Alex Schibuola

In Offense of Ben Bernanke, Part III: Bernanke, Blinder, and Underpants Gnomes

by Alex Schibuola on December 14, 2010

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes:

Here’s the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, ‘by lowering short-term interest rates,’ you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that’s mostly Treasury bills). Yes, they print money. [Italics added]

But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities.

I’m afraid that’s only partial credit, though. What the Federal Reserve has yet to elaborate on is why this “stimulates” the economy. You should know, Professor Blinder, that investment appears to be interest-rate inelastic. You wrote this in your journal article, “Is There a Core of Macroeconomics That We Should All Believe?”

The claim that QE2 is supposed to “stimulate the economy” bothers me. For those of you who watch the TV show, South Park, it reminds me of the underpants gnomes episode. The gnomes collect underpants and give the following explanation for why:

Underpants Gnomes:

Phase 1: Collect underpants.

Phase 2: ???

Phase 3: Profit!

Bernanke and Blinder:

Phase 1: QE2.

Phase 2: ???

Phase 3: Economic recovery!

I still want a better explanation for Phase 2… from the Fed. They say they want to be clear and explain their thinking, but I have yet to hear an explanation other than that.

If you want a more sane explanation for QE2: one could point out that many of the Fed’s current assets are maturing. This means that cash will be flowing back into the Fed and they want it out. Thus, the Fed is trying to keep its balance sheet steady rather than expand it per se.

I surmise that they intend to raise the opportunity cost of holding Treasuries, thus making private sector debt and equities relatively more enticing to hold. Then banks go back to private lending, commercial paper, corporate bonds, etc., and investment expands. So it looks like the people at the Fed have discovered a free lunch. But as ECON101 teaches us, Professor Blinder, There ain’t no such thing as a free lunch!

In Offense of Ben Bernanke, Part II: The Natural Rate of Unemployment

by Alex Schibuola on December 14, 2010 · 2 comments

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes: “All in all, it looks like the nation and the world need an Economics 101 refresher. So let’s start with the basics.”

All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics.

There are three types of unemployment: (1) frictional, (2) structural, and (3) cyclical. I am frictionally unemployed if I leave my current job and take time off before starting my new one. I am structurally unemployed if I lose my job to globalization or minimum wage increases, etc. I am cyclically unemployed if the economy is in recession.

Keynes referred to cyclical unemployment in proposing his solutions. The Fed might be gravely mistaken to assume that today’s high, persistent unemployment rate is purely cyclical. The Fed can only impact cyclical unemployment, not structural or frictional. The sum of frictional and structural unemployment is the natural rate of unemployment. The Fed cannot alter this.

There are many reasons why structural unemployment rather than cyclical unemployment might be at play:

  1. Exchange rates are more volatile: unpredictable monetary policies and debt crises are the cause. If I am in an industry that relies heavily on exports, I am in danger of unemployment.
  2. Health care reform: the costs have yet to be determined and increase employment costs. Needless to say, employers care about the total costs of hiring employees, not just the money wage/salary they pay workers. This uncertainty overwhelms the tiny tax credits offered in the stimulus package.
  3. The housing market is still sick. If people can’t move easily, labor mobility is constrained. It’s more difficult for me to find work if I can’t move.
  4. Higher, extended unemployment benefits reduce the incentive to be employed, at the margin.
  5. The Dodd-Frank Act also imposes numerous uncertainties on the financial sector. This complicates the process of linking savers with investors. Consequently, investment is curtailed and higher unemployment results.
  6. The uncertainty about the capital gains tax rate didn’t help. Increasing taxes on capital decreases capital accumulation (investment). It does not help it. If productivity-increasing equipment costs me $200,000 and I’m willing to pay $250,000 for it, that’s great! If I have to pay a $60,000 tax on it, that’s bad: The equipment now costs me $260,000 and I was only willing to pay $250,000 before. Now I won’t buy it. I am worse off. The equipment supplier is worse off. The employees of the equipment supplier are worse off because they’ll need fewer workers for production.

If 10 percent is the new natural rate of unemployment, then fiscal policy simply crowds out private investment — private sector spending declines 1 for 1 with increases in government spending in that case. Monetary policy is completely impotent.

In Offense of Ben Bernanke, Part I: The Fed is Competent?

by Alex Schibuola on December 14, 2010

in Economy

Professor Blinder writes: “To create the fearsome inflation rates envisioned by the more hysterical critics, the Fed would have to be incredibly incompetent, which it is not.”

First off, I’ll admit that critics of Dr. Bernanke may use bad logic. Nevertheless, a good economist will tell you that people are rationally ignorant: The opportunity costs of becoming an expert at everything, such as nuclear physics, foreign policy, and macroeconomic policy are very high. Consequently, people take many mental shortcuts. Politics is no exception.

Politicians fill this void usually by concluding an argument such as, “that so and so is a Nazi.” Translation: “so and so” or “such and such” policy is bad. In econ-speak: the costs exceed the benefits to society. While the applied logic of politicians and pundits may be (probably) wrong, it doesn’t mean that Dr. Bernanke and the Federal Reserve don’t warrant criticism.

Now, truth be said, I believe Dr. Bernanke to be a first-rate academic and a very well-intentioned person. However, I doubt his ability (or anyone’s for that matter) as Federal Reserve chair. After all, they’ve been tasked with a fool’s errand: maintain full employment and a stable price level — and if there’s time, to maintain stable long-term interest rates. Underlying this is the premise that they can find the market-clearing interest rates better than the market itself.

You should give the Fed more credit, Professor Blinder. They failed in the early ’20s, they created and exacerbated the Great Depression, they let inflation get out of hand between the ’50s and ’80s, and there are strong theoretical propositions pinning the stock-market bubble of the 1990s and the housing bubble of the 2000s to the Federal Reserve.

If you were to read former Federal Reserve Governor Frederic Mishkin’s textbook on money and banking, one chapter documents how every decade since its inception, the Fed always found a new way to mess up. The Fed is just not that great.

Professor Blinder writes: “All in all, it looks like the nation and the world need an Economics 101 refresher. So let’s start with the basics.”

Let me conclude Part I by stating: All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics.

See also:
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Naked Body Scanners — Coming to a Neighborhood Near You!

by Alex Schibuola on November 30, 2010 · 1 comment

in Nanny State, Personal Liberty

Well, you can forget the airports-only naked body scanners — they’re now coming to a neighborhood near you. Forbes reports that “American Science & Engineering. . .has sold U.S. and foreign government agencies more than 500 backscatter X-ray scanners mounted in vans that can be driven past neighboring vehicles to see their contents.”

My take: This whole War on Terror is getting out of hand. What happened to the Fourth Amendment (i.e., no unreasonable searches and seizures without probable cause)?

The Department of Homeland Security’s mission statement says that their ”overriding and urgent mission is to lead the unified national effort to secure the country and preserve our freedoms. . . . The citizens of the United States must have the utmost confidence that the Department can execute both of these missions ['both' refers to terrorism and natural disaster response].”

“Preserve our freedoms”? How does having federal agents put their hands down my pants or take naked photos of me preserve my freedom?

“Citizens of the United States must have the utmost confidence”? What does “must” mean? Quite frankly, I don’t think the government could run a lemonade stand efficiently.

As my colleague Hans Bader astutely pointed out in a recent blog post, the government failed to stop the Christmas bomber last year and that the “TSA often fails to detect explosive ingredients and fake bombs in performance tests. A study found that the TSA is more than twice as likely to fail to detect a bomb as the private security firms it replaced.” Ask the people of New Orleans how satisfied they are with DHS’s FEMA response to Hurricane Katrina.

It’s about time to have a chat about national security and freedom. Unfortunately, we have to recognize that there’s a trade-off involved that is all too easily ignored. If freedom is our end, we have to recognize that the means to “preserve” it might undo the whole thing.

The Case for Private School Vouchers

by Alex Schibuola on November 23, 2010 · 3 comments

in Odds & Ends

If you had a choice between two identical cars, would you choose one that costs $7,500 or one that cost $15,000? The $7,500 one would be a better value, of course. Now, if you had to pay $15,000 for a car because an organization lobbied Congress to force you to do so, would you be angry? Yes, of course.

What if I replaced every instance of the word “car” in that last paragraph with “schools,” would you still have the same reaction? This is what we face in America’s education system. Which organization imposes this forced purchase? Teachers unions—the National Education Association (NEA) and American Federation of Teachers (AFT)—which adamantly oppose school choice and other substantive reforms that could help struggling schools improve, and get kids out of failing ones.

The NEA likes to quote studies showing that public schools have comparable academic achievements to private ones. While that strikes me as unlikely, let’s just say it’s true. Even then, the costs per student at public schools are twice that of some private schools! Once again, given two identical products, with one being half the cost, which would you choose?

Monopolies are undesirable. In addition to charging high prices, they produce inferior products. Why then are we so willing to accept the monopoly of government schools? The opposite of monopoly is a competitive industry. Competition means choices. And choices mean that competitors have to provide a superior product at the lowest price possible.

Ever notice how our university system is world-class, but our primary and secondary schools are considered second-rate among developed nations? What is the primary difference between the universities and the primary and secondary schools? Choice. When competition prevails, society wins. When monopoly exists, society suffers.

A monopoly controls the supply of its products. This allows them to charge a higher price and to produce lower quality goods. Unions are the labor market’s equivalent to monopolies. Unions control the supply of labor, which allows them to charge a higher price for labor, i.e., wages.

Quality in teaching is compromised by the lack of incentives that unionization engenders—outstanding teachers do not get additional compensation, while subpar teachers face little chance of dismissal.

That is why teachers unions fear school choice so much. If most public schools were truly comparable to private schools, then why would parents ever choose to use voucher programs to send their children to private schools? Public schools need to compete. The private school voucher system would allow us to reinvigorate our educational system and cut government spending simultaneously.

Photo Credit: Tncountryfan’s Flickr Photostream

Crony Capitalism, the TSA, and Insider Trading

by Alex Schibuola on November 23, 2010 · 1 comment

in Odds & Ends

An additional dollar of resources that government uses means one less dollar of resources for the private sector. The private sector’s use of resources must satisfy consumers’ wants. If they don’t, businesses won’t make profits. A government’s use of resources however makes no guarantee about satisfying consumers’ wants.

Take for example, the video game and movie series Resident Evil. It’s about an evil corporation that produces an army of cannibalistic zombie warriors. My willingness to pay for cannibalistic zombie warriors is $0. I imagine most people share my unwillingness to pay. Quite frankly I’d rather have a beer, or a million other goods. All those resources used to produce zombies (scientists, security guards, cement and equipment, etc.) become unavailable to satisfy my preferences for an additional beer or other wants.

So who on earth is willing to pay for cannibalistic zombie warriors? Governments are. If the zombie warrior example is to extreme for you just consider the following government waste of resources: Amtrak, bridges-to-nowhere, nuclear missiles, your DMV, the TSA’s full body scanners, etc. No single human is willing to pay for them so no business is willing waste resources to produce them.

But if a government can take resources from people (taxes) and spend it as politicians choose, businesses can avoid producing to satisfy consumer wants. Rather, by making the right political campaign contributions, businesses can avoid satisfying consumers and just get contracts from government. All of a sudden insider trading by politicians becomes a lucrative trade and crony capitalism reigns supreme.

The TSA full-body scanners are a particularly egregious case of this. George W. Bush’s former Homeland Security Secretary, Michael Chertoff has a personal financial stake in the production of full body scanners produced by Rapiscan Systems (a subsidiary of OSI Systems). Notably, the CEO of OSI Systems recently joined President Barack Obama on the recent trip to India. No doubt it was a great opportunity to convince Obama of the “necessity” of full-body scanners in the ironic battle to protect freedom.

OSI’s 10-Q statement reports that “Revenues for the Security division for the three months ended September 30, 2010, increased $3.8 million, or 8%, to $51.1 million, from $47.3 million for the comparable prior year period. The increase was attributable to… a $8.1 million increase in people screening equipment as a result of wider adoption of body scanners…”

If OSI Systems is representative of the crony capitalist industry, you can see here how much better crony capitalist firms (see blue line) are performing relative to the S&P 500 (see red line).

The President, as leader of the executive branch of government, is supposed to protect and defend the Constitution of the United States, which (via the Fourth Amendment) protects Americans from government searches and seizures without probable cause. I consider TSA searches to violate this.

Any economist will tell you that incentives matter. If current and former executive branch members have a personal, financial incentives regarding issues (especially ones that contradict the Bill of Rights/Constitution) they’ll be more likely to shirk their sworn duty to defend and protect the Constitution.

Time to Privatize? The Economics of Social Security

by Alex Schibuola on November 16, 2010 · 3 comments

in Economy

Government spending reform is not an option. It’s a necessity. Reforming Social Security goes a long way here. The most sensible reform would be to privatize it. To see why, one needs to understand the economics of Social Security.

First: What is saving? When we buy stocks, bonds, and CDs with our money, we call it “saving.” In the economics sense, when we save, we abstain from consuming resources today. Businesses use the saved resources to produce more for tomorrow.

Suppose an economy produces a stock of corn. We can either consume it or save it. The saved corn is planted and makes more corn next year. This is saving and investment, in the economics sense. Here’s the link between “saving” and saving: I decide not to spend all my money consuming corn. Rather, I buy a bond from a farmer. I am “saving.” In doing so, I also leave corn on the shelf of the supermarket. This is saving.

The farmer buys the leftover corn using the money from the bond I bought. He invests by planting the corn. In a year, it becomes more corn. He sells it to the supermarket for money which he uses to repay me for the bond, with interest. Now I have the money, and I can consume more corn or save again.

This corny story is an analogy for gross domestic product (GDP), the measure of all final goods and services produced within a nation in a year. It includes all the corn, cars, soda, etc. produced by a nation. The saved portion of GDP becomes investment. Investment creates more GDP in the future.

So is Social Security saving? No. Those paying in today don’t consume it or save it. The government receives the money, but they don’t leave it in a personal account; they transfer it someone else who uses it to consume resources. In other words, the government takes corn from you and gives it to your grandma. Now she can consume it. There’s no real saving because no corn gets planted to make more corn tomorrow.

If there’s extra money in Social Security, government takes it and buys corn to consume itself, e.g., to build corny missiles. It gets replaced with a government IOU, Treasury bonds (aka higher future taxes). Not only is this not saving, but the corn missiles mean there is even less corn for individuals and businesses to consume and invest too.

Identically, imagine you “save” $1,000 of your income, but buy a new TV instead of depositing it with a bank. Since you’re “saving” and not a scheming politician, you write an IOU to yourself, promising to repay yourself $1,000 with interest. Is this “saving” plan stupid? It is. This is Social Security.

If Social Security were privatized, people would deposit their income with a bank. People actually save resources that businesses can invest. We, as true savers, get more resources in the future.

“Lockbox” proposals are equally flawed. In this instance, government doesn’t reach its hand into the cookie jar. It keeps the extra cash stowed aside. This is like putting money under your mattress. Once it’s out of circulation, it serves no purpose. Less money in circulation relative to real GDP means the average price level goes down (deflation). The Federal Reserve would just print more money to offset this.

Remember, the purpose of actual saving is to allow you to consume more in the future — not today. Social Security retards this process whereas privatized Social Security means actual saving. If people defer consuming some corn (GDP) today with a bank that lends it to someone to invest, then there will be more corn (GDP) tomorrow. This is the economics of Social Security.

Dear Progressives, Wake Up!

by Alex Schibuola on November 11, 2010 · 1 comment

in Politics as Usual, Sanctimony, Zeitgeist

Daniel Hennninger has an excellent op-ed in The Wall Street Journal today. If you haven’t seen it, check it out. He nails the Obama administration’s greater flaws on the head.

The tremendous irony of the progressive movement is that they thrive on “good” causes. They love small business, but they do more than anyone to kill it (e.g., 1099 forms for expenditures meeting or exceeding $600). They care for the poor, but they do more than anyone to keep them poor (e.g., minimum wage). Their remedies for crony capitalism only exacerbate it (e.g., Fannie Mae and Freddie Mac). They profess their love of political freedom, but actively move to subvert it by dismantling economic freedom (e.g., forced purchase of health insurance).

Dear progressives,

Economic freedom is a necessary condition for political freedom. In the entire history of the world, there was never a nation that had political freedom without economic freedom.

Your good intentions are paving the road to serfdom. Or since you don’t like roads these years: Your good intentions are laying the high-speed rail tracks to serfdom. Quit breaking business — the engine of true progress.

In short: Don’t tread on us.

Consumer Leverage and Government Deficits

by Alex Schibuola on November 10, 2010 · 2 comments

in Economy, Stimulus to Nowhere

The Wall Street Journal published an excellent interview of Tom Hoenig, president of the Federal Reserve Bank of Kansas City. He is the lone voice of dissent regarding the Fed’s low-interest rate and QE2 policies.

He recognizes that consumers were over-leveraged going into (causing) the financial crisis and recession. Consequently. it takes time to re-balance. He’s absolutely correct. It’s a point that is all too easily overlooked by policy makers.

When the value of things I own (assets) is low relative to the value of things I owe to others (liabilities), I am highly leveraged. I don’t own enough things to pay off my debts. In other words, I’m close to (or am) bankrupt.

To prevent bankruptcy, I need to save more/borrow less (they’re identical). To save more, I must consume less. The conventional wisdom is that consuming less (saving more) sends the economy into a downward spiral. Therefore, if I won’t consume more, the government will for me.

What gets overlooked is that my attempt to deleverage gets offset by the government’s attempt to spend. When the government initiates deficit spending, it means my tax liabilities go up.

If I consume $5,000 less worth of goods and use this saving to pay off $5,000 worth of mortgage debt, I am deleveraging. Government realizes the error of my ways and benevolently intercedes on my behalf. It decides to spend $5,000 more on high-speed rail to offset my saving. To do so, it must borrow $5,000.

Government borrowing is the equivalent of future taxation. This means I’ll have to pay $5,000 later in taxes just like I’d have to pay $5,000 later on my mortgage debt as if I never paid it down in the first place.

The ultimate result is that the action of government puts me back in the same position I was trying to escape in the first place: being too highly leveraged. It simply draws out the problem that exists in the first place and delays the rebalancing.

A Crazy Welfare Statistic

by Alex Schibuola on November 4, 2010 · 4 comments

in Economy

If we took the entire 2009 total government transfer payments paid to persons and distributed it amongst the households below the poverty line, how much would each household receive?

Answer: $238,490

How much, if we divided all the government transfer payments from 2009 to all U.S. households?

Answer: $17,475

There’s a lot to say about this number. But this is a blog. Here’s what bothers me. Income inequality is alway an issue. It drives the call for more welfare programs. Here we are paying out $17,475 per U.S. household ($35,000, if we just gave it to the 50 percent of households with the lowest incomes). What is going on here!

Perhaps it’s true: the rent is too damn high!

I’m very welcome to comments on this matter. Methodology is discussed below.

Methodology:

Total government outlays (federal,state, and local) is separable into three major categories: (1) government purchases (where the government buys and uses final goods and services, e.g. defense spending, toilet paper for Social Security Administrative offices), (2) Transfer payments (e.g., I take money from you and give it to your grandparents, who spend it), and (3) Interest payments on debt (e.g., paying the interest on government debt). This transfer payment (“government social benefits: to persons”) data is from the Bureau of Economic Analysis (BEA, Table 3.12). I focused on the transfer payments to person (approximately $2.1 trillion dollars in 2009). The largest components of this are Social Security, Medicare, Medicaid, and unemployment payments. The data on households come from the U.S. Census Bureau (U.S. households, households in poverty).

I have generated annual data going back to 1959. I’ve converted it to real, 2009 dollars. Please e-mail me at aschibuola@cei.org if you’d like to see the data.

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