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Bob Frank has an essay in the NYT adapted from his new book The Darwin Economy. The thrust of it seems to be that many goods are positional.

When the ability to achieve important goals depends on relative consumption, all bets on the efficacy of Smith’s invisible hand are off. As Darwin saw, many important aspects of life are graded on the curve, and in such cases, individual incentives often lead to mutually offsetting efforts.

The rat race is rent dissipation.

This is an idea I used to push strongly, until Justin Wolfers convinced me otherwise. I used to think happiness was largely zero sum and that the benefits of great wealth came only from the relief of great misery: infectious disease, deformation, major depression, etc.

Yet it seems real happiness does come from greater levels of consumption even if you don’t beat out your neighbors. Still, your neighbors do matter, interestingly enough for things we wouldn’t think of like, longevity.

All of that being said, the larger point I want to make is how evolutionary thinking is taking hold into everything we do.

Sometimes, I read articles from maybe 20 years ago about love or ambition or beauty that are rooted concepts other than in evolutionary psychology. It feels like reading an article on Wicca and its use in treating pneumonia.

As I have mentioned, to me the idea of the firm as some sort of conscious maximizer seems naive if not outright silly. The large scale failure of corporate strategic planning, an obvious inevitability.

No, there is one idea that rules them all – selection. Things are what they are because the world culls out the other possibility. Existence is the art of the possible and science is the study of selection, on one level or another.

The world around us is filled with three kinds of particles, not because there are only three but because the others decay to fast. Molecules “seek” low energy states because in the ever present jostling that is reality they are much more likely to fall from a high place to a low place than the other way around.

Even time itself has the arrow that it does because there are more high entropy states than low ones. Watch long enough and the low entropy ones are bound to dominate your observation.

That’s why I describe the effect in different terms – we will tend to observe those things which are highly observable. To understand our world then is to understand the rules of observation.

What are we likely to be able to see. That is what is likely to be.

I think this can reduce some great mysterious to absolute simplicity. Why for instance are we all alone. How can it be that we are the only intelligent species we know.

How can it be otherwise? There were once many species of homo, now there is but one. The same will be true for intelligent life in general. The average intelligent creature will look out into the world and see only others like her, because for her to exist the others must either have been killed or not have arrived to kill her yet.

Every thing about our world has been selected for. The unstable particles have decayed. The unstable species have gone extinct. And, the unstable economies have collapsed.

Matt Yglesias brings up my favorite stylized fact about health care. The rise and fall of HMOs. I was – as you might imagine – an enthusiastic supporter of HMOs.

They seem like a wonderful innovative way for the market to development demand side cost control measure. And, they crashed and burned in the most horrific manner imaginable.

Matt says

But people have spent the past ten years voting with their feet away from this option. You often hear arguments about health care costs invoke the fact that the health care sector benefits from lots of explicit and implicit subsidies, which is true. But those subsidies weren’t suddenly created at the moment the worm turned on the HMO issue.

But, its worse than that. I remember the HMO episode vividly. They became the most hated name in American business. The constant source of material for late night comedians. A plot device anytime a TV writer needed an “evil” entity.

As a result both political parties caved in to popular pressure and went after the HMOs. From the LA Times circa 1998

Faced with growing voter concern about health care, both President Clinton and House Speaker Newt Gingrich on Thursday called for a bipartisan approach toward empowering consumers with a patients’ "bill of rights."

"I don’t believe this is a partisan issue anyplace but in Washington, D.C.," Clinton said during a rally on Capitol Hill with congressional Democrats and two maverick House Republicans.

This slips under my definition of Liberalization Failure. You can point to all the things that are wrong with government controlled health care but when you leave cost control to the private markets the populist backlash is so severe that governments can’t help but make the problem even worse.

Thus you end up with the most costly health care system on the planet.

I like to keep my judgments provisional but its reasonable to suggest that we are debating between the more or less nominal theory of the Great Recession: myself, Scott Sumner, Brad Delong, Paul Krugman, etc and the real theory of the Great Recession, Tyler Cowen, Arnold Kling, Narayan Kocherlakota, etc.

Tyler has rightfully demanded to see evidence of the liquidity trap we allege. I think such evidence is emerging. See my last post. See evidence from Kash on transatlantic cash flows. See the situation in Switzerland.

However, the obvious reply is – why only now.

I would suggest that the seeds of a liquidity trap were planted early on – low inflation combined with a collapse in household balance sheets and a sharp rise in liquidity demand in the face of a financial crisis.

Yet, governments attempted to beat back the trap with stimulus and emergency monetary policy. Now, both of those forces are waning. More and more central banks are tightening and stimulus is fading all across the globe.

The liquidity trap in its full form is emerging. If we want “predictions in a liqudity trap” I’ll offer that effective negative rates of return on bank deposits after fees are considered and a sharp rise in retail sales of home safes are the next steps.

My hope is that “natural obsolesce”  in the form of a deteriorating fleet of motor vehicles and a housing shortage will push down liquidity demand and get us out of the trap.

However, if we look at Japan, the housing shortage was dealt with in a bit of a different way.

Convertable Table

The young singles ratio is getting increase in the society. These people live alone in small apartment in the city. They would like to have multipurpose furniture for using small room efficiently. There are two chairs and on table. Ordinary these are two chairs and table. But When they watch TV. It can be Sofa. And when they go to sleep. It is going to be a single bed.

From the LA Times

Americans are pumping money into bank accounts at a blistering pace this year, sending deposits to record levels near $10 trillion on escalating fears that the U.S. economy is on the verge of another implosion.

There’s no sign that the flood into checking, savings and money market accounts is slowing down. In the last three months, accounts at U.S. commercial banks have increased $429 billion, or 10%, almost double the increase for all of last year.

There’s one big problem: Banks don’t want your money.

"Banks and credit unions are doing everything they can to get rid of the cash except make loans," said Mike Moebs, a Lake Bluff, Ill., banking consultant.

In an essay in Commentary James Pethokoukis seems to endorse New Keynesian economic models

“New Keynesian” models, like one used by the European Central Bank, sought to incorporate [permanent income effects] and predicted that the Obama stimulus would have just a fraction of the impact estimated by Romer and other White House economists. Instead of creating 3 million jobs, perhaps the actual total was 600,000, or about $1 million a job (assuming approximately 80 percent of the stimulus has been distributed.) That would mean the job growth that has occurred has been mostly a result of the natural recovery of the economy.

Such estimates sure seem to better reflect the miserable reality of the past two and a half years than what the White House is selling. The anti-stimulus models also imply that for the Recovery Act to have had the impact Obama sought, it would have needed to be six times larger, or roughly $5 trillion in borrowed money.

So I haven’t cracked open the ECB model and maybe it has one-to-one Ricardian Equivalence with no liquidity constraints at all. That means that households would have simply saved all of the temporary tax cuts and spent none of them.

In an economy in the midst of a credit crisis that seems unlikely, but I want to  focus on another one of James’s points: we would have need “$5 Trillion in borrowed money.”

He says it like it’s a bad thing but my response is: so what?

Either way you slice it we have a good deal. If we had enacted $5 Trillion in tax cuts and every bit of it was saved then the total liability that US households face would not have changed.

They would owe more in future taxes but they would be able to pay down their mortgages and other debts. And, that is a net plus because the rate at which the government borrows is much lower than subprime mortgage rates and indeed currently negative in real terms.

Having the government basically arbitrage the public-private spread is a net win for US households.

On top of that I think it likely that some households who didn’t have crushing debt burdens would have taken advantage of the flood of foreclosed homes, cut rates on hotel rooms and dealer mark downs on new cars to get some really great deals.

That would have been good for those well positioned households and good for the US economy which was facing a flood of foreclosed homes, empty hotel rooms and autos piling up on dealer lots.

It would have been good for those less well positioned households because they could have paid down their debt.

The price would be higher future taxes later but with the government paying such low interest rates the real costs of those future taxes would have been smaller than the taxes that were cut.

Moreover, the United States could have potentially avoided the devastating effects of a long term balance sheet recession.

Now astute readers will note that higher tax rates in the future produce disproportionately higher excess burdens. My simple quip – courtesy of Jim Tobin -  is that it takes a heap of Harberger Triangles to fill an Okun’s gap.

The larger point is that if the taxes were repaid over time, from a larger base and under low and potentially negative interest rates the country could come out ahead in pure dollar terms, not even counting the reduction in suffering that would have occurred from a lighter and shorter recession.

Not much I am going to say in this edition except to point out the incredible dominance of IT equipment in US investment and how much has changed in such a short period of time.

Actual chained value data is available back to 1995, which is convenient for my point since it was the last year in which investment in industrial equipment matched investment in information processing equipment.


What’s interesting is the extent to which Information Processing is coming to dominate all investment period. For example, here are Non-residential structure – all of them from offices to malls to mine shafts – compared to IT.


Matt Yglesias is upset about the double standard applied to Green Job rhetoric

So when politicians want to talk about economic growth, they tend to talk about “jobs.” Absolutely all politicians do this. When governors want to brag about how lots of people have moved to their state, they say they want to “create jobs.” When critics of carbon pricing say that cap-and-trade will “destroy jobs,” what they mean is that it will slow economic growth. When Newt Gingrich says we can “create jobs” by drilling for oil everywhere, he’s saying that he thinks the optimal long-term growth strategy for the United States is to try become more of a natural resource extraction economy. It is true that when Barack Obama touts “green jobs” as the future of the American economy, he’s saying something that doesn’t literally stand up to scrutiny. What he means is that he wants a higher productivity economy that also has less pollution. But the only analytic error he’s making here is the exact same analytic error that all politicians are making when they talk about “job creation.”

So there are two issue here.

1) I am not sure that politicians understand the difference between jobs and prosperity. When I was young and naive in the ways of the world I would write reports for legislative commissions on tax reform proposals. A question actual members of the commission – who are more knowledgeable that the average legislator – always asked was: “what will this do to job creation.

I said that job creation is primarily determined by the number of people who want to work and the quantity of money in circulation and that it was unlikely that any of these proposals would affect either of those in a meaningful way.

“So you are saying it does nothing to the economy” was the reply.

“No, I am saying it does nothing to job creation. You can have plenty of jobs and a crappy economy.”

This conversation went nowhere fast.

But, I learned. Now, I convert economic efficiency into “jobs” by dividing the efficiency gains by twice the average wage.  If you want to be really fancy town then you can use the input-output tables to do this on a market by market basis. Then you say “this proposal could create as many as X jobs”

Which is entirely true. If the supply of labor was perfectly elastic at the prevailing wage then it could create X jobs. Of course, if people have realistic preferences then your mileage may vary.

2) Green jobs do defy this general approach. The reason is that you are usually talking about getting the same economic output through some less efficient means – at least in a market sense.

The return is a cleaner environment, but there is no basic reason to think that would be reflected in higher real output per hour worked. Now some people try to use lower asthma rates and such to do a conversion. However, the fact remains that green jobs in general should not be productivity enhancing.

Liberalization failure is a term I use to suggest that efforts to reduce government intervention could actually increase government intervention. The concept tree goes something like this.

Market Failure: When the market does not achieve efficiency because of some problem. We often think of these as being do to externalities, asymmetrical information or market power.

Government Failure: When attempts to correct market failure suffer from rent seeking, rational irrationality or other deviations from the solutions economists theorize. These deviation could wind up making the actual result of government intervention worse than the original externality.

Liberalization Failure: When attempts to leave a market to its own devices results in a social backlash and the adoption of policies worse than what would have prevailed had the government taken the economists’ orginal recommendation.


Imagine the following scenario which might very well play out in climate change politics.

The market fails to price carbon, creating a market failure and an excess of carbon in the atmosphere. Economists recommend creating a market for carbon.

Government attempts to create a market for carbon but the process is so riddled with back room deals, special provisions, and permit handouts that it would do little to reduce carbon and would produce significant distortions. This is government failure.

Aware of this problem economists convince the government to decline to act on carbon. The public outraged by the lack of action, however, demands the adoption of stringent anti-carbon regulations and renewable portfolio standards that are far more costly than would have been the poorly implemented carbon market. This is liberalization failure.


I am not aware of whether or not there is already a literature on liberalization failure and if so what it is called. Though per Tyler Cowen I should assume that there is.

Nonetheless, I think its another level of unintended consequences that’s worth considering.

Now I am fully aware that the process of creating ever more levels of failure puts us on the Nihilistic Escalator, whereby we wind up concluding that no effort to improve outcomes can succeed.

I’ll try to do a post that issue later.

So I wanted to do this big post analyzing all parts of Equipment and Software investment and coming up with a grand theory but that was taking a long time in part. because it is hard to export graphs from BEA. Plus, I realized no one would read something that long anyway.

So we’ll do bits and pieces.

So you can break out investment in Equipment and Software into 4 categories. Information Processing Equipment, Industrial Equipment, Transportation Equipment and Other Equipment.

If you like to get all meta – which I do – then this makes sense. On one level we don’t actually ever “create” anything. We just rearrange atoms into configurations that are more to our liking.

So to do that we have to first figure out what configuration we want. This is the information part.

Then we have to go gets some atoms. This is transportation.

The we have reconfigure them. This is the industrial part.

Then we have to send the newly configured atoms to people who want them. This is transportation again.

Sometimes the atoms we want are located deep underneath the ground and we have to get them out. However, this extraction of atoms is mostly covered under “non-residential structures” not equipment because you use big honking machines that are attached to the ground.

So anyway. In this first post I want to compare the two “biggest” categories which are information processing and transportation. I put biggest in scare quotes because one of these categories has actually fallen to third place recently. It should be obvious which.


So the blue line is investment in Information Processing and Communication equipment. The yellow line is investment in Transportation equipment.

Now these are indices marked so that 2005 is 100, for both. In actual dollar terms IT is significantly larger than transportation.

However, you can see that investment in transportation equipment simply cratered, falling by an astounding 70+% in 2008.

Disentangling investment in various transportation components will take some work and I’ll save that for a later post.

Jeff Sach’s  a column on the nature of our jobs problem. His key point I think is this

Our growth and employment problems are structural, and need a structural response. . . .

The structural problem is that America has lost its international competitiveness in basic industries including textiles, apparel, and several other areas of manufacturing. The production jobs are now in China, India, and elsewhere, where wages are much lower while productivity is more or less comparable to the US (and where production often involves US companies, using US technologies, producing overseas and re-exporting to the US market). Only US college grads can resist the international competitive pressures; high-school grads have found the labor market fall out from beneath their feet

I don’t think Sach’s diagnosis is quite right but he is identifying the symptoms of a larger syndrome. I like to break the economy into Goods and Government vs. the Private Service Sector.

Goods and Government make up a lot of what we used to think of as the middle class: Textile Workers, Riveters, Machinists, Carpenters, Teachers, Fire Fighters, Police Officers, etc. Not wait staff but not doctors and lawyers either. The middle middle.

I want to contrast the employment in these two super-sectors because its so striking. Here is employment data going back to the end of WWII

FRED Graph

Up until about 1975 or so the two super-sectors were growing at roughly the same rate and each commanded about half of the workforce. Then the two started to break apart and private services marched higher and higher while goods and government experienced over going on 40 years of stagnation. Unless something major changes there will have been almost as many workers in goods and government in 1975 as in 2015.

Indeed, if as I suspect, manufacturing and teacher employment continue to trend downward there may be fewer in 2015 than in 1975.

This is not just a story about manufacturing either the ratio of government workers to private service workers had a strong peak in the 70s

FRED Graph

While the ratio of goods producing workers to private service has been declining pretty steadily since the 1950s

FRED Graph

Preliminarily I might say that up until 1975 the US was running a de facto Nordic Model, where declines in middle class manufacturing jobs were made up for by increases in middle class government jobs.

That stopped around 1975 and since then there has big a large divergence.

By: Lars Christensen

The Market Monetarist school has emerged in the blogosphere as a clear competitor to mainstream Keynesians as well as to the Austrian school thinking. However, Market Monetarists have really not been very clear about their intellectual heritage.

In my recent paper on Market Monetarism I identify two overall Market Monetarist principles:

  1. Money matters.
  2. Markets matter.

These principles have some origin in economic literature. Here I present a short reading list that should get aspiring Market Monetarists up to date with the background on Market Monetarist thinking. The list is highly incomplete and I encourage others to pitch in with reading material, which is or should be important for the intellectual development of Market Monetarism.

Money Matters

Of course Milton Friedman is mandatory reading for anybody. Read everything Friedman wrote, but I think Money Mischief is an excellent introduction to a lot of Friedman’s thinking. Here you will learn why inflation is always and everywhere and monetary phenomenon, why it is highly unlikely that a fiat central bank would find itself in a liquidity trap liquidity trap, and of course why low interest rates is not the same as easy monetary policy.

It’s not possible to understand the concept of monetary disequilibrium and the monetary transmission mechanism without having read Leland Yeager and Clark Warburton. The Fluttering Veil is a collection of Yeager’s papers and Depression, Inflation and Monetary Policy is an excellent collection of Warburton’s research.

Concerning the monetary transmission mechanism you course have to read Brunner and Meltzer, but its complicated and not nearly as exciting as Warburton and Yeager.

Scott Sumner loves Mishkin’s textbook on monetary theory, but frankly I find it somewhat boring compared to reading Yeager and Warburton.

Markets Matter

Yes, we all know Sumner’s and Woolsey’s NGDP futures ideas so there is no reason to tell you too much about that (Ok you should read Scott’s The Case for NGDP Targeting). However, the use of market pricing as a tool for the conduct of monetary policy is not a new concept! It enjoys a rich intellectual history. Literature regarding Swedish monetary policy during the 1930’s – Cassel and Wicksell is a great place to start. Berg and Jonung’s 1998 paper Pioneering Price Level Targeting: the Swedish Experience 1931-37 is another excellent resource. For a more contemporary discussion of market-based approaches to monetary policy, check out Johnson’s and Keleher’s excellent book Monetary Policy, A Market Based Approach, from 1996.

An often-forgot kinship is the relationship between the Market Monetarists and the Free Banking Theorists. David Glasner’s and George Selgin’s books on Free Banking are mandatory reading. Both tell the story about how basically a perfect competition Free Banking world will end up has having a fully elastic money supply and as a consequence effectively have Nominal GDP targeting. This should in my view be the welfare theoretical foundation for the Market Monetarists’ focus on NGDP targeting. Another excellent “free banking” book regarding targeting the price level is Selgin’s nice little book Less than Zero (that will also remind you that Market Monetarists are not inflationists).

Reading on Current Events

The leading Market Monetarists have told a very valid and impressive story on why the Great Recession happened and how the Federal Reserve failed in doing something about it. However, in my view the story told by Scott Sumner and Robert Heztel among others is far from complete. Hence, in my view the explanation for the crisis is far too US-centric as it ignores the massive increase in European dollar demand in late 2008 and 2009 and later again in 2011. This explanation clearly has something in common with the increase in gold demand leading up to the Great Depression (Scott Sumner could tell you all about that!). Obviously Barry Eichengreen has a lot to say about that in Golden Fetters (who will write the book “Green Fetters” about excessive demand for dollars as a cause for the
Great Recession??). However, remember when you read Eichengreen that a central bank that is doing its job (ie calibrating its policy instruments such that it expects to hit its target), “fiscal stimulus” is redundant at best. Also, have a look at Douglas Irwin’s excellent working paper Did France cause the Great Depression? – just the title of the paper makes it worth having a look doesn’t it?

And then of course both Robert Hetzel and Scott Sumner have books in the pipeline – I am sure they will be worth reading. These guys are at the core of the Market Monetarist movement – so gentlemen please get your books out asap!

I don’t know if I’ve heard anyone say this and I am not quite sure what I think about it myself, but one way to view the economy in the Information Age is that the returns to specialization are falling.

So, those who like such things can go all the way back to Adam Smiths pin factory and think about all the tasks involved in making pins and how each person could become more suited to that task and learn the ins and outs of it.

However, in the information age I can in many cases write a program to repeatedly perform each of these tasks and record every single step that it makes for later review by me. The individualized skill and knowledge is not so important because it can all be dumped into a database.

What really matters is someone who gets pins. Not the various steps involved in making pins but the concept of the whole pin. What makes a good pin a good pin. How do pins fit into the entire global market. What the next big thing in pins.

This individual will be able to outline a pin vision that she or just a few programmers can easily implement. One could say this is the story of Facebook or Twitter. Really good ideas and just a few people needed to implement them.

However, as IT progresses and machines can do more things it could be the story of the economy generally.

In contrast to The Great Stagnation, I would call this The Rise of Generalist or perhaps to be consistent The Great Generalization.

Even if you stop and think for a minute about all of the things that your computer or now even your phone can do, are you now wielding the most generalized tool ever conceived?

I should write more on this but for now I’ll get a brief primer on how I think about inflation and how it differs from what I read most other places.

One of my common quips is that “there is no such thing as immaculate inflation” or that “inflation cannot proceed through magic.”

What do I mean by this?

Well, inflation in the common sense of the term is a rise in all wages and prices. In the long run small rates of inflation shouldn’t effect the economy that much. However, in the short run it can cause discomfort or joy depending on your situation. Not all prices rise at the same rate and some people have contracts – mortgages for example – that are specify a certain amount of money to be paid.

Inflation lowers the value of that money and so makes the mortgage easier to pay for the borrower but less profitable for the lender.

That is all well, good and important at a macro level.

However, at the same time inflation must proceed through market processes. Demand for some product must rise or supply must fall. Generally, the inflation we experience is from a rise in demand caused by cheap financing. That cheap financing is a result of the Federal Reserve printing more money.

However, as this money works its way through various markets we should seem them respond as markets respond to increased demand, through an increase in both output and prices.

So when we crack open the BLS report on inflation we can look at different markets. We see for example that are rents rising. This adds to our overall estimation of inflation but it also suggests a tightening rental markets which should make apartment construction more profitable.

We may also see a rise in the prices of automobiles. This summer the increasei in car prices came from a decrease in the supply of automobiles as a result of the Japanese Tsunami. However, as that fades we might be able to interpret future increases in price as a tightening of the car market and expect sales to increase.

We also see used car prices going up. This suggests that natural obsolesce is working its way through the used car market and pushing people into newer cars.

We can take a step back and interpret these events as saying liquidity demand is being satiated. Or, we can take a micro perspective and say that the demand for goods and services in these markets is increasing. Either way we look at it, however, demand driven inflation should be drive a rise in production.

In an economy with little unemployment we would expect this to bid up wages as employers competed for scarce labor. The result would simply be higher prices and wages and a distortion of long term contracts like mortgages.

However, in an economy with high unemployment we should expect some of this to result in an increase in hiring. Thus I see when I see rents rising, I think that means that construction employment will rise. When I see new car prices rising I think that means manufacturing employment will rise.

It is always possible that inflation is actually occurring first in commodity markets. This in turn is causing the supply in various individual goods markets to contract and thereby bidding up prices.

However, by looking at a the economy on a market by market basis we should be able to tell which is which. This is one reason why inflation driven by gasoline prices is “bad.” It almost certainly represents an increase in the price of a commodity – oil and a reduction in the supply of gasoline.

This means that we expect contraction in the gasoline market. In addition through income effects we should expect a contract in the demand in other individual markets.

When inflation is coming through the commodity markets it means that either the commodity is in short supply generally or that it is being pulled away from the US market by demand elsewhere. In either case the result is less real resources available for US households and firms.

However, when inflation is coming through the final goods market it means that real resources are being pulled towards US households and firms. That implies both that US households and firms are trading out of cash and into real goods and that the net effect in each individual market will be an increase in output.

Reihan Salam flags this post by Jed Graham as informative.

I am sure Jed Graham is a smart and nice guy. Yet, I am not sure how to take this assemblage of points.

The root of the economy’s ills is often said to be a lack of demand or elevated debt levels. While both explanations have merit, the underlying problem is depressed business investment.

Despite a healthy rebound in software and equipment spending over the past 18 months, real U.S. private investment has only reached 1999 levels.

. . .

A central problem has been the bursting of the real estate bubble. In 1998, business software and equipment outlays accounted for about 42% of private investment. Now it’s 62% because of the sharp decline in spending on residential and nonresidential structures.

. . .

Whether it’s hiring a worker or buying a new piece of equipment, companies consider “the risk-adjusted return,” said Mark Vitner, senior economist at Wells Fargo Securities.

Given increasing economic, tax and regulatory uncertainty — including sweeping rules from new health care and financial reform laws still to be finalized — companies are setting a higher bar for spending.

So, Fixed Private Investment is composed of three major categories Residential Investment, Non-Residential Structures and Equipment and Software.

Graham is acknowledging a boom in E&S and bubble burst causing a decline in Residential Investment. So implicitly we are talking about missing Non-Residential Structures.

So lets break out Non-Residential Structs into its constituent parts.


That’s a little hard to see without zooming in but the action is in dark blue, the light puke color, and green.

The dark blue is office buildings, the light puke is multi-merchandise (malls), and the green is manufacturing.

I think its not too much a stretch to tell a story about why malls and manufacturing would not be adding additional structures in the wake of the largest fall in retail sales on record.  Here is year-over-year growth in real retail sales. The series changes in 1992 because of discontinuation.

FRED Graph

and of course a lot of that fall in retail aales was cars, still a major part of US manufacturing. Here are car sales yoy

FRED Graph

Now offices. Here the key factor is office vacancy rates. I am going to borrow a chart of this from Bill McBride

We see vacancy rates climbing pretty steadily from 2007 on through 2010. You could make the argument that they were climbing because businesses were not opening or expanding because of uncertainty and to some extent that is the story I would tell.

However, if the uncertainty leveled off in 2010 then it is likely related to the financial crisis. Indeed, I don’t have a chart handy but a lot of the vacancy rise was Finance, Insurance and Real Estate related.

So it doesn’t really seem that the bar business spending went up. They were buying more equipment and software. What went down was structures and those declines seemed closely related to the financial and housing crises and the sharp decline in retail spending.

So this is the first inflation report where I got what I’ve been looking for: Rent of Shelter was up 2% year over year, though Owners Equivalent Rent is still clocking in at 1.4% year over year.

I am still not getting the kind of action I’d like to see in new cars but used cars clocked in an impressive, 5.4% year over year.

This is an indication that stocks in both cars and housing are being to show upward pressure. This should provide the impetuous for an increase in both construction and industrial production.

This Fall looks weak but I am still holding out hope that the fundamentals are going to come through for us on this. Especially with the Fed Funds at zero out to 2013, we should be able to get some action in these two categories.

Doing the rounds on Mises circuit I am usually identified as a liberal or a person from the left. I don’t really much care so I take that ID.

However, I think its interesting to note that Reihan Salam lays out a conservative vision for what ails America that I agree with.

(1)  . . .a series of federal (subsidies for mortgage debt) and local (zoning restrictions, rent regulations, etc.) interventions have made affordable, high-quality housing scarce in many of the countries most productive and regions regions . . .

(2) Resistance to HOT lanes, private toll roads, etc., exacerbates the accessibility problem by forcing us to rely on slow-moving public bureaucracies that face a number of political imperatives that compel them to, among other things, deploy labor inefficiently, devote resources to projects that aren’t cost-effective, etc.

(3) Allowing for more specialized educational providers and providing parents with flexible K-12 Spending Accounts (KSAs) could help drive down the cost and quality of education.

(4) By transitioning to competitive pricing in Medicare and catastrophic insurance for all but the sickest and poorest under-65s, we would in theory encourage the emergence of low-cost business models for the provision of medical care,

(5) Per the Chen and Chevalier research, we could take a number of steps to attack the supply constraints on the number of licensed medical providers,. . . More aggressively, we could further empower nurse practitioners and physician assistants to undertake work that is currently the province of physicians.

(6) Reform of the FDA could drive down the cost of developing new drug therapies, making them more accessible.

(7) And I imagine that patent reform would have a salutary impact on middle class in all kinds of unpredictable ways.

I think number (4) is more or less a waste of time but I am not really against it. Perhaps ironically, I think people focus way too much on the demand side in health care. The demand side is too dominated by signaling and emotionality to get any traction. The supply side is where all the action is.

Now I am largely in favor of redistribution, but as always I ask – what’s wrong with cash?

Bob Murphy continues his thought experiment

In this hypothetical scenario, potential GDP would have gone up 10% in one year. Then real GDP would have crashed 10% (or so) the next year. So if the CBO looked at output in the year that the drills etc. were being produced, they would have plotted a dotted line from that point to the right, and then wondered what the heck happened to Aggregate Demand in the subsequent year to make real GDP crash. After all, the economy would have had the same number of workers and machines.

In this scenario, there’s no “technology shock” or “resource shock” or anything like that. What happened is that people falsely valued goods produced in the boom year. The economy actually wasn’t capable of producing $1.1 trillion of real GDP that year. Yes, businessmen paid $150 billion for the infrastructure to be created and installed, and yes consumer prices in the economy didn’t shoot up to offset the rise in nominal GDP. But those businessmen paid too much for the equipment.

There are at least a few important things to note

1) There is a clear aggregate demand story here. When the oil as discovered there was a positive wealth shock. Indeed, it would be recorded as such in the Flow of Funds report. When the oil was found not to be there there would be a negative wealth shock.

These can and do happen and are recorded. Here for example, is Total Assets of Households and Nonprofits over the last two business cycles.

FRED Graph

You can see the asset value run-up from both the dot-com and housing bubbles and the tiny fall from dot-com and serious collapse from housing bust. So from the point of view of explaining the series of events through traditional AD-AS lense there is no problem.

Interestingly if you extend out the circa 1995 slope you run right into where we are now. But, that’s a story for another day.

2) The other issue is that potential GDP and maximum possible GDP are not the same. The BEA attempts to estimate sustainable GDP and it is possible to exceed that. That is the output gap can be negative.

FRED Graph

As you can see the BEA estimated the economy to be running well above sustainable levels in the late 1990s and only slightly above sustainable levels in the mid-2000s.

3) Now why only slightly above in the mid-2000s. Wasn’t the housing bubble huge? In prices yes. In output, no.

Here is construction spending as a fraction of GDP over the same period

FRED Graph

This is a theme I talk about it a lot so I can go into it more but the boom in housing construction was not actually that big. It peaked around 2005. It was offset by a decline weakness in commercial construction. That picked up in 2005 but was in decline by 2007.  And public construction ran low right up until 2007.

Combine that with the fact that construction is not that big a part of the economy to begin with and the bubble wasn’t really that big.

It looks big in part because prices were so distorting and because single family suburban construction really was moving like gangbusters. That’s where a lot of us live but its not where all Americans live and its not where most Americans work. Urban and rural construction was in the dumpster.

There is a strong argument that this was classic crowding-out though I am not totally convinced. In any case the boom was small and nothing compared to the bust.

Tyler Cowen asks

“They are a cornerstone of Chrysler’s unlikely comeback: 900 employees turning out a Jeep Grand Cherokee sport utility vehicle every 48 seconds of the working day at an assembly plant here.

Nothing distinguishes them from other workers at the Jefferson North plant, except their paychecks. The newest workers earn about $14 an hour; longtime employees earn double that.

…the advent of a two-tier wage system in Detroit is spiking employment for one of the country’s most important manufacturing industries.”

Here is much more, interesting throughout, and I thank Miles Robinson for the pointer.  By the way:

“Workers at Jefferson North said that the pay gap had not created visible tension.”

See the article for some qualifiers on this front, but there is nothing unusual or shameful in using the prospect of promotion to induce discipline.

A simple question: is this a) macroeconomic good news, or b) macroeconomic bad news?  That it “has to happen” may be bad news, I mean “that it is happening,” given initial conditions.  I vote for a), good news, what do you vote for?  What are liquidity trap proponents supposed to answer?

I am voting for good news all the way.

You might argue that lowering wages for existing workers would worsen their ability to service debt. However, this is only for new workers, which means it only improves their ability to service debt and it reduces unemployment and increase capacity utilization at the same time.

The fact that they have seem to overcome the efficiency wage and moral problems that New Keynesians posit is great news. And, that it is news supports the idea that these issues are important in understanding recessions.

There was some rebound from the truly awful August numbers but we are still seeing major contraction – consistent with recession.

From the NY Fed

The Empire State Manufacturing Survey indicates that conditions for New York manufacturers worsened for a fourth consecutive month in September. The general business conditions index inched down one point, to -8.8. The new orders index held steady at -8.0, while the shipments index dropped sixteen points to -12.9. The inventories index, negative for a third month in a row, fell to -12.0—a sign that inventories continued to decline. After dropping significantly over the summer, the indexes for both prices paid and prices received climbed several points, suggesting that the pace of price increases picked up. Employment indexes were below zero, indicating that employment levels and hours worked fell over the month.

Its hard to look at this chart


And not be instantly reminded of this chart

FRED Graph

Suppose that we had a stead upward trend upon which you imposed the chart above. You would get the chart at the top.

Bob Murphy asks

An economy is chugging along nicely at full employment, and price inflation is within the desired range. Real GDP is $1 trillion. Then geologists think they’ve discovered a humongous deposit of oil that will make Saudi Arabians feel like chumps. The problem is, the oil is buried pretty deep. So the oil industry in this country (not foreigners) spends $150 billion buying new drilling equipment and other necessary infrastructure. At the end of the year, the macroeconomists report that real GDP was $1.1 trillion. There was an extra $150 billion in output in the sectors producing the oil equipment, but that was only partially offset by a $50 billion drop in output elsewhere. The apparent discovery of the oil increased the productivity of the factors in the economy, which is what allowed potential GDP to go up 10% in a single year.

The next year, to their horror, the people in the oil industry realize that it wasn’t an oil deposit at all, but just some empty bottles that John Maynard Keynes had buried back in 1936. The entire drilling apparatus overnight becomes almost completely worthless, because it can’t be easily disassembled and shipped elsewhere.

So: Assuming no other technological discoveries or workers gaining skills, real output at best will drop back to $1 trillion in the new year, and will actually be less because some of the maintenance on other production processes would have been shunted into the oil industry the year before.

My question: How would macroeconomists in the CBO do their graphs? Would they go back and mark down the $1.1 trillion “real output” figure in the previous year, because that was obviously a mistake? Or would they say, “No, real output really was that high last year, and it just collapsed this year”?

The short answer is no. Real output in the year in question was 1.1 Trillion. Gross Domestic Product is our attempt to measure real output and it would reflect that.

I think there are a few important concepts related to Bob’s question. One is Net Domestic Product, which according to Bob’s description did not rise as fast as Gross Domestic Product and could possibly have fallen.

Net domestic production is Gross Domestic Production minus the Consumption of Fixed Capital.

Its not beach reading by any means but for those who are really interested I strongly recommend the BEA Conceptual and Methodological Handbook.

A key chart that may prove useful


Now in fairness to Bob’s point the consumption of fixed capital is measured using the perpetual inventory method. Key in this calculation is economic service life, which must be imputed based on historical measures. Yet, Bob is postulating a strong shift in economic service life.

This would not be picked up immediately in Net Domestic Product calculations but would be picked up as the series was revised over time.

Essentially the BEA must wait until the capital has actually worn out early before going back and saying that it was wearing out at a faster than average rate.


However, the oil in the ground in would not factor into any of these statistics at all.

This is GDP and its cousins are attempting to measure productive output and income. The oil was not produced by human beings. Instead it is a measure of wealth. It would be captured in the Federal Reserve’s Flow of Funds report.

The increase in the value of the land under which the oil was located should be captured in Net Assets of Households and Nonprofits. When the oil was found not to be there then a corresponding negative entry would be entered.


Lastly, neither Flow of Funds or NIPA captures the concept of welfare which is itself distinct from either wealth or production. It depends on taken advantage of areas where the total rather than marginal willingness-to-pay exceeds the total rather than marginal cost.


This is of course also distinct from what I would term social welfare, which involves having some non-income based aggregation method across individuals. Of course nothing like this even remotely exists.


A closely-watched measure of Australian consumer confidence rebounded strongly in September as lessening fears of a hike in interest rates and better news on the economy helped offset  turmoil on global markets.

The survey of 1,200 people by Westpac Bankand the Melbourne Institute released on Wednesday showed its index of consumer sentiment jumped 8.1 percent in September to 96.9. That followed hefty drops in August and July and still left the index down 14.4 percent on September last year.

"This is a surprisingly strong result," said Westpac chief economist Bill Evans.

He thought it likely that diminished fears of a rise in rates from the Reserve Bank of Australia (RBA) may have helped sentiment. The central bank made it clear last week that it was best for policy to stay on hold while markets were so volatile.

So I know that the BEA has been trying to snazz up its site recently and some bells and whistles. There is even a flash/silverlight/HTML5 interactive thingy, where you can swap in out and out data.


FRED has an old clinks and text interface but now we have 837 new series on population and employment.

I have to jump off the bus right now. But later today I will show you how deep the rabbit hole goes.

Greg Ransom writes

2 body astronomy has simple, linear mathematical laws, natural kinds, and physical constants.

Economics doesn’t have anything of the kind.

As Greg’s statement implies and physicist well know – once you move to the three body problem the simplicity collapses.

However, our solar system has at least nine major bodies and millions of lessors ones.

We are lucky that one of those bodies is soooo huge that it swamps all of the others. If were not for that the nature and natures laws would be a shrouded in mystery as the laws governing the behavior of economic agents.

Its worth mentioning that once we reduce the number of economic agents in an experiment – which we can and do perform – our basic “laws” assert themselves quite nicely.

Indeed, when we create frictionless environments like financial markets our ability to use mathematical models to interpret predict and earn profit on what happens goes up substantially.

I was going to comment on this comment by Russ Roberts

He treats it like a discovery of fact. As in “Blinder and Zandi weren’t sure of the distance between the earth and the sun but when they measured it, they found it was about 93,000,000 miles.” That isn’t the way econometrics works.

We can and should talk about this more but I would suggests that exactly how econometrics works.

After all no one has – in my jargon – taken a ruler to the sun. No one has actually trekked from the earth to the sun with a tape measure to get its distance.

Indeed no one has even been to the sun or even out of earth’s orbit. People confidently mock those who say the sun is not at the center of the solar system but has anyone been outside the solar system to look down and check? Certainly not.

All of this is based on measurement and inference. And people trust the measurements and inferences of physical scientists even when they make wild conclusions based on highly technical derivations, complex models and slight differences in obscure measurements.

Two guys screw together a few half-silvered mirrors and all of a sudden the passage of time is just a fancy illusion. Is that more convoluted than Donohue and Levitt?

Anyway, Robin Hanson makes my longer point for me

They key difference, I think, is that more interested parties see themselves as losing if the public listens to economists, and these parties therefore dispute economists in public. Such interested parties also influence individual economists, and so weaken within-economics consensus. In contrast, few care enough about what physicists say to dispute them in public.

From the depths of the recession which began in 2007, and severely intensified in 2008:Q3, there has been an ever-growing chorus of (minority) opinion in the blogosphere regarding the nature of the recession, the causes, and the proper prescription for returning the economy to growth. The practitioners of this style of macroeconomics have since been dubbed the “quasi-monetarist” school, of which I consider myself a member. “Quasi-monetarism” has always been a somewhat unsatisfactory title for this group of thinkers, but it has stuck — so far.

Lars Christensen, however, seeks to change that in a new working paper entitled “Market Monetarism: The Second Monetarist Counter-Revolution“, in which he lays out the core tenets of the quasi-monetarist market monetarist view. I will lay out some of the quotes from the paper here, also check out his post at Marcus Nunes’ blog.

The Birth of Market Monetarism

Market Monetarists generally describe recessions within a Monetary Disequilibrium Theory framework in line with what has been outlined by orthodox monetarists such as Leland Yeager (1956) and Clark Warburton (1966). David Laidler has also been important in shaping the views of Market Monetarists (particularly Nick Rowe) on the causes of recessions and the general monetary transmission mechanism.

Put simply, the “market monetarist” view of money says that in a monetary exchange economy every market is a n+1 market, and an excess supply of all goods constitutes an excess demand for the medium of exchange. Thus, the market monetarist view of recessions is that recessions are always and everywhere a monetary phenomenon.

Another key feature of Market Monetarists (and probably the feature from which Lars derived the name) is our determination of the stance of monetary policy, for which we look to market indicators of the trend rate of NGDP:

Markets Matter

In a world of monetary disequilibrium, one cannot observe whether monetary conditions are tight or loose. However, one can observe the consequences of tight or loose monetary policy. If money is tight then nominal GDP tends to fall — or growth is slower. Similarly, excess demand for money will also be visible in other markets such as the stock market, the foreign exchange market, commodity markets, and the bond markets. Hence, for Market Monetarists, the dictum is Money and Markets Matter.

The use of market indicators of the stance and expectations of the future path of monetary policy (as opposed to short-term interest rates) is one of the defining features of the Market Monetarist movement, and it is very important from a practical standpoint. Many errors in reasoning in business/economic news stem from one line of reasoning: “low interest rates = easy money”.

Against Neo-Wicksellian Analysis

Mainstream economists and particularly New Keynesian economists place interest rates at the core of monetary policy. Furthermore, central banks mostly formulate monetary policy with an interest rates framework. Market Moentarists — as tradition monetarists — are highly critical of this approach to monetary policy and monetary analysis, which Nick Rowe has termed Neo-Wicksellian analysis (Rowe 2009).

Market Monetarists particularly object to the use of interest rates as the measure of monetary policy “tightness”…

…This view of course is in stark contrast to the prevailing New Keynesian orthodoxy where low interest rates are seen as loose monetary policy and have a significant impact on how monetary policy is analysed.

As Scott Sumner, and I believe Nick Rowe have pointed out, the movement of interest rates is just one of many effects of monetary policy. Though because interest rates are immediate and visible (indeed, the interest rate on reserves is an administered rate), we are often “tricked” into thinking interest rates are the dog, not the tail.

Interest Rates are NOT the Price of Money

A very common fallacy among both economists and layment is to see interest rates as the price of money. however, Market Monetarists object strongly to this perception. As Scott Sumner spells on in capitals: “INTEREST RATES ARE NOT THE PRICE OF MONEY, THEY ARE THE PRICE OF CREDIT” (Sumner 2011C). On the other hand, the price of money or rather the value of money is defined by what money can buy: goods. Hend, the price of money is the inverse of the price of all other goods — approximated by the inverse of for example consumer prices…

…Bill Woolsey: “An increase in the supply of credit isn’t the same thing as an increase in the quantity of money. While it is possible that new money is lent into existence, raising the quantity of money over a period of time while augmenting the supply of credit, it is also possible for the supply of credit to rise without an increase in the quantity of money. Purchases of new corporate bonds by households or firms, for example, add to the supply of credit without adding to the quantity of money”

While there is a relationship between the supply and demand for money and credit, they are not the same thing.

The Liquidity Trap Fallacy

My favorite, since I’ve been a vocal opponent of the concept of the “liquidity trap”:

In line iwth the reasoning on interest rates above is the Market Monetarist’s rejection of the so-called liquidity trap. Almost every day the financial media quot economists claiming that central banks are running out of ammunition because interest rates are close to zero. This is the so-called liquidity trap. Market Monetarists object strongly to perception that monetary policy is ineffective at rates close to zero. If one single issue has dominated Market Monetarist blogs over the last couple of years, it has been that monetary policy is highly efficient in terms of influencing the nominal economic variables such as nominal GDP or the price level. Market Monetarists do not believe there is a liquidity trap [1]. This is consistent with traditional monetarist teaching (see for example Friedman 1997).

[1] This annotation was added by myself in an attempt to explain what is going on with the concept of the liquidity trap, which has a very slippery definition. Being fair, the original concept of the “liquidity trap” — that of Keynes — pertains to the effect of the so-called “conventional monetary policy instrument” (open market purchases of short-term government debt) on raising the “conventional monetary policy indicator” (inflation) [Update: at the zero lower bound].

However, “conventional monetary policy” is a construct, the same way that other “conventional policies” instituted by governments is a construct. The only “trap” involved is the “trap” imposed by conventional thinking.

Market Monetarism rather than Quasi-Monetarism

Throughout this paper I ahve used the term Market Monetarism. However, none of the five main Market Monetarist bloggers uses this term. Instead, they in general use the term Quasi-Monetarist to describe their views. I am critical of this term, as it does not say anything about the school other than it is a sort of monetarism. “Quasi” undoubtedly also makes it sound like a half-baked version of an economic school.

An economic school’s name naturally should represent the key views of the school. The Monetarist part is obvious as there is a very significant overlap with traditional monetarism. The difference between Market Monetarism and traditional monetarism, however, is the rejection of money supply targeting and the assumption about the stability of velocity is at the core of MArket Monetarists’ reformulation of monetarism.

Instead of monetary aggregates and stability of velocity, Market Monetarists advocate the use of markets as an indicator of monetary (dis)equilibrium. Furthermore, Market Monetarists advocate using market instruments such as NGDP futures, and in the case of William Woolsey — free banking — as a tool to stabilize the policy objective (nominal GDP).

Do read the paper, as it is an interest crash-course in the economic dialog and thinking in the “Market Monetarist” corner of the blogosphere, and includes a possible research agenda. Though I am not mentioned at all in the paper (sad face!), I do consider myself of the “Market Monetarist” school, and I think that the name works well enough. What do you guys think of the name?

P.S. If I have any contribution to make, I suppose it would be my suggestion to redefine inflation as celerity.

P.P.S. If the quotes aren’t exact, it is because I had to type them myself. Acrobat, incidentally, is not a very friendly medium. The full paper should be posted as a blog post! I’d be willing to do it here, if Lars gives me the permission!

Bob Murphy mentioned that the price of gold must be keeping Keynesians up at night. I was on Peter Schiff’s radio show the other day and the topic of gold featured prominently.

Its appealing to think of gold as a true store of value and that fiat currency and fractional reserve banking are fake.

However, the quantity of gold in existence is simply dwarfed by the size of the global economy. This makes it hard for gold to play a fundamental role, even absent concerns about monetary policy.

In human history there have been a little over 5 billion ounces of gold mined.  A good fraction of it is I believe still in existence. About 50% is as jewelry and about 10% have industrial applications, leaving roughly 40% for investment and trade.

That’s about 2 billion ounces. Even at today’s prices, which I would call a bubble, we are looking at about 4 trillion dollars worth of gold. That’s for the entire world to use.

In contrast:

Total liabilities at non-financial US businesses are a little over $11 trillion

Total US Household liabilities are a little over $14 trillion

Total liabilities at US Financial institutions are about $18 trillion

Total US State and local liabilities are about $2.3 Trillion

Total US Federal liabilities are just under $10 trillion

So the US alone is running liabilities in excess of $55 trillion. That’s well over 10 times the value of all gold and its just the US. There is an entire rest of the world we’d have to split the gold with.

This is before we even get into GLD and its efforts to manipulate the world price of gold. Even at gold’s currently inflated rates it can’t seriously backstop even the US market.

I know some people who read my blog know Don Boudreaux personally and perhaps eat lunch with him regularly, so I am hoping this message gets through.

This kind of stuff is just unseemly.

This Keynesian explanation is adolescent. Lazily identifying the symptom as the underlying problem, Keynesians then craft a "theory" that shows just how inadequate spending can in fact cause inadequate spending. How clever of them!

It’s understandable that many people untutored in economics fall for this nonsense. Just as many untutored in geography naturally think the Earth is flat (looks that way, doesn’t it?), many untutored in economics, upon seeing businesses closing up and workers being laid off, conclude that the problem is inadequate spending (looks that way, doesn’t it?).

Really? No liquidity demand? No deep uncertainty? No sticky prices? No monopolistic competition? No dual role for money as a medium of exchange and a store of value? No efficiency wages? No flight to quality?

Just low spending begets low spending. Keynesians must really be ignoramuses.

Its one thing to disagree with a theory, its another to erect such an insulting straw man. Why do this?

I look forward to Boudreaux’s promised column on regime uncertainty. If he has an alternate theory of recessions, then I am happy to hear it. Yet, I would prefer if he did not begin by spitting on mine.

Additionally, if Don Boudreaux wants to debate these ideas personally I will be more than happy to. Not because I want to “show him up” though I know a lot of people watch debates for this. But, because by actually engaging one another’s ideas intensely and seriously I think we can come to a deeper understanding.

Commenter Ed says and Timothy Lee seconds that

You wrote: “One cannot have a stock portfolio that perpetually returns 10% a year inside of an economy that only returns 3% per year.”

That was an incorrect assertion. It is incorrect in theory, and it is incorrect in practice, since it is emphatically not the case that “if there is only one investor who keeps re-investing his dividends.” I mean, the whole point of a 401(k) is that when you’re retired you’ll stop re-investing your dividends and consume them.

You are of course right that the value of stocks cannot grow faster than the economy in the long run. But the “return” on stocks also includes the value that is taken out of the market and consumed rather than reinvested.

This is correct. I should say one can have a stock portfolio that perpetually grows by 10% a year inside of an economy that only returns 3% per year.

You can have a stock portfolio that perpetually yields 10% a year inside of an economy that grows at any non-negative rate.

Though I think we agree that the ability to keep high yields going in the face of continual investment depends on disinvestment. The fact that you are investing in real assets doesn’t change the fact that there is an effective speed limit on the growth of the total market.

He says

The easiest way to see why this argument is wrong is with a concrete example. Suppose we’re in an economy with a 0% annual growth rate. Its stock market has just one stock, ACME, which always costs $100/share. Every year, ACME pays dividends of $10 per share to its shareholders. If you have a portfolio consisting entirely of ACME stock, and you always re-invest your dividends in buying more ACME stock, then you’ll consistently get a return of 10 percent a year.

Now, Smith is right in a trivial sense. Obviously, everyone holding ACME stock can’t simultaneously grow their portfolios by 10 percent per year, because they’d have no one to buy stock from. But that fact doesn’t tell us anything about individual investors. At any given time, some investors will be looking to cash out, while others will be looking to buy in.

This is precisely my point.

So eventually if there is only one investor who keeps re-investing his dividends then eventually he will own all of ACME. At that point the growth rate of his portfolio will fall to zero.

He can still earn a positive yield on his portfolio but he can’t keep growing it because there is nothing left to buy.

Now, of course this will take a long time with one person starting with say $1000. However, if – as the financial industry did – you attempt to sell this concept to millions of people all at the same time you are going hit the “nothing left to buy” constraint faster.

At that point attempts to buy the more stock can only bid down the yield. No more real growth is possible.

I wanted to do this proper with estimates and the like but I just don’t have time. So let me sketch. I am going to leave out links as well, so I can do this pure stream of consciousness.

Garett Jones had this paper where he showed that a bunch of the jobs created by stimulus weren’t really created but taken from other employers.

Some people including Tyler Cowen have suggested that this means stimulus is not as effective as we thought because crowding out occurs through the labor market even if not through the capital markets.

This isn’t right. If you get a 50/50 unemployed to employed take up on stimulus spending then I think that gives you a multiplier around 2. That is lower than some of the estimates but not that low and it presumes that the government is no worse at finding unemployed workers than the private sector.


Well, first let me bat back what I think is the bad intuition. Suppose you had a stimulus program that provided jobs only to the unemployed and was funded through issuing of bonds which did not move the interest rate because the economy was at a zero lower bound.

Well then even ignoring the desire to lower the unemployment rate you got a completely free lunch. You extracted no capital from the economy and you extracted no labor yet, at the end you had some product – a bridge or whatnot.

That would mean that we should have stimulus out the wazoo. There are some issues with providing work that was dignified because I think that’s important for the opportunity cost of idle labor.

However, lets assume the opportunity cost was effectively zero – because we can give people dignified, skill building work – then we should stop only stop spending once we have employed every single unemployed person.

That’s because their actual product doesn’t matter. We are getting the capital and the labor for free so unless the Y has negative value, you are good to go.

It also means – if you assume the private market can do the same thing – that the multiplier is infinite. It works like this. You employ one unemployed person. They use the money to buy some stuff. The market searches another unemployed person to produce that stuff. That person then takes the money and buys more stuff which the market directs to another unemployed person and so on.

You only have to employ one person and then it whips through the entire economy and brings us back to full employment. This is because by assumption here there is absolutely no crowding out in the labor markets.  That means there is a sort of frictionless transference of stimulus.

Now this obviously isn’t how any of us think stimulus works.

That’s because implicitly we are assuming that there is crowding out in the labor market. 50/50 crowding out means that the employment transmition becomes the infinite sum of 1/2 + 1/4 + 1/8 . . . which is of course 1.

Since, you extracted no real resources to start this process off you increase GDP by 1*the initial amount of employment for a multiplier of 1.

So, seeing crowding out in that range is not inconsistent with standard multipliers. If you get 33/66 employed-unemployed hiring then you should get a 2/3 + 4/9 + 8/27 . . . which I think is 2.  That would be a big multiplier.

Just a quick note on this since both Mankiw and Barro brought it up. Its true that investment, particularly business investment is extremely volatile. However, that does not imply that it is the primary contributor to decreased output.

So for example, compare the change in absolute numbers of Consumer Durable Expenditure  (Red) and Investment in Equipment and Software (blue) over the last recession.

FRED Graph

You can see that E&S dipped lower and recovered higher, but not by much. That’s because even though its more volatile it is smaller in size.

Both however, are swamped by residential construction.

Now lets add residential investment (Green)  and government consumption (orange).

FRED Graph

The total carve out in residential investment is much larger than either durables or equipment and software and it has yet to recover.

Also you can see that while government whether the recession pretty well it is strongly offsetting growth in durables and equipment and software.

Another indicator -  one that I prefer in some ways because its real market transaction without a lot of imputation – is to look at retail sales vs. new orders for capital goods.

These are both monthly series and are the actual amounts that companies versus consumers are plunking down cash for.

FRED Graph

Retail and food service is just a much bigger driver in terms of the change in spending patterns. This is simply because it is far larger. We can look at the two in levels together.

FRED Graph

Retail and Food is just much bigger. We can also mix the scales so we can see the relative performance.

FRED Graph

You can see new orders is more volatile as you would expect. Its just so much smaller. That’s why it contributes less.

Tyler Cowen says

Temporary losses tend to be undone in future periods.  For one thing the Solow model implies catch-up growth, furthermore cyclical losses may exhibit mean-reversion.  There is in the meantime some depreciation of labor skills, from unemployment, but long-run output and welfare really does for the most part depend on the forces which govern economic growth.  (Increases in the variance of consumption are not enough to overturn that emphasis.)

The first part is of course true. If the recession does nothing to alter the pace of technological growth (broadly conceived) then it does very little to alter the welfare of citizens in distant periods.

Where I have to take issue is with the bolded section. I assume Tyler is saying yes some people are hurting especially badly, but concern about long-run productivity trumps that.

Well, as always it depends on the magnitudes and in particular how powerful the policy affect is going to be. In the extreme case imagine that we could totally eliminate all cyclical unemployment in the United States and it would lower the GDP growth path by .0000000001%

Just as a note government policy ought to alter the path of GDP but not its long term rate of growth unless it affects technological accumulation. So we would be talking about shifting society a few minutes into the past in order to eliminate all current cyclical unemployment.

Its hard not to take that. You would really have to have an incredibly low discount rate and not care at all about the fact that people in the future are likely to be much wealthier to begin with to think that deal isn’t worth taking.


On the other hand I see another way Barro’s plan could work. He says

I had a dream that Mr. Obama and Congress enacted this fiscal reform package — triggering a surge in the stock market and a boom in investment and G.D.P. — and that he was re-elected.

which suggests to me he is thinking that by altering the long run desired capital stock we could get a boom in investment that wiped out the GDP output gap. This seems highly unrealistic, though perhaps he has some back of the envelopes on it.

On the other hand if households internalize the long run gains as increases in their stockholdings this could repair balance sheets and allow for an increase in consumer spending, which could in turn promote a general recovery.

I said in a previous post

Keynes made the point that there is deep uncertainty and so maximization fails. However, this is only true if maximization is a conscious process. If instead maximization proceeds through evolutionary means this need not be true. The firm doesn’t have to understand what its doing anymore than you need to understand how you are breathing.

Just this morning though I was thinking I might like a thermodynamic/evolutionary view better.

In this case you have lots of firms bumping around like gas molecules in a jar. They have no real idea what they are doing, of course.

However, selective pressure eliminates molecules/firms moving in a particular direction. In real life say, firms serving lower-middle income consumers. These firms are destroyed.

This changes the net velocity of the economy in the direction of firms serving upper income customers. Remember we have to sum-over the velocity of all molecules/firms.

The result we will experience at a macro level is increased pressure towards a an economy that serves high-income consumers. Looking at aggregate we interpret this as an economy-wide movement, but of course we know its selection combined with random motion.

Indeed, if take a far enough perspective it may even look as if the economy planned or somehow organized itself to accomplish this, but no such planning or organization occurred.

Now, where is the rub. The rub is in the “temperature” inside the vessel. If the temperature falls then the molecules/firms will continue along their way but at a slower rate.

And, indeed, the pressure will fall. The economy will look like its going wherever its going at a slower pace.

This temperature could correspond to something like animal spirits. A hot economy causes all firms to move more vigorously in whatever direction they are moving. This means bad firms are selected out faster and good firms move further in direction of progress and so the net pressure is greater.

This corresponds with one of my favorite stylized facts which is that job turnover falls during a recession. This means at least by one measure a recession economy is less dynamic. It even has fewer jobs destroyed.

That could correspond to lower selective pressure.

Here is your gratuitous chart of the effect I speak of.

FRED Graph

This is Total Separations. That’s a measure of how many jobs are being “destroyed” see how tightly it matches the business cycle and our feelings about the economy.

Total seperation, which includes quits does better than total layoffs.  Total layoffs don’t look that different than 2006 and never really rose during the awful jobless recovery of the early 2000s.

FRED Graph

I find that a really interesting an important fact.

Note: This post got a lot longer than I intended but I drifted into addressing a lot of issues. I hope it is not too painful.


I want to stick with this Social Security is a Ponzi Scheme theme for a while because it brings out many of my long standing points.


First, is people fundamentally not getting the nature of finance and confusing real assets with claims on real assets. This is what I am trying to bring out in my stories about Allen Stanford’s Ponzi Scheme and Apple Computer.

People think one is “fake” and the other is “genuine” but in both cases what you have is a financial asset, a promise. And, a promise is only ever as good as the intention of the people making it. Allen Stanford had no intention of making sure he made good on his promises.

In a similar vein I would argue that Apple has no intention of making good on the implicit promise to transfer profits to shareholders. That Sir Allen used investor money to party in Antigua and Apple used it to revolutionize consumer electronics is an important social difference but its not an important difference for the investor.

In neither case do they have any intention of acting in the best interest of their investors. And, further what allows them to get away with this is the power of their reputation. Sir Allen was knighted. Steve Jobs could be beatified if it went to a vote of the American people. Absent a crisis there is no way that investor claims are going to be honored by a democratic state against such popular men.


Second, the long standing problem of affect. Ponzi scheme is a term that is supposed to make you feel nervous and bad. Thus, people who are opposed to Social Security like the idea of attaching this term to it. People who are in favor of Social Security dislike attaching this term to it.

However, in neither case are people really discussing anything of substance. They are making minor points about whether or not their phrasing can win out and thus their affect can prevail in the minds of readers. This is intellectualism at its absolute worst.


Third, the importance of taking ridiculous, sarcastic, facetious and otherwise mocking statements serious. This is a long standing practice of mine for dealing with “class clowns.” There is often someone in lecture who gets a kick out of making snarky comments about what the professor is saying.

Rather than dismissing them, I think its best to treat as if they were a completely rational and well thought out position. Partially, this is because it draws the person into your frame. You can think of it as the opposite of “stooping to their level.”

And, also because it’s a good learning exercise. If something is asinine we would like to be able to say exactly why its asinine.

So here is a cartoon curtsey of the Mercatus Center


Now this is supposed to offend/embarrass proponents of Social Security. Its supposed to allow opponents an opportunity to snicker. However, lets take it seriously and look at the points its making.

I’ll just note a couple of important things about the two pictures first and then we can discuss.

  1. Payer in the Ponzi picture is rich, while the payer in the social security picture is poor
  2. The payer in the Ponzi picture is handing over his money voluntarily while the payer in the Social Security picture is doing so at gun point
  3. The person receiving the money in the Ponzi picture is a private citizen, were the person receiving it in the Social Security picture is the federal government

So, I think that point (1) is not particularly relevant to this analysis. Its relevant to the potentially regressive nature of the payroll tax but that is somewhat orthogonal to the point about “Ponzi schemes.”

What we really want to focus on are points (2) and (3). They are important.

First, point (2) is important because one has to ask why the investor is voluntarily handing over money. In the SS picture it is clear that he has no choice. He is being forced to.

However, in the (2) he is choosing to.


Well, in general because the Ponzi scheme architect has mislead him. He has caused him to believe that the money will be used to create enforceable claims on real resources. This claims will be worth more in the future than the cash is to today. Thus the Ponzi is a good investment.

Indeed, however there are no enforceable claims. Either there is outright deceit as in the case of Madoff and Stanford or there is trickery as in the case of chain letter. The Madoff case takes advantage of the principle of lying.

Lying works by telling someone something that is not true. If they believe you then you can get them to operate on the basis of a state of nature which is not in accordance with the actual state of nature.

Trickery works by taking advantage of someone innate confusion over the state of nature. The victim in this case does not understand the difference between a “hope” and a “legally enforceable claim” and you use that to sell hope as if it were legally enforceable claims.

This misdirection is the key problem with Ponzi like schemes. The problem is not that they are unsustainable and will come crashing down, as I will address later. Indeed, a Ponzi scheme need not crash. Indeed, legalized gambling is effectively an open Ponzi scheme structured so that it will never crash.

Point (3) is that in the Ponzi picture the person taking the money is a private citizen where in Social Security it is the Federal government.

This is also important because the private citizen is bound by the laws of the Federal Government but the Federal Government is bound only by popular sovereignty.

So, inherent in a transaction between private citizens is that the government represents a force able to coerce the terms of this transaction. If the recevier of the money skips town for example, the government will endeavor to find and imprison him.

This means that as long as the two private parties are honest about the terms of their agreement there is a good chance the agreement will hold.

This state of affairs does not exist between a private citizen and the federal government. The federal government can at any time refuse to honor the agreement and ultimately the citizen has no recourse. This is more complicated in the case of formal contracts and division of powers but the basic issues that no one can coerce the institution with a monopoly of coercion stands.

In particular because social security has no contract and exists only at the whim of the legislature, there is no protection whatsoever from popular opinion moving away from honoring the claim.

Thus while the private taker of cash cannot easily announce that he has changed his mind and the giver will receive a “return cut” the government could in theory simply change its mind and say that the giver will receive a benefit cut.

Outside of the frame is also the issue I touched on earlier that the coercive power of the state means that it has no trouble making good on these claims.


Now one final quick word on expectations. So if you got to Vegas, for example, the money you hope to win only comes from money someone else has lost. This is what I think gives people the sense of “Ponzi scheme.” Nothing is being created. Only money is being shuffled around.

However, in Vegas they do not hide the fact that this arrangement yields a negative rate of return. Well if it yields a negative rate of return then it is sustainable, despite the fact that it is just shuffling money.

Now you might say okay but no one thinks that Vegas is an investment. Fine.

However, people do think that the stock market is an investment. Yet, they do not see that it is bound by the same constraints. Investment brokers will confidently and with pride point out how stocks returned over 10% per year since the Great Depression.

They do not realize – I believe – that they are obviously leading their clients to believe that unsustainable returns are possible. The economy is only growing at 3% a year. One cannot have a stock portfolio that perpetually returns 10% a year inside of an economy that only returns 3% per year.

That would imply that the share of the economy claimed by stocks is rising each year. First, this is empirically inaccurate but more fundamentally it’s a problem because one cannot have a sensible claim on more than 100% of the entire economy.

If your claim on economic product is growing faster than the economy this must eventually become the case.

This is why I say the deceit not the money shuffling is the key driver of unfortunate consequences.

We can tell people straight up that they will earn negative returns and then have great fun at a money shuffling party called the Bellagio Hotel and Casino.

Or, we can invest in real resources but lead people to believe these investment will yield unrealistic returns – as in the case of many 401(k)s – and then we are going to wind up with a lot of tears and broken dreams.

Robert Barro has a piece in the NYT on saving the economy. Mostly its an exercise in “Now More Than Ever.”

That it is to say, here are some things that I think are generally a good idea. The economy sucks and people want to do something about it. So, now more than ever we should do what I have always wanted to do.

Now point of fact, I mostly agree with Barro’s long run vision. He wants to eliminate the corporate tax and enact a VAT. I can go with that.

However, again we shouldn’t view that as a substitute for solving our current problems. Moreover, I think this leads us down the wrong path

Today’s priority has to be austerity, not stimulus, and it will not work to announce a new $450 billion jobs plan while promising vaguely to pay for it with fiscal restraint over the next 10 years, as Mr. Obama did in his address to Congress on Thursday. Given the low level of government credibility, fiscal discipline has to start now to be taken seriously.

I do not think today’s priority should be austerity. Today’s priority should be expanding the economy, putting slack resources to work and easing the intertemporal strain on households.

To do this the government should take advantage of its ability to borrow in the credit markets freely, easily and at negative cost. This is a luxury afforded to few entities.

On a deep level this extends from the institutional framework and unquestionable coercive power of the United States government. No other collection of human beings has ever achieved such a thing and there are real yields to having it.

We should not let it wither on the vine.

Greg has a piece in the NYT. A key point

While the sluggish housing market can explain the slow pace of residential investment, it is not the whole story. Business investment has also been weak. Over the last two years, nonresidential fixed investment has grown by only 12 percent, whereas during the two years after the 1982 recession, it grew by 27 percent. Similarly, the narrow category of spending on business equipment and software fell more than twice as much in this recession as it did in the 1982 recession, and it has been slower to recover.

My first inclination of course is to go straight to the data. Unfortunately FRED data only goes back to 1995 and so I have to download the archived data straight from the BEA website and for some reason that is going slow right now.

However, I can respond to this point Greg makes

The great economist John Maynard Keynes suggested that investment spending is in part determined by the “animal spirits” of investors, which he described as “a spontaneous urge to action rather than inaction.” Recessions occur when optimism turns to pessimism, and businesses are reluctant to place bets on a prosperous future. Recovery occurs when investor confidence returns.

I tend to disregard this type of thinking as astrology. Its largely prejudice on my part but I tend to think businesses can be more or less modeled as profit maximizers.

Keynes made the point that there is deep uncertainty and so maximization fails. However, this is only true if maximization is a conscious process. If instead maximization proceeds through evolutionary means this need not be true. The firm doesn’t have to understand what its doing anymore than you need to understand how you are breathing.

Now, what I do believe is that Modigliani-Miller fails and that when businesses are profitable in the current period this affects investment in the current period. This goes along with my general evolutionary view of the firm.

Anyway, that having been said I think the real interest rate is the key driver here. I don’t have a problem with trying to gin up a little business confidence but we shouldn’t see it as a replacement for greater monetary and fiscal stimulus.

So my last post was on Sir Allen and the defenselessness of investors against his attempts to wile away their fortunes.

Now we turn to flower of a different color. One with a substantially better reputation, Apple. Though perhaps we shouldn’t be so quick to separate the two.

Here is a chart of Apple’s stock return along with dividends


You can see that the last time Apple wrote a check to its investors was in the mid 1990s. Meanwhile you can tell by the share price and the volume (lower bars) that most of the money “invested” in Apple has occurred well after that.

But surely Apple is producing a product and making profit much, different than what Stanford did. Well where is that profit going?

Much of it is going into a War Chest that is earning largely negative interest rates.

Its clear why Apple Executives might want to build up a fund to be able to battle it out with Google as long as possible. Its not clear why that is to the benefit of current shareholders.

Lets see what else Apple Executive saw fit to spend shareholder money on:

Here are Apple Headquarters at 1 Infinite Loop, Cupertino, CA


Nice digs. But apparently not nice enough. Apple wants a new facility. One fit for the Masters of the Technological Universe.

Here are so renderings of the proposed new building

Screen Shot 2011-08-13 at 12.10.47 PM

And a cross section

How about the champion of the new Apple, Steve Jobs. Here is the home that Jobs demolished to make way for his new home

jackling house

I don’t have pictures of Job’s new home or his new yacht. But I know the later is being designed by Phillipe Starck. One of Starck’s creations is below

None of this is to say that Job’s is a bad man or that Apple hasn’t done wonderful things. Instead its to compare this level of consumption with the payout to Apple shareholders.

Let’s add up how much of the iMac, iPod, iPhone, MacBook and iPad profts have been paid out to the owners of Apple. Well lets think. . . oh yes I have it now, ZERO DOLLARS! Not one single penny.

So far is this really different from what Allen Stanford did? I hear some of his investors actually got redemptions. But, I am sure Apple investors will get their money some day, right.

I mean how many pioneers who dominate their industry in a world class way ever go on to not pay back their shareholders.

Bernie Madoff had the most famous of the modern illegal “Ponzi schemes”. Yet, Allen Stanford was also a household name to CNBC viewers.

I’ve never quite understood exactly what Madoff was up to. That is, did he intend to run his business legitimately but just couldn’t make the returns he wanted. Was he looking to expand and saw this as “stop gap” that never stopped. Did he go into it fully intending for this to be a scheme. I just don’t know and the few reports I have heard are conflicting.

Allen Stanford on the other hand is really easy to understand. Here was a man who understood the concept of Other People’s Money and took full advantage of it.

You may say oh well in the end he got his. Uh-huh. Let’s review.

Here is a bad scene from Sir Allen’s life

though you’ll notice he doesn’t exactly look depressed. Maybe its because he is still remembering the following

That’s his cricket team winning the Super Series

That’s him cavorting with the wives of some other cricket players. Ones who are losing to his team if I am not mistaken.

That’s him after being Knighted Sir Allen.

This is him making a grand entrance in his helicopter

This is his yacht Sea Eagle parked at his home in Antigua

Stanford International Bank's Antigua headquarters

This is his office in Antigua

Texas billionaire Allen Stanford gives members of the media a thumbs up as he leaves the Bob Casey Federal courthouse in the custody of U.S. Marshals in Houston June 29, 2009. REUTERS/Steve Campbell

This is a picture of Stanford after his three mistresses showed up together to support him court.

You can do whatever you want to Allen Stanford. He is now broke. He got beat up in prison. He may very well spend the rest of his life there. But, he’s 61 years old now. These experience were his life. You can’t take that away.

Once you realize that, you realize the fundamental vulnerability that everyone has in handing over your assets to someone else. There is just no recourse against the other person consuming them.

You have to trust and that’s at the heart of what I call The Big Externality.

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