Saturday, April 30, 2011

Book Review (Kindle Single) - Three Cups of Deceit

Is a Kindle Single a book? It's longer than a long-form article in, say, The Atlantic. But shorter than, say, Keynes' General Theory. Yet longer than any of Seth Godin's "books." I don't know.

Anyway, Three Cups of Deceit by Jon Krakauer is a somewhat depressing read, given the amount of time I've spent reading and defending Greg Mortenson. Nick Kristof devoted a column to praising Mortenson's work. To Kristof's credit, he has RT'd several articles critiquing him, including this one which sounds credible. Mortenson has a lot of explaining to do. And it's turned into a he said, she said thing.

Krakauer donated over $70,000 to Mortenson's Central Asia Institute and quit donating when he saw how opaque the accounting was, and that Mortenson had no accountability. Here is the best that Krakauer has to say:

IN ALL FAIRNESS, Greg Mortenson has done much that is admirable since he began working in Baltistan sixteen and a half years ago. He’s been a tireless advocate for girls’ education. He’s established dozens of schools in Afghanistan and Pakistan that have benefited tens of thousands children, a significant percentage of them girls. A huge number of people regard him as a hero, and he inspires tremendous trust. It is now evident, however, that Mortenson recklessly betrayed this trust, damaging his credibility beyond repair.
The stories in Three Cups of Tea that I had doubts about were ones where locals make profound remarks that we have to trust were translated correctly, or where Mortenson happens to meet some important person who immediately blesses his work. According to Krakauer, most of those stories are made up-- there are people who claim they never happened. Worse, the dates Mortenson gives for these stories don't line up with historical record in those people's lives (like his attending Mother Theresa's funeral). Mortenson's sequel, which I haven't read, is worse in that he's never actually visited the places featured or witnessed the events himself. Apparently, a lot of people over there haven't seen him in a while... But much of the problem is Mortenson's need to embellish actual events.

There are plenty of anonymous current and former CAI employees who bash Mortenson, and several former board members with serious complaints. The turnover on the board and lack of accountability are indeed problematic, both legally and from an operations standpoint.

I think Krakauer and 60 Minutes did a terrible job trying to interview Greg with "gotcha" tactics. If Mortenson is so bad, why do so many people who have seen his work vouch for him?

Mortenson was raised in Africa, and Three Cups has plenty of quotes from people frustrated with him because he just doesn't seem to be "on our planet." I know plenty of Third Culture Kids who act that way-- they're almost not real. I don't mind this, because I want my own children to be TCK's, but it's a problem when the symptom is sinful-- compulsive lying. I'm troubled by most of what I read in Krakauer's book, and I'm glad he wrote it.

Three Cups of Deceit introduces us to other foundations doing good work there, and other Americans who also had the same bold spirit-- either working with NGOs or doing PhD dissertations in the remote parts of Central Asia. I found that encouraging.

Let's go and do, but let's be honest and transparent about it.

Going to give this 3 stars out of 5. Could have had a lot more on-the-record stuff earlier, and that would have helped everyone.

Book Review (#6 of 2011)

The General Theory of Employment, Interest, and Money by John Maynard Keynes. I found this free at Project Gutenberg and is the first ebook I've read exclusively on my iBooks (instead of Kindle & Kindle apps). I decided it would be great to read it since I just finished Wealth of Nations. My highlights and notes are legion, but Apple/iBooks doesn't put them out on a website for easy copy-and-paste like Amazon does.

This review is not intended to be exhaustive, it's just my main take-aways. Like WoN, the GT is a book you read a lot about but really need to read for yourself. In some ways, it's a more difficult read than WoN because some of Keynes' thoughts are underdeveloped and ambiguous. It made me appreciate the Hicks-Hansen IS-LM framework more (particularly with foreign exchange added in later, since Keynes is mainly thinking in terms of a closed economy).

GT needs to be read with a commentary. I used the ever-helpful Ekelund & Hebert textbook, and for the first 12 chapters used commentary from Tyler Cowen (who apparently quit posting after Ch. 12). I didn't have any epiphanies like renowned conservative Judge Richard Posner, who claimed recently reading the book converted him to Keynesianism.

Keynes is primarily dealing with one big weakness in economic thinking: interest rate determination. He explores all historical explanations of interest rates, from Ricardo, Mun, Marshall, Pigou, Wicksell, Von Mises, and many more, and finds them wanting. He contributes his liquidity preference theory to the mix, and shows how that can augment others' previous contributions.

Besides harping on the failure of the classical British school of thought to explain interest rates, he also harps on the classical model's failures in explaining unemployment. Writing from 1936, unemployment had been high for years. His "animal spirits" explanation of fluctuations in Investment is often derided but I don't see how reasonable people could say it's wrong. We've seen 2 very recent examples-- the tech bubble and the housing bubble-- that Shiller and others point out prove Keynes' point.

Even though Keynes blasts his teachers Marshall and Pigou, he also pays tribute to the classical school for its contributions to the world, and his own upbringing. He devotes considerable space in a late chapter, however, to Mercantilists. The free trade arguments of Smith and Ricardo are generally held up as economic Gospel, and as such Mercantilist ideas had been ignored and discarded. Keynes makes the point that the Mercantilists had figured out that by increasing the money supply one could lower interest rates and stimulate the economy-- something the Classical school found abhorrent.

As Milton Friedman later showed, Keynes' biggest problem was his lack of faith in monetary policy to stimulate investment. Everything monetary in Keynes' view revolves around the interest rate. And if the central bank can't get the interest rate low enough to stimulate investment anymore, then you're in the "liquidity trap." This has led to the problematic current thinking of monetary policy being ineffective at the zero lower bound.

Keynes seems to ignore the possibility of creating an excess of money beyond what people want to hold, so that people will eventually spend that money. Output will rise, unemployment will fall, and prices will eventually rise as well. This is why I prefer a Hayek/Sumner idea of a central bank ignoring interest rates and targeting M x V growth instead.

The original sin of Keynesianism is this whole obsession with monetary policy via interest rates. Following that was then Keynes' skepticism of monetary policy to do anything stimulative in his 1936 environment. Which meant that the only other entity left was the government-- hence, he advocated government investment to replace or enhance private investment.

It's not an unreasonable conclusion. If the economy isn't quickly self-correcting and monetary policy is useless, the only way to stimulate investment is to have the government plan to keep it going. Save for a "rainy day" during the boom years, run deficits when the private economy turns downward, and you can keep the party going indefinitely. For Keynes, the trade-off between inflation and unemployment is a long-run one, which Phelps & Friedman later reminded us isn't true.

I liked how Keynes addressed Austrian economic concerns/criticisms at the time. Austrians believe that "malinvestment" is created by keeping interest rates "artificially" low. People wouldn't build houses or purchase other capital equipment if interest rates were higher. But Keynes points out that a) who's to say which investments are mistaken?, and b) by raising interest rates to snuff out the malinvestment, you also snuff out the legitimate investments. Having the government choose investment projects probably wouldn't be any more helpful, but as Skidelsky put it, we can put up with a little bit of government waste if it means getting rid of the waste of human capital that unemployment causes. Keynes solution is to keep the interest rate from rising to prolong the boom indefinitely (and where this fails, enter government investment).

Milton Friedman believed that had Keynes lived longer (to read Friedman and Schwartz's book probably) he probably would have changed his mind about some of his prescriptions, particularly about monetary policy. And Keynes would not have agreed with Keynes' disciples' prescriptions for the U.S. economy in the 60's and 70's. Probably so. But Keynes would have definitely been useful the past few years to remind us that prices aren't going to start really rising until unemployment falls and we get closer to capacity.

Cowen and others point out the numerous errors and mistakes in the GT. That's fine, is there an economic book out there that didn't have errors and mistakes (WoN is full of them)?

But Keynes' contributions in how we think about and teach the macroeconomy are huge. We are indeed all Keynesians now, even though none of us is anymore (Friedman quote again).

I give the book 3.5 stars out of 5. I'm definitely a better macro teacher this semester having read it.

Friday, April 29, 2011

Lawrence White on Hayek

Since the new Keynes vs. Hayek rap is out (and fantastic!), it's worth pointing out that on the same website there are some greater in-depth looks at the ideas of Keynes and Hayek with Keynes' biographer Robert Skidelsky and Austrian monetary economist/historian Lawrence White. In this video, White explains Hayek's views on monetary policy given a central bank. I've mentioned this before, as I've read White's paper on the views of Hayek and Robbins during the Great Depression-- highly recommend if you're interested. White wrote the textbook that my professor used in my undergraduate Monetary Economics course (still sits on my shelf).

As the video above points out-- Hayek was sometimes a pragmatist. The job of the Fed should be to stabilize nominal income (NGDP), offsetting decreases in velocity (ie: an increase in demand for money) by increasing the money supply. Not mentioned in the video is that Hayek later in life regretted calling for liquidation and deflation, agreeing with Milton Friedman that the Fed had done a bad job and should have worked to keep deflation from occurring. White seems to be saying that Hayek wouldn't have joined all the Rothbardian Austrians today who seem eager to see high unemployment, deflation, and "liquidation."

In other words, Hayek believed in something called aggregate demand (NGDP or P x Y) and believed that if you have a central bank, they better be certain to intervene with demand-side policies to keep it stable.

Wednesday, April 27, 2011

On free markets and central banks

As we await Ben Bernanke's "historic" post-FOMC announcement press conference today, I think it's worth thinking about central banks. A stated belief in "free markets" is often a litmus test for classifying someone's economic thinking (and hiring that someone). But can you believe in central bank intervention and free markets at the same time? Milton Friedman is a perfect example that the answer is "yes." No one denies that Friedman was one of the most influential libertarian-leaning promoters of free markets in the 20th century, and yet, he was pragmatic about a currency controlled by a central bank and opposed a gold standard.

There are some economists today who argue that we should have "free banking" where the currency is controlled by the private banking system, as it was in the U.S. in much of the pre-Federal Reserve era. Market forces would control the supply of money. That's all well and good, but it's not the system we have in place today nor is it likely to be so.

In the meantime, our central bank controls the main levers of the money supply. Its job is to equilibrate supply with demand. Milton Friedman and Anna Schwartz "proved" that the Fed didn't do a good job of this during the Great Depression. Other economists have shown that Bernanke and the Fed also didn't do a good job of that during the crisis. Many economists have made the strong case that Friedman would have supported QE2, just as he advocated for similar policy in Japan in the 1990s. As the previous link shows, there is a strong conservative (ie: "free-market") case for QE2.

Milton Friedman was also not always and everywhere opposed to fiscal stimulus. He understood that government had to run deficits during recessions. The University of Chicago was preaching monetary and fiscal intervention long before Keynes.

In short, Milton Friedman believed in something called "aggregate demand." Just because you believe in aggregate demand doesn't mean you don't believe in free markets.

F. A. Hayek believed in a social safety net, and government taxation of negative externalities (both of which are held up as proper roles of government in Road to Serfdom). Both Friedman and Hayek preferred to be called "classical liberals," (as opposed to "conservatives") along the lines of Smith, Ricardo, Say, etc. Even Jean Baptiste Say, arguably the "founding father" of supply-side economics didn't believe his "law" held always and everywhere. If these three don't pass your "free market" litmus test, then your litmus test is broken.

Monday, April 25, 2011

A response to ABC World News

I've been meaning to link to this Mark Perry post for a while, but just forgot. Dr. Perry is responding to the same ABC World News series I mentioned before that caused me to permanently change the channel. Diane Sawyer openly lauded self-proclaimed socialist Senator Bernie Sanders for his proposed legislation requiring all U.S. museums to sell only American-made items in its gift shops. Congressman Nick Rahall, D-WV has now introduced such legislation. This is ironically un-American, in my opinion, and not welfare-enhancing.

Perry chimes in emphatically:

(W)hy stop there? Why not then legislate that all of the displays, contents, artwork, artifacts, and animals at every of the 20 Smithsonian properties be "made in the USA" as well. And require that all food served at Smithsonian Museum restaurants and cafeterias be "American made" only. In other words, why restrict the "made in the USA" policy to just the gift shop and not the entire museum?

And the Smithsonian's National Zoo probably has a higher concentration of foreign animals than any of the Smithsonian museum gift shops have foreign-made Americana. So we'd have to start by getting rid of the Chinese pandas which should be considered as great a threat to Americans as Chinese-made snow domes, baseball caps and statues of Obama in the Zoo gift shop. After all, we have brown bears and black bears that are real "American" bears and why shouldn't those be displayed instead of the Chinese pandas? And then we would replace all of the other foreign animals with patriotic American animals and make it a real NATIONAL Zoo. Right now it's not a "national" zoo at all, it would be more accurate to call it the Smithsonian INTERNATIONAL Zoo, and that's un-American.

Wednesday, April 20, 2011

Thought for the Day

I'm sick of seeing Donald Trump on the news. David Frum links to a post about the GOP's "war" on Trump at The New Republic by Ed Kilgore that is worth reading. Frum adds his own thoughts, which I think are spot-on (emphasis mine):

Here’s the thing Republican leaders and pundits need to understand. (I said it yesterday, but let’s say it again today.) America has not had a mass conversion to ideological libertarianism. Instead, Americans who feel robbed and duped by the series of financial and economic disappointments and disasters from the dot-com bubble onward are boiling with rage against their financial and political leadership. Conservative Americans express that rage in terms learned from talk radio and Fox News. But the fact that these conservative voters express their rage by talking about “debt” and “taxes” does not mean that they want what K Street wants: a Ryan budget that cuts spending on people like them to finance tax cuts for people much richer than them. They are just using familiar words to express a new and unfamiliar emotion of betrayal and resentment. The GOP establishment has successfully directed those emotions against the Obama administration. But there’s no guarantee that the emotions will remain fixed in that direction – because after all, the establishment GOP is offering little or nothing to allay the discontents producing the anger. Conservatives like liberals have suffered unemployment, the loss of savings, the decline in housing values. Conservatives like liberals find themselves suddenly poorer for reasons they do not understand. Conservatives like liberals fear and dread that Medicare and Social Security will soon be cut to rescue the country’s finances. If the GOP wants to finish Trump, GOP candidates had better learn to speak to those anxieties – to offer a remedy more effectual than the snake-oil now being peddled by Tim Pawlenty.

Tuesday, April 19, 2011

Austerity and Growth

I like his columns, but Derek Thompson at The Atlantic sometimes frustrates me, as he does in this piece. Republicans have been pointing to a study showing that certain other countries who cut their deficits saw big GDP growth as a result. Many economists have been arguing that the conditions that created that growth in those countries can't exist here. What's the deal? We cover this in Macro 101:

Now, congressmen like Eric Cantor are coming at it from a very naive Adam Smith perspective-- if you shrink the size of government then capital flows to the private sector and it grows to replace it. Think of a fixed-sized pie where one crowds the other out. But Republicans have lacked an explanation of the mechanisms that make this work.

However, Paul Krugman is attacking it from a naive Keynesian perspective: decreasing government spending decreases aggregate demand, income, and all economic activity. The way the private sector would grow here is either 1) by a decrease in interest rates making investment cheaper and boosting the private economy, and also prices falling making exports cheaper; or 2) Something else stimulating aggregate demand. But in Krugman's mind since the Fed has pushed the fed funds rate to zero, there can be no gains because interest rates can't fall and there can be no boost in aggregate demand.

Both sides seem to ignore open economy Macro 101. I disagree with Thompson and others that
1.) Our currency can't depreciate against others to boost exports.
2.) Monetary policy is unable to stimulate aggregate demand while at the "zero lower bound."

The more long-run model goes like this:
Y = C + I + G + NX
National Saving = (Y - T - C) + (T - G) where T is Net Taxes. The T's here cancel out, so
National Saving = Y - C - G . So, rewrite our first equation:
Y - C - G = I + NX, or National Saving = Investment + Net Exports.
Net Exports = Net Capital Outflow (this is also an accounting identity)

Net Exports is the difference between Saving and Investment. The U.S. saves a much lower amount than the level of investment that occurs, so our Net Capital Outflow is negative (we're a net borrower) and we run a trade deficit. The way this occurs in the model is that real interest rates are greater than they would be if we saved more. Our economy is #1 in the world and our firms pretty safe to provide capital to. Our currency is also around 60% of the world's "reserve currency" meaning many institutions hold dollar-denominated assets for safety.

This is the "global savings glut," many East Asian households save an estimated 30-50% of their net income, and there is less relative domestic Investment that occurs there, so the surplus flows abroad to the U.S.

Bottom line: If you want to boost net exports the only way to do this is by increasing national saving relative to investment. This isn't some right-wing idea, liberal Keynesian Joseph Stiglitz talks about this in every book he writes. How do we increase national saving?

National Saving = Y - C - G. So, either households Consume less, or Government spends less. If we were to boost our savings rate then there would be a "global dollar glut," making the dollar depreciate and boosting net exports. Then the world would complain that we're flooding the world with cheap goods, just as it complains China does now. (China would be forced off its own export-growth strategy in order to maintain full employment. They would have to stimulate domestic consumption and investment. We'd sort of switch places, in other words.)

Now, the Fed can also cause our currency to depreciate in nominal terms, which in the short run also lowers the real exchange rate and boosts net exports. It does that simply by creating it, and can create as much of that as it wants (until prices rise).

But we can answer Krugman's aggregate demand point as well: Aggregate demand is simply nominal GDP (NGDP, P x Y in the quantity equation). As Beckworth, Sumner, Nunes, and others have spent the last several years pointing out, NGDP targeting by the central bank would help stimulate investment and aggregate demand. The Fed basically let aggregate demand fall off and has yet to get it back.

We're sort of in the exact opposite case we were in during the Reagan administration, when the Volcker fed was tightening the money supply while Reagan boosted government spending. In this case, however, we want the government to reduce spending and the Fed to pursue massive expansion to offset the decline in aggregate demand. If you buy into the fallacy that the Fed can't boost aggregate demand except by lowering interest rates, then you disagree with this (as Krugman does). But if you know the Fed can boost AD by means other than focusing on an interest rate (as Milton Friedman did and Scott Sumner does, but modern Republicans mostly do not), ie: through NGDP targeting, then you know it can happen.

Sunday, April 17, 2011

My reaction to 60 Minutes piece on Three Cups of Tea

Update: Greg Mortenson replies much more in depth in this article here. People should be harping on the guy who "co-authored" the book, it seems to me.

Steve Kroft and 60 Minutes ran a critical piece on Greg Mortenson tonight. I care because I just wrote a review of the book. The accusations boil down to the following:

1. While his achievements are incredible, not all of his stories are true. Some stories in Three Cups are fabricated or wildly exaggerated and there is evidence that some schools are in disrepair or weren't built by Mortenson.

2. The Central Asia Institute has only had one fully public audit of its books in the last 20 years.

3. Only 41% of Central Asia Institute spending goes to actual school-building. Much of the rest goes to U.S. promotion. The proceeds of Mortenson's books to go Mortenson and not CAI.

4. Mortenson declined on multiple occasions to be interviewed by 60 Minutes.

Mortenson and the CAI have responded on their website. My own response to each point above:

1. The book's co-author states in the Foreword that Mortenson gave him an enemies list to interview, and that many people had problems with Mortenson's style and lack of accountability in certain areas. So, there's not much of a story to me there. Several journalists have visited Mortenson's schools and vouched for his stories, helping propagate his message. So, we know it's not all lies.
One of his accusers in the 60 Minutes piece makes the point that thousands of children have been educated and that Mortenson "isn't a Bernie Madoff." But there are instances where witnesses can't corroborate his stories, say he's lying, and where Mortenson claims to have built more schools than he has. For example, in one war-torn province of Afghanistan Mortenson claimed to have built 11 schools. The actual number is supposedly three. Even his accuser notes that building any schools in that region was an incredible feat. But there are many places in Three Cups where Mortenson admits to not knowing how many schools he's actually built or is supporting. There's a lot of information missing about how thorough 60 Minutes investigation was. Given it'd be in one of the most physically and politically hostile environments on earth, I wonder how big the budget was for this piece.

I mentioned in my post that it took a huge leap of faith to believe the profundity of the villagers Mortenson conversed with was being accurately translated, or that Mortenson had the language skills to engage in the in-depth sorts of conversations he was involved in. Some parts of the book mention a translator, or difficult English, or state he was slowly learning, etc.

Mortenson has done something no one else has been or is willing to do. He's got to be a little bit nuts. I've known otherwise intelligent people who repeat falsehoods they fully believe are true, and I believe this is Mortenson's problem. If the way he's a little nuts is that he's sort of a compulsive liar, I'm okay with that. Because if there weren't thousands of children in schools run by his foundation to prove his story, and accolades from many journalists and government officials who've been there, then I'd say 60 Minutes was onto something. Quibbling about details of how he stumbled on Korphe seems silly. It seemed 60 Minutes was really relying/piggybacking on the work that Jon Krakauer did while writing his own yet-unpublished slam piece. I will read it when it's printed.

2. I agree this is problematic, but some of the murkiness of expenses is understandable. Mortenson flies off to Pakistan and disappears and doesn't track every receipt. Okay. His board can't reign him in or fire him because he is the CAI (Three Cups talks with board members who quit over Mortenson's antics).

3. CAI was paying Mortenson less than $30,000 a year for several years, barely enough to live on with his family (this went unmentioned by 60 Minutes). It doesn't surprise me that they decided he should keep his royalties and live off of them. CAI reports that Mortenson has donated large sums of his proceeds back to the organization and gives a full accounting to 60 Minutes' questions. (I think some of 60 Minutes questions are laughable.)

No charity sees 100% of its revenue go to its cause. If it costs $2,500 to build a school in Pakistan and $2,500 to fly across the U.S. to do a fundraiser, of course 50% of your expenses are going to be for U.S. promotions. The 41% number doesn't have a benchmark next to it. How do other charities measure up? No mention by 60 Minutes.

4. The guy lives like a recluse half the time, but I agree it's a bit odd given that he's been interviewed by many media outlets that he'd dodge 60 Minutes. Here is Mortenson's response to 60 Minutes' questions. Supposedly 60 Minutes didn't send the questions until last week. He stands by his Korphe story and I wouldn't totally discount his comments about Balti language.

Did Steve Kroft read either of the books? I doubt it from how he talked in the piece.

"Not Enough Money"

That's the title of this wonderful piece by Ramesh Ponnuru in the National Review. Sadly, it was written a couple of years late, but it's nice to see that some people in a conservative news organ are now trumpeting the ideas of Friedman, Beckworth, and Sumner-- namely that the Fed holds much of the blame for our current economic malaise as Bernanke & co. failed to keep NGDP growing at its normal, expected rate and pursued monetary policy that was too tight just before and during the recession. Viewing expansionary monetary policy through the lens of lowering nominal interest rates is a Keynesian and very dangerous error. QE2 was necessary and we probably need a QE3.

As I've repeated and linked to Sumner and Beckworth several times to explain, the Fed pursued a tight-money policy during the recession given the scope of the massive increase in demand for money. It allowed inflation expectations to fall throughout 2010, causing real interest rates to rise and growth to stagnate. Those economists are pushing for central banks to target NGDP instead of inflation. It looks like the Bank of England is privately pursuing this policy as they continue to expand the monetary base in the face of higher inflation. Real GDP and unemployment in England aren't doing so well. (The irony here is that the Bank of England is giving the Conservatives ammunition to cut government spending by countering with expansionary monetary policy. Rep. Paul Ryan and Gov. Tim Pawlenty want to cut U.S. government spending in the same fashion but blast the Fed for pursuing the expansionary policies that would make the spending cuts palatable).

The "quasi-monetarist" position of these economists is very simple: an increase in the demand for money (for safety or whatever reason) is a decrease in velocity, causing nominal GDP to fall. (M x V = P x Y). If your money supply is manipulated/controlled by a central bank, then it needs to increase the money supply in response to the increase in demand. Milton Friedman advocated this throughout his career in various ways. He pointed out that ultra-low interest rates aren't a sign of ultra-loose monetary policy, they are a symptom of too-tight monetary policy.

Marcus Nunes is an economist who has also joined the fray. This is a favorite post of his with 3 graphs that tell the story. Note the MZM measure of money and velocity at the bottom.

Why does all this matter? Well, the European Central Bank is in the midst of tightening money in response to respond to headline inflation. The result will well likely be a more rapid departure of Ireland, Greece, and perhaps other PIIGS from the Eurozone. Slower growth in Europe is bad for the rest of the world as well.

The U.S. also seems to have an endless supply of quacks like Glenn Beck who have been predicting hyperinflation since 2007. A friend sent me a forward of recent statements made by a California congressman that talks about interest rates and Fed policy:
"Once the Fed ends QE2, even if it doesn't reverse it, the markets will then have to absorb a new influx of long-term bonds at a time when our ability to pay them is in question. The Fed can cure a bunch of this simply by printing a lot more money. That, however, will result in an inflationary period with major wealth destruction and economic malaise."

There's a misunderstanding that the Fed engaging in QE2 is all about lowering long-term rates (probably because this is actually the official explanation of Bernanke and most Keynesian-leaning economists). But QE2 has been successful precisely because it has caused an increase in long-term rates. As David Beckworth has pointed out, inflation expectations fell off in 2010 and it was only when the Fed started pondering QE2 out loud that this reversed. Interest rates on 30 year loans are higher now than they were in November.

Why would we be happy about an increase in inflation expectations? Because inflation and economic growth are historically correlated. As incomes increase and unemployment falls, people buy more stuff. Velocity increases and prices rise. When actual inflation is less than what people were expecting when they originally borrowed and lent, wealth is essentially transferred from borrowers to lenders over the life of the loan, which has hurt household balance sheets in the recent downturn. The Fed had allowed both actual inflation and then inflation expectations to falter, just as they allowed the NGDP growth trend to falter, and they are now bringing those expectations back in line with the trend.

The Fed ending QE2 in a couple months won't cause long-term interest rates to rise unless the economic recovery is well-underway. Several economic forecasters have revised their growth projections for Q1 2011 to less than two percent, anemic growth that would cause unemployment to rise again. Inflation isn't a problem right now. An increase in gas prices does not equal inflation. Conservative and liberal economists can agree on this point: You can't have an upward spiral of inflation without wage increases, and wage increases don't appear to be forthcoming (so long as unemployment is just under nine percent, this isn't a concern).

If the Fed were to follow the ECB and start contracting the money supply (raising short-term interest rates), the result would likely be even lower NGDP growth projections, falling inflation expectations, falling interest rates while seeing a decrease in investment, and higher unemployment.

Right now, demand for money remains high. So long as our currency is controlled by a central bank, its duty is to increase the money supply right now. More money, please.

Wednesday, April 13, 2011

Book Review (#5 of 2011)

Three Cups of Tea by Greg Mortenson and David Oliver Relin.
I mentioned many of my deeper thoughts on this book in a previous post. My mom bought me this book so, thanks, mom! But she has no idea the hare-brained ideas I get from reading these books.

Mortenson is impressive. He is driven with a singular purpose-- build schools, primarily for girls, where there are no schools other than radical Islamic madrasas.

One overall message I get from this book (and that Mortenson got to deliver to the Pentagon and Congress) is that the only way to win the war on terror is to build trust and promote education. Dropping bombs that sometimes kill civilians only serves to alienate people and deepen their resentment of the West. If the only American a rural Afghan sees is one carrying lethal weapons then we've lost the war on terror. Mortenson saw too many students in his rural villages become "collateral damage."

At one point the Pentagon offers to give Mortenson millions of dollars, covertly through off-shore accounts, to build schools. But he declines because the attachment to the military was too big a risk to take. I had read previous interviews and op-eds by Mortenson before reading this book, which had already shaped my views on the war. But the book isn't about the war, it's about improving the outcomes of thousands of kids that had either been neglected or forgotten.

Questions I asked while reading this book:
Why hadn't anyone done this before?
Why didn't the government build schools?
Why didn't private charities, Islamic or otherwise, or other NGOs build these schools?
Why didn't the locals, who built their own houses and often shared the wealth of the village, build these schools?

I think the villages didn't build these schools themselves because they had more pressing needs, or it was seen as a somewhat wasteful use of materials and labor. It took an outsider to put up the capital for the new investment to take place. And it took a commitment of ongoing funds from Mortenson's foundation to pay the teachers and provide supplies-- without which the buildings would be worthless. In some cases, maybe the idea had never occurred to them. Many were used to the idea that their children would never be able to compete with children from larger towns, so it never occurred to them to try.

Mortenson found ways to build these schools cheaper than the World Bank, the local governments, or an NGO ever could. There was basically no red tape for him.

I'd like to read his sequel.

4 stars out of 5. You have to assume the profound statements the locals make throughout the book, sometimes in uneducated English, were properly understood/translated. And you know they were edited for clarity. Sometimes assuming Mortenson somehow (almost magically) had the language skills to properly translate was a bit of a stretch of faith for me. But I trust the authors strove for accuracy and authenticity. It's an amazing story.

Wednesday, April 06, 2011

Book Review (#4 of 2011) Wealth of Nations overview

You can use the wealthofnations tag to find my reviews of each of the five books of The Wealth of Nations separately. These are my overall concluding thoughts:

While I disagree with some of Murray Rothbard's scathing critique of Smith and WoN, he does make a valid point when he says:
For, in one way, the Wealth of Nations is like the Bible; it is possible to derive varying and contradictory interpretations from various – or even the same – parts of the book. Furthermore, the very vagueness and obscurity of a work can provide a happy hunting ground for intellectuals, students and followers.

It's easy for people to pick and choose Smith quotes to back up particular ideological positions. For example, you can find passages where Smith advocates progressive income taxes, stricter bank regulation and interest rate ceilings, government-sponsored education, and some restrictions on free trade-- a non-laissez faire prescription. He also seems quite the religious skeptic at times, where at other times he praises piety and the Presbyterian church.

But there are many places where Smith is just being pragmatic in his prescriptions. If you're going to have a progressive income tax, here's the best way to do it, etc.

But mostly Smith espouses his view of individual liberty pretty clearly. The government should allow individuals to freely choose their businesses, prices, trading partners, etc. because that will lead to the most efficient and just outcome for society.

Rothbard's (and Schumpeter's) critique of Smith is over his obsession with gains from the division of labor and his classification of people into "productive" and "unproductive" categories. I understand this, to a point. I think Smith does a good job extending the gains from divisions of labor into international trade, whereas Rothbard does not. Smith shows that division of labor is limited by the scope of the market, and the greater the amount of international trade the greater the scope.

Overall, I think Smith is simply making a lot of observations of society around him and of history and trying to weave it into a coherent framework within his own philosophy of personal liberty. He takes pains to repeat important points again and again.

Maybe he missed the Industrial Revolution happening around him. Maybe he plagiarized examples like his famous pin factory from encyclopedias. But the book was already 900 pages, right? What more needs to be said?

4 stars out of 5.

Monday, April 04, 2011

Book Review, Wealth of Nations Book 5


Smith switches gears in this chapter to deal with what the role of government should be (what services it should provide) and how best to pay for those. He seems to be prescribing best policies to government officials. He compares various tax structures in Europe to Great Britain and seems to favor Great Britain's system as better than most.

A primary role of government is to defend the state from invasion. A nation can either be defended by a citizen militia or by a more expensive standing army, and Smith explores pros/cons of both.

Men of republican principles have been jealous of a standing army, as dangerous to liberty. It certainly is so, wherever the interest of the general, and that of the principal officers, are not necessarily connected with the support of the constitution of the state. The standing army of Caesar destroyed the Roman republic. The standing army of Cromwell turned the long parliament out of doors. But where the sovereign is himself the general, and the principal nobility and gentry of the country the chief officers of the army; where the military force is placed under the command of those who have the greatest interest in the support of the civil authority, because they have themselves the greatest share of that authority, a standing army can never be dangerous to liberty. On the contrary, it may, in some cases, be favourable to liberty.

Another crucial role of government is to defend property rights and exercise justice. Smith notes that this system benefits the rich more than the poor but there is quid pro quo:
Men of inferior wealth combine to defend those of superior wealth in the possession of their property, in order that men of superior wealth may combine to defend them in the possession of theirs.
He examines how various countries pay their judges and legal clerks and points to some unintended consequences and conflicts of interest that arise. Smith then turns to other roles of government, provision of pure public goods and educating the populace:
After the public institutions and public works necessary for the defence of the society, and for the administration of justice, both of which have already been mentioned, the other works and institutions of this kind are chiefly for facilitating the commerce of the society, and those for promoting the instruction of the people. The institutions for instruction are of two kinds: those for the education of the youth, and those for the instruction of people of all ages.
Smith notes that various companies were chartered or subsidized by the British Crown, and as such were charged to build things to protect their interests, like armed outposts overseas. Smith spends part of this chapter showing that state-funded companies tend to become parasites that otherwise would be bankrupt. GM, Chrysler anyone?
If the trading spirit of the English East India company renders them very bad sovereigns, the spirit of sovereignty seems to have rendered them equally bad traders. While they were traders only, they managed their trade successfully, and were able to pay from their profits a moderate dividend to the proprietors of their stock. Since they became sovereigns, with a revenue which, it is said, was originally more than three millions sterling, they have been obliged to beg the ordinary assistance of government, in order to avoid immediate bankruptcy.

"Pro-business" government policies are typically anti-market policies that favor a few companies at the expense of the citizenry. Smith sees a role for the government in education and is operating from a context where primary education was religious in nature. He gives a history of higher education from ancient Greece to modern Europe. He gives a brief history of the church in England and Scotland after the Reformation. Smith was an avowed Presbyterian in order to hold the Chair of Moral Philosophy at Glasgow. But this chapter is one of the few that showed respect he had for the Church.

Smith basically applies his thoughts on the market to church-- competition being a good thing as opposed to a state-dominated monopoly. I think he clearly favors separation of Church and State the way our founders drew it up-- no government-sanctioned monopoly allowed.

But if politics had never called in the aid of religion, had the conquering party never adopted the tenets of one sect more than those of another, when it had gained the victory, it would probably have dealt equally and impartially with all the different sects, and have allowed every man to choose his own priest, and his own religion, as he thought proper. There would, and, in this case, no doubt, have been, a great multitude of religious sects. Almost every different congregation might probably have had a little sect by itself, or have entertained some peculiar tenets of its own. Each teacher, would, no doubt, have felt himself under the necessity of making the utmost exertion, and of using every art, both to preserve and to increase the number of his disciples.
Smith things competition for disciples is good because it creates a variety and moves society away from extremism:

The interested and active zeal of religious teachers can be dangerous and troublesome only where there is either but one sect tolerated in the society, or where the whole of a large society is divided into two or three great sects...But that zeal must be altogether innocent, where the society is divided into two or three hundred, or, perhaps, into as many thousand small sects, of which no one could be considerable enough to disturb the public tranquillity. The teachers of each sect, seeing themselves surrounded on all sides with more adversaries than friends, would be obliged to learn that candour and moderation which are so seldom to be found among the teachers of those great sects, whose tenets, being supported by the civil magistrate, are held in veneration by almost all the inhabitants of extensive kingdoms and empires...and the concessions which they would mutually find in both convenient and agreeable to make one to another, might in time, probably reduce the doctrine of the greater part of them to that pure and rational religion, free from every mixture of absurdity, imposture, or fanaticism, such as wise men have, in all ages of the world, wished to see established; but such as positive law has, perhaps, never yet established, and probably never will establish in any country; because, with regard to religion, positive law always has been, and probably always will be, more or less influenced by popular superstition and enthusiasm.
This is fascinating. "Positive law" is apparently some true universal law agreed on by everyone. But it is influenced by popular "superstition and enthusiasm" by various sects espousing their own points of view. More competition means finding more common ground and moving away from religious dogma toward some sort of ecumenicism. Smith decries the State using the Church to coerce people through fear. The Roman Catholic church could frighten people with the threat of excommunication, for example, if their sovereign became a Protestant. The reformation stripped away this fear and created the idea that kings and peasants are equal in the eyes of God.

In some countries, as in Scotland, where the government was weak, unpopular, and not very firmly established, the reformation was strong enough to overturn, not only the church, but the state likewise, for attempting to support the church.
Smith explains that as Protestants groped for agreement in doctrine, you had a battle between Lutherans and Calvinists. Smith examines church governance in both sects. Calvinist congregations elected their own ministers. Lutheran ministers were appointed. Smith says the Calvinist model:

(S)eems to have been productive of nothing but disorder and confusion, and to have tended equally to corrupt the morals both of the clergy and of the people. The latter part seems never to have had any effects but what were perfectly agreeable...As long as the people of each parish preserved the right of electing their own pastors, they acted almost always under the influence of the clergy, and generally of the most factious and fanatical of the order...So small a matter as the appointment of a parish priest, occasioned almost always a violent contest, not only in one parish, but in all the neighbouring parishes who seldom failed to take part in the quarrel.
Smith then praises the Presbyterian church. He points out that in many cases in Europe the church no longer needed funding from the State to operate, the tithes were sufficient to run the operations. It appears that in many instances the wealthy and sovereign people would give property to the church as an act of piety. The church would then use that land to farm and run a business (Rodney Stark talks about this some in Victory of Reason), making the citizenry respectful and dependent upon the church. But Smith warns against clergy becoming wealthy themselves, or at least living like they're wealthy:

A man of a large revenue, whatever may be his profession, thinks he ought to live like other men of large revenues; and to spend a great part of his time in festivity, in vanity, and in dissipation. But in a clergyman, this train of life not only consumes the time which ought to be employed in the duties of his function, but in the eyes of the common people, destroys almost entirely that sanctity of character, which can alone enable him to perform those duties with proper weight and authority.
Smith deals heavily with taxation. Government operations have to be paid for, including allowing the sovereign to live a decent and fashionable life. Smith gives four principles for taxation (paraphrase):

1. Citizens should be taxed according to their means, or according to the proportional benefit they gain by having a government. (Ie: wealthier people benefit more from having their property protected, they should pay more taxes).

2. The amount, method, and due date of the tax should be clear and uncomplicated.

3. Every tax should be levied at the time when it's most convenient to pay it.

4. The tax should be as low as possible to fund the state.

Smith delves into detail about land taxes, consumption taxes, import tariffs and custom duties, taxes on interest and wages, etc. All have benefits and drawbacks. Some are progressive, some are regressive. In regards to sales taxes, Smith notes that the burden falls on the "necessitous person," or on whoever's curve is most inelastic. However, there are several points where he makes the mistake of saying the tax incidence "always falls on the producer." We have the idea of what is modernly derided as a "Laffer curve," which is all about price elasticity of demand.

High taxes, sometimes by diminishing the consumption of the taxed commodities, and sometimes by encouraging smuggling frequently afford a smaller revenue to government than what might be drawn from more moderate taxes...When the diminution of revenue is the effect of the diminution of consumption, there can be but one remedy, and that is the lowering of the tax.
(ie: sometimes you increase tax revenue by lowering a tax). Don't tell conservatives, but Smith also favors a progressive income tax (emphasis mine):
It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion.

Smith seems to be naive about corruption of sovereigns and dictators. He never met Gaddafi:

Even a bad sovereign feels more compassion for his people than can ever be expected from the farmers of his revenue. He knows that the permanent grandeur of his family depends upon the prosperity of his people, and he will never knowingly ruin that prosperity for the sake of any momentary interest of his own.

Smith ends the chapter dealing with government debt. He says it never ends well, a nation always ends up either defaulting or defacto defaulting by devaluing its currency. A country that runs deficits in peacetime is going to have to borrow heavily in wartime (hmmm). But a nation of merchants seems to be able to lend to the government without eliminating their capital stock:

The same confidence which disposes great merchants and manufacturers upon ordinary occasions, to trust their property to the protection of a particular government, disposes them, upon extraordinary occasions, to trust that government with the use of their property. By lending money to government, they do not even for a moment diminish their ability to carry on their trade and manufactures; on the contrary, they commonly augment it. The necessities of the state render government, upon most occasions willing to borrow upon terms extremely advantageous to the lender.
This is a great example of how history repeats itself:

The progress of the enormous debts which at present oppress, and will in the long-run probably ruin, all the great nations of Europe, has been pretty uniform. Nations, like private men, have generally begun to borrow upon what may be called personal credit, without assigning or mortgaging any particular fund for the payment of the debt; and when this resource has failed them, they have gone on to borrow upon assignments or mortgages of particular funds... Like an improvident spendthrift, whose pressing occasions will not allow him to wait for the regular payment of his revenue, the state is in the constant practice of borrowing of its own factors and agents, and of paying interest for the use of its own money.
Two solutions, says Smith: Either find a way to raise more taxes without making it onerous, or cut government spending.

The chapter ends abruptly dealing with the pressing issue of the war with the American colonies. Britain has already incurred huge debts defending its colonies, who have contributed very little back to the British treasury. Taxing them more would warrant representation in Parliament, which Smith dealt with in a previous book. Here is the last sentence:
If any of the provinces of the British empire cannot be made to contribute towards the support of the whole empire, it is surely time that Great Britain should free herself from the expense of defending those provinces in time of war, and of supporting any part of their civil or military establishment in time of peace; and endeavour to accommodate her future views and designs to the real mediocrity of her circumstances.
Okay, that's a very long review. I will write one final post summarizing my thoughts on the entire book.

Friday, April 01, 2011

Just pay them... (continued)

The PBS Frontline on Money March Madness is worth watching. And it appears to have caused the NCAA President to at least say he's open to discussion about paying players in some fashion. He wouldn't disclose his salary when interviewed, but the interviewer makes the point that he likely earns more money than he did presiding over the University of Washington, with thousands more employees than what he has now.

The 10-year March Madness deal signed between CBS, Turner Sports, and the NCAA was worth $10.9 billion. The Bowl Championship Series earned $125 million in TV revenue last year. The SEC's 15-year package with ESPN is worth $2.5 billion. Coach Rick Pitino earned over $6 million last year, John Calipari about $4 million-- plus travel, cars, endorsements, etc. The players you turned in to watch, however, earned tuition, books, a university meal plan, and received some apparel--little more. They also signed the rights away to the use of their image, meaning the NCAA makes money off of jerseys with their name and selling their images to EA Sports and old games to ESPN Classic.

Consider student employees of universities-- work study, RAs in the dorms, and graduate students who are researching and teaching. They typically get a tuition remission and some type of stipend or salary. I have one student who has been offered up to $27,000 to attend a particular university as a graduate student. The schools compete for her attendance by offering money. But athletes do not have the same rights, they're expected to perform their work without the stipend. Why?

Michael Lewis, author of The Big Short, The Blindside, and other bestsellers, basically says you only care about athletes getting paid if you have a "weird" desire to see justice done. "Justice" came to mind reading this transcript of HBO Real Sports where several Auburn players allege they received large payments from boosters. That made me happier, they were closer compensated to what they were worth. One player sold his championship rings to keep his sister from being foreclosed on-- another NCAA violation.

The classical theory of wages says that workers are paid according to the marginal product of their labor. If they're producing multi-million dollar profits for performance, then paying them a salary of $0 makes little sense. Not paying for their low-income parents to attend games, for example, seems cruel in light of how much money the NCAA is making off of them. Economist Andrew Zimbalist, who Frontline interviewed, estimates that star quarterbacks are worth around $3 million. But the NCAA operates as a cartel and gets to pay players whatever it chooses.

It's important to understand that while the NCAA is profitable, the schools themselves are LOSING money through athletics. Only 14 out of 120 BCS programs have an operating surplus, the median school lost $10 million last year. One can argue that private donations to athletics necessarily crowd out donations that may otherwise have been made to the university. Shortfalls also have to be offset from a university's general fund.

Sonny Vaccaro and others are currently exploring a lawsuit against the NCAA looking to change things. His summer camps paid a key role in feeding the beast and now he has a guilty conscience about it. I hope they're able to see change happen.