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Net Human Product and Our Purpose April 25, 2013

Posted by federalist in Economic Policy, Education, Government, Open Questions.
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There is a great Twilight Zone episode, “A Small Talent for War:” An alien emissary appears in the United Nations to announce that humans on Earth have not progressed as fast as they had hoped. We have a small talent for war and have wasted our time bickering over borders with crude weapons, far short of the “better things” for which they bred us. Therefore, they have resolved to terminate the experiment on this planet. The American ambassador pleads the case for humanity. The emissary agrees to give the world 24 hours, though he doubts anything can be done in so short a time. When he returns, the General Assembly proudly presents the emissary with a world peace treaty. He leafs through it and then laughs, explaining that their objective was for us to develop weapons and warriors to fight across the galaxy, not to merely to achieve peace amongst ourselves. The episode ends with alien destroyers descending on Earth.

This essay is a discussion of existential matters: Something that, after adolescence, few people stop to consider in any broad context. Discussion following my post on falling fertility raised the Grand Question: What is our Purpose? In the context of that post a successful human life was one that created positive net production in our global marketplace. That’s a fine measure if our Purpose can be expressed as economic activity. But can it? Is our goal as a species to build the maximum economic power? I.e., to produce the greatest possible value of goods and services, where value is defined by the market of individual human wants and needs? By default, and in actuality, the answer is yes.

But we fancy ourselves an “intelligent” species, and so we should not simply accept the evolved answer to the Grand Question: I.e., to what end should our species devote its resources? If the answer is “to satisfy our instincts” then as a species we seem no more intelligent than any other life form.

Are we intelligent life?

We know the key characteristics of all successful life: survival and reproduction. We are currently an apex predator on our planet. As a species we are the apex predator, so we’ve got that to our credit. But we are surrounded by other species that are more survivable than our own: We know there are planetary catastrophes that would extinguish our species but spare “lower” life-forms that can survive more extreme conditions and extended deprivations. So in terms of survival our species is relatively unremarkable.

We console ourselves with the fact that we are “intelligent.” This does indeed seem to be a rare thing: In our own fertile sphere we are unique in our capacity to invent tools, and to create, store, and transmit information. Furthermore, we have achieved reasonable mastery of electromagnetics, to the point where we can send bursts of information into deep space and scan for other life doing the same. Yet our ability to create and harness energy and matter on a meaningful scale is abysmal. We can only transmute elements in the tiniest quantities, and the total energy our species can unleash, even in an uncontrolled fashion, would barely make the faintest ripple in our local space-time fabric. So by some measures we might be extraordinarily intelligent, while by others we may be pathetic.

The rest of our specie’s activities are no more notable than that of any other locally successful life form. In fact, we know that we are only one unlucky gamma-ray burst or other stellar event away from being wiped from the face of existence. Truly successful life would not be so vulnerable.

Intelligent or not, a successful life form would be one that could project itself across interstellar spaces, in some manner able to reproduce and survive on a vastly larger, less precarious scale. Could we achieve such a thing? Almost certainly not in our corporal forms, which have evolved only to survive and reproduce in the fragile fringe of our home planet. But in theory we could build interstellar seeders: self-replicating, self-healing machines that trawl outer space and seed our form of life anywhere it can take root. Our seed sphere would grow slowly, limited by the speed with which our machines can travel, but still exponentially as frontier seeders transform ambient matter and energy encountered en route to spawn more seeders. Perhaps it is possible to design seed rays: packets of energy that, when they encounter matter of suitable composition, transform it into seeders. Though that sounds vastly more difficult, it would allow our seed sphere to grow at light speed.

As intelligent life shouldn’t such large-scale survivability be one of our goals? One might argue that the absence of such a capability is evidence that we are not “intelligent life.” Intelligence may include the ability to create tools and transmit information, but life that cannot alter its evolved behavior and nature to better pursue its objectives does not sound intelligent. And since survival is the most elementary characteristic of life we, as a species, are clearly coming up short.

This brings us back to the Grand Question: What is our Purpose? Nature has given us an evolved, or “default” answer, and that’s mostly what we’ve accepted: Our default Purpose is to maximize Gross Production and Production Capacity – economic measures that we can sample with reasonable accuracy. These measures have steadily increased throughout history. But they reflect predominantly individual interests, not the reasoned, collective interest of our species. For example, included in Gross Human Production today are such things as:
• The construction and maintenance of coastal cities below sea level
• Gold-plated palaces and jumbo jets for sheikhs to fly their extended family around to the world’s finest resorts
• Manicured golf courses where the wealthy and non-producing (“retired”) try to hit balls with high precision

We have enormous production potential, but what are we producing? If one assembled any group of humans and asked them to vote on worthwhile projects for their – or any other human’s – spare time would any of the above examples be on their list? The sad fact is that we, as a species, have no intelligent Purpose.

Does it take a visit from a xenocidal alien emissary? When faced with a clear and present threat we unite in large groups and concentrate our excess capacity on survival and achievement. Think of the unified action witnessed during the World War II and the Cold War. But no leadership seems capable of marshaling such a response to anything less clear and present. For example, know the consequences and probabilities of a large asteroid impact, but haven’t waged any significant effort to protect ourselves from possible extinction from one. And the threat of a nearby gamma-ray burst is so abstract and challenging that almost nobody addresses it.

I wish we could unite behind one or more “Net Human Products:” Something that humans collectively produce that increases over years and generations, and that our species could hold up and say, “Here is something we did besides just surviving and pursuing our instincts.”

There are, of course, philosophic and religious answers to the Grand Question, but I don’t think they make good measures of Net Human Product. In the most general terms, most measure human success as something like maximizing the number of people who achieve peace with their creator, themselves, and/or their surroundings. But these are human-centric measures: In the end, some number of human beings have lived and died, and some proportion did so in accord with any particular philosophy. That tally may make adherents feel good, and some philosophies may be conducive to higher Net Human Products, but either way they are at best a means, not an end in this discussion.

What do humans produce that endures? Civilization has produced remarkable terrestrial monuments, although over eons our watery planet will eventually erode these all into oblivion. We have managed to sling a few small artifacts out of our heliosphere. Aside from those the substantive human products that have the potential to survive every natural catastrophe and all the assaults of time are our culture and our technology: Everything that can be transformed into data, which can be replicated and beamed to arbitrary recipients at nearly zero cost. We might measure our Net Human Product in terms of the quantity and quality of that data, and the means we have to protect its integrity and longevity.

Maybe if we reconsider our collective objectives we will refocus our resources. For example, instead of spending tens of billions of dollars each year on professional sports, the demand for entertainment and product placement will shift attention towards teams of developers and their efforts to raise our Net Human Product.

Can we spark a “Moon-Shot” program on a global scale to make our species truly “intelligent” by addressing the shortcomings I mentioned earlier? Can we motivate individual human beings to join an urgent struggle to develop fusion energy and interstellar seeders? Can children go to school aspiring to study the STEM subjects that will enable those technologies? Can we go to sleep each night as worried that a gamma ray burst will obliterate us before we succeed, as we did during the Cold War that a nuclear holocaust would destroy everything we know and love?

America’s Fertility Problem February 11, 2013

Posted by federalist in Economic Policy, Education, Human Markets, Social Politics, Taxation.
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America is fortunate to be lagging the demographic collapse that is plaguing Europe and the Orient, so we will have time to observe both the socioeconomic problems that low fertility creates and the means of fixing them.

Already some European countries have adopted extreme measures to stimulate childbearing: From tax credits and grants to increasingly generous time-off and childcare programs.

Jonathan Last, author of What to Expect When No One’s Expecting: American’s Coming Demographic Disaster, summarizes the current state of affairs in America and looks at some potential policies to motivate reproduction.

Indeed, for most Americans it is irrational to choose to have children today. The marginal cost to an educated working couple is staggering: Direct financial costs alone can run well into six figures and, if one pays for the “best” education, can even break seven figures. At least one earner is usually taken out of the workforce for years, incurring substantial opportunity costs in career and earning potential. And we rarely credit parents for the time, stress, and emotional agony of raising a child to maturity. Relatively speaking, life without children is a luxury: a carefree existence flush with money and freedom.

In a selfish world in which women often out-earn men and couples can easily avoid reproducing, who is having babies? Those too incompetent to use birth control, or too ignorant to rationally account for the full costs? Those on the fringes who can actually expect a net positive return on childbearing thanks to welfare systems?

There are many who bear children for religious and altruistic reasons. Indeed, when it comes down to it, modern childbearing is a gift to society as a whole. Children might grow up to honor and support their parents, but government will all but guarantee that as adults they will pay taxes to support their grandparents’ generation.

Until recently children were mostly unavoidable products of adult couplings, but they were also greatly desired because they eventually conferred status and security on their parents. Just as modern contraception has divorced coupling from reproduction, the senior welfare systems of modern government have severed parents from the support they could traditionally expect from their particular children.

Among Jonathan Last’s policy prescriptions for restoring fertility:

  • Recognizing that children are the future tax base, reduce the cost of bearing them by significantly cutting the tax burden on parents. (Or, presumably, wait until we are so far down the demographic cliff that we have to go European and outright pay people to bear children.)
  • Destroy the higher education cartel, which defers marriage, increases the opportunity cost of stepping away from the workforce to bear children, and then exacts a final, enormous toll to get the child out of the nest and into the most desirable jobs.

Marriage: Legal Costs and Benefits January 17, 2013

Posted by federalist in Economic Policy, Social Politics, Taxation.
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I have suggested that advocates for legalizing same-sex marriage might be largely motivated by government financial benefits.

It is probably hopeless to disentangle the full costs and benefits that accrue to marriage and child-bearing from government policies (everything from welfare programs to tax codes). But a recent essay claiming that marriage accrues only benefits prompted some interesting counterpoints. E.g.,

The fact is that taxes make marriage extremely expensive for almost all successful opposite-sex couples, more so if they have children, even more so under the new Obama tax rates. Income tax liability is generally lower (not higher, as Arnold and Campbell assert) for unmarried earners, and lower still for single parents than married parents.

The only notable exception to the marriage penalty is for same-sex married couples in community property states, who (thanks to DOMA) divide their income 50/50 and file single or single head-of-household returns–which always saves them a bundle compared to any other tax status.

So gay marriage has in fact produced some handsome financial dividends for its practitioners.

Economic interests promote freedom May 3, 2012

Posted by federalist in Economic Policy, RKBA.
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Minnesota is one of the 10 states where gun silencers are still prohibited. But when a gun company threatened to move its manufacturing to a neighboring state, Shooting Wire reports:

A couple of weeks ago, Minnesota Governor Mark Dayton signed a bit of legislation (H.F. 1816) into law that accomplished a couple of things. The primary goal – allowing Minnesota firearms dealers to legally possess suppressors for research and development, product demonstrations and law enforcement sales, was one that was easy to see.

The second thing it accomplished was actually what it prevented. It kept JP Enterprises from leaving Minnesota for more a more hospitable business climate. If the bill hadn’t passed, JP Enterprises had planned a relocation to either Wisconsin or South Dakota – places where the suppressor laws were more lenient.

I don’t think JP is even a notably large employer.

I wonder if a large number of gun manufacturers got together they could exert enough economic leverage to get the Firearms Freedom Act passed in one or more states? It would certainly be profitable in a large state since commerce in suppressors and “short-barrel” rifles would be liberated from the ATF’s $200 tax, paperwork, and excessive delays before buyers can take possession.

Another Problem Inflation Would Help June 13, 2010

Posted by federalist in Economic Policy, Finance, Pensions.
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Public pension liabilities are the millstone dragging governments into the depths of a sea of red ink, deficits, and even bankruptcy. In a sad twist on this mixed metaphor, it is the pensioners who have managed to tie the millstone to the necks of the “little ones” — the younger generations working to pay increasing taxes to fund exorbitant pension benefits that were promised but never funded.

A few governments have discovered that they might be able to relieve a bit of the weight by reducing “cost-of-living adjustments” (COLA) — especially when those have historically had little or no relation to actual changes in the cost of living. For example, the WSJ notes that Colorado’s pension system had been granting a fixed 3.5% COLA every year to beneficiaries. If the COLA for defined-benefit pensions can be reduced below the rate of inflation, then inflation would gradually erode the real cost of the crushing unfunded pensions.

Of course, only the federal government has the power to inflate the dollar. But faced with a deluge states and municipalities sinking into insolvency under the weight of pension obligations, this would be yet another motive to nudge inflation higher.

(Predictably, pension beneficiaries are using every possible legal maneuver to prevent this. If only they had been so attentive when their unions and politicians were crafting extravagant future benefits to be borne by future generations.)

Farm Subsidies Plumb New Depths May 21, 2010

Posted by federalist in Diplomacy, Economic Policy, Government Spending, Markets, Special Interests, Uncategorized.
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Commodity farmers are a tenacious special interest, and the federal government seems to have no shame in pandering to them.

The Obama administration would rather subsidize foreign farmers than reduce domestic subsidies that violate our trade agreements:

Rather than reduce the U.S. subsidies to American cotton farmers that are the cause of the trade fight, the Administration is proposing that U.S. taxpayers also compensate Brazilian cotton farmers for the harm done by the U.S. subsidies. Thus the absurd U.S. cotton program would dip into the Commodity Credit Corporation to pay what is a bribe to Brazil so it won’t retaliate.

Capital Gains and the Inflation Tax January 15, 2010

Posted by federalist in Economic Policy, Finance, Taxation.
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A great many opponents of the Federal Reserve Bank argue that fiat currencies, like the dollar issued by the Fed, have no inherent value and that we are at the mercy of a government-sanctioned currency monopoly to preserve our assets. I have explained that this is not accurate because nobody really has to hold dollars, and even if you are required by government or custom to use dollars for transactions there are small conversion costs from many other currencies and stores of value, so you can choose to minimize your exposure to value deflation resulting from the inflation of any particular currency.

However, even if you eliminate your exposure to dollars you are still harmed by dollar inflation because the government has imposed a “capital gains tax,” which the IRS has implemented essentially as a dollar inflation tax. The peril of fiat currencies is that debtors (like the states or state-sponsored entities that issue them) have an incentive to inflate their way out of debt. National debt becoming too onerous? Just print some more money to pay it off and enjoy the added benefit that this will inflate the currency (deflating the currency’s value) which reduces the real size of the remaining debt. Of course, if nobody uses your currency this will only go so far. But if you assess a tax on the basis of the value of your currency, as the U.S. government does, then it still gets you: As the dollar devalues all other assets appreciate in dollar terms. Call that appreciation a “capital gain” and tax it.

Doesn’t seem fair, does it?

Inflation Conspiracies January 6, 2010

Posted by federalist in Economic Policy, Finance, Taxation.
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If you are a debtor, and your debts are denominated in dollars, then dollar inflation directly benefits you by reducing the real cost of your debt.  So imagine the moral hazard when one of the biggest dollar debtors — our government – happens to have the ability to inflate the dollar!  (Not to mention that, due to our tax code, dollar inflation is itself a tax that increases government revenue.)

Rick Bookstaber notes the political spin on this situation:

Suppose all the Good Guys (Joe Consumer and Homeowner) are loaded with debt, and suppose that this debt is payable to the Bad Guys (Rich People and Foreigners). What can you do about it? Oh, and also suppose that the debt is mostly in nominal terms. Answer: You inflate.

What will happen when politicians realize that they can surreptitiously redistribute wealth from capital owners to both the government and the indebted?  Since this is consistent with our government’s tendencies over the last century you may wonder why it’s not already happening.

For one thing, there is supposed to be a mechanism to prevent this:  The dollar’s supply is regulated by the Federal Reserve, which was supposed to be both (A) independent of the federal government, and (B) interested only in maintaining dollar stability.  However, some time ago they gave up on the latter point, with muddled pronouncements about balancing dollar stability with other economic objectives like employment.  And the last year or so has seen the evaporation of any semblance of Fed independence from the government.

So the institutional barriers that originally secured the dollar’s value are effectively gone.  The only other thing that holds back politically-motivated inflation is the fact that inflation only has the desired effect if it’s unexpected.  If the government came right out and said, “We’re going to 6% annual inflation in order to reduce our debts, increase our revenues, and help all the debtors who vote for us,” it wouldn’t work for long:  Owners of existing dollar-denominated debt would be hurt, but when the government went to expand or rollover its debt it would find lenders demanding annual rates at least 6% higher than they do now.  Likewise with individual borrowers.

In fact, if the dollar was abused too much people would probably stop lending in dollar terms at all: If you wanted a loan, repayment might be demanded in Euros, or barrels of oil, or ounces of bullion.  (Several of my recent investment posts deal with practical means of hedging against dollar inflation.)

And this is where the conspiracy comes in.  Bookstaber explains:

To do inflation right, you have to be a little sneaky. Especially if you don’t want your creditors feeling totally screwed and have them walk away the next time you need to borrow. Don’t announce it as a policy. Have it just happen. In fact, have it happen in spite of all of your best efforts to reign it in. So you need a controlled burn that looks like it is spontaneous. Who knows, maybe this idea actually is making the rounds.

Given the political inclinations of the current establishment it’s not hard to imagine.

QOTD: The Climate-Industrial Complex May 21, 2009

Posted by federalist in Economic Policy, Energy, Markets.
2 comments

The always incisive Bjorn Lomborg describes the emergence of a “climate-industrial complex” of politicians, special-interest groups, and for-profit corporations.

 Spending a fortune on global carbon regulations will benefit a few, but dearly cost everybody else.

The Case for Government Investment March 28, 2009

Posted by federalist in Economic Policy, Government Spending, Markets, Taxation, Transportation.
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As a libertarian I like to believe that anything worth doing will be done by for-profit entities.  But we know that in practice there are many public goods and services worth providing that will not be provided in anarchy — typically because they suffer from at least one of three characteristics:

  1. They require more up-front or concentrated capital than private entities can reasonably provide.
  2. Potential returns are too risky or distant, rendering the risk/reward calculus untenable for a profit-seeker.
  3. Returns are too difficult to capture for a non-government entity (practically by definition of a public good).

If public infrastructure investment can reliably increase economic activity, then not only can government capture returns on the investment through constant-rate taxes on a growing economy, but it would even be reasonable to fund the investment with government debt.  This is, in broadest terms, the premise for a large amount of the Obama administration’s proposed deficit spending.  Robert Reich today presents a reasonable argument based on this premise:  He suggests that the United States grows and competes internationally based on its productivity, and that public goods like a ready base of strong human capital and infrastructure are critical to growing productivity.

Only those Americans whose parents can afford to give them a high-quality private education and health care, and who can situate themselves in locations with excellent infrastructures of telecommunication, transportation, public health and safety, have been able to link up with global capital on more positive terms. But not even they are entirely secure economically, because they face growing shortages of talented people they can rely on within easy reach, and can’t entirely avoid the disadvantages of a deteriorating public infrastructure, such as ever more congested roads and airports.

Obamanomics recognizes that the only resource uniquely rooted in a national economy is its people — their skills, insights, capacities to collaborate, and the transportation and communication systems that link them together. Public investment is the key to attracting long-term private investment so that a nation’s people can prosper.

Tax Competition March 1, 2009

Posted by federalist in Diplomacy, Economic Policy, Taxation.
5 comments

A few years ago I highlighted the importance of tax competition in restraining government and encouraging government efficiency.  The US and EU are waging a new war against “tax havens.”  Daniel Mitchell, who recently published Global Tax Revolution has also put a few videos advocating the preservation of tax competition on the Cato blog.

Citizenship is a Public Good January 24, 2009

Posted by federalist in Economic Policy, Human Markets, Taxation.
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And as I previously suggested, we should consider selling such public goods in lieu of taxing citizens to fund government.  That citizenship might qualify for such consideration was suggested today by James Kardon in a letter to the WSJ:

Immigration can be the key out of our current financial morass. The attack of 9/11 may have caused the current crisis by inciting the government to encourage real estate price inflation and, more importantly, slowing the immigration of talented people, caught in the red tape of the Department of Homeland Security. We could rescue the housing market and kick-start growth again by selling green cards to solvent immigrants for, say, $200,000.

If you build a valuable country why should you give it away via lottery, as the United States presently does with green cards?  Especially when there are so many people willing to commit not only their allegiance but also real capital?

Let Profit Guide Government Spending (and Bailouts) January 23, 2009

Posted by federalist in Economic Policy, Energy, Finance, Government Spending.
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How can we avoid turning a government bailout into a political boondoggle?  As I suggested yesterday on Rick Bookstaber’s blog:

The expectation of profit is the only way to prevent politics from perverting market interventions. If government can interfere at times and in ways in which it does not expect to make a profit then you may as well tell special interests to grab their sacks and form a line to have them filled with taxpayer money.

But if there is a true financial crisis then, by definition, there is an objective opportunity for a liquidity provider to realize excess profits in the distressed markets.

If we insist that government can only intervene in times and ways in which it can expect a long-run profit (without abusing its power to “change the facts on the ground”), then we take most of the political hazard out of the equation. Instead of the current debate we see — are Paulson and Frank just funneling tax revenue to their friends and cronies in NYC? — the only debate would be on whether the long-run fair value of assets being bought by the government is clearly above the price at which the government can buy them.

(Profit is the same criterion I previously proposed for managing the Strategic Petroleum Reserve.)


Trust Funds of the World: Unite! December 29, 2008

Posted by federalist in Economic Policy, Finance, Pensions.
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State and local government pension funds contain several trillion dollars in assets.  I have previously highlighted the significant hazards of public defined-benefit pensions, but I neglected to note a particularly terrifying one: Many of these funds are overseen by novices.

Some time ago the WSJ reported on Stanford’s “Committee on Fund Governance” forum report:

Some recommendations are so elementary they seem hardly worth stating. One suggests trustees educate themselves about their duties. “A fund should identify and disclose its leadership structure,” reads another. Many funds profess to follow these and other principles. Yet Mr. Clapman says his group found “a very large percentage [of funds] are not doing one or more of” the report’s recommendations.

There is no reason for every trust to get involved in investment management when the only thing that varies between funds is how much they owe and when.  They’re all trying to do the same thing — and all for public benefit — so there should be huge economies of scale to merging their funds.  A number of UK endowments realized this and joined a cooperative called OXIP (Oxford Investment Partners).  Vanguard is a cooperative investment company in the US that offers similar outsourcing of investment management.

But outsourcing investment management does not go far enough.  Any ongoing exposure by taxpayers to pension obligations is dangerous and unjustifiable. Taxpayers, shareholders, creditors, and employees have no business carrying the risk that pensions will be underfunded or mismanaged, or that investments will not perform as projected.

Defined-benefit pensions should buy annuities to cover their liabilities. For a small fee this transfers the risks of longevity, investment performance, and investment management to third an insurance company which is formed and regulated precisely to handle those risks.  (As an added bonus, buying annuities from an insurance company makes it nearly impossible to obscure the present value of pension benefits being promised.)

The status quo is outrageous: The same government officials who offer pension benefits to government employees get to pick the models that predict how long pensioners will live and how well investments will perform.  These perennially optimistic projections make the pension obligations look cheap, but some taxpayer money is still taken and put in a trust fund to invest against those obligations.  Of course, these funds are under government control, which means they are constantly threatened with political abuse.  Meanwhile, the trustees are not investment experts, so they have to pay for a staff, which has to pay for consultants, which recommend funds of funds, which invest in individual funds.  Every party in this investment management chain collects fees, but none of them guarantees anything.  So when the trust fund comes up short the taxpayers have to cough up yet more money to cover pensions promised long ago, and nobody is held to account for the failure of the trust to meet its obligations.

If governments were not allowed to run their own pension fund scam, they could still offer defined-benefit pensions: They would just have to provide them by purchasing (up front) annuities from insurance companies.

Proper Market Bailouts September 23, 2008

Posted by federalist in Economic Policy, Finance, Markets.
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Last week U.S. capital markets were in unprecedented distress and were on the verge of locking up, imperiling both the U.S. economy and world markets.  Over the past year excessive leverage throughout the markets began to unwind as market participants realized that many assets were worth less than they had previously believed.  This gradual unwind became critical last week when it began to happen too fast for market participants to react in an orderly fashion.

In the normal course events capital markets are like a nuclear reactor, pooling capital and risk to create heat that powers the economy.  Without the concentration and free exchange of capital and risk no heat is generated and economic development is stagnant.  However, the same leverage and risk exchange that fuel the economy can produce critical conditions that can spiral into a system meltdown.  Meltdowns can be provoked by systemic frauds and bad government regulation, of which the massive government-sponsored mortgage debacle was a prime example.

Whatever the root causes, the U.S. markets were undergoing a protracted delevering that began to look like a meltdown.  Until recently private sources of capital have always stepped up to halt such crises by buying distressed assets and institutions at deep discounts.  But last week the unwind became so fast and widespread that no private entity could intervene: So many market entities and normally low-risk assets were caught in the unwind that there was simply not enough leverage and liquidity in private hands to put a stop to it.

This is a painful and difficult thing for us free-market adherents to acknowledge.  We may very well be able to pin some of the blame on past government interference in the markets.  But we can now see how large-scale fraud and mismanagement can cause markets to fail in a catastrophically contagious way: i.e., one that threatens the ability of regular people and companies that depend on modest debt financing or the lowest-risk assets to go about their daily business.

Is a government-sponsored bailout justified in such circumstances?  I am inclined to believe so, just as the government should have the ability to issue gobs of debt to jump-start a defensive war for our survival (as in WWII, for example).  When assets cannot find buyers even at distressed levels, and when this market failure will trigger a meltdown, the government should be able to buy distressed assets at a discount.  When contracts and their counterparties that are essential to the operation of the capital markets are in danger, and when their failure will exacerbate a meltdown, the government should be able to backstop those contracts.

Many conservative writers are appalled at the bailout proposed by the U.S. Treasury, and for many good reasons.  It is fraught with moral hazard, and it risks increasing the ongoing involvement of government in markets.  Therefore, a proper government-sponsored market bailout should adhere to the following principles:

  1. Anyone who stood to gain from a risky position should ultimately bear the maximum possible loss if that position is bailed out.  For example, equity holders in bailed out GSEs and banks should lose all their equity.  Debt holders should also be charged for losses that are not recouped.  Even money market investors know that their investments are at risk and should take losses where they occurred.  Bailouts can provide liquidity to halt the vicious cycle of selling, but ultimately losses need to be born by the market, not the taxpayers.
  2. Anyone who participated in fraud should be prosecuted.  This would include mortgage brokers and debtors who lied, and brokers and underwriters who misrepresented the liquidity of auction-rate securities.
  3. The government intervention should be strictly temporary.
  4. Government liquidity should ultimately make a profit for the taxpayers.  Liquidity should always be able to earn excess returns in free markets.  When the government steps in to buy assets and contracts in a crisis, it should do so at a steep discount.  It can afford to hold those assets for as long as necessary, but its ultimate goal should be to cash out those assets or return them to the market — at a profit.

Brace for Dollar Inflation August 25, 2008

Posted by federalist in Economic Policy, Finance, Taxation.
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The Wall Street Journal editorial board has been cautioning the Fed on its loose money policies for some time now.  Two recent op-ed’s step up the warning.

The Federal Reserve has only one lever to push: the short-term lending rate for dollars, which affect the “supply of money.”  Ideally it would only use that lever to control one thing: inflation.  However, as Ben Steil explains, economics are complicated and the effects of interest rate changes on inflation can be delayed and indirect.  So the Fed has allowed itself to consider questions like employment, GDP, and market conditions when setting its rate.

For example, with credit and liquidity crises racking the markets the Fed has dropped its rate perilously low even as inflation has hit dangerous highs.  The Fed argues that it can solve the market crisis and that the current recession will deal with inflation before long.  So far the Fed has gotten away with this — markets are still pricing in an expectation of nominal long-term dollar inflation — presumably thanks to the credibility the Fed has banked since the early 1980s.  I.e., people still believe that the Fed will finally make the hard call to raise rates if the recession doesn’t pull us back from the brink of inflation.

Gerald O’Driscoll (“Washington Is Quietly Repudiating Its Debts“) doubts this can continue.  The presence of political pressure in the Fed’s calculus should give us pause.  The U.S. government is piling on obligations: Debt spending, unsustainable entitlements, and now government bailouts of market makers.  It will be increasingly difficult for government to resist the temptation to inflate its way out of its debt — certainly not while the Fed is willing to subjugate a stable dollar to concerns of market strength or shorter-term financial stability.

A stable currency is a tremendous boon to market efficiency and general welfare.  Large or unexpected inflation takes money from creditors and transfers it to debtors, with bad results for the overall economy.  Fortunately, it is possible to limit one’s exposure to the risk of excess inflation, as I suggested earlier.  This is a good time to increase your hedges against dollar inflation.

Stimulus: The Differences Between Spending, Saving, Storing, and Investing August 2, 2008

Posted by federalist in Economic Policy, Taxation.
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It’s easy to criticize the Federal government’s plan to “stimulate” the economy by sending money to taxpayers who didn’t earn too much last year.  The government believes that those people have the highest marginal propensity to spend.  I.e., the government is trying to boost current retail spending by taking money from both future taxpayers who can’t spend now, and from current wealthier taxpayers who presumably are more likely to save than to spend.  The government’s canard is that this is the best way to lift us out of the current credit crisis and recession.

It’s worth reading Steve Waldman’s exposition on the Paradox of Thrift.  “Saving” can take the form of storage or of investment.  The latter stimulates, the former does not.  I.e., if we save in the form of stocks, bonds, or other stakes in capital markets we are really making an investment in future production, which in a virtuous cycle both enables future consumption and increases current employment and incomes.  However, if we save by accumulating stores of value — say land or old art — we do little more than create scarcity rents for those who possess that fixed supply.

It does appear that saving is now skewing more towards storage than investment.  Waldman explains why this may be happening, and why “stimulus” spending is not a good response:

Storage eats wealth, while productive enterprise creates it. People know this. No one “invests” in gold or oil when a financial system is working. They do so when it is broken. Like now.

Encouraging people to go shopping in order to help the economy is not “second best” policy. It’s a desperate last resort. We’re not at a point where there’s so little economic activity that we can’t foresee future wants. We’re at a point where people are beginning to shift from investment to storage because of a well-deserved loss of confidence in the financial system. Encouraging consumption now is nihilistic. It feeds into a vibe (I feel it personally, do you?) that saving is so uncertain and money so volatile that one might as well spend, ‘cuz who knows what tomorrow might bring. The right way to sustain aggregate demand and maintain current income is to figure out what we should be investing in … and then to put current resources to work. Our financial system is failing spectacularly because it erred grievously. It built homes and roads and sewers that oughtn’t have been built, it “invested” in vacations and plasma televisions, and it paid itself handsomely for doing so. That’s not a problem we can spend our way out of.

Priorities From the Copenhagen Consensus June 7, 2008

Posted by federalist in Economic Policy, Energy, Government Spending, Social Politics.
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Philanthropists, activists, big charities, governments – there are many entities with lots of time and money and ideas for spending their resources to improve the world.  They frequently do a very poor job of it.

I have applauded the Copenhagen Consensus Center before.  The results of their latest panel, ranking the expenditures that will produce the greatest economic good in the world, should be studied by all of the aformentioned entities.  At the top of the list: Nutritional supplements, free trade, and vaccinations.

Hauser’s Law of Taxation May 20, 2008

Posted by federalist in Economic Policy, Government, Taxation.
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David Ranson dusts off some econometric results that should be the basis of all discussions of tax policy. In 1993, Kurt Hauser found, “No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP.” This invariance still holds true, and Ranson dubs it “Hauser’s Law.”

The data show that the tax yield has been independent of marginal tax rates over this period, but tax revenue is directly proportional to GDP. So if we want to increase tax revenue, we need to increase GDP.

What happens if we instead raise tax rates? Economists of all persuasions accept that a tax rate hike will reduce GDP, in which case Hauser’s Law says it will also lower tax revenue. That’s a highly inconvenient truth for redistributive tax policy, and it flies in the face of deeply felt beliefs about social justice.

Presidential candidates, instead of disputing how much more tax to impose on whom, would be better advised to come up with plans for increasing GDP while ridding the tax system of its wearying complexity.

But perhaps we are too charitable with the tax-the-rich crowd’s intentions? It may be that they are not concerned with maximizing tax revenue but rather with using tax policy to minimize income inequality. And it may be that politicians are more concerned with acquiring the patronage of special interests through a byzantine tax code than simply maximizing the tax revenue at their disposal.

Tyranny of Special Interests: 110th Congress Edition May 15, 2008

Posted by federalist in Economic Policy, Government, Special Interests.
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How can a minority extract rents from a majority in a democracy? Congress has illustrated this for years with abusive “earmarks.” Past posts (here, and here) have addressed the structural defects of our democracy. But this week Congress gave us an exceptional lesson in political logrolling: A small coterie of wealthy farmers secured record subsidies by … well, the Wall Street Journal summarizes it nicely:

If you wonder why urban Democrats would vote for this rural giveaway, the answer is they have been bought off with roughly $10 billion in extra funding for food stamps and nutrition welfare programs. Someone should tell them that their constituents might not need this cash if the farm bill didn’t help keep food prices high.

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