A Plan for Economic Recovery

The cries for relief from the economic recession reached a state of pure, irrational cacophony with the recent request by the pornography industry for a government bailout. While many will likely reject the very idea of such a request out of hand, it fits in with the popular focus of how to pull us out of this significant downturn. “Saving jobs” is all anyone seems to care about. While it is annoying and painful to lose a job (I lost my own job in November partially as a result of the crisis), the job loss is the symptom, not the disease. Even the “credit crunch”, which caused so many closures in fringe firms and industries, is still an intermediary between the disease and the symptoms. While I will not get into the precise cause of what I have termed the “disease” here, which has a multitude of possible causes being widely discussed by professional and academic economists, I will go into how the new administration should deal with improving the economy in the medium to long-run over short-run “solutions” that will come back to bite us later.

1. Raise Interest Rates. It is well-documented empirically that it takes somewhere between eighteen and twenty-four months for a change in the money supply to fully work its way through the economy. Interest rats where they stand now are at an unstable level, whereby the Fed is effectively giving money away to banks. That form of subsidization distorts the economic realities banks face. To lower interest rates to the level they are at right now, the Fed continually needs to expand the money supply at ever expanding rates, which results in some of the highest annualized inflation rates in almost two decades (upwards of 6%) that we’ve seen in recent months.

Bernanke must return to the “inflation-targeting” philosophy he has promulgated in the past. While I don’t agree with Bernanke’s economics on any level, the spirit of such a philosophy applies to exactly these types of situations. While he may not be afraid of using the keys to the printing press, inflation above a “normal” level isn’t going to help anything in the medium run.

When he takes office, Obama must not look to the Fed as a revenue source. He cannot expect the excessive liquidity provided by the fed to continue and should support its elimination. Funding of greater government spending must come from taxation, not from the printing presses.

2. Eliminate Public Debt. There have been frequent complaints that the remaining solvent banks have not been willing to loan money as quickly as they have been in the past. The fallacy of such complaints is twofold: One, that the ease to which banks lent in years past was very likely one of the factors that got us here in the first place and what banks are doing right now makes sense, and Two, that the government can easily make a dent in the credit crunch simply by eliminating its debt. The “true” cost to the government borrowing lies in that, through the sale of treasury bills, it takes money (crowds out) from private bonds. The treasury bills, since they are riskless, effectively set the floor below which no private bond will ever be sold. If debt is eliminated and this floor drops, the option of raising money by floating a bond, which beforehand was unprofitable for a firm, may now make sense. Eliminating this debt is very simple and requires no further bureaucracy to get set up; just swap a few items in the treasury’s ledger. While the debt is Bush’s fault and his mess, Obama must be the one to clean it up.

3. Get out of Iraq. We need to reduce military spending drastically. Once that state is stable enough, or it is determined that we can no longer do any good, we need to pull out completely. Each dollar spent there could go towards a tax cut, elimination of our debt, or building infrastructure, all of which improve the economics of taxpayers far more directly than marginal improvements to the security of the new Iraq state. To Keynesians who believe that our spending there helps in the same sense that paying someone to dig a hole and fill it helps unemployment, I disagree since I see little evidence that our economy is in such an extreme situation. A tax cut will go straight towards the areas of consumption taxpayers have had to give up in recent months (such as retail), spurring job growth, or to paying down debt, keeping the banking system solvent and increasing its profitability. Paying down the debt would help growth even more directly through the means I mentioned above. While the current recession may appear more closely to the Great Depression during which Keynesian methods were supposed to have worked versus the cost-push stagflation during which Keynesian methods failed, those methods appear to me to be cosmetic. We are far from needing to resort to spending for the sake of spending, whether it be in the military or in social programs, in the current economic situation.

4. This is an ok time to build infrastructure, but don’t be stupid about it. With all that being said, now does seem to be the time to use government spending to spur internal improvements, but I only say so with significant caveats.

1. Don’t determine a certain amount of money to spend and keep spending until you hit it. Congress must force good opportunities to come to it instead of seeking them out. We want the public spending first to help citizens in real, genuine ways that private firms have problems providing. We should not be spending arbitrarily just so someone can have a job.
2. Don’t use this as an opportunity to support green infrastructure. These forms of technology are only asked for right now in areas of relative affluence, and as such, support of them is a subsidy to the rich. Green infrastructure must remain in the hands of local governments in the interests of their constituents rather than a holistic macroeconomic plan.
3. Don’t do anything the states can’t do themselves. If something only benefits one or some states directly, the state can make the judgment on its own whether it is worth to tax and spend on the infrastructure. Anything else quickly degenerates into pork belly-seeking situations.

5. Let the industries and firms fall. If the market says too many cars are getting produced, the government should not be in the business of promoting such a level of production. Not all industries are failing right now; such failure says something about whoever does. An unprofitable business model has no place in society unless someone is willing to support it charitably. Let the market determine where those people are best utilized elsewhere. We have had no problems letting that happen in 2001 with tech firms. Perhaps that was because it was so easy, in hindsight, to see why dot coms were so stupid. If the business models of the auto makers, retailers, financial firms, and pornography studios have been unable to withstand the crisis, the market is rejecting their usefulness. We need to stop looking at the jobs being lost and instead remember that all jobs must ultimately serve a purpose. The purpose of many of the firms within those industries has ended.

The economic downturn is ultimately a systemic problem. However, we don’t have clear evidence has to what exactly caused the system to fail, but we can fix the intermediary factors that contributed to such a failure and avoid screwing it up more. The question should not be about eliminating job loss, but about ensuring that the system is set up in such a way that the remaining private firms can find new, better roles for them as soon as possible without causing further problems later.

Health Care: The New Castle in the Air

Back on September 25th, I advised anyone reading this blog to get out of the stock market ASAP and to put any assets they had in something as “real” as possible, preferably a diversified mix of precious metals. Although the market had already begun its perciptuous decline, those (if any) who had followed my advice would have saved a lot of money. Yes, me pointing this out is a bit of both confirmation bias and self-calling, but part of the reason I started this blog was to keep any projection I had permanent both to keep myself honest and to increase my credibility.

In the previously linked-to blog, I claimed that it would be my only investment advice ever. I suppose that was untrue. Despite the recession, I believe a new bubble is forming. Like the housing bubble, tech stocks, tulips, or what have you, semi-informed people have become enamored with this industry. Supposedly, it is fundamentally “different” from any other group of firms, immune to downturn, and about to take advantage of rapidly expanding demand. This industry is health care.

This is not to say that health care has nothing going for it. Certain factors mentioned, such as the coming surge in demand, are in every sense real. However, since everyone is aware of these factors, a sober, rational adjustment has already been made to the prices of those stocks. Further increases in price in the absence of other information will not match the firm’s “fundamental” value (after taking into account a simple “normalization” of the prices of all stocks should overall economic conditions improve). Despite this, health care stocks are poised to increase rapidly in value if confidence can be restored in the economy. In contrast to the “alchemy” of financial firms, hospitals, drug companies, and related firms do something tangible and “real”. With the collapse of both real estate and finance, health care may well appear to be an excelletn place to park one’s money as the population ages.

The conditions necessary for a bubble to spontaneously manifest are met. Common people, who only get wrapped up in active portfolio managing during bubbles, are happily perpetuating stories about how getting training in health care is a “smart” move. That may well be the case, but the awareness alone of the growth potential of a certain industry unnnecessarily directs attention and dollars in its direction. Wallstreet and the unarticulated market have already made its judgment on the growth potential of health care firms. Any attention by the non-professional will only skew pricing. Compare your attitude towards health care firms today to what your attitude towards tech firms was in 1997, right before the bubble formally began taking shape. The parallels are likely striking.

This is not to say that I believe that a bubble in health care stocks is inevitably going to form. Systematic errors by the market are exceedingly difficult to identify; as such, my observation here is only anecdotal and conjecture. Regardless, a tactic of taking a small portion of your assets and putting them in a mutual fund built around health care right now seems like a low relatively low cost move. If I’m wrong, which, I’ll face it, with projecting something like this, is a strong possibility, you might lose compared to what you would have made in an index fund. The gains, on the other hand, of getting in right before a bubble forms are staggering. Ultimately, what I recommend is to invest a small portion of your savings into such a mutual fund (or a well-diversified collection of stocks, if you can manage it), and sell it two years from now, no matter what happens. If a bubble is going to form, it will form by then, and it’s better to get out half way through a bubble then after it pops.

Bankruptcy: A Hidden Bubble-Enabler

Economic bubbles are an accepted fact both popularly and academically, but their causes are subject to debate. Monetarists posit that reactionary, Keynesian monetary policy causes the normal ebbs and flows of the economy to fluctuate more drastically, since central bank’s “stabilizing” actions take time to work their way through the economy. Austrians argue that contemporary banking systems allow lending institutions to push the savings rate of an economy above its true level, resulting in overstocked inventory and production capacity that the consumers cannot afford. Those with a financial bent see investors who focus on capital gains in the stock market, bidding up the price above and beyond its fundamentals simply because other people will probably bid the price up more until the bubble finally bursts. Still others focus on psychological factors that cause common investors to overvalue categorically the future prospects for the economy as a whole. Depending on one’s assumptions and background, any of these explanations may be appealing. They largely possess internally correct logic and are not necessarily mutually exclusive.

While these models require certain assumptions regarding the intrinsic framework of the economy, these explanations do not need to be the whole story. Stepping on a gas pedal causes a car to move faster, but its rate of acceleration also depends on the texture of the road, the power of the engine, and the weight of the car, among myriad others. One, two, or three of the above positions may be the analog of stepping on the gas pedal and the power of the engine, but there is no reason to believe that there does not exist an equivalent to the less important texture of the road.

I conjecture that one of these factors is the very existence of bankruptcy law in the United States. This is a very strong statement; I’m firmly aware of this. At the same time, if you dissect what bankruptcy law really is and really does, its existence and nature is peculiar and bizarre.

Declaring bankruptcy is a painful, terrible thing. No one wishes it for herself. Due to factors entirely outside of his control, bills may add up and the bank may even seize an individual’s house. Bankruptcy, while very damaging to one’s reputation and prospects, allows a way out and a fresh start. Creditors couldn’t have ever really expected to get paid, but bankruptcy allows swift resolution and the opportunity for them to get something, anything. On a case-by-case basis, the process allows a resolution and the likely best outcome for all parties.

When lawmakers write public policy, however, their job is not one specific case study or example. It is (or should be) what is best for the economy looking forward. The existence of bankruptcy as an alternative to forever digging out of a hole of bills eliminates a cost associated with taking on financial risks. No one wants bankruptcy, but its difficulties set a mathematical lower bound for the downside risk of a particular venture. For instance, say, opening a pizza parlor has a 3/5 chance of succeeding, 1/5 chance of failure, and 1/5 of utter failure, with the latter two options both resulting in bankruptcy. However, if “failure” means “$500,000 in debt” and “utter failure” means “$10,000,000 in debt”, the entrepreneur does not see the full cost to opening the pizza parlor. Presumably, since he declared bankruptcy at $500,000 in debt, being bankrupt was better (and hence less costly) than a $500,000 debt and much less costly than a $10,000,000 debt. This asymmetry encourages citizens to put themselves in situations that result in massive failure by only making them pay for a fraction of the cost of that failure.

Call bankruptcy what it really is, a statute automatically written into any contract that allows an individual or corporation out it if she really, really has problems paying it.

While eliminating bankruptcy as an option may decrease demand for credit since the borrower now faces the true cost of borrowing, it also, arguably more importantly, eliminates many of the moral hazard issues that banks have to put up with right now. The lender must ask for collateral and do all sorts of background checks because it really can’t trust the borrower to present himself honestly. However, with the elimination of bankruptcy, this cost would be reduced since the borrower can be trusted much more fully to police himself. While certain moral hazard issues still exist (if the borrower is successful, the bank is only going to get paid back what it lent while the borrower can possibly receive an unlimited high return), this fixes one side of the equation. Thus, while two effects are at play, there combined effect of these is an empirical question that requires study before asserting that it would either increase or decrease the quantity of investment across the economy.

However, I’m not too concern with the small-time entrepreneur, but the stockholders of financial firms.

Incorporation laws, virtually worldwide, allow the owners of a business to hide their personal assets from bankruptcy courts when profiting from a business. Therefore, the lower bound effect of bankruptcy alluded to earlier is pushed higher. The only thing the owner has to lose is the equity in the firm. In contrast to real bankruptcy, she gets to keep her house.

The same thing holds true with shareholders of public company. If the firm they collectively own makes a risky investment, and the most they could lose is the value of their stock, they will not value the investment efficiently. The shareholders must feel the effects of the choices of the board of directors if the market is to hold them accountable for choosing managers who are too risk averse. If this philosophy were to be adopted, suddenly, stocks stop becoming an interesting hobby, one where there are real repercussions for risk. Stocks become far less fun to speculate upon when the stockholder could lose his house by holding them.

The direct economic effect bankruptcy laws have on society is a misallocation of resources in favor of stocks over investment vehicles. This is primarily of academic concern, although it ultimately has negative consequences down the line. The real problem for the economy is its upwards bias for prices across all stocks. Any such bias facilitates the complete collapse of the market, setting the stage for the already mentioned orthodox causes of bubbles to consummate. While practically and morally, giving an individual or corporation a second chance through bankruptcy may seem ostensibly to be a bad outcome to worse alternatives, policy makers must weigh the negative effects of misallocation of resources and bubble-enabling against such benefits. If bankruptcy laws should ultimately remain in place despite their costs, so be it, but the costs must enter the discussion.

I have not found any literature in libertarian (Monetarist or Austrian) economics that may provide another solution for this problem, and whether there are arguments for bankruptcy as being an innate aspect of private property. If this question has been discussed elsewhere, please direct me to it.

A Different Economic Perspective on Traffic

On his New York Times Freakonomics blog, Steve Levitt discusses “profits” and government intervention in the scope of people cutting in line in traffic. If an aggressive driver cuts in line on the road, social welfare is reduced, as people entering the ramp (or wherever) feel unequal costs and subsequently will not allocate themselves efficiently. Levitt concludes that police officers should concentrate their efforts to dissuade such behavior instead of, for instance, speeding, since the latter’s social cost is far less.

Levitt’s argument, technically, is really that line-cutting is rent-seeking and that speeding is profit-seeking. Not to be confused with what you pay for your apartment, “rent” is the term economists use to differentiate unjust gain from profit, which is no more than the financial return one can expect to get given the costs involved. In contrast, rent is the result of government intervention (for example, protectionism), market power, or criminal action. When a pickpocket steals your credit card, her gain is rent. When a firm increases its profits by keeping out foreign competition or receiving subsidies, its gain is rent. Finally, as Levvitt points out, when someone cuts you in line, what he gains is rent.

The most apt metaphor in intuitively understanding the difference between rent-seeking and profit-seeking behavior is to consider all the available goods in the economy as a pie. Profit-seeking behavior desires a larger proportion of the pie, but in doing so, also makes the pie bigger. New technologies and other cost-cutting measures perform such an action. Rent-seeking activities take that larger slice of the pie while making the pie smaller or leaving it the same size. Levitt assumes that the jerks who knowingly disregard those waiting in line do not make the pie bigger. Theirs is a zero-sum action, or that their gain in cutting is canceled out by the loss from everyone else.

Levitt’s other assumption, that speeding is profit-seeking, is enlightening. It calls into question the very structure of the traffic laws of western nations. If it’s five AM and you’re shooting down the interstate at 85 miles per hour, there is very little chance that you’ll hit someone. There is a benefit to driving at a higher speed, and if our assumption is utility maximization, one must balance the loss of life against time savings. Obviously, there is already a certain degree of balancing involved, as otherwise speed limits would be even lower. In any case, speeding in good weather with few others on the road seems intuitively to increase the size of the pie rather than a zero-sum action. Cops should eliminate irrefutable rent-seekers before prosecuting crimes whose true total costs are far more indefinite.

Perhaps, this definition of rent-seeking does not tell the whole story. Instead of assuming a utility-maximizing, pie-”centric” environment, let us take into account property rights and freedom of association. The effects of corporate welfare, crime, and tariffs could all transfer wealth without increasing the size of the pie, but that does not mean that the size of the pie is what matters. Corporate welfare and crime each requisition a portion of a citizen’s income for another’s wellbeing; that is theft, either arguably or literally.  Tariffs financially dissuade citizens from making an informed choice in a transaction; that depresses free association. Considering the factors of why rent-seeking is not beneficial to society, rather than tunnel-visioning the lack of benefit, allows more perspective.

This analysis falls apart when bringing it back into questioning traffic laws. Personally, when I drive, I always leave a car’s length of space between myself and the next bumper, even when traveling 15 miles per hour. I feel justified since, well, the law says I should, but also because I have the right to. However, this isn’t necessarily utility-maximizing, but more importantly, there is no cosmic, underlying “right” I have to that space on the road. Abstractly, you could stretch right to life to fit the notion that I have the “right” not to be very slightly endangered by someone else taking that space, but that doesn’t really mean much in practice. As they say, the right of my fist is up to the skin of your nose. Since I don’t really have the right to the ten feet in front of me (which precludes a line cutter from entering) in any meaningful way, a certain amount of anarchy on the roads is inevitable through this understanding.

Again, let’s rephrase, in the terms of an economic principle I’ve discussed at unconscionable length elsewhere on this blog, externalities. To summarize, externalities are economic transactions where the people making the transactions do not feel the full cost or benefit of what happens. If manufacturing a good causes pollution, it is a negative externality, and the producer sells too many of the goods to be socially optimal since he doesn’t feel the true social cost. If your neighbors’ property values rise because you cut your grass beautifully, it is a positive externality; not enough landowners make their land looks nice. Externalities focus on third parties who are affected but in no way really partake in the transaction.

Rent-seeking behavior is similar, but it affects the second party in the transaction, directly or indirectly. A thief’s behavior is rent-seeking in that it directly hurts the person from whom he is stealing (there are externalities within that “transaction”, where the property values of those nearby are hurt, but that is secondary). Likewise, limiting the market through tariffs directly constrains the consumer to the benefit of domestic industry. Far more lucidly, this model of rent-seeking demonstrates how the line-cutter steals from another driver.

But really, steals what? Despite the rules of the road the government provides us, you don’t have a cosmic right now to be queued. The classic example of failed public goods is the Tragedy of the Commons. In the analogy’s dated environment, local farmers brought their herds to the public commons, where anyone was free graze. Since no farmer had any incentive to limit his herd’s consumption, the commons became desolate and everyone gets screwed. Analogously, someone cutting you in line is the equivalent of a rival farmer’s livestock aggressively chomping on every bite of grass right before your cow had a chance to. It’s a jerk move to do, but there isn’t anything cosmically wrong when the good was free to all in the first place. The government legislating against it means nothing… and to say otherwise is begging the question.

The best model for considering jerk drivers is the second model, which I previously rejected. The real problem here is the lack of private property on the roads. If someone breaks a rule on a private road, however arbitrary that rule may be, she is breaking a fundamental, cosmic law of property rights. If the rule is truly arbitrary, then the owner is screwing himself out of profit (assuming that it is a tolled road), and if nothing else, rules for private property can be far more categorically accepted than whatever the local government decided this morning. That is to say, a dissenter can always break a law on public property if he believes that dictated regulation to be unreasonable, but societal concerns are immaterial on private property.

I conjecture a corollary to the Tragedy of the Commons. Since there isn’t ever anything cosmically true about the regulations we choose for public goods, those with differing respect for the law will align themselves differently, thus resulting in a misallocation of those goods. The line-cutters may be right in assuming that the length I put between myself and the car in front of me is not socially optimal and that they might as well jam themselves in there. Most, or any of them, may not think that, but it is a justification. If a private firm (even a monopoly) is in control of the roads, it pays for its mistakes and is subsequently rational. If you cut in line and get banned from the local highway simply because the firm wants to eliminate predatory behavior, guess what jerk? You’ve lost your job since you can’t make it to work on time and you’ll have to move. Such punishments may never pass the legislation, but private owners can do whatever they want.

Until then, we’re getting by with social niceties and fines.