Wednesday, June 18, 2008

The data is not the economy

The map is not the territory - Alfred Korzybski

The Washington Post's Neil Irwin explains Why We're Gloomier Than The Economy:

Ask Americans how the economy is doing, and their answer is stark: It is not just bad, it is run-for-the-hills terrible. Consumer confidence is at its lowest level in almost 30 years. Only 12 percent of Americans think the economy is in good shape. On the Internet, comparisons to the Great Depression are widespread.

But the reality is different. According to most broad measures of how the economy is doing, it's not all that grim.

Soft? You betcha. In recession? Quite possibly. And a crisis in the financial markets has rattled nerves for months now. But so far, the economy is holding up better than it did during the last two recessions in 1990 and 2001. Employers haven't shed as many jobs, the unemployment rate is still relatively low, and gross domestic product has kept rising. Things are nowhere near as bad as they were in the Great Depression, or even during the severe recession of 1982-83. The last time consumers were this miserable, in May 1980, the jobless rate was 7.5 percent and inflation was 14.4 percent. Now those numbers are 5.5 percent and 4.2 percent respectively.

OK, that wasn't the explanation, just the statement THAT consumer confidence data isn't holding "true" to historical norms.

Here's the explanation:

But now, coming off two decades of prosperity and low inflation, Americans have come to treat low unemployment and inflation as givens. We have gotten so used to things being good, in other words, that even when conditions become somewhat bad, it feels terrible.

Perhaps he is on to something here. Prior conditions "color" current perceptions, to an extent. 65F can feel quite cool when coming from 90F and quite warm when coming from 20F.

While this phenomenon might explain some of the apparent disconnect, I think a more obvious cause of the disconnect are the changes to unemployment and inflation data since the 80's.

A recent report (April 8, 2008) by John Williams of Shadow Government Statistics speaks to this issue:

Net of gimmicked methodologies that have reduced CPI inflation reporting and inflated GDP reporting, the U.S. economy has been in a recession since late-2006, entering the second down-leg of a multiple-dip economic contraction, where the first downleg was the recession of 2001 that really began back in late-1999. Annual CPI inflation currently is running around 11.6%, again, facing further upside pressures.

An older report (Sept. 2007) touches on Unemployment:

The statistically-sounder household survey showed seasonally-adjusted employment tumbling by 316,000 for August, following a 30,000 decline in July. The seasonally-adjusted U.3 unemployment rate held at 4.64% +/- 0.23% in August, versus 4.65% in July. Unadjusted August U.3 fell to 4.6% from 4.9% in July, while the broader U.6 measure eased to 8.4% from 8.6% (unadjusted) but rose to 8.4% from 8.3% (adjusted). Net of the "discouraged workers" defined out of existence during the Clinton Administration, the traditional unemployment rate continues to run around 12%.

It looks to me as if the consumers have a better sense of things than the data crunching economists, for they are not laboring under the view that the data is the economy. For them the economy is just what they experience in a monetary sense. While the change in oil prices has not been as rapid as in the 73-74 or 79-81 period, a trebling of oil prices is a trebling of oil prices (to wax tautological).

I am reminded of a little short story by Jorge Luis Borges:

Of Exactitude in Science

...In that Empire, the craft of Cartography attained such Perfection that the Map of a Single province covered the space of an entire City, and the Map of the Empire itself an entire Province. In the course of Time, these Extensive maps were found somehow wanting, and so the College of Cartographers evolved a Map of the Empire that was of the same Scale as the Empire and that coincided with it point for point. Less attentive to the Study of Cartography, succeeding Generations came to judge a map of such Magnitude cumbersome, and, not without Irreverence, they abandoned it to the Rigours of sun and Rain. In the western Deserts, tattered Fragments of the Map are still to be found, Sheltering an occasional Beast or beggar; in the whole Nation, no other relic is left of the Discipline of Geography.

Tuesday, June 17, 2008

If this is a crime...

Federal prosecutors, capping a yearlong investigation, are preparing to file criminal charges against managers of two Bear Stearns Cos. hedge funds whose collapse helped mark the start of the credit crisis.
At issue is whether the managers intentionally misled investors by presenting a rosy picture of the funds at a time when they were privately communicating with colleagues about their worries over how the investment vehicles would ride out weakness in the mortgage market. Any indictments would be the first criminal charges against Wall Street executives arising from the credit crisis that swept the financial world last year

If we're going to criminalize panglossian efforts to paint a rosy scenario they better start building a bunch of new jails. We in the US have a long history of "putting lipstick on a pig."

Last night I watched a History Channel documentary on Franklin Delano Roosevelt which detailed, inter alia, the hiding of his ill health from the public, particularly during the 1944 election, when he was clearly near death. I guess misleading voters isn't as criminal as misleading investors.

This might bring a sigh of relief to certain past and current members of the Bush administration whose forecasts and descriptions of events in Iraq were at least as far off the mark as the offensive statements from the 2 fund mangers noted above.

Has it been 5 years since we saw that Mission Accomplished banner on the USS Abraham Lincoln?

But, as already noted, misleading voters is not the issue. Misleading investors is.

Then again, maybe misleading investors is not such a big deal. Consider Treasury Secretary Mellon's gem from the last Great Depression: I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress.

Here's a whole page of misleading statements.

Of course, one needn't go back so far in time to find senior financial officials putting a nice spin on a dicey situation. We may have to wait a few months for the truth of this statement by current Treasury Secretary Paulson to be tested (I have, it seems worth noting, been reading this refrain for months): the worst is likely to be behind us.

The only difference I can see between Paulson's and Bernanke's happy talk and that of the Bear Stearns Hedge Fund Managers is that the US Treasury hasn't gone bust......yet.

Sunday, June 15, 2008

Zen and the Art of Monetary Maintenance (ZAMM I)

It must be evident, however, that the mere introduction of a particular mode of exchanging things for one another by first exchanging a thing for money, and then exchanging the money for something else, makes no difference in the essential character of transactions. It is not with money that things are really purchased.....The pounds or shillings which a person receives weekly or yearly, are not what constitutes his income.......The farmer pays his labourers and his landlord in [money], as the most convenient plan for himself and them; but their real income is their share of his corn, cattle, and hay, and it makes no essential difference whether he distributes it to them directly, or sells it for them and gives them the price; but as they would have to sell it for money if he did not, and as he is a seller at any rate, it best suits the purposes of all, that he should sell their share along with his own, and leave the labourers more leisure for work and the landlord for being idle...... There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order. J. S. Mill, Principles of Political Economy

The Modern Trinity: Mechanical Mind-set, Human Brain attuned thereto, Industrialization.

We can thank (or curse) Newton for widely propagating a view that hitherto few had discovered and nurtured, the mechanical perspective- God made and wound the watch with us in it, left it to run, and gave man the wit to see how it worked (with the caveat that we could only ever view the machine from within, like fish in a fishbowl). From this vantage point many repeating processes could be understood, predicted, and perhaps, improved.

Within a generation of publication, the ideas of Newton's Principia Mathematica began to bear their fruit, England's cotton mills being a prime example. The flying shuttle made weaving so efficient that mechanised spinning became a necessity. These radical efficiency increases soon exposed new bottlenecks, carding and cleaning, the latter of which recalls Eli Whitney's Cotton Gin. And so on and so on- a self perpetuating process that dragged mankind into a new world.

Other fruits grew on the same ideological tree. Modern medical practices flow from the view that our bodies are (reasonably identical) machines. If our individual bodies could be seen as machines, why not our individual minds (psychology), or even collections of people (sociology, economics, government etc.)?

It was from this perspective that Adam Smith famously inquired into the Wealth of Nations, and saw money as "the great instrument of commerce," i.e. a machine. J. S. Mill's quote above expresses the notion more explicitly- money is the machine we use to make trade more efficient. Like all machines, however, it must be kept in good working order, lest it create its own bottlenecks.

Views in our post-modern world seem to me far removed from those Newton propagated. Industry, the State, and Finance, to name a few elements of what is collectively known as "the system" are no longer viewed as transparent, malleable, mechanical processes. They have become inscrutable and in ignorance of their workings many live in a kind of fear.

To this fear, or disquiet, if you prefer, Robert Pirsig addressed his Zen and the Art of Motorcycle Maintenance, which I like to think of as a collection of ideas for surviving in the modern world. In his words: The ideas began with what seemed to be a minor difference of opinion between John and me on a matter of small importance: how much one should maintain one's own motorcycle. It seems natural and normal to me to make use of the small tool kits and instruction booklets supplied with each machine, and keep it tuned and adjusted myself. John demurs. He prefers to let a competent mechanic take care of these things so that they are done right.

How does one maintain one's own motorcycle? By learning how they work, i.e. by viewing them as machines that convert potential energy in fuel into mechanical energy that moves you much more efficiently than you could move under your own steam. That the machine needs to be kept in tune, that you can sense if it is in tune, and that you can tune it yourself are vital aspects of this understanding. Pirsig advised people to "look behind the curtain" and on more machines than just motorcycles. If you can learn to tune a cycle, perhaps you can learn to tune yourself.

This essay is not that ambitious, confining itself to the view of money as machine- monetary instead of motorcycle maintenance.

But, you might be thinking, I don't run the money machine, guys like Paulson and Bernanke do. Marshall McLuhan would argue (with my agreement) that they don't really run the machine either, but that is another essay. My point is that just as one can learn to tell if a motorcycle is running well or not, and thus, if it should be fixed, how long and what form the fix will be, and whether to trust it on a journey (and if one thinks of saving for future, sometimes far into the fuure expenses, as very long journeys, in time instead of space, than this seems a useful exercise) one can learn to make similar judgements about the monetary machine. As we are forced to allow the monetary mechanics to fix that machine, wouldn't it be nice to know if they are on the right track?

Further, and for our purposes, quite important, let us understand what motorcycles (money) do and don't do. Motorcycles (money) move us more efficiently than we could move ourselves, they don't, of themselves, make us more prosperous, happier, or better people, although when they are not working they can cause the opposite.

Monetary Policy is the name we give to the process whereby modern monetary mechanics maintain the money machine. In, The Role of Monetary Policy, Milton Friedman argues: The first and most important lesson that history teaches about what monetary policy can do -- and it is a lesson of the most profound importance -- is that monetary policy can prevent money itself from being a major source of economic disturbance.

Profound indeed. The goal of monetary policy, as he goes on to argue, should be to provide a monetary climate favorable to the effective operation of those basic forces of enterprise, ingenuity, invention, hard work, and thrift that are the true springs of economic growth. While I disagree with Friedman's means to that end, I agree entirely with that end, and the implications thereof. To wit, a masterful monetary policy without enterprise, ingenuity, invention, hard work, and thrift would not generate prosperity. Whether one could see enterprise, ingenuity, invention, hard work, and thrift in rent seeking, by, say, trying to control distribution of a vital commodity like oil, I'll leave to you to decide.

Returning to the converse of the above, which is Friedman's point, don't let a poorly run monetary machine stifle enterprise, ingenuity, invention, hard work, and thrift, because it will. If your motorcycle is not running you can't get to work. If the money machine is not running, new ideas can not be put to work. If your motorcycle is not running you tend to spend a lot of time thinking (worrying) about it. If the money machine is not running, you spend a lot of time thinking (worrying) about that. Normal modes of saving, from which investment funding flows, become less efficient, and in some cases, destructive- like a motorcycle whose engine has seized.

To the extent you have noticed some of the signs of a poorly running money machine noted above, you might be wondering how long and what form the fix will take.

I hope to be adding coherence to some of the ideas on this topic I've been noting, but not publishing, lately in the coming days.

That discussion will be two-pronged: 1) a discussion of my sense of the ideal money 2) a more practical look at the effects of continuing attempts to use money of no intrinsic value.

It seems worth noting that the man who propagated the mechanical mind-set, Isaac Newton, was also Britain's Master of the Mint as the Pound Sterling emerged onto world trade as a standard of value. He put England on a firm gold standard.

And I think we have yet to build a better mouse-trap.