For you deficit hawks

So, there is a great movement afoot to stymie macroeconomic expansionary policy for the remainder of Obama's term, and if, god forbid, a Republican takes office, clearly for his term (and one term it will be if they attempt to real in the deficit).

So the federal deficit stands at 13 trillion dollars.  Check out the linked site.  It's pretty amazing.  That's a pretty large number, and it's pretty scary for most Americans.  But for all the wrong reasons.  The reasons I've heard counted include inflation, China, bonds, and personal savings.  I'm going to handle some of these in this post.

Inflation--First of all, there's been almost no signs of inflation.  Infact, inflation rates were negative for much of 2009 and are hovering at 2% for most of 2010.  As Paul Krugman has pointed out ad nauseum, the real risk we run is deflation.  That's where prices get so low that production levels decline because firms no longer have the capacity to produce.  Deflation is a nasty spiral, and it's not entirely clear how to get out of it, once the spiral begin.  That's in comparison to inflation, for which we have a number of well practiced tools.  If that's the case, why are so many people worried about inflation?  Well, simple, when debts are so huge, it's been the practice of floating currencies to print more money.  By expanding the money supply, you can pay your debts, up until the point that your currency loses all value.  That's how Germany attempted to deal with WWI reparations.  But there are absolutely no signs of this happening.  2% inflation is exceptionally low.  Remember, in the recessions of the 80s, inflation climbed as high as 14%, in 2006, inflation was higher than it is now, at 4%.  The Taylor rule, pegs good inflation exactly at 2%.

China-Bonds--I'll handle these two together because they're related.  So, to raise the money supply, the Fed sells treasury bonds on the open market.  Commercial banks buy them, but also the central banks of other countries buy them too.  And, as you've no doubt heard, China owns a whole bunch!  Five years ago, they owned nearly 850 billion.  These fears about China have been going on for thirty years, and are a bad hangover from the Cold War.  The fact is, China's been a great bogeyman for U.S. politicians, particularly Republithugs, for years.  And I'm not really sure why.  Is it that they think China will invade?  Such a thing, while catastrophic if it occurred, is so unlikely as to be pure fantasy.  More likely, people are worried over the vast effects that the Chinese exert over our economy.  There are some major levers that the Chinese have, by owning so much debt, not to mention the equities they own in the country and the world, but the most troubling to U.S. politicians currently, is how they devalue their own currency.  So the aggregate demand equation goes as follows.  Aggregate Demand= C+I+G+(X-MI).  That is, Consumer Spending + Investment + Government Spending + Exports minus Imports.  The most popular way to stimulate demand is by becoming an export nation.  No one likes the government to spend, consumers always spend at the Marginal Propensity to Consume (MPC) which is directly related to their income (excepting cheap credit!).  Investment means, new houses and new factories, so it's hard to stimulate that (the only way is through tax credits, which might not accomplish anything anyway).  And that leaves exports.  And there are several ways to stimulate exports.  Have a cheap dollar, and have a cheap labor force.  China values its currency against the U.S. dollar.  But it does so at 8 to 1 (7 to 1 since mid 2009. )

But this nebulous fear of the Chinese, is just that, nebulous.  China doesn't want to change it's relationship with the U.S.  They've attained great wealth through us.  We are their biggest customers!  And if they undermine the U.S. capacity to repay it's debts, they'll be forced to take a major writedown.  A writedown that could destabilize their entire political system (already on the verge of destablizing).

Let's not talk about war.  It's silly.  Plus, both the U.S. and China have spent billions on war plans that will go into effect the minute hostilities break out anyway. 

All of this to say, don't worry about the deficit.  Worry about employment and economic change.

Employment speaks for itself.  The unemployment rate is bad, 9.5%, again worse in the 80s, and full employment is actually around 5% unemployment, but still bad enough to be a game changing issue this November. So new jobs need to be created.  And that means more stimulus.  People are fond of pointing to Japan's lost generation as a benchmark for when increased government spending did not raise aggregate demand--but Japan is very different from the U.S.  Moreover, Japan left its lost generation with state of the art urban areas, transportation of all varieties.  Whereas our infrastructure is still decaying faster than it can be rebuilt, despite the stimulus money already spent.  Moreover, why the hell is Obama building more roads?  Repair the existing, add a lane or two if you must, but the stimulus money really needs to come to expanding urban areas.  We no longer have a factory or agricultural based economy.  To be sure large percentages of our GDP come from those industries, but the largest stake came from our health and finance sectors.  These are urban professionals!

This is where we get down to the real problem here.  Change.  Nothing's changed.  The internet bubble is gone, so is the housing bubble.  How do we spur real change?  Innovation.  Where are the innovators?  They're going to business school instead of engineering school because the payoff's higher.  The U.S. should be dumping a load of stimulus funds on universities.  The coffers of the NIH and the WHO need to be replenished.  Disclaimer: I'm engaged to a graduate student, so I have a financial interest here.  But where is the next thing going to come from?  Not better coffee, not a new brand of food, not a new iPod, or iPhone.  It's going to be game changing when it happens, but it will only happen here if we invest in our human capital.

Enough.  I need to get to work.
Change

Macroeconomics Post 3: The Role of the Federal Reserve

So the last chapter before the final was an illuminating one, in part because it dealt with one of the central debates of economic policy.  In the the common parlance of liberals and conservatives, the issue has been framed by conservatives as the role of "big government."  But, the book explains, this is a read herring.  The issue for Macroeconomists has nothing to do with the size of government, because that is fiscal policy--it's a different issue.  Most economists believe in the economy's auto-stabilizers like unemployment insurance and the graduated income tax.  The issue, says Baumol, is actually the degree to which the government attempts to regulate the economy, or to what degree the "self-corrective" market is allowed to be free.  This battle largely takes place at the Federal Reserve.

So the Federal Reserve can affect the economy in several ways.  1)  They can change the interest rate 2)  They can change the money supply.  There is a third way that is rarely used 3)  It can change the reserve ratio for banks.  The Big Debate in Macro is whether or not the Fed should worry about 1, or 2. 

Keynsians think the Fed should concentrate on the interest rate.  This keeps the interest rate relatively stable, and with several underlying assumptions, it helps expansionary policy work effectively to stimulate the economy.  The monetarists, lead by Milton Friedman and his ilk, believe that the key is actually the money supply.  They think the interest rate should be determined by supply and demand.  The key concern of the monetarists is inflation, and when the Fed lowers the interest rate, they expand the money supply--and chance inflation.  Now in practice this hasn't really been the case.  The correlation between low interest rates and high inflation hasn't really born out.  Even when adjusted for the "two year lag" that monetarists believe affect inflation numbers.

Anyway, economics is over now, but it was a fascinating class that I wish we could have gone more into depth on.  Next stop Forensic Accounting and Tax!

Art or Bonds?

Just a quick post here.  Planetmoney did a good little podcast on the economics of art selling.  As an art hobbyist, I found it intriguing because I do occasionally produce canvases, and I do occasionally have an opportunity to try and sell them.

The gist of the podcast is that the return on Bonds is always higher than the physical investment of a piece of art.  Well duh.  It turns out that one of the metrics of a how a painting is sold turns out to be popular swings in taste.  Though not surprising, this can have alarming effects on the price of your art investment.  A Van Gogh will always be worth millions, but if French Impressionism goes out of style, that could shave millions of dollars off your investment.  Whereas your investment in a bond is by its very nature a fixed investment.

There is one thing that they don't talk about in the podcast which surprised me.  Art is very fragile, and very space consuming.  One of the things we learn about in economics is that money, by it's very nature has to be fairly easy to store, and it has to be easily divisible and difficult to counterfeit.  There is a ton of risk in the art market that what you're buying is a fake, and moreover, if the housekeeper decides to dust the painting with dillouted ammonia, he'll destroy a 20m dollar investment in five minutes!  Your whole house could burn down and everything in it, and a bond will still retain its value, so long as the company, or government which backs it continues to exist.  It's funny too, because just the day before, "All Things Considered" ran its own podcast on the artmarket and they talked to an art seller whose client had had that very thing happen to him.  His housekeeper ruined his investment.

I am a nobody, and my art is only midling realism.  I paint mostly acyrylic and oil canvases between 8.5 x 11 and 30 x 40 inches.  In fact, a 30 x 40, canvas is the largest canvas I've ever worked on.  I may have the opportunity to sell some of my paintings fairly soon, so how would I price them?  And what am I likely to get for them?  So here, you have a piece that I have never shown before, that I am going to attempt to sell, it's an oil painting of a famous Japenese Garden in Florida.  It's 30 x 40 inches, and comes preframed, as in, I wanted to hang it myself and framed it to make it look nicer.  Cheap frame, but it looks good.  So how much, and what can I expect?  Well, the painting is only one of its kind.  Not easy to reproduce.  Even the cost of getting a lamine of the painting would be a good $100, though the price would then come down on each print thereafter.  Morevoer, getting it properly scanned at this point would require removing it from the stretchers which would damage the painting considerably.  Printing it based on a photograph?  Possible, but getting that well done would be fairly arduous as well, and lighting and veneer are critical issues.  What is this painting worth to me?  Well, two women in my life like it very much, and both would like to keep it.  But at least one wouldn't begrudge a little extra flow, and a little extra wall space.  Given that the painting took me three years to complete (long periods of no work done) my asking price is $2,000.  But, as with any work of art, I would expect to bargain on the price.  Is it worth 2,000?  Certainly, my name will never be worth anything, at least, not as a painter.  But sentimentally, the painting is definitely worth that much to me.  But I could piss $500 away in two weeks, and there I am, without one of the two oil paintings I've done.  Is that sentimentality worth a payment on my debt that would be negligable at best?  No.

Here's another one.  An oil 30x40 of the Rio Grande.  Also framed.  I have far fewer takers on this one, though as a painting I enjoy it more because of the feeling of space that the Rio Grande valley evokes.  Again, I'd ask for $2,000.  But neither of the two women in my life who wanted the first painting are particularly interested in this one.  Neither of them were cowboys for Halloween, I guess.  But I'd be more willing to part with this painting because it would make at least one of the women in my life very happy.  Particularly if I made a buck for it.  But here again, we come into some interesting economics about art.  I have a target audience for this, I know a guy who hails from this part of the world.  Would he be interested in a painting like this?  I have no idea, but if anyone would, it would be him.

Which leads me to the last topic for today.  Prices.  Prices are determined by the negotiations of buyers and sellers.  If there are no buyers for a particular asset, it's difficult to set a price.  This, we're told, is the reason why toxic assets had such variable values during the height of the crisis.  Or at least, that's what Planetmoney would have us believe.  But the avabilability of buyers and sellers is really only one aspect of price.  This is why so many long term investors, like those who buy and sell for pension funds, have such a negative feeling for shortsellers.  They aren't bothering to value an asset based on its actual worth or quality, but on speculation that the price will drop because of external market factors.  If the factors were internal, it would be a variant of insider trading.  If the perceived demand for my paintings is low, so is the value.  If the perceived quality of my paintings is low, so is the value.  But if the quality of my painting is perceived as really high, and demand is still low, then so must be, the price.

Macroeconomics Post 2: Real Wages

So, I had my first class.  Our professor is something of a surprise.  He apparently directs some sort of hedgefund.  He didn't share that with the class.  I learned that through the infamous series of tubes.  To shield myself, and him, I won't say much--other than that he managed to offend me in the first class.  That said--so far I've been pleasantly surprised by Macro.  There seems to be general agreement (at least between my professor and his textbook, Baumol) that certain social welfare programs are actually very helpful.

Unemployment insurance is definitely one of those things.  As Baumol defines it, "a government program that replaces some of the wages lost by eligible workers who lose their jobs"  these economic outflows help prop up aggregate demand in times of recession, and help even out swings in the economy.   Baumol also points out that on the chart of Growth rate of real GDP the tempermental swings in growth are much mitigated after Keynsian use of monetary and fiscal policy take over post 1950.

These are all things I've heard economists talk about extensively, usually negatively.

But what I really wanted to talk about was real wages v. inflation.  This isn't the chart in the book, just the best I could find on the internet.  Now reading this in the book, I admit I was a bit offended--I misperceived what Baumol meant.  The implication of the chart is that in the last decade, wage growth has largely kept up, and, even surpassed inflation.  I was all set up to get mad because I've talked about minimum wage economics and how the poor keep gettin' poorer.  It took me a minute to remember, well, duh.  That's not economics--its common sense.  My point about prices rising is that the scales have tipped to favor the apocrophyal 1%.  That's the 1% of the population making 90% of the money.  All that chart is saying that prices rise--afterall, one man's wage is another man's cost.  Wages are prices.  Now, this chart doesn't actually address purchasing power-though Baumol infers that it does by referencing the fact that inflation can reduce purchasing power.  Granted--but that's not what I've been on about in this blog.  Ravingleftatic is all about the income disparity between the upper-middle and lower class.  That chart doesn't say a thing about that.  Having just finished statistics, I'm guessing that the data on income distribution is probably left skewed, meaning that the mean is greater than the median.  There are fewer outliers, but they're making so much more money than the median income is lower. 

The other interesting thing to point out is that since inflation rates differ between different items, then I wonder if its possible to practice arbitrage on price inflation.  Probably not--I suspect that inflationary price changes tend to work in particular market baskets and industries, which might make it difficult to find enough commonalities to trade based on that inflation.  Then again--why not?  That's what stock speculation is all about, buying high and selling low isn't it?  Speculators bet that the current price of an object is undervalued.  Before the Great Depression it was fairly common for traders to falsely sell a product to extreme levels just to raise the price of a bad stock.  Securities lawyers call that inflation, why shouldn't Macroeconomists

Macroeconomics, Post 1, GDP

After a disappointing semester at B-school, I've decided to spend more time blogging about my classes.  I hope that this will encourage my thinking about topics in class, and applying them (hopefully correctly!)

So our Macroeconomics text is posted here by Amazon Associates.  It's William J. Baumol's Economics: Principles & Policy, 11th edition.

So while reading on my lunch hour, I learned some pretty interesting things about the GDP which I didn't know before.  I'd definitely heard about it, and had a very vague sense of what it was, but I never looked too closely at the definitions, which are interesting.

Nominal v. Real GDP.  This is the same definition from Micro.  Nominal is priced in today's dollars, Real is priced in terms of change over previous years, adjusted for inflation.

GDP:  "The sum of the money values of all final goods and services produced in the domestic economy and sold on organized markets during a specified period of time, usually a year."

Some interesting things to note:  Products that are sold on the secondary market, are not counted in the GDP!  I found that to be astonishing given that so much of our income goes to second hand items.  We spent 600 dollars on a used couch last year.  There are some good reasons for this, and some that I don't understand.  No one but me will ever know about the used couch.  It was bought with cash, and no record of the transaction exists with any official source.  So it's impossible to track.  However, a used car dealership doesn't add to the GDP?  That seems a bit extreme, because they do track those sales, and they do report income to the IRS, and they are taxed on that income.  No, GDP just includes goods that are made in the current period.

The other huge thing I didn't know was that GDP only counts final goods.  The example Baumol uses is computer chips.  Computer chips are components, not final goods.  So does that mean, a chip manufacturer and distributor like Celestica doesn't contribute to the GDP?  That might be a bad example because I'm not sure if Celestica is American or Canadian.  Baumol uses Intel.  Intel's goods are not considered final, but are intermediate, and so to not double count their sales, they are not included in GDP at all!

The Celestica thing brings up another key point about GDP.  Geographic boundaries are important, but complex.  Any product produced in the U.S. regardless of whether or not it is a foreign company, gets counted in GDP.  Says Baumol "if your family owns a Toyota or a Honda, it was most likely assembeled ina factory here.  All that activity of foregin firms on our soil does count in our GDP." (It would be excluded in GNP however, Gross National Product.)

So I have some questions for the professor:

1)  If companies like China, India, Taiwan, are all producing a ton of foreign goods, does it mean that their GDPs reflect that?

2)  Much of what the above mentioned countries produce are intermediate goods, in other words: parts.  Does that mean they are not counted?

3)  GDP is a governmental statistical measure.  Governments are different.  If the U.S. Government says the GDP of Greece is X billion dollars, and the government of Greece says the GDP is 4X billion dollars, who's right?

America's Shame

I just wanted to go record with this: I am so ashamed of my country. The oil spill in the Gulf of Mexico is such a worldwide catastrophic event that it puts Japanese whaling, poaching Africans, rainforest destruction, European wolf depopulation, yada yada, etc. etc. to shame. Its hard to imagine a more offensive affront to man, god or nature.

Obama, Bush II, Clinton, Bush I, Republicans, Democrats, Government Regulators, I blame you.

Oddly, I don't blame the oil companies. They're businesses, they're supposed to enlarge profits, and drop costs. They were doing what they were supposed to doing. It was government that dropped the ball. And the people, for letting themselves get hoodwinked into thinking that industry could or would self-regulate. Why do I blame the regulators? Well, that should be pretty obvious, but just to enlarge. Political purges of beaurocracy are pretty common, and the Bushies were particularly efficient at this, but the hypocrisy and degredation of those who call themselves regulators and allow these things to happen ought to be punishable by life in prison. I'm sure there are many principled regulators out there, and I don't blame them, exactly. But at a certain level, willful ignorance is acceptable only in certain areas. I don't blame financial regulators for looking the other way--not as much--because a failed financial system really only hurts humanity, and really only hurts humanity temporarily. But environmental and industrial regulators are really stewards of the entire earth, in perpetuity. When they fail, it not only hurts humanity, but it hurts humanity for the rest of its existence. When they fail, they not only hurt the environment, but the alter it indelibly for generations.

I'm so disgusted I can barely breathe.

as a caveat, I would like to add that I would never will any violence or physical unpleasantness for these people. But I absolutely hold that they should be prosecuted to the fullest extent of the law. And if the law isn't severe enough, it ought to be rewritten.

as a further caveat, I admit my own guilt. I've protested politics before, but I've never personally done anything, except for occasional donations to the WWF, to help the environment.

Athens and The Bond Kings of Pennsylvania

So this piece is a commentary on something I heard in Planetmoney this week. As usual, I'm one or two weeks behind the times, but the issue is the debt crisis in Europe. My commentary is based on an idea that was very much reflected in the American financial crisis.

Basically, the good people of PIMCO, one of the largest funds in the world, and others like them were buying bonds like water in Europe and other countries. Without getting too much into the finance of it--when it became clear that the bonds would not be paid off, PIMCO sold them and took the loss. But Greece still needed the money, and so they issued new bonds. Which, of course, nobody wanted to buy.

This is the basis of the European debt crisis.

The popular refrain on the fiscal right, is that it's the people's fault. They've been irresponsible with their money. This is certainly true--and there is little point in arguing it. But what I haven't heard is an acknowledgement that it takes two to tango. For every irresponsible dollar spent, there were just as many irresponsible dollars lent. Whether you blame the ratings agencies for giving Greece a triple-A, or the EC, for accepting false assurances in Greece's bid for acceptance into the EU, you have to admit, that "free money" came from somewhere, and usually it came from investors who were willing to take a higher risk in return for a greater return. That the turkeys came home to roost, is just part of the game.

But let's accept this premise that it's not the fault of the lenders, and ONLY the fault of the payees. Ok, but lets not forget that the BLS has proven that wages have fallen over the last thirty years and that the average American has less of his own money to spend. Those facts are probably the same for Western Europe as well. It's not surprising that given a credit card with a low interest rate, that people wouldn't go ahead and use them. I also resent the implication that the vast majority of these expenditures were completely frivolous. That's certainly the image that we are made to see, and shows like "The Real Housewives of _____" delivered on that promise. But those shows were popular precisely because people were outraged by the immoral spending of these profligate women. But is that how most Americans spent the last decade? I honestly don't think so.

When it comes right down to it, we all live beyond our means. I know that I certainly do. And I don't have an iPhone. I haven't taken a vacation in two years. There are weeks that I just barely squeak by. But it's like Citibank says, we want to "live richly." Yes, you can surivive on beans and rice, but a full and complete life means sometimes enjoying those fruits that are just out of our reach. I can't blame anyone for that kind of spending. I think there's a huge difference between paying for dinner five nights out of seven nights at midrange $12 entree restaurants, and wantonly buying $500 shoes or jewelry, random trips to Vegas or New Orleans, buying a new TV just because you're tired of your old one, and gettingnew phones everytime they're released, or upgrading computers every two years.

But maybe that's just a justification: I could also make the argument, that delayed gratification only works if you actually delay that gratification. The fact that we eat out five out of seven days of the week is really pretty obscene. And it's worked out so that we HATE our local restaurant options. We're bored to tears of them.

In the end, it comes down to risk management, and both parties are guilty of poor capacity to manage risk.

One last point. The Planetmoney podcast closed with the argument that bailing out Greece would just kick the can down the road. I totally get the economic arguments for that. But sometimes governments must do distasteful things to protect their people. That is, afterall, what democratic governments are set up to do, protect their citizens--not the purity of their markets. There are already riots in Greece. This is the type of conflagration that under the worst sorts of circumstances could end in war. Stability has a price, and that price is 350 billion Euro.

In accounting, a poor practice, or an illegal one in some contexts, is earnings cushioning. It infers lying to the investor, hiding debts of varying kinds, or paying off future debts in advance to inflate profits in the future. There are dozens of techniques for this--what people call "accounting magic." But this obscures one very crucial fact about accounting that us Ravingleftatics have a hard time swallowing: Lying about your finances is never good, but history has provided many examples of companies that got through hard times and managed to legitimately succeed, by these sorts of tactics. All of which to say, if the exuberant spending of the new millenia had been more carefully monitored, we could well have eased the debt out of the process without a financial meltdown.