there are only two things you can do with the world’s oil production: consume it, or store it.

If the price is above the level at which the demand from end-users is equal to production, there’s an excess supply — and that supply has to be going into inventories. End of story.

Krugman ignores two elements of the oil market. Explictly, he ignores forward prices. Implicitly, he ignores the decision by producers either to pump oil or keep it in the ground. As Tyler Cowen put it,

Isn't it easy enough to argue that the relevant hoarding is of oil in the ground rather than oil in strategic reserves or panic stockpiles?

Now, there is nothing inherently wrong in making financial investments in the form of derivative contracts rather than outright loans. You're doing something similar whenever you buy or sell an option rather than the stock itself. But, if you were to sell an option through an organized exchange, the exchange would require you to satisfy a margin requirement, delivering for safekeeping good funds such that if the price of the underlying asset against which the derivative is written moves against you, you are able to make good on your commitment.

If anything like a reasonable margin requirement had been in effect, Bear Stearns could not possibly have gotten into contracts totaling $13.4 trillion notional. But these weren't traded on a regular exchange, so there was no margin requirement, and apparently no real limit on the size of the exposures that Bear Stearns could take on, or the size of what they could bring down with them if they fell.

And that raises the question, Why were counterparties willing to accept these trades with no margin to guarantee payment? To this I'm afraid the answer is, they figured Bear was too big for the Fed to allow it to fail. And on this, I'm afraid they proved to be exactly correct.

I would feel better if Bernanke were less focused on how to "provide liquidity" and more focused on how to get the system deleveraged and more transparent.

I don't think you can regulate your way out of liquidity booms and busts. Let me formulate Kling's Law of financial markets; During a boom, as risks premiums are falling, financial activity tends to flow out of the regulated sector. Instead, risks accumulate either in mis-regulated firms (think of the S&L's around 1978-1981) or in unregulated firms.

I think that Ben Bernanke is making a reasonable contrarian speculative play, betting that the assets that he is buying are illiquid rather than insolvent. It turns out that his balance sheet is not all that large relative to the market, and now he seems to be looking for ways to expand it. I am not sure I trust any one institution that much.

I know this financial "crisis" is the sexiest thing in economics these days. But I would like to see something worse than a 5 percent unemployment rate before I expand the Fed or demand new forms of regulation.

One theme of the talk is the importance of really creative people to the economy. This may be a valid form of elitism, although I'd like to leaven his views with those in, say, Common Genius (which I have not yet read). But I am worried about the ease with which that sort of elitism slips into the elitism that says that government knows best. I'm not accusing Florida of that, but I think that a lot of his favorite clusters of people do slip into it.

Near the end of the talk, he discusses the potential for backlash against the elites. Usually, this issue is framed as one in which the lower classes will demand wealth at gunpoint. Actually, my guess would be that the lower classes resent elitist politics at least as much as they resent others' wealth.

The latest issue of The Atlantic has a book review of Austerity, which describes Britain after World War II. I get the sense from the review that the economic egalitarianism was not much appreciated by the folks who supposedly benefited, perhaps because of the political arrogance.

Anyway, be sure to watch the video. There are lots of interesting things in there, about the importance of mobility as well as other issues.

1. Population. Europe has a lot more people than the U.S., with all the predictable Simonian benefits: Far more variety in architecture, lifestyle, culture, and so on, plus great roads, and short travel times.

2. History. European civilization is thousands of years old, and it shows. It's got castles. Lots of castles!

3. Rural beauty. Much of the rural U.S. is poor and ugly. Rural Europe combines natural beauty with culture and affluence.

4. Better groceries. European groceries taste better than American groceries. Grapes are bigger and sweeter. The cookies are really yummy. The bread is fantastic. Especially here. The excellence of European groceries, combined with maddeningly slow restaurant service, lead me to have at least one picnic meal per day.

5. Open borders. Within the EU (plus Switzerland), you can cross national borders at 100 miles per hour. Crossing from Switzerland to France is as easy as driving from Virginia to Maryland. Seriously.

and last:

6. The Alps. Awesome.

You probably won't hear from me for two weeks, but if you see me there, I'd love to meet you.

This movie put me in a reflective mood. When I was young, under heavy Randian influence, I was as convinced as Colonel Nicholson that you had to live under the daily guidance of Principles. But when I actually observe my life, I'm struck by how small the role of Principle actually is. Yes, there are many principles I live by; I don't lie, steal, adulter, murder, or knowingly accept beliefs on emotional grounds. But in all honesty, I have no need to refer to any of these principles on my typical day.

How is this possible? Here's the explanation that currently makes the most sense to me:

1. If you're dealing with reasonable people, Principle rarely comes up because reasonable people can amicably reach good outcomes on a case-by-case basis.

2. If you're dealing with unreasonable people, Principle is of little help, because unreasonable people (Colonel Nicholson is a case in point) usually stubbornly hew to their own bizarre principles. If you're stuck dealing with unreasonable people, the reasonable person's best option is to carefully craft the best approach that the unreasonable people will accept. It's sad but true.

Admittedly, it's possible that my experience is more a reflective of my timid, non-confrontational personality than the world. (Don't laugh; I'm only intellectually aggressive).

Any thoughts?

Meanwhile, here is my model.

Think of there being two prices for oil; the forward price, say, for delivery one year from now; and the spot price, for delivery today.

The forward price reflects the market's view of long-term fundamentals in oil production and oil demand. Relative to that, and to other factors such as the interest rate, there is a normal inventory of oil along with a normal spread of the forward price over the spot price. The spot price is bid up to the point where refineries are just willing to hold the normal inventory. If the spot price is unusually low relative the forward price, then they hold above-normal inventories until spot prices rise. If the spot price is unusually high relative to the forward price, then refineries try to unload their inventories while they can get a good price.

In that model, I don't see how the level of inventories relates to the level of prices at all. I only see how it relates to the discrepancy between the spot price and its normal relationship to the forward price.

I assume Krugman has a different model. As to his larger question of whether the price of oil represents a bubble, my behavior shows that I agree with him that it is not. I would not dream of buying put options on oil futures, which says that I do not think that oil is clearly overpriced. However, I do not look at inventory levels as an indicator of whether or not forward prices are a good predictor of spot prices.

Suppose that the forward price of oil were ridiculously high relative to long-term fundamentals. In that case, I would expect refiners to bid the spot price up to ridiculously high levels also, while holding a normal level of inventories.

UPDATE: The first comment leads me to dredge up this old post on how oil companies should be using futures prices.

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding — an increase in private inventories of black gunk. This actually happened in the late 1970s, when the effects of disrupted Iranian supply were amplified by widespread panic stockpiling.

But it hasn’t happened this time: all through the period of the alleged bubble, inventories have remained at more or less normal levels.

HT: Tyler

Students routinely fail; some fail multiple times, and some will never pass, because they cannot write a coherent sentence

Note: != is a computer-language expression for "not equals"

Me, I want to believe whatever is true even if that makes me unhappy. And with that attitude, I doubt attending church would make me happier.

our brains didn't evolve in a way that allowed us to thoroughly evaluate how well our beliefs represent reality.

...Marcus does supply us with a whole host of ways to trains our brains to act more rationally. My personal favorite is his first, "Whenever possible, consider alternative hypotheses." He recommends forcing yourself to come up with a list of alternatives even if you are absolutely certain... Or "Always weigh benefits against costs."

Sounds easy but as Marcus notes, few of us rarely consider what else we could be doing that's of more value (spending time with your partner or family, calling up an old friend, writing a thank-you note) than watching a "CSI" marathon on TV.

1. You may have already heard about Brooks' finding that the conservative are happier than the liberal, and the religious happier than the secular. But did you hear that extremists of left and right are both happier than the moderates who lean in their direction? Brooks has a nifty explanation:

Why are ideologues so happy? The most plausible reason is religion - not real religion, but rather, a secular substitute in which they believe with perfect certainty in the correctness of their political dogmas... True political believers are martyrs after a fashion... They are happy because - unlike you, probably, - they are positive they are right.

2. Happiness researchers who study the link between income and happiness often conclude that people are deluded, petty, or full of envy. Brooks has a totally different take: People don't want to drag down their fellow man; they just want to feel successful. The General Social Survey actually measures the feeling of success; Brooks takes advantage of the data to reach a true "a-ha" moment. Given two people with identical income, education, age, sex, race, religion, politics, and family status...

The one who feels successful is about twice as likely to be very happy about his or her life than the one who does not feel successful. And if they are the same in perceived success but one earns more than other, there will be no happiness difference at all between the two.

Of course, successful people make more money than unsuccessful people, on average. But it is the success - not the money per se - that is giving them the happiness.

3. Some simple regressions inspire this striking "speculation":

[G]overnment spending, financed with taxation, is an "X-factor" helping to explain why growing national prosperity generally does not raise happiness.

4. Chew on this:

The average happiness level in America has not changed since the early 1970s, but inequality in happiness has actually fallen.

5. Unemployment creates true misery, but retirement doesn't.

6. Once again, Europe's not the workers' paradise people want you to believe:

[J]ob satisfaction is generally much lower in Europe than it is in the United States. A 2002 international survey showed that, while 51 percent of American adults reported being completely satisfied or very satisfied with their jobs, only 36 percent of the Dutch gave this answer, as well as 35 percent of the British, 33 percent of the Spanish, and 32 percent of the French.

7. Finally, from the "people who like markets the least need them the most" department:

[I]f liberals and moderates gave blood like conservatives do, the blood supply of the United States would increase nearly by half.

I believe in our ability to perfect this union because it's the only reason I'm standing here today.

Remember when I was suggesting ideas for Libertarian Folk Songs? Check out "The New State of Perfection." Unfortunately, what I wrote as satire sounds frighteningly close to Obama's speech.

Thanks to Stephen Bainbridge for pointing out the Obama remark.

Leaving labels aside, if I had a platoon of Ph.D students, my suggestions for research would be based on what I see as the following shortcomings in mainstream economics.

1. Too much emphasis on characterizing equilibrium conditions in mathematical terms. Not enough emphasis on the processes of economic and institutional change.

2. Too little role for entrepreneurs. In Austrian economics, entrepreneurs can be arbitrageurs/equilibrators (Kirzner) or creative destroyers (Schumpeter).

3. Too much knowledge attributed to economic agents. Mainstream economics misses the role of markets as a learning mechanism; instead, it posits economic agents who have little or nothing to learn.

4. An assumption that when incentives are poorly aligned (aka "market failure"), government involvement is necessary and sufficient to address the problem. As a result, mainstream economics does not allow for institutional entrepreneurs--entrepreneurs who develop new solutions to incentive problems.

With that as background, let me suggest some research avenues.

1. Institutional change. Douglass North has focused on this. But there is a lot more to be said about the conditions that give rise to institutional change, the actors who bring it about, and so on. The work of Vernon Smith and others on institutional design is also relevant, but I am more interested in how the market goes about creating new institutions than in how an economist would advise someone to design an institution.

2. Long-term growth. Yes, plenty of people look at this issue. But as Robert Lucas famously said, once one sees the magnitudes involved it is hard to think about anything else. And it's fair to say that de Soto, North, William Lewis, William Easterly and others have only begun to develop theories and evidence on this issue.

3. Employment fluctuations. We have much more interesting data now, with statistics on gross flows in the labor market, which are much larger than the net changes in employment and unemployment. This data ought to be exploited by researchers who think in terms of disequilibrium, market learning, and creative destruction.

4. Innovation, especially financial innovation. Again, there is a lot of room for useful work to be done in a framework that does not start by assuming away the main problems--local knowledge and the need for trial-and-error learning. Local knowledge, in my view, is the key to understanding financial markets--and why "transparency" is a false goal. Even outside the financial sector, the innovation process is poorly understood. Amar Bhide and William Baumol have made useful contributions, but there is much more useful work to be done.

amendment to the House budget calls for a study of a 2.5 percent assessment each year on university endowments over $1 billion. The tax would affect nine of them, and in theory could generate an enormous amount of revenue; Harvard alone, with its endowment of $34 billion, would be on the hook for $840 million a year. But a tax of this magnitude on the state's universities and colleges would be economic suicide.

Major research universities are the closest thing Massachusetts has to a goose that lays golden eggs. The nine schools in question employ a total of 27,000 people and pay $4.5 billion a year in wages and salaries, according to the Association of Independent Colleges and Universities in Massachusetts. They bring in brainpower and outside research dollars. They fertilize the local healthcare, technology, and financial-services sectors - three other cornerstones of the local economy.

Greg Mankiw thinks that Harvard would respond by changing its state of incorporation. Is this another opportunity for Delaware?

Elsewhere, The Washington Post reports,

The funds that pay pension and health benefits to police officers, teachers and millions of other public employees across the country are facing a shortfall that could soon run into trillions of dollars.

...State governments alone have reported they are already confronting a deficit of at least $750 billion to cover the cost of the retirement benefits they have promised. But that figure likely underestimates the actual shortfall because of the range of methods they use to make their calculations, including practices that have been barred in the private sector for decades.

"There's been a government in our city since 1779," said Mark Jinks, chief financial officer for Alexandria. "You can't be sure that the promises made to private sector employees will outlive their company."

On the same front page, The Post has a story that explains how state and local fiscal policy really works.

Over the past two decades, the influence of the unions representing public employees in the county has grown dramatically. Former and current government officials say Montgomery's bargaining system -- along with labor's political clout -- gives workers as strong a voice, if not stronger, than taxpayers in budget talks...

"Although you may know in your heart that the only way to deal with this particular deficit is to broach the union contracts, it is difficult for politicians who wish to be reelected to vote against the union contracts because the unions can rise up and defeat you," said former council member Nancy Dacek, who was defeated after three terms by a union-backed rival.