David R. Henderson  

Jane Mayer's Problem

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George Melloan, a retired editor of the Wall Street Journal, had a review in a recent issue of the Journal of Jane Mayer's new book, Dark Money: The Hidden History of the Billionaires Behind the Rise of the Radical Right.

The review is pretty good but he made a huge economic error and, in doing so, passed up a chance to make an important point.

Quick background for those who don't know: Mayer's book is a hit piece on Charles and David Koch.

Melloan writes:

She chides the Kochs for opposing President Obama, noting that their fortunes have tripled since he came to power. Ms. Mayer doesn't seem to understand that the fortunes of wealthy people on both left and right were ballooned mainly by the asset inflation engineered by the Federal Reserve. Small savers have been the victims.

Where's the error? Since the discussion is about the Kochs, I'm assuming that they don't hold a lot of the toxic assets whose prices the TARP artificially increased. That, therefore, leaves one mechanism by which the Fed can cause asset inflation that would affect the Kochs: keeping long-term interest rates low. But the Fed has virtually no effect on long-term interest rates. Long-term interest rates are low. That doesn't mean the Fed is the cause. Do I know the cause(s)? No, l don't. But it makes no sense to use an explanation that can't be true just because we aren't sure of the right explanation.

Here's what I would have written, had I been writing that part of the review:

She chides the Kochs for opposing President Obama, noting that their fortunes have tripled since he came to power. But this puts her in a contradictory position. Throughout the book, Mayer shows that she believes strongly in two premises: (1) David and Charles Koch are smart and devious, and (2) their main goal in their political activism is to preserve and enhance their wealth. But then, if Obama's policies caused their wealth to triple, they should be strongly supporting him. They aren't. So which assumption should Mayer drop? Either (1) the Kochs are not smart and devious or (2) their main political goal is not to preserve and enhance their wealth. My money and a lot of other evidence are on (2).


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COMMENTS (23 to date)
Roger Koppl writes:

Oops. You make it sound like you think they're "devious." I figure you don't mean to say that! Maybe a quick edit is in order?

Don Boudreaux writes:

David,

About your last point: I, too, had the very same thought when I read in Melloan's review that passage from Maye's book. Indeed, I was going to blog on it. But I discovered that, while it might be true that the Kochs' wealth tripled on Obama's watch, it multiplied by 5+ between 2001 and 2009. (I've since deleted the notes to myself that I made, so I'm going here in this parenthetical on memory, but I believe that the public record shows that in 2001 Charles Koch's net worth was $3B while in 2009 it was $17.5B. The numbers for David K. are almost identical.) So Mayer could defend herself by saying "See, the Kochs are greedy for the kind of wealth growth they get under a GOP administration!"

Now I don't for a moment believe that the Kochs' many enemies are correct to insinuate that the Kochs' political activities are meant to enhance the Kochs' personal fortunes at the expense of others. Nor do I deny that Mayer and her ilk are likely guilty of shifting the grounds of their argument, when convenient, from "The Kochs are great beneficiaries of big government!" (regardless of the truth of the assertion) to "All the Kochs care about is greedily enhancing their personal fortunes!"

Lawrence H. White writes:

So do you reject empirical studies like this indicating that the Fed has affected long-term interest rates?
"We find that Operation Twist lowered long-term Treasury yields by about 0.15 percentage point (15 basis points), an amount that was highly statistically significant, but moderate."
Titan Alon and Eric Swanson, SF Fed

foosion writes:
(2) their main goal in their political activism is to preserve and enhance their wealth. But then, if Obama's policies caused their wealth to triple, they should be strongly supporting him.

These are not contradictory. They could want to do more than just triple their wealth. Think of how much faster it would grow under their preferred policies.

David R. Henderson writes:

@Lawrence H. White,
I don’t reject such studies. I’m just not familiar enough with them. I’ll take a look at the study you cite. Thanks.
I do think, though, that 0.15 percentage point is close to “virtually no effect."

David R. Henderson writes:

@Don Boudreaux,
Good point. Thanks. I do think, though, that Mayer must believe that they have done well because of Obama. Otherwise, why would she mention the tripling? But this could well be yet an illustration of the general principle that I should not blog about a book review without reading the specific part of the book at issue.
@foosion,
See my response to Don Boudreaux above.

Effem writes:

Bank bailouts did far more to preserve/enhance large fortunes than monetary policy. If you are insulated from a disaster comparable to the great depression you can take far more risks with your assets.

bill writes:

I think the Fed has caused the low long term rates through its ineptitude. If the Fed had done its job right (like Scott Sumner has laid out), 10 year Treasury bonds would probably pay 4% right now. Obama is partially to blame for that because he has left seats open for much longer than necessary.

Regarding the angle Mayer seems to be taking. Dems are always on about how poor people that vote Republican voting against their own interests. But of course the opposite would be true (rich should only vote Republican) if economic self interest were the only factor any voter should consider.

David R. Henderson writes:

@bill,
If the Fed had done its job right (like Scott Sumner has laid out), 10 year Treasury bonds would probably pay 4% right now.
Remember that what matters for present values of assets is real interest rates. Are you suggesting that real rates would be anywhere close to 4%?

Andrew writes:

Mr Henderson writes:

"Here's what I would have written, had I been writing that part of the review:

She chides the Kochs for opposing President Obama, noting that their fortunes have tripled since he came to power. But this puts her in a contradictory position. Throughout the book, Mayer shows that she believes strongly in two premises: (1) David and Charles Koch are smart and devious, and (2) their main goal in their political activism is to preserve and enhance their wealth. But then, if Obama's policies caused their wealth to triple, they should be strongly supporting him. They aren't. So which assumption should Mayer drop? Either (1) the Kochs are not smart and devious or (2) their main political goal is not to preserve and enhance their wealth. My money and a lot of other evidence are on (2)."

I am not sure how persuasive this is alone.
1. There is logical ambiguity in the phrase "main goal." It is compatible with other goals and motives, and it admits of short, medium and long term strategies. 2. A strategic political agent might oppose another political force and still come out advantaged (a) because that opponent *didn't get what he wanted* and/or (b) the strategic political agent might conclude that it was partly *because* they fought that they received their gains. 3. Presidents do not control the entire political system in the American constitutional system. 4. Who says that Koch and other Men of Capital aren't secretly pleased with centrist Democrats and take partial credit for the continuity in financial policies between GOP and Dem administrations? The Kochs might end up opposing HRC but they know that they have nothing to worry about her in office. 5. People can be "smart and devious" without being fully rational. 6. It can be rational to exaggerate your opposition to moderate alternatives to shift the goalposts.

[indention added for clarity of who is quoting whom--Econlib Ed.]

I agree with Melloan. The Fed created asset inflation. Although maybe the Fed did not exactly "engineer" or intend that outcome.

To explain, I have not been much convinced by explanations given by professional macroeconomists for events during the past 10 years. So I have cooked up my own explanation. I will continue to be satisfied by my explanation unless someone here can put me right.

The Fed created all that money to stimulate aggregate demand, I suppose. But people don't spend money on current consumption just 'cause they got it. Uncle Milton said something like that. People saved that money.

Banks too. Bank reserves shot up, right? So the pumped money became demand for long term assets. Stock and bond prices went up. Interest rates stayed low. Real estate prices went back up.

So that would explain the Koch's recent-seven-years increase in wealth. The Fed's new money created demand for long-term productive assets held by the Kochs.

How is that wrong?

David R. Henderson writes:

@Andrew,
Touche.
As I said in an earlier comment above, there is danger in writing about a book review without having read the book. So maybe what I’m wondering is answered in the book. But here’s what I’m wondering: Does Jane Mayer get what you get?

David R. Henderson writes:

@Richard O. Hammer,
How is that wrong?
Let’s try this in steps. First step: Do you agree that the price of an asset approximately equals the present value of the future stream of income from the asset?

@David Henderson
Do you agree that the price of an asset approximately equals the present value of the future stream of income from the asset?

Yes, I expect arbitrage to hold that.

David R. Henderson writes:

@Richard O. Hammer,
Yes, I expect arbitrage to hold that.
Good. So then it comes down to one or both of 2 possibilities for your view to hold:
1. The Fed can indeed substantially reduce long-term interest rates (a big component of the denominator in present value calculations.)
2. The increased money in the economy caused the incomes from those assets to be substantially higher than otherwise.
Which of those two do you believe?
BTW, if I don’t answer you soon after you answer, it’s because I'm on my day job and I take little 5-minute breaks through the day to respond to comments.

@David Henderson
I believe the fed can substantially reduce interest rates.

Guessing your next step, David, perhaps I should tell that I never swallowed the zero lower bound on interest rates. This is another of my disaffections with mainstream macro.

To explain: Imagine before money and banks, a primitive hunter gets lucky and kills a moose which could feed him for six months. After he eats 1%, his bellyfull, wolves circle. The days are getting warm; rot starts. This hunter would gladly trade 80% of this carcass now if he could be guaranteed 20% back fresh in one month. He would jump at something so good as -50% interest.

The very idea that we can have assets today and hold them intact until next year shows development of fancy and stable institutions which we can not always take for granted. In a financial crisis when asset prices are falling and when some investors expect the central bank to pump and cause steep price inflation, those investors look for anywhere they can keep most of their stuff safe. (That was me in fall 2008.) Will not some of those investors be happy to accept -5% interest on cash deposits?

David R. Henderson writes:

@Richard O. Hammer,
I believe the fed can substantially reduce interest rates.
I think it’s clear in context that by “fed,” you mean Federal Reserve, not federal government. Here’s where we differ. I believe it can’t and my belief has nothing to do with the alleged zero lower bound. It has everything to do with the Fed being a relatively small player (even if the biggest player) in world capital markets.
See Lawrence H. White’s comment above, where he points to a 0.15 percentage point drop in interest rates due to Operation Twist, which was carried out when the Fed was a bigger player, relative to world capital markets, than it is now. I could believe 0.15 points. But that kind of drop won’t get you close to, say, a 50% increase in stock prices.

David R. Henderson writes:

@Richard O. Hammer,
By the way, your paragraph beginning “To explain” would have made Irving Fisher proud.

bill writes:

You are correct. I don't think real rates would be 4%. Or near it.

But the Fed has virtually no effect on long-term interest rates.

That's true only in the short term. Over the medium term, different choices will lead to different long-term rates. Choices made by the Fed during the 1970's led pretty directly to double digit long term rates by the end of the 70's.

Also, I'm not sure you're correct about real rates versus nominal rates. When the Treasury auctions off its next Treasury bond, it will pay a nominal coupon. It sells TIPS using a real coupon. And the correlation isn't one to one (ie, there have been times when TIPS paid -0.50% real and other times they paid 0.50% real while a 10 year Treasury paid 2% nominal in both cases. Those deltas are used by some (including me) as a market forecast of inflation.

Mark Bahner writes:

But I discovered that, while it might be true that the Kochs' wealth tripled on Obama's watch, it multiplied by 5+ between 2001 and 2009.

According to "KochWatch" (caveat lector), the Koch's net worth was relatively constant at $7 billion from 1999 to 2004/2005, then shot up to $48 billion by 2011.

KochWatch

I don't think it's a coincidence that the price of oil went up by...well, maybe a factor of 3?...(but on a wild ride) during that time.

Oil Prices

Hazel Meade writes:

Isn't Jane Mayer the same person who wrote the original hit piece in the New Yorker that got the left all riles up about the Koch brothers in the first place?

IIRC, she made the same error in that piece, in which she asserts that Fred Koch's hatred for communism must have been because he had a business falling out with the Stalinist government. Because, apparently in her mind, nobody could come back from the Stalinist USSR hating communism for any other reason.

Alex Demitraszek writes:

Surely if the Koch's wanted to enhance their wealth than surely philanthropy and political activism are the worst ways to go about it. If both assumptions are accurate then one would expect to see drastically different investing behaviors from the Kochs.

Kenny writes:

A third alternative explanation – the truly cynical one – is that the Kochs are even more devious than their haters imagine and that the Kochs do in fact secretly support Obama, but know that they can best support him by publicly opposing him!

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