Some Common Sense Economics

The economics geniuses will be out at Jackson Hole this week to discuss the world’s economy.  I love what my friend Yra Harris wrote:

In July, Barry Ritholtz posted an interesting article by Alan Jay Levinovitz in Aeon Essays titled, “How Economists Rode Maths to Become Our Era’s Astrologers.” The final paragraph sums up my continued theme of “it ain’t rocket science”: “There is no longer any excuse for making the same mistake with economic theory. For more than a century, the public has been warned, and the way forward is clear. It’s time to stop wasting our money and recognise the high priests for what they really are: gifted social scientists who excel at producing mathematical explanations of economies, but who fail, like astrologers before them, at prophecy.”

There is no doubt, macroeconomics is an inexact science.  Yra’s right though. There is certainly more than enough data that shows one form of macro works, and the other doesn’t.  That’s why I love the video “It’s a Wonderful Loaf” by Russ Roberts.

There is further drama at this Jackson Hole meeting because Fed Chair Janet Yellen’s term is up.  Will Trump re-appoint her or go a new direction?  Given the tactics of the Fed over the past several years, I’d like to see him appoint a strong freshwater economist to head the Fed.

The Fed has a dual mandate proscribed by Congress.  However, I think the people at the Fed should entertain another underlying mandate.  Restoring faith in free markets.  America has lost faith in free market capitalism.  A lot of people are totally uneducated about what it means and what it’s done to lift standards of living.  We don’t have a lot of great examples of free markets in America anymore.

What we have in America today was accurately described in City Journal as “fake capitalism”.  Not only that, but our country is littered with crony capitalism (see which tarnishes real capitalism. Paraphrasing economist Allen Metzler,  “Free market capitalism is engaging in actions where your actions don’t impinge upon other people. You have freedom of choice and can buy and sell anything you want. Free-market capitalism protects private property rights.”

Subsidies, mandates, price floors, price ceilings, rules on labor and other regulations all get in the way of free markets.  It’s pretty hard to name a market that doesn’t have some sort of government intervention.  Even venture capital is regulated somewhat.  The IRS says who can invest and who can’t.

We do need some rules, but in the US we have gone way too far.  Look at what New York governor Andrew Cuomo is doing with natural gas.

The US Housing market is often cited as a “free market”.  However it is riddled with all kinds of subsidies.  The debate over what to do with the US health care market is also instructive. Democrats want socialized medicine.  Republicans can’t agree on anything.  The way the market worked prior to Obamacare and after Obamacare wasn’t anything close to free market capitalism.  That’s why it was so expensive.

Here is an example on how far we have gone to interfere and screw up different markets from the City Journal article.

The federal government delivers $20 billion in annual subsidies to farmers, decreasing the price of corn and soybeans, ingredients in the processed foods that have contributed to the nation’s obesity problem. Washington also subsidizes energy. Oil, gas, and coal get nearly $2 billion in direct annual subsidy, according to the Institute for Energy Research. Renewable energy gets $27 billion. Such subsidies distort energy investments, obscuring what kinds of investment the market on its own would support, and they have a dramatic effect on energy prices. When critics of capitalism denounce markets, then, they’re often making a category mistake.

All you have to read is the paper on the Economics of a POW Camp to understand.  Each prisoner got the same ration (same “income”).  When there were totally free markets, a huge economy inside the camp exploded.  There were gains from trade.  As soon as a centralized authority intervened to fix prices, the economy cratered.

We have lost our way in America.  Maybe the folks at Jackson Hole should read the paper.




41 thoughts on “Some Common Sense Economics

  1. Jeff, I cannot express loudly enough how much that I think that the ZIRP policies of the Central Banks are giving us this slow, stall speed growth. The retiring folks don’t have enough in the bank at 1.5% CD rates to live on and make gifts or loans to their heirs. Low interest rates are a hindrance for free spending. In the very short run it was OK, but it is a big negative now.

    1. Agree. I can listen to them make a case for QE1. But, I think the continued QE was really poor economic policy-and as you say it hurt the elderly. It also hurt poor people and the middle class because they couldn’t really take advantage of 0% interest rates. As we well know, the rate of interest charged is really a price based on the demand for money. If it’s 0%, there is no demand-no velocity. Not surprising there is low inflation because there is no GDP growth.

    2. I’m a “retiring folk”. Age 65 and still working, well off in income producing property and stocks. All of which have risk, and lots and lots of work.

      Pray explain why I could possibly deserve a large return on simple savings with NO risk and no work?

      Take your time. Take infinity time. Because there is no reason at all.

      No risk, no work, no reward, that’s the facts, and to hell with anyone who wants the gravy without the cooking.

      1. Time value of money. The floor of no (actually low, but still non-zero, because your savings account is subject to a 10 day delay on the withdrawal period) risk is not zero, but slightly above that. Remember CD’s? You got a higher interest rate the longer the hold period was. The only non-risk investment is the mattress, and even that is the victim of any inflation.

      2. Nobody is saying a large return, just some return. Savings need to be encouraged because that’s what forms the backbone of investment. Savings represent the stored value of previous investment (either time or money depending on occupation) that can then be put into new investment or held awaiting better investments.

        This is where savings banks come in. There’s lots of low risk investments out there, but finding them can be difficult. When you open savings account, your aren’t just parking your money somewhere, you are actually making an investment in the bank itself. The bank will then use a portion of the savings that you deposit with them as the funds for those aforementioned low risk investment. That interest rate is just price the bank is offering you for the temporary use of your money.

        That said these are low risk investments and therefore have low rates of returns. Historically going back to the 1950’s the interest rate on savings about 4-6% (Ballparking here, I’m sure someone will come along to correct me, but this is good enough for the argument). This was good because it provided banks with the resources to make new investments and because the investments were being made on a finite supply of savings, it forced bankers to actually seek out good value for their investments. This also help keep the value of money somewhat in line with the value of actual goods and services. That last can’t be stated forcefully enough. It means that money that is saved at least retains the value that it had when it was saved.

        It’s great that you’re well off with property and stock and you’re right that it takes a lot of work. But not everyone has the education or temperament to do that kind of work. The idea of Saving is so that people who couldn’t do that work could put aside some of their earnings and provide those resources to those who did have the knowledge and temperament. Because folks who don’t have much to begin with don’t have a high tolerance for risk, the Savings account with return was created with those people in mind.

        Unfortunately, QE has almost eliminated the demand for money from savings. New money is not answering this demand, it’s exceeding it – raising the supply of money relative to demand. This makes some large investments more practical because even if the investment fails, it has lower repercussions because the money now has less relative value than it did at the time of the investment. You can now go big for less risk. But there’s some downsides too. Not only does it remove the incentive to save, it can actually de-incentivize as money will now lose value as it sits. For people on fixed incomes or living off of savings this is bad. Not only does their money not go as far, their opportunities to transfer into better investments as they try to educate themselves. So people who have the ability and opportunity to play the modern market can score but people who don’t get increasingly froze out.

        QE has one other bad outcome, because it separates investment from saved value, there’s less incentive to see that money as finite resource that needs to be taken care off. This leads people to taking riskier and riskier bets that not even the ongoing devaluation can cover. This is what leads to the inflation of bubbles that ultimately crash to detriment of the economy as a whole – especially to folks on the lowest rungs who don’t have the knowledge or ability to see it coming.

          1. The long term historical return on bonds is about 4%. The long term historical inflation rate hovers between 2%-3%.

      3. “Large return”, how about just long term average return which in bonds is around 4%.

          1. whoops, made a mistake. The historical discount rate is right around 4%. Bonds are a different story, but their long term rate of return isn’t stellar at around 6.99%.

    3. ZRP effectively masks market signals, and is the biggest distortion of the free market imaginable. usually investors can compare investments against benchmark interest rates, but with the rate effectively zero, any investment rooms better. Of course without the ability to measure relative risk against government bonds, billions get squandered, malinvesment which drags everyone down.

      The only possible benefit (and an unintended consequence, to my mind) is the destruction of wealth on this scale is balancing out the creation of fiat money vie QE, otherwise we’d be seeing hyper inflation.

      1. Is there enough demand to create inflation? No turnover in cash, no velocity. Low anemic GDP.

        1. Even with anemic demand, the ever increasing amount of “money” being injected into the economy “should” be creating inflation, as more money is being used to bid up the prices for things which are in demand. As Freidman told us: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. “

          If the Trump Administration can enact its economic policies, releasing the pent up demand may trigger the inflationary spiral.

          1. Certainly within the realm of possibility, especially if the Fed is lax in getting out ahead of it by raising rates and reeling in excess capital in the market.

    4. I like the slow growth as opposed to the boom and bust cycles we usually have. Free spending is a problem that causes the boom and bust cycles.

      1. having govt intervention into each and every market doesn’t smooth out cycles. If you think today’s economy is like the 1870s or even 1930s economy, you need to read Monetary History of the United States. Keynesian economics doesn’t work. It distorts markets and leads to less efficient decision making.

    1. I was just about to post the same thing. Good catch. I would say that predecessor implies (at least to me) that Mario was right before Andrew. There were three governors in between.

  2. The folks that are going to Jackson Hole will not listen nor will they read the paper . . . because . . . they are “the folks that are going to Jackson Hole.”

  3. I have argued for many years on my blog that QE wasn’t about monetary stimulus. It was all about supplying the world’s enormous desire for risk-free cash and cash equivalents. Very strong money demand drove down the interest rate on cash to zero or thereabouts (thus pushing up the price of money). If the Fed hadn’t offset the intense demand for money with QE the world would have suffered a serious liquidity shortage and ultimately deflation. QE is best understood as a way for the Fed to create T-bill equivalents (i.e., cash) by buying notes and bonds. QE was not “printing money.” The proof of my assertion is the fact that inflation has remained low and relatively stable, and the dollar has not collapsed. The Fed managed to supply just enough liquidity/cash to meet the demand for such. That is the Fed’s primary job, since that is the way to ensure functioning markets and low/stable inflation.

    Interest rates have been very low not because the Fed set rates artificially low. They have been very low because of the market’s huge demand for short-term, risk-free securities.

    The economy has grown at a sub-par pace for many years not because interest rates have been low but because the market’s willingness to invest and take risk has been weak. Risk aversion has been a hallmark of this recovery for many years. Fiscal policy is one big reason for the lack of animal spirits: high taxes and burdensome regulations have weakened the economy.

  4. But then we have the Crash of 2008. It changed my thinking on these issues. Without a federal effort starting with Bernanke, Paulson and Geithner, we would have gone down. It was insane what the banks did and everyone in the CDO business.

    Is economics almost undecipherable today, yes. Too many regs, sure but toss everything, no.

    1. That “we would have gone down” is highly debatable. You’re using the “too big to fail” argument.

      Certain firms would have gone down, many of them deservedly, but other, solvent firms would have purchased their useful assets at fire sale prices, reallocating capital to more productive uses.

        1. There would have been plenty of equity in 2008. Bear Stearns purchase made that pretty clear. Lehman positions transferred through CME clearinghouse without a blink.

          1. My original comment was referring to the equity Paulson put into the Banks.

            Nobody was touching Bear without the aid of Mr Bernanke even at 2 bucks a share.

          2. Don’t forget, the govt intervention into the market was the base of how the whole house of cards was built (which is my original point in the post) Paulsen basically bailed out his cronies. Letting the banks go bust and through bankruptcy would have been painful no doubt, but we might have a better system today instead of massive oligarchy’s.

    2. QE1 and the measures the Fed took in 2007, 2008, not in question. QE2 and beyond, totally in question. I also think bankruptcy is healthy. If a firm takes too much risk, why should taxpayers bail them out?

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