Tuesday, July 20, 2010

Blinder's Blindnesses

Alan Blinder, the well-known professor of economics at Princeton, wrote an opinion piece in the Wall Street Journal today. He claims that the fiscal hawks who fear that the stimulus hasn't worked are wrong, and that their refusal to give in on the unemployment benefits issue is misguided--what he labeled "pretty anti-Keynesian thinking."

Well yes, Professor, that's on purpose.

[Thanks to for the image of Brueghel's Blind-Leading-The-Blind]

Blinder later specifies that he is referring to Keynes's recommendations to increase federal spending, and to the idea of reducing taxes so as to increase consumers' discretionary income and hence consumption.

But Blinder himself differs from Keynes (taking permission for his inconsistency from Ralph Waldo Emerson) in that he does not endorse tax reduction. Blinder's own Keynes-bis prescription is, on the contrary, to raise taxes by allowing the Bush tax cuts to lapse (because "we can't afford them"), and to "combine more stimulus in the short run with more budgetary restraint for the long run."

This means, I assume, that the government should allow the tax cuts to lapse and use the increased tax revenue to prolong unemployment benefits (basically a redistribution of income). Then Congress should increase federal stimulus deficit spending and worry about the consequences later (believing, I guess, that wishful thinking today will restrain tomorrow's budget in spite of itself).

Thus, he declares, "Obama's Fiscal Priorities Are Right."

I see several problems with his reasoning.

Problem 1. The spender-Congress's plan, to date, is to increase federal spending through more stimulus AND to raise future spending in the long run when the new health care laws kick in and when the coming baby-boom Social Security/Medicare/Medicaid entitlements explode. This is the opposite of Blinder's long-run recommendations.

Problem 2. By increasing both taxes and unemployment benefits Blinder thinks he is simply redistributing wealth, i.e. taking from Peter to pay Paul, justified by the arguments that (i) taking from the rich is not printing money or incurring more debt; (ii) giving $1 in unemployment benefits, or giving $1 in middle-class tax cuts, or giving a $1 cut to a wealthy taxpayer is "identical" in its impact on the budget; and (iii) more consumption will cure the recession.

This is unproven on three fronts.

a. Let's say we grant that an unemployed person is likely to spend the $1, and let's even grant that a middle-class wage earner will most likely spend it. How can Blinder maintain that a wealthy person, with his armada of lawyers, will still declare the same amount of taxable income if the taxes were to increase substantially? The Laffer curve seems to suggest that wealthy taxpayers will find a way to avoid paying taxes as the tax rate climbs to a more punitive level.

b. It may be true that unemployment benefits financed by the confiscated earnings of the wealthy might force GDP income to shift out of capital investment and land in consumption. But is this a proven recession-buster? It might just have the opposite effect, especially if it's on a large scale.

c. I think Zandi's quantitative model may need a little peer review, and preferably not by a Princeton economist. Today's Wall Street Journal mentions two NBER studies that indicate:

- "... a one week increase in potential [unemployment] benefit duration increases the average duration of the unemployment spells of UI recipients by 0.16 to 0.20 weeks" - 1990 study by Lawrence Katz

- "It is well known that unemployment benefits raise unemployment durations" - Raj Chetty of UC Berkeley

- Another study in March of 2010 by Michael Feroli (J. P. Morgan Chase) concludes that "lengthened availability of jobless benefits has raised the unemployment rate by 1.5% points."

3. Blinder says, "[W]e know one thing for sure: As the unemployment rate rises, the disincentives that worry conservatives become less important because there are fewer jobs to find...." Less important? That is nonsensical. He is saying that the chances of finding a job are reduced, but does this mean we have a better excuse to discourage people from accepting work?

I think the contrary. If people are under financial pressure, people will consider working in a different field than they're used to, or at somewhat lower pay, even if only temporarily. This is a GOOD thing, because the bubble economy created imbalances in the workforce that need to be rebalanced. However, if you throw them more benefits, the disincentives will operate to prevent people from hunting for, and accepting, alternative work, and skilled-labor job offers will continue to go unfilled--yes, that's right, skilled workers are hard to find, even today.

Lastly, I would respectfully ask Professor Blinder to drop the moralizing. It's namby-pamby and weak. He says, "In the 1930s, FDR taught us that heedless self-interest is both bad morals and bad economics." P-u-l-lease. He's beginning to sound like a climatologist: "Let's just do the right thing, whether we can prove it's actually beneficial or not."

Not my kind of morals, economics, or science.

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Saturday, July 10, 2010

Nature's Golden Standard Is Back (Whether The Macro-Managers Like It Or Not)

The news about gold swaps on the back pages of the Bank of International Settlements report made a few waves last week. Some immediately reacted in shock, claiming this is potential bad news for gold bugs because it augurs a future glut of gold supply on the market if and when the swaps fall through.

But this is not potential bad news for gold bugs, only for gold speculators. Because I am a gold bug, when I heard the news my immediate reaction was, "Hey, this is great. Some financial entity out there got so desperate that they had to use their gold as collateral. It's probably a large European bank or even a central bank, and this may not be the last time it happens. Gold is definitely coming back into style."

[Thanks to BuyCostumes.com for the image of Mother Nature.]

A real gold bug like me believes that gold is Nature's monetary base, no matter how politico-academics try to manage their fiat (paper) money without it. The fact that central banks still store the yellow stuff is evidence in support of this, so when I learned that some important entity, perhaps even a central bank, was actually using gold as collateral in a borrowing transaction, I realized it was just more evidence in support.

Thus, in my e-mail update from Mineweb.com, I wasn't surprised to find a link to this article entitled "BIS gold swap--best news to hit gold in 30 years." Author Julian Phillips remarks:

"What is significant about this or these transactions is that gold is being used in international settlements after so many decades of being sidelined in the monetary system!"

This is surely what it looks like to me, too.

The poor speculators, however, unnerved by the slightest tidbit of information, are trying to figure out which way the gold price will move over the next few months. We gold bugs don't really care about the short run, because we know that in the long run there's too much paper money (or its equivalent) floating around, explaining gold's rise relative to a number of currencies. But contrary to us, the speculators don't see the joy here.

They think that gold is just a "hedge against future inflation." Therefore, their next question becomes: Will we get "inflation" (which to them means U.S. price increases) enough to spur the Fed to reign in the fiat dollars? The consumer and other figures suggest not. So should the gold speculators panic and sell it all?

I say that this double-dip will maintain prices, and therefore the Fed is not about to retire any fiat dollars for a while unless general prices start to rise. It would also surprise me if the Europeans manage to retire any euros, what with the PIIGS problem. So without a CPI increase does this mean we will not get "inflation" and the speculators should dump gold?

Well, that depends on how you define the word "inflation." I've been down this road before--it's one of my pet peeves--and I'll do it again by referring you to a modern web dictionary's definition of the word "inflation":

"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services."

Interesting that they used the word "or." When can one have a "persistent decline in the purchasing power of money" without an "increase in the level of consumer prices"? Simple: when credit doesn't reach consumers through an increasing paycheck, or through home equity. Where is it, then? In the pockets of speculators, corporations who don't care to invest just now (and rightly so), Wall Street, Freddie and Fannie--in fact anywhere but in the wallets of consumers.

Therefore, general prices will not rise. BUT: the price of gold will rise, because gold is Nature's golden standard, the barometer of "inflation" as defined above in italics. And this italicized inflation situation exists now and has been growing, according to my theory, since consumer prices stabilized in 2008, and perhaps even since earlier than that.

More proof that one can have a decline in the purchasing power of money at the same time as stable prices: Gold compared to the CPI basket of goods has remained stable over time, e.g. about 2.5 ounces/ basket in 2004, the same as in 1942. (Source: www.northerntrust.com/library/econ_research/daily/us/dd052605.pdf.) With the recent increase in its price relative to a number of currencies, however, gold will buy more goods now than is customary. So we have a relative "decline in the purchasing power of money" without an "increase in the level of consumer prices."

Another perspective: Purchasing power in consumer hands is being syphoned off through higher taxes, higher corporate profits (they are not spending, but they are still pricing at the same level), a stagnation of average wages or loss of jobs, and decreasing home equity.

So who is bidding up the price of gold? Anyone with savings they want to protect from further erosion of purchasing power, including many small and large investors, huge hedge funds, enormous pension funds, sovereign funds--anyone who has money to save and who realizes that the dollar and some other currencies have been "over-printed," and that the central bankers are only watching the CPI.

So if the BIS report sent chills up your speculating spine, don't worry. The macro-managers are about to mess things up good, and Mother Nature has yet to sing her last song.

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Friday, July 02, 2010

The Evils of Fiat Money: Voice from the Past

[Thanks to the-gold-market.blogspot.com for the image.]

In doing some research I came upon the following quote:

"Whenever commodity prices are far removed from a stable relationship with the alleged gold content of the monetary unit concerned, there is something, probably more than one thing, seriously wrong. Included in the maladjustments may be extensive abuse (misuse, unwise use) of the banking system with resulting inflation, serious overexpansion of capital facilities in various lines, unwise speculation in tulip bulbs, commodities generally, Florida lots, common stocks, Canadian mining stocks, or what have you, and possibly serious distortions among wages with steel workers getting more than college professors, etc.

"How anyone can imagine that all such distortions, maladjustments, abuses, etc. can be miraculously cured by devaluation is beyond me. Devaluation simply satisfies the most ardent pressure groups for the time being and greases the skids for the next slide by gradually destroying the stable middle-class element of society; it confirms all the unwise in their unwisdom; makes unsound banking look like sound banking; and, after two or three doses, virtually assures the ultimate destruction of the monetary unit as the strengthened pressure groups demand more and more. Such, in my opinion, is the obvious lesson of history, ancient, medieval, modern, and recent. Perhaps things will some day be different, but I doubt that."

As I read this I couldn't help but think how right he was. Everything he described has come to fruition today.

The date? 1953. The writer? Edward C. Harwood, founder of the American Institute for Economic Research. Would that such wise men were still around today.

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