Friday, February 20, 2009

Why "Stimulus" is Wrong

A strident response from an adherent to the Austrian School of Economics to my last post, Multipliers, Imbalances and Weights, Oh My!, suggests to me that choosing the terms of debate is at least as important to the outcome as choosing the field of battle. In this case, the term "stimulus" is a poor choice as it has become "loaded." It connotes the worst elements of Keynesian Economics- that the state should "goose" the economy to increase stalled growth through unproductive, make-work jobs.

Decades ago the preferred term for such policies was "intervention" perhaps with the hope that the state could be conflated with the divine- a conflation which acted as stimulus to the polemics of the Austrian School, notably from Mises: in face of the modern tendencies toward a deification of government and state, it is good to remind ourselves that the old Romans were more realistic in symbolizing the state by a bundle of rods with an ax in the middle than are our contemporaries in ascribing to the state all the attributes of God.

Even von Mises, however, did not fall into the trap of assuming that all state actions were "interventions" or "stimulus" and thus doomed to failure. Mises was no anarchist, he merely wished to find an intermediate position from which to argue the virtues of limiting the scope of government action: But he who correctly perceives the impracticability of anarchism and seeks a state organization with its apparatus of coercion in order to secure social cooperation is said to be inconsis­tent when he limits government to a narrow function.

Mises' argues, and I agree, that the state should operate within the structure of the market, and not try to impose its "will" thereupon. This was the thrust of my endogenous vs. exogenous conceptions of government. An intervention, as Mises argues in his Critique of Interventionism: is a limited order by a social authority forcing the owners of the means of production and entrepreneurs to employ their means in a different manner than they otherwise would.

We must distinguish between two groups of such [limited] orders. One group directly reduces or impedes economic produc­tion (in the broadest sense of the word including the loca­tion of economic goods). The other group seeks to fix prices that differ from those of the market. The former may be called “restrictions of production”; the latter, generally known as price controls, we are calling “interference with the structure of prices.”

Mises goes on to detail what qualifies as an "intervention" (in our case "stimulus") and what does not:

Measures that are taken for the purpose of preserving and securing the private property order are not interventions

Partial socialization of the means of production is no intervention in our sense. The concept of intervention as­sumes that private property is not abolished, but that it still exists in substance rather than merely in name. Nationaliza­tion of a railroad constitutes no intervention; but a decree that orders an enterprise to charge lower freight rates than it otherwise would is intervention.

Government measures that use market means, that is, seek to influence demand and supply through changes of market factors, are not included in this concept of intervention. If government buys milk in the market in order to sell it inexpensively to destitute mothers or even to distribute it without charge, or if government subsidizes educational in­stitutions, there is no intervention.

In more concrete terms, Eisenhower's Interstate Highway Project was not, with some exceptions, an intervention or stimulus. Laborers were paid the going wage, supplies were purchased at market prices, most (but not all, thus creeps in an intervention) land was purchased at going rates. To the extent that Obama's infrastructure projects are implemented with the same philosophy, they too would not constitute an intervention in the Misesean sense.

Historically, such projects often, but not always, prove wildly profitable. Persian Qanats and Roman Aqueducts are early examples of state driven projects with huge multipliers on growth (we'll leave aside the issue of Roman slave labor, which would constitute an anachronistic intervention). The point being, so long as the state facilitates projects the private sector is happy to supply and work on, this is not an intervention.

Bridges to nowhere would be an intervention, profitable high speed rail would not. We will see where the Obama plan falls between these 2 extremes.

In my next post I'll turn to the interventionist aspects of Obama's plan, much of which deals with finance.

Friday, February 13, 2009

Multipliers and Imbalances and Weights, Oh My!

By the way, these days everybody thinks they're an economist. President Obama

It's Friday the 13th. Centuries ago a group of Monks/Warriors turned Bankers known as the Knights Templar were arrested on secret orders from King Philip the Fair on a Friday the 13th in October, 1307. Philip owed the Knights quite a bit of money- what better way to cancel a debt than to outlaw your banker- and besides, their raison d'ĂȘtre as warriors and bankers, the Crusades and the financing thereof, had ended in failure.

Another dream of Globalization bites the dust. I suspect today's Bankers are hoping they are treated somewhat better than the previous financiers of Globalization. Imagine what one could discover from the CEOs who just visited Washington if they had faced a Medieval Inquisition?

Today's Bankers are made of much softer stuff. I doubt one would need waterboarding to get them singing, a simple threat of making them ride the NY subway to work each day would likely be sufficient.

But enough of the trip down history's lane, today's post is about the perils of economic debate in the public arena- like the scene from the Wizard of Oz, pundits are faced with the terrors of the unknown on a dark road, but instead of Lions and Tigers and Bears, it's Multipliers and Imbalances and Weights.

Take the debate between the Left and Right in America on tax cuts vs. increased spending. The Right, despite evidence of the past 8 years (which, as an aside does not debunk any theoretical argument in favor thereof, more on that later) would have us believe that tax cuts are the true Yellow Brick Road, while the Left would have us believe that all public spending is stimulus.

While past results are no guarantee of future returns, as I had to learn to pass my Series 3 exam- humans, after all, are not stones- the multiplier effect of the Bush era tax cuts has been limited mainly to increased building of economically unproductive mansions in Greenwich, Connecticut, exorbitant payments to prostitutes- haven't these guys heard of Bangkok?- and increased profits for Caribbean Junkets. Tax reductions on the upper class would have been much more simulative if today's rich had behaved more like the Protestant Ethic imagined- live frugally and reinvest.

This behavior could, of course, change and the upper class could dispense with their retained income in accordance with the Protestant Ethic derived assumed weights in Right Wing econometricians' imagination. The theory behind the virtue of tax cuts rests on the assumption of wise dispostion of the additional funds they control.

While I agree in principle, given the dire need for US infrastructure improvement, and the lack of initiative shown by the private sector in that regard of late, with the decision to shift the flow of funds away from the upper class and towards such projects, the returns from such spending will depend on the guiding vision and the efficiency with which the funds are spent. If the Left Wing fund distributors prove as greedy as the Right Wing Financiers, the effects wil be the same.

Funds spent to rebuild and improve suburban roads and malls will, in my view, have a much lower multiplier on growth than funds spent on more energy efficient goods and people transportation. Funds spent to construct new schools with lots of new technology will, in my view, have a much lower multiplier effect than funds spent on attracting and retaining better educators. More teachers, fewer bankers is my motto in that regard.

Alas, economic debate in the public arena is driven more by dogma than empirically based multipliers.

The final boogeyman on the dark road of depression is Imbalance (External)- a condition which arises when a nation imports far more than it exports. Recall the cries of outrage from our foreign trading partners occasioned by the phrase "Buy American" in the stimulus legislation.

To the extent that one cause of the financial malaise is the burden of funding the US Current Account, "Buy American" could be just what the economic doctor ordered.

Alas, a reduction of that imbalance (as occurs with any major shift in the flow of funds) will lead to profit reduction for some. Thus do recessions become depressions. The need for change becomes obvious and yet few want to change- trading a few extra quarters of profits for the life of the corporation.

Oh well, as Dorothy learned on her way back home, this too shall pass. Perhaps, to expedite the process, we could throw a bucket of water on the Bankers on their next trip to Washington.

Tuesday, February 10, 2009

Economic Recovery Plan: Analysis and Suggestions

Despite hitting a few bumps in the road, President Obama's plan for Economic Recovery is almost ready to be enacted. The plan has two main features; 1) a Treasury-led rescue of the financial sector (Financial Stability Plan) 2) substantial public works spending (American Recovery and Reinvestment Act of 2009).

In toto the Economic Recovery Plan will add more than $1T to the already rapidly increasing Federal Deficit and given the rather short duration of US Federal Debt, one key issue will be finance.

Last week's release of the quarterly refunding details explains how the Plan will be financed; 1) by increasing the quarterly refunding amounts 2) adding a monthly 7-year note auction 3) reopening the 30-year Bond in the month following the quarterly auction.

It's a quarter later than I expected (if you recall I argued that the November Refunding could be the straw that breaks the US$'s back- I was surprised by Paulson's decision to finance TARP with bills) but the effects will be similar- substantial increases in longer dated Treasury issuance will lead to higher rates and a weaker $ over time. Additionally, the risk of a "failed" auction on other markets will grow. While today's auction of 3-yr Notes went reasonably well (99.87, 2.67 Bid-to-Cover ratio, $14.3B to indirect bidders) weak foreign demand for longer dated issues, like this week's 10 and 30-yr and the monthly 7-yr will be ominous signs. With petro-$ recycling, thanks to the crash in oil prices, not a large factor, Asian demand for US Debt becomes paramount.

The Financial Stability Plan, as described by Treasury Secretary Geithner has four steps:

1) Clean and strengthen banking sector balance sheets by initiating more consistent, realistic and forward-looking risk assessment practices and providing additional capital support to banks in need thereof.

2) Establish a Public-Private Investment Fund whereby the Treasury will partially finance private sector purchases of so-called "toxic debt."

3) Work with the Fed to buy newly securitized loans in the small business, student, consumer, auto and commercial mortgage markets from the banks

4) launch a comprehensive housing program- details to be released later.

As best I can tell, Mr. Geithner's plan is merely a combination of the two approaches Paulson considered and will leave us, the tax paying public, with both toxic banks and toxic debt. I suspect a less ethically challenged Treasury Secretary would have devised a plan that apportioned more of the losses to bank shareholders.

To digress a bit, appointing Mr. Geithner to Treasury given his tax issues is akin to appointing an old Dead Head like me to the Office of National Drug Control Policy. Methinks Mr. Geithner is already learning the difficulties of cleaning house with dirty hands.

As a shareholder of a local bank I'm talking my book here and suggest a better plan would be to treat the big banks which failed to assess risk properly as failed ventures, wipe out their capital and use the funds to finance the expansion of regional banks with a better track record of risk assessment. Let's do some creative destruction and clear the financial decks, so to write.

Comparisons have been made between the US response to the current crisis and Japan's response to the crisis which emerged in the early 90s to the effect that the US response is (and needs to be) more "expeditious and forceful," by which is meant quicker and more expensive. I think we will find that greater speed and more capital will not be the answer. Japan's problem is our problem- bloated financial corporations which have gained power and are reluctant to relinquish it.

In a sense the same argument which put Geithner at Treasury despite his tax problems is that which informs his plan- just as he, despite his shortcomings, was supposed to be the best man for the job, so too are the current leading financial institutions, despite their obvious shortcomings, supposed to be the best for their job. This has little to do with Capitalism but much to do with Cronyism.

In sum, while I think real sector conditions, barring a "failed" auction (not a small probability event) will improve marginally in the spring, I suspect, as was the case in Japan, it won't be too long (late summer/early fall of '09) before debate begins on another Financial Stability Plan- one which will hopefully lean more on the wisdom of Volcker and less on that of Summers and Geithner.

In blunt terms, the "changing of the guard" the election of President Obama was heralded to bring has yet to manifest in Finance. As Einstein argued, insanity is defined as doing the same things and expecting different results.

Let's do something different.

Let Capitalism work.

Tuesday, February 03, 2009

On Confidence

A lack of confidence is one of the few causes of the current and all previous economic crises with which most economists agree. "Restore confidence," they argue and recovery will soon follow.

This leaves open the question of how confidence is "restored," and to what one refers when one uses the word, "confidence."

Is confidence that which is measured by consumer confidence surveys or is it something else?

The English word, "confidence" comes from the Latin confidentia, which translates literally as, "with faith," or more colloquially, "to trust fully." This definition begs the question, faith (or trust) in what? In the arena of economics, to be confident is to have faith (or trust) that one's actions will lead to the desired effects- a confident employee has faith that his employer will deliver the agreed upon wages and/or other benefits in trade for their labor, a confident investor has faith that his investment will generate the expected returns.

More generally, confidence in an economic sense is faith in the economic system, be it socialist, capitalist or other variant.

Under that head, confidence of economic participants will rise when the actions of the faithful are rewarded, and will fall when the actions of the faithful are not rewarded. If, for example, one sees others who labor faithfully get their promised rewards, which might include a pension for many years of service, one will come to believe that they too can be so rewarded.

Consumer confidence, perhaps confidence of the masses might be better, is, under this head, a widespread belief that the system works as promised.

Currently, consumers, i.e. the masses, are said to lack confidence. I agree, in a sense, but suggest that a different, and pernicious confidence is growing- the faith that the system works, not as promised, but as revealed. Idealism is being replaced by pragmatism, which makes restoring the beneficial confidence that much more difficult.

The system, as revealed, seems only to work for a small class of people, for whom the rewards are many, regardless of transgression.

A laborer who fails to pay taxes may well lose his home and perhaps be jailed while others who fail to pay get posts in the new Cabinet because they are allegedly the "best people for the job"- a sorry commentary on the quality of US administrative personnel.

A laborer who faithfully works for a business for many years may well find that, for no fault of his own, his promised pension will not be paid in full (or at all) while a CEO who runs a business into insolvency retires with millions.

A small business which fails to properly forecast future economic conditions is forced to liquidate and fire its employees while a large bank or other favored financial institution which fails to properly forecast future economic conditions is bailed out and gets to give its employees bonuses, or other perks.

While there may be hidden issues which rationalize such events to some, I suspect these rationalizations will fail to sway those whose trust in the system they were promised was broken. Indeed, the rationalizations may only serve to increase confidence in the system as revealed, which is a cynical system.

To the extent that the ideals of America are virtuous, which is to say that non-meritorious aristocracy and monopoly do not lead to the best economic outcomes, restoring the confidence of the increasingly pragmatic masses in those ideals will only happen when the facts on the ground match the ideals.

Trust repaid is trust increased and trust broken is trust decreased.

Sure it's obvious, but that doesn't mean it's easy.

I am asked to speak from time to time at the local Rotary Club and during my most recent visit I found, for the first time, a not-so-silent majority express the view that the system was predatory, not participatory. Restoring their confidence will not be easy.