You are currently browsing the monthly archive for January 2012.

Arnold Kling says

Circling back to Austrian economics, the crisis we are having does resemble the crisis that Austrians were predicting. That is, they thought that money was too easy and that this would result in malinvestment. In his essay on Austrian economics, Yglesias dismisses this because the decline in the economy proved to be so widespread. However, I would argue that the patterns of specialization and trade are so complex and interdependent that the crash in housing could in fact lead to widespread disruptions. It affects real estate agents, attorneys, firms involved in the manufacture and distribution of household durables, and so on. It has huge relative regional effects. It reverberates through the financial industry. It affects people overseas who had counted on an ongoing mortgage securities market.

I don’t think this is really correct either.

There are several problems but I think biggest is that the readjustment that one would expect, and that we got, went off without hitch and was associated with stable unemployment despite the fact that rebalancing had been going on for roughly 3 years, the unemployment rate in early 2008 was no higher than in 2005 – the year residential investment peaked.

FRED Graph

Indeed, a more complete answer might be that rebalancing was halted by a huge increase in the price of oil. That’s what caused that dip in the current account balance going into 2008.

However, while that played a role I don’t think that’s the crux of what went on and its hard to explain why unemployment continued to rise even as rebalancing caught up.

Not to be too, whatever, but I think only guys who got the over outline right were the folks like myself who were harping about collateral values and bank balance sheets and the people who thought that land price declines could have real wealth effects.

My current primary thinking is that something similar occurred. Instead real wealth effects from housing, we had household balance sheet effects. And, in the collateral game the total supply of low risk assets – the collateral crunch – was more important than I anticipated.

I am as I mentioned before also flirting with the notion that part of the whole story of 2000s is a decline in labor’s share of national income and that the drop in inflation expectations and the rise in the dollar in 2008 simply made that adjustment far more difficult.

I should say that Paul Krugman came close. If I remember his argument was that based on Tobin’s Q the US was still over capitalized going in the late 2000s and would have to see a sharp drop in the trade deficit and perhaps even run a surplus.

The fall of the dollar would not be enough to accomplish this and so US consumption would have to contract. However, it would not simply contract on foreign goods but US goods as well and that this would drag the US into recession.

It seemed like that could have been starting to happen in early 2008 but its hard to tell because any possible effects were swamped by the massive balance sheet moves.

Mark Thoma asks

. . . but should economics be value free, at least in principle? I used to think the answer was a clear yes — we should do our best to promote positive analysis and avoid normative — but in recent years I’ve become much more open to other possibilities.

I’m still not fully convinced that we should abandon the principle of promoting positive analysis over normative, I want to believe it’s possible, but as it stands many people disguise normative conclusions behind positive analysis — and these are some of the top people in the profession. (One of the reasons my views have evolved is the surprising and rather blatant political posturing hidden as economic analysis from some top economists on the other side of the political fence — I refuse to sit by idly while those games are being played. It’s also amazing how often economists get theoretical and empirical results that support their political leanings. I’d like to believe that their economics is pure and that it drives their politics, and not the other way around, but given how often prior political beliefs are confirmed through what is supposed to a scientific process, you have to wonder if we aren’t more like lawyers arguing an ideological position than scientists in search of the truth.

I think the vast majority of economics is likely to progress ultimately free of ideological constraint. The simple reason: this too shall pass.

I’ve had conversation with non-economists over whether or not economics will be radically different in the wake of the Great Recession. My answer, is probably not very much. When its all over you will be gone, but we will still be here.

That’s true for most ideologues. When its all over they will go back to doing whatever it was they were doing before. There will be no stimulus package for them to be exercised over. No non-standard monetary policy to make them fret about hyper-inflation. No dismay over progress sending them into the arms of radically alterative statistical accounts of the GDP and inflation.

We will have the luxury afforded to other disciplines, that of being boring.

Some areas will have controversy for the foresee able future – the effects of taxation for example – however, the long project to flush out Daivd Hume’s 350 year old observation that money and industry are somehow connected will recede back into the towers of geekdom.

As per usual I am going to co-sign something that Matt Yglesias wrote.

I don’t exactly want to "defend" the Federal Reserve from the scorn that’s been heaped on it after the release of the 2006 FOMC transcripts, but it is worth paying attention to the timing. . . .

[Residential Construction] enters negative territory in the last quarter of 2005. Then it stays negative all four quarters of 2006, and during all this time the FOMC members are makign statements about how the economy should survive the housing bust. Then it’s negative for four more quarters throughout 2007. And then for the first two quarters of 2008. And all that time from the latter part of 2005 through all of 2006 and 2007 and through the beginning part of 2008, the Federal Reserve is basically doing its job correctly.

Watching at the time it was clear that the US Housing Bubble Burst, the 2008 recession and the Global Financial Crisis three related but definitely distinct things.

Indeed, here is Private Fixed Residential Investment over the boom and bust. Its not my favorite indicator but its denominated similar to what I am going to compare it to. We get a familiar picture.

FRED Graph

Now I am going to layer over-top of that the inverse of net exports. Which is in fact net imports, and subtracts from GDP.

FRED Graph

And, here is the two summed together for the net contribution to GDP growth.

FRED Graph

You can see that by the time the recession hit the Housing-Export complex was actually adding to growth.

Now, why is this an important complex to look at?

Because, as many commenters have noted the boom in residential construction was in large part financed by large external deficit. We borrowed money from the Chinese (and Germans and Japanese) to build a bunch of homes in the United States.

However, the way you borrow money from other countries is by running a trade deficit. As residential construction shrank, so did the trade deficit. This provided the economic offset that kept the economy from going into recession in 2005 as residential construction rolled over.

By the beginning of 2008 though other sectors of the economy – notably non-residential construction and manufacturing, were beginning to weaken. This tipped the economy into recession.

Here is nonresdential fixed investment, a category that includes both nonresidential construction and equipment and software, plotting along with the sum of durable and non-durable goods consumption.

FRED Graph

Both turned downward in late 2007 which brought on the recession proper in 2008.

Both the consumption of services and the government sector peaked after the recession began.

FRED Graph

The growth in both is so strong its hard to see the change, so this is a zoom in.

FRED Graph

You can see the both kinking in the 3rd quarter of 2008. Government goes from slow to an outright fall. Services goes into a much faster fall which it sustains into 2009. That’s the Global Financial Crisis.

We only have real service data going back to 1995 but we can see how different the service and government sector response was this time around as opposed to dot-com.

FRED Graph

In the 2001 recession the hit to government and services is barely noticeable where in this recession there has been essentially stagnation since the middle of 2008.

And, the two sectors together are quite large, accounting for about 2/3rds of GDP.

So, we can see the three events, residential construction collapse, recession proper and Global Financial Crisis all as distinct events.

First, Kevin Drum writes

Just out of curiosity, did anyone ever really believe that "don’t be evil" stuff? I mean, Google’s a big corporation. They’ve been a big public corporation for nearly eight years. Big public corporations are in business to make money and enhance their stockholders’ wealth, and that’s that. Google has long been big enough and profitable enough that they could sort of pretend otherwise now and again, but even that was only bound to last as long as their competition remained weak and ignorable. That’s no longer the case, and Google is responding normally.

I don’t think its immediately obvious whether Google is in the business to make money and enhance shareholder value and that’s that.

They are probably not indifferent to making money and Wall Street will do its best to make sure that they are not indifferent to stock price, over the short term. Whether or not buy and hold forever investors are looked after is another matter.

However, Google is an organization and like most organizations is run by a combination of the moral authority of various leaders and the official chain of command.

What the people who sit atop the chain of command or who command respect within the company want is hard to tell. At one point the dominate interest seemed to be in creating an extremely consumer focused product. Slowly the dominate interest seems to have moved towards empire building.

That is, creating a super massive corporation that leads and is involved in as many aspects of the tech frontier as possible.

For large successful organizations it is difficult to resist the latter pole. This is in part because such organizations attract people who want to build empires. So, slowly the moral authority in the organization begins to shift in an imperial direction.

Second, I appear to be the only person in the world who prefers the new Google suite. Especially, now that you can choose compact.

Reihan Salam writes

There is no denying that corporate profits are reaching stratospheric levels while employment levels are essentially stagnant. If you own a piece of Home Depot or Whole Foods or Amazon, congratulations, 2011 was a banner year for you. But if you’re a typical American worker, well, that’s another story.   

The Commerce Department recently found that personal incomes were $265 billion lower over the years 2008, 2009 and 2010 than had originally been assumed, while corporate profits were $343 billion higher. Indeed, corporate profits now represent 12.6 percent of GDP — the highest number in 60 years.

. . .

An economy that invents more new products and processes will be a wealthier economy — and one that creates more jobs. Until we stop protecting established firms and inhibiting start-ups, we can expect slow growth, high unemployment and ever-increasing resentment toward corporate America.

Obviously its far from clear to me that the owners of corporations necessarily benefit from record corporate profits but lets leave that aside for now.

The issue of corporate profits vs. incomes for the average American I increasingly think plays an important role in the recession.

Though I think of it in a different way. What the macro-economy “wants” to do – for unspecified micro reasons – is to transfer large amounts of national income away from the median household and towards corporations and a working elite.

However, nominal rigidities – in wages, land prices and debt – prevent the macroeconomy from easily accomplishing this. In a smooth world workers incomes would fall, the value of the land that workers live on would fall, the debt burdens of workers would fall and the economy would move forward with a much larger fraction of future output moving into the hands of corporations and small working class.

As a note: I do keep refer to corporations as a residual claimant because I think there are important ways in which corporations actually consume resources as an entity. That is, if you forced the corporation to cash-out to its owners every quarter and then raise cash every quarter, it wouldn’t simply be a transactions cost issue, the resource consumption pattern in the economy would be very different.

In any case, this problem could be solved macroeconomically by increasing the rate of inflation. This would allow real wages to fall, real land prices to fall and real debt levels to fall, while real corporate profits rose to soak up the residual.

The micro issues are more complex and of course its not even completely clear what they all are.

And, to be sure this is just a sense, I am not hanging my hat on this theory.

Accepting the absurdity of everything around us is one step, a necessary experience: it should not become a dead end. It arouses a revolt that can become fruitful.

~ Albert Camus

One of my long themes is that people have a natural – and I believe unexamined – attraction to sustaining certain activities.

The CEO wants to keep his company from going bankrupt. The doctor wants to keep his patient from dying. The statesman wants to keep his polity from collapsing.

However, all companies go bankrupt. All patients die. All polities collapse.

Seeking to sustain these things as an end unto itself is absurd.

In contrast, I argue that life and everything in it is an extraction problem:

How can we take more?

How can we get more out of life?

How can we more fully seize the day?

Those three questions have different frames. The first greedy, the third idealistic. Yet, underneath it all is the same question. Time is short. Resources are limited.

How do we use the time we have, to make the resources we have, fit our vision of the best possible world?

We get wrapped up sometimes worrying whether we are signaling that our vision for the world is noble or that our vision is base. Are we doing it for the good of humanity or only for ourselves?

However, in all cases it is our vision. And, some of the worst atrocities in history were committed by people who at the time genuinely believed that they were making the world a better place.

Part of coming to the world honestly is to know that we are extracting. We are imposing. We are here to change what is into what we wish it to be. That’s the beginning and the end.

Then we can come back and more honestly ask, how do we extract in the best possible way. How do we do the best we can with what we have.

And, how would we know if we weren’t?

Paul says

So what the story of Romney and the auto bailout actually shows is something we already knew from health care: he’s a smart guy who is also a moral coward. His original proposal for the auto industry, like his health reform, bore considerable resemblance to what Obama actually did. But when the deed took place, Romney — rather than having the courage to say that the president was actually doing something reasonable — joined the rest of his party in whining and denouncing the plan.

And now he wants to claim credit for the very policy he trashed when it hung in the balance.

He also says

Cowen apparently wants me to make the best case for the opposing side in policy debates. Since when has that been the rule? I’m trying to move policy in what I believe to be the right direction — and I will make the best honest case I can for moving in that direction.

Look, economic policy matters. It matters for real people who suffer real consequences when we get it wrong. If I believe that the doctrine of expansionary austerity is all wrong, or that the Ryan plan for Medicare would have disastrous effects, or whatever, then my duty, as I see it, is to make my case as best I honestly can — not put on a decorous show of civilized discussion that pretends that there aren’t hired guns posing as analysts, and spares the feelings of people who are not in danger of losing their jobs or their health care.

This is not a game.

But, if this is not a game, and if consequences really matter, then why is it wrong or even cowardice for Mitt Romney to Say Anything to be elected.

Lets take this by its smoothest handle for those with Paul’s perspective on things. The conventional wisdom coming into the 2012 was that the economy was going to be in horrible shape and that it was highly likely that President Obama would lose based on “A Time for A Change” thinking.

That is, swing voters would conclude that the Obama administration has failed and vote for the alternative.

Mitt Romney says to himself, well look either I am the alternative or someone else is. I look around me and all of these other guys are freaking nuts. Much better if I am President than if they are. Unfortunately, to get there I have to do some unsavory things.

However, which is more important to me: avoiding sullying my hands with unsavoriness or preventing the country from being run by nuts.

Would it not be selfish to choose the former? Doesn’t Mitt Romney have a moral responsibility to Say Anything to become the Republican Nominee? If congeniality is not a shield against the moral responsibility of allowing millions of people to suffer then why is honesty?


Another milestone was passed in 1932 when Sears established the store planning and display department. Before merchandise had been fitted into buildings, now buildings were built around merchandise. The first store to be built from the inside out was the Glendale, California store opened in 1935.

. . .

Another important approach to urban customers was made through catalog sales desks, which were installed in the retail stores. In another move, Sears opened catalog sales offices in towns too small to support retail stores.

. . .

In 1969, Sears announced plans to build a new headquarters building in downtown Chicago. The 110-story Sears Tower became the world’s tallest building at 1,454 feet when it was opened in 1973. The staggering amount of materials needed to construct the building included 76,000 tons of steel, 2 million cubic feet of concrete, 16,000 tinted windows, 1,500 miles of electrical wiring and 80 miles of elevator cable.

Sears grew into the largest retailer in the world on the back of path breaking innovation, a position it held until the early 1980s. This morning

Sears Holdings (SHLD.O) suffered a new setback when a major business lender, CIT Group (CIT.N), halted loans that Sears’ suppliers use to finance the goods they sell to the chain.

The news triggered fears that other lenders to the retailer’s suppliers would follow a similar path, making it harder for the company to do business.

"It could start a snowball effect for Sears," said turnaround expert Gene Baldwin of CRG Partners.

Refusal of CIT and other lenders to finance Sears’ suppliers could force it to draw on its line of credit to pay for goods up front, Baldwin said. If too many vendors seek prepayment, banks could be pressured and cut back on lines of credit for Sears, making it harder for Sears to buy inventory.

Not if. When.

Will Wilkinson writes on one of my favorite topics

Some say our sense that life means something is an illusion, or that it would be an illusion if there were no god. Some say free-will is an illusion. These claims confuse me.

The water I seem to see on the hot horizon is an illusion. The bend in the stick in the water in the pond is an illusion. These claims have sense because I know what it is to see water, am acquainted with the sight of a straight stick. But how does free-will really feel? What is it like for life really to mean something? These questions smack of nonsense. What is the genuine article against which to compare the alleged counterfeit?

"That four-sided triangle you saw was an illusion." Does that make sense? No. A four-sided triangle is impossible. There is nothing it is like to see one. There is nothing it is like to seem to see one. The can be no counterfeit of an impossible original. (But what is this an illusion of? Is there really an illusion?)

"That free will you thought you felt, that was an illusion." What? How would you know? Maybe you have a theory that says every event is necessitated by the laws of nature and the prior history of the universe. In such a world, can there be something it is like to experience the absence of necessitation?

There are at least two issues here. One, under what conditions could we meaningfully call something an illusion. Second, does free will fit those conditions.

Will suggests that we would need the familiarity with the genuine experience to meaningful suggest that something seemed to be it, but was in fact an illusion. However, I don’t think that’s quite right.

Suppose that Will came to me announced that last night he had seen the Ghost of Christmas Past. First, it would make sense for someone to argue that this must have been an illusion since ghosts do not exist.

Moreover, if I then showed him a system of mirrors that I had used to create an image of a translucent person, Will could sensibly say, “Oh now I see it was only an illusion.”

This is because despite never have seen a ghost and it arguably being impossible to see a ghost we nonetheless have a consistent notion of what it would mean to see a ghost. If we have an experience that we believe to be consistent with that notion but then is latter shown to be inconsistent with that notion then we can say the previous experience was illusory.

Now, in the case of free will I think we do have a consistent conception of what this means and moreover we can show that there are experiences which are inconsistent with the notion.

There are a number of these but the most convincing to me go as follows.

First, we set up a video camera. Then we open Will’s skull. Then we sever the corpus callosum. We then place a divider between Will’s right and left eyes. We then post a message seen only by the left eye that says “Touch Your Nose”

Will will likely touch his nose.

Then we ask Will. Why did you touch your nose. He might say something like – I just wanted to make sure you hadn’t paralyzed me yet.

We say thank you very much. We sew Will back up and then we play the recoding for him.

Will then sees that while he believed the touching of his nose to be contingent on a process he was consciously aware of, this was not the case. Specifically, it seemed as if the act of touching his nose was contingent upon his wondering whether we had paralyzed him. Indeed, the act of touching his nose was not contingent on that act of wonder.

Because of this we can meaningfully say that Will experienced the illusion of free will.

Paul says

I re-estimated the same kind of rule (with equal coefficients on unemployment and core inflation) in 2010, and got somewhat different coefficients; here’s what the picture looks like with the updated numbers:

Not so close to exit from the liquidity trap, is it?

Some readers may already be asking whether it makes sense to say that the newer version of the rule is “right”; hold that thought for a minute.

Next, as Ryan Avent says, it’s far from clear that the numbers will actually move us closer to the crossover point in the near future. Core inflation, after rising for much of 2011, seems to be heading back down; unemployment may not fall much even if job creation is pretty good, because discouraged workers will come back into the work force.

But the main point is that using historical estimates of the Taylor rule is not a good way either to predict Fed policy or to recommend Fed policy at this point in our history.

Remember, a Taylor rule estimated on historical data is in effect an estimate of how the Fed thinks, not what it should be doing. So if your Taylor rule calls for a positive interest rate, it’s saying that this is what the Fed would do if it still thought the way it did on average over the period 1988-2008

I’m not sure that’s really correct.

The underlying presumption is that the Fed did a pretty good job at stabilizing the macro-economy in 1990s. This means whatever process they used for determining the Funds rate, whether it was smart analysis or throwing bones, stabilized interest rates in the vicinity of the natural rate.

If we then go back and say, well we think in fact the natural rate is a function of unemployment and inflation and then we say well what did they do relative to unemployment and inflation then we have a function that spits out an interest rate which stabilizes the economy around the natural rate.

Now, you might not want to do that. Indeed, I don’t think you want to do that. I think you need to run below the natural rate to catch-up lost growth. However, you could use this formula as a rough and ready guide to where the natural rate might be.

Thus suggesting that we the natural rate may be about to rise above zero – which is what Greg suggested in his original post.

He writes

About a decade ago, I wrote a paper on monetary policy in the 1990s (published in this book). I estimated the following simple formula for setting the federal funds rate:


Federal funds rate = 8.5 + 1.4 (Core inflation – Unemployment).

Here "core inflation" is the CPI inflation rate over the previous 12 months excluding food and energy, and "unemployment" is the seasonally-adjusted unemployment rate. The parameters in this formula were chosen to offer the best fit for data from the 1990s.  You can think of this equation as a version of a Taylor rule.

Eddy Elfenbein has recently replotted this equation.  Here it is:

This is functionally equivalent to my argument about the natural rate. Essentially, Greg’s rule attempts to match the Funds rate to the natural rate (with a little bit of kick on each side for stability).

I never asserted so absurd a proposition as that something could arise without a cause.

~David Hume

I on the other hand will assert something so absurd.

This is motivated by a number of posts I have seen on the methods, limitations and philosophy of science. However, before responding to those individually I think its worth getting out my general view.

My sense is that reality is like a giant block. This block extends in a number of dimensions but four are most relevant for our purposes. The three easily observable spatial dimensions and the time dimension.

At different points within the block some properties of the block vary. These are the fundamental fields. They give the block a composition.

Now, so it happens the composition of the block is patterned. So, that a given value for properties at one point in the block mean that a range of values at nearby points is more likely than other values.

In our everyday experience this allows us to perceive objects. So if I look out and say “I have an arm” I am talking about a pattern in the block.

For example, I mean that if I can only perceive a portion of the block composing the “arm” that I none the less have some pretty strong guesses about what the nearby portion of the block is like. If I then perceive the nearby portions and they do not match my guess then this is surprising. Its surprising because of the patterns.

We can call a specific pattern a shape, so that I can say my arm has a shape. Alright.

That’s all very natural in the spatial dimensions, but the same thing happens in the time dimension. Objects have a shape in time.

The difference is that I perceive space and time in different ways. This possibly extends from the fact that time has a useful meta-pattern. It is this meta-pattern that we refer to as “the laws of physics.”

In any case reality is completely described by the shape of all objects in space-time. This is because the shape of objects in space-time indicates the patterns in the block’s properties and the block and its properties are the whole of reality.

What I think of as science, though I have no interest in claiming the word science, so we can call it sclience if people object is building a map of space-time for the purpose of being able to look up the shape of various objects.

Now for relatively large nearby objects within a particular slice through time this is trivially easy. I open my eyes and boom! I perceive a map of objects. All sorts of fancy stuff goes on in my brain to make this happen but from my point of view its really, really easy.

Unfortunately, this doesn’t work for small objects, far away objects or objects at another slice in time. Which is of course a pain.

So I go about using whatever techniques at my disposal for expanding the map.

The attempt to do this in the time dimension has led people to posit the notion of causality: that if this thing happens then something else will happen. Really though this is just a discussion of the shape of things through time.

Its no different than saying, if I have a forearm then I have a wrist. Its not as if there is some meta-physical relationship between forearms and wrists. And, it wouldn’t really make sense to say having a forearm causes me to have a wrist. Its just that the shape of arms is such that forearms are usually in direct proximity to wrists.

This is the same with the shape of things through time. In time things usually have a certain shape. However, trying to apply some sort of meta-physical specialness to this doesn’t really add anything.

Similarly. its not clear what one really adds with the phrase “everything must have a cause.” There is some shape of things through time, sure. However, are you saying that there must be some identifiable pattern to that shape? I don’t see why that has to be true and its not even clear that it is in fact true.

There could be regions of space-time where all four dimensions are completely mixed-up with no pattern at all.

So, it seems to me that there is no point in getting all emotionally caught up in this notion of causes. We map space-time as best we can and that is that.

Jim notes:

Smith wrote in his original post that:

On the one hand you can buy Apple stock for $375 a share and pay $7 to ScottTrade. On the other hand I also have a trash can in which you can deposit your $375, pay me $5 and I will set it on fire for you.

Clearly, I am offering the better deal as in both cases you have approximately zero probability of getting your money back and I am willing to burn it for $5 whereas you have to pay ScottTrade $7.

He wasn’t saying that there is a risk that Apple will never pay out enough cash to shareholders to justify the price of the stock, but that there is “approximately zero probability” of this happening. If a share of Apple stock has the same value as a pile of ashes, then it is not only worth less $375, it’s worth less than $1. That sure sounded to me like he was arguing that Apple’s stock price of $375 is “too high.”

I do have a long thesis about what looks like an increasing principle-agent problem in American business, though it could simply be an unaccounted for increase in the wages of skilled labor. In either case, however, it represents an immeseration of capital that I think may be under-appreciated.

The above statement though was primarily me being an ass. More formerly one might say I was engaging in hyperbole to stress a point.

That point is that the underlying value of owning stock doesn’t come owning the underlying company, its assets, or its profit stream. It comes from being able to extract real goods and services from that company.

Because we live in an economy where things are usually easily bought and sold, nationwide liquidity is typically not in short supply, and markets and the court system function well, people begin to forget this.

They use accounting methods for valuation. However, valuation always comes from your ability to take. Or more completely, to impose your will on the structure of the universe.

In our much more narrow case this means a couple of related things

  • If no owner of Apple stock is actually in a position to force Apple to transfer command over goods and services to the owner then the stock certificate is just a sheet of paper.
  • To that end, if the management of Apple take steps that lessen your ability to extract real goods and services from them then they make your stock certificate more paper-like.
  • Possession caries enormous power. If I already have command over goods and services ceteris paribus this greatly increases the probability of me having command over goods and services in the future relative to someone’s promise or in this case intimation that they will give me command at a later date.

Now I don’t think these principles are lost on people but they are not at the forefront of their minds. Which is why I think people become so easily confused in a credit crisis or a wholesale collapse in equity values or some other event. And, they speak and act as if things are going “wrong.”

Nothing is going wrong. This is the way things always were.

It also contributes to folks getting tripped up by adding-up constraints and possessing what is generally a greatly overinflated sense of the importance of moral hazard, sustainability and related issues. However, I’ll leave it there for now.

A protracted battle will blunt weapons and dampen ardor. . .

Then even the wisest of counsels would not be able to avert the consequences that must ensue.

Therefore, I have heard of military campaigns that were clumsy but swift, but I have never seen military campaigns that were skilled but protracted.

No nation has ever benefited from protracted warfare.

I am very much behind in commentary but I wanted to throw this out there.

When I asked why don’t politicians simply Say Anything? This is what I had in mind.

From King of PBain

If you wonder why America has lost so many manufacturing jobs overseas, look no further than Mitt Romney – the King of Bain.

Think you know Mitt?

Think again . . .

Quoting the President out of context is amateur hour. This my friends is agitprop.

Jim Manzi replies to me on Apple cash including a post I previously missed. I am going to reply to Jim’s points not necessarily in order.

He writes

I have no idea whether Apple stock should be a buy, sell, or hold, but if Smith is right that the current shareholder base of Apple massively misunderstands the true capital requirements of the business, then he has a huge moneymaking opportunity. If he really believes in his investment thesis, he should borrow a lot of money and short Apple’s stock.

So, I am not actually making any statement about whether Apple’s stock price is “too high” or “too low.” I have a general thesis about the corporate commons but here I was actually responding to the assertion by many folks that Apple’s stock price is surprisingly low and has relatively speaking not kept up with the company’s growth.

My original case is that Apple has increasingly signaled that it intends to burn lots of shareholder value and one has to consider that when valuing the stock. Or, to put it another way one has to consider that the stream of discounted future profits includes a considerable number of negative values and Apple has signaled that it is not taking steps to minimize the number of negative values.

Since, then I posited the reactor model

His most recent post on this subject develops an analogy between the workforce of a tech company and the particles in a sub-critical fission reactor. This is meant to be literally (as far as I can tell) a sketch of a mathematical model for why Apple requires a huge amount of cash on hand to retain its employees. At best, it is pure speculation. And based on any practical experience in a tech company, it’s also extremely implausible that Apple would start to shed important engineers, or be at a disadvantage in recruiting, if it had built up, say, $40 billion on the balance sheet instead of $80 billion.

Its totally true that my model sketch is pure unadultered speculation. However, I think some folks are missing how this would work in practice.

Its not that if Apple had say $10 Billion in cash that some engineers would wake up tomorrow and say, “I don’t know guys I really think I would do better some place else”

Its that 18 months from now, when previously unknown 15 year-old engineer Jenna Markozy invents Gablet, a device that controls your entire professional and personal life by you making simple and highly intuitive clicking sounds that Apple could be in trouble.

If it has only $10 Billion then it will watch as all the top engineering grads head to Gablet and slowly its best engineers bleed over there as well.

If it has $70 billion then it either offers Jenna $30 billion for Gablet or it sets aside $60 Billion to build a Gablet destroyer. In either case it gets keep offering engineers the prospect of working on the Next Big Thing.

Yet, unless Apple got a deal on Gablet or you appeal to “synergies” then its shareholders do not benefit from the purchase of Gablet. Apple simply transferred the discounted present value of Gablet’s profits to Jenna and in return received ownership of the company. At face value this is a wash as far as shareholders are concerned.

Though there remains the strong possibility that the growing Gablet division comes to carry the infrastructure for the rest of Apple, which is equivalent to Apple slowly burning itself down.

Shareholders on would have been better off to simply have Apple dissolve itself and take the cash and invest it Gablet. Or, equivalently for Apple to buy Gablet and then dissolve the remaining parts of Apple. However, how likely do we think either of these scenarios are?

Now suppose that Apple spends its hoard building a Gablet destroyer. This opens the possibility for pure burning of the corporate commons. You might say well no this is just competition and that’s good. Ok.

But, do you imagine a conversation at Apple headquarters that goes like this. We have a decent chance of developing a Gablet beating product. However, if you look at the resources involved the net return is doesn’t make risk-adjusted sense. We should simply continue to produce Iphones and Ipads for the next year or so until Gablet completely drives our sales to zero, then dissolve the company and payout to shareholders?

This conversation seems absurd. Yet, there must exist some set of numbers that makes this the optimal choice. If no one ever chooses it then that is prima fascia evidence that they are not optimizing.

So, that’s how the model would workout in real life.

Jim also says

I’ve started and run a pretty successful enterprise software company, and I generally held a lot of cash on the balance sheet. From the perspective of shareholders, there can be many good reasons for this. First, do you know when cash-on-hand is most important? When nobody else has any. You can buy up the best talent, patents, and assets when they are cheap; you can make big technology investments when they are cheaper; you can make big marketing pushes for the resulting new products when competition for customer mindshare is lower, and so on. When times are good (or at least not catastrophic) it seems like you could always get your hands on cash when you needed it, but that’s least true when you most want it. Cash is the option to act decisively at the moment when this can create large advantages for the company

Now there could be reasons why this could make sense and I have tossed them around before. If this conversation keeps going I will bring them up. However, I want to show why at face value this doesn’t make sense.

In Jim’s scenario he has a lot of cash on his balance sheet and that allows him to make strategic purchases. But, by construction you know who doesn’t have that cash – Jim’s shareholders.

If Jim had paid out the cash to his shareholders then they would have it. And, if Jim could convince them that he really did have all of these great opportunities they could give it back to him. The fact that no one wants to give Jim cash should be taken as evidence that giving Jim cash is not a good idea.

You could say “well maybe there is just not enough cash available period.” This is a monetary policy question and is important but so involved that we should take it up in another post if people are interested.

However, here is the key thing: Having cash for opportunities like this is always a good idea for Jim and for the prospering of his company. But, both the market and the economy are indifferent to this. Jim is simply a vehicle through which resources are mutated into more desirable forms. Whether he or his company prospers is neither here nor there for the economy or for a properly diversified investor.

All that matters is the total return on capital and that’s the question we are trying to get at. There are decisions which undoubtedly help an individual company prosper but undoubtedly drive down the economy wide return on capital.

Apple is apparently holding the cash outside the U.S., so another possibility is that they’re playing for time before repatriating it because they think corporate tax rates might come down. They might be playing any one of a million tax angles.

Yeah, this is just akin to saying that I am reading their signals wrong which of course could be true.

Another possibility: A massive cash pile can discourage potential competitors from entering important markets, because they know you can retaliate by either crushing their foray into your territory or by going after their cash cows. The U.S. will hopefully never launch its nuclear weapons, but we use them every day.

Again, its clear why this is good for Apple. Its not immediately clear why its good for a diversified shareholder who also own stocks in the companies that Apple is deterring. Though, you could make the argument that this helps tacit collusion among large firms are therefore generates monopoly profits for everyone. That is an interesting angle, though many of my IO friends tell me that tacit collusion never works out in practice.

First, big tech companies often don’t pay dividends for a long time, until they do. Sometimes, these dividends are massive and continuing. Second, if there are continuing growth prospects for Apple that require cash (sometimes in ways that aren’t obvious, as per the first part of this post), then it makes sense for me as a shareholder to not want dividends for some time. The present value of the anticipated dividend stream is higher by getting more money later.

The links point to MSFT numbers. I want to do an add up – maybe a reader can do it for me – on what the future dividend and buyback stream would have to be to justify MSFT’s share price at various times discounting by the AAA corporate bond yield.

It may very well end up being that MSFT buyers at any point will have walked away to the good. We shall see.

What’s not clear, however, is that MSFT shareholders are better off having not gotten the money sooner. Mixing MSFT assets with cash reduces the options for me as a shareholder. I could want a bigger stake in MSFT real assets, in which case I would buy more stock with my dividend. I could want the cash somewhere else.

However, forcing a group assets – Microsoft real and Microsoft owned T-bills – to be bought and sold in a particular ratio makes it harder to achieve the portfolio balance I want. It may be the case that with a significantly large portfolio this constraint is non-binding but I would have to think about it.

What seems clear though is that the shareholder is unlikely to gain by imposing this constraint.

I don’t believe in anything approaching purely efficient markets. But any time a journalist or academic claims that some company could create enormous value by taking some simple action, the obvious question to them is, “Why aren’t you a billionaire?”

Key in my claims is that under none of these hypotheses is it in the interest of the Management to take these actions. Whether its in the interest of shareholders to take some action different than what they are taking I am not taking a stand on.

What is true – and a puzzle – is that under some variants of my claims it would be in the interest of private equity to take over the firm. The private equity problem is difficult as well though. Because, its clear how given these principle-agent problems one can create discounted present value using private equity.

Its not perfectly clear how one extracts that value.

Determining the ideal control strategy for economic production is extremely difficult.

David Brooks argues that despite the fact that Liberals constitute the bulk of the American elite, no one wants to call themselves liberal because

The most important explanation is what you might call the Instrument Problem. Americans may agree with liberal diagnoses, but they don’t trust the instrument the Democrats use to solve problems. They don’t trust the federal government.

A few decades ago they did, but now they don’t. Roughly 10 percent of Americans trust government to do the right thing most of the time, according to an October New York Times, CBS News poll.

Why don’t Americans trust their government? It’s not because they dislike individual programs like Medicare. It’s more likely because they think the whole system is rigged. Or to put it in the economists’ language, they believe the government has been captured by rent-seekers.

This doesn’t seem quite right to me.

For one thing a plurality of Americans are Democrats and the growing ranks of Independents are drawn heavily from new voters and former Republicans.

Moreover, I don’t have hard data on this but the demographics should suggest than the ranks of liberals would be falling. A cursory look at America suggests that the liberal fertility rate is well, well, below replacement.

I am very much open to suggestion but my sense is that imbalance between liberal prominence and liberal affiliation probably turns around two related phenomena.

First, the term liberal is heavily associated with the social-sexual mores of the American upper class. Most Americans reject those. And, members of the upper class who are right-of-center on economic issues tend to call themselves fiscal conservatives or libertarians. My baseline sense is because Milton Friedman and his disciples convinced them that this was an acceptable cosmopolitan alternative to the label liberal.

Thus, one has to both embrace upper class social-sexual mores AND be traditionally left-of-center to be comfortable with the term liberal. The term progressive does better precisely because it does not carry that social-sexual baggage.

Second, many racial and ethnic minorities – blacks in particular – are solidly Democratic because they fear white Christian nationalism from the Republican Party. I am not arguing whether such fears are justified but they are undoubtedly real.

This means that when defining the goals and ideals of the liberal establishment, the cultural sentiments of ethnic minorities carry little weight. You are not going to lose the black vote by saying nice things about gays, veganism, or Prague in May.

This allowed Democratic leaders to flaunt their upper class values in a way that Republican leaders could not. Though things are changing for both groups.

Yet, it did not endear blacks to those values and so you still have many black Americans who answer “Conservative Democrat”, when pollsters ask for their affiliation.

As a part of our continuing series. From CNBC

Germany sold 3.9 billion euros of six-month bills at a yield of -0.0122 percent on Monday, the first auction on record with a negative yield.

They go on

The result underscores the safe haven appeal of German debt in the midst of the European debt crisis continues. Negative yields indicate that investors are so nervous about protecting their money that they’re willing to essentially pay an interest rate to keep it safe.

This kind of phraseology irks me a bit as it makes it sound like the key issue is investor preference, but the underlying message is essentially correct.

Ryan Avent writes

A common argument at this point in the discussion is that the Fed is recusing itself from the business of macroeconomic stabilisation and fiscal policy should therefore be used to bring down unemployment. The inflation constraint prevents this, however.

The realization that the Fed moves last is important and I am confident that this is what Ryan is getting at.

However, in the interest of deep understanding its important to point that this is not – in fact  – true.

There is – practically at least, possibility theoretically – no limit on the ability of the fiscal authorities to bring down unemployment regardless of the Fed’s inflation target.

The easiest way to do this would be to raise taxes on current workers and use the money to hire other workers. First order response of this policy be lower  the after tax real wage.

You simply continue this process until the after tax real wage is reduced to a level consistent with full employment at the current level of nominal expenditures.

You face two second order responses, one that will tend to increase unemployment, the other to lower it.

The first, is this: If government workers are less productive than private workers. And, if enough private workers are drawn out of private employment into government employment then total output can fall. This means that the current level of nominal expenditures would tend to produce inflation and the Fed must contract nominal expenditures. This will cause more private sector workers to become unemployed and counteract your effect.

However, so long as the productivity of government workers is not sufficiently negative then this is self-limiting. As the number of private employs falls, the marginal product of private labor will rise. This will offset the total productivity loss and unemployment will still fall.

The second, is that as long as effective labor elasticity is not negative a decline in the real wage will cause labor supply to fall. Falls in labor supply mechanically reduce the unemployment rate.

My progressive friends have been used to pooh-poohing any notion of an economic turnaround. Now, a few of them smile a night with dreams of Smithianism dancing in their head.

Brian Beutler reports

There’s some return on capital in the economy — when you build a new building or piece of machinery it has some rate of return,” Smith explained. That potential return is why in normal times people take risks instead of just hoarding cash — it sets what’s known as the “natural rate of interest.” During the recession, that rate actually became negative, leaving people content to let their money idle at zero interest rather than invest it in the economy.

Years later, things need to be replaced, the housing supply becomes inadequate, and demand increases, pushing that rate up. Smith thinks it’s now higher than zero — and barring an external shock, should be enough to usher a recovery.

“Watching the rents rise, watching the used car prices rise, I thought at some point this is going to catch — it’s going to be a self-reinforcing cycle,” Smith said. “Eventually any recession is going to end from this very effect.”

If that happens in the next few months, throw everything you think you know about 2012 out the window. Republicans have one game plan for beating Obama and it rests on voters believing the country’s best days are behind it. They’re now starting to grapple with their options if by mid-year, the unemployment rate is falling fast toward eight percent.

I see I have some folks interested, so lets keep this going. A commenter writes

To give Karl more data:

I.e. the defrosting of the permafrost areas is expected above 500 ppm. The permafrost layer alone contains methane equivalent to 400 ppm of atmospheric CO2.

That makes 500+400 = 900 ppm of CO2 equivalent. Should I continue the calculations with suspected deep sea methane deposits?

Karl, we are driving a muscle car at 7000 rpm and have no idea what the engine does at 10,000 or 15,000 rpm.

Your point of handling global warming via migration is akin to suggesting that those vibrations that can be felt at 7000 rpm should be solved by passengers shuffling away from the middle of the accelerating car …

My general crisis management strategy is to first consider the far outlier and then work back in.

So, yes lets at minimum assume the permafrost goes and we get 900 ppm. If deep sea methane is even a slight possibility, lets add that as well and outline the scenario.

My understanding is that PETM was equivalent to 1700 ppm.

So at least some baseline questions would be

  • In an extreme scenario can we get to or cross 1700 ppm equivalent?
  • If we reach 1700 ppm-e what is the maximum rate at which the earth could close in on equilibrium temperatures?
  • Will any quasi-reasonable amount of force make our Diff-EQ system overshoot or can we expect a 20C+ ceiling?

Crowd sourcing this will help because so much of the literature is focused on 2C+ or 4C+ max and we really want to talk about 20C+ scenarios.

He writes

File this one under “unmitigated good news”: America’s employment situation turns out to have been rosier, at the end of 2011, than anyone had dared hope. There were 200,000 more people in work last month than there were in November, and the unemployment rate — by far the single most politically-important macroeconomic statistic — fell to 8.5%, the lowest rate in three years. All data series are noisy, of course, and we’ll surely see volatility in this one over the course of 2012. But it really does seem that there’s a bit of fire in the American belly right now, and that things are going to continue to get better over the course of this year unless and until some new crisis comes along.


That is all.

Ken Rogoff has a much commented on piece up at Project Syndicate. I can’t help but feel something must have been lost in publication.

There is a certain absurdity to the obsession with maximizing long-term average income growth in perpetuity, to the neglect of other risks and considerations. Consider a simple thought experiment. Imagine that per capita national income (or some broader measure of welfare) is set to rise by 1% per year over the next couple of centuries. This is roughly the trend per capita growth rate in the advanced world in recent years. With annual income growth of 1%, a generation born 70 years from now will enjoy roughly double today’s average income. Over two centuries, income will grow eight-fold.

Now suppose that we lived in a much faster-growing economy, with per capita income rising at 2% annually. In that case, per capita income would double after only 35 years, and an eight-fold increase would take only a century.

Finally, ask yourself how much you really care if it takes 100, 200, or even 1,000 years for welfare to increase eight-fold. Wouldn’t it make more sense to worry about the long-term sustainability and durability of global growth? Wouldn’t it make more sense to worry whether conflict or global warming might produce a catastrophe that derails society for centuries or more?

So, presumably a “catastrophe that derails society for centuries or more” would lower the “long-term average income growth rate.”

But, if not then not.


Let’s use a numerical example. Suppose that we invented the flux capacitor tomorrow. The flux capacitor alone produced output equal to $100 Million per capita per year – thus greatly increasing the long-term average growth rate.

Unfortunately the flux capacitor was self-consuming. So, its output was set to fall 2% every year from the moment of its creation. Thus, implying that overall output wgeneration after generation would get poorer for probably two centuries or more.

The flux capacitor is by design unsustainable. Its creation will usher in an era of decline for as far as the eye can see. There will be absolutely no economic progress for dozens of generations.

Is the flux capacitor bad?

It seems to me to be greatest invention man would have ever produced. Not to use it would be a moral crime on par with worst atrocities in human history.

Yet, it is unenduring, unsustainable and will derail society for centuries or more.

Is any of that important?

Or is what is important the lives that actual people live? In the world with the flux capacitor people will have vastly more opportunity to build the life that they want and to live their dreams.

That seems like a better world.

Tyler writes

If indeed there is a continuing (modest) recovery, what are we to make of it?  I see a few options:

1. Government responded to the downturn with vigorous policy actions and brought recovery.

2. We were in a liquidity trap, but enough depreciation of capital and consumer durables is pulling us out of it.  As marginal rates of return rise with depreciation, spending will go up.

3. The neo-Keynesian model applies, and enough nominally sticky decisions have been reset to undo most of the initial negative AD shock.

4. The economy had a strong positive technology shock.

5. A mix of default, savings, and refinancing have led to some balance sheet repair.

6. We had a strong positive AD shock through higher global demand for our exports.

7. Banks recapitalized through playing the spread and now they are lending again to marginal borrowers, thereby spurring economic activity.

8. Recalculation has proceeded apace.

(1) certainly played a role in that the Fed did bring the Funds rate down to zero, expanded its balance sheet and backstop the banks. More could have been done and the downturn– I believe – have been shorter. But, less could have been done and things could be worse, see Europe.

Fiscal policy I think moderated the worst of the downturn but probably played very little role in bringing on the current recovery, though it could have played more.

(2) is my main story and I am sticking to it.

(3) is appealing and seems somewhat true in that land prices, for example, have indeed come down enormously.

(4) No, if anything technology is effectively declining as gains from trade with China are falling.

(5) To some extent but non-financial balance sheets are not in that much better shape. High margin companies are still high margin. Households are still heavily indebted.

(6) No, if anything the export shock is weakening.

(7) This was a pre-requisite but it had occurred some time ago

(8) No, this is basically the same economy that existed in 2003. If anything its changing structurally at a slower rate. For example, here is the log of ecommerce sales as a fraction of all retail sales.

FRED Graph

A number of people responded to my posts on Stimulus, Climate and Apple. I will try to respond to a sample. Feel free to comment again if you think your point wasn’t covered.

On Stimulus

Stimulus: Giving money to everyone would be great. Unfortunately, it is a non starter. People are afraid someone else will get more than them. People are afraid it devalues their effort and money. People with money look upon it as an opportunity to prosper at the expense of others and blame them for their situation. When people are threatened in their own situation, they are not amenable to remedying that of others.

My thought is that this why framing it as a tax cut helps. Then you can say, no people just get to keep their money.

On Apple

AAPL is worth its future earnings, plus its cash hoard. Suppose AAPL were to become unprofitable. At that point shareholders could pressure for its dissolution, and, its cash hoard would be distributed– it has no debt, so its assets must be paid to equity holders. Now suppose AAPL remains profitable. Then there is no reason to liquidate, and the company continues to exist, the hoard continues to grow, and shareholders get paid from new shareholders, who in turn have a claim on the hoard. In each case, you have a claim on the cash hoard. Where I think you go wrong is your assumption is that an unprofitable AAPL would maintain a no-dividend policy while losing money, burning through the cash even until debt and liquidation. The current no-dividend policy is maintained by a very profitable company such that investors maintain confidence in management of their cash assets. Were investors to lose that confidence they could always use their votes to change the policy.

I think this is the exact right way to go about the problem. So, the question we would want to ask is how much success will the shareholders have at forcing dissolution. The history of US companies seem to suggest, not much.

Indeed, I am not aware of a major company that went into voluntary liquidation.

More likely it seems to me, is that AAPL would be bought-out and dissolved. However, management can fight this in part by moving their cash hoard into difficult to liquidate assets.

So if we ask, when AAPL is dissolved what is the modal estimate that shareholders will receive, I am guessing the answer is zero. Now, of course the expected value is not zero, but discounting back from the point of dissolution and considering an appropriate amount of uncertainty is likely to give us quite a small number. This should be a source of concern for investors.

Moreover, the larger point is that APPL’s management and staff is opposed to dissolution. At a minimum I think folks should recognize that.

On Climate

Moving to cooler places would likely not work due to difficulties in migration. The world does not currently have an equal population distribution of people over land largely due to constraints by nation-states on immigration. Typically those restrictions have been by the favored restricting the unfavored. There is little reason to expect this would change in the climate change case. Even if it did, as shown in the EU, language knowledge can be a huge barrier to moving even among highly-developed societies without any legal restrictions. While this might not be an issue in large polities such as the United States it’s far from clear to me that many people in the developing nations would have anywhere they could feasible move to in the “too cold” parts of the world.

I think this is good as well. One thing we might be interested in asking, however, is what policy would we advocate if we knew that leaders would adopt our policy. This is by no means the end of the question, but it could help anchor our goals.

Simply based on what we are discussing here it seems like agreement to reduce migration restrictions would be preferable to an agreement to reduce carbon emissions. For one, the immediate effect of the former is to expand global GDP while the immediate effect of the other is to reduce global GDP.

Clearly there are more considerations, but I think the “maybe opening immigration is preferable” argument is a serious one.

I think you are misunderstanding the problem with climate change, because you are focusing on the word “climate” rather than the word “change.” The problem isn’t that hot places will get hotter; it’s that all places will get different. The costs of adapting to change are roughly quadratic in the rate at which the change happens. As climate change accelerates, the costs of adapting to that change will become very high. Under some scenarios, they will become so high that they exceed all our available resources, and our species will become extinct. Under more plausible scenarios, the species won’t become extinct, but the world will just suck, because we’ve spent thousands of years (and more intensively the last couple of hundred years) adapting to a world that was a certain way, and all the benefit of that adaptation will be lost when the world ends up being a different way.

I think this gets to the heart of the matter and helps explain why my position is so weird.

When I read literature on climate change authors make suggestions like: under a worst case scenario our entire civilization could be destroyed within 50 to 100 years.

As some who thinks about capital structure my response is, oh well that’s not so bad. Our entire civilization will have to be rebuilt in 70 years anyway.

The expected useful life on most long lived structures is around 75 years or so to begin with. Expected macro-economic depreciation, however, is significantly faster than that for several reasons.

Maintenance Costs: Over the lifetime of a structure routine maintenance costs will typically exceed building costs by as much as a factor of 3. Thus most of the cost of the structure is not in building it, but keeping it functional. And, even with regular maintenance most structures will no longer be operational or will need major renovations after 75 years.

Population Growth: As the population expands the capital stock is spread over a larger number of people. This means more structures will have to be built anyway to support new people. Indeed, the world population has more than tripled over the last 75 years, meaning that most structures were built for a population size that did not even exist 75 years ago.

Tastes and Technology: As time moves along fashions change and technology changes. People wind up wanting different structures. Often larger and more elaborate than the ones they had before. This implies two things. One, that our built environment is expanding faster than population and so an even greater portion of it is new. Two, that many structures are abandoned, demolished or renovated even before their useful life is up.

Putting all those factors together an effective macro-economic depreciation rate of 10% is not unreasonable. That suggests a half-life of roughly 7 years. Which means that in 70 years we will have gone through 10 half-lives which implies a 99.9% deterioration.

Or to put it another way, within 70 years 99.9% of the value of all of our structures will have come from new construction, repairs, renovations or remodeling that have occurred between now and then.

This is why I suggest that it is not a matter of whether or not we will rebuild our civilization but where.

Add to that the fact that one of our major goals as humanity is to foster growth in the tropics. Which is in large part to say that the current set of structures in the tropics are woefully deficient. Rather than attempt a big build there, why not attempt a big build somewhere else and move the folks to the new place.

Lastly, and most importantly, we have no idea what the end state of global climate change is going to look like. We can only guess and some of those guesses are pretty frightening. There’s a real chance that the CO2 we’re pumping into the atmosphere will eventually cause runaway global warming, an extinction level event for we poor, misguided homo sapiens.

Is this really true though?

During the Paleocene–Eocene Thermal Maximum temperatures were roughly 15C –20C hotter than they are today. Yet, as best we can tell the conditions prevalent at the time were not consistent with a human extinction level event.

Now perhaps things will be different this time. Perhaps it will get even hotter. Perhaps some other dramatic effect will cause the climate to be much harsher. Still, we would want to have some reason for supposing that this is true.

There are many unfortunate things in the world. And, of course, this will all end very badly. There is nothing we can do about that. All that we have is to do the best we can with what we’ve got.

The question before us is: is dramatically curtailing our use of fossil fuels the best we can do?

No, in fact I am suggesting that H. Pylori is the cause of all peptic ulcers.

~ Barry Marshall 1983 just before an entire auditorium walked out on his presentation on the causes of peptic ulcers, previously believed to be the manifestation of a large number of distinct underlying conditions.

From Wikipedia 2012

A peptic ulcer, also known as PUD or peptic ulcer disease,[1] is the most common ulcer of an area of the gastrointestinal tract that is usually acidic and thus extremely painful. It is defined as mucosal erosions equal to or greater than 0.5 cm. As many as 70–90% of such ulcers are associated with Helicobacter pylori

Kevin Drum writes

Don’t forget lead! Lead lead lead lead. When is the connection between reduced lead levels and reduced crime levels finally going to penetrate the minds of American journalists? I know it’s not sexy and I know everyone wants to ignore it because you can’t tell heroic stories about lead, but it’s almost certainly the single biggest contributor to crime reductions nationwide.

I don’t know the research behind lead and crime. However, overwhelmingly the presumption should be that epidemics have a single precipitating factor.

People are sometimes confused by the fact that complex conditions have a long list of necessary factors. However, the odds against more than one necessary factor pushing the phenomenon across the line into epidemic at the exact same time are astronomical.

Not to go to far astray but this is why recessions likely have a single precipitating factor. They spread too fast and burn out too quickly to be multi-casual. A fifty year period of off and on stagnation, that might be multi-causal. An 18% collapse in industrial production over 18 months? That has a vector.

A good rule of thumb – I believe – for epidemics economic, biological or social is this: If it spreads along lines of communication its entropic information. If it travels along major transportation routes its microbial. If it spreads out like a fan, its an arthropod. If its everywhere, all at once, its a molecule.

At least three controversies have caught me by surprise while blogging: stimulus, climate change adaptation and dividend policy.

In each case I felt like I offered a pretty straightforward quasi-obvious take on an issue that was brushed aside in favor of a food fight.


I was obviously a non-player in the larger stimulus debate but the fact that no one echoed my sentiment seemed strange to me as it looked like the basic starting point for a conversation.

In late 2008, early 2009 the economy was crashing and lots of families, businesses and institutions were reporting serious cash flow concerns. Either they were running short or were afraid they would run short. Relatedly credit was rapidly drying up as collateral values were falling and unsecured credit was becoming very difficult to obtain.

So, here is an idea. Lets give people a bunch of cash. They say they’re afraid they won’t have enough cash. We have a cash making machine. Lets use our cash making machine to make cash and then give it to people.

If you care about the weeds of these type of things then I would have suggested that we suspend the payroll tax yet have the US Treasury issue IOUs to the Trust funds of roughly $1 Trillion to cover the approximate value of lost revenue. Everyone still gets their credits.

If you want to be horribly weeds-y then you can say we will have the Treasury deliver $1 Trillion in 13-week notes to the Federal Reserve. The Federal Reserve will then enter $1 Trillion into the Treasury’s account, which will then be used to clear transactions from the Treasury’s account to the account of banks processing payments from Treasury to vendors, employees, retirees, etc.

Yet, the core idea is pretty basic. We use our cash machine to print cash and then we give it to people.

I would expect someone to say: I hear where you are coming from Karl but . . . . and that would be worse than where we are now.

The closest someone came was when I brought it up to Peter Schiff on his radio show and he said “well if that’s such a great idea why not give people $1 million”

To which I replied, “ultimately that would create a lot of inflation”

To which he said, “well then won’t this plan?”

To which I said, “Yes, but 300 times less”

To which he said, “Oh so you think a little inflation is good. I happen to think no inflation is good”

And, that I think, was a conversation with a meaningful endpoint. Peter essentially argued that any inflation was worse than what we have now. I argued that some inflation would actually be better than what we have now.

Yet, most of the argument went like this: Saltwater! Freshwater! Multipliers! Keynesians! Liquidationists! Big Government! Dark Ages of Macro! Pretense of Knowledge! Trains, Yeah! Trains, Booh! Aggregate Demand! Regime Uncertainty! You’re an Idiot! You’re an Ass!

But, the core strategy of looking at a problem, taking the most obvious solution and then at a minimum trying to explain exactly why it won’t work was largely bypassed.

Even if you know the simple answer is a bad answer I think its worth going through this process just so everyone can be on the same page and be sure that they are in agreement as to why the simple answer won’t work.

People will say that this was an ideological problem, but I am skeptical as I’ll explain below.

Climate Change

One of the core ideas behind climate change is that if humans continue to burn fossil fuels then the earth will become warmer.

As it stands there are some places on earth that are so hot that no one wants to live there. There are also some places that are so cold that no one wants to live.

A baseline guesstimate might be that if the earth got warmer then the number of places that were too hot would expand and the number of places that were too cold would contract.

A possible strategy then would be for humans to move from the places that are newly too hot to the places that were formerly too cold.

Now this may very well be a horrible idea. In which case I would expect someone to say: I hear were you are coming from Karl but . . . . and that’s why that plan won’t work.

I’ve received a lot of email and tweets on this issue. I have tried to go through them all. So far I haven’t seen one that comes at it like that. Lots of folks mocked me. Some were kind enough to send along information on exactly how hot the too hot places might get and what the consequences of excess heat might be.

Yet, so far, nothing addressing why moving to cooler places won’t work.

Again, even if we are certain this won’t work its probably worth stepping through exactly why it won’t work. At least so everyone can be on the same page.

Dividend Policy

I’ve made what I assumed to be the banal observation that a key part of how firms compensate their owners is by transferring command of goods and services to those owners. In practice, that is to say, giving the owners cash.

At the same time Apple has sent repeated signals that it does not intend to transfer command of goods and services to its owners.

Now to the extent these signals are accurate I think they would cast some doubt on the potential for Apple’s owners to be compensated by Apple.

Now again you might say: I see where you are coming from Karl but . . . . and that’s how Apple’s owners will be compensated by Apple.

I even have some ideas on how this could happen.

Yet, and its still early, I believe not a single response has addressed this issue. Most have centered around estimates of my IQ. Some have addressed how Apple’s current owners could be compensated by future owners and a few have suggested that Apple is a great company because it does not intend to compensate its owners.

Again though, we haven’t stepped through exactly how the Apple compensation process might work. And, I think its worth doing so that at least everyone can be on the same page.


Now my take on this is that it extends from over-chunking. People try to take on ideas to aggressively rather than cutting them up into tiny pieces. I watch folks around me do this all the time. I even watch them get into bitter disputes over the answer. However, the larger the dispute gets the bigger chunks people try to take. They say, well you just don’t get XYZ where XYZ is some vastly complex set of ideas.

Rather, I would suggest we say ok, lets start with something everyone agree on. Then slowly, bit-by-bit, lets make our way to the point of disagreement. Once there we will often find that the nub of contention is quite small and that the answer is trivially obvious.

Indeed, this is so often the case, that my primary concern is making sure that once we get to the nub the obviousness of the answer does not serve as a source of pain and embarrassment for the person arguing the opposite.

There are a lot of ways to avoid this but one helpful technique is once you get close to the nub act as if the answer is going to be what the other person believes. Then act surprised to find that it’s the opposite and importantly don’t mention that this now proves your point. Simply continue on constructing the argument until the other person says, “You know actually I think you may have been right.” At which point you’ll want to change the subject as soon as convenient, so the other person will not have to ruminate on their wrongness.

There is always plenty of time later for pointing out how awesome and brilliant you are, but if you do it in the middle of a serous discussion it will only serve to hurt the other person’s feelings.

Adam says that he is now open to the possibility that Apple’s vast cash holdings represent a Principle-Agent problem. Indeed, my claim is not even that thorough. My point is simply that many Principles misunderstand what’s going on here.

It could be a classic Principle-Agent problem but my current thinking runs more like this:

Apple’s cash hoard represents a trust fund that keeps its designers and engineers working together and creating spillover effects between themselves. These spillovers are the source of Apple’s profits.

A traditional firm works like the following: You get together some workers, some machines and some raw materials. You use them to create a product which you sell. The workers are paid their marginal product which is the wage. The machines are paid their marginal product which is the rental rate on capital. The materials are paid their marginal product which is the price of commodities.

The organizer of all of this gets a return for taking on the risk of coordinating all of this activity and that is profit.

Now, for princple-agent reasons the organizer often buys the capital outright instead of renting it, so mixed in with the profit is a return on capital.

That organizer is the residual claimant. That means if the organization fails she loses money. If the organization succeeds she makes money. Thus we often measure the wealth of the residual claimant by whether or not the the revenue from the product is exceeding the cost of paying the factors. That is by free-cash flow.

Some folks prefer to use net income rather than free-cash-flow but I think that this is a mistaken understanding of the difference between common equity and holders of other securities, which is more of degree than kind. However, for our purposes this is neither here nor there.

That is a traditional firm.

Now, what about a Tech firm. It works more like this:

We get a gather a bunch human capital together. Each element of human capital radiates ideas. I say radiates because I think the process is fundamentally different than labor supply.

The ideas radiating from one element of human capital hit another element of human capital and increase its size. The radiation from a element of human capital is proportional to (really a concave function of) its size.

As you gather together more elements of human capital the pile grows in size and radiative force. However, because the concave down nature of the growth process several related things are true

  1. The pile can never go fully critical. It can go critical over some small range but the expansion will be self-limiting because of the concave down function.
  2. The marginal radiative return to adding new elements to the pile hits some maximum where marginal congestion outweighs marginal spillover.
  3. The marginal radiative return to each element grows the longer its in the pile.
  4. The marginal radiative return to each element is an increasing function of the size of the elements in its pile.

For simplicity we assume that the radiated ideas are captured by a black-box Intellectual Property mechanism which turns them into output at a one-to-one ratio. One idea yields one unit of output. This is done so that all of the action happens in the pile. We could have just as easily assumed that the pile itself was radiating output but I think that would have confused the matter.

Now here is our core problem. For a mature pile the sum of all the discounted marginal products of all the elements in the pile is less than the discounted total product of the pile. This is because if any element leaves the pile it will decrease the productivity of the pile but it will increase the equilibrium size of the rest of the elements within the pile partially offsetting the loss in productivity.

However, if the all the elements of the pile up and leaves, then the entire discounted total product of the pile goes with it.

My guess is that if we simulated this constraining the payouts to be discounted marginal products that the elements will keep wanting to seek different long term arrangement schemes. The evolution of the process will be completely dependent on the iteration mechanism. That is, who moves when.

One could solve this by creating a pile trust fund. This fund pays out to the elements of the pile who stay in for the entire game, or in our case until bankruptcy.

The cash pile that tech companies amass serves as this type of trust fund. It pays out to the employees who stay until bankruptcy.

If this is what’s going on – and this is just my random musings with no evidence – then there is no principle-agent problem.

What there is, however, is a misunderstanding by some folks as to what the actual residual is. The large pile of cash is not, in fact, free cash flow that can be paid out to the providers of capital. It is a trust fund that must be paid out to the employees.

Likewise much of the projected profits are really best thought of as retained wages, not actual returns on equity.

Karl has been blogging about Apple’s large cash holdings for some time now. His point is that management is taking advantage of shareholders by holding too much cash instead of paying dividends. My initial reaction when he first blogged this was “no way”. Then after the second or third post on it I had been converted to a “maybe”. Karl isn’t alone in arguing that cash holdings are too high, and Apple isn’t alone in guilt; there is a good bit of literature arguing corporations hold too much cash and trying to explain why. While the agency problem may not explain excess cash holdings overall, I do think it is at least one possible explanation, and that it may apply for some firms, especially Apple.

One uncontroversial fact is that cash holdings have been going up over time for firms. There are several explanations for why, and Karl’s agency problem is just one. For instance, one theory is that taxes provide firms with incentives to hold cash, and another is that there are frictions in access to capital markets so firms should hold more cash when shocks become more likely.  A 2006 NBER working paper from Bates, Kahle, and Stulz provides a good overview and some interesting empirical insights. Here is how they summarize the literature on Karl’s agency problem theory of cash holdings:

As argued by Jensen (1986), entrenched managers would rather hold on to cash when the firm has poor investment opportunities than increase payouts to shareholders. Dittmar, Mahrt-Smith, and Servaes (2003) find cross-country evidence suggesting that firms hold more cash in countries with greater agency problems. Dittmar and  Mahrt-Smith (2006) and Pinkowitz, Stulz, and Williamson (2006) show that cash is worth less when agency problems between insiders and outside shareholders are greater. Dittmar  and Mahrt-Smith (2006) and Harford, Mansi, and Maxwell (2006) provide evidence  suggesting that entrenched management actually spends excess cash quickly.

The paper provides some empirical tests of the agency problem explanation and do not find the evidence in support of it:

Agency theory predicts that cash holdings will increase for firms with high free cash flow. Our evidence on the changes in cash holdings for subsamples of firms is largely inconsistent with the agency explanation. In particular, we find that cash holdings increase more in firms that are financially constrained, as proxied by negative net income, than for other firms. Further, larger, more established firms are more likely to have agency problems of free cash flow that could lead to an increase in cash  holdings. However, the increase in cash holdings is much more significant for smaller and recently listed  firms.

I don’t know the literature well enough to say whether or not these results are consistent with most of the research in this area, but they should at least make us somewhat skeptical of the agency explanation. However, while agency problems might not explain the increase in cash holdings overall, Karl could still very well be correct in the case of Apple.

An important and related issue here is that as firms have held more cash they have also decreased net debt, which has implications for the question of whether the corporate income tax is causing firms to have too much leverage. Mihir Desai, for example, has argued:

While excessive leverage is sometimes associated with the tax code because of a presumed debt bias for corporations, concerns over the role of tax policy in fostering the financial crisis appear unfounded…. For the non-financial corporate sector where the presumed debt bias is thought to exist, the startling fact is how unlevered that sector was prior to the crisis.  In particular, the rise of cash balances and the decline of net debt is the  dominant corporate finance trend of the last decade.

He provides the following graph showing that leverage for non-financial corporations is not high by historical standards:

Reading the literature on leverage and the corporate income tax I have moved recently from thinking this is obviously a big problem to thinking that perhaps this isn’t as big of a problem as we commonly think, or perhaps it is not a problem at all. Points to Karl and Tyler Cowen who have both been arguing this.

For his part, Desai argues that there are three main explanations for the excess cash holdings issue:

 1. Weak product market demand

2. Regulatory and macroeconomic uncertainty

3. A coordination problem leading managers to be frozen into not spending

Desai proposes a tax that could fix the coordination problem if in fact that is the cause. Karl’s explanation of an agency problem implies some possible solutions relating to changing shareholder rights, and a tax might help here too. But the relationship between excess cash and low corporate leverage raises the question of whether it is in fact a problem at all. Desai argues:

“…the remarkable underleverage of the  non-financial sector prior to the financial crisis was a saving grace in ensuring that the financial crisis was not nearly as severe as it could have been.”

The overleveraging of banks is a persistent problem that regulators seem unwilling or unable to fix, and this creates serious macroeconomic risks. Perhaps we should just be glad for the corporate sector’s opposing bias against leverage and not worry about taxing it away. Excess cash may be a problem at the firm level, but it could be a boon at the macro level.

This also raises the question of whether we should be reconsidering the wall between commerce and finance. If non-financial firms have a bias against leverage, than allowing them to take banking business from financial firms is one way to eat away at leverage in the financial system. Letting Walmart get into retail banking would be one obvious way to do this.

On the other hand, perhaps allowing non-financial firms into the banking business will just remove their bias against leverage and infect that currently safer sector with the leverage problem. It’s an issue worth discussing more.

Dear Shareholder:

We at Apple would like to thank you for standing by us all through the years. To our original investors we owe particular gratitude. If it were not for you, we of course, would not be here today.

I am writing to you because some have expressed concern that despite having $70 Billion in cash on hand Apple has declined to pay a dividend. Allow us to explain our position on this matter.

Paying a dividend would conflict with our core mission here at Apple. That mission is hanging out in Northern California and being AWESOME. We design the most sought after products in the world. We are building the most advanced headquarters in the world. If we meet a man or woman at a bar in Sunnyvale and they ask “So you work for Apple, huh” we can be confident that the evening is going to go our way. This is a dream come true.

Paying a dividend and burning down our war chest would jeopardize all of that.

You see, one day a competitor will come along and cut our core product line out from underneath us. We will need all the cash we can muster to fend them off. When that cash is done, we will mortgage the company. The first several times we may be successful. However, as is always the case, eventually time will get the best of us and we will be unable to meet our creditors demands.

We will go bankrupt. Our creditors will seize the equity and the shareholders will be left with nothing and having made zero return on their investment.

To our original investors, who are truly dear to us, we can only hope that you have long since sold out to some greater fool. If not, please do so at your earliest convenience.

To our newer owners: We hope you have a wonderful day and a pleasant tomorrow.

Always Yours,

The Management and Staff at Apple, Inc

I have pooh-poohed the notion that we will see an uptick in office construction any time soon. I still think we are a ways off but I am not sure if growth in office construction is as crazy as I once thought.

Here is real per worker spending on private office space.

FRED Graph

We are hitting very low, lows.

On the other hand office vacancies have almost certaintly topped.

Notice for example that our vacancy rate is roughly the same as 1993 but real spending per worker is roughly 1/3 lower. Vacancies will almost certainly decline throughout 2012 and reports of fairly decent rent increases are already swirling.

Its not crazy to think we could have a meaningful uptick here by the end of the year I think and baring disaster 2013 may have some decent building.

Arpit Gupta has a piece on taxes and labor supply.

Here are a few things to remember

Marshallian labor elasticity is what we normally think of as labor elasticity. It measures how people will respond to an increase in their tax rate if the taxes are used to say, pay down the debt.

You have two effects here. One, taxes make working less worthwhile so people work less. Two, taxes make you poorer so you tend to work more

Hicksian labor elasticity is what you get when you take away the income effect. So you pretend that taxes make working less worthwhile but you ignore that taxes make you poorer.

This seems strange but it is important to economists because welfare measures are properly done using Hicksian elasticity not Marshallian.

Frisch Elasticity is a little more complicated but in essence it measures what happens if we tax a consumer and then turn around and give the money right back to her.

This is important because if you think of an economy with a government budget constraint then something like this is happening. Usually the money doesn’t just disappear, you use it for something that presumably benefits the tax payer.


All of that having been said I think when we communicate the effect of “taxes” to lay people we are really talking about Marshallian effects. This is because the pubic thinks about welfare in its own terms and because most taxes fund what are effectively transfers and so the tax payer doesn’t get the money back.

What you should then do is separately talk about the effect of benefits. So, you can see that taxes may have very little effect on behavior as Marshallian elasticities are low. However, benefits have stronger effects as Hicksian and Frisch elasticities are higher.

This makes the whole thing clearer in the non-economists mind. Taxes do not discourage people from working. Benefits do discourage people from working. If we taxed Americans to fund a war in Iran labor supply would probably rise. If China gave a huge gift to the United States to fund a reduction of the SS eligibility age to 55 then labor supply would fall.

This makes sense no?

And, it fits with the differing elasticities that we measure.

He writes

The trend of nondruable goods spending is tracking the pre-recession trend.  So, at this point, we are seeing overall consumption supported by a rebound in durable goods spending that offsets a deterioration in the path of spending on services.  The bounce in durable goods spending will come to an end at some point, as 16 million units is likely an upper bound for auto sales.  Will service spending accelerate to compensate?  Or will we see a new normal, with a constrained consumer spending at a path and rate below those prior to the recession?  I am sympathetic to that outcome, with a corresponding increase in export growth to foster rebalancing of the economy (of course dependent upon growth in the rest of the world, something in question at this point).

But that still is not a story that rapidly returns the economy to potential output.  Which brings me back to a familiar place – putting aside the threats to the economy, it is easy to see a positive growth path for the economy, but more difficult to see a rapid closure of the output gap. 

These are the trends but I don’t know exactly what to make of them. For one, looking at PCE services is a nightmare because so much is housing, finance and medical care. Most of which consumers do not pay for directly and none of which is chosen on a month-by-month basis.

The larger issue though has to do with why we think the economy is depressed. If you think that practically speaking the nominal interest rate is too high then is hard to see a world where autos come back to 16 million units, construction comes back to 1 million units and the economy, the Fed is accommodative and the economy is not booming.

Under both of those conditions the natural interest rate will rise strongly. Fed policy that is now mildly contractionary will become heavily expansionary. This is without any need for more QE.

Projecting these trends out into the future without a narrative about how they interact doesn’t make a lot of sense to me.

Now, yes the Fed could tighten in the face of rising prices and keep the gap going. However, if it doesn’t tighten and if contagion from Europe doesn’t kill us then it looks like the natural rate is set to rise which in turn means it looks like general Fed policy is set to turn accommodative.

I know you don’t smoke weed, I know this; but I’m gonna get you high today, ’cause it’s Friday; you ain’t got no job… and you ain’t got shit to do

The headline number at 200K is decent. As always we care more about the internals.

  • Construction up 17K, almost all of which was non-residential specialty trades. I am guessing this means oil and gas extraction installations. Combined with the 8K mining jobs, that would mean 25K jobs in December from natural resource extraction. Don’t sneeze at this.
  • Manufacturing up 23K with metals and motor vehicles doing well. This is as expected.
  • Non-Durables were flat. I still need to spend more time with this but from looking at the industrial production data this is where we are weak. Its not clear what’s going on here. Is this trade related? Has there been some technology change I am not aware of? I don’t know, but non-durables have been surprisingly weak.
  • Wholesale and Retail Trade clocked in at 12K and 29K respectively. Not bad and consistent with rising consumer expenditures.
  • Transportation came in big at 50K on 42K couriers and messengers. I am not sure if that is a strike resolution of something, but keep that in mind.
  • Information managed not to fire people, coming in at 6K, call that a win.
  • Financial Services likewise clocking in at 2K
  • Professional and Business Services was weak at 12K with a particularly disconcerting drop of 8K in Temp workers. We always like to see temps going up as they lead the cycle
  • Ed and Health added 29K, YAWN
  • Leisure and Hospitality added 21K with a respectable 24K going towards food service. This is always important to me for several reasons. One, we don’t get a lot of real time data on food service despite it employing nearly as many people as manufacturing. Two, this is where the marginal worker gets a job. When you need “a job” you see if the local bar and grill is hiring. They are. That’s good for low skilled Americans.
  • Government shed12K workers with a still amazing 9K local government education workers. This has gone on well longer than I thought it would. Perhaps, it will keep going on but the fundamentals are not there. We should be adding teachers. Not in the moral sense but in the sense that retail sales, and hence sales tax revenues, are rising and class size is something that parents as consumers care a lot about.


All in all, it’s a decent report. In line with the Smithian view though we have to look harder at that messenger and courier number. We are seeing an increase in autos as expected. Construction has not yet kicked as expected.

The rest of the private sector economy is humming along at decent rate. Here is Private Sector Service growth over the last decade.

FRED Graph

Today’s number of 164K is well in the median of what would expect in the current climate.

Here is goods and government over the same period

FRED Graph

and a zoom in on the last year since I don’t know how to ex-census from FRED

FRED Graph

Today’s Goods and Government number of 38K is a nice positive and its really where we will be looking to for the strength in the economy as we move forward in 2012.

Most folks don’t work in Goods and Government but most of the action happens here. If Goods and Government starts clocking in with number like 75K to 100K then the economy will be booming.

Business Insider has some commentary on 2012 GDP estimates from some the major banks.


I would have to sit and count each sub-sector to come up with a number but 2.2% sounds low to me. The 3% number sounds more reasonable.

Bank of America: This answer sounds like pure charting to me. The future will be like the past, only more so. I don’t see in particular reason to think that exports will be a strong factor in US growth. For one, increasing oil prices will drive down net exports. For two, a falling Euro will cut into US exports not only to Europe but to the developing world as European firms compete against American firms.

If you think the Euro is not going to fall then you should say why.

CITI: This is a non-answer


Deutsche Bank: Someone here reads Modeled Behavior. Or, the actual BEA tables. Notice the separation of business equipment, which is another term for transportation equipment, from Equipment and Software. I like it.

Goldman Sachs: Non-Answer

JP Morgan: The first sentence upsets me a bit. Did you even look at the sub-sectors? Is it not clear that the strength is from a mild bounce back in transportation equipment combined with a roaring boom in IT equipment and software that was barely impacted by the recession.

If you think that we are returning to sustainable levels then you think that E&S will continue to be strong. If you think that something has changed about the software boom then that’s another story.

Housing and other structures are also obviously very low but what’s the case for 2012. Its not the same for housing and non-residential structures from where I sit.

I have heard numerous reports of folks with different insurance being denied at the pharmacy. Which means that a number of people I know are already “off their meds.”

This is not going to be pretty folks. Seriously, someone needs to get on this.

Nick Rowe writes

There are 4 possible positions to take on the debt. One of them doesn’t make sense; the other 3 do. Which of those 3 is right is an empirical question.

Here are the 4 positions. I gave each one a name. I made up the quotes.

1. Abba Lerner.The national debt is not a first-order burden on future generations. We owe it to ourselves. The sum of the IOU’s must equal the sum of the UOMe’s. You can’t make real goods and services travel back in time, out of the mouths of our grandkids and into our mouths. The possible second-order exceptions are: if we owe it to foreigners; the disincentive effects of distortionary future taxes; the lower marginal product of future labour if the future capital stock is smaller.

2. James Buchanan/uneducated person on the street.The national debt is a burden on future generations of taxpayers. Foreigners are basically irrelevant. Any second order effects of distortionary taxes and lower capital stock are over and above that first order effects of the taxes themselves.

3. Robert Barro/Ricardian Equivalence.The national debt is not a burden on future taxpayers (except for the deadweight costs of distortionary taxation) but only because ordinary people take steps to fully offset the burden on future generations by increasing private saving to offset government dissaving and increasing bequests to their heirs to offset the debt burden.

4. Samuelson 1958.If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.

I personally was taught 1 as an undergraduate. And I believed in 1 until about 1980, when I spent some time reading Buchanan and Barro arguing with each other. And I worked 4 into my own beliefs soon after.

And now, I believe 1 is false. The truth is some sort of mixture of 2,3, and 4. What precise mixture of 2,3,4 is true is an empirical question. My prior is one third-one third-one third.

Okay, I really will resist the urge to make this about something deeper but I absolutely insist that you read Eliezer on “If a tree falls in the forest . . “ which is basically the same question Nick is pondering.

I think that 1, 2 and 4 are essentially correct and that 3 could be, it just happens not to be in the world we live in.


I think a lot about debt dynamics and so (4) is how I usually frame the world. It is indeed true on average in a country that conducts monetary policy like the United States. The economy will outgrow the risk free rate of interest. The intuition is actually the exact opposite of Nick’s. If it wasn’t true then it would be possible for a single saver through the magic of compound interest to acquire claims on the entire economy. If there are even two such savers in the entire economy they will prevent one another from doing so.


Lerner’s point in (1) is that government spending takes command of good and services in the current period. Thus the opportunity cost of using those services is borne in the current period. This is true irrespective of how the government spending is financed. Its true if there are taxes, bonds, confiscation, money printing, or simple trickery.

If you are concerned that the government – as neither a utility nor profit maximizer – will make poor use of goods and services then this is what your concern centers around. The potential economic inefficiency from government spending that takes place in the current period.

This is highly relevant for macro policy as many macro economists claim that the opportunity cost of goods and services is extraordinarily low during recessions and thus the government should take command of them.


Buchanan’s point is most accurately – in the sense of being true not necessarily what he meant: the utility costs of government action always come at the point of the forcible rearrangement of claims. When claims are rearranged via consent no one faces a reduction in utility. It is only at the point where claims are forcibly adjusted that people feel the pain of government action.

Its important to note that spending is neither here nor there. We could collect taxes and then throw the money into the river. We could simply order Jim to give $500 to John. We could order that Taxi fares will be $10 per mile. We could order that no one will eat chicken on Wednesdays.

It doesn’t matter. It’s the fact that government is forcibly rearranging claims that matters. This hurts and it hurts when the rearrangement occurs. By using bonds we can push the rearrangement into the future so that the pain of government spending is felt later.

This is basically correct except for the fact that if people see the hurt coming they will take defensive behavior and draw some of the hurt backwards in time. Which leads us to.


People recognize the distributional consequences and are aware that if someone receives a bond for $100 as an asset that someone else must face a liability of $100. To the extent the bond is an asset the future tax is a liability because they are fundamentally connected.

I think this winds up failing in practice for a number of reasons but primarily because the bond holder can know with probability one that he has an asset. But, the sum over all probable liabilities for all current citizens will not equal one because it is not only possible but likely that the tax will fall in part on residual claims that are not yet in existence.

Obviously, there are immigrants and children who are not completely accounted for by their parents. However, there is also importantly technology which is not yet in existence.

For example, the owners of Facebook will pay part of the debt for the military build-up in the 1980s. However, the return on Facebook extends not simply from physical and human capital that was deployed in the 80s or could have been foreseen to be deployed in the intervening period. It is also the return from the development of the internet, which creates a set of residual claimants who cannot be known in 1980 nor can anyone in 1980 take action based on the future creation of this claim.

Put simply, suppose Mark Zuckerberg was 100% owner of Facebook and faced all of Facebook’s burden. Suppose also that the Zuckerberg dynasty was completely aware that this was going to happen. What would they have done about it in 1980? Nothing. Because the claim falls on a tech that does not exist in 1980, nor do they have any direct influence in creating – that tech is the internet.

UPDATE: Nick Rowe drew me in so its his fault, not mine. The point of the Eliezer link is that “is debt really a burden on future generations” is a non-question. Just like “If a tree falls in the forest but no one is around to hear it does it make a sound”

The question is: what states of nature do we expect to actualize.

In the tree question we expect that any measurement of air vibrations will produce a positive result but we also expect that no human mind will process these vibrations as the experience of sound.

This is the beginning and the end of the question. There is no “does it really make a sound” because really making a sound is not a thing. It only feels like it’s a thing because of mistaken wiring in the human mind.

Similarly, really being a burden on our grandchildren is not a thing. There will be a different mix of products produced within the economy. That is a thing. Some people will be happier. Some people will be sadder. Those are things.

However, really a burden, that is non-thing. There is no really. There are only states of nature.

As I mentioned before, I am tickled at the people have taken to calling me an optimist.

I can assure you that I am always up for a conversation on how this will all turn out very, very badly in the end; how your life has no fundamental purpose or meaning; and how creating new life is an act of selfish violence for which the perpetrator is forever indebted to the person on whom life was inflicted.

And, yes I have been party to creating new life. Yes, it was selfish. Yes, I owe a debt to that person. No, I do not in anyway pretend that I have done him a “favor.” To pretend such is deeply, deeply vile.

At the same time, the data is the data. Sometimes it suggests that the near future will be contain events we think of as favorable. Sometimes, it suggests the near future will contain events that we think of as unfavorable. This has nothing to do with my or anyone else philosophical disposition because it is a product of the unfolding of impersonal forces.

Event chains will go one way or they will go the another. Nothing more. Nothing less.

People do have a tendency to project their own feelings about the world generally on to their forecast of how events will unfold. This is obviously bias and its not clear to me why its so widely accepted as normal.

Now, I do think there is some genuine misunderstanding here, but I see for example that people who think that Presidential election will not go their way or that middle class America will face relative impoverishment tend to have negative forecasts about the economy.

Some of that may be a general tendency to just attribute to much influence to Presidential elections and middle class wellbeing. However, I do think some of it is a tendency to think that in a world where things are not going your way, things will tend not to go your way.

However, “going your way” is something that exists inside of your mind only. The world has no idea whether or not it is going your way. It is simply doing what it does. So the fact that lots of other bad things are happening is in-and-of-itself not predictive that more bad things will happen. This is because bad doesn’t really carry any metaphysical power. It would need to happen to be the case that your sense of badness was aligned with the mechanics of the world.

As a last note I wrote on the back of my business card some months ago: Obama 49, Romney 48. I handed the card to columnist from the Daily Beast who speaking at the same event I was. I don’t remember his name.

I think that was a bias free guess based on my interpretation of economic fundamentals. We’ll see how well I do.

As a starting note, if we are indeed in “The Turn” then am I am fairly confident that I will be the only economist to have correctly called in real time all the following:

  • Start of the Recession: I announced in Jan of 08 “The US is now in recession” missing NBER by one month
  • The Global Financial Crisis: I predicted a looming “Japanese scenario” in early 2008
  • The end of the Recession: I announced in July of 2009: “The US is no longer in recession” hitting NBER on the nose.
  • The Turn: I predicted a pick-up beginning in autos and spreading to multifamily and the rest of the economy in the Summer of 2011.


Now to the data.

The obvious releases. ADP forecasts roughly 325K new private sector jobs in Dec., which if it holds under revision would make it the strongest ADP report ever.

FRED Graph

New Claims for Unemployment Insurance falling to 372K, well into growth territory.

Here there has been much talk about the Seasonal Adjustment so lets just glance at the Non Adjusted Numbers.

Here is the last 10 years

FRED Graph

Now here is the last year plus, that will be a little more helpful in seeing the seasonal patterns.

FRED Graph

The mini-spike we just passed corresponds to the first mini spike on the left. As you can see we are about 50K below it.

Perhaps more promising is that the huge spike on the left should be occurring for us starting this week and peaking two weeks from now. We’d have to add an additional nearly 300K new filing to meet that peak and we are not nearly on pace to do that.

This means its likely that the we will be well ahead of last year in terms of new claims. Finally, we can look at raw year over year change to get a sense of the pace of the fall.

FRED Graph

We are running about 40K clams les than a year ago, which at this level is a bit more than a 10% improvement.

We also got some descent news out Challenger and Grey though that rarely update my priors very much. Its not bad data, it just doesn’t contain much new information.

What I really care about is the RIES data. This is what matters. All this other junk is ultimately backwards looking. I want to know what the marginal productivity of capital in the United States is and the potential for investment going forward.

And, remember capital and buildings are largely two different words for the same thing. And, what do most of our buildings do? They are a place where families sleep and eat breakfast.

RIES has data on apartment vacancies:

Straight down like a bullet.

Not only are we likely to see an increase in the number of folks looking for an apartment this year, but we will have a record – yes record – low number of new apartment buildings coming online this year.

I need to spend some quality time with this data series but I am pretty sure that we can be confident that 2012 will give us the tightest year of apartment vacancies in recorded history. Yes, the tightest year in recorded history.

I will see how much time I can devote to this data over the weekend and give an update next week.

This in turn means higher rents.

Higher rents do several things.

1) They make building new complexes more profitable and importantly an easier sell to the bank. I should do a whole post on this, but there is this important phenomenon where its very hard to sell a bank on the potential of low vacancies but very easy to sell the bank on actual low vacancies.

I think this stems from the fact that its always in the borrowers interest to lie. In any case what it means is that for financing reasons you can have big overshoots in massive construction projects like offices and apartment building. Too few before the boom, too many afterwards. We are in the way too few stage.

2) This make single family rental conversion more profitable. I was actually in this business for a while. It’s a pain in the ass. It really is. You can see why almost all single family is owner-occupied. However, there are times when the profits are just too juicy to pass up.

There are times when the current rent – current rent – will pay your mortgage, taxes, insurance, maintenance plus a buffer on a property This means you need no rent increases to make this deal work and the property could literally be worthless when the mortgage is up and you still would have made money.

You can’t walk away from it. Investors won’t walk away from that. Its too juicy. Even if it does mean 4am calls about a domestic dispute that wound up smashing your windows and now the kids are freezing.

3) They make buying make more sense. Folks have to live somewhere. You look at rents and they are screaming higher. Then you look at a potential mortgage lots of young couples will say – who cares about the property value – the mortgage alone makes it worth it.

Don’t underestimate the ability of wide-eyed young couples to do this. I had a family member just buy a home in what we affectionately call “the hood.” Her and her husband have solidly middle class jobs. The mortgage, however, was lower than their rent.  When you are young and feel like you can handle the neighborhood, whether it is full of foreclosed homes or folks engaging in off-label pharmaceutical sales, you will take it.

All of those things are positive for recovery.

What we really are looking for now though are multifamily starts. Apartment buildings. I am not calling for a million SAAR on multifamily, but I am already saying that this is not crazy. And, it would represent a transformative boom.

A boom that will not only pull America out of the slump but change the way our cities look. If our cities will have them. I’ll outsource that conversation to Ryan Avent and Matt Yglesias.


Seem to have ended the year strong but not quite as strong as I might have thought. I was looking for continued gain, up to 13.8M SAAR or so and it doesn’t look like we will see that. The numbers for Honda and Toyota are key as I had expected a stronger rebound from them than we are seeing so far.


Construction ended the year completely as expected, up slightly mainly on residential multifamily. Public construction seems to have stopped falling and this is consistent with my view going forward. We should see sales tax receipts improve for state and local governments and with that a willingness to fund more projects.

Non-residential construction will probably continue to be driven by oil exploration well into 2012. The office market just doesn’t feel ready to come back. Though we might see increased hospital construction. I would have to look more into that.

Fed Policy

It looks like the Fed is building the institutional infrastructure to make a creditable commitment to be irresponsible. Of course, it is couched in terms of the Fed making explicit what it thinks a responsible path for interest rates would be. This is potentially very helpful, but it naturally depends on how bold they are willing to be.


Kevin Drum makes the point that the global economy is energy constrained. I think that is correct and it underlies some of views about US energy policy. I don’t think we are likely to see “many" wild swings in oil prices, though. Such swings generate a huge arbitrage opportunity. To take advantage of it what you need is a place to store excess capacity. Oil – being the accommodating resource that it is – provides that naturally. We call it the ground.

In a world of high prices and tight capacity the smart thing is for folks with shallow wells to actually decrease pumping. This will lead to higher prices sooner, but smaller spikes as you start pumping only during the spike.

Also, its not clear that in the face of very easy money that this has to be contractionary. I’d have to think more about it, but the natural response is to push labor and capital towards energy extraction, conservation and alternative production. What’s key is that high energy prices should make the Fed less hawkish not more.

Growth is Banal

I wanted to do this as post titled “BREAKING: Humans primarily concerned with survival and procreation.”  My point is that Matt Yglesias is right that economic growth is primarily about doing the same old stuff in new ways because quite frankly the range of stuff that most humans want to do is not that wide.

Fruit Tree Recessions

Nick Rowe does business cycles with fruit trees. I should write more on this but if Nick reads the following he probably know what I mean.

If there is uncertainty in this economy then Y will not equal C, properly defined, because some folks will hoard trees and allow the fruit to go uneaten or at least use it in some non-typical way.

Further, the propensity to hoard trees should create a bond market and an interest rate which reflects the desire of folks to tree hoard.

Ron Paul

I take the opposite position as Will Wilkinson and Adam. To quickly get to the heart of my opinion, even if Ron Paul were at some point an out-and-out white supremacist, I don’t think this should be a permanent albatross around his neck.

I have an easy time forgiving these things because I grew up in an environment where homophobia was simply the air that we breathed. The things I have said, and honestly done, bring me to tears when I think about them.

I am forever sorry. I cannot even bare to ask for forgiveness.

Why A Recovery Now

Brad Delong asks why I think the recovery is starting now and how fast it will be. So the short answer is I don’t know how fast. It depends on how fast the natural rate of interest rises and how long the Fed signals that it will keep the overnight rate at zero.

My answer for why now and not before is that what drives of the natural rate of interest in this environment is marginal productivity of capital, which rises as the capital-to-labor ratio falls from depreciation and population growth.

When we think of growth models we usually have something like a factory in the back of our heads but the same thing should apply to household consumption. More folks combined with older cars and no new housing units increases the marginal return to durable goods.

Eventually it rises high enough to push the natural rate above zero. What I was looking for were signs that this was happening which I expected to show up in rents and used car prices. Both were rising through the middle of 2011, telling me that this would likely begin to happen in 2012.

Yves Smith is Not a Smithian.

She rips into Matt Yglesias’s Smithian take on 2012. A couple of things to note.

  • I don’ think the distressing gap tells us much as a predictive device. The short answer is that its not clear which way the gap will close.
  • I don’t think the shadow inventory is hyper relevant as far as my forecast are concerned because if the houses stay vacant the people have to go somewhere – likely apartments. Moreover, these numbers actually aren’t that big when you compare them to the short fall in housing production. And remember a multifamily project can take over a year to complete. So when we are talking 2012 starts we are talking 2013/2014 inventory.
  • The point about the Wicksellian natural rate is not that it is determinate of rates we see but that it tells us whether the prevailing rates are contractionary or expansionary.
  • Lastly, and this is a long conversation, I just don’t think its true that middle class incomes will need to rise for the economy to recover. The quickest road to recovery in my mind would be an inflationary burst that caused middle class debt burdens to erode but real incomes to fall. The set-up of the global economy right now seems to be to shift income shares towards resource extractors and a high earning elite. Monetary policy that makes it difficult for this to happen – by holding down inflation – will slow the recovery.

How Many Conversions Were There?

Dean Baker makes the point that lots of housing units came from conversions of industrial or commercial property and thus aren’t counted in starts. My sense is that they should be counted in new home sales and inventory which track starts pretty closely. We don’t see a lot of new home sales or inventory that never showed up in starts. However, this is an point to look deeper into.

Honey, Flies and Macro

Paul Krugman says that he only treats mendacious idiots as if they are mendacious idiots. The thing is, that its not clear to me that badgering political opponents is an effective strategy for convincing contemporaries or speaking to posterity.

Part of what Paul winds up doing is causing people to resent reasoned analysis or even intelligence generally. This is the opposite of helpful.

Send Me to Siberia

Mike Casey wants to send me to Siberia. I am happy to go. Novosibirsk is nice, in June.

More seriously, moving to the top of the world is an obvious response to a warming world. Its made even more appealing by the fact that in some of the damage models you see negative numbers for Russia and Canada. Its seems natural that this would prompt someone to say – ah, well then we should get more people into Russia and Canada.

Now, I would expect responses along the lines of, yeah we thought of that but here’s the deal . . .

Instead, the – I believe exclusive – response I’ve gotten on Siberia is mocking me for suggesting that people move to North to avoid global warming, implicitly on the grounds that Siberia is cold and barren. Yet, that seems like an objection that certainly doesn’t make sense, no?

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