EclectEcon

Money and the Monetary Base: the changing relationship

In the fall of 2008, the US monetary base exploded. The Fed bought up tonnes of assets, thereby pumping all sorts of reserves into the monetary system. See this graph:

That action should have set off a gigantic monetary expansion and thwarted the deflationary/recessionary pressures the economy was suffering then, but it didn't. 

There are two reasons the sky-rocketing monetary base did not head off or at least dampen the depth and length of the recession:

1. There was a truckload of liquidity that dried up when the shadow banking system collapsed. That by itself probably caused broadly-based measures of the money supply to shrink somewhat, but the increase in the monetary base should have more-than-offset that effect.
2. More importantly, the Fed began paying interest on the required reserves that commercial banks held with the Fed. Rather than lend and create more money and stimulate the economy with all the new reserves created by the Fed, instead the commercial banks just sat tight, reduced their risks, and made buckets of profits, paying next to nothing on deposits while earning a bit more than that with their deposits at the Fed. 

Here is a graph to show what happened:

I see there was a much smaller effect in the Euro area, and I have no idea what caused such a huge drop in the UK. 

But this graph (h/t Kais) likely highlights an important reason for the depth of the recession and the slow recovery. I wrote about this bizarre policy change back in 2008 here. So did Scott Sumner. The rationale for the policy still puzzles me. 

I gather the Fed (along with Paulson and Geitner, et al.) were trying to shore up the solvency, not to mention liquidity, of the major banks in the US by having the Fed give them some money that otherwise would have reverted to the US treasury (net profits of the Fed, to the extent that the Fed is unable to spend or hide them, go to the Treasury). At the same time, it looks like a monumental transfer of wealth to their friends on Wall Street. Ugh.

More Toothless Treaties from the EU

Once again European leaders have announced a treaty to deal with the sovereign debt crisis in Europe, most notably resulting from fiscal profligacy in Greece, Portugal, and Italy. These agreements are toothless. They have no enforcement mechanism, and they do nothing different from what the initial EU and Euro treaties did: they extract promises from all parties that they will act to reduce their annual deficits and, if they do, then other countries might help them through the difficult periods. From WaPo:

European leaders adopted a groundbreaking new treaty Monday that binds them to imposing caps on deficits and government debts to combat the painful financial crisis that has sabotaged prosperity across the continent and left it slipping toward recession.

The treaty, endorsed by 25 of the 27 European Union governments, was intended as a gesture to show skeptical financial markets that European governments are at last committed to gaining control over lax borrowing habits that over the last four decades have helped create dangerously high debts.

I nearly lost my coffee onto the computer screen when I read that. As the article further notes,

... [A] chorus of European officials and economists have questioned the wisdom of the treaty in the first place. The pact was unnecessary, they contend, because European rules — merrily ignored over the years — already forbid excessive government deficits ...

These promises might sound nice politically. But unless they can be enforced (how?), they merely prolong the agony and open the door for protracted gamesmanship. 

What will Germany (and France? others?) do if Greece (along with Italy and Portugal?) does not get its fiscal house in order? 

• Invasion and conquest are not likely options.
• Tell them they must try harder.
• And we really mean it this time.
• Kick them out of the EU and the Euro pact? 

The last option is the only realistic one. The only question is, how long before it happens, before Greece de facto defaults even more on its debt by abandoning the Euro, and consequently many financial institutions, counting on bailouts from the IMF and their own gubmnts, lose buckets of money? Or will the taxpayers of these countries hosting these banks once again be required to bail out the stockholders and creditors of those financial institutions? 

This is moral hazard, writ large on an international scale.

- - - -

Addendum: Stratfor points out that a variant of the first option listed above is not beyond the realm of possibility:

The German government proposed last week that a European commissioner be appointed to supplant the Greek government. While phrasing the German proposal this way might seem extreme, it is not unreasonable. Under the German proposal, this commissioner would hold power over the Greek national budget and taxation. Since the European Central Bank already controls the Greek currency, the euro, this would effectively transfer control of the Greek government to the European Union, since whoever controls a country's government expenditures, tax rates and monetary policy effectively controls that country. The German proposal therefore would suspend Greek sovereignty and the democratic process as the price of financial aid to Greece.

Though the European Commission rejected the proposal, the concept is far from dead, as it flows directly from the logic of the situation.

 The EU rejected this proposal. Understandably. How might the EU enforce it if Greece, at the last minute, refuses to hand over the controls to their gubmnt?

 

Supply Management, Risk, and Exploiting Consumers

A few weeks ago, I posted a link on Facebook to an article criticizing supply management schemes in the agriculture industry in Canada. Supply management raises prices to consumers by restricting the supply of farm products such as milk, eggs, and chickens. It does this by limiting the amount of quota (licenses to produce given amounts). And when supply is restricted, prices are driven up by the forces of supply and demand. The article focused on the role of marketing boards (who enforce supply management) in restricting the choices of consumers, limiting our ability to buy farm-fresh, less-"manufactured" produce. But it also nicely summarized the criticisms from most economists concerning supply management:

The Canadian food cartel goes by its own special name: “supply management.” Critics have charged that supply management makes food disproportionately expensive (especially for the poor), cripples our agricultural sector and is holding us back from entering lucrative trade deals with Asia.

In response to this article, a former student wrote,

Yes, quota is expensive - but what it does do is allow organizations (like farm credit canada) to lend out money to farmers because of a 'guaranteed' price. 

and in a later comment he wrote,

[B]esides farm credit canada - I am not sure that any financial institution uses quota as collateral. In fact - sure about that.

These two comments about supply management require some careful consideration. 

His first comment suggests that there is some over-riding social justification for providing a non-market mechanism to reduce price variability and risk for farmers. I don't see it. Farmers (especially now, but perhaps less so 50 years ago) are in touch with markets all over the world and can readily deal in commodity futures to hedge their risks. Providing high, stable prices is not the only way to reduce the risks that farmers face.

Essentially, the student is arguing that consumers should be forced by marketing boards to pay higher prices as a way of buying insurance for farmers to protect the farmers from price variability. This argument never held much sway for me even before farmers could trade futures on the internet. If farmers (or any businesses, for that matter) are concerned about price variability, they can save more during the good years to see them through the lean years. If doing so is costly to the farmers then, to be blunt, perhaps some farmers (likely the least capable ones) would exit the industry, and prices will rise (or stop falling as much) enough to cover all the costs and risks of all those remaining in the industry. 

Both the market solution and the marketing board solution for dealing with risk lead to higher prices. However, the market solution lets the market determine what risks should be compensated and by how much. Furthermore, it is abundantly clear that marketing boards set supply restrictions that are too tight and force prices higher than they would otherwise be. The evidence: farmers are willing to pay millions of dollars for quota. The only reason they do so is that they expect returns that are sufficiently high to cover the opportunity costs of buying the quota. And they only reason they can expect such high returns is that they receive higher revenues from higher prices.

The student raises an interesting question in his second comment. If quota reduce risk, why won't financial institutions allow farmers to declare that quota are assets that can be pledged as collateral for loans? One possibility is that there is high political risk attached to the quota --- at any time a more libertarian gubmnt could be elected that would abolish supply management schemes. I doubt this argument should carry much weight. More likely, the quota cannot be pledged as collateral because of some legal fiction that they still belong to the gubmnt (as is the case with taxi licenses in some jurisdictions) even though they can effectively be bought and sold.

As a result, we have double gubmnt intervention in the markets for commodities: (1) marketing boards restrict supply and force up prices. But then farmers are unable to use the quota as collateral, and hence (2) we have the farm credit intervention as well. 

What a mess! And because the quota have value, untangling the mess to move toward more nearly market-oriented solutions will be politically difficult, if even possible.

---

Before readers get the wrong idea, I am quite sure there are many marketing boards like the various vegetable marketing boards in Ontario that do far less harm because they do not have the authority/ability to practice supply management. These boards do pretty much the same things that are done by trade association-type groups in many jurisdictions in the US. My only question about these groups in Ontario is why the gubmnt provides them if private trade co-operatives can accomplish the same things.

High School "Economics"? A tragedy in so many cases

A Facebook friend who is in high school wrote, 

Was just exposed to the most patronising, liberally biased video in class, which is being taught as fact. How is this allowed?

It was a 45 minute video about how we should feel bad for having more than third world countries and should therefore stop buying and producing things for ourselves until others have the same stuff as we do. I wasn't allowed to suggest alternatives. I was also told I was out of line for suggesting that perhaps this wasn't the best source we could have used.

To every student who faces this situation, and to every teacher who wants to consider alternatives, I have two recommendations.

First, read the famous Krugman piece about third-world labour, In Praise of Cheap Labour. It is a classic, very readable piece that points out how much better off workers are in the third world because we buy stuff that they manufacture.

Second, look for some Free to Choose videos by Milton Friedman. These are some of the best analyses, again at an accessible level, of policy formation that does and does not help poor people. 

 

More on Gun Control

My gut instinct is to oppose guns and to favour gun control legislation. But gut instincts can be wrong.

Ever since John Lott and others started examining the relationship between gun control legislation and crime, I've had to put my instincts in check. The evidence seems pretty strong that jurisdictions that allow people to carry guns have less crime. As one street person once said, "Are you really gonna mug someone if you think they might pull out a gun instead of their wallet?"

Here is just the latest tidbit of evidence used by John Lott to support his position. Excerpts:

Murder and violent crime rates were supposed to soar after the Supreme Court struck down gun control laws in Chicago and Washington, D.C.
 ...

But Armageddon never happened. Newly released data for Chicago shows that, as in Washington, murder and gun crime rates didn't rise after the bans were eliminated -- they plummeted. They have fallen much more than the national crime rate.
...

In the first six months of this year, there were 14% fewer murders in Chicago compared to the first six months of last year – back when owning handguns was illegal. It was the largest drop in Chicago’s murder rate since the handgun ban went into effect in 1982. 

Meanwhile, the other four most populous cities saw a total drop at the same time of only 6 percent. 

Similarly, in the year after the 2008 "Heller" decision, the murder rate fell two-and-a-half times faster in Washington than in the rest of the country. 

It also fell more than three as fast as in other cities that are close to Washington's size. And murders in Washington have continued to fall. 

I would rather not believe the evidence that keeps piling up, but it is too overwhelming to ignore.

Some years ago, when I was president of the Canadian Law and Economics Associaton, I tried to persuade people to invite John Lott to be a keynote speaker. People objected that he was too controversial. 

 

Some Important Facts about US Taxes

From John Lott, who points out what ought to be obvious about (1) double taxation and (2) which income groups pay what share of taxes:

[L]et's take a simple example. Suppose Warren Buffet invests his money in a company and that company earns $1. The company pays 40 cents in income taxes. If the remaining 60 cents is paid as a dividend, the 15 percent dividend tax rate leaves the stockholder with 51 cents, for a combined effective tax rate of 49 percent. The analysis is the same if the company keeps the money, raising the value of the company stock, and creating a capital gain. The rate would be higher if there is a state income tax.

 Mr. Buffett's secretary in Nebraska simply doesn't pay a 49 percent marginal income tax rate. When President Obama addressed Congress on September 8, he claimed that his proposals didn't amount to "class warfare." Of course, the president then went on to claim that the wealthy aren't paying their "fair share" of the taxes. 

But the wealthy are already bearing a much larger share of taxes than their share of income. For example, the top 1% of Americans in terms of earning might account for 20% of total income, but they already pay 38% of income taxes. By contrast, the bottom 75 percent of workers make 33 percent of total income and pay only 13.7 percent of income taxes. 

Is It Possible to be a Quasi-Libertarian?

I tend to think of myself as a libertarian or at least as having strong libertarian tendencies. What this means, I think, is that I recognize the gubmnt has important roles such as law enforcement, provision for contract enforcement and the common law, and (dare I say this) the provision of some sort of social safety net. But the problem with this last gubmnt activity is that it creates distorted incentives and opens the door for lobbying for increased gubmnt actions to raise the height of the social safety net. This is a problem, potentially, because the higher the social safety net, the lower are the incentives for people to prepare for and plan for different contingencies in their own lives.

Unlike many libertarians, I am willing to tolerate this problem to some extent. I am willing to use the force and power of gubmnt to require that we all become "our brothers' keepers" to some extent. But not much, especially when individuals choose to take risks of serious personal loss that they ought to know about and ought to prepare for (yes, this is a normative statement).

I was prompted to write this by a recent Bryan Caplan posting at EconLog, where he writes,

[C]ritics of libertarianism will never run out of empirically plausible "hard cases."  When faced with these hard cases, the best response we'll ever have is, "Charity can probably provide for the deserving poor.  Everyone else should live with the consequences of their actions - and stop blaming total strangers for failing to help them."

This conclusion of his posting captures my views pretty well. At the same time, I have little objection when the gubmnt provides some basic family welfare (e.g., beans have high protein content and will keep people from starving). 

Having said this, though, I'm not at all in favour of using gubmnt to force us all to help out all people who suffer calamatous losses. For example, consider those who lose their homes to hurricanes, floods, etc. These are clearly insurable risks, and it is beyond me that people choose to live in high risk areas without having adequate insurance. If the answer is that the insurance premia are "too high" (whatever that means), then I still see their choice to live there as a voluntary decision; they could have lived elsewhere.

In these instances, I support the role of (and indeed have contributed to) private charity to help people through the transition after natural disasters, and I have offered assistance to people who have maxed out their deductibles and co-pays for various unexpected calamities. And that is an important part of my quasi-libertarianism: private charity must step up, especially to the extent that gubmnt doesn't always do a very good job.

Planning, the Profit Motive, and Disaster Relief

We learned from hurricanes Andrew, Katrina, Ike, et al., that the most effective planners for hurricane relief were those responding to the profit motive --- firms like Walmart and Home Depot for example. Based on their data analysis, they planned in advance to have supplies on hand before the hurricanes struck, to make sure they could reopen quickly after the hurricanes, and to have supplies on hand quickly after the storms passed.

We're seeing it again as Irene approaches the US East Coast. From NPR, no less [h/t Cafe Hayek]:

Forecasters don't expect Hurricane Irene to make landfall until Saturday. But for nearly a week now, big-box retailers like Walmart and Home Depot have been getting ready.

They've deployed hundreds of trucks carrying everything from plywood to Pop-Tarts to stores in the storm's path. It's all possible because these retailers have turned hurricane preparation into a science — one that government emergency agencies have begun to embrace.

At Home Depot's Hurricane Command Center in Atlanta, for example, about 100 associates have been trying to anticipate how Irene will affect its East Coast stores from the Carolinas to New York.

At times like this, the Command Center looks much like NASA Mission Control during a shuttle launch, says Russ Householder, the company's emergency-response captain....

[D]istrict managers have been focusing on stocking a short list of items, Householder says, including generators, chain saws, water and tarps.

Householder says those supplies are flowing to stores because of a process that began months ago, at the beginning of hurricane season.

"We take storm product, both pre- and post-strike product, we stage those in containers and we have them in our distribution centers, really ready for a driver to pull up and pick up and take them to our stores," he says.

Don Boudreaux at Cafe Hayek adds, 

... when you and your neighbors are homeless, hungry, and thirsty following a natural disaster, would you prefer to rely upon the devotion to public service that allegedly motivates FEMA workers, or to rely upon the devotion to their own self-interests that undoubtedly motivates executives, workers, and suppliers of private companies such as Wal-Mart and Home Depot?

After watching the comparative successes of market forces vs. bureaucrats, despite the imperfections of the market, I'd rather trust it.

People Respond to Incentives: Divorce and Real Estate Speculation in China

Whenever people are rewarded for being single, there is an incentive for at least some of them to remain single or even fake divorces. The latest evidence comes from China, where couples fake a divorce so that each of them can legally buy more homes, in hopes of cashing in on China's real estate bubble that is being fueled, in part, by the growing wealth in China [h/t Jack].

[G]overnment initiatives to curb a housing bubble are behind the trend. China has raised the down payment for second mortgages, and about 40 Chinese cities have begun to limit apartment purchases to two per family, or one for non-locals. The government has also asked commercial banks to stop offering loans to third-home buyers.

To get around the restrictions, Chinese couples are flocking to so-called fake-certificate companies, which sell phony divorce papers for 300 yuan, or about $45. Getting “divorced” allows couples to register properties under separate names.

Of course the total transaction costs are higher than just $45 [US]. There are also the emotional costs of even faking a divorce. These can arise from the fakery of it all and/or from the uncertainty it might create about the longevity of the marriage. And I'm sure there are others, too.

But the point is: when incentives are provided, people respond to those incentives. An equally important point is that human ingenuity finds creative ways around gubmnt regulations, something we must keep in mind when trying to interfere with market forces.

 

President Obama's Change of Heart Regarding the Debt Limit

As regular readers of EclectEcon would guess, I think gubmnt size is an important issue, and I think that in both Canada and the US, gubmnts are too big. I was pleased with the shrinking of gubmnt that occurred under US President Bill Clinton, and I was distressed with the increased gubmnt size that occurred under George Bush, especially during the last year of his second term. 

For US President Obama's change of heart, check out the quotes in Snopes: 

[in 2006, as a senator]: The fact that we are here today to debate raising America's debt limit is a sign of leadership failure. It is a sign that the US Government can not pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government's reckless fiscal policies. Increasing America's debt weakens us domestically and internationally. Leadership means that "the buck stops here." Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better.

In contrast with 

[in 2011, as President]: I think that it's important to understand the vantage point of a senator versus the vantage point of a president. When you're a senator, traditionally what's happened is, this is always a lousy vote. Nobody likes to be tagged as having increased the debt limit — for the United States by a trillion dollars. As president, you start realizing, you know what, we, we can't play around with this stuff. This is the full faith and credit of the United States. And so that was just an example of a new senator making what is a political vote as opposed to doing what was important for the country. And I'm the first one to acknowledge it.

The President's epiphany leaves me unimpressed. His initial attacks on raising the debt ceiling were clearly motivated by his political opposition to George Bush. But both clips seem superficial. And I am not at all impressed with his attempts to gloss over the important issues of 

• regime uncertainty and the recession. So long as businesses and consumers are concerned about what the gubmnt might do next, they are less likely to invest for the longer run.
• the size of gubmnt. We have long passed the point at which the more economic activity is controlled by politicians and bureaucrats, the less efficient will the economy be and the lower will be our economic growth rates.

 

The Spiraling Euro

When the Euro was created, I was one of the skeptics who wondered how long it would survive. As the Euro flourished and gained strength on international markets, I figured there must be something about it that I just didn't understand.

And now I think maybe I understood it pretty well in general but didn't (and still don't) understand the time lags and dimensions.

My early concern was the same as my ongoing concern about the Euro: How can a central monetary union survive if the members of the union cannot discipline or force fiscal responsibility upon its more profligate members? 

Der Spiegel has an excellent 5-part series about the Euro crisis [h/t MA] that seems pretty comprehensive. Some highlights:

The monetary union is a fair-weather construct, as a number of economists said from the beginning. American economist Milton Friedman, for example, predicted that the euro would not survive its first major crisis, and later, in 2002, he added: "Euroland will collapse in five to 15 years."

The reason for the skepticism by Friedman and others was that the monetary union has little or no way to force countries to adopt fiscally responsible policies. Countries like Greece (though I confess I expected Italy to be the most flagrant borrower) can run up massive debts and play "chicken" with the rest of the members of the union. At that point, the solid members must decide what will hurt worse, bailing out Greece (and others to follow) or watching the disruptions emerge as Greece (and others?) default and/or withdraw from the currency union.

 In the end, a country with a large deficit has three options. First, it can declare itself insolvent and, after restructuring its debt, attempt to rebuild its economy. Second, it can also withdraw from the monetary union and reintroduce its national currency. Third, it can convince the creditor countries to keep issuing new loans, thereby providing it with permanent financing.

For more than a year now, European governments have been trying out a fourth option: muddling through.

And I fear that "muddling through" will do little more than make the agony worse in the future.

I might be wrong. Politicians in Greece, Spain, and Portugal might eventually be able to use enough force to implement the requisite austerity programmes. Voters in those countries might eventually come to recognize that their politicians and financial managers had (mis)led them down a path that was unsustainable. 

For the sake of the people holding Greek bonds, I hope these "muddling through" scenarios can work. But meanwhile, I have little interest in holding the debt or equity of financial institutions heavily invested in Greek, Spanish, or Portuguese gubmnt bonds.

In the case of Greece, it looks as if many financial institutions are bailing out.... themselves:

German banks and insurance companies have systematically reduced their holdings of Greek government bonds. Since the beginning of 2010, they have reduced their total exposure from €34.8 billion to €17.3 billion, not including debt held by the state-owned development bank KfW. Insurance companies have reduced their investment in Greek bonds from €5.8 billion to only €2.8 billion in the last year.

This seems like a sensible strategy. What surprises me, though, is that many financial institutions have not unloaded all their potentially bad debt. I suspect there are two (and probably many more) types of explanations for holding onto the Greek and other debt:

• The firms that continue to hold Greek debt expect the taxpayers of other countries to bail out Greece....again. They are betting that Greece will be deemed "too large to fail" in the eyes and wallets of many European politicians and bankers.
• The firms that continue to hold Greek debt are under immense political pressure to sacrifice potential soundness of their investments for the sake of possibly holding the Euro together.

Part 5 of the article sets out some possible outcomes:

[W]hat happens if a country can no longer meet its payment obligations or if a member leaves the monetary union? And how can imbalances in a common currency zone be averted?

There are essentially two alternatives. The first is a radical one, in which the governments pull the plug and leave the beleaguered countries to fend for themselves. The second, more pragmatic solution is to continue muddling along, though somewhat more efficiently, and to hope that things improve. Neither option will be cheap.

 

 

Ann Coulter on Mob Riots versus Political Movements

From a Townhall article, quoting Ann Coulter,

The high-water mark of mob behavior, she believes, was the French Revolution. "The American Revolution was a revolution of ideas," she explains. "The idea of a constitutional, representative democracy, based on the consent of the governed, in the form of three competing branches, was revolutionary. The French Revolution -- which hardly deserves to be mentioned in the same breath as the American Revolution! -- was a protracted mob action, which mostly consisted of some French people mindlessly beheading other French people. The French Revolution was not inspired by some groundbreaking political manifesto like the Declaration of Independence. It was more like a street riot that got out of control and went on for years because they let it.

This distinction is probably important for understanding the Arab Spring. On the one hand, the revolution of ideas might help many protestors win support from the West; on the other hand, much of the protest action seems more like mob rule, an attempt by a different gang to wrest control from the encumbent gang. I would like to think the US State Department is at least considering this distinction.

Lotteries are a Tax on the Innumerate

from here via Bart:

Pedantic note: the word "only" is often placed too early in a sentence, as in this cartoon. It belongs in front of the word "because".

Is the US Economy Just on a "Sugar Rush"?

I've been concerned for some time about the huge US gubmnt deficits and the huge monetization of their debt that the Fed is carrying out via "quantitative easing" [a euphemism for having the Fed buy up gubmnt debt]. Here, via reader MA is someone else who shares these concerns.

The trouble with this latest US recovery is that it amounts to little more than an economic “sugar-rush”. The recent growth-burst is built on monetary and fiscal policies which are wildly expansionary, wholly unsustainable and will surely soon come to an end. When the sugar-rush is over, and it won’t be long, the US will end up with a serious economic headache. Investors should keep that in mind.

.... It is undeniable ... that the latest wave of euphoria to have spread across corporate America, and into the echo chamber that is Wall Street, is ultimately based on quantitative easing and a series of unaffordable tax cuts.

It seems likely the Fed will fully implement QE2 – the latest $600bn bout of money-printing - following the $1,700bn programme already completed. This is in spite of protests from countries as diverse as Thailand, Australia, South Africa and China, all of them complaining that America’s unprecedented monetary expansion is causing dangerous bubbles in markets going way beyond US equities.

... Global investors are increasingly wondering what happens when the money printing stops and those debt service costs rise. More and more interest is being shown in the fact that America’s total sovereign liabilities, including off-balance sheet items such as Medicare and Medicaid, amount to $75,000bn – no less than five times’ annual GDP.

Very disconcerting stuff!

 

Energy Policy Conference: a worthwhile afternoon session

After things got off to such a questionable beginning, I was quite pleased as the day wore on.

First, the Saskatchewan Minister of Energy said (as a minor part of an otherwise forgetable speech) that people in the West might accept the proposition that carbon taxes are a good idea, but one thing they will not tolerate is having the Canadian federal gubmnt impose carbon taxes on the western provinces and then redistribute the funds to the eastern provinces [shades of the old National Energy Programme, as I said earlier]. I don't know how the provinces will stop the feds, but I can see constitutional challenges on the horizon....

The primary afternoon session that I attended included Jeremy de Beers [law, University of Ottawa] who knows a LOT about biofuel production and trade. He and I had a great talk after his session, during which he said that if gubmnts would set a carbon tax then all the other rent-seeking nonsense would be unnecessary [my words, not his]. Another of the panelists in the session was Stever Dorey from Charles River Associates (based in Trono). He was very astute in his discussion of energy policy and noted that regulations create incentives for mischief-makers to create more mischief [a reference to rent-seeking in the guise of being in the public interest]. 

As I say in the title of this posting, it was a worthwhile session, seeing that there were presenters here who recognize the importance of prices, incentives, public choice mechanisms, and the private sector. 

But the concluding session was a bit of a bust, again, with general, vague statements that seemed more like something from  "planners" than should be taken seriously.

Energy Policy Conference: An Unholy Alliance?

As I listen to the speakers and look through the programme for today's conference (available here), I see that every person on the programme is paid by taxpayers, directly or indirectly. There are professors of policy, representatives of consulting firms with gubmnt contracts, bureaucrats, and politicians. It would be a much better-balanced programme if there were representatives from, say, C.D. Howe or The Fraser Institute, here as well. As it is everyone who has spoken is really into planning, which, of course, concerns me considerably. Examples:

• People talk about developing technologies rather than providing a fertile atmosphere for the private sector to do these things 
• People talk about energy sustainability but never mention the role of the price system.

Where is Hayek when we need him (and I simply cannot pinch hit for him given my own inabilities). Someone needs to quote Hayek on the importance of markets to provide incentives and especially information.

Update: Hayek said it so well in 1945. Please, please read this.

Opening Session: We Don't Need No Steenking Energy Policy

The opening panel is introduced with the question "Where is Energy Policy?" I simply cannot fathom what that means, so we're off to a good start! And of course problems like gasoline line-ups (in the US! not Canada!) etc. are used as examples that we don't have an energy policy, when in fact they are the result of energy policy. The word "crisis" has already emerged. 

Damn. Too bad I didn't think to set up an "Energy Policy Cliche" Bingo game.

The next cliche: Let's get people talking about these crucial issues. 

Why does it matter that Saskatchewan is an energy exporter? My guess is that it matters to people in Ontario who think they have some sort of claim to Saskatchewan's energy.... shades of Canada's National Energy Programme in the 1970s.

Surprise, surprise: the provincial deputy minister of energy says it energy policy should be a provincial policy. 

"Energy policy is too important to be left to economic ideology..." Says a CEO of a firm that depends on gubmnt contracts. Surprise!

 I can't keep blogging this on such a detailed basis. More later.

We Don't Need No Steenking Energy Policy

I'm attending an all-day conference called "Taking Charge: Towards an Integratred Energy Policy for Saskatchewan." My priors are that "energy policy" means several things:

• Politicians and bureaucrats make investments with taxpayer funds, thus trying to pick winners. They aren't risking their own money (albeit they are to some extent risking their reputations), and so they have a tendency to take on other issues as well
• Energy policy too frequently devolves into "crony capitalism". Individuals and firms, with specific agendas or specific products and services to sell, use an abundance of scarce resources to try to convince bureaucrats to "invest" in their products. One glaring example: bio-fuels, nominally justified by the argument that they reduce carbon dioxide output when, in fact, they increase carbon dioxide output AND they amount to little more than a convoluted way to increase the demand for the output from farmers (much to the distress of poor people around the world facing rising food prices).
• I'm in awe of the hubris and arrogance when "planners" think they can plan better than private investors in the marketplace. E.g., in the opening remarks, we're told that energy is the most important policy issue facing us today. Hmph.

My observations and comments will follow as the day progresses.

 

The 2011 Gubmnt of Saskatchewan Budget: some good, some not-so-good

I spent the noon-hour today at a luncheon where the Minister of Finance for the Province of Saskatchewan talked about the budget which was tabled in the provincial legislature yesterday. Here are some of my reactions to his talk and to the budget:

The Good:

• No rent control. As Saskatchewan grows and as more people move here, the demand for housing has increased dramatically, driving up rents in many places. These higher rents have affected tenants who would like to be better off. But the evidence everywhere is that rent controls actually lead to a reduction in the amount of housing available and lead to increased discrimination in housing markets. A better way to alleviate what are perceived as housing problems is to reduce the restrictions and red tape for new development; doing so would allow markets to adjust more rapidly and more smoothly to increases in demand.
• No minimum wage increase. I really doubt if it matters much in this growing economy, where there seems to be a shortage of workers at the minimum wage, but to the extent that is the case, the growing demand in the marketplace will take care of raising the wages for York Sociology Graduates unskilled labour. To the extent that it isn't the case, raising the minimum wage would inevitably mean some of those workers will not be hired.
• Tax reduction. I would prefer reductions of the marginal tax rate on incomes to the hodge-podge of exemptions and deductions that appear to be responses to the typical rent-seekers. Also, it looks as if the tax reductions are being funded primarily by expectations of increased royalties on potash (and other resources) instead of reducing the size of gubmnt; relying on royalties from high commodity prices can be risky.
• Paying down the debt (and putting more into a long-term fund). Paying down the debt reduces the annual interest costs to taxpayers. It also (and this is a big plus in my mind) means those funds are not being used to increase the size of the bureaucracy: the more the debt is paid down, the less likely it is those funds will be used to increase gubmnt intrusion into people's lives. Also putting more funding into a long-term fund should serve as a means of smoothing gubmnt budgets: when royalties from natural resources are high, more is put into the fund, and when royalties are low, money can be used from the fund to smooth gubmnt spending.
• Increasing enrolments in medical schools. An important way to deal with shortages in the provision of health care, given that we don't require co-pays to reduce the demand, is to increase the supply. For the sake of Saskatchewan taxpayers, I gather there are incentive provisions (e.g. percentage loan waivers or tuition rebates) to keep some of the graduates in Saskatchewan. But as one who ordinarily lives in Ontario, I wish every province would encourage its medical schools to increase enrolments.

The not-so-good:

• Keeping university tuition low. I think gubmnts should encourage universities to price discriminate, i.e. charge higher tuitions fees but also have generous aid (not just loan) programmes as a way of implicitly charging lower fees to students who might otherwise not attend university.
• Bio-diesel fuels. Good grief. These are the types of programmes that (a) do NOT reduce carbon emissions; in fact they increase them, (b) are driving up food prices around the world, and (c) are thinly disguised additional hand-outs to farmers. As it is, the budget includes numerous other hand-outs to farmers (e.g. property tax reductions); they could do without this one which has such horrible side effects.
• Payments to municipalities. I understand the political reality that there is a desire to force taxpayers in larger communities to send some money to the smaller communities. But there is no excuse for taxing the entire province and then giving some of that money to the larger cities (e.g. Regina, Saskatoon, Moose Jaw, etc.). A better approach would be to reduce provincial property taxes even more and let these larger municipalities raise more of their own funds, if they want to. That way they could each choose their own size of gubmnt, and fewer resources would be wasted as municipalities line up with the other rent-seekers to feed at the provincial trough.

All-in-all, the budget was a decent one, given the political realities. But at some point voters need to take longer-run perspectives on the size of gubmnt, and it would be nice if gubmnt itself would play a role in this.

"Inside Job" Ignores Gubmnt Culpability in the Financial Crisis

Paul Sperry in The Great American Bank Robbery implicitly points out that the film, "Inside Job" does a job on Wall Street without mentioning the culpability of gubmnt bureaucrats and regulators in the financial crisis of 2006-9 [disclaimer: I requested and received a review copy of the book from the publisher]. He makes this argument explicitly elsewhere.

Some of his key points about the film:

WHAT'S WRONG is how his film never mentions the real culprits in the crisis, which were the political zealots at HUD who slapped the affordable housing mandates on Fannie and Freddie, and how those same culprits have returned to the scene of their crime and are making the same reckless housing policies under Obama.

WHAT'S WRONG is how this filmmaker, Charles Ferguson, personally gave hundreds of thousands of dollars to Obama and Dems and even met with Obama while pretending he DOESN’T have a political agenda. 

Democratic Rep. Barney Frank, the House banking panel chief, is lionized in the film as the conscience of regulators, when in fact he was one of the architects of the financial disaster. He insisted there was nothing wrong with Fannie Mae and Freddie Mac and opposed tougher oversight.

The film claims minority borrowers were "put into" subprime loans by "predatory lenders" such as Countrywide Financial. Yet it was HUD that put Countrywide into the subprime business.

After the Clinton HUD threatened to investigate Countrywide for lending discrimination, the mortgage lender signed a government contract agreeing to relax its lending standards and increase the number of minority loans. Countrywide soon became the biggest subprime lender. If Ferguson had done his research, he would have found that HUD was the biggest predatory lender of all.

The banks were indeed culpable for having executed a very successful (and, for the most part, legal) end run around the capital requirements of Basel I and Basel II. But the regulators and politicians were at least as culpable for all the things they did, too. In that regard, I highly recommend reading Arnold Kling's "Not What They Had in Mind," which is required reading in my course on the financial crisis .

.

The Long-Term Budget in the US: scary!

The OMB (office of the management of the budget) in the US has released budget projections for the next decade. What with social security, medicare/caid, and a host of other entitlements, the picture is not pretty [from Cato, h/t JAB]:

Importantly, this picture does not show the deficit or the debt. Rather, it shows the increasing size of gubmnt per se. The projection is that after a brief slight decline, the federal gubmnt is going to continue to use an increasing amount of the country's scarce resources. 

This is disheartening to those of us who contend that bureacrats and politicians are notoriously poor at allocating scarce resources. Look for even more wasteful rent-seeking (and lobbying). Look for even more wasteful queuing. I.e., the above graph doesn't even begin to show the true costs of increasing the size of gubmnt. 

Gubmnt failure, not market failure, is likely to have a more dampening impact on economic growth in the future.

 

Commodity Prices: the long and the short of it

I attended a luncheon address today by John Murray, one of the Deputy Governors of the Bank of Canada. His talk was about commodity prices.

It was a straight-forward presentation of important facts, carefully hedged in many ways. And yet he seemed to address important issues, especially for the Saskatchewan and Canadian economies.

• An important item in his presentation was that after correcting for the rate of inflation, real commodity prices haven't risen much, if at all, in the long run. Unfortunately many of the data series he used to make this point ended over a year ago, and the recent run-up of commodities prices was excluded from consideration.
• He made the well-known but still very important point that growth in the emerging-market economies is having a big impact on the increasing demand for commodities. This growth in demand is likely to continue to put upward pressure on commodities prices (a projection which marks a deviation from the past as outlined in the previous point and which merited no comment from him).
• While Murray wouldn't go out on the limb and tell people that the wild swings in commodities prices are not due to speculators' actions, he did emphasize that in general speculation plays an important role in dampening price swings. He also noted that during the recent run-ups of commodities prices, inventories have dwindled, indicating that these price increases are the results of real economic forces. If they had been the result of speculative action, we should have seen inventory increases, not decreases!

His policy recommendations included increasing the transparency in financial markets. Notably, he also spoke strongly in favour of structure reforms that would increase the flexibility and the ability to adjust and adapt throughout the economy. He specifically mentioned reducing the importance of price controls and subsidies where they exist.

Overall, his points were solid.

Addendum: I'd like to thank Ken Rasmussen for making it possible for me to attend the event at no charge. Ken is the Director of the Johnson/Shoyama Graduate School of Public Policy in Regina, which was a co-sponsor of the event.

Moral Hazard, Manitoba Style

Most people seem to be expecting floods along the Red River and the Assiniboine River in Manitoba this spring as the meltwater in the northern midwestern US states and in Manitoba from the winter's heavy snows leads to huge run-offs [h/t Ms. Eclectic]. The floods sound as if they might be tragic and might cause considerable loss, and so the Manitoba gubmnt is already making preparations for flood control and flood relief.

What really astounded me about the story cited above, though, is that people continue to live and farm in these areas AND expect the Manitoba gubmnt to help bail them out both figuratively and literally.

One of the people fearing what's to come in the spring is Mary Elizabeth McKenzie, who for nine years has lived with her husband on a farm south of Winnipeg.

It seems they are always either preparing for a flood or cleaning up after one, she told CBC News.

"I've lost the ability to live my life the way I choose it," McKenzie said.

She said she's lived through 11 floods and in five of them has had to evacuate a number of animals from the farm.

She has lived through 11 floods in nine years?? And she still chooses to live there?

What if the people living along the river flats absolutely knew the gubmnt would not bail them out? What might they choose to do differently?

• Some would search for private flood insurance. But surely private flood insurance would have very high premiums for homes and farms that were constantly in jeopardy. In addition, the insurers would be reluctant to provide coverage for certain types of especially high possible losses [chicken farms come to mind as a possible example because of the high costs of trying to evacuate all the chickens].
• Others, not wanting to pay the high premiums for private flood insurance, would move elsewhere to live or farm.
• Still others would form local co-operatives to build levies or dykes along long stretches of the rivers in flood-prone areas.
• And some would refocus their farming to emphasize activities that are less likely to be harmed by intermittent semi-regular flooding. 

But with the provincial gubmnt providing flood control, flood relief and loss compensation, many people like the one quoted above end up choosing to take on more costly risk than they otherwise would. Provincial taxpayers bail them out and pick up some of the costs of the risk; but these same people get to keep the gains from taking the risks if the floods do not materialize or are not so serious. Not only do they not bear all the costs of their decisions, but they take on more risk than they would if they did have to bear those costs.

Unless I'm missing something, this reads like a classic example of moral hazard:

Moral hazard occurs when a party insulated from risk behaves differently than it would behave if it were fully exposed to the risk.

Moral hazard arises because an individual or institution does not take the full consequences and responsibilities of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to hold some responsibility for the consequences of those actions. For example, a person with insurance against automobile theft may be less cautious about locking his or her car, because the negative consequences of vehicle theft are (partially) the responsibility of the insurance company.

 

Ban the Penny: The Momentum Continues

20 years ago, EclectEcon advocated getting rid of the penny. Several years ago, Greg Mankiw joined the club. And now Russ Roberts has joined, too. 

As several people have pointed out, and as my previous posting on the topic showed, businesses have long been on board with "penny cups" next to the cash registers, and some are beginning to post signs that theirs is a "penny-free environment". 

My expectation is that soon pennies will disappear. But it would likely be efficient for gubmnts to hasten their demise. 

For more from my testimony before a Senate committee on eliminating the penny, see this.

PM Harper on Anti-Semitism and Israel

An excellent summary of Canada's position. Here are some excerpts:

In Canada, we have taken a number of steps to assess and combat anti-Semitism in our own country. But of course we must also combat anti-Semitism beyond our borders, - an evolving, global phenomenon. And we must recognize, that while its substance is as crude as ever, its method is now more sophisticated.

Harnessing disparate anti-Semitic, anti-American and anti-Western ideologies, it targets the Jewish people by targeting the Jewish homeland, Israel, as the source of injustice and conflict in the world, and uses, perversely, the language of human rights to do so.

We must be relentless in exposing this new anti-Semitism for what it is. Of course, like any country, Israel may be subjected to fair criticism. And like any free country, Israel subjects itself to such criticism – healthy, necessary, democratic debate. But when Israel, the only country in the world whose very existence is under attack – Is consistently and conspicuously singled out for condemnation, I believe we are morally obligated to take a stand. Demonization, double standards, delegitimization, the 3 D’s, it is a responsibility, to stand up to them.

Electric Car Sinkholes

Despite pronouncements by politicians in both Canada and the US to the contrary, J.D.Powers has recently announced that even with the various gubmnt subsidies, electric cars are going to be priced waaayyyy out of line with the prices of other cars for the next decade or so. See this and see Mark Collins' Canadian take on it, too. It sounds as if the electric car is yet another example of gubmnt failure overwhelming any hint of market failure. 

Maybe it was karma, but the Volt’s launch coincided with publication of a 72-page report by J.D. Power and Associates that confirmed, in devastating detail, what many other experts have found: Electric cars still cost too much, even with substantial federal subsidies for both manufacturers and consumers, to attract more than a handful of wealthy buyers – and this will be true for at least another decade.

What little gasoline savings the vehicles achieve could be had through cheaper alternative means. And electrics don’t reliably reduce greenhouse gas emissions, since, as often as not, the electricity to charge their batteries will come from coal-fired plants.

The Obama Energy Department has suggested that, with the help of federal money, manufacturers can ramp up mass production and bring the price of electric-car battery packs down 70 percent by 2014 – thus rendering the cars more affordable.

If it will eventually be profitable for firms to increase production, and if there is a reasonable chance that the prices of battery packs will drop by 70%, they why on earth is the gubmnt involved? Why isn't private capital being invested in the production of electric cars? If you think the answer is that doing so is too risky for the private sector, then it is also too risky for taxpayer investment, too. Gubmnt intervention in this market will distort capital markets even more, attracting scarce capital away from other, more efficient uses.

What is worse, the intervention of the gubmnt in a portion of the market means that others will be very reluctant to enter this sector the auto industry. Who knows how much subsidy will be available for different producers, and who knows whether or how much favouritism will be shown toward GM with gubmnt programmes? 

 

Yea, Sparky!!

It looks as if my friend, King Banaian (aka "Sparky") has won a very narrow victory to become a member of the state legislature in Minnesota. King has strong libertarian tendencies (small gubmnt). He is the former chair of the economics department at Minnesota State University, St. Cloud. This was the right year for an advocate of small gubmnt to be running, but it is still a hard battle when trying to convince the electorate that, no, the gubmnt is not there to provide goodies for voters. But King has both the intelligence and the charm to pull it off. The state of Minnesota is very fortunate.

King and I share a number of other interests, including baseball (we were both active in rec.sport.baseball back in the old days of newsgroups on the internet). And several years ago, we had a great several days together in Chicago, exploring several different pizzerias. Wrap-up and links here. 

Update: Oops. The link above provides my wrap-up but the individual reviews all were posted Jan 5-8, 2007.

The Most Important Ballot Initiative Facing Washington Voters Today

via Ted Frank (please click on the image to enlarge it):



The full text is here.

Predatory Pricing on an International Level

I always tell my students who think that dumping and international predatory pricing are bad, from a consumer perspective "Hurt me some more!" Bring on the lower prices.

Tim Worstall makes a similar point in his piece about rare earth production in China:

[T]he truth is that though most of the rare earths, both metals and oxides, do come from China, this isn't the same at all as having a monopoly that is sustainable -- as Beijing is about to find out in a fairly painful manner. Now that the specter of a monopoly being exercised for political ends has been raised, there will be sufficient political will to break that monopoly.

Two important facts about rare earths help explain why: They're not earths, and they're not rare. China has reached its dominant supplier position through good old-fashioned industrial aggression, not innate geographical superiority. Cheap labor, little environmental scrutiny, and a willingness to sell at low cost [sic] have made other producers give up. For competitors, like the owners of Mountain Pass, a California mine that shut down in 2002 partly due to the China factor, that has been a daunting combination. For the rest of us, it has been fantastic: Affordable rare earths have helped power the information-technology revolution, driving down the cost of everything from hybrid cars to smart bombs.

But the non-rarity of the rare earths themselves means that China's position isn't sustainable. That California mine, for instance, could potentially supply 20 percent of world demand, currently around 130,000 tons a year. Another facility, Lynas Corp.'s Mount Weld in Australia, has the capacity to produce a similar amount. In fact, there are enough rare earths in the millions of tons of sands we already process for titanium dioxide (used to make white paint) to fill the gap, while we throw away 30,000 tons a year or so in the wastes of the aluminum industry. There's that much or more in what we don't bother to collect from the mining of phosphates for fertilizers, and no one has even bothered to measure how much there is in the waste from burning coal.

If rare earths are so precious, why isn't the United States working harder to collect them? The main reason is that, for these last 25 years, China has been supplying all we could eat at prices we were more than happy to pay. If Beijing wants to raise its prices and start using supplies as geopolitical bargaining chips, so what? The rest of the world will simply roll up its sleeves and ramp up production, and the monopoly will be broken.

Worstall continues, pointing out that gearing up production outside China will not be quick or easy, but his point is a very good one. Let me add that if users of rare earth minerals are concerned about continued supplies from China, they (and speculators!) will have a very strong incentive to stockpile supplies.

And that is where Worstall possibly goes a bit astray from his usual common sense approach. He concludes his article with,

In the end, the question of whether China has been using its rare earths access to threaten Japan doesn't matter as much as the possibility that it might -- and the certainty we'd better do something about it.

Just who is this "we" he is saying had better do something? Is he talking about speculators who might stockpile supplies now in anticipation of making profits should China decide to use its current dominant position in rare-earth production for political purposes? Or is he saying that private entrepreneurs should be re-opening mines and refining processes outside China so they can profit from the possible reduction in supplies from China? If he means either of these two possibilities for "we" then I heartily agree.

I hope by "we", Tim doesn't mean gubmnt policy makers. There is no good reason for taxpayers outside China to support, or to trust their politicians to support, rare earth operations so long as China is willing to donate the products to the rest of the world.

And the risk?  If it is too costly for private entrepreneurs to bear the risk of gearing up production now, it is difficult to understand why or how politicians would be in a better position to assess and assume (on behalf of the taxpayers) the risk. 

In fact, the major risk of gubmnt involvement at this point is the uncertainty on the part of entrepreneurs about what gubmnts might do. If there is a risk that politicians might try to influence developments in the industry, there will be a strong incentive for entrepreneurs to wait on the sidelines and NOT undertake what would otherwise be profitable, speculative investments.

Stop Quibbling over Terror Profiling

"Stop Quibbling over Terror Profiling" is the title of one of the best columns ever written by my friend and colleague, Salim Mansur. It should be required reading for everyone, but especially for those who are concerned about the profiling of young Muslims in our defense against terrorists. 

Here are some pithy quotes, but be sure to read the whole thing. It does a great job without ever having to discuss probabilities, statistics, and inference:

The arrests last week in Ottawa and London, Ont., of four of eight suspects allegedly linked with the global Islamist movement reveal again how vulnerable Canada and other democracies are to Islamist “homegrown” terrorism. ...

These alleged terrorists are not emerging from the ranks of the desperate poor, hungry and homeless. They come mostly from the aspiring middle class background of immigrant families, and their education ironically makes them readily susceptible to the sort of identity politics that thrives on the cocktail of Third World resentments and grievances....

There will be more such cases, and the terrible thought is some of these homegrown terrorist plots may succeed as it happened with the July 2005 London, U.K., bombings, or get barely foiled as were the attempted attacks in July 2007 in Glasgow and London (those arrested in this episode of terrorism were all Muslim doctors), or the failed bombing in New York’s Time Square by Faisal Shahzad, a Pakistani-American.

There is ample evidence, if proof is still needed, that homegrown terrorists in the post-9/11 world are predominantly Muslim males primed by Islamist ideology. ...

[The] time to quibble over “profiling” is long past. This is not a matter of becoming “illiberal,” for liberalism, which I hold dearly — as I do my faith tradition as a Sunni Muslim — is not a suicide pact.

Our common security requires a clear understanding of where our threat emanates from, to focus on that threat with necessary resources, and to remove blinders of political correctness that only weakens our efforts in defeating Islamism.

And for all my friends, please note Mansur's distinction between Islam and Islamism.