday, December 23, 2008

More on Why the Stimulus Will Be A Mess

Harvard Economist Greg Mankiw posted a letter from a reader of his blog today. The reader is a government administrator who worked on the initial setup of the Department of Homeland Security. Here are some of his words:

I work for the DoD and when the Department of Homeland Security was established,we helped them with many things, not the least of which was contracting. To make a long story short, you cannot juice up a government agency's budget by tens of billions (or in the case of the stimulus package, hundreds of billions) and expect them to be able to process the paperwork to contract it out, much less oversee the projects or even choose them with any kind of hope for success. It's like trying to feed a Pomeranian a 25 lb turkey. It's madness.

It was years before DHS got the situation under control and between the start and when they finally assembled a sufficiently capable team of lawyers, contracting officials, technical experts and resource managers, most of the money was totally wasted. Now take the DHS situation and multiply it by 20 and you've got the Obama stimulus package. Even if they hand the money to existing governmental agencies, the situation will be the same. Those existing agencies are working full time administering the budgets they have. They can't just add a zero at the end of each contract and be done with it.

Monday, December 22, 2008

On Bubbles and Rationality

Henry Blodget with The Atlantic, writes an article today on market bubbles and rationality. He provides a pleasant reprieve from all of the blame game going on. He thinks we each need to take responsibility. This is admirable, but it fails to recognize that as much as we like to think that we have libertine free will, our behaviors are often shaped (but not dictated) by the legal and economic framework that other people have subjected us to. Here are his two money paragraphs:

But most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational—or at least they’re a rational and unavoidable by-product of capitalism (which, as Winston Churchill might have said, is the worst economic system on the planet except for all the others). Technology and circumstances change, but the human animal doesn’t. And markets are ultimately about people.
First, bubbles are to free-market capitalism as hurricanes are to weather: regular, natural, and unavoidable. They have happened since the dawn of economic history, and they’ll keep happening for as long as humans walk the Earth, no matter how we try to stop them. We can’t legislate away the business cycle, just as we can’t eliminate the self-interest that makes the whole capitalist system work. We would do ourselves a favor if we stopped pretending we can.

Mr. Blodget is correct in that bubbles are a normal and rational phenomenon. That we see bubbles not just in housing and tech stocks, but in Beanie Babies and baseball cards reveals that it is an inevitable human phenomenon. However, he goes too far when he claims that nothing can be done. We need to dig down and understand how a bubble starts.

There must be a first mover. A bubble can not start unless an item has gained value above historical rates of return and it must be gaining value at rates superior to most other investments. While homes were gaining 15% annually in some markets, this understates the huge rate of returns available when these homes were purchased on the margin. That is, if you put $25,000 down on a 200,000 home, a 15% increase in value increases your equity by 120%. In short, the critical mass of dupes that feed a bubble must have real data to be duped. Something has to be pushing up that value before so many fall for it like suckers.

This "unnatural" rate of return can be created by a number of forces: A restriction on supply, an artificial expansion of credit, or a government subsidy. Whenever any government policy is considered, especially one of significant scale, the potential for a bubble should be considered. These side effects can be avoided by careful analysis, or more easily through a dogged hostility to market manipulation through legislation. A bubble may be hard to stop, but we can prevent so many from getting started.

Mr. Blodget relates a tale of the thinking involved in the real estate bubble and it starts with this:

In fact, for as long as we can remember—about 10 years, in most cases—house prices haven’t gone down. (Wait, maybe there was a slight dip, after the 1987 stock-market crash, but looming larger in our memories is what’s happened since; everyone we know who’s bought a house since the early 1990s has made gobs of money.)

This is the first mover. There is a sense that unnatural rates of return are normal and that a housing bust is unlikely. Why were rates of return unnatural? The artificial restrictions of various housing restrictions. His entire tale rests on the proximate cause of government intervention.

In the end, however, Mr. Blodget is correct. The ultimate cause is us. Our desire to control the behavior of others through the force of government led us to pass these housing restrictions. Whether its to keep poor people out by banning dense housing, or to reduce the evils of urban sprawl and SUVs, so many of us want someone to make the world better for us by making it worse for someone else.

Sunday, December 21, 2008

A Trillion Dollar Mistake

This is an essay I sent out to my e-mail list. Many of the thoughts have been included in previous posts here on this blog.


In recent weeks the idea of a massive economic stimulus plan has been mentioned in the news. As the weeks have gone by, the size of this plan has grown tremendously. What started as a now paltry $160 Billion has now grown to an estimated $1 Trillion. This money is to be spent on a number of so-called investments in our nation’s infrastructure. Don’t be deceived. Remember those wild-eyed accusations of Socialism brought up during the campaign this fall? This is it.

During the Great Depression a British economist named John Maynard Keynes tried to come up with a theory to explain what had happened. Classical economics didn’t really have a good answer. Another economist named Ludwig von Mises, had discovered what I believe is the correct theory, but Keynes’ theories captured much more attention from politicians at the time. One of Keynes’ theories suggested that the government could unlock the fear and panic by having the government spend massive sums of money on numerous projects. It was believed that this new spending would “prime the pump” and get the economy rolling again. Unfortunately, this thinking has some fatal flaws.

First and foremost it ignores where the money comes from. In any economy, private investment is used to buy new machinery, build new buildings, and employ new workers. In Keynes’ economy this new government investment would do more of the same thing. So where does the government get the money? They must first borrow it from private investors. If government spending rises by $1 Trillion, the money must first be borrowed out of the pockets of people in the economy, thus private investment must drop by a similar $1 Trillion. So, instead of ABC Incorporated buying new machines, building new buildings, and employing new workers, the government is going to do this.

At first glance, one might think it’s worth the risk and for this strategy if it is just the government spending and buying the exact same amount of money as private companies. However, this is incorrect as well. Government spending is going to be less efficient and often times, simply wasted, when compared to private spending.

This truth is the fundamental failing of Socialism and Communism. An individual or company can quickly figure out society’s verdict on what they chose to invest. Did they make a profit or did they lose money? The government, on the other hand, does not have this feedback. Unless the waste is astoundingly obvious, the average citizen doesn’t complain enough to matter to politicians. Waste goes unnoticed.

Politicians, not constrained by the need to make profits, also tend to invest in projects that sound really nice, but are really a waste of money. The vast majority of Obama’s green initiatives sound really nice, but individuals don’t invest freely in them because the projects simply don’t pay for themselves. They are feel good money pits.

The third, and most sinister problem with this enormous government spending plan is the inescapable influence of lobbyists. If you ever hated the kind of privilege that connections in Washington held today, just imagine the feeding frenzy over a trillion dollars of chum falling into the spending pool. Spending will be shaped by the people who can spin the best story and pull the right strings.

Governments do not have the ability to calculate good investments, nor do they face the proper consequences of bad investments. It was only 19 years ago that the world cheered as the Berlin Wall fell and the world knew, in one instance, that Socialism was such a catastrophic failure, yet now our next President believes that a little bit of Socialism is what our economy needs.

If it weren’t bad enough that the basic assumptions of this plan were wrong, there are still more problems unforeseen by Obama’s short-sighted advisors. What happens a few years down the road to the companies and people dependent on these massive government contracts? As the willfully naïve Paul Krugman, a recent Nobel Prize winner in economics and the main proponent of Keynesianism in the world today, wrote so eloquently at his blog, “I don’t really know the answer”. Well, Mr. Krugman, I do know the answer. They will either lose their jobs, go out of business, or lobby the government to keep spending money to keep them afloat. Getting rid of this wasteful spending will be like pulling teeth.

The massive burden will one day have to be paid back. The “stimulus” will not help the economy, more likely hurt it. We will pile up massive debt, which means higher taxes in the future. We will be stuck with the politically difficult task of cutting people off the government dole. This policy is dangerous and ill-conceived.

Saturday, December 20, 2008

How bout them Aggies

SmartMoney magazine produced a ranking of colleges and universities that offered the greatest return on your education dollars. My alma mater Texas A&M ranked a lofty #2, right behind the University of Georgia. That other mostly overrated university in Austin came in just beneath us (as usual) at #3. Texas A&M pulled ahead because the median Aggie makes more money 15 years after graduation.

Explaining the Laffer Curve

If you have ever wondered what the Laffer Curve is or what makes people like me believe that if we raise capital gains taxes, like Obama pushed in the election, tax revenues will fall, then watch this video. You can also go to Center for Freedom and Prosperity and watch all three in their series.

Update - screw it, I can't get the embedding progrmaming to workright. Click here

Where's the Money - Robert Murphy Comments

Economist Robert Murphy tackles, in this post, the conundrum of a massive increase in the money supply by the Fed, but only small signs of inflation so far. If you recall I also tackled this here and linked to Louis Woodhill's article on it here.

Dr. Murphy ascribes some of the same causes as I have. Namely, that some of the new money supply is being held at the Federal Reserve and not being loaned out. you can see, the increase in reserves is basically just sitting in the (electronic) vaults on the Fed's ledger. Even though banks have the legal ability to make new loans to customers (which would increase M1, M2, MZM, etc. by more than the base itself increased), they aren't doing so
He does not mention Woodhill's observation that the Federal Reserve is now, for the first time, paying interest on these deposits, allowing banks to pick up a spread by keeping deposits into checking accounts and standard savings account at the Fed instead of loaning them out.

However, he does go on to outline some disconcerting implications about these reserves:

What happens when the panic in the financial sector subsides, and banks feel comfortable lending again? Well, loosely speaking, it means that the amount of money in the hands of the public (as opposed to reserves that commercial banks have on deposit with the Fed) can increase the same percentage as reserves have increased.
Now obviously Bernanke is not going to sit back and let prices go up by a factor of 14. But how does he suck reserves out of the system? Why, he has to sell off the trillions in new assets that the Fed has recently acquired. And of course, this is precisely all of the "troubled" assets that nobody wanted to hold in the first place, and that had caused the major players to seize up.

And even if Bernanke decides to hang on to all of the mortgage derivatives--you know, the ones that are going to make us taxpayers so much profit in the coming years--and he just dumps U.S. Treasurys, guess what that does? It lowers the price of Treasury debt, meaning interest rates rise.
This will run up against some serious political problems.

1) The Obama administration plans to borrow massively, driving up interest rates. (If you believe in Keynesian stimulus the economy should grow nevertheless)
2) The economy is predicted to still be recovering from recession.

How exactly does the Fed justify driving up interest rates, and slowing the economy, in a recession? The actions needed to stem this massive inflationary pressure may not be politically feasible. Yikes.

He supports buying gold:

I hope my advice to acquire physical gold and silver makes more sense now.

Thursday, December 18, 2008

Somali Pirates - We're Still Not Using Guns

Back in November I was perplexed as to why ships sailing near Somalia were not hiring mercenaries and arming themsevles with high powered guns. Well, it seems some companies have hired mercenaries and it didn't work, because they gave them NO GUNS!

From Bloomberg:

The owners of the Biscaglia, a Liberian-flagged chemical tanker, paid thousands of dollars for three guards to protect it from Somali pirates.

It didn’t work. Brigands struck on Nov. 28, seizing the 27,350-ton vessel and its crew of 25 Indians as it headed toward the Suez Canal. After failing to repulse the pirates with deafening sonic devices, the unarmed guards jumped ship to escape and were plucked from the Gulf of Aden by a German navy helicopter.
Guns people, Guns!

Paul Krugman Says Something Smart

On his NYT blog Krugman had this post:

"Kevin Drum writes that

One way or another, there’s really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can’t spend more unless they make more.
This is a widely held view, and I’m as much in favor of a strong middle class as anyone. Nonetheless, I’d say that in terms of strict economics it’s wrong. There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people. "


This idea that the economy can't grow without a strong middle class is perposterous. It is thrown about by progressive politicians all the time, and it makes no sense. I think of it from a different angle than Krugman, but at least he admits that it's wrong.

Wages move towards the marginal product of labor. In laymen's terms, the more valuable your services the more you can demand from your current employer or the next. On average, people are paid what they are worth. Workers are, again on average, not getting ripped off.

The overall economy is a function of savings, investments, human capital, and the efficient allocation of those resources. High wages for the middle class will be commensurate with individual productivity.

Wednesday, December 17, 2008

Bailout Backlash

We're mad as hell, and we're not going to take it any more!

This weekend I watched Mitt Romney on one of the Sunday political shows. He gives lips service to free markets and then turns around and spends half his time talking about how we need a stimulus. Not the $1T spending style, but one mixed with spending and tax cuts. We've seen a number of moderate Republicans duck their heads and acquiesce to massive government intervention. Why? Because they are afraid. They haven't taken the time to properly educate themselves on economics, so they just want to look busy until it blows over.

If Republicans want to revive their influence, they have to take a stand. They have to start not just talking, but shouting, that we must end these bailouts and so-called stimulus packages. The average American does not like this at all. They are getting angry, and if the economy doesn't recover soon there is going to be hell to pay for the party left holding the bag. If Republicans speak up loudly now, they won't be holding that bag.

Brent Budowsky, from The Hill, has a column today with a lot populist overtones that echoes some of the sentiment that I see growing.

Americans have begun an angry backlash against bailouts that could become a national revolt in 2009.
Virtually none of this money directly helps average Americans. Virtually none of it trickles down to the people who suffer the most and pay for the program.
The public backlash is only beginning. It will rise with every new scandal and Ponzi scheme and every new increase in credit card rates. It has already infected good judgment in the auto case, where major support is needed, tied to major plans for industry renewal.

I do not oppose bailouts, I oppose bailouts managed with banana-republic standards of secrecy and incompetence in which recipients of massive taxpayer largesse work against those who pay for this largesse.
Bailout money is not a private account that belongs to Fed Chairman Ben Bernanke, Fed governors, the Treasury secretary or the banks. It is the people’s money. It should be used to benefit the people. It should be monitored through the checks and balances of the democratic process.

Secrecy is the enemy of equity, integrity and common sense. Secrecy is the friend of negligence, misjudgment and corruption. There are probably selected instances where the Fed should not disclose, but show me $2 trillion of secretly spent money and I will show you trouble.

In the coming days I will be writing about the Bloomberg case and offering specific bailout proposals on The Hill’s Pundits Blog. The backlash is coming. Time is short. The dangers are extreme.

Michael Williams For Senate

Way back in June of this year, I attended the Republican Party Convention of Texas as a delegate. A number of people gave speeches, some good, some bad, but the person who really caught my attention was Michael Williams. This is what I wrote at the time:

Michael Williams, Texas Railroad Commissioner - Very good! He came across knowing much more than I do about the economics of energy, which is unprecedented in any politician that I have ever heard. Funny, engaging, and persuasive. I hope that he runs for the Senate in 2010 to replace the retiring Hutchinson. The crowd loved him.

Well, now he is running for Senate as announced here. If elected, which it would be hard for him to lose, I fully expect him to quickly rise to national prominence. I'd like to know more about his policy positions, but he came across having a good grasp of free market fundamentals as I recall. I suspect that he will be more stridently pro-market than Kay Bailey Hutchison, of whom I am not a big fan. We shall see.

Tuesday, December 16, 2008

Making a Turn towards Inflation

No doubt, many of you saw that the Federal Reserve lowered its target rate to record lows in a range between 0 and 0.25%. The stock market seemed to applaud the news, but there is a side effect to this action, inflation.

The value of the dollar slumped significantly. According to Bloomberg, the dollar lost quite a bit of ground to foreign currencies today.

USD-Euro down 2.5%
USD-Yen down 1.8%
USD- Pound down 1.8%

Since Nov. 23rd the Dollar has lost 11% against the Euro. Since Nov. 4th, the Dollar has also lost 11%, and nearly 20% since August.

From my casual analysis, trends in the relative value of currencies is simple. When interest rates in Country X are higher than in Country Y, the currency in Country X tends to appreciate. I have only analyzed comparisons between the U.S., U.K., and the Euro region, so this relationship may not be so simple around the world.

Another piece of related news, Jean-Claude Trichet, who is the Europe’s equivalent to Ben Bernanke, was analyzed and quoted in a Bloomberg article:

European Central Bank President Jean- Claude Trichet said there’s a limit to how far the bank can cut interest rates and signaled policy makers may pause in January.

“Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes,” Trichet told journalists in Frankfurt late yesterday.
Currently, the ECB (European Central Bank) has set its rate target at 2.5%. This is well above America’s 0-0.25%. This bodes poorly for the dollar against the Euro. It also bodes poorly for our recent spate of low oil/gasoline prices, as I have been pretty well convinced of the correlation between the dollar movements and the price of oil.

Less impressive, but still worth noting, is the spread between TIPS and Treasuries. The five year differential jumped from a session low of -0.9 to close at -0.64. Not a huge change, but a sign that deflation fears were somewhat abated by today’s Fed move.

This Is Why I Don't Take Environmentalists Seriously

It's not often that I see a news report that makes my jaw drop, but this one took the cake.

The Title from Reuters:

In "eat local" movement, Cuba is years ahead
Ahead? A country that struggles to feed itself is ahead of the U.S.?

Salcines says he is hardly sleeping as his 160-member cooperative rushes to plant and harvest a variety of beets that takes just 25 days to grow, among other crops.

As he talks, dirt-stained men and women kneel along the furrows, planting and watering on land next to a complex of Soviet-style buildings. Machete-wielding men chop weeds and clear brush along the periphery of the field.
Life is so great that they are hardly sleeping?

Since they sell directly to their communities, city farms don't depend on transportation and are relatively immune to the volatility of fuel prices, advantages that are only now gaining traction as "eat local" movements in rich countries.
Advantages? Are you serious? Modern civilization thrived because we could trade for food from far off places. What did primitive people do when drought or pestilence attacked their "eat local" lifestyles? They starved to death!

They [urban gardens] sprang from a military plan for Cuba to be self-sufficient in case of war. They were broadened to the general public in response to a food crisis that followed the collapse of the Soviet Union, Cuba's biggest benefactor at the time.
So they planted these gardens because they were having a hard time feeding themselves. We should emulate them why?

In Alamar, the members get a salary and share the garden's profits, so the more they grow, the more they earn. They make an average of about 950 pesos, or $42.75, per month, more than double the national average, Salcines said.
Wow, $42.75 per month, now I'm seeing why Cuba and its "eat-local" plan is the ideal.

The gardens sell their produce directly to the community and, out of necessity, grow their crops organically.
It's a necessity because they are so poor that they can't afford pesticides or fertilizers.

Unlike in developed countries, where organic products are more expensive, in Cuba they are affordable.
Of course they're affordable! These people are only making $42.75 per month!

Some experts fear that rising international food prices along with the destruction of the hurricanes will return Cuba to the path of agrochemicals.
Fear!?! Are they afraid that Cuba's people will rise above subsistence style farming? What is wrong with these people? How divorced from any rational moral system do you have to be to describe the possibility of people rising above $42.75 per month as something to be feared?

Monday, December 15, 2008

Tao Te Ching - The First Libertarian?

In college I read the Tao Te Ching and found it to support many libertarian ideas. I wasn't sure how the book became a religion, but that's a different story. Last night I received an e-mail from Dave Cribbin who has started a new blog called Dave's Right Side. In a recent post he has an interesting quote from the Tao Te Ching, among other historical writings that seem to support the supply-side notion that lower taxes lead to more revenues and a stronger economy.

The Tao Te Ching Curve Was written in the fifth century BC it's author also understood the Laffer Curve. Chapter 57 contains the following passage:

Run the Country by doing what's expected. Win the war by doing the unexpected. Control the world by doing nothing. How do I know this?

The more restrictions and prohibitions in the world the poorer the people get. The more experts a country has the more of a mess it's in. The more ingenious the skillful are the more monstrous their inventions. The louder the call for Law and order the more the thieves and con men multiply.

So a wise leader might say: I practice inaction and the people look after themselves.I love to be quiet and the people themselves find justice. I don't do business and the people prosper on their own. I don't have wants and the people themselves are uncut wood ( naturally virtuous)

Fixing the American Economy

In the beginning, all men were created equal and endowed by our Creator with certain inalienable rights. Over the years, this equality has been perfected in difficult lurches through the duress of war and protest, but that first proposition of equality is yet still a radical notion. Even today, some 200 years later, those who believe themselves more equal than the rest of us still blithely deny our ownership of this most hard fought freedom. In contrast, our founding fathers, who were in general a group of men with significant wealth and power, chose not to abuse their position to abscond, but to abdicate these privileges and risk their very lives to give birth to freedom and justice. It was to them self-evident, that in the eyes of God and the eyes of the law all men must be equal.

In these days of economic fear, we have become dispossessed of this birthright. Our prosperity is no longer so determined by strength of will or content of character, but by the size and effectiveness of our public relations. Once proud business leaders wrap themselves in the flag and fall prostrate to grovel at the feet of our politicians. How can we not reward such talented beggary, a skill once selfishly monopolized by drunks and addicts, now so eloquently apprehended by the wealthy and powerful? The rest of us, the forgotten ones, are now obliged to ride at the back of the bus because we cannot spin sob stories quite so earnestly.

What of my brother, who struggles to make ends meet? What of my sister, who pinches pennies to pay for college? What of my parents, my aunts, my uncles, my cousins? What of my friends and neighbors? What of their jobs and their life savings? Currently, over 500,000 Americans file for unemployment weekly. Why did we not protect their jobs? The tales of terror from the auto industry claim that three million people will lose their jobs if they are allowed to collapse, yet every 6 weeks this number of job losses is wrought upon the rest of us. Does my family deserve less than others do, or should we quietly accept our new second-class standing?

Even more egregious than an auto bailout, is the so-called stimulus program designed by the incoming administration. Dazzled by economic alchemists, these grand planners suggest that we can spin debt into gold, and beseech us to ignore our better judgment. We are to lay our trust in a gaggle of political quacks to invest properly the estimated $1 Trillion borrowed, half the size of the entire Italian economy. Those of us who question this new leviathan are pat on the head and told to run along.

We cynics have coped with this new injustice by waffling between despair and detachment, resigned to complain from the sidelines and acquiesce to the high priests of the mystic calculus of economics. Yet these passive positions betray the very foundation of freedom and equality. It is individual action and the use of reason that gave birth to civilization and anointed humanity with the power to sustain our lives and procure for ourselves the destinies we each conceive.

What of my brother, should they help him? The very question is an insult to the strength he possesses. Implied in this is an assumption that they are more able to bear his burdens, and a confusion that struggle is needless pain. Up high in the ivory tower, he may appear to be a wobbly-kneed foal, mired in muck with his excessive burdens in tow. If they lowered themselves perhaps, they could better assess this situation. From such an altitude, one cannot see the sinews seethe beneath his chest, nor hot veins running jagged down his legs. One cannot hear his teeth grind the bit and whip taut the reins as his ferocious determination tears his cargo from the muddy clutches of the earth.

What kind of fearsome man is this? The common one. The standard model assumed by our founding fathers to populate every corner of the world. Where they see lambs in want of a shepherd, I see lions in want of wildebeests.

Bailouts and stimulus are a poison, convincing individuals not to act, but to wait for assistance. Prescriptions for our current ailments should affirm that all are individually capable of sustaining our recovery. No man’s job is more important than another’s. No man’s wealth is more important than another’s. The only stimulus we need is to free the faculties of individuals to rebuild our economic order one brick at a time. We are not in need of one great hero, but 300 million of them.

Robert Murphy Makes the Austrian Case

The Austrian School of Economics, which is a school of thought, not a literal university, prefers to correlate economic expansions and contractions to the expansion and contraction of the money supply and manipulations of interest rates. I agree with this part of the theory, but I think there are additional pieces that they need to add to complete the story.

I continue to believe that interest rates were a secondary factor as a cause for the housing boom. However, Robert Murphy makes his case at in an essay titled "Evidence that the Fed Caused the Housing Boom". It's a good read, but if the density makes you leery, I have included the most compelling graphic below. It compares 30-yr mortgage rates to the year-over-year changes in the S&P Case-Shiller home price data.

Because of this evidence, I am willing to update my thoughts on the housing bubble process to include a few basic time steps.

1. Housing supply restrictions cause growing prices
2. Extrapolation of rates of return (speculation)
3. Low mortgage rates allowed more borrowing
4. Incorrection securitization allowed speculation to grow more rampant
5. Bust

Sunday, December 14, 2008

El Paso Paradox - More From the Houston Chronicle

I previously blogged about the odd fact that the city of El Paso, TX has one of the lowest murder rates in the U.S., but is located across the Rio Grande from one of the most violent cities in the Western Hemisphere: Ciudad Juarez, Mexico.

The Houston Chronicle had some interesting data about these two cities in Sunday's paper.

El Paso, a city of 600,000 reported just 16 homocides, a rate of 2.7/100,000.
Ciudad Juarez, a city of 1,500,000 reported 1500 homocides. A rate of 100/100,000.

The murder rate in Ciudad Juarez is 37.5 times that of El Paso.

The Chronicle article goes on to say:

Overall, reports of violent crime are down about 4 percent compared with 2007, El Paso Police spokesman Darrel Petry said.
An interesting phenomenon.

Saturday, December 13, 2008

Credit Crisis is a Myth - Reuters Drops a Bomb

Reuters printed this article (HT: Robert Murphy) outlining a report from Celent, a financial services consultancy. I blogged here and here that I believed that the entire "crisis" was grossly overstated and based on an insular Wall Street perspective. The entire article is fantastic so read the whole thing, but here are the choicest of excerpts:

The credit crunch is not nearly as severe as the U.S. authorities appear to believe and public data actually suggest world credit markets are functioning remarkably well, a report released on Thursday says.
"It is startling that many of (Federal Reserve) Chairman (Ben) Bernanke and (Treasury) Secretary (Henry) Paulson's remarks are not supported or are flatly contradicted by the data provided by the very organizations they lead," said the report.
"I don't think they're fabricating stuff but what I think they are doing is taking the situation of a handful of institutions and generalizing that to the market as a whole, incorrectly," said Marenzi.
Regarding U.S. business access to credit, the report says:
*Overall U.S. bank lending is at its highest level ever and has grown during the current financial crisies.
*U.S. commercial bank lending is at record highs and growing particularly fast since May 2007.
*Corporate bond issuance has declined but increased commercial lending has compensated for this.
*lending hit its highest level ever in September 2008 and remained high in October and that overall interbank lending is up 22 percent since the start of the financial crisis, taken to be mid-2007.
The article goes on with information from the report that reveals little or no evidence of a broad credit crunch in the U.S., Europe, or Japan. Please go to this article and forward it to anyone you think might be interested.

Stimulus Talk Rises to $1 Trillion

According to Foxnews:

Obama's Economic Advisers Considering $1 Trillion Stimulus Plan

Less than three weeks back I mentioned this:

If anyone is aware of how I can invest in the future size of the coming "stimulus" package that would be great. Just a few weeks ago Obama was suggesting a $150 Billion package. Within that last week I was none too surprised to see Paul Krugman pushing "at least $600 Billion". Now, Obama's advisors are topping them all.

$700 Billion...
That would have been a 43% return in just 19 days!

Just imagine how badly this could effect the economy if they are wrong (which they are). Imagine how much corruption and lobbying is going to go on with this sort of spending spree. This is going to be a mess of historic proportions.

Friday, December 12, 2008

Crowding Out

I have mentioned before how I believe that the massive increase in U.S. borrowing will crowd out private investment, and thus hurt economic growth. Something that I hadn't thought of was how U.S. borrowing will attract foreign capital and force other governments to raise their interest rates to compete with the U.S. Our borrowing may hurt their economies as well.

From the Financial Times (HT: Objectif Liberte):

Investors shunned one of the most liquid and safest assets in the world on Wednesday as a German bond auction came close to failing in a warning sign for governments attempting to raise record amounts of debt to boost their slowing economies.
The auction of two-year bonds saw only just enough bids to meet the €7bn ($9bn) the government wanted to raise. This was almost unheard of before this year as investors typically clamour to buy these securities.
However, the prevailing view among analysts is that problems in raising debt so soon after many governments have announced fiscal stimulus programmes to revive their economies are a worrying sign with vast amounts of supply due in the coming months.

Governments in Europe are expected to issue more than $1,000bn next year, while the US is expected to raise up to $2,000bn. With up to $2,000bn in government-backed bank bonds also expected next year, analysts say the market faces grave dangers of being “crowded out” as some governments struggle to raise debt or have to pay much higher yields.
A banker said: “They couldn’t get the price they wanted. There is a lot of competition in this space, and they were having to offer big premiums to interest investors. The fact it was year-end didn’t help.”

Victory for Now

Senate Republicans block the Auto Bailout Bill!
From Yahoo.

I'm sure they will try again, especially given that Bush wants this to happen, but it's nice to Republicans have a little guts.

Thursday, December 11, 2008

Cash and Treasury Bill Bubbles

This article from Bloomberg relates how Russians are moving their wealth into U.S. Dollars and jewelry. If this sort of flight to the dollar is happening worldwide it helps explain why the dollar has gained value even while the Fed has exploded the money supply. It's interesting to see how people there are so adept to adjusting to currency devaluations and bank panics. One lady has bank accounts in three different currencies. Honestly, I would have to do some research even to find a bank that offered this service here in the U.S.

Also from Bloomberg, this article describes the frenzy to buy short term Treasuries which act a lot like cash.

Treasuries have some bubble characteristics, certainly the Treasury bill does,” said Bill Gross, co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co., which oversees the world’s largest bond fund.
Rising supply of government debt to pay for the bailout of the economy and financial system has done little to damp demand.
There is basically insatiable demand for Treasury bills,” Ira Jersey, a New York-based interest-rate strategist at Credit Suisse Group AG, said in a Bloomberg Television interview. “There is a number of reasons for this, not only angst over deflation and what’s going on with risky assets, but there is also just a lot of cash that does not want to take any credit risk.”
David Rosenberg, the chief North American economist at New York-based Merrill Lynch, said last week that demand for Treasuries had reached the “bubble” phase like in technology stocks in 2000 and real estate six years later.
Deflation may worsen the economic downturn by making debts harder to pay and countering the impact of Fed rate cuts. Deflation also makes bonds more valuable, even with yields at record lows.
...said Mitchell Stapley, who oversees $22 billion as chief fixed-income officer for Grand Rapids, Michigan-based Fifth Third Asset Management. “The flight out of Treasuries is something that will be breathtaking.”
This whole scene reminds me of my final quotes on this post on my so-called "cash bubble" a few weeks ago. If everyone runs out of Treasuries as fast as they have run in, we are in for a horrible spike in inflation.

The White Stuff

I have been to Yellowstone National Park in the winter with over three feet of snow on the ground, but for some reason, snow in Houston always gets me giddy. In the last 30 years it has snowed here, at least where I live on the south side of town, four times. Last night about an inch and a half of snow collected on my front lawn.

The most amusing things you will see in Houston when it snows are photos on local TV of 9 inch snowmen built from accumulations on cars. We also don't have as many plants and trees that turn brown in the winter, so you see snow on palm trees, southern oaks fully leafed, and green grass. Of course, my flower beds with all their tropical plants will now be dead for the rest of the winter.

Wednesday, December 10, 2008

Why College Costs Keep Rising

It is the conventional wisdom that every American should have the opportunity to go to college so that they too can achieve the American dream. It is alleged that we need to increase college aid to achieve this goal. Unfortunately, reality trumps these idealistic goals.

First, many schools don't want to get any bigger, they want to become more illustrious. They want to move up the famous U.S. News and World Report college rankings. Almost all of the college rankings judge schools by the amount of resources they spend per student. What incentive does this give universities that want to improve their standing? Get and spend more money, and maintain your student body size.

To help students afford college, the government subsidizes attendance in many ways. From grants, to subsidized students loans, to simple budget increases for universities. This increases demand. If the supply of student slots does not increase, the price to attend will rise until the subsidy has been completely negated for those at the margin. When the government spends more, a restricted supply will push prices upwards. It becomes a vicious circle of higher prices and increased subsidies.

The other justification for these kinds of subsidies are that they help the economy and increase incomes throughout the entire community. Steven Malanga writes today at RealClearMarkets in response to the lack of skepticism of this paradigm by the press:

A few researchers, however, have asked these questions, and the answers aren’t always pretty, nor are they part of the conventional wisdom. One of the skeptics is Richard Vedder, distinguished professor of economics at Ohio State University and head of the Center for College Affordability and Productivity. He’s spent years observing the upward spiral of tuition at American colleges and universities and the increase in government’s subsidies for higher education. His research suggests we are already over investing in our public universities.

For one thing, Vedder has found little evidence that government spending on higher education stimulates an economy. He has run hundreds of regression analyses trying to understand the relationship between subsidies for public universities and local economic growth, and what he’s found is that at best the spending produces no gains, while at worse, “the more states spend on higher education, the lower the growth” over time.

On the question of whether state spending actually lowers tuition and costs for students, he goes on.

...state universities devote a small proportion of incremental public financing to keeping tuition low. In one study, the Center for College Affordability determined that on average public universities use only 30 percent of public funding increases to hold down tuition costs. Instead, public universities have been pouring more money into intercollegiate athletics and student services, raising salaries rapidly and increasing hiring of non-instruction personnel. In 1975, for instance, the ratio of non-instructional staff to instructors at America’s colleges and universities was about 4.5-to-10. Today, it’s about 8-to-10.
He also makes some good points that not every student is capable of performing well in college, if you want to read the rest.

I Have a Man-Crush

According to this story with The State, a South Carolina newspaper, (HT: Club for Growth), the governor of that state, Mark Sanford, wants to do the following:

1. Eliminate state Corporate Income Tax

2. Pay for it by eliminating Corporate Welfare tax breaks for politically desireable industries.

3. Switch the codified state income tax for a Flat Tax

Isn't he just dreamy. Maybe my wife would let me put his poster on the closet door.

Tuesday, December 9, 2008

Endearing Video for School Choice

This is a sweet and gripping video from the Institute for Justice. (HT Club for Growth)

I try to be as fair as I can be when discussing political topics. School Choice, however, is one of those issues in which I find the dogged defenders of the status quo to have a callous disregard for the welfare of children. I consider this essay of mine one of my favorites on the topic.

Where's the Money? - Update

Last week I mentioned the perplexing situation of how the money supply has exploded, yet inflation is not even on the radar. Louis Woodhill takes a stab at explaining what's going on, and it seems reasonable:

Right now, the Fed is paying 1.00% interest on excess reserves (which are the vast majority of bank reserves right now). This is equivalent to offering banks one-day T-bills at an interest rate of 1.00%. The current yield curve for T-bills starts at 0.01% for 3 months, rises to 0.28% for 6 months, then to 0.50% for 12 months, and then reaches 0.92% for 24 months. Given this, it is clear that the interest rate the Fed is offering on bank reserves is far above market for a risk-free investment.

Given that the Fed has been offering banks an above-market return for sitting on their money, it is not surprising to find that this has been exactly what they have been doing. Bank lending has plunged. The velocity with which money circulates through the economy has also plunged, taking demand, output, and employment with it.
What the Fed’s new policy has accomplished is to “sterilize” the massive increases in the monetary base the Fed has been engineering in an effort to prop up demand and the economy. From August 1 to November 1 (the last data point available) the monetary base increased from $871 billion to $1.482 trillion. This 70% expansion in just three months is more than the percentage increase over the preceding ten years.

The way that I understand it, is that when you put $1,000 into your checking out, a bank would normally try to find a business to loan some of that money at a higher rate of interest. Now, however, they can pick up arbitrage by paying 0.75% interest on your checking account deposits, then placing your money with the Federal Reserve earning 1.00% interest, and picking up a risk free return of 0.25%. This margin seems paltry, but for a bank, volume can make up for margin. Money isn't going into the economy because of this easy arbitrage.

This practice of the Fed paying interest on deposits is actually new, starting earlier this fall in response to the supposed Credit Crisis. Woodhill is imploring the Fed to stop the practice immediately because it is suppressing loan activity.

Monday, December 8, 2008

New Homeschooling Data

Long time readers know that my wife and I plan to homeschool our boys. This is for a number of reasons, but for me, the primary one is academics. The Hoover Institution put out a publication (HT: NCPA) recently that details numerous facts about homeschooling and those that homeschool.

The stereotype is that homeschooling is for religious zealots, but according to a survey they site religion is the minority motivator.

They also analyzed household income which reveals that homeschooled children come from homes with approximately the same income as public schools. Although, this is obviously skewed by the fact that so many mothers are staying at home to school them instead of working.

Isn't Obama Just Adorable

As President-Elect Barack Obama articulated his so-called stimulus plan on "Meet the Press" this Sunday, he managed to slip in a few jokes (From CNN):

"You know, the days of just pork coming out of Congress as a strategy, those days are over."
Bwah, ha, ha, ha, ha...

"We are not going to simply write a bunch of checks and let them be spent without some very clear criteria as to how this money is going to benefit the overall economy and put people back to work. We're not going to be making decisions on projects simply based on politics and -- and lobbying."
Oh stop, you're killing me! Ha ha ha...

You're going to spend $700 Billion on a stimulus package next year and you really think that politics and lobbying aren't going to be a major part of this? Are you insane? How stupid do you think we are?

Sunday, December 7, 2008

Racist Louisiana Republicans? Not quite.

Last year, Louisiana elected Bobby Jindal, the first Indian-American elected as governor in the history of the United States. Now, they have made another first by becoming the first congressional district to elect an American of Vietnamese descent. Anh "Joseph" Cao and Bobby Jindal both happen to be Republicans.

For a state long stereotyped as hopelessly backwards and filled with racists, the citizens of Louisiana continue to make history and can now claim their rightful standing as the most color blind state in the nation.

Thursday, December 4, 2008

English Real Estate Prices

Here in the U.S. we tend to think of ahousing bubble as something new. However, it is clear from S&P Case-Shiller data that home prices in Los Angeles rose 69% between Jan. 1987 and Jan. 1990, then they proceded to drop 27% over the next 6 years. It is also insightful to look at the experience that other countries have had with land use planning.

According to Vincent Benard at Objectif Liberte, England passed a "Town and Country Act" in 1949, and then expanded it in 1965. This was a series of laws to "protect" English cities from bad development by creating review committees. Since that time, it has been much more difficult to build new homes. My theories on home prices and supply restrictions predict that this will cause abnormal growth in home prices, followed by speculation (a.k.a. extrapolation), then a bust. Did this happen?

Let me define abnormal growth in home prices as being a point in time where home prices grow significantly above income growth. We saw this ratio of home price/income grow from a traditional multiple of 3 up above 10 in our bubble.

The chart below reveals that this is not the first home price bubble in England, but the 4th gyration. (HT: Objectif Liberte)

This notion is reiterated by this graph of real home prices (I assume this means inflation adjusted).

I have said before that I think the housing bubble will repeat itself. Looks like England proves this all too true.

Wednesday, December 3, 2008

Texas Faces Huge Surplus

Leonard Gilroy from the Reason Foundation, with whom I've partaken of some fine Vietnamese food (which makes me super cool by association!) has a piece on Texas' $11 Billion state surplus.

Some excerpts:

A recent study by the Center for Budget & Policy Priorities found that at least 41 states have recently faced, or are facing, budget deficits. Today 13 states are staring at budget shortfalls in excess of $1 billion in fiscal year 2009, with California ($31 billion) and New York ($6.4 billion) leading the pack. Moody's recently reported that 30 states are in recession, and 19 more are at risk.
Texas is currently the envy of the nation with an $11 billion budget surplus. How did the state do it? For starters, the Texas Constitution gives the state Comptroller of Public Accounts (a chief fiscal officer, of sorts) the responsibility to certify the state's budget and send back any spending bills that the state can't afford. It's an elected position and the current comptroller, Susan Combs, launched a "Where the Money Goes" website to boost transparency and show taxpayers where their money is going. Having a third-party enforce prudent fiscal forecasting and spending helps to avoid the situation so many states now face—governors and legislators gravitate to the rosiest of revenue projections to help justify new spending, and then when the mythical money doesn't materialize, the state faces a budget "crisis."

Texas also engages in performance-based budgeting—tying a given programs' funding to its effectiveness at meeting clear performance targets. A Sunset Advisory Commission conducts mandatory periodic reviews of all state agencies to find duplicative or unnecessary programs that must be cut. Since the Sunset Commission was created in 1977, over 47 governmental agencies have been eliminated and another 11 have been consolidated.
Ah, maybe this is why Texas Governor Rick Perry wrote an op-ed against state bailouts from the Federal Government. Why should my tax dollars go to bailout other irresponsible states?

Guess who's likely to get my third consecutive unapologetic vote for Governor in 2010?

Supply Side Stimulus

Richard Rahn of the Cato Institute outlines an economic restoration plan in an op-ed for the Washington Times today. He also bashes the “Keynesian claptrap”, which is always fun. I liked some of the proposal, so I wanted to expound on it.

1. Cut payroll taxes for two years – Payroll taxes are the FICA and Medicare taxes removed from your paycheck. Of these taxes, you pay half and your employer pays half. By cutting this tax, tax home pay for the employee increases and employment costs for the employer fall. This should give more incentive to hire.

However, because the tax cut is temporary the effects will be small. It is unlikely to see much increase in demand for professional positions as companies generally expect new professional hires to spend several years at the firm. The unemployment rate for college educated people is also generally very low (~2%) and doesn’t tend to spike as much during recessions.

For low-skill labor this could be a boon. Unemployment rates for low-skill labor is often quite high (~8%) and tends to jump quite a bit during recessions relative to other labor demographics. Employers who simply need warm bodies don’t expect that these employees will make a career of flipping burgers. This temporary measure could have a worthwhile impact to alleviate temporarily unemployment.

Given that there are some benefits, this would be a less bad stimulus than direct government spending. The tax cut encourages more output, and allows businesses to allocate efficiently the resources to profitable ends. The drawback is that it still requires borrowing, which gives incentives to move capital from its most efficient allocation to one less so. It may help your local Jack in the Box, but only at the expense of your local biotech startup looking for a loan. I just don’t think there are enough positive supply-side effects from this kind of tax cut to mitigate this fact.

I say "less bad stimulus" than government direct spending because of the points that Mr. Rahn makes:

Some advocate government spending on infrastructure as part of a stimulus package. In theory, government infrastructure spending (highways, bridges, dams, etc.) can help the economy: if the project meets a solid cost-benefit test; if it is well-managed; if there is little or no corruption; and if it can be done quickly to help the current downturn. Do you want to bet your tax dollars on all of those "ifs"?
2. Cutting Corporate Income tax – This idea I can more whole-heartedly support. First, and foremost, we would become more competitive internationally. In the long run, more operations would be located here in the United States. Sure there are countries who have labor so cheap that we can not compete for the lowest skill jobs, but we can compete for high wage/high skill jobs. As Europe continues to cut their corporate tax rates, it will become more and more pressing for the U.S. to do the same. Secondly, there is an immediate benefit. My company has (legally) arranged business operations to move profits out of Japan to the United States to save on taxes. We have done the same to move profits from the U.S. to other low tax countries. If those profits were repatriated, the tax flows would stay in our country and no theirs.

The other effects of cutting the corporate tax rate that I like are gains in efficiency and drops in lobbying. If companies are paying less corporate taxes there is less incentive for them to engage in creative tax accounting. These people and resources could be employed in more productive tasks. In a similar way, lower tax rates gives less incentive to game the tax code through lobbyists.

It would still require borrowing to replace this tax revenue, but I think there are enough supply-side effects to make this worth doing.

3. Assuring the market that capital gains taxes will not be increased – This costs nothing and would help our ailing stock markets. Some of the market drop is based on fears of Mr. Obama’s campaign pledges to increased capital gains taxes. The capital gains tax is by far the most destructive form of taxation the government imposes. History has shown that raising this tax actually lowers tax revenue, and drags down economic growth by destroying capital. Higher capital gains taxes are a lose-lose proposition.

Mr. Rahn also encourages allowing individuals to reclaim taxes through capital losses. I completely disagree. This would exacerbate the already pro-cyclical nature of tax revenues. It would be better just to get rid of them.

In general, good ideas. I have toyed with the payroll tax cut before, but it doesn’t look like a panacea. So, I shrug my shoulders at the payroll tax cut, and give a big thumbs up to cutting corporate tax rates and maintaining current capital gains taxes.

Tuesday, December 2, 2008

The Consumption Myth

You will hear economists with Keynesian sympathies, and just about every journalist in America, espouse the idea that we need to spend more money to get the economy going. John Tamny addresses this fallacy today at RealClearMarkets.

The notion that consumption is the economy’s driver is not new. We’re regularly told that consumption constitutes 70% of our economy; a notion that couldn’t be more mistaken. Indeed, how is that people consume without producing first? Don’t the two balance? By definition they have to.
At first glance this thinking makes sense; that is, until we take a micro view. Looked at from the perspective of an individual, we see that excess consumption can only impoverish. Indeed, imagine the health of the United States’ economy if every individual spent every dollar made?
The better answer is for individuals to act in their economic self-interest. In saving for a rainy day or even for a distant retirement, savers can help themselves all the while knowing that their savings will either support the consumption of others, or in many instances serve as seed capital for tomorrow’s entrepreneurial ventures.
So with Christmas and the economy in mind, individuals should do that which enhances their own economic outlook the most. If that means lots of work and lots of saving, those who do both should go forth with certain knowledge that they’re bringing the economy the greatest stimulus of all.

Good thoughts to ponder.

Monday, December 1, 2008

Paul Krugman Is Wrong

Nobel Prize, several books, PhD, leading economic thinker on the Left, but he's still way off.

From his column today:

The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates, which makes businesses unwilling to spend on new plant and equipment, and that this in turn reduces the economy’s long-run rate of growth. Under normal circumstances there’s a lot to this argument.
This is what I have been arguing.

But circumstances right now are anything but normal.
Kind of like last Tuesday when the pull of gravity fell by 10% for a few hours.

What about longer-term rates? These rates, which are already at a half-century low, mainly reflect expected future short-term rates. Fiscal austerity could push them even lower — but only by creating expectations that the economy would remain deeply depressed for a long time, which would reduce, not increase, private investment.
A half-century low? Really? Moody's AAA Corporate bond rates are not at half century lows. They were lower earlier this year and have averaged below or the same for several years now. They were also lower in the 1960s.

Of course, what he is really talking about are Treasury rates. Corporations don't borrow at the lower treasury rates, they borrow at corporate rates. Private investment has to do with private interest rates not government interest rates.

One might think that I'm being overly technical, and I would respond not technical enough. You see, he is also referring to nominal interest rates, which also mean very little. The real interest rate is the true borrowing costs for corporations. Earlier this year when corporate bonds were yielding 5.25%, the TIPS-5yrTreasury measurement of inflation was running at 2%. This implies that real AAA rates were running at 3.25%. Now, these corporate bonds are yielding 5.75%, and the TIPS inflation is running at -0.7%, implying that AAA corporate bonds are really yielding 6.45%. Crowding out causing higher private interest rates? Seemingly.

He goes on:

The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.

The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.

This is all accurate, it just doesn't prove that we should start a fiscal stimulus plan.

Allow me an analogy to show why this happened. Let's say I'm the king of a small Caribbean island where all economic activity is fishing and growing sugar. The country is in a recession. I decide, let's borrow money from America to build cute little castles on our island because I'm a crazy loon. My citizens start building castles, which provides many jobs. Several new businesses open on the island that provide cut stone and gargoyles. Output shifts and employment shifts to building castles. After a few years I decide that I am too far in debt and that we now have enough castles. Not only do the government employees lose their jobs, the cut stone and gargoyle manufacturers also go out of business. A dramatic shock to the economy takes a while to sort out. A man who has spent years laying stone can't just become an expert fisherman in a day.

As I quoted him here from his blog on what happens after you come off of fiscal stimulus:
But eventually the economy will have to come off life support. What will
take the place of the stimulus? I don’t really know the answer..."
Forgive me one more analogy. Imagine your son has built a plane out of legos. I walk in and smash it and tell him to build a house. It takes him a while, but he builds a house. Then I come back in and smash it again and tell him to build the plane again. It takes a while, but he does.

The answer, Mr. Krugman, is that the "fiscal stimulus" will cause a recession when you start. Then when the economy gets used to the reorganization the fiscal money will run out. Coming off the stimulus will cause yet another recession.

Sunday, November 30, 2008

Housing Double Dips

Earlier this year, numbers from the Case-Shiller index were starting to look a little better. At one point, 9 of the 20 markets they tracked were showing price appreciations. However, the most recent data revealed that housing prices may be double dipping. Every single housing market they track lost value in the last month.

Cities like Dallas, Charlotte, and Cleveland, which had had positive appreciation rates for several months, showed a surprising deterioration.

I have a few guesses why this might be happening: Weaker economy, deflation, and seasonal variation (fewer purchases after school starts). However, I can't point to anything definitively just yet.

Mia Culpa: I have been suggesting for several months on this blog and a few others that housing prices were going to be effectively flat by this point. I was wrong. Not sure why though, until I figure out what has changed.

Pictures of Government Interference

Did the bailout prevent the market from finding a clearing price for mortgage backed securities?

A while back I introduced a market index for market backed securities, located here. I also used this augmented graphic below.

In the above graphic, I showed how the value of mortgage backed securities tanked when Henry Paulson finally announced that none of the bailout money was going to buy these assets. Interestingly, the value of these assets finally hit a bottom, and bounced back in value.

A coworker and I have been confused as to why no one wanted these assets because the implied rate of return was getting pretty huge. The Wall Street panic should end when no one has to write down any more assets.

If a bottom for this market could have been achieved back in August, panic would have subsided and many clear-headed investors would pour money back into these assets. Instead, the bailout increased uncertainty and delayed the ability of companies and investors from knowing where the bottom was going to be. Should they sell now or should they wait for the Treasury to buy them at a higher price? Should they buy or will prices fall further? The bailout prevented these questions to find answers, because the market was kept from performing its normal information gathering tasks.

Tuesday, November 25, 2008

Unemployment Benefits Cause Unemployment

David Henderson writes at Forbes today about the effects of extending unemployment benefits on the unemployment rate.

When the government subsidizes an activity, it gives people an incentive to do more of it. That's true also of unemployment benefits. To receive unemployment benefits, someone must be unemployed. The unemployment benefit system, in short, pays people to be unemployed.

By signing the law on Friday that will extend the length of time unemployed workers can receive unemployment benefits and by signing a similar law last July, President Bush has made our unemployment rate higher than otherwise. The legislation that Bush signed will provide seven additional weeks of payments to people who have exhausted their benefits or will exhaust them soon. Those in states where the unemployment rate is above 6% would be entitled to an additional 13 weeks above the 26 weeks of regular benefits.
I have alluded to this effect before, but Henderson lays this out pretty well with lots of data and links to academic journal papers. He doesn't mostly rely on pontification like yours truly.

What annoys me about this practice of extended unemployment benefits, is that many use a high unemployment rate to justify further interventionist policies.


Note - I am out of town this week, so forgive me if the posting is less than inspiring.