Arnold Kling  

Economists with Pseudo-Knowledge

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Department of "What?"... Work-Safe Readings for Macro...

I am shocked at the behavior of my fellow economists during this crisis. They are claiming to know much more than they do about causes and solutions. Rather than trying to understand and explain what is going on, they are engaged in a fierce battle over narrative.

(UPDATE: Mark Thoma raises issues with the Minneapolis Fed paper cited below. I would dismiss neither the paper nor his critique. I think the question of how badly off the financial markets would have been without intervention is going to be very hard to answer, particularly in a short period of time.

Some commenters below cite instances of startups having trouble with funding. I would expect that, based on the crash in the stock market. If you invest in startups, your exit comes either from going public or being acquired, neither of which looks very likely with stock prices in the toilet. To the extent that there is any venture funding going on at all right now, the assumption must be that in two or there years the market will come back. I hope the market does come back, but efficient markets theory says that the best guess about where it will be three years from now is where it is now, plus a few percent. Venture funding is a whole lot riskier today than it appeared to be a month ago.

Unfortunately, we'll never see the controlled experiment where we go back two months and Paulson and Bernanke say, "Let the chips fall where they may. No bailout." We'll just have a never-ending argument over whether that would have been better or worse.)

[UPDATE 2: The debate on the Minnesota paper continues, with a rejoinder by Alex.]

For example, many economists breathlessly cited high short-term interest rates in interbank lending markets as an indicator of credit markets "freezing up." However, as some Minneapolis Fed economists point out, the volume of lending does not indicate such a freeze. In fact, very short-term interest rates are a ridiculously melodramatic indicator to use, because even a small increase in default probability can cause the annualized interest rates to soar. (Thanks to Alex Tabarrok for the pointer to this article.)

Where are the stories of businesses canceling projects because of lack of funding? Yes, I am sure that there are homebuilders who want to do their part to contribute to the excess of housing stock and are being told to get lost by banks, but are there economically sensible projects being canceled?

Speaking of dogs that are not barking, where are the stories of struggling homeowners? The struggling homeowner is the staple of political speeches ("we have to help struggling homeowners") but the media are not exactly filled with stories of people who lost a lot of money on their homes. Maybe because they didn't put any money down to begin with, so they have not lost anything. I suspect that news organizations are trying to find struggling homeowners to profile, but instead they are finding mostly struggling speculators.

Another point of issue in the narrative battle is the percentage of subprime loans made by Freddie and Fannie. Because they accounted for less than, say, 1/5 of all subprime loans, we are supposed to say, "Phew! It wasn't their fault! It was the private sector's fault!"

If Freddie and Fannie undermined their safety and soundness by only insuring 15 percent of all subprime loans, wasn't that enough? After all, the way I understood the Freddie Mac charter when I worked there over ten years ago, they were not supposed to back any loans that were not of investment quality. Zero. Nada. Zilch. I just don't see how my fellow economists (Thoma, Chinn, and others) can work up such passion over the fact that Freddie and Fannie accounted for less securitization of subprime loans than did the private sector.

My main beef with economists is that standard macroeconomics does such a poor job of describing what is going on. The textbooks models are pretty much useless. Where in the textbooks is "liquidity preference" a demand for Treasury securities? Where in the textbooks does it say that injecting capital into banks is a policy tool?

Graduate macro is even worse. Have the courses that use representative-agent models solving Euler equations been abolished? Have the professors teaching those courses been fired? Why not?

I have always thought that the issue of the relationship between financial markets and the "real economy" was really deep. I thought that it was a critical part of macroeconomic theory that was poorly developed. But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation.

Economists ought to admit that we do not know much about what is going on today. Neither do the Fed Chairman and the Treasury Secretary. Of course, the market demand is for "strong" leaders and for "strong" economists, who can fool the public into believing that they have great knowledge. The ones who do this best are those who have fooled themselves.


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COMMENTS (87 to date)
Gary Rogers writes:

Always a geek. Never a suit. I like the way you think!

Ashish Kulkarni writes:

"But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation."


As a post-grad student who has suffered his fair share of abstruse mathematical models that had nothing whatsoever to do with anything approaching a modicum of reality - thank you.

Sam Wilson writes:

It doesn't take a Ph.D. in Economics to answer this one.

Who do all these economists work for?

Who are the primary benefactors of the current "bailout"?

QED.

Gorgasal writes:

"Where are the stories of businesses canceling projects because of lack of funding?"

One of our customers, a major retailer, just postponed a large IT project for twelve months, explicitly because of the financial crisis. And yes, at least we would argue that the project is economically sensible.

Zach writes:

Keep it coming, Arnold! Don't pull any punches!

Bob writes:

Gorgasal,

Might "financial crisis" actually mean "recession" at this point? Given the state and trajectory of retail, my prior would be that a lot of similar projects would be getting postponed absent the credit crisis (assuming that we were in a similar economic slowdown).

A more illuminating example would be in an industry that is still growing. The WSJ had an article citing postponed projects in hospitals. Even better would be an example of a bankruptcy lawyer that couldn't get a loan...

Tom G. writes:

Perhaps you mean: Economics is about people responding to incentives. Show me the incentive!

Gabriel Herrero-Beaumont writes:

These are times to act, not to understand or explain (you had 200 years for that). These are times for solutions. I am sorry, this will hurt, but it is time for politics.

David R. Henderson writes:

Arnold,
Don't hold back. Tell us what you really think. :-)
Seriously, though, one of your best blogs ever, and that's a high bar.
Best,
David

Rationalitate writes:

Thanks for confirming what I've always thought since my C- in freshman macroeconomics.

MGR writes:

Exactly.

Thank you for pointing out that knowledge is precious and time is being wasted. What is required at this time is a genuine attempt to understand what is happening today, leveraging our understanding of history, but viewed through a forward looking prism with a clear head and some curiosity.

Too often, "analysis" consists of historical comparisons, anecdotal percetions and disjointed theory, at least insofar as what is presented for public comsunmption ad nauseam. Perhaps the quality of analysis is better at the institutional level, but as Joe the Average, I wouldn't know about that.

In any case, I am sadenned that my understanding of these times is not improved much by the general sources of information. But I am happily encouraged that the Internet makes it possible for me to seek out relevant and useful knowledge, and I dare say, find genuinely well intentioned work of individuals that is actually helpful in my quest for a deeper understanding.

Thanks, Arnold. I find your material worth reading every time.

Dave writes:

I like the way you think. And so far all the hard evidence is in your favor, so I've been following your lead. :-) But, on the subject of "Where are the stories of businesses canceling projects because of lack of funding?", the word in Silicon Valley is that few companies are hiring, and that in the near future, few companies will be buying startups, and VC funding will be scarce, too.

What do you think? Unfounded? Just a crisis of confidence? An expected drop in aggregate demand for some other reason?

Mark Thoma writes:

This seems like it might be more the expected economic conditions than the funding, though the 13% it is paying on auction bonds (see end) seems to have affected the decisison (they expect less business, higher costs, so they canceled):

OHSU pulls back on plan to expand the Kohler Pavilion
TED SICKINGER
The Oregonian Staff

Oregon Health & Science University's plan to expand its KohlerPavilion hospital wing has become the latest local victim of the U.S. credit crisis.

OHSU Chief Financial Officer Brad King sent an e-mail Thursday to employees explaining the decision not to go forward with the expansion of the Kohler Pavilion, which would have required $350 million in bond financing. ...

The university had intended to go to market with a bond offering this fall to finance the expansion, but it now believes market conditions make that plan unrealistic. ...


In his e-mail, King told employees that OHSU has a sound financial footing to weather a downturn, but he outlined a number of factors that could hurt the university if the downturn is prolonged. They include rising unemployment and charity care, along with falling personal incomes that would tighten the state's budget and ability to support Medicaid and higher education funding. Likewise, reduced federal budgets could mean cuts in research funding and Medicare payments, while banks may be less willing to lend students money they need to attend OHSU.

OHSU already is feeling the pain of the credit crunch, paying interest rates as high as 13 percent on some of the $240 million in variable-rate bonds that it issued to pay for past projects. Investor appetite for so-called auction-rate bonds has collapsed in the current credit crunch, triggering painful rate increases for many borrowers, regardless of their creditworthiness. OHSU would like to refinance those bonds but has few attractive options in the current market.

El Presidente writes:

". . . [B]ut are there economically sensible projects being canceled?"

What is and is not economically sensible (aka financially viable) has changed because of shifts in credit. This is not hard to understand. You don't have to have a situation in which people are walking away from high profits to warrant concern. A general decline in profitability across the board combined with the other markers we see are sufficient to make an educated guess about what's going on. Are economists supposed to be limited to forensics now instead of policy analysis and prescription?

The bigger problem is focusing exclusively on the possibility of credit (money to lend) to the exclusion of dealing with credit-worthiness (income to repay loans). Banks will not lend until people can pay them back, that is, until making loans is more profitable than holding onto the money for themselves. This is the crux of a liquidity trap, no? Feeding them money doesn't help anybody else pay them back. Distributing money at the other end of the spectrum does. Intermittent stimuli won't do it either. It will have to be a sustained change in income distribution. You can give money to poorer people, take it away from richer people, or some combination of the two. Whatever you do, you will have to close the gap between their respective reservation prices in order to get the transactions happening again. For goodness sake, a four-year-old could understand this. The company store model only works when indentured servitude is legal. Short of changing that, we've hit the wall and we will need to recover.

paul_lukasiak writes:

I just don't see how my fellow economists (Thoma, Chinn, and others) can work up such passion over the fact that Freddie and Fannie accounted for less securitization of subprime loans than did the private sector.

Come on... Fannie and Freddie were being blamed by certain politicians for the whole crisis. Pointing out that these two companies accounted for only 15% of the "bundled" subprime loans was a rebuttal of misinformation spread by polticians and the media.

My pet peeve is when people say that the housing bubble caused the crisis -- but the US doesn't have a single "housing market" -- rather it has hundreds of markets some of which were already deflating when others were just starting to "bubble".

Nor was it subprime (and sub-subprime) mortgages that created the crisis -- as long as housing prices continued to rise, those mortgages were solid, and while subprime and sub-subprime mortgages also contributed to the bubble, there is a reason why so many unsustainable mortgages were issued.

The crisis was caused by the creation and expansion of the derivatives market, which greatly expanded the market for "bundled mortgage" securities. The market for such securities was limited to those who were willing to accept returns based on prevailing mortgage rates. When the derivatives market started dividing up those securities into traches, and offering higher rates of return for higher risk traches, it created a much bigger market for those "bundled mortgage" securities. Subprime and subsubprime loans became increasingly available because of a flood of available new mortgage capital created by the derivatives market -- and when the housing bubble started deflating, the more "high risk" traches became nearly worthless -- and the house of cards collapsed.

Henry Hazmat writes:

Someone has Lucas and Stokey issues.

O writes:

Arnold,

As a graduate econ student, I have long struggled with the feeling that I'm wasting time toiling over representative agent models and solving Euler equations that reveal little about the real world. The complete lack of applicability of everything I've learned in 3 semesters of graduate macro to the largest economic crisis since the great depression has really made me wonder what it's all worth. If you were to design a reality based graduate macro program, what would the key concepts and readings be?

Adam writes:

Exactly right.

Frank Howland writes:

Arnold:

I quickly read the piece you linked to from the Minneapolis economists. The data show that things started going haywire around the first week in September. Bank credit, loans and leases, commercial and industrial loans all shoot up sharply at that point. To me this indicates something strange was going on. After all as far as we know the economy didn't suddenly start growing much more rapidly at the beginning of September. More likely, don't you think, businesses were forced to go to banks to obtain backup credit because they were locked out of commercial paper and bond markets. I would not be as optimistic as you and the Minn Fed folks are in interpreting the data.

I could give the media several stories of struggling homeowners, if they cared, but they don't.

Why are these stories not in the media? Because they're embarrassing. These are people who leapt for the American dream, missed, and fell flat on their faces. A speculator may have lost millions of dollars on houses, but he's not starving. Even in admitting his loss, he's bragging of his economic might - he not only controlled millions of dollars in real estate, he still does! It's just not as MANY millions anymore.

We might put that on display, but only as part of a collective story where many people have lost money, or an evil slumlord is whinging about his fortune while his remaining tenants live in filth and squalor. Culturally, Americans detest publicity of PERSONAL failures - only our collective failures and individual wickedness are subject to the media's morbid fascination for negativity.

The homeowner who loses his family home is not just losing money, but failing in his (or her) job as head of the household. A good provider should not lose the house, or even put the family at significant risk of losing the house. It is not that these people are not out there, it's that none of them want anyone to know who they are.

Michael writes:

Arnold:

There is so much talk going on, it is mind boggling. I've been flipping through my macro, derivatives and finance textbooks looking for insight. I would love to hear your answer to O's question: "If you were to design a reality based graduate macro program, what would the key concepts and readings be?"

stochastic calculus porn + mathematical masturbation = one of the best sentences I've read in months. Thank you.

Dan Weber writes:

I know that the NYT has been doing at least some stories on "struggling home-owners," because at least some fraction of them get picked up by Tanta over at CR so he can tear them apart.

http://calculatedrisk.blogspot.com/search/label/Picking%20On%20Poor%20Gretchen

Jake Shannon writes:

Whoa, as a libertarian with a M.Sc. in Financial Engineering (and supporter of Austrian economic theory), that's the best phrase to succinctly describe the epistemology of modern finance I have ever seen, awesome!

Mencius writes:

Arnold,

Basically, what you've discovered is what the Austrian School have been saying for the last 75 years.

The problem is that just because the people who have the name jobs and win the big prizes are charlatans and onanists, doesn't mean the Austrians are 100% right about everything. They almost surely aren't. After all, they've been saying the same thing for the last 75 years. Surely, if they'd had the name jobs and won the big prizes, they would have gotten bored with this.

It is not too late, however, for anyone with a reasonably young, soft brain to learn Austrian economics and try to bring it into the 21st century, repairing whatever errors he or she may feel the Austrian orthodoxy contains. For those with a neoclassical background I recommend working through Rothbard's Man, Economy and State.

Brad Hutchings writes:

O's question sounds like the economics version of the repeatedly asked question about what should be taught in a computer science curriculum. These quickly focus on which language should be taught over what the timeless concepts that students need to grasp are, like navigating different levels of abstraction.

O, I doubt that any curriculum anyone could come up with would prepare you to fully understand today's times. Arnold is in a very unique position to analyze and discuss the situation because he did time at Freddie when it was much more conservative and sound in its business approach. And, having done well with his Internet company, Arnold was a leading scribe of the Internet Bubble, sounding the alarm from the inside long before popular business culture picked up on the problem. So, my advice from the outside is soak up what you can, experience what you can in your career, and someday, you might be uniquely positioned for the interesting happenings of the time.

But one piece of advice... Find a graduate level graph theory course in your computer science or math department that you can take. Follow that with any courses or lectures you can find on operations research. They'll give you the perspective you need for all the interesting problems of the day.

Methinks writes:

These are people who leapt for the American dream, missed, and fell flat on their faces.

When did the American dream become an entitlement to buy things you cannot afford? The dream needs a makeover.

Itos lemma writes:

Stochastic calculus is a tool that makes computations easier. Nothing more, nothing less. Just like algebra, it is a tool. Very few macro people do stochastic calculus-math finance people do, and, most of them want formulas, not economics.

Most stochastic calculus finance has become, in practice, more and more complicated ways of applying Modigliani and Miller to new instruments, that themselves would not be useful if Modigliani and Milller actually applied.

Now macro guys now routinely work with multiple agent models with frictions. I think you are still thinking about late 1980's macro, in which there is an attempt to model people responding to incentives (no matter how crude) rather than 'consumption' and 'investment' functions which themselves are internally inconsistent, and unrelated to the basic economics.

But all that being said, I completely agree with Arnold that the economics professions has little idea about the importance of financial intermediation, and how the real and financial sides fit together. If I see one more discussion of 'liquidity trap' or 'effective demand' I am personally going to scream, because those ideas are fuzzy and undefined, and unhelpful.

Ironically, some of the most important papers on the relationship between financial intermediation and the real economy were written by the current Fed Chairman...

Marko writes:

Arnold,

Did Fannie and Freddie SECURITIZE subprime? I thought they BOUGHT subprime for their own portfolios, which is evidence of insanity.

I think, however, that they INVENTED Alt-A, and that is a crime.

zbicyclist writes:

If our economy is over-leveraged, and we want to lower the leverage, isn't a credit tightening required?

Is "crunch" really hype for a credit tightening?

logo designer writes:

Arnold great point about the media, I have not seen stories about struggling homeowners either...
First time reading and loving your posts!! keep them coming...

Megan McArdle writes:

I am aware of a startup with a decent business model that just had the plug pulled because of the credit crisis. It might have failed, of course, but the issue was on the supply side.

T Heller writes:

Any comments on this letter?
-----

Senator ______:

I just read this story, in which an FAA official cheer-leads the privatization of Midway Airport, a deal that could close before the end of the year.

http://www.chicagobusiness.com/cgi-bin/news.pl?id=31509

This is *not* a deal that should be cheered. It uses private investment capital to simply displace public ownership of an existing economic asset. THIS IS NOT A NEW *ECONOMIC* INVESTMENT -- it is simply a financial transaction.

Given that we are being warned of an impending and deep national economic recession, these sorts of deals should not be cheered, least of all by federal officials. What we need are NEW -and genuinely economic- INVESTMENTS, not cherry-picking sales of already-existing public facilities to private parties, including large banks and life insurance pension funds.

I sure hope Citibank won't be using any of that bank bail-out money to finance this deal.

Pedro P Romero writes:

A different approach to macro...

http://www-ceel.economia.unitn.it/staff/leijonhufvud/files/macro.pdf

Frejus writes:

Let me get this straight. You use a paper to argue your case (fed paper), and then when another argument undercuts the paper (point from Thoma), you declare that it's all balderdash anyway.

Sometimes it's not clear what you are saying, other than spinning narratives about suits and geeks and other arguments that are tenuous at best.

Dave writes:

>

I've been mostly ignoring the media, but NPR had one. Sorry, can't find a link to the transcript I read.

Amicus writes:

Economists ought to admit that we do not know much about what is going on today.
========
Pardon me, but can you quantify that?

[ducking away ...]

El Presidente writes:

Methinks,

When did the American dream become an entitlement to buy things you cannot afford? The dream needs a makeover."

What dictates what one can afford? To be more direct, the problem isn't that they want things, the problem is that they can't afford them. What they can or cannot afford is in large part dictated by things outside of their control. When real wages are declining, are people supposed to want less? Who has benefited from a declining median real wage, and could that possibly have something to do with the incompatibility between what people dream for and what they can afford?

For folks who insist that Marx was wrong, libertarian free-market types go a long way toward making him seem prescient by the policies they advocate. I don't believe that Marx's vision is inevitable, but it becomes more and more plausible when wealth is consolidated and people are told that they'll just need to dream smaller. Let his work be cautionary, and just don't go there. Would you back a rattlesnake into a corner? How much more foolish is it to tell PEOPLE to go f*** themselves? If you don't want destruction, stop picking a fight. If you want peace and prosperity, act like you give a damn. Taking it for granted is foolish.

Methinks writes:

Arnold,

A question about credit markets, please. Isn't the problem that in aggregate, too much money was lent on terms that were too lenient and did not account for the actual risk taken? Thus, in aggregate, we're over levered. So, as Marko points out, isn't a crunch required to delever? Of course, a crunch is only a relative crunch since we've been in a period of historically tight credit spreads and this incredible tightening of credit spreads happened across all loans and worldwide. It wasn't confined to the mortgage markets, although the housing bubble was also a worldwide phenomenon.

Going forward, lenders don't seem to be inclined to lend on such loose terms anymore. Thus, businesses that would have found cheap debt financing before won't now. Further, there is more perceived uncertainty (there's always uncertainty, but perception of the amount of uncertainty changes). When there's more uncertainty, it is natural for liquidity providers to widen spreads to compensate for the increased uncertainty. Sometimes, that means wider than they had been historically because during that period in history, perceived uncertainty was much lower.

Some economists seem to be presenting the fact that everyone who wants a loan won't be able to get one on loose terms anymore as a catastrophe. But, that seems natural to me as lenders return to demanding compensation for a given level of risk instead of practically ignoring risk altogether. Historically high credit spreads may not be dysfunctional at all right now. Might they just reflect real risk?

Jon H writes:

"I think, however, that they INVENTED Alt-A, and that is a crime."

Uh, no. Alt-A was originally a class of loan above sub-prime, but below prime, and not 'conforming' to the standards required by the GSAs (Fannie and Freddie).

Fannie and Freddie got into buying Alt-A loans but that was pretty late in the bubble. Before that, it was all banks and other lenders.

P. Allen writes:

Arnold-

Economics does explain this financial malaise, it’s called a severe widening of the output gap. (Or in other words, an output gap that is distended beyond a more acceptable range in the short run). It is the above average amount of created productivity over the course of the last quarter century that is wedging the gap wider. The good news is, we have a tremendously balanced economy as a result (perhaps more balanced then ever before and the reason why it will be very difficult to record two consecutive quarters of negative GDP). The bad news is, this doesn’t provide much in the way for earnings growth for stock investors over the long run.

Just look at the data, over the last eight years, GDP growth has lost a half of its quarterly volatility (as measured by one standard deviation of the mean) at the expense of a third of its growth rate with respect to its post WWII average. Not a bad tradeoff if you ask me. It is this balance, consequently, that is making the financial sector that much more volatile since it can not “pass through” its difficulties into the broader economy much in the same recent vein that higher food and energy prices never flowed through into core CPI. Consequently, this is a “game changer” for financial expectations.

Great point about economists in the financial sector because that is where the recession actually took place. (For all you quants out there, it was the 3mo/10yr Treasury curve that inverted in 06-07, NOT the 2yr/30yr curve. We have never had an economic recession where the 2yr/30yr did not invert first, nor will we). The output gap will compress back to a more normal shape, it’s just that we want it to happen by realizing more potential growth versus letting it go to waste, obviously easier said than done. By the way, this is the real reason behind the once profitable endeavor that was creating leverage (that is to contain and bridge the output gap), not the greed / ignorance scenario that plays so well during election season.

Meijerink writes:

"But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation.

Interesting...is that why no woman has ever won the Nobel prize for economics?

Randy writes:

El Presidente,

"What they can or cannot afford is in large part dictated by things outside of their control."

Bull. More precisely, the largest part of fortune is determined by personal choice. Yes, there are those who are exceptionally lucky or unlucky, but if we eliminate these extremes the importance of personal choice is obvious to all but the most politically motivated.

Irving writes:

Baloney. "Personal choice" doesn't dictate if you're born in Somalia or San Francisco. It doesn't account for genetic dispositions for health and wellness - if you're genetically predisposed to have Down's syndrome, or even a costly, debilitating chronic disease, your earning potential is going to suffer. There are vast swaths of "fortune" you're simply being blind to, because it doesn't fit into your economic model.

More to the point, how does one learn to make good personal choices? It is a learned skill; it's not an innate property of intelligence. I would submit that you are raised in dire economic straits by people who make bad choices, you'll have little opportunity to learn how to make good choices.

Yes, some poor people do make exceptional personal choices. And some rich people make utterly idiotic ones. With wealth comes lawyers, though, and many tools to escape the consequences of your actions. Poorer people are much less likely to do so. (A quick glance at incarceration rates proves the theory.) We celebrate the self-made man because he overcomes the odds, not because he meets expectations.

Christopher Phelan writes:

Arnold,

There seems to be a disconnect here between "Where are the stories of businesses canceling projects because of lack of funding?" and "Graduate macro is even worse. Have the courses that use representative-agent models solving Euler equations been abolished? Have the professors teaching those courses been fired? Why not?"

The three Fed economists you favorably cite are exactly those teachers of said graduate macro (as am I).

Modern representative agent macro has, relative to the past, severely discounted the importance of the financial side of the economy. In these models, real things are mainly caused by real things.

The first part of your post was essentially "where exactly is the evidence that the sky is falling?" As with you, I haven't seen it in anything real (yet). If we have a huge financial crisis without a correspondingly huge real crisis, then modern macro will have been vindicated, not discredited.

We'll have to wait and see.

Randy writes:

Irving,

"There are vast swaths of "fortune" you're simply being blind to..."

True. My concern is with what it takes for an average American to be a part of the American productive class. I have no interest whatsoever in any brotherhood of man or bringing about heaven on earth. These are nothing but religious fantasy and I am not religious.

"I would submit that you are raised in dire economic straits by people who make bad choices, you'll have little opportunity to learn how to make good choices."

Public school is free for all. If the political activists in charge of the schools have chosen to promote a belief in fate and dependancy then the outcome is predictable, but the students still have a choice. They don't have to buy into the nonsense. They can choose to be productive instead of political.

Robert Speirs writes:

Sounds like Arnold has been reading Nassim Nicholas Taleb.

Orlando writes:

The politicians are using the 'credit crisis' to hide the fact the recession was caused by high prices in commodities which forced consumers to stop buying. They will take credit with the resounding boom that will occur when commodity prices stabilize some 50% below their peak as being far sighted enough to push the bail out through.

There are two events being combined into one for political purposes. I can't believe economists can't see through this, so it must be selective reporting by the media.

Even in the worst instance, the Depression, the credit crisis did not hit until the fourth year, the slow down and market crash came first. In this era of light speed reporting, somehow this major fact is being ignored. The credit crisis is a dud, the 'recession' is being caused by global warming alarmists trying to price commodities beyond competitive price.

Don't tell me there is no oil when communist Cuba now has the 5th largest reserves in the World, when it had none three months ago.

Steve Roth writes:

Arnold, I'd be very interested in hearing your opinion on this recent Times OpEd:

http://www.nytimes.com/2008/10/01/opinion/01buchanan.html

Talks about agent-based simulation modeling (rather like some weather models) as an alternative to more purely theoretical approaches.

Louie A writes:

"But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation."

Then Wall Street turned around and abused Black-Scholes, CAPM and other mathematical models that are impractical in the "real world" by completely IGNORING ALL THE ASSUMPTIONS THAT MUST HOLD:
1)It is possible to short sell the underlying stock.
2)There are no arbitrage opportunities.
3)Trading in the stock is continuous.
4)There are no transaction costs or taxes.
5)All securities are perfectly divisible.
6)It is possible to borrow and lend cash at a constant risk-free interest rate.
7)The stock does not pay a dividend.

and we all know what happens when you assume to much...

El Presidente writes:

"Bull. More precisely, the largest part of fortune is determined by personal choice. Yes, there are those who are exceptionally lucky or unlucky, but if we eliminate these extremes the importance of personal choice is obvious to all but the most politically motivated."

That is a remarkable unsubstantiated claim. I will concede that choice does indeed determine the larger part of fate that is subject to it, but who's choice and who's fate? My choices affect my rate of assent but not my origin or the obstacles I will encounter. How then can they DETERMINE my destination? It's convenient to say that poor peole are just defective, or stupid, or lazy, or that they just made bad choices. It's convenient, but it's despicable. It's a warm blanket that shields ideologues from reality. Let's be realists. How many people chose to be poor in the US in 2007? I'll say more than zero. Would you say less than 37 million?

"Public school is free for all. If the political activists in charge of the schools have chosen to promote a belief in fate and dependancy then the outcome is predictable, but the students still have a choice. They don't have to buy into the nonsense. They can choose to be productive instead of political."

First of all, public school is free for none. They are paid for by taxes. Whether one pays for them directly or indirectly is an important consideration, but "no charge" is not the same as "free". There is no such thing as a free lunch. Graduation rates in Los Angeles (my home town) are exceptionally low for two reasons:

1. Graduating from high school usually won't earn you a LIVING wage, much less one that will allow you to retire in good health before you turn 70. To put it another way, jobs that pay that type of wage require either less than or substantially more than a high school diploma. Less-than, if you are willing to risk your health. More-than, if you would prefer to take on massive debt to pay for school. There's a pleasant choice, huh? Have you noticed that increasing labor productivity has not translated to a proportional increase in real wages over the last 20 years? That kind of undercuts your argument, doesn't it? Not to mention that more of a household's primary resource, time, has been drawn into the economy with reducing marginal returns. This leaves less time for things like caring for those children who are enrolled in those wonderful free schools you speak of.

2. Per-pupil spending in CA has gone from the top quintile in the nation to the bottom with no appreciable comparative advantage in the efficiency of labor. This occured as the result of a tax reform designed to protect the wealth of land owners and the profits of land developers. It was a subsidy to land, in relative terms, and has bled the state dry in infrastructure maintenance costs on sprawling development and interest to finance operating revenues in economic downturns.

It's not because of the political ideology or social philosophy of teachers. Nice try. If we won't pay people to be educated, why would they become educated? We have stopped valuing general education. Instead we value specialization for a few and desperation for everybody else. Nothing drive down real wages like hunger. Amen for consolidation, huh? Like Keynes said, "In the long-run, we are all dead." Choose your way out of that.

I behave like a libertarian might expect because I want to maximize my benefit to myself and to others, but I'm not so gullible as to drink the kool-aid and believe that I can bend the economy to my will. The best I can do is usually to work within constraints. I did not create them and I cannot change them alone. I'm not a quitter, but I'm not a sucker either.

"When did the American dream become an entitlement"

It didn't, but Americans have culturally decided it should be, which is smacking headlong into the economic reality that it isn't.

There's a fundamental idea in much of America that every American deserves to have a good job with good pay, a single-family home with a white picket fence, and 2.5 children. Related to this are some other entitlement ideas: that one's rights of "life, liberty, and the pursuit of happiness" translate into "free health care, laws against other people doing distasteful things, and actual happiness at all times".

The reality is that you don't have an entitlement to these things. You have an entitlement to work for things and make choices. These entitlements are not unrestricted; you have to work within the strictures of your local market, and make choices that are available to you. If you work hard and make good choices, you should be rewarded by achieving your goals, but this is not (and should not be) guaranteed.

Americans don't like that. The new American dream is "do nothing and have everything". The old dream is the correct dream; to enjoy the fruits of your labor. If your labor bears no fruit, you get to enjoy nothing. If it bears bitter fruit, your enjoyment is limited. But if your labor bears sweet fruit, and a lot of it, you get to have and enjoy your American dream. It is the new perception of this dream - that it is an entitlement - which needs to be altered.

And we can't do that. Culture moves the way it moves, and like economics is the result of human action but not human intent. Unlike economics, it is frequently irrational and unproductive.


David Zetland writes:

I believe the correct word is "mathurbation."

Martin Brock writes:
I am shocked at the behavior of my fellow economists during this crisis. They are claiming to know much more than they do about causes and solutions. Rather than trying to understand and explain what is going on, they are engaged in a fierce battle over narrative.

I agree completely.

If you invest in startups, your exit comes either from going public or being acquired, neither of which looks very likely with stock prices in the toilet.

Right. I would never start a veterinary practice, because I want to be a veterinarian. I'd only form a corporation employing veterinarians while lobbying for regulations increasing economies of scale in this business, so I could flip my "property" to an investment bank a few years down the road. My sister, the vet in private practice who was valedictorian of a class of a thousand, is obviously an idiot.

Because in modern "capitalist" terms, "companies" are like "widgets". They're just titled abstractions that absentee financiers buy and sell.

Venture funding is a whole lot riskier today than it appeared to be a month ago.

Well ... maybe it is but only because new ventures may have more trouble competing with established companies now than in the past, despite the declining value of existing companies.

The tanking of the share market is irrelevant to venture capitalists, or should be, because venture capitalists don't invest in the shares that are tanking now. Why would the declining value of existing companies portend failure of a new company? Why would GM's looming failure threaten Tesla? Maybe GM's survival threatens Tesla more.

We'll just have a never-ending argument over whether that would have been better or worse.

Right.

Where are the stories of businesses canceling projects because of lack of funding?

Where are the stories of new ventures being canceled?

Speaking of dogs that are not barking, where are the stories of struggling homeowners?

I know a few unfortunate souls who bought at the top, but you definitely have a point here.

I suspect that news organizations are trying to find struggling homeowners to profile, but instead they are finding mostly struggling speculators.

They're struggling for the attention of the Bailer Out in Chief, successfully.

Another point of issue in the narrative battle is the percentage of subprime loans made by Freddie and Fannie. Because they accounted for less than, say, 1/5 of all subprime loans, we are supposed to say, "Phew! It wasn't their fault! It was the private sector's fault!"

Because they accounted for less than, say, 1/5 of all subprime loans, we are supposed to say, "It's all their fault!" That's the song my choir is singing anyway.

If Freddie and Fannie undermined their safety and soundness by only insuring 15 percent of all subprime loans, wasn't that enough?

No. It wasn't. For one thing, the bailout wasn't a given. It was a risk that early buyers of these bonds took. They took it because they didn't like the yield of other "safe investments". The absence of other investments, the competing assets that "investors" didn't buy, is the silent dog you ignore.

I just don't see how my fellow economists (Thoma, Chinn, and others) can work up such passion over the fact that Freddie and Fannie accounted for less securitization of subprime loans than did the private sector.

Yeah, you do. They're on the opposite side of an incredibly mindless, dualistic, rhetorical dialectic. They're missing the forest for the trees. Aren't you?

But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation.

I resemble this remark. Statistics don't lie. Statisticians lie. The particular stochastic models we construct matter.

One problem is that economists model "investment in labor" with things like educational institution building, educator salaries, productivity enhancing technology and the like. How about the cost of raising children? How about the number of children we've had ... or haven't had? How about the capital market distortions created by the statutory benefits of accumulating entitlement to rents rather than raising rent payers? The payroll tax surplus peaked this year. This dog is barking loudly.

El Presidente writes:

Caliban Darklock,

"The new American dream is 'do nothing and have everything'."

Interesting hyperbole. I think you have it backwards. Americans work more hours per capita than the citizens of any other industrialized nation and they still don't have guaranteed health care, which all the rest do. Care to explain? Is it that we don't work "real" hours, or that we're just a bunch of slackers riding the clock? Is it that all the other nations are full of whiny greedy bastards too (and apparently more effective ones)? It's not necessarily that average Americans want everything for nothing, they just want an equitable stake in a social bargain. Comparable pay, if you will. Nobody is suggesting that we ought not to have to work. It's not in the Aremican ethos to propose such a thing and it doesn't comport with present reality. That's a non sequitor.

Nicholas Shackel writes:

This remark

"But the economics profession for the past thirty years instead focused on producing stochastic calculus porn to satisfy young men's urge for mathematical masturbation."

is a nasty piece of anti-male sexism. It is an indication of the success of misandrist prejudice that so many men are willing to express contempt for other men is this way.

John F. Opie writes:

Hi -

Great post, and 100% on the ball. What I call the econometric fetish has been enormously damaging to the profession. I could bore everyone with anecdotes of colleagues using hyperbolic trends in co-integrated equations because it makes the fit so much better, but who were at a complete and total loss as to what it actually *meant*.

I am convinced that a good part of the problem is that there are very, very few economists left in corporations, as they were replaced by lawyers and accountants who were better at telling stories than the economists, and management loves a good story. That these stories had nothing to do with economics was ignored.

Our profession has failed its most important customers: real business owners who need to understand what is going on.

Martin Brock writes:

Nicholas, I haven't seen "misandry" for a while. You must be recently divorced. I identified with a "men's movement" for a while in the nineties, when Warren Farrell, Christina Sommers and Cathy Young wrote on the subject and also Camille Paglia to some extent. Some of the arguments are very compelling, but they never gained much traction. The most virulent feminisms seem to have lost traction too though.

Randy writes:

El Presidente,

"How many people chose to be poor in the US in 2007?"

Indirectly, most of them. They may not have chosen to be poor, but they made choices that resulted in little if any income. And I'm okay with that. I did the same when I was younger.

"...public school is free for none."

Its free to the students.

"Graduating from high school usually won't earn you a LIVING wage"

Bull. I have not seen a single report of high school graduates dying in the streets. I used to be one of those high school graduates working low wage jobs. Bouncing from job to job. Sharing the rent. It was great. I've never had more freedom or more time to party.

"We have stopped valuing general education."

True. Because so much of it is propaganda. I knew that even when I was in school. Didn't you? Why should we expect employers to forget it? But still, the people who want to learn do learn. They choose to be productive even in a highly political environment.


Mr. Econotarian writes:

http://www.freddiemac.com/governance/pdf/charter.pdf

The term "investment grade" is not there.

On the other hand, here is the Freddie Mac definition of "mortgage":

(h) The term “residential mortgage” means a mortgage which
(1) is a mortgage on real estate, in fee simple or under a leasehold
having such term as may be prescribed by the Corporation, upon
which there is located a structure or structures designed in whole
or in part for residential use, or which comprises or includes one
or more condominium units or dwelling units (as defined by the
Corporation) and (2) has such characteristics and meets such
requirements as to amount, term, repayment provisions, number
of families, status as a lien on such real estate, and otherwise, as
may be prescribed by the Corporation. The term “residential
mortgage” also includes a loan or advance of credit insured under
title I of the National Housing Act whose original proceeds are
applied for in order to finance energy conserving improvements,
or the addition of a solar energy system, to residential real estate.
The term “residential mortgage” also includes a loan or advance
of credit for such purposes, or purchased from any public utility
carrying out activities in accordance with the requirements of title
II of the National Energy Conservation Policy Act if the
residential mortgage to be purchased is a loan or advance of credit
the original proceeds of which are applied for in order to finance
the purchase and installation of residential energy conservation
measures (as defined in section 210(11) of the National Energy
Conservation Policy Act) in residential real estate, not having the
benefit of such insurance and includes loans made where the
lender relies for purposes of repayment primarily on the
borrower's general credit standing and forecast of income, with or
without other security. The term “residential mortgage” is also
deemed to include a secured loan or advance of credit the
proceeds of which are intended to finance the rehabilitation,
renovation, modernization, refurbishment, or improvement of
properties as to which the Corporation may purchase a
“residential mortgage” as defined under the first sentence of this
subsection. Such term shall also include other secured loans that
are secured by a subordinate lien against a property as to which
the Corporation may purchase a residential mortgage as defined
under the first sentence of this subsection. A “secured loan or
advance of credit” is one in which a security interest is taken in
the rehabilitated, renovated, modernized, refurbished, or improved
property. Such term shall also include a mortgage, lien, or other
security interest on the stock or membership certificate issued to a
tenant-stockholder or resident-member by a cooperative housing
corporation, as defined in section 216 of the Internal Revenue
Code of 1986, and on the proprietary lease, occupancy agreement,
or right of tenancy in the dwelling unit of the tenant-stockholder
or resident-member in such cooperative housing corporation. The
term “residential mortgage” also includes a loan or advance of
credit secured by a mortgage or other lien on a manufactured
home that is the principal residence of the borrower, without
regard to whether the security property is real, personal, or mixed.

El Presidente writes:

Indirectly, most of them. They may not have chosen to be poor, but they made choices that resulted in little if any income. And I'm okay with that. I did the same when I was younger.

Why would you choose poverty? Was it a religious thing? I mean, choosing to do things that are more or less rewarded is one thing, but did you actually aim to earn poverty level wages? Dismissing the issue of distribution by saying that people make choices that result in low income is tantamount to saying that the distribution is equitable in a prima facie sort of way. If you feel that your dogma prevents you form considering whether or not that is reasonable, I will have to respect your religious beliefs. Can we not afford higher standard of living? I too have been poor, but I never chose it; not once. Maybe you were lucky. Maybe I'm a worthless piece of crap. Maybe you overestimate the value of choice.

Bull. I have not seen a single report of high school graduates dying in the streets. I used to be one of those high school graduates working low wage jobs. Bouncing from job to job. Sharing the rent. It was great. I've never had more freedom or more time to party."

Fabulous hyperbole. With regard to what is and is not a living wage and to people dying in the streets, obesity, coronary disease, and other chronic conditions that contribute to morbidity and mortality are strongly statistically correlated with poverty; that is, relative poverty (below 50% of median). I wasn't suggesting that anybody was dying in the streets (nice jab) although I have personally seen several who did. Some because of black market activities, others for want of shelter and nutrition. Have you done a considerable amount of study about or had persistent personal interaction with the urban poor?

Randy writes:

El Presidente,

"...did you actually aim to earn poverty level wages?"

My aim was to work as little as possible. Trust me, it doesn't take much to get by.

"Dismissing the issue of distribution by saying that people make choices that result in low income is tantamount to saying that the distribution is equitable in a prima facie sort of way."

I have no idea what you mean by "the issue of distribution", nor what you mean by "equitable". I think that perhaps you're overthinking it, or perhaps overly emotional about it due to some sort of religious ferver. Learn, work, live. Its not that complicated.

"Have you done a considerable amount of study about or had persistent personal interaction with the urban poor?"

Nope. I've been to such areas. I have no idea why anyone would want to live there. But I figure they must find some value in it or they would leave.

Arnold Kling writes:

Mr. Econotarian,
I may be out of date in my thinking. When I was at Freddie Mac, the term "investment quality" was very much a part of the charter. Look at this older document:
http://financialservices.house.gov/banking/91200mb2.pdf

"there is a tension between the GSE Charter Acts’ safety and soundness goal
mandating that mortgages purchased should be of investment quality and the goal of
providing more affordable housing, both goals enacted by Congress."

your document is from January of 2005. The one I quoted from is from 2000.

El Presidente writes:

I have no idea what you mean by "the issue of distribution", nor what you mean by "equitable".

I am referring to the negotiation of wages (equitable) and distribution of income (the issue of distribution). If you don't think we have any control over these things, then you should examine the changes in income distribution following changes in tax policy, like the recent cuts in capital gains rates or the reduction of marginal rates under Reagan. If you've given serious consideration to game theory, you should know that RELATIVE distribution of leverage (AKA wealth) amongst the parties to a transaction has a great deal to do with the terms they will arrive at.

I think that perhaps you're overthinking it, or perhaps overly emotional about it due to some sort of religious ferver. Learn, work, live. Its not that complicated.

It's that simple, huh? Perhaps I am thinking and feeling too much. Perhpas you are not doing enough of either.

Nope. I've been to such areas. I have no idea why anyone would want to live there. But I figure they must find some value in it or they would leave.

Where should they go and how would they get there? I guess there must be gold laying on the street somewhere and they're just a bunch of idiots for not going to pick it up. They must really like poverty, huh?

Adam Smith wrote more than one book, ya know. Economics was where he looked for ways to ease suffering. Of course, you'd have to be willing to acknowledge suffering and search for its causes in order to actively do anything about it. Empathy is a prevalent basis for human morality and one Smith wrote about very well. If you think the urban poor are either urban or poor because they like it, you have a serious lack of understanding and empathy where they are concerned. Smith would say that without empathy you are unqualified to say what is right or wrong with respect to them. That would leave you in an akward position if you intend to give advice on government policy. So, maybe your argument is with Adam Smith.

I have one last question for you. If your low-wage employment was so wonderful, why did you ever give it up?

Randy writes:

El Presidente,

"If you've given serious consideration to game theory, you should know that RELATIVE distribution of leverage (AKA wealth) amongst the parties to a transaction has a great deal to do with the terms they will arrive at."

Serious consideration? No. Just enough to recognize that my leverage is my ability to produce. The political class has leverage in its ability to extract rent from my productive activity, but theirs is not unlimited leverage. Without my production, they have nothing. They know it - and I know it.

"Perhaps I am thinking and feeling too much. Perhaps you are not doing enough of either."

Perhaps I just recognize that all the thinking and feeling is nothing but disguised propaganda. I dismiss it, because it is in my interest to dismiss it.

"Where should they go and how would they get there?"

Wherever they choose, and a bus ticket costs very little. Been there, done that. Finding work is not a problem for those who don't believe that the world owes them a living.

"Of course, you'd have to be willing to acknowledge suffering and search for its causes in order to actively do anything about it. Empathy is a prevalent basis for human morality..."

Ah, the guilt trip. I grew up Catholic. I know all about that particular brand of propaganda. I don't buy it from the old religions or the new. Your morality is a tool for your benefit. I have my own.

"If your low-wage employment was so wonderful, why did you ever give it up?"

I discovered that I liked having stuff. Freedom is good. Having stuff is good. I have discovered a balance that works well enough for me.

Bill S writes:

With all due respect I think you are totally ignoring rather dire messages from some reasonably useful forward-looking indicators of prospects for the U.S. and global economy.

For example, the Bloomberg Financial Conditions Index is a weighted average of a variety of capital market stress indicators (Libor, TED spread, hi-yield spreads, etc.) that have historically signaled changes in the U.S. economy over the next several quarters. Following the Lehman bankruptcy, the indicator has signaled a massive tightening of financial conditions. Compared to the norm of the last two decades, conditions have moved from minus three standard deviations prior to the Lehman bankruptcy to 8-to-10 standard deviations since. A simple regression analysis (no stochastic calculus required) would indicate that one of the next few quarters would be likely to see real GDP decline at an 8%-to-10% annual rate barring a quick recovery in financial conditions. And industry surveys by Wall Street economists like Ed Hyman show a major drop in economic activity beginning soon after the shock (he has real GDP declining at a 4% annual rate in Q4 and the output gap growing to 7% in the first half of next year as unemployment rises to 8%).

As another example, check out the message from inflation adjusted securities, which are now projecting 5-year inflation at zero! That compares to a 2.8% implied inflation forecast before the Lehman shock. Exercise for the interested student: what would the implied output gap, unemployment rate, and decline in real GDP be to be consistent with that sharp of a drop in the inflation rate? What would the corporate bankruptcy rate be over the next 5-years consistent with current high-yield bond spreads (hint--over 50%). It's also noteworthy that the TIPS yield curve is highly inverted now, with 6-month real yields at 9.5% vs 10-year at 2.5% or so. In other words, investors who control billions of dollars of fixed income funds -- who have strong incentives to make the right call -- are clearly interpreting the Lehman shock as a deflationary event of major proportions even with the TARP and massive Fed interventions.

Or take a look at global commodity prices, which have been in a virtual freefall since the Lehman shock. Freighter traffic is halting because credit lines are disappearing. Moreover, commodity related currencies have been plummeting in recent weeks -- including the Australian dollar, the Canadian dollar, the South African rand, the Brazilian real, etc. Recent research by Ken Rogoff suggests commodity related currencies are good leading indicators of where commodity prices are headed over the next quarter or so -- so more weakness looks likely across the board in commodity markets.

So, sure, let more financial institutions fail. In the immortal words of Andrew Mellon,
"Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate.... That will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people."

That advice worked out great in the 1930s.


Caliban Darklock writes:

"Care to explain?"

Sure!

Those of us who work all kinds of hours, have all kinds of health care.

Those of us who work no hours at all, have no health care at all.

The former think it's unfair that they have to work all kinds of hours.

The latter think it's unfair that they don't get all kinds of health care.

Both groups, as a general rule, would happily choose to work no hours at all and have all kinds of health care.

Clear enough?

"It's not necessarily that average Americans want everything for nothing, they just want an equitable stake in a social bargain."

I believe the conditions I just described ARE an equitable stake in the social bargain. No work, no health care; much work, much health care.

After all, if Randy and I are doing all the work, what is YOUR equitable stake in the proceeds? Because I believe the technical term is "squat".

As someone in the "much work" category who is quite satisfied with doing much work, I do not believe that giving some of my health care to someone who has none would make me happy. It would be equitable, for certain definitions of "equity", but on my planet equity is the result of investment. If you don't make one, you don't get any, and that is precisely the way it should be.

El Presidente writes:

Caliban & Randy,

Focus with me. You refuse to engage in empathy, so let's talk about self-interest. Who's gonna protect you when the people to whom you are indifferent decide to kick your ass and take your things? I'm not saying it's right. I'm saying it could happen. Your preferred eviscerated state will be useless. You might have the guns, but they have the numbers. It would be better for you if we didn't get to violence, even if you each feel a little bit slighted in the mean time. It would be better for everyone if you would engage in empathy. Then, you wouldn't even feel slighted. Go ahead and exercise your power of choice. It'll be liberating.

Capisce?

Randy writes:

El Presidente,

"You refuse to engage in empathy, so let's talk about self-interest."

Now we're getting somewhere.

"Who's gonna protect you when the people to whom you are indifferent decide to kick your ass and take your things?"

We'll take care of them. Do you really think that the productive class is incapable of responding to violence with violence? Get real. The government is all that stands between them and annihilation. Or perhaps we'll hire someone to take care of them. But then, that's what we thought we had with government. Turns out the people we thought we were hiring were a bunch of untrustworthy thugs and confidence men.

"It would be better for everyone if you would engage in empathy."

I disagree. The confidence men turned our empathy against us. It is now time for cold hard reason and the application of logical consequences.

Martin Brock writes:

Randy,

How do I know that you're really one of the productive ones? How do I know that your job isn't part of the confidence game?

Maybe you only believe mistakenly that you're productive, because you believe the confidence men telling you how useful you are. Maybe the confidence men only pay you to busy yourself to keep you out of trouble.

Maybe you're a TSA officer searching handbags for toothpaste or an accountant with the Office of Financial Stability or a research analyst at the Fed or an astronaut.

Maybe you're accountant with a bank paid to fill out forms from the accountant at the OFA.

Maybe you design strategic bombers.

Maybe you write software for strategic bombers, but you don't know the software is for strategic bombers, because a layer of abstraction obscures the purpose to protect national security.

Maybe you build basketball courts in public schools.

How do I know the difference?

Pete Crabb writes:

Mr. Kling,
I too am shocked at what our fellow economist can claim to know about the current financial and economic situation. I am also shocked, however, at your irreverent characterization of the discipline. We certainly deserve criticism, but your words do more harm than good. When other scientists fail, they return to the lab and try again. Let’s do the same.

El Presidente writes:

Randy,

Do you really think that the productive class is incapable of responding to violence with violence?

Two words: French Revolution

I think you embrace definitions that do not comport with reality, at least as I observe it. There is an unsubstantiated fiction that real wages are equal to the marginal productivity of labor. It is only true so long as markets are nearly perfectly competitive. They very rarely are. Who is the 'productive class'; the people who produce or the people who get paid; the slaves or the masters; the serfs or the lords? If the former becomes much larger than the later, it won't even be a close contest. There will be bloodletting and it will be indiscriminate. That's not good for anybody, not even you, but antagonism and indifference certainly invite it. It will not only destroy life and property but also erode the precious property rights that libertarians hold so dear. If you have already made up your mind, what good is the power of personal choice you speak so highly of? You'll never demonstrate it. You may as well be a robot. Take Marx as cautionary, and you will not have to acknowledge him as prophetic. I encourage you to choose to do your part to ensure he does not become correct. I was in Los Angeles during the '92 riots. I watched the looting and mayhem. I assume you were not there, from what you've told me. I don't want to see that again and I'd appreciate it if people like you were not so cavalier about it. I suppose asking a libertarian to have empathy is a fool's errand. They'd rather roll the dice for all of us and hope they come out on top.

Caliban Darklock writes:

"You refuse to engage in empathy, so let's talk about self-interest."

Yes, let's talk about that.

When my business collapsed a couple years ago and my clients simply refused to pay their invoices, I paid my contractors out of my own pocket and lived off credit. Now my credit rating is trashed, and I remain some $40,000 in debt. (It used to be well into six figures. I figure in another two years, I should wipe it out.)

This is my own fault and the result of my own choices. My contractors were contracted under the basic principle of commissioned work: when the client pays, they get their cut. The client didn't pay, and they were not contractually entitled to a cut of anything. I was entirely within my legal rights to tell these people they could go pound sand.

But they had families to feed and bills to pay, so I "advanced" them the money they were supposed to receive - even though I knew I would never receive it. Because I did have an obligation to those people, even if I wasn't legally obligated.

There's self-interest in that, to be sure, but there's also empathy and concern for my fellow man. Just like the homeless guy at my exit from the highway; when I needed someone to move some boxes in the office, I offered him $50 to come do it. (A temp would have cost me $120.) He laughed and told me he'd make more than that begging on the highway. So I apologised for wasting his time and left.

I didn't say "look, if you do a good job, maybe I'll train you at my own expense and give you a permanent position at $15 an hour - with a potential career path into the consulting ranks, where it's all commissioned but the average pay works out to about $27 an hour". He wouldn't hear that; people never do. They hear "$27 an hour" and gripe incessantly until that's what they get.

He made his choice. Four years later, he's still begging on the side of the road. Granted, if he'd taken a job with me, he would no longer have it... but he'd have solid experience on his resume, and industry contacts, that could get him a similar job elsewhere. Some of my former contractors are now making three times what they did working for me.

Self-interest isn't always what you think it is. Having turned down work while carrying a sign that said "will work", the man at the exit didn't just lose out on that admittedly-uncertain future, he also made himself a liar in my eyes. He hasn't gotten so much as a dime from me since. I will accept a certain amount of dishonesty and disloyalty from someone trying to move up in the world and achieve his dreams, but not from someone trying to go nowhere and do nothing.

Randy writes:

Martin,

"How do I know that you're really one of the productive ones?"

That's a good question. With the political class so deeply entrenched in so many areas it can be difficult to know. I have given it some thought though, and I figure that a good place for the concerned individual to start is to detemine whether or not their customers have the right to dump them at will, and without being forced to accept a replacement of someone elses choosing. My customers can dump me and choose their own replacement or no replacement. They haven't dumped or replaced me so far, so I feel it safe to assume that I am producing something of value. How about you?

Caliban Darklock writes:

"How do I know that your job isn't part of the confidence game?"

It is. All jobs are part of the confidence game. The question is whether you are playing the confidence game, or some other game.

I had a company that employed people and turned a profit. If I were playing the confidence game, I would care about the money, and the people would just be the fuel that ran the engine. If I were playing a more enlightened game, I would care about the people, and the money would just be the fuel that ran the engine.

But you don't know whether I care about the money or the people. Indeed, you can't know. All you know is what game you're playing, and whether my goals line up with yours right now. When they stop lining up, you have to do what drives toward your goals, and I have to do what drives toward mine. That might make us allies now and enemies tomorrow, or enemies now and allies tomorrow.

Whichever way it goes, we're both part of the confidence game, even if neither of us is playing it. Because the people who are playing it are still playing on the same field, so they have to play with us - and we have to play with them. If you play well, you get to have fun and make money, and so do the other people on your (temporary) team. If you play badly, you don't have fun and you don't make money - and neither do the people on your team.

If you don't like the people on your team, leave, and join a different one. That changes the definition of "playing well". But the key factor is this: your job is to have fun and make money, which will help the people on your team have fun and make money. You do not ever take away other people's fun or money. That is simply an accident of playing well on your part combined with playing badly on theirs.

In the end, it is their playing badly that costs them the fun and the money, not your playing well - so it is completely inappropriate of them to blame you for it, and it is every bit as inappropriate of you to feel responsible for it. Or, for that matter, to rub it in their faces and act like a jerk. It's a game. Whether you win or lose, be a good sport about it.

El Presidente writes:

Randy,

It is now time for cold hard reason and the application of logical consequences.

It is always that time. However, it is no so wise to assume that what you have reasoned must be true for everyone else or the consequences YOU believe to be just are in fact so. We are not moral authorities. We are moral agents. I think that is a distinction lost on people who are willing to run headlong into violence simply because they believe they will win. If we are interested in the discipline of economics, then let us not forget the purpose for it's existence: the betterment of life for people, ALL people. Otherwise, it is no more than the porn that Arnold has called it. If it does not have a bearing on human welfare, or instead is passively indifferent or actively hostile to it, then it has no value. Yes, let's use some cold, hard reason, and let the consequences be logical . . . if we will not make them beneficent.

El Presidente writes:

To All

Staff has flagged my comments for review, and for good reason. I was rude and I apologize, specifically to Randy and Caliban, but generally to all for lowering the tone of discourse in this thread. I thank staff for pointing it out and will endeavor to be more civil in the future.

Chris writes:

Now we all know the beauty of having a Joe the Plumber come along and explain the implications of Barack Obama's tax policy. When a plumber can do a better job of explaining Barack Obama's tax policy than Doug-Holtz Eakin, an Ivy League trained economist, you know we are living in Bizarroworld.

Randy writes:

El Presidente,

For what its worth, I did not find your comments to me particularly rude. Perhaps I'm just used to a whole lot worse. In fact, I find your arguments quite well written - though nothing I haven't heard many times before.

Randy writes:

El Presidente,

I missed a post. Didn't mean to ignore you.

"Who is the 'productive class'?"

Those who produce. It extends all the way from CEOs to janitors. I've never found much use in a breakdown of society by income levels. Anyone who's ever held a job knows that not everyone gets paid the same - and for good reason. That doesn't change the fact that to be on the job is to be part of a productive team. The only people who concern themselves with such things are the members of the political class - and they do it to advance their own agendas. You bring up the Watts riots. This was brought about by instigators from the political class for whom violence, threats of violence, and rumours of violence, are the only methods. My advice to the rioters would be to stop screwing around with other people and get a job.

Randy writes:

El President,

"If we are interested in the discipline of economics, then let us not forget the purpose for it's existence: the betterment of life for people, ALL people."

Actually, I think of Economics as 'the philosophy of the real'. That is, I don't think it has anything to do with 'the betterment of life'. It simply describes what is. Make the right choices and prosper. Make the wrong choices and fail. It is morally neutral. Perhaps that's why I like it.

El Presidente writes:

Randy,

I think of Economics as 'the philosophy of the real'. That is, I don't think it has anything to do with 'the betterment of life'. It simply describes what is.

That's alright. I think of it as a social science (the branch of academia where it usually resides); one concerned with the behavior of people. If there were no people, there would be no Economics. Chemistry would still work. Physics would remain. But, Economics? Arnold has suggested that there are economic questions which should only be addressed by sociologists. To me, that sounds like a an academic cop out. Economics does not describe a physical reality, it describes the interaction of humans with a physical reality and with one another. To say that it cannot address social issues is to reframe economics as just a collection of mathematical and scientific skills; a hobby and little else. That's not why it was created, and that isn't the sentiment that drove the most renowned economists. Hayek, Friedman, Keynes, Smith, Ricardo, and on, and on, and on did their work because they wanted it to benefit others. We don't have to stop being good people in order to be good economists. There is room for morality in economics. There is room for ethical practice. In fact, I don't know how one could avoid causing harm to others if they set out to interact with them but had no regard for them.

You bring up the Watts riots. This was brought about by instigators from the political class for whom violence, threats of violence, and rumours of violence, are the only methods.

I was actually referring to the riots of '92. The Watts riots occurred in '65. They were quite similar, but the death toll and value of property damage were considerably higher in '92. When you witness lawlessness for an entire week, you get a different perspective on what it means to be part of a society. Libertarianism seems slightly less relevant when your life, liberty, and pursuit of happiness are in jeopardy. Funny thing is, homelessness, poverty, and a variety of other conditions can bring about similar peril. It doesn't require riots. The riots were retribution, both times.

As for violence, I believe this was a discussion I tried to initiate on another thread recently. Nobody seemed interested in discussing the government's role in exercising a monopoly over the use of force. If there's anything for which the price should be raised and of which output should be decreased, I would think it is violence. To say that a political class (something for which I would still like a clear definition) uses violence, is restating the obvious with respect to government in language that seems to do little but allow us to hate somebody. A government that does not have the power to deprive people of liberty and property does not have the ability to enforce laws. I thought you were a libertarian, not an anarchist.

My advice to the rioters would be to stop screwing around with other people and get a job.

Think they'll listen? I mean, they wanted jobs in the first place. They didn't volunteer to be unemployed, and many of them took jobs that wouldn't pay the bills because they were the only jobs available. We were in the midst of a national recession compounded by a regional recession due to industry flight. They were pissed because they couldn't find jobs and they felt they had done everything that could reasonably be expected. Then they watched police get away with a brutal attempted murder on video; the same police that would roust them on a regular basis for being poor or homeless or being in the "wrong neighborhood". You might disagree, but I believe first-hand knowledge would change your perspective.

When wealth is consolidated, where is somebody without wealth to get a job except from somebody with wealth? We only have one currency. And if they can find a job, do you suppose the wage will be closer to that desired by the employer or the employee? The same incentives are at work as with oligopolies. Oligopolies have a long, extensive, and often thoroughly misunderstood history in Los Angeles. Oligopoly has been, and continues to be, a dominant market form for several of our resident industries.

You may have heard it all before, but I haven't heard a plausible solution from your perspective. I would love to think that libertarian ideals would solve the problem. They haven't. In fact, they were largely responsible for causing the biggest problems in Los Angeles.

Andrew writes:

We don't have to debate which would have turned out worse: we *know*!! Socialism does not make money. At best, it produces goods...maybe at rates meeting demand, maybe not. In the case of financials, you just need to translate the "goods" to capital -- where there's increased demand for capital, how does a socialist state provide more? I think we all know. And we know what that means. And it isn't good. There is *no* way this can lead anywhere but hyper-inflation.

Government control by definition introduces inefficiency, because it reduces competition. They will say not in this case...that markets had already frozen. That really only happened because of their fear-talk. But let's indulge. Suppose the markets froze anyway. The core problem that caused all this mess was too much credit. The government solution is to regrease the wheels for more lending? That's counter to the situation!! What must occur, and cannot be prevented, is deleveraging -- a natural and unpreventable *shrinking* of the financial system! Because its growth was artificial and ill-gotten! Efforts currently underway are merely attempts to reinflate the bubble...and therefore can only mean delaying the deflation that has to happen. That may well mean it happens *harder* than need be.

Our entire economic system is collapsing for one reason: it is based upon a fraudulent view of the human person! We have moved from the human person with intrinsic value and rights (including life), to one where rights are granted by the state...including *maybe* personal property rights...and maybe not. And the government now decides how much, if any, of these rights we get, and how much of our earnings we retain.

Only a view of the human person as intrinsically good and of infinite value, having rights endowed by their Creator, will lead to a view that government is there to serve *mankind*, not the other way around!! We've become socialist...personal property rights are now dead...right to life has been gone for some for 30+ years now...and the rest of us will soon be viewed as cogs in the wheels, to produce for the state. Nay, that latter is already here!! What else do you call the Entitlement Government?? Workers are to provide income tax to the state, to pay for the Social Security, etc., of others! Producers for the sake of The State. Marx has taken over.

P.S. -- Google the latest Democrat proposals regarding nationalizing our 401Ks!! They are seriously thinking of grabbing those, and we'll all be the gracious recipients of government bonds yielding 3%! I guess they had to get more funding for Social Security somewhere!!

El Presidente writes:

Government control by definition introduces inefficiency, because it reduces competition.

Despite what people may think here, I too prefer competition. It is when competition is muted by consolidation that things go sour. I would prefer vibrant competition to anticompetitive consolidation. But, when faced with the latter, I believe the government must intervene because an economy based on competiton cannot tolerate significant amounts of anticompetitive behavior for long. It is corrosive. I don't assume your critique is aimed at me. Nonetheless, I'd like to say I'm not arguing for socialism. I'm arguing for responsible and durable capitalism. The best way to ensure that occurs is with preventive measures (regulatory and/or fiscal) to make certain private industry is engaged in competition and not domination.

Caliban Darklock writes:

El Presidente:

I also do not find your responses out of line. Accordingly, I do not find your apology necessary, but I accept it all the same.

"I believe the government must intervene"

I actually agree on this. I believe totally free markets tend to become chaotic, and chaos is bad. However, totally controlled markets tend to become stagnant, and stagnation is bad too.

I do not believe a reduction in competition is always bad, any more than I believe an increase in competition is always good. As a general rule, these broad-brush ideas of "more good, less bad" is accurate for competition, but at the narrow ends of the bell curve things tend to flip around. There's a point where massive competition overwhelms the consumer with so many choices he can't make one, which is bad. There's a point where minimal competition provides near-perfect consumer information, which is good. But what is best for the market usually rests somewhere between the fat part of the curve and the tail ends.

Given infinite time, the market would converge on a single solution, but because there are two equally valid solutions the market is equally likely to converge on either, which overall tends to produce a suboptimal solution clustered on either side of the center. It can be useful for a government or other regulatory entity to step in and tip the balance, encouraging the lion's share of the market to converge on one solution.

Of course, I don't really know what I'm talking about, so I could be completely wrong.

Martin Brock writes:

Randy,

... a good place for the concerned individual to start is to detemine whether or not their customers have the right to dump them at will ...

Who can't be dumped at someone's will? Is the Federal political class limited to Representatives, Senators, the President and VP?

What if my customers belong to the political class? Suppose I receive 100% of my income from members of the political class. Am I also a member of the political class, even though I can be dumped at their will?

Who is my customer? Is that someone buying my labor or someone buying the fruits of my labor?

My customers can dump me and choose their own replacement or no replacement.

Do you work for the TSA searching handbags for toothpaste with costly, high tech machinery? I suppose these people can be dumped at will. Do you sell these people the high tech machinery? Do you sell shoes to people selling high tech machinery to people searching handbags for toothpaste?

People in these positions satisfy your definition. I can't distinguish you from them based upon what you've told me about your business. I still don't get it.

How about you?

Specifically? At the moment, I write software that, I hope, aids people employed by electric utilities to keep track of power lines and how the lines interact with other lines and with electrical equipment to deliver power to other people's homes and businesses.

Are my customers these other people purchasing electricity or users of the software at the electric utility or managers of these users specifying software requirements or managers of these managers or shareholders in the utility or my own managers or their managers or shareholders in my employer?

Which of these people belong to the political class?

It's all very confusing to me.

Martin Brock writes:

Maybe if I inherit my position and no one is entitled to dump me, then I'm a member of the political class? Would that include Bill Gates' daughters?

Caliban Darklock writes:

@ Martin Brock:
"Who is my customer? Is that someone buying my labor or someone buying the fruits of my labor?"

I thought about this at some length a year or so ago, and it's really quite simple: the customer is paying you.

This is entirely distinct from the notion of who your consumer may be.

Your software is built for a company that writes you a check. That company is your customer, but not your consumer. The consumer is the human being who uses your software.

Sometimes this can involve conflicts. It's similar to the differences in shareholder theory and stakeholder theory.

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