What is Capital?

I have thrown around the word capital quite often recently in my economic analysis. I have struggled to find a concise definition, so here’s my own. Capital is all accumulated resources not intended for consumption now or in the future.

The five bucks in your wallet that you plan to use at Burger King for lunch is not capital, but the five bucks you stuck in a jar last night to save up for that restaurant you want to open is capital. Capital is not necessarily money. Money is only a medium for exchange. Money only represents the goods that you plan to buy. Money for a hamburger is not capital, but money for the hamburger oven is. Any item you plan to use, but not consume is capital.

What is the Role of Capital?

Capital allows individuals to pursue increases in output and material comfort.

Imagine being on a deserted island. In the lagoon are fish and in the trees are coconuts, both you are able to harvest. However, there are also wild chickens on the islands. They are too fast to catch, but occasionally you run across their nests and take their eggs.

You realize one day that if you built a chicken coop. The chickens will stay close by because they would feel safe in the coop, and you can harvest the eggs more frequently. If there exists no spare time away from harvesting coconuts and fish, the coop can not be built. You must save food for the construction period. This savings is capital.

This capital allows you to pursue an increase in material comfort by tiding you over while you pursue this new idea. You can then build the chicken coop and your food intake will grow commensurately. This is how the economy grows. Less capital, less growth. More capital, more growth.

What is the Role of a Capital Market?

Capital markets link those with capital and those with ideas. It allows new ideas for increased production by those without sufficient savings to pursue those ends. It also allows those with capital to increase their wealth by finding a use for their capital.

Assume now, in the story above, that you have no savings and have no ability to save up fish and coconuts without starving. However, Susan is a much better fisherman that you and has some savings of dried fish. Susan is not very handy with building so she cannot build the coop for herself. If you present your plan to Susan and she believes that you can build the coop in the amount of time you estimate the two of you can make a deal. She gives you her capital, the dried fish, and both of you share the output of eggs. You are better off by expanding your diet with an easy bounty of eggs, and she is better off as well.

Why is Redistributing Wealth Bad?

To conceive of new ideas for production requires a focus in the pursuit of these ideas. Those without this focus are unlikely to conceive of new ideas. To develop a valuable skill set that allows for production above sustenance, like Susan, requires a focus on that task as well. The greater the focus, the greater the output, and the greater the accumulation of capital. By taking money away from those focused on increasing new skills and new ideas for production, and giving these resources to those focused on just consumption we reduce the amount of capital in the economy. With less capital, we achieve less growth and less material comfort.

Using our story, imagine a government requiring you and Susan to give the wood for your chicken coop over to John who uses it for firewood. John is able to enjoy a brief increase in material comfort, but all three are worse off in the end because there are now no eggs to eat.

What Happened to Peak Oil?

Just a few months ago the world was running out of oil. Worldwide production had peaked and it was going to be all downhill from there. If this was the case, what should have happened to oil prices? If there is a short supply of a highly desirable product, the price should go upwards. If we were running out with few alternatives the price should begin to approach infinity.

Now that the price has dropped 56% from it's all-time high for West Texas Intermediate, what happened to the worldwide shortage? Did it ever exist?

My friend John Tamny of RealClearMarkets repeatedly claimed that oil prices were merely a product of a weak dollar. I gave him some credence, but thought he was blowing the dollar-oil link out of proportion.

Here's a graph I compiled going back to 1986, using data from the EIA, the dollar index from the Fed Reserve. I inverted the dollar index for illustrative ease. I adjusted the WTI price by the Consumer Price Index to get the values in constant 1986 dollars. A higher red line means a weaker dollar.
The correlation isn't perfect, but clearly John is on to something.

The quick and dirty theory goes like this. The value of the dollar weakens, which means we have to pay more for imported goods. Oil, more and more, is an imported good. Weak Dollar = High Oil Prices. Strong Dollar, like we've had over the last few weeks = Low Oil Prices.

Make Work Redux

Another week means that another terrible idea from Barack Obama moves its way to the top of the heap. Unemployment jumps, so what do we need to do? Give people random tasks to accomplish. At only $150 Billion over 10 years, it’s a bargain as well.

The Left is ratcheting up their writing output to make the case for this classic make work plan. I try not to read children’s literature, but I plodded through this article written by Robert Pollin from the magazine “The Nation”. You’ve little need to read the whole article given this snippet near the start:

The recession is certainly here, so the question now is how to diminish its length and severity. A large-scale federal government stimulus program is the only action that can possibly do the job.

He goes on to mention that the $150 Billion stimulus earlier this year didn’t do much, nor the $700 Billion Treasury bailout, but the Fed’s $540 Billion guarantee of money market funds was spot on. I guess batting .333 is pretty good for baseball, so surely that’s golden proof we need to risk another $300 Billion at Mr. Pollin’s discretion (his plan is different than Obama's $150B).

What he and Mr. Obama are proposing is to “invest” billions into government directed “green-collar” jobs. The government apparatus will allocate these precious funds to various alternative energy projects, as we move into a new age of carbon free utopia. Apparently, even millionaire venture-capital environmentalists are too thick to invest in this sort of wishful thinking, so the government is going to fill the gap with rainbows, bubble gum, and the well oiled machine of government bureaucracy that we all know and love. If we all clap our hands and believe our little hearts out, those lobbyists circling over head won’t feast on this doe-eyed little program either.

If it gives people jobs, what can it really hurt? Well, Kenneth Green at the American answers:

Unfortunately, the idea of government “job creation” is a classic example of the broken window fallacy, which was explained by French economist Frédéric Bastiat way back in 1850. It is discouraging to think that, nearly 160 years later, politicians still do not understand Bastiat’s basic economic insight.

Mr. Green explains the Broken Window fallacy in his article and you can read it on Wikipedia. You can also go to my Amazon applet and buy Bastiat’s book. Destroying wealth can not possibly help the economy. If so, Hiroshima and Nagasaki owe us some money for the stimulus package we dropped on them in August of 1945. In a similar vein, the government can not create new jobs by taking resources away from other job producing entreprenuers.

He wraps it up with a good synopsis:

Obama’s “green jobs” plan would indeed create jobs, but it would do so by killing other jobs. Is that really the type of energy policy Americans want?

Obama’s policy idea is called Central Planning. History does not seem to show that this kind of activity works out very well. This is the same sort of make-work scheme that FDR employed to help the Great Depression needlessly drag on.

Where Did the Republicans Go Wrong?

In a word, Competence.

The autopsy on this election cycle for Republicans has already begun. Two camps are forming, like they do after every Republican loss. Should the party go to the right or to the center?

The political scientists believe that the Republicans should go to the center. After all, it is easier to find uncommitted votes in the middle. They want to plot a strategy that will satisfy those waffling centrists.

The party faithful, mostly want to move more conservative. They argue that conservative principles give a passion to the race that motivates the base and draws all Americans to a distinct difference between the two parties. They believe that the Left withers when a clear comparison of the ideals of the Left and the Right are placed against each other. Some would even prefer to go down fighting for what they believe in, even if it is not a winnable strategy.

The reality is that the political scientists have it all wrong, and the party faithful have it mostly wrong. The difference between John McCain and Ronald Reagan was not position on the issues, it was command of the issues.

While John McCain may be supremely qualified to be Commander and Chief of the Armed Forces, when he said, “The issue of economics is not something I've understood as well as I should”, not only was it a gaffe exploited by the Democrats, it was also an admonition of incompetence. Before the economic storm hit in October he seemed to be satisfied with his ignorance, and was left scrambling for answers. When Barack Obama dropped his guard and let some of his soft socialist sentiments slip out, John McCain lacked the wherewithal to offer a different vision. Sure, he could note the dark connotations of Obama’s words, but his understanding of economics was too poor to score the kind of knockout blows that flowed so freely from the mouth of Ronald Reagan.

The fatal mistake that Republicans have made for a decade now, is wanting to win politically and strategically, but not morally and intellectually. We need to stop complaining about the coach and start hitting the weight room. We need to do our homework. Those who want to be the Republican leaders of tomorrow need to stop trying to “Rebrand” their ideas, and make them deep and clear. They must know what they believe and why, to be expressed with an elegant ease that burns through the slick veneer of silver-tongued salesmen.

The problem for McCain and all of the other also ran Republican primary candidates was that no single person was fully competent in every aspect of their belief. None rose above mediocrity in their grasp of economics, defense, and social issues. So you disagree with the party base. Who cares? So the political center doesn't agree with you. Doesn't matter. Know what you are saying and stick with what you believe. If you are confident, passionate, and accurate, you will persuade.

So my advice to Republicans? Stop trying to look better, just be better. Get to work.

******

Addendum: This Ann Coulter piece just cracked me up. You can hate her, but you have to admit she's funny.

About My Blog

I have now been writing this blog for about 16 months. In that time, I think that I have grown considerably by the simple compulsion to post. Finding more information, more ideas, and deepening my understanding of economics, has been a fulfilling pursuit. Hopefully, those who have traveled this blog along with me these last months have grown in their own sophistication and understanding of virtue of free markets.

I believe my role as a blogger is to be a bridge. The talent of mine that I exploit is making complex concepts into simple terms. The level of discourse on this blog is still fairly high, but I also send out an e-mail letter with an audience who appreciates simplicity. I hope to get back to some of my more passionate essays more frequent a few months ago.

While I may quote blogs and papers from professional economists, I do not consider my role to be their equivalent. I do simple data analysis from time to time, but I am not an academic and don't want to be held up as an authority on their par.

Having said that, I do ridicule some very intelligent economists from time to time, even ones that I overwhelmingly agree with. Because of this, I invite all the vitriole that the internet has to offer. I try to respond to every message left on my blog. My goal is not merely to speak my beliefs, but to perfect my ability to persuade. If you believe in the virtues of an unfettered market, make me be better. Challenge me whenever you do not understand what I try to explain, and criticize me when my point is inaccurate.

Thanks to all who read, comment, or e-mail.

Be Careful What You Wish For

Just a few thoughts on the election last night:

I have to smile at the sentiment, and truth, of this post at the Club For Growth.

Bipartisanship? Are you serious? You think that after so many members of the Left reflexively marginalized the conservative talk radio set with unsubstantiated vitriole that those people are going to come up smiling? Then you talk of passing the Fairness Doctrine to muzzle their medium? Are you serious? You don't put out fires with gasoline.

It is a learning experience to see how a powerful narrative can allow so many people to glaze over alarmingly dangerous ideas. This explains a lot about history.

Update:
I concur with this post from Arnold Kling at EconLog.

Major Economist Agrees With My Bailout Comments on McCain

I'm starting to think that I know what I'm talking about. I wrote here that

"As I watched the debate between McCain and Obama last night, I began to realize that if McCain had voted against the bailout he could [have] completely slaughtered Obama. Had he kept his vote close to the vest and rebuked the bailout at the very end, it would have passed the Senate and likely the House, and Obama would be left holding the blame."

Here's Bryan Caplan's post:

Blase's magic bullet is simple: McCain should have opposed the bailout. There was a lot of popular resentment of it; it would have put a mile's distance between McCain and Bush's failures; it would have given McCain a great populist issue to ride; and it would have put Obama in the awkward position of defending Bush to the country. Even though the public wanted to "do something," McCain could easily have screamed "Yea, but not this!" from the rooftops - and people would have listened.

The main counter-argument: If McCain had opposed the bailout, it might not have passed - making it much harder to campaign against it. Indeed, Obama might have seen the trap and opposed the bailout, too, making it even harder for McCain to make the bailout his central issue. I wouldn't dismiss these possibilities. But even if they came to pass, an anti-bailout McCain would have had better chances than he does today.

5 Myths about the Great Depression

A nice article in the WSJ today on the Great Depression. Nothing terribly deep, but a good summary of the time period. Some excerpts: (Myths are underlined)

- Herbert Hoover, elected president in 1928, was a doctrinaire, laissez-faire, look-the-other way Republican who clung to the idea that markets were basically self-correcting. The truth is more illuminating. Far from a free-market idealist, Hoover was an ardent believer in government intervention to support incomes and employment. This is critical to understanding the origins of the Great Depression. Franklin Roosevelt didn't reverse course upon moving into the White House in 1933; he went further down the path that Hoover had blazed over the previous four years. That was the path to disaster.

- Enlightened government pulled the nation out of the worst downturn in its history and came to the rescue of capitalism through rigorous regulation and government oversight. To the contrary, the Hoover and Roosevelt administrations -- in disregarding market signals at every turn -- were jointly responsible for turning a panic into the worst depression of modern times. As late as 1938, after almost a decade of governmental "pump priming," almost one out of five workers remained unemployed. What the government gave with one hand, through increased spending, it took away with the other, through increased taxation.

In the same way, George Bush is often painted as a free-market ideologue. This is a gross exaggeration. Bush has a thought pattern I see most often with people with MBAs. They believe in markets and supply-side economics, but their understanding is superficial. When you get into the smaller details they believe in numerous limitations on personal freedom.

On a Totally Unrelated Note

Because election day will be consumed by politics out the whazoo I wanted to write about a very important topic that provided some heated debate at my office yesterday.

Do football referees have a cognitive bias towards media darlings?

To preface, I graduated from Texas A&M, and I have been an Aggie football fan ever since I was a little kid. This past Saturday night, ABC Sports showed the match up between two of my school’s archrivals: Texas Tech and the University of Texas. It’s a toss up which of these two teams we are supposed to hate more than the other each year. While Texas Tech won the game with some late game heroics, I felt that it was obvious that the calls heavily favored the Longhorns of the University of Texas.

For several years now, the Longhorns have consistently benefited from poor refereeing. However, I do not believe that there is any kind of conspiracy; I simply believe that all schools that have a recent history of being very good or happen to be media darlings receive better treatment by referees. Were I to watch a large number of games by USC or some other powerhouse I would expect to feel the same way. Furthermore, I do not believe that referees during the game are aware that they have a bias. There is simply a cognitive difficulty in seeing the game as it truly is when there is a preconceived notion of who is “supposed to win” the game.

In the NBA, it is generally accepted that star athletes get the benefit of the doubt and receive fewer penalties and their opponents are called for more penalties than reality would dictate. Players with bad reputations, such as Dennis Rodman and Ron Artest, often suffer more penalties than they ought to as well. I do not think this bias is intentional, it just simply is a product of preconceived notions. I see no reason why this same bias would not be extended to whole teams and other sports.

Having said that, I do not believe that this is simply an unpleasant fact that must be accepted. When I was young, I was your typical fan who always saw my own team as the one getting the short end of the stick. As an adult, I don’t see it that way. It has actually been quite some time since I have seen my team, the Texas A&M Aggies, face a significant number of bad calls.

My officemates, who just happen to be Longhorn fans, claim that my analysis is based on my bias against their team. But, in my defense, the only other team that I have accused of consistently receiving favorable refereeing was the Utah Jazz. When I finally met a Jazz fan in college from Salt Lake City and confronted him with my accusations that John Stockton built a career on the “moving pick” and roll, he laughed and said that he totally agreed with me.

AIG Bailout Won't Work?

This Washington Post article has some interesting news on AIG's bailout. (I know I linked to a Houston Chronicle reposting, but the Washignton Post requires a password) Because I am an employee of AIG I won't post any commentary.

"A number of financial experts now fear that the federal government's $143 billion attempt to rescue troubled insurance giant American International Group may not work, and some argue that company shareholders and taxpayers would have been better served by a bankruptcy filing."

"Echoing some other experts, Ann Rutledge, a credit derivatives expert, said she is not sure how badly the financial system would have been rocked if the government had let AIG file for bankruptcy protection"

"What we see now are a lot of games by the government to keep these institutions going with a lot of cash," she said.

Are Male Hispanic First Names Dying Out?

While the percentage of children born to Hispanics is rising, the popularity of traditional Hispanic first names for male babies is declining. As opposed to everyone's grandmother who claims that "They are just taking over the place", Hispanics seem to be conforming to U.S. culture and using traditional Anglo and modern American first names.

Using data from a Houston Chronicle applet that mines Social Security Data, I charted the rise and fall of new male Hispanic baby names over the last 45 years. If a name was the 100th most common name I gave it a value of 0. If it was the most popular baby name, I gave it a value of 100. If it did not make the top 100, it was given a value of 0.

Here is my chart.



Notes: I wasn't sure if Angel and Diego were specifically or overwhelmingly Hispanic names, so I left them off. They actually showed rapid increases in popularity during the last decade, but both declined in popularity in the last year (2007).

Another Economist Groping in the Dark

Economist Arnold Kling, at Econ Log, talks a little bit on this post how most explanations for the housing bubble have one serious problem: The international nature of the boom.

He quotes Robert Shiller (Of the Case-Shiller Index)

Dramatic home price booms since the late 1990s have been in evidence in Australia, Canada, China, France, India, Ireland, Italy, Korea, Russia, Spain, the United Kingdom, and the United States, among other countries.

Kling goes on to say:

What makes this a difficult fact is that so many explanations of the house price boom are U.S/ specific. It is hard to argue that the Community Reinvestment Act or the repeal of Glass-Steagall are what account for the home price booms in Norway or Spain. In fact, Shiller's view is that bubble/contagion is the only theory that can account for the multinational nature of the home price boom.

Not to beat a dead horse, but housing supply restrictions are the only reasonable solution to the geographic differences in the housing boom. Every single one of the other explanations fails to account for both the international nature of the boom, and the fact that Texas, and other high growth areas, had no boom. I have sat through presentations of Smart Growth/New Urbanism for the U.S., U.K., Australia, New Zealand, and France. I am willing to bet that many of the booms, but not all, can be explained by the significant increase of land use restrictions.

To review, here’s a list of the common culprits of the housing boom and whether they can account for the international and State-by-state differences with the housing boom.

Community Reinvestment Act – Nope
Repeal of Glass – Steagall (Deregulation) – Nope
Rampant greed and fraud – Nope
Fannie Mae/Freddie Mac – Nope
Low interest rates by the U.S. Federal Reserve – Nope
Arnold Kling’s Securitization Theory – Nope
Land Use Regulations/Supply Restrictions - Yes

Most of these explanations probably had some bearing on the situation, but they fail the critical test of geography.

One last note: I do give some credence to Shiller’s contagion theory, but only as an ancillary cause.