US CPI 0.00%

November 19, 2020 | Leave a Comment

Dr. Zacek  writes: 

Question for all the smart people here. Why is the CPI 0% in the USA if whatever I buy here in AZ, I pay considerably more compared to 9 months ago (end Feb)?

What is it I am missing? What did go cheap sooo much to compensate the CPI composition for all this:

Organic Eggs +50%

Coca Cola tins/bottles +20-30%

Toilet paper +30-50%

Full tank of gas +20%

Long term apartment rent +15-20%

Property prices +30%

Construction Labor +25%

Average Hollywood movie shoot/location per day +75%

Firearms +25-30%

Ammo +150%

Average doctor bill +xxx%

Rudolf Hauser writes: 

One problem is the unchanged market basket at a time when people’s buying habits have changed. So one sees declines in such things as airline prices because fewer people are flying but the weight that receives in the calculation has not changed. Meanwhile, prices of many items in demand are rising.



"Department of Justice and Department of Health and Human Services Partner to Distribute More Than Half a Million Medical Supplies Confiscated from Price Gougers"

Victor Niederhoffer writes: 

The speculator as hero. The siege of Antwerp.

Rudolf Hauser writes: 

For the private sector to inventory supplies, etc. for potential future periods of shortages requires a return for their investment and the risk that such shortages will never happen. Someone or some organization should be able to charge higher prices during such a shortage so that they precautionary investment will be rewarded. That will encourage such future behavior to be warranted. There also is a worthwhile function when someone buys large amounts in areas with adequate supply in order to make then available in areas of shortages.

From a demand standpoint, pricing insures that those who get the most value from a scarce product will be buyers when it comes to most goods and services.

But things are different when after a crisis is clearly at hand, someone purchases large amounts with the intention of cornering a market and selling at inflated prices. Nor is price a fair distribution mechanism when it is a matter of life and death and it would have maximum utility for all and the ability to purchase is limited by the means to pay at one's disposal. The most basic human right is the right to survival in oth non-human animal world and in the human world. Any enforcement against price gouging should be limited to such agents, not those who purchased before a crisis situation was well known. Nor should agents who purchased before a crisis be forced to sell at any point in time. It is in their advantage to sell when the shortage is greater. If they hold off selling, it may be because they see an even greater need in the future, and they might just be right. In that case society would be better off if they hold off selling. When the future is so uncertain, better more judgements than fewer making such decisions. 



 I think Ms. Shelton's odds for surviving the attacks by CNBC et. al. will improve significantly if she adjusts her Lafferite theology. In a old C-SPAN interview I watched this morning I saw her making the same claim that Boris Johnson made this week on his hustings tour: "lowering taxes raises more revenue".

Clearly, it doesn't; taxes are the government's revenue, and lowering them means that the government has less to spend. This confusion has been a chronic problem for "conservatives" ever since Professor Laffer first scribbled on his napkin. It seems to have created a fog even for Laffer. How else can one explain his support for a single tax rate across all income levels? As a policy and political platform "lowering taxes" is a pure folly equal only to the defense of "capitalism". (Ms. Shelton commits that sin as well; she is an advocate of "democratic capitalism" which is itself an oxymoron.)

Where the progressives are instinctively right is in their belief that the rates should increase as income brackets go up. Where the progressives are and always will be disastrously wrong is to believe that the fundamental purpose of a tax system is to inflict punishment on the rich, to be a collective act of revenge against those who make the most.

A flat tax rate ignores the common sense truth we all see around us: the successful are much better than the poor at making money and the rich are much better at making money on their money. All the babble about the American dream ignores the obvious fact that the power law applies to enterprise just as it applies to the ability to hit baseballs 400 ft. All of us who love the sport can play the game, but only a very few can make the All-Star Game roster. What produces more wealth for both the government and the people who pay taxes is the lowering of TAX RATES if you get the proper shape for the stair-step of brackets and rates. The current tax code has gone a long way towards achieving that result; that may explain the seemingly inexplicable–how both net wages and tax collections can continue to grow in the United States even as they flatten out elsewhere.

Rudolf Hauser writes: 

The Laffer curve idea that lowering marginal tax rates increases revenues only works to the extend that it makes it cheaper to pay the tax than the costs and losses incurred in trying to avoid the high tax rates. In regard to the incentive impact on growth, it is best not to focus on how much the tax rate is reduced than on how much after tax income is increased. The incentive impact of reducing the tax rate five percentage points is a lot more important when the initial marginal rate is 90%, thereby increasing after tax income by 50%, than it is when the initial rate is 50 and the increase in after tax income is only 10%. When the cut applies to the capital gains tax rate, there might initially be a larger increase in tax revenues, as many long term investors might tax advantage to sell their stocks that they only held for so long because of the tax consequences of selling and/or to repurchase the shares to establish a higher cost base should the tax rate be increased again in the future.

But beyond that, there is a conflict of interest between the wealth of the nation and the wealth of the government. Lowering rates does increase the incentive for greater growth. But if the average tax rate is only 20%, the growth in the economy has to increase five-fold for the tax cut to result in more revenues. That is unlikely in most cases. It also has to be remembered that many people are by nature game players, that is they are very competitive and like to win. Why would a billionaire have any incentive to work hard? After all, he has more money than he could ever need to satisfy his consumption needs? It's because gaining the most money is like winning the most points in the game. So even when the government takes a large share of the gain, there is still the competition to have the most points, that is after tax profits and wealth, even with the reduced incentives. Naturally, that only applies to some people. Many will behave like the British aristocracy of old and become a leisure class. But it does explain why we were still able to have economic growth when marginal tax rates were so high in the 1950's, along with the fact that the various loopholes, etc. reduced the actual tax rates that were paid. 

Stefan Jovanovich replies: 

I hate to disagree with RH, especially this week when I am enjoying a biography of Gresham that I owe to his recommendation. My view may be distorted by my experiences as a low-rent criminal, both with and without a law license. My direct observation of both clients and customers is that they all followed the Gompers rule where taxes and penalties were concerned. ("What does labor want? We want more schoolhouses and less jails; more books and less arsenals; more learning and less vice; more leisure and less greed; more justice and less revenge; in fact, more of the opportunities to cultivate our better natures, to make manhood more noble, womanhood more beautiful, and childhood more happy and bright.") Taxpayers want to pay LESS at every possible rate. When rates are confiscatory - at the rates that Democrats have traditionally favored - taxpayers literally stop being taxpayers. They find ways to categorize their wealth and income so that it is not subject to any rate at all. They don't look for marginal reductions; they look for escape.

The ability to escape explains the seeming paradox of the 1950s when private incomes and wealth grew even though the legacy tax rates of WW II remained in place. Thanks to the magic of non-recourse debt financing, the effective tax rates paid in the 1950s were no higher than they were in the 1980s after Reagan's tax cut. The 1954 Tax Act became the bible of the 1950s whiz kids in Beverly Hills whom I was lucky enough to go to work for in the 1970s and it made their fortunes. (The reference is deliberate: Tex Thornton's Litton Industries offices were just down the block on Little Santa Monica.) 

When Jerry Ford, the economic moron who succeeded those other economic morons Johnson and Nixon, signed the 1976 tax reform act, he not only did me out of a job (no more 8-1 write-offs on real estate, oil & gas and movie deals); he also raised the effective tax rates on the wealthy to where they had been in the late 1940s. It produced exactly the same kind of inflation that Truman's vetoes and price freezes had done. The Federal government collects roughly 21% of the national income. The individual income and employment tax share is about 17%. It is rumored that Kevin Hassett's magic calculator at CEA produced a Laffer ziggurat (it is never a curve) that begins at 5% and ends at 30% for all personal incomes; its output was 20% of the national income - 3% more than the current collections. The result was never published because it would be the ruin of the Republican Party.

Integrating Social Security and income taxes would be even worse than Bush's "privatization"; and they would never be able to get it through the Rich's brains that their loss of exemptions and carve-outs would be more than offset by a simple 30% top rate. But, to be fair to the Rich, they know - from long experience that a simple stair-step is a Congressional impossibility. What would Representatives do is they could not offer special rules for wool growers and weavers? Still, as a thought experiment, it is intriguing. 

Alex Forshaw writes: 

Getting back to Stefan's original post, I don't understand how anybody can take seriously someone who for tight money in 2011-13 who's simultaneously in favor of loose monetary policy today. (Stephen Moore, Shelton, others) You can be for one or the other but not both, unless you 'evolved' to a completely different philosophy… which rarely happens honestly in my observation.

Stefan Jovanovich writes: 

Let's go back to RH's point as well. If monetarists think that "money supply" is both the fulcrum and the lever for Archimedesian economics, we taxistas tend to have the same certainty that tax rates move everything. They don't.

For me Ms. Shelton's heresy is the belief that legal tender in any form can be a "store of value". I also find her giving Jefferson and Madison credit for putting the U.S. dollar on "the gold standard" the worst kind of Ron Paul historical fiction. If credit is to be given to Virginia Presidents for fixing the dollar by weight and measure, it has to go to the first and last of the Founders - Washington and Monroe.

Rudolf Hauser writes: 

The monetarist point is simply that an excess of money ( the accepted means of exchange and those liquid assets held that are considered reasonable means of quickly obtaining the means of exchange at minimal cost) results in an attempt to dispose of the excess, which initially results in more nominal purchases of other assets and goods and services and subsequently inflation as the sellers of those goods and services realize that the increased production was not really economical. When there is a deficit of such liquidity, the opposite happens. If income and nominal wealth gains go to those who have a low propensity to consume, the increase may mainly be reflected in higher prices of existing asset, both physical and those financial claims behind such assets. If monetary policy is erratic and causing erratic inflation, the increased uncertainty as to the future might deter future real economic growth potential. Aside from that, monetary policy has negligible impact, if any, on real growth potential. Another mechanism is the increase in money driving up prices of financial assets, thereby lowering interest rates. That in turn can shift some purchases of durable goods financed on credit and investments likewise financed on credit to be shifted forward, whereas a deficiency of money can work in the opposite direction. Stefan believes that the central bank can control interest rates. But a central bank can only keep interest rates low when it has created an inflationary situation by continuing to accelerate the rate of monetary growth. When that stops or the public expectations catch up with what is really happening, those interest rate will rise. As the central bank is not the only creator of near forms of money, the demand for money created by the banking system can change for numerous reasons such as opportunity costs, the speed of transaction settlements, inflation expectations, and financial uncertainty. One impact of financial uncertainty is reduced access to quick credit and less confidence in the ability to convert such assets as commercial paper into money that can be used to settle transactions quickly and at minimal cost is diminished. Shifts in the demand for money depend on public desires for the amount of money they wish to hold and are not well understood or necessarily constant.

In contrast the main impact of tax policy is on economic growth potential. There are both temporary shifts as changes and expectation of changes in tax policy can drive income recognition forward or backward and the far more important permanent effects. To the extend producers try to pass on tax increases to consumers, it might have some inflationary impact as industry shifts the tax burden on to consumers, but since the income of consumers is not increased, eventually it should mainly have a real impact on the purchases of goods and services.



To the extent that Bitcoin has any fundamental value other than speculation it is as an alternative private means of transaction payment. One of its main attraction is the limited amount of bitcoins that can be created. From what I have read the validation process relies on complex computer programs that become more expensive to run over time running up more costs for electricity, etc. for those maintaining the records. Eventually the finite limit is reached when no more coins are created.

What then will be the incentive for any players to continue to run the block verification system? And even before then, if the value of bitcoins does not increase sufficiently, will it still pay so many to try to mine bitcoins. If transaction fees become necessary and if the cost of validation is not linked to the value of the transaction, will it not become uneconomical to engage in modest sized transactions? And if that is the cast would not its real purpose of another means of paying for transactions be defeated?

While the amount of bitcoins may be limited, what is to stop other players from coming up with their own systems? While there is a limit to the amount of bitcoins and newly created coins, there would appear to be no limit to the number of cyber coins that can be created, in essence creating many competing currency. What then is to prevent cyber coin inflation that reduces the purchasing power of all such coins. And if cheaper verification methods are not created would not that increase the cost to sellers of goods and services of transacting in so many different currencies whose relative values might fluctuate violently?

Might not this wild speculation turn out to be the tulip bulb bubble of the 21st century eventually?

Andy Aiken writes: 

Rudy, yes, new cryptocurrencies and digital assets may be issued, but there is no reason to expect that this will weaken the value of bitcoin. Digital assets are unique and non-fungible. When the Venezuelan government hyper-inflates the bolivar, it doesn't affect the purchasing power of a dollar. In fact, it may even bolster the dollar's value, and we see a similar phenomenon in cryptocurrency. During times of relative risk aversion, the % of the total crypto market cap that bitcoin represents (referred to as bitcoin dominance %) increases.

There are different types of digital assets:

1. Platform coins

Ethereum is an example of a platform, but there are others. Companies can issue tokens on the platform easily and use them for governance or stakeholder management. Although the most visible type of token issuance is through ICOs, there are many companies that will use them internally/privately only. The growth of usage of the platform will necessitate the use of the "gas" that powers transactions, which in the case of Ethereum is ether. Demand for ether will rise as the network grows, but in my view upside from here may be limited until some of the companies/apps based on the platform start delivering on their promises. Ether isn't a strict cryptocurrency like bitcoin, although it may be used as a currency. It is the transaction token for the Ethereum platform. The rise of this platform has led to the emergence of prominent competitors, each with a similar transaction token. Some of these are EOS, NEO, Aeternity, and Lisk. In my view, purchasing a platform token is a way to benefit as an investor from the success/growth of the platform. But this is a messier/more volatile investment due to the inherent risks.

2. Tokens used within a specific blockchain-based application

There are specific tokens/coins that allow participation in a unique blockchain use case. For example, Augur is a decentralized prediction market launching next year. The tokens entitle the holder to a share of all transaction fees from the prediction markets, as well as voting rights to settle disputed prediction outcomes. Users of the platform can create markets at will, and operate as market maker. The blockchain basis ensures privacy/anonymity for participants while ensuring quick, accurate settlement. There are other interesting applications of the technology with an associated token, such as Golem (distributed computing), Air and Civic (identity verification), Storj and Sia (distributed storage).

Many of these business models will fail, and the associated tokens will decline to zero. Those that succeed could increase in value significantly, perhaps even surpassing the value of the associated platform token.

3. Currencies

Bitcoin itself is the reserve currency for cryptocurrency, and I believe it will continue to play this role indefinitely. There are others that intend to play the strict role of currency, such as a. Privacy coins (DASH, Monero, Zcash). The networks for these coins use strategies to obscure sender/receiver of transactions, or blind the transactions themselves. b. Credit system coins (Maker, X8currency (not yet released), Decred). These coins attempt to build a non-debt based credit system for cryptocurrency. The business model is of critical importance here, so much DD is necessary before investing here.



On the way to the office today I was blasted by Bloomberg from so many angles and reporters about Trumps "I will keep you in suspense".

A little context to remember is that during the Republican primary debate, all of Trump's opponents solemnly raised their right arm to pledge to support the Republican nominee, whoever it might be. Trump was the lone holdout, and he took heat for it.

Then more than half of them reneged on their pledges, including Jeb! Bush and St. John Kasich.

The truth is that if any candidate seriously suspected fraud, or a miscount, or whatever, they would field an army of litigatin' lawyers, as did Al Gore. Trump's the only one honest enough to acknowledge that.

Rudolf Hauser writes: 

You may recall that Nixon did not do that in 1960 despite the likelihood that the Chicago vote was rigged and that winning Illinois would have given him the presidency. He did not want to put the nation through such a crisis.

Stefan Jovanovich writes: 

It is a nice story, which Nixon did his best to promote; but the numbers do not support RH's assertion. Nixon only got 219 votes; adding Illinois and its 27 would have left him 24 short. Subtracting those votes from Kennedy's total of 303 would have left him with 276, 6 more than he needed. What few people mention about the election is that it was the last time a 3rd candidate won electoral votes. Harry Byrd won 15.



Do we want to protect the jobs of those who work in industries where the U.S. is uncompetitive, or do we want to allow U.S. consumers as a whole to minimize their cost of living? [I]t's one or the other. - Howard Marks.

[It is not a question of uncompetitiveness, or the future coming of robots.] A tremendous percent of middle class jobs are already obsolete. Indeed many of the jobs and even entire professions have been obsolete since they came into existence as part of things such as the "great society" program. Regulation, the welfare state, etc, is a huge middle class jobs program. It's not really the supposed beneficiary who truly benefits, it's the overhead, the regulation enforcers, compliance officers, case workers, etc.

The real crisis is that these 'Make work" jobs can now often be done by software of by a communication line to a cubicle farm in India–it kind of killed the idea of it–kind of like offshore manufacturing arbitraged the increased labor protections and union rules, etc. It's not that automation is making more jobs obsolete (though it is), it's that it is making jobs that have always been obsolete more transparently obsolete to more people.

I don't think we will see mass "joblessness" much more likely, we will see a massive expansion of regulatory state in a way that requires "jobs". take the boondoggle of the TSA who mostly just inconvenience the rest of us. If there is not enough crime to hire all the people with social work degrees or who would like to be police officers, etc, we will import criminals to create the need. etc. It's already happening.

Rudolf Hauser writes: 

Or create more crimes so that more people living their ordinary everyday lives become criminals for not being in compliance for some stupid regulation.

Stefan Jovanovich writes: 

To add my worn shilling to what Ed and Rudolph have so beautifully said: so much of the warfare in European history from the Greeks onward can be attributed to the need to find something for the "middle class" males to do. The Great Alexander's initial Macedonian Army - the one that crossed into Asia - was over 75% mercenaries, and their replacements were almost entirely mercenaries. (The good people back home in Macedon who still had farms and pastures wanted and needed no part in his conquests.) Where would the British Empire have been without all the younger gentlemen who were never going to inherit?

Productivity has absolutely nothing to do with the number of hours worked. Part-time workers are no more "marginal" than full-time ones; they just can't put in a full day because they have other responsibilities. (Having owned 7 "small" businesses, I know more than I would like to about this basic fact of economic life. There are only two categories of employees: those who actually want to be told what the job is and then left alone and those who think kissing higher asses is what employment is really about.

Before the labor "reforms" of the Progressive era, coal miners and mill workers and garment workers were paid on the piece rate. This "horror" was complemented by the fact that people could work "odd" shifts - for the women who were garment workers, that could be 8 hours on Sundays (not the Jewish Sabbath), 4 hours on weekdays so there was time for shopping, cooking and childcare. The Progressive reforms were based on the notion that women should not be in the workplace and they most certainly should not be competing with men. A "man" should have a full-time job with wife and children at home. Almost all of the current social legislation - disability, unemployment, welfare - is still premised on this ridiculous presumption. And, of course, payment for piecework is as completely illegal as selling moonshine.

Machines do not have to be "more productive" than people to be a sensible investment. People are a very large liability tail; and they require management by other human beings, which is, of course, the very activity that is least capable of being measured economically. (Try doing a look-up on productivity in government and education, where middle management - mostly gone from manufacturing and distribution - is now the principle job category.) The tax and labor codes also help; you can get a great deal more after-tax profit out of money spent on equipment than the same money spent on labor.



 Recently there was a discussion on the site of money and credit and the relationship of the two. Allow me to give you my take on this issue.

While they are related, money and credit are two different concepts. As the world became more complex and people were dealing more with strangers than with people they knew, barter became rather inefficient. Having all goods and services priced in a standard unit, i.e. the currency unit, was a more efficient way to transact. That way one only had to know the price of any item in dollars rather than in terms of every other available good and service. It was even more convenient to receive payment in that form of money and to buy using such money.

In essence money in its narrow definition is that which will be accepted by the government in payment of taxes and that which is generally accepted in transactions throughout the country in question. It is a question of ultimate settlement. You can pay by credit card, but the seller is not really paid until the credit card company pays the seller in money. That is why the credit card is not really narrow money.

The narrow money or ordinary people and businesses consists of currency and checking accounts. Both can be deposited into the seller's checking account. But when banks net out all the checks drawn each other's bank, they have to settle in bankers money, namely currency (insignificant) and their reserve balances at the central bank (i.e., the Fed). The latter is referred to as high powered money. High powered money is not public money—it is banker's money. So when banks keep this idle as excess reserves, it does not impact general CPI type inflation as it cannot be used by the public to bid up the price of goods and services because it is not something that the public can spend.

In addition to narrow money, any asset that has a steady value and can rapidly be converted into narrow money at minimal costs is quasi money and is the relevant measure when one considers not only the money needed in the active transaction process but also that the public wishes to hold as liquid balances. Assets have varying degrees of such moneyness that changes as market conditions change. For example, quality commercial paper had a reasonable degree of moneyness, but the financial crisis in 2008 when it was not sure if companies could refinance and pay off such commercial paper when due, almost totally eliminated any moneyness such paper had.

There is no single measure of broader money. Rather one might choose a definition of such a variable like M2 realizing that it is only a proxy and that the demand for such money will change in part based on the available moneyness of other assets.

People produce for their own use (of great importance when people lived on farms but relatively insignificant today) and for what they can sell to others. When people earn more on what they produce than what they spend on consumption, they save the difference. They may invest some of this on their own businesses or houses. To the extent they do not invest it themselves, it is savings that must either be kept in narrow money or invested either in credit or equity. (Equity might be considered a special form of credit in which neither the return on investment or the principal is specified but dependent on residual values of the enterprise and for most of rest of this discussion considered included with credit.) So credit is the sum of production values in excess of what the producers either consume or invest themselves that in turn is borrowed by others who are either consuming or investing in excess of the value of their production. (I might add that inventories are considered self investment.)

Money is not always necessary when there is a credit transaction. For example, an business might supply drilling equipment to an oil company in return for a future payment of so many barrels of oil (a loan) or a certain percentage of the oil produced (more akin to equity). But most credit transactions are done with the exchange of money, just as most other transactions for the purchase of goods or services are settled in money. When a bank makes a loan, the borrower sees it in an increase in his or her checking account balances. They are then free to buy goods or services using their checks in payment.

In this case the bank has created narrow money and there is also a credit transaction. This is what makes this business of what is credit and what is money a bit confusing. When the borrower buys something, the seller receives a check and deposits it in his or her bank. The money is still in the system. The borrower still owes the bank for the loan but no longer has the money. These are separate items. The money is what was used to facilitate the transaction. It is not credit. Nor is the credit money. It still exists even after the money has left the hands of both the bank that created it and the borrower.

In a sense all money is credit. When you deposit a check, the bank owes you for that money. Currency is a form of non-interest bearing loan to the government. Much is made of sound money in the form of a commodity such as gold. When governments settle with each other, they can only settle in what is generally accepted by most nations as ultimate payment. Gold services such a purpose. As long as it is widely accepted, a reserve currency such as the dollar will also serve as international money. But as it relates to its use as backing for a domestic currency caution on this assumption is in order.

Gold does have value in and of itself for industrial uses and as jewelry. But to the extent there is a demand for gold as money (i.e. as a store of value or as a backing for money), total demand is increased and with it the price of gold. If people lost confidence in gold for this purpose its value as money would disappear and the price reduced again to what its industrial and ornamentation use would value it at.

In that sense it is no different than any other form of money that is dependent on its general acceptance except for its value. The general desire is to maximize the well being of people by producing as efficiently as possible. Gold requires a lot of resources to produce. Fiat money does not. Hence fiat money is a much more efficient form of money.

The main argument for the use of gold is as an insurance against overproduction of money as in the case of gold that is related to the physical availability of the metal and the difficulty of its production. But gold backing can always be stopped by government action. So the only form of insurance is to deal in and hold the gold oneself. Unless the government prohibits ownership of gold as it had in the U.S. for a few decades, there is no reason why any individual cannot do so now. Both fiat money and gold backed money are dependent on government integrity and discipline, so there is no reason not to go with the more efficient form of money.

In our economy, money is created by the Federal Reserve. It can do so in two ways. One is to lend to the banks (or, when permitted, to anyone else). Another is to buy some asset and paying by a check drawn on itself, i.e. the creation of reserves at the Fed. It does not matter for the purpose of money creation, if what it buys are Treasury bills or bottles of fine wine. What it creates is high-powered money. To convert that into public money (M1), the bank has to use its reserves to buy assets or make loans. When a loan is made, the borrower has purchasing power that allows them to consume or invest just as with any loan. When the Fed buys securities it just changes the asset composition of the seller.

A certain amount of money is necessary for the transaction process, such as the time a mailed check is in the hands of the postal system. The rest is held as for purposes of liquidity. When the supply of money is equal to the demand for these two purposes (without fueling a overall rise in prices), money does not add to the savings available for investment or to raise prices. When it is in excess of this amount, it will be spent as holders attempt to reduce money holdings from their portfolio. But since it does not change what can be produced, it means that one will eventually end up in higher inflation. Until the general rise in the price level is realized, suppliers may assume that the real value of their offerings has increased and increase production that will turn out not to be profitable (money illusion). The amount of money demanded will depend on the efficiency of the transaction process, the opportunity cost of holding money (the interest rate on investments and the inflation rate) and how cautious people are. Crisis and uncertainty clearly increase the demand.  It also depends on the moneyness of other assets, which changes with conditions.

Money is just one asset in a portfolio. The amount of money desired will often be viewed as desired percentage of the portfolio. So when excess money creation can end up being used to bid up the price of existing assets such as equities and real estate to the point where the excess creation of money is equal to the desired percentage of the increased value of the portfolio and/or to increase the nominal volume of transactions until the amount of money to support the higher level of transactions equals the increased supply of money. The monetary creation process may end up directing more activity into credit and investment at the expense of consumption as the process does impact who gets their hands on money.
If the government does not prohibit it, anyone can attempt to create private money as Bit-coin has attempted to do. It will never be a complete form of transactions money if the government refuses to accept it in payment of taxes. But if one can get most people and businesses to accept it as final form of payment and to price their goods and services in terms of it, it can be a semi-complete form of transactions money. But the large swings in price of Bit-coins in dollar terms and the limited acceptance of it as final payment for transactions means it has not made the grade. I doubt anyone prices what they sell in terms of bit-coin irrespective of what has happened to the bit-coin to dollar pricing.

Before the Fed, banks issued their own notes. They were never a complete form of transactions money in that notes from a geographically distant bank were not usually accepted in full without a discount for the uncertainty of the solvency of the issuing bank. One could argue that would be less of a problem today. In many respects that is true, but ex deposit insurance and the Fed, consider the experience of 2008 and tell me why such notes would be more trusted than prime commercial paper was during the worst of that crisis.
In times of financial crisis, the desire for more liquidity becomes manifest and financial institutions might not have enough of it forcing them to sell less liquid assets to obtain it. This depresses financial and other asset prices to distress levels. In such times, it should be the function of the Fed to provide liquidity to solvent banks (or at least those that would be solvent but for distressed pricing on their assets). Failure to do so can create a wave of bankruptcies because of lending to lenders. If loans were all just made to ultimate borrowers, the failure of those businesses and consumers would impact that institution but would not necessarily spread throughout the system. But when most lending is not for ultimate purchases, every such failure by ultimate borrowers can cascade throughout the entire financial system. That risk is compounded when institutions are highly leveraged and have only thin equity cushions to absorb losses.
Hence, gross credit is another factor to consider. When loans are made that will in turn be used to make other loans (or equity purchases), the total gross amount of debt in the system is increased. When the ultimate borrowers are not able to repay that debt, it can impact the ability to repay of all the borrowers who used credit to extent credit. When this chain of non-ultimate lending and obligations undertaken by various contingent financial instruments becomes too extensive, the whole system becomes more vulnerable to panic because in situations of distress liquidity becomes scare and there is panic selling of all saleable assets along with the depressed pricing that results and no lender can have much confidence in any borrowers convoluted balance sheets so dependent on others in the credit chain.
Net credit is dependent on the amount of savings in the economy. It can be domestic savings or foreign savings (the current account deficit).  The question is if there is enough productive investment that can make efficient use of that credit or if it will be used for consumption (i.e. most of the use of government deficits) or investment that will not earn enough to allow repayment. Someone recently asked me if the low interest rates might not mean that monetary policy has been too tight. I answered him and will send that answer out in a following post because it deals with this question in the current context.



This is the response to an fellow economist who wondered given Milton Friedman's comments on Japanese monetary policy in the 1990s if our current low interest rates were a result of Fed policy having been too tight. It was written on July 9th.

I can see that your focus is on the sentence that "Low interest rates are generally a sign that money has been tight; high interest rates that money has been easy." Starting from an overheated situation (or any other for that matter), a tightening of monetary policy in terms of slower or negative monetary growth will slow nominal economic growth, including real economic growth, or even turn such into negative growth. Typically with more of a lag, inflation will also come down.

While the initial tightening of monetary growth will raise interest rates, the decline in inflation premiums and in real interest rates because of the slow real economic environment will cause nominal interest rates to decline. This is the basis of the statement above. In Japan the Bank of Japan kept monetary growth too low. That contributed to keeping the economy depressed and interest rates down.

The current situation is somewhat different in that our monetary growth has not been that slow and our economy has had mediocre growth, but interest rates are still low. In the past two years M2 has grown at a 6.2% rate and at a 6.9% rate in the past year.

There is false impression that the Fed controls interest rates. It only influences them. The impression that the Fed controls rates is one of the ways that the Fed influences rates by its interest rate targets, but it is through the creation or contraction of reserves that the Fed has its direct impact.

As noted above, the initial efforts as reflected in monetary growth rates has a lagged impact of economic activity and prices, which in turn moves interest rates. So the question is, if we have had respectable monetary growth, why has nominal economic growth not been higher and why are interest rates still so low.

Slow growth and low inflation abroad is one factor, but one would expect differing interest rates due to different local rates of inflation and economic activity to impact forward exchange rates and spot exchange rates rather than mainly a convergence of interest rates. A difference in the supply of money and the demand for money should impact economic activity. But aside from that the Fed's impact on real economic activity is limited.

Erratic and inflationary monetary policy will create more uncertainty, which in turn will hinder real growth potential. A situation of accelerated monetary growth can shift some demand forward (and a contraction the reverse), as participants engage in capital and durable goods spending (investment) sooner to lock in the lower interest rate costs. It could even result in overall investment being higher because the lower cost of capital might allow more investments to be profitable to a greater extent than periods of higher interest rates might permanently reduce investments. However the poor economic conditions of the time also tend to reduce expected returns, limiting the impact of temporary lower capital costs. But overall these impacts are either limited or temporary.

Real growth will depend on technological developments, capital investment, culture (including attitudes toward risk and innovation), legal and regulatory conditions, political conditions, etc. Savings depends on the desire of people to save for emergencies, retirement, education, etc.; rates of return; inflation; income distributions; diversification opportunities; acceptable risk levels on investments, etc. Investment depends on expected rates of return, the ability to get money to those willing to make capital investments, capital market trends, alternative uses of borrowed money, etc. The relation of savings to interest rates is complicated.

On one hand, people tend to prefer current consumption to deferred consumption, so require returns on savings to postpone consumption. But the marginal utility on basic necessities in retirement or future medical costs, etc. might be higher than on additional current consumption.

In essence people may have fixed level of savings objectives based on the expected costs of that future consumption. When returns are low, more savings flows might be required to meet those objectives. The net effect of these two reactions is an empirical question that can vary from place to place and from time to time.

Income distribution is a factor in this savings/investment situation. When you have countries such as China running up dollar reserve balances for domestic political and social reasons and others such as the oil producers some years ago having such strong revenue growth that they also accumulated dollars, you had a larger amount of savings provided to the U.S. As income growth has mainly gone to the upper 1%, etc. who have a lower marginal propensity to consume for obvious reasons, overall savings is high. (Note that since some of these saved funds will be borrowed by consumers, you would have to have a focus of savings by income groups, not just overall households to really analyze this question.)

But if income growth of the main part of the population is minimal to negative and population growth is limited, who will buy the increased output that results from investment? That lowers the prospect of future returns.

Increased regulatory burdens and delays, also discourages investment, as does all the uncertainties about the EU, future growth potential in China, the U.S. election outcome, etc. There is also a reluctance to undertake some types of risk, which makes it more difficult for new businesses outside of a few high tech glamour areas to get the necessary investment. With returns so low, those with savings will tend to bid up prices of existing assets. That reduces term spreads on interest rates, overpricing longer term securities and may also result in bubbles in other areas.

The ability to borrow cheaply encourages short term speculation. Excessive monetary creation may not result in faster nominal economic growth under such circumstance with attendant higher consumer price inflation but result in asset price inflation instead.

That is what happened with the housing bubble in the first decade of this century. The government has to create more favorable conditions for economic growth and reduce the advantages of crony capitalism to deal with some of the income misdistribution.

In essence I disagree with the conclusion that low interest rates here are a result of monetary policy that has been too tight. There are two approaches to monetary policy. One is to focus on interest rates, with moves by the Fed to nudge interest rates either above (tight policy) or below (easy policy) the fundamental non-inflationary real rate.

The other is to aim to have the money supply equal the amount of money demanded in a non-inflationary environment. Friedman favored a constant non-inflationary rate of monetary growth. Both approaches depend on an assumption for the latter items, that is, the fundamental real interest rate and the non-inflationary demand for money. We cannot measure either.

Given the experience of recent decades, I no longer assume a stable demand for money and hence do not necessarily believe a steady rate of monetary growth is the ideal policy for all situations. We do not really have an ideal measure of money. It seems that a measure that is broader than pure transactions money (M1) is desirable, that is the inclusion of some deposits or instruments that can easily be converted to transactions money with minimal or no cost. Friedman and I have both tended to favor M2.

But there are many other short term assets that have a degree of moneyness that varies over time. I prefer to look at both approaches to determine how easy or tight monetary policy is. Monetary growth at present at a time when other assets like short-term Treasury bills have a high degree of moneyness seems modestly easy to me. I say modestly as international uncertainties might increase the demand for money.

I should note that monetary growth has not been steady and there have been some periods when the growth rate was a bit too low. That may or may not have had some temporary impact on economic growth over short periods. Recent higher growth suggests that this is not a current problem.

There are some who believe that the real fundamental interest rate has declined so much that monetary policy is currently tight. I believe that most have lowered their perception of this rate from the past norm but not by so much as to characterize the current policy as tight.

I might also note that some like Meltzer have preferred to focus on the monetary base. My focus is on public money, that is what the public uses for its transactions, which is M1, or can easily convert to M1, such as M2-M1. Aside from the currency component which is present in both, reserves are bankers money. That is transactions between banks require use of the monetary base.

In theory rapid monetary base growth should result in banks making loans and buying securities. But if they hold such as excess reserves, it is like hoarding cash. It has no direct economic impact. The only impact is whatever impact results from a shift in bank holdings from the securities they have sold to the Fed to excess reserves. That is the impact on the interest rates on those securities relative to the Fed funds rate may be impacted.

The public does not have reserves in its balance sheet. As such those inactive reserves would not be expected to have any impact on the public's economic activity. The longer term risk is that those excess reserves will be utilized, rapidly increasing M2 growth at some future time if the Fed is not successful in counteracting such trends. That would likely result in more inflation.



This forthcoming presentation might be of interest to some Spec readers.

IAQF/Thalesians Seminar Series - A Talk By Dr. Tobias 

Nonlinearity and Flight-to-Safety in the Risk-Return Tradeoff for Stocks and Bonds

When: June 16th 2016, 5:45 PM

Where: NYU Kimmel Center, Room 914, 60 Washington Square South, New York, NY



I was listening to  the rebroadcast of last night’s Charlie Rose show this afternoon. One of his guests was Maria Konnikova, author of The Confidence Game: Why We Fall for It…Every Time. While I have not read or even seen the book, based on the interview it seems that this book on deception and how people are conned might be of interest to many on the list.”

The top review posted is less than impressed by the book, so I offer no assurances about how good the book will turn out to be.




 After reading this article "The Rich Are Already Using Robo-Advisers, and That Scares Banks", I wonder three things:

1. Making a broad assumption that most of these "artificial intelligence" schemes do similar things isn't it likely to cause even more herding behavior as assets in these plans increase?

2. Placing money in several plans and observing what's done might provide foreknowledge of what might be executed in the future.

3. Are they using ETFs or individual stocks? From the small amount I've read about these plans it seems to be ETFs.

For sure the assets in these plans are not currently enough to move markets -yet. But like ETFs which began as a small force and grew to be of great influence they could eventually move markets on their own. It's the commoditization of investment advisors in a similar way that ETFs commoditized retail trading.

Rudy Hauser writes: 

I would add the move by pension funds into equity investing. When my late friend, Prof. Paul Howell, who at the time ran the NYC pension funds, wrote an article in 1958 that appeared in the Harvard Business Review and madeg the case why pension funds should mainly be invested in equities, it had the largest request for reprints of any article in that publication up to that time. The idea of pension funds investing most of their assets in stocks was a new trend at the time. I would also add the event of mutual fund investing, that really took off in the decades after WWII.

Stefan Jovanovich writes: 

Another really dumb question for Jonathan and the other pros. But, first, a brief description of what those of sitting in the bleachers see as the great events in "financial history" since WW II.

1. End of fixed commissions; "discount" brokerage
2. Retail/commercial trading in Financial futures
3. Retail/commercial trading in Options
4. Derivative trading
5. Retail/commercial trading in Currencies

Now the dumb question: Which, if any, of these 5 developments are the historically comparable to the rise in ETFs?



 Will China liquidate its holdings of US debt to pay for the recovery?

"BLACKROCK WARNS: China's debt has lost its potency and is now 'turning into poison'"

Jordan Low asks: 

What would they do with the US dollar? Convert it back to RMB and hurt Chinese exporters? 

Rudy Hauser writes: 

To get rid of dollars they could import goods and services, make investments dominated in other currencies or buy other currencies. They could just invest in other U.S. investment possibilities (including equities, real estate, etc.) In the aggregate the only way foreigners can get rid of U.S. dollars is to buy goods and services. They can also make fixed investments, but the returns and proceeds upon sale would be in U.S. dollars, so they would not really have reduced their dollar holdings. They can of course make investments in the U.S. that decline in value. (They could also convert to currency and burn it, but that is not a logical choice.) An other alternative is to give the dollars to Americans as a gift, another unlikely choice. Yes, the Chinese could buy RMB for dollars if they find someone who has RMB to sell. To the extent Americans hold RMB that they would sell for US dollars, the gross positions would change but not the net positions.



 Given Vic's interest in trees, I am posting this link to some amazing photos of trees. A friend had sent me this link today. I believe you will find it worthwhile viewing.

Marion Dreyfus writes: 

I wrote this about the first tree in this extraordinary series of trees.


He was a lad off to war and fortune. He was in Flanders. He propped his bike against the beloved oak Where in a nimbus of earnest he had embraced his girl expecting her to wait. He felt sure of her, sure she would. And left his gawky 3-speed. A lad of 18, younger then than he'd be now uncynical, unjaded, just a country lad. And the years passed, decade folding over decade. And his girl was affianced to another felled by the waiting for him. But the tree never forgot. And year with year by year on year it stood silent, sentinel awaiting his return, that lad who, ere he left, had lain beneath these capacious shading arms. And not wanting to abandon its friend the tree widened in girth, and stretched in height, enfolding the now-rusted Raleigh incorporating the boy's loveleaving but the handlebars and wheels spoking outlifting the bike with its annual spurt from its packed grassy mound. There for all time awaiting the lad's eager return. The tree grandfather to its earlier self. And the bike? The bike, not still shiny but loyal and mute, keeping its vigil too should his lad ever return.



 The Iranian Revolution led by Ayatollah Khomeini had consequences outside of Iran/Persia as well; it was the inspiration to the Arab world for much of the radical movements increasing influence. Until then the Arab world was ruled either dictators who were not extreme Muslims or monarchs who had ties with the West that had colonized or heavily influenced the Arab world earlier in the century. Khomeini not only took control from a Western supported Monarch who had tried to bring more modern ideas into Iran threatening the interest of the clergy but also espoused a desire to export his version of Islam throughout the Muslim world and then throughout the world. This desire to recreate a Muslim caliphate was a common thread throughout these stirrings. The origins go back further in time but the Khomeini revolution reignited. The movements gained considerable support in the Islamic world. Most like the Muslim Brotherhood were willing to move to their goals more gradually. The roots of these moves trace back to the Saudi brand of Islam known as Wahhabism. It is based on the most conservative of the four schools of Sunni Islam (Hanbali) using the doctrine of some of the more extreme theoreticians of that school. The alliance of the Saud clan and family of Muhammad ibn Abd al Wahhabi (the founder of the Wahhabi school)was to the advantage of both families. The former gained legitimacy for their attacks on caravans and the latter muscle behind their religious doctrine. That relationship has continued over time. The Saudi monarchs have followed traditional Islamic tactics of aligning with lesser enemies to defeat the main enemy at the time. As such the Saudi's first aligned with the British to deal with the Ottoman Empire and subsequently with America to deal with such threats as the likes of Nasser and the communists. They supported radical movements elsewhere but not at home. In essence, they paid lip service to the ideas of converting the world to Islam but did not seriously pursue that goal. The lifestyle of the Saudi monarchs did not quite conform to their religious teachings, offending the more extreme groups. The Sunni's often view the Shiites as heretics, which is even worse than being an infidel. This dates back to the early days and a question of succession as head of the religion, but there are considerable other differences. The Iranians hoped to become the leaders of the move against the West. Among the Sunni, groups such as those led by bin Laden exposed a desire to bring about the ultimate goals much more rapidly by violent means. These extreme views attracted only a small minority of Muslims but enough to become a threat to be reckoned with. The Islamic State is only the latest significant manifestation of these groups. By gaining military victories and proclaiming a reestablishment of the caliphate they have gained more followers. They currently have no power to be more than regional problems. The main concern would be if events in Pakistan allowed them to gain control of some nuclear weapons there.

The war between Iraq and Iran was started by Iraq. When the Iranian counterattack started to make some progress, Iraq resorted to chemical weapons. (We provided some help in that effort and did not condemn it at the time except when it was used internally.) This development caused many Iranian lives and had a profound effect on the Iranian psychic. The desire never to be at such a disadvantage in weapons of mass destruction was probably the main factor in the Iranian desire to have a nuclear weapon capacity. The political situation in Iran is complex with many competing groups. On the whole there has been a moderation in the extreme goals of Khomeini. The leaders of Iran had reason to fear the U.S., which was another reason to build a nuclear capacity as the only way to insure that Washington would not try to repeat past efforts to overthrow an Iranian regime. But the actual foreign policy of Iran has not been marked by recklessness. They might be very content to achieve a state like Japan in which they could build a nuclear weapon on short order but avoid getting that capacity before it was needed for self defense. Even if that were not the case, I doubt that they would be so suicidal as to use them unless attacked despite their threats against Israel. I suspect they will confine themselves to conventional (i.e., not nuclear) means and operate through proxies. If we were to attack their nuclear facilities, I fear it might result in an Iranian counterattack on American targets and on Western energy supplies and transport routes. This might then lead to a wider war that would involve a major US ground involvement. The assumption that the Iranians would just accept the consequences of such an attack without a significant response is conceivable but not an outcome I would count on. Both we and Iran have an interest in attacking the Islamic State.

 The Shiites in Iraq were repressed by a Sunni government under Saddam Hussein even though they became a majority in the country. The Alawites were an oppressed minority in Syria until the French took control. Following the strategy of the British they put the Alawites in control. The Alawites as a minority group could be counted on to work with the French as they needed the French power to retain their position of power. The gained influence in business and the military as a result. The latter gave them the ability to retain power under the Assads. Under the Assads and under Hussein, both more secular regimes, non-Islamic minorities faired far better than they would under more religiously extreme Sunni regimes. Neither had ambitions of world conquest. Yes they are/were ruthless dictators but they were a better alternative to the chaos that now dominates both countries. There is no question that Iran desires a more dominate position in the Middle East and aligns with the current Shiite regime in Iraq and Assad in Syria, and might at some point harbor wider goals of conquest. For now it has its hands full with internal and regional concerns and will for quite some time to come.

The Sunni extremists have been responsible for terror attacks on Western soil. The Iranians have done so regionally but not on Western soil, even though they would have to potential to do so. Unlike the Sunni extremists they have not been trying to convert Muslims in the West to engage in terror attacks in the West. The likely terror attacks by Sunni's have to be put in perspective. On the whole they are not a worse concern than regular crime. Even another success on the part like 9/11 as horrible as it is, would not be a major blow to the U.S. These groups are a concern but not something that will easily lead to our downfall.

In short, I do not agree that Iran is as great a threat as the author of the article Vic referenced suggests. To the extent these various groups fight each other they are not an immediate threat to the West. Over time, both Iran and the Islamic State will have to be contained, requiring that we keep up our military strength.



 I came across this article lately with lots of good pictures: "17 Bookstores that will Literally Change Your Life".

It got me thinking about one of our last remaining bookstores in NYC, Strand. Strand sells both used and new books. They were able to sell new books at lower prices because they purchased and sold reviewer’s copies at a 50% discount to the listed price. It used to be that if they did not have a reviewer’s copy in stock one could put an order in to be notified and the book held for a number of days when a copy did become available. But the industry has changed. Reviewer’s copies have become relatively scarce. A large section of their basement used to hold the reviewer’s copies. Now that is down to a few shelves worth. I have not even tried to order a copy and have noticed that the shelves behind the information desk no longer contain those copies put aside for those who have asked. The new books that are not sold as reviewer’s copies are discounted by much less than the discount at Amazon.

Strand still has a used book section for University press books, but I notice that many of those have “not for resale” stamped on the sides. I have no idea what the legal liabilities are for those initial sellers, Strand or the ultimate buyers when they are resold anyway. Strand still sells used art books typically at a 40% discount. Most of their shelves are still devoted to used books.

Many of the book stores of the 17 pictured, unlike Strand, are attractive. Strand now has air conditioning, unlike the hot basement in the summer in ages past. But attractive it is not. Ages ago we had Scribner’s on Fifth Avenue, which was attractive but is long since gone. The next best in that regard was probably Rizzoli, which recently closed its NYC store. They are apparently looking for a new location. It’s a real shame that NYC does not have one of these great book stores aside from Strand. But I have been as guilty as so many others in browsing at those stores and then buying where I could get the best price. Even Barnes and Noble has changed in that large sections of their stores now sell items other than books, often games and such for children.



Martin Feldstein's editorial in today's WSJ notes studies that show inflation is more related to short-term unemployment than to long-term unemployment and that the former has now declined to levels consistent with more inflation and wage pressures. He is concerned that the Fed might be slow to react in response, which is a fear I also hold.



 As of December 4, 2013, US banks had $2.493 trillion on deposit at the Fed. (Source: FRB H.4.1 Report). This amount includes required and excess reserves. The amount has increased by 63% over the past 12 months and approximately 300% since the Fed started paying interest on the balances. Bernanke started paying IOER during the financial crisis, but banks had wanted this for years. Some fraction of this reserve growth is due to QE and some fraction is due to the above-market rates that the Fed is paying. (This is the so-called IOER "Interest on excess reserves.") Right now, the Fed is paying about 0.25% on IOER and the t-bill rate is 0.02%. So the Fed is paying more than 0.23% above the market. On a balance of $2.5 trillion, this is a direct subsidy to FRB member banks of roughly $5.75 Billion per year and with each QE day, the amount grows.

This subsidy is theoretically being financed by the Fed's holdings of longer-dated securities so it's positive carry for the Fed. However, from the perspective of a risk-averse banker, and ignoring capital haircuts and the risks/spreads etc., a banker would need to buy treasury securities with a maturity of greater than 2 years to get the same yield as parking overnight money at the fed. So banks are behaving quite rationally.

The elephant in the room is the rate that the Fed pays on IOER. Talk is brewing that along with the announcement of a taper, the Fed will reduce the IOER rate. I submit that this is a highly unstable equilibrium and a change in IOER will have unintended (and unpredictable) consequences. Let's imagine that the Fed cuts IOER to zero. You will suddenly have $2.5 trillion looking for a new home. Where will it go? T-bills are already at 0 yield. So if banks just buy T-bills (even outside the fed) then that is a classic liquidity trap. Or, it's possible (but improbable ) that it will suddenly go into the real loan market. If that happens, the economy would go gangbusters with possibly little upward pressure on rates since $2.5 trillion in supply is a lot of money. Or, this gusher of ?dumb? money will listen carefully to the fed's forward guidance and collapse all rates towards zero out to the 2-year etc. I think this helps explains why Bill Gross is bullish on the front end of the curve because the curve is highly arbitraged between 2 years and 5 years. So it's possible that a taper announcement combined with a drop in IOER could turn out to be very bullish for the bond market. And this would persist until the Fed actually raises the funds rate.

Additionally, dropping the IOER might appease some critics about the size of the fed's balance sheet (ignoring the sheer quantity of bonds that remain). The IOER has been a subsidy to re-capitalize the banks. And now that this process is largely complete, the subsidy of $5.75 Billion/year should end and watching the gusher of $2.5 trillion leave the reserve account will be interesting, to say the least.

Bottom line: The IOER is a bigger deal than the taper announcement. The pundits will figure this out in due course.

Alston Mabry writes: 

"Remember that money we gave you, so you could give it back to us, and then we'd pay you for keeping it with us?"


"You can't have it back."

Bud Conrad writes: 

Rocky, Thanks.

The Fed has to buy up the new debt issuance from the government to keep rates low. It is also buying the MBS to keep mortgage rates low and to allow the banks to keep on their books holdings that might otherwise be declared toxic waste from being written off. So they can't stop QE purchases.

They have to fund the purchases some how. At present the Fed has been paying over market rate to keep the deposits of Excess Reserves to obtain the money to buy the Treasuries and MBS/Agencies. I don't see how the Fed balances its books if the banks withdraw $2.5 trillion. Then the Fed would look like a commercial bank that has a run from depositors and is quickly iliquid. The equity account is only $65 billion. The Fed is like a very leveraged hedge fund. If the depositors want to withdraw their money, the Fed would have to sell off assets or EXIT, which would cause panic in the markets.That seems even less likely. So Al is right: "You can't have your money" has to be the response.

So the Fed is trapped into continuing the payments on the deposits (IOER) as long as they have income from the Treasuries and MBS to pay for it. The idea that the Fed prints up currency is a little misleading because the actual physical demand for paper is decided by the public's conventions, and there is less use for the dollar bills with more transactions being done with credit cards. So as rates rise they will be raising the IOER rate, and at some point that gets so big that it uses all the asset income, and then the Fed has to go to the government for a bailout, which means the tax payer supports the banks getting their huge interest payments.

As an aside, does anyone know if the big banks can go to the Fed and add money to their deposits to earn the above market rate? Banks are supposedly free to with draw the accounts created out of thin air to pay for QE purchases, but can they add to those deposits? It would seem not because the amounts would rise even more dramatically.

Rocky Humbert replies: 

Bud: If your head is spinning, I suggest you sit down. If you look at the situation as I articulated it, then don't you agree with my analysis….? (This is a macro-economics conversation. No conspiracy theories allowed. ; ) Namely, the Fed could theoretically exist with only $1 of equity. Their equity is irrelevant because of their ability to print currency. And so long as the currency is accepted and relatively stable, everything works. For the Fed, currency is the same thing as a paper check. So if Citibank and the other big banks say "we want to withdraw $X trillion in excess reserves" the fed can hand them a check for $X trillion. And Citibank can take that check and spend it however they want. Whether the check has a picture of Ben Franklin or looks yellow or purple or is electronic is not material. It's credit creation… (This is when the S-Man chimes in.) I believe that before the Fed existed, this was how all banks operated — namely, there was essentially no difference between XYZ Bank's check/draft, their self-issued currency, etc etc.

Rudolf Hauser writes:

There is a bit of misunderstanding here. A reserve balance at the Fed is a bank's checking account at which it holds bankers money. That is the only money, other than currency, that another bank will accept in payment unless it is willing to keep a deposit in the bank that is in the negative position of the transaction. When a bank wants to reduce its balance at the Fed, it does so by buying other assets, such a T bills, or making loans. The seller or borrower now either deposits that money in their own bank or makes loans. This process continues if no other bank receiving deposits or proceeds of sales of assets to these spenders decides to hold excess deposits. Eventually enough ends up in checking accounts so that all the excess reserves reduced by the first bank have either become required reserves or held by other banks that have increased their excess reserve balances. The Fed does not have to sell any assets or pay out anything. The reserve balances just get moved around and converted from excess to required reserves. This of course increases M1 and M2 balances and is inflationary. If the Fed wants to avoid this it either has to make holding excess reserves more attractive by raising the rate it pays, selling assets it holds, borrowing cash via reverse repos or by converting excess reserves into required reserves by raising required reserves that have to be held against any checking or other accounts.

The risks are that eventually the banks might want to reduce excess reserves, resulting in a expansion in M1 and M2 that will be inflationary. Real growth is being held back by factors other than lack of liquidity. While faster M1 and M2 growth might push some demand forward in time resulting in some temporary faster real growth, the type of growth that would clearly have to lead to higher prices for either assets and/or goods and services. Alternatively, the Fed could take the measures noted above. It's ability to pay more on excess reserves is at some point limited by what the Fed earns on its assets and the amount of equity it has. But do not forget the first hit is on the U.S. Treasury which is currently getting large contributions from the Fed, which pays most of its profits to the Treasury. This is currently a large cushion. Selling assets will cause interest rates on those assets to rise, potentially considerably depending on how much the Fed sells among other factors. Even if the Fed does not try to upset the situation, rates might rise because of actual and expected inflation. This might create problems for some holders of long term debt and securities. The least destructive way might be to raise reserve requirements, but this might create problem to the extent that excess reserves are not evenly distributed among the banks. All these moves would be politically unpopular. This is why I am somewhat skeptical of the Fed to get us out of this situation. They could do it, but it will require a FOMC with a lot of wisdom, determination and courage to do so and a Congress that does not take away the Fed's nominal independence to pull off.

anonymous writes: 

Zerohedge quotes Bridgewater on the process of QE noting that not just the amount spent, but what it is buying dictates what the economic effects are. If the assets are more risky and less like cash, the effect is supposed to be more. Seems to me the creation of new money is the big cause of the effect. and then how that money is used is the other half of the equation. It's my view that the new money sits on the Fed balance sheet and impairs its inflationary effect. The reason it sits as excess reserves is that the Fed pays above market rate on the deposits. The $ 2.5 trillion times a reasonable interest rate in normal times of 4% would cost the Fed $100 B, and that is close to it current earnings for its assets of Treasuries and MBS Rising rates is not good for the Fed either.

Bridegwater and commentary:

In the past we have explained how QE continues to "fail upward" because instead of injecting credit that makes its way into the economy, what Bernanke is doing, is sequestering money-equivalent, high-quality collateral (not to mention market liquidity)- at last check the Fed owned 33% of all 10 Year equivalents - and by injecting reserves that end up on bank balance sheets, allows banks to chase risk higher in lieu of expanding loan creation. Alas it took a few thousands words, and tens of charts, to show this. Since we always enjoy simplification of complex concepts, we were happy to read the following 104-word blurb from Bridgewater's Co-CEO and Co-CIO Greg Jensen, on how QE should work… and why it doesn't.

The effectiveness of quantitative easing is a function of the dollars spent and what those people do with that money. If the dollars get spent on an asset that is very interchangeable with cash, then you don't get much of an impact. You don't get a multiplier from that.

If the dollar is spent on an asset that's risky and very different from cash, then that money goes into other assets and into the real economy. That's really how you see the impact of quantitative easing. What do they buy? Who do they buy it from? What do those people do with that money?

Of course, this is why sooner or later the Fed will proceed to "monetize" increasingly more risky, and more non-cash equivalents assets, until "this time becomes different." Which it never is, but the Fed will still try, and try and try.



I had often wondered why someone with great wealth will continue not only to sometimes still work so hard but to risk all in ventures in the quest for even more rather than keep in safer investments that will be enough to give them a great luxurious life. I later realized that there are different objectives that are the focus of people's lives that seem innate or driven by personality types that are. One of the most common I find are the "game players." To prove to themselves that their lives matter they prefer competitive activities in which the goal is to come out on top. The money might matter to some extent for what it buys, particularly for buying power, but part of it is just a way of keeping competitive score. People are not necessarily confined to one trait; they can be more complex than that - but one may dominate. Those who favor high taxes on the rich sometimes point to good growth in the economy like in the 1950's when those marginal tax rates were outrageously high. Of course, loopholes allowed the wealthy to often pay less than those rates, but that can hardly be the entire answer. Rather, I suspect that some will be competitive irrespective of the haircuts because even with the disincentives they still want to be the ones who come out on top. Hence, the destructive effects need not be quite as great as one might expect. But if the disincentives are too great they may just start playing other competitive games, such as who will be on the political top under a communist society, and stop playing the economic game in which wealth is the measure of success.



 "Those well-known experts who had pulled off a big windfall by going against the tide and winning were, over the long term, the worst at forecasting."

That sounds understandable to me, and there is a research to prove it.

The original article on Harvard Business Review requires registration.

Victor Niederhoffer writes:

This article provides confirmation of the idea that has the world in its grip. Egalitarianism prevails. Especially at Harvard. I will have to read the article to see all its biases. But it was guaranteed to be published in the HBR.

Rudolf Hauser writes: 

Not having read the HBR article, I cannot comment on that particular study. But I would note that the nature of the forecast and time frame are important considerations. The news article did note that the study only looked at three years of data. If the forecast related to only quarterly trends the conclusion that it might have just been a fluke forecast could be valid. But say someone had predicted the financial collapse we saw in 2008 with valid reasoning but was off in timing. In that case his or her forecast would be wrong for part of the time but someone who acted on it might have had some years of underperformance but avoided the debacle that was to come. That forecaster might be someone to listen to in the future. But even being right once for the right reasons does not mean that the person will be correct all the time on such major calls or even that they will ever be right again. In the end, one should listen to the reasoning but make one's own decisions.



When people talk about market efficiency, they are talking about two different concepts. In one sense, the market can be said to be efficient if no one can consistently outperform the market based on skill. A somewhat weaker form would be more lenient when it comes to consistency. Some would be expected to outperform just based on random luck. If some outperform it, it can't be said for sure that it might not have been based on skill rather than just on luck.

The other sense of efficiency is that the market price is a good judge of the true fundamental value of a security. If this were the case the overall market would not be a volatile as it is. In an efficient market in which the market was indeed a good judge of fundamental values, the annual market return would not deviate much from the long-term required return on the market. All factors that influence value would be correctly evaluated and priced into the securities. But we are not good at forecasting the future. Let us say an unexpected recession hits the economy. We know we will have recessions. The unexpected nature of that recession might just be a matter of timing. But say it is an additional recession. It would mean a year of disappointing earnings, and one would expect the stock to decline by the amount of earnings shortfall. Now if there was a change in the assumption about the nature of the economy it might also require a change in risk premiums demanded. But this occurs much too frequently to blame that. If one does what Hetty Green did and buys in panics and sells in booms, one could do well. The problems come in that the market in this that there are too many factors in the future for any to forecast correctly and psychology influences markets in shorter time spans as do liquidity premiums. If the market deviates from efficient values in this sense, someone who could consistently forecast fundamental values could still fail to outperform because they cannot forecast how much the market will deviate from that true value. They might not have the staying power hold out until the market does return to that true fundamental value. Clearly this becomes more of a problem the shorter one's time horizon. In the very short time span of a trader, fundamental values might have little importance and other market factors might be dominant. Then only the first definition of market efficiency would have any relevance.

In sum, I ask the question are the markets efficiently smart or efficiently stupid and conclude the latter is more likely than the former.

Jonathan Bower writes: 

I'd say markets are efficient depending on your time frame and expected holding period. For every fundamental investor that sees a "fair" price, there are a dozen other participants who see a mispricing and vice versa.



 I recently read the wiki page about The Endowment Effect.

Basically, it says the one values his possession much more than others value it.

Thaler conducted the following experiment. He randomly gave some participants a mug, which sells for $6 in a store. He then asked the ones now owning the mug to give a minimum price below which they would not sell the mug, and asked the ones not having the mug to give a maximum price above which they would not buy the mug. It turns out that the owners valued it for $5.25, while the bidders valued it at $2.75. He concluded that the very fact that the persons owned the mug made them give it a higher value.

Very interesting research. But I wonder if the conclusion is as that simple.

First, I wonder what would happen if the owners were asked to buy another mug. How would they now value it? Since it is not a critical item to have and they already own one, it is reasonable to believe that they would bid an even lower price than the bids from those who didn't own it, isn't it?

Second, what about selling short is allowed in the experiment? If the people who didn't own the mug were asked to price it if they would sell it short. I bet their price would be even higher than what the owners offered, and very likely be higher than the $6 store price.

Any input on this, please?

Gary Rogan writes:

Leo, I'm not sure it's productive to attempt to extend these "effects", and there are many of them, beyond their original definition without doing actual experiments. This particular effect seems to be as simple as "defend what's yours harder than you would attempt to get the same thing from someone else", one of the ancient evolutionary developments. Primitive (as well as advanced) animals demonstrate the same effect when fighting for territory, that's why the challenger loses most of the times. Of course someone who has a relatively useless (from their original standpoint) mug to begin with doesn't want another one. Personally I find it more interesting to think about the practical value of the original effect. In the behaviorist books it's supposed to manifest itself by "holding on to losers too long". Every time I read this I always think about whether the logical conclusion is that a rational person should always sell "losers". Sometimes they bring up the tax loss effect, and that's fair but it doesn't get to the heart of the matter. Considering this question, and all the robotic trading that goes on, how would one take advantage of this effect? 

Pitt T. Maner III writes: 

The self-storage business might be an area where this effect is felt most strongly. There is a lot of rent money being paid (by baby boomers and those who have left houses) and property used to store old things instead of buying new.

Rocky Humbert writes:

This is a fascinating subject for exploration. Being only slightly tongue-in-cheek, I wonder what effect negative real interest rates have on the willingness of people to hold onto "junk" ? To the extent that "the cost of carry" (i.e. monthly rental fees) are small, hoarding is a rational behavior. Also, there was an article in the WSJ last week discussing the effects of "clutter" on marriages and home life. Lastly, there may be a "depression-era" and "aging demographic" effect occurring here. In the situations where I've (sadly) had to empty out elderly relative's apartments, I've discovered that depression-era people hoard useless things like return envelopes from bills, archaic car and doorkeys, memorabilia from bygone days, etc. I think that there are many interesting factors at work in this trend — and there is market-related utility in thinking about them.

Jim Sogi writes:

It's really hard getting rid of one's "junk". There is a weird attachment to the stuff. Its almost painful to throw stuff away. Then there's the issue of getting rid of the junk, and then needing that item the next day. Feng Shui has some good tips on clearing the clutter. There must be some sort of hardwired effect causing one to collect stuff. Look at the bag people pushing around carts of junk.

Craig Mee writes: 

I'm with you, Jim, and in the tropics, clutter, dirt and smells brings mosquitoes, which is a very good reason to keep things clean.

On a side note. I've had a lot of trouble with mosquitoes, though I went to a friend open air villa the other evening , and when dusk hit, no mosquitoes ? I looked around and put it down to a) everything was white, walls , furniture, coverings, a well cared for garden, two ceiling fans, (some sea breeze) and importantly I thought …lights under the table we were sitting at. ie everything was clean , tidy, and white, with air.

Further, I read once, if you haven't worn clothes for a season, toss them. That's certainly worked for me.

No doubt those who make money in one particular stock , get attached, (you see it)…it clutters their mind, and they will drag any positive out of fundamentals, value, whatever to get back involved. Got to clear the clutter, or put it out of sight, to free the mind.

Rudolf Hauser writes:

In considering the impact of the pure psychological effect on value from ownership, one should not ignore the economic effect. The cost of the purchase is not just the purchase price of the item but the value of all the effort that went into finding the item in the first place and how difficult it might be to be able to buy it again. Then there is the risk of the replacement being defective or other problems in the acquisition thereof that might happen. One also has to consider the potential cost of needing an item and not being able to acquire its replacement in time to meet that need. As an example, I once wanted to buy a new ink eraser to replace the one that wore out. I then found that I had to run around to seemingly countless stores to find this inexpensive item –an effort countless times more expensive in opportunity cost than the price of the item itself. Needless to say, when I finally found the item, I purchased a whole box full to insure that I never would have to spend so much in search costs again for that item. Nor would I have sold those again except for much more than I paid for them.

As for the psychological impact, say one has purchased an object of great beauty at a price that subsequently appreciated considerably. The new higher price might be one at which one would not consider it prudent to buy given the overall state of one's financial resources even though it is an item one might wish one could buy. But already possessing it one has the excuse for buying it via not selling it because one already had done the deed in effect. When an item is not unique or rare and is easily replaced when a new one is needed, one would not suspect that same tendency to value the item in possession more than the same item not in possession. It would be interesting to see if this effect still persists in that case and how it compares to the former.

A stock would be of the latter type at least in small quantities. With larger quantities there is always the uncertainty as to how much such purchases might impact the price, which would the economic reason as opposed to a psychological reason. A psychological reason might be the emotional difficulty of making a decision that one is not anxious to repeat, ignoring the fact that with an investment an implicit decision has to be made every day as to whether to continue to hold or not. The difference is that to sell or purchase is an active decision whereas to hold can be a passive decision. In effect holding is also a way of putting off a decision.



 On a moral note, which I feel totally inadequate to opine upon, why is it considered so universally reprehensible to be a stool pigeon, or to dessert a sinking ship? Maturin always refused to spill the beans on his fellow mariners even when it would have helped to defeat the French or save his ship, or help out his best friend, because of the moral stigma.

Jack Tierney comments: 

This dilemma is dramatically presented in "Scent of a Woman." Al Pacino gives a rip-roaring soliloquy on why his "ward" is justified in not implicating three associates who violated the school's honor code - first, by behaving in an ungentlemanly manner, and second by not admitting to it. Due largely to the speech, the young man is exonerated to cheers from his fellow classmates and much of the faculty. The line from the speech that I recall vividly goes something like this: "Many times I was faced with the choice of doing right or wrong. In every case I knew what the right decision was. I never took it. Why? Because it was too damn hard!"

Almost everyone seemed happy with the conclusion. I was not. As far as I'm concerned. the over-riding issue is whether, once we have sworn to adhere to a code, it is permissible to toss it to the winds because popular opinion or powerful forces believe otherwise. The young man and Pacino are, unsurprisingly, both portrayed heroically. Hollywood has a history of lionizing scoundrels and demonizing those who spoke against them. Should that be the template by which we measure honorable behavior?

Rudolf Hauser comments: 

This may well be something some of us are genetically programmed to do. The fact that the trait is so common across cultures is suggestive of this. Genetic traits depend on survival of the gene that carries them, which means they aid survival and reproduction. The logic is that on the evolution of reciprocal altruism is that it genetically paid to help one's siblings since they shared many of the same genes, increasing the odds that the gene that encouraged such behavior would be more likely to survive since some of one's siblings would share that gene. But then there was a recognition problem.(The evolution of such traits is likely to have started among our pre human ancestors who did not have the benefit of language.) An older sibling would know who its younger siblings were but not the other way around. But the odds of the gene thriving would increase if it acted in the interest of those who helped one as they might be older siblings. Members of the same tribal group would be more likely to share that gene than outsiders. But altruistic behavior has costs to the entity engaging in it. The most favorable trait would therefore be to appear to be altruistic without being so in fact but benefitting the altruistic behavior of others toward oneself. But that is costly to those who do engage in altruistic behavior, so a genetic response in which the behavior of cheaters and traitors is punished would tend to reduce such cheating. Experiments have shown that people are willing to punish cheaters even if it has an economic cost to them of doing so. Along similar lines, there is more of a hostile attitude toward those outside a group than those within one's group. Both of these traits account for why it is considered so reprehensible to be a stool pigeon or engage in other behavior inconsistent with what are viewed as societal obligations to the group.

From a moral standpoint, doing what is right morally is far more important than loyalty to someone whose moral behavior turns out to be reprehensible. The purpose of liberty in part is the belief that one should be able to act on the basis of one's individual conscience rather than following the possibly evil dictates of society. The opposition of society to such behavior is one reason the fight for liberty is often so difficult and why individuals are often reluctant to stand by what they believe to be right.



 Have you seen this article- "Obama: Government Job Slayer". Supposedly Obama has cut more than 500,000 government jobs. 

Jack Tierney writes:

Members of the military are counted as government employees. For many who weren't sure this became evident during Clinton's administration — you might remember his assertion that government had become too big and he intended to cut back on its size. One of his follow-up pronouncements declared that substantial cuts had been made. However, the cuts were primarily in the military numbers; about 700,000 full-timers and 275,000 reservists.

Cuts that became an election issue…primarily in the Bush/Kerry confrontation — Kerry had been a supporter of the cuts. At almost any other time this might have served him well - but 9/11 cast a giant shadow.

Rudolf Hauser writes: 

I believe the recently released public sector employment numbers refer to total government employment at the BLS definitions, which exclude the armed forces. The seasonally adjusted numbers from Jan. 1993 to Jan. 1997 show an increase in government employment of 692M, but a decline in Federal government employment of 247M. The corresponding numbers from Jan. 2001 to Jan. 2005 show and increase in total government employment of 900M and a drop in Federal government employment of 26M. The numbers from Jan. 2009 to June 2012 show a total decline of 633M but a slight rise in Federal government employment of 16M. In essence all of the trends referred to where in state and local government employment, something that Clinton and Bush can hardly be credited for and a decline that Obama can only be blamed for by arguing that he made the economy so bad that those governments revenue trends brought about the drop. It certainly had nothing to do with a desire on Obama's part to reduce the size of government.



 Greece has been "sold"; should America be for sale?

A footnote to the Greece default/restructured bonds is a detach-able coupon that pays an amount based on future Greek GDP.

See this article for more details.

Interestingly, Professor Shiller recently proposed (in a recent Harvard Business Review article) that countries should replace their sovereign T-Bills with "shares" that represent earnings of their economies. Read this article. Should other countries go down this path, it will open a Pandora's box of unintended consequences, incentives and problems.But first things first. If the USA does an IPO, will it be a "hot" deal???

And, does it give new meaning to "selling America short…"

Rudolf Hauser writes:

This idea strikes me as very stupid. GDP is not a reliable measure containing many assumptions and imputations. Such an instrument would give governments a strong incentive to cheat and the GDP is an easy measure to manipulate if so desired. It is also a number that is constantly and often significantly revised. How would the instrument handle this. Would investors who were overpaid have to return some of those funds? Aside from more modest revaluations every year, major revisions in the methods of calculation are made every number of years along with benchmarks based on more extensive surveys which are not conducted every year. For how many decades would such adjustments have to be made? Any investor who trusted the honesty of such instruments should have his head examined.

Rocky Humbert writes: 

One notes the large and relatively liquid market for global inflation-linked bonds..which are also vulnerable to gov't tampering and revisions.

I agree that there are many consequential problems with selling what is essentially floating rate debt, with the coupon linked to GDP…too numerous to type on my blackberry…

However, I have total confidence in Wall Street's ability to underwrite, and Mr Market's ability to "value" these securities (just like they did with subprime CDO's based on arcane and idiotic models.)

Gary Rogan adds:

Some day there may even be a pan-european agreement that Greek GDP was actually negative and investors are required to compensate the Greek government for the privilege. If they can rule that a default is not a default but an agreement to pay less, anything is possible.

John Floyd writes: 

In fact there actually used to be. I do not think it exists any longer, a traded market in a few major econ. Indicators such as employment, CPI, and a few others I believe run by some of the banks ( DB and perhaps GS) in para mutual style betting. I don't believe the total payouts ever got very large though.

Rudolf Hauser responds: 

Unlike other economic indicators, the non-seasonally adjusted CPI figures are not subject to revisions. That is what makes them useable in legal contracts. It is true that adjustments for quality changes allow for some manipulation, but it pales in comparisons with the assumptions that are made in calculating GDP. The revision problem alone is enough to make it an undesirable instrument even if the government statisticians are perfectly honest and unbiased in their calculations.

Other traded indicators were in essence just bets on what the government statisticians would report on the next released indicator. That is different than an instrument that will have a life of many years or even many decades. A short term trader has no reason to give a damn about true fundamental values -only about what the price will be in the short term, which only depends in small part on fundamental values. That is not true of a long-term investor. As to the markets knowing how to properly price securities, if that was so you would not have so many major losses (or gains) in securities seen so often in history.



 The first hat was the blue Policeman's hat worn by my father. I thought it made him look a giant and one dared not dispute his authority. I learned from him that the hat was a universal symbol of authority and respect. And that it was made of a sturdy felt that protected the head from falling objects, blows with a stick and even gun shots. The hat came in handy whenever I got into trouble in school. Artie would go into the principal's office with his hat on, and his holster, and ask the principal if he had read me my rights before disciplining me and extorting the confession from me. The funny thing is one of those encounters got me into Harvard. Although I was very good at tennis and college boards, Harvard accepted only a handful of Jews from all of Brooklyn in those days, and I didn't have the 100 average that thousands of other National Junior champions among applying Brooklynites had. But the principal was so incensed by my father's visit that he wrote on my application that Harvard should not admit me. The man who interviewed me had been exposed to a similar blackballing and was so incensed that he insisted as a big donor that they admit me.

 In those days, indeed throughout the history of our republic until 1950, everyone wore hats in the winter. But near the beach, at Sea Breeze Park on W. 4th street, where the checker tables were, it was customary to take the hat off when the temperature was above 80. There was one person however, who a crowd always stood behind, who never took his hat off even in the summer. I learned that it was Tom Wiswell, the world go as you please checker champion. I eventually took weekly checker lessons from him for 20 years. He wrote to me once, "I wore my hat, I won many tournaments, Wylie was the first checker teacher and I will the last. It's time for me to take my hat off.". At the age of 85 he suddenly lost his memory and I never saw him again. But I will always love him, and I will never take my hat off again, except when in the presence of a lady, or if I ever patronize a lady of the night for the first time, in his honor.

 My next encounter wiith hats came at the foot of my grandfather Martin, who was genius court interpreter that spoke 50 languages at least. After working as chief accountant for Irving Berlin's music firm, he became a highly successful speculator in stocks, channeling most of his trades through Bache and Company. Like some of his descendants however, he had one major failing. He liked to trade on 20 times leverage and when the depression came and many stocks fell 20% in one Black Friday, he lost everything. He was always studying the market thereafter and loved to buy the can't misses, true blues like Western Union and Radio and Trolley and Canal which were the blue chips of his day. He told me for my Bar Mitzvah that he would buy me 10 shares of any stock I liked under 10. I asked him what was the best for the long term, something that I could hold onto for growth and peace of mind until I went to college, and that was near 10. Hat Corporation of America he told me, people will never stop wearing hats. They make them in all varieties. There are thousands of uses. And they have a monopoly on all the machines that are necessary to make them. You can wear this one for ever and sleep well with it under the bed. "But Martin," I said, "I read that there were 110 hat manufacturers in 1900 and only 7 left today. Hats have been in a decline since 1900 because people don't want to be formal any more and they don't walk to work." "Never Mind," he said, "the time to buy a stock is when it's out of favor. They have a new method of manufacturing where they substitute a resin for the felt that totally automates what was once a hand made process." Hat as it was called never spent a day above 10 after I bought it and like Union and the others eventually receded to below 1 before being delisted and declaring belly up. 

Whether it was because of the car, or the many overhead vestibules, hats have continued their decline ever since. They received what the owner of the HCA called their death blow when Kennedy became president because he never liked wearing a hat. When Cavanaugh the owner told him he had ruined the hat business, Kennedy took to always holding a hat but never wearing it.

T.K Marks comments:

 At the end of each evening my father would gingerly place his hat in its box on the top shelf of half (quarter) of my parents' closet.

Infants should be handled so delicately.

It was a Homburg if my memory serves correct.

The thing would sleep there, upside-down in its comfy confines, till the next day's dawn came around.

Then both it and he would be off to catch the Long Island Rail Road so that they would both be an hour early for work.

Rudy Hauser comments: 

Given all the talk of hats, I should perhaps add my own comments since I have been wearing hats for many years. Back when I was young I did not wear hats. But after one snowy day which I encountered with a bare head, I decided to wear a hat in the winter. I choose a fur hat made with relatively inexpensive rabbit fur. Drafts from air conditioning in trains that aggravated an allergy induced sinus headache caused me to add hats for the remainder of the year. In the moderate temperature range of spring and autumn, I wore a derby hat I purchased at a very reasonable price at the South Street Seaport for a few decades. Unlike a true derby this was made of soft rather than hard felt. In recent years I have worn a better quality Homburg. In the summer I wear a Panama hat. It has the advantage of helping keep the head a bit cooler in the sun and protecting my face from sunburn.

As to the impact a hat has, back when I was an economist for a money management firm, I would go down to Washington on occasion with a small group arranged by an economist/political analyst consultant consisting of a small number of his institutional clients to visit with government officials. One member was a distinguished lady who was the political policy advisor of a major mutual fund complex. She had once remarked (not to me directkty) how my presence with my derby added a certain dignity to our group. One of the Panama style hats I wore was not a true Panama and was rather flexible, creating its own unique sharp from long wear. My boss and colleague had indicated that it was time to have it replaced. We had both attended a meeting of the Mont Pelerin being held in Cambridge as his guest. Chuck had made the remark in the earshot of a fine classical liberal of the British peerage, who remarked that the hat had character and should be retained. I often hear compliments on my hats on the street. This even applies to my very old and worn rabbit skin fur hat, whose black dye has faded and now is a shade of black and brown with little bits of the fur missing. My attitude is that it still keeps my head very warm, and should I be discarded just because I have lost hair and what I have left is turning gray? Since my response to the latter question is in the negative, I see no reason why I should treat the hat differently.

But the hat business has clearly suffered greatly. To my knowledge there were only two very good quality hat stores left in Manhattan, and the one on Madison Avenue in the 40's closed well over a decade ago leaving only one on Fifth Avenue around 30th Street. There is (or at least there was as I am not sure if it is still in business) a hat store downtown, but the selection of quality hats is not that great, although it did have many lesser quality hats. There is a cigar store on Lexington that has high quality hats, but its selection is very limited.

Sam Marx comments: 

With the government backing them (and Peter Lynch saying good things about them ), even FNM seemed indestructible.



 From Bruno's quote from Steve Coleman:

Money is not real in the first place, it is an agreed upon concept, in fact just another idea. This particular idea has no value unless everyone agrees on its worth.

The price of money is inflation and none of us individually determines what that price will be. That is something we do in the aggregate by our spending on the total available goods and services offered for sale. Rather we use a uniformly accepted medium of exchange to determine the value of everything we buy relative to money, which for individual purchases is a constant. It is the buyer's claim on some of the stock of available goods and services and in making a purchase one determines the worth of a particular purchase relative to the value one places on all other potential purchases. So when Coleman performs, etc. he sets a price of his production relative to the value of all other goods and services and what people are willing to pay for his performances, etc. is based on how they relatively value that product, not what the price of money or its worth is.

If an artist gains much satisfaction from his or her creative expression they may well be willing to continue to do so even if society is not willing (or able) to pay for it. That is no reason for the artist to refuse payment if it is offered and he or she are otherwise willing to perform or give away/sell their creative product to those particular buyers.



 The FT (via Bloomberg) is reporting that industrial giant Siemens withdrew 500 million Euros from a French bank and put it on deposit with the ECB. The story says that they now have between 4 billion and 6 billion euros on one-week deposit at the ECB. (They were able to do this because they have a "banking license.")

Putting aside the obvious troubling implications, this story raises interesting theoretical questions regarding the conduct of monetary policy, and practical questions regarding the role of commercial banks in a dysfunctional financial system. Macroeconomics final exam question: What is the monetary effect of funds being withdrawn from commercial banks and placed on deposit with a Central Bank, while the same Central Bank simultaneously provides unlimited liquidity to the commercial banks to finance those very withdrawals?

The image of a hamster on a treadmill comes to mind. Here's the link.

Rudolf Hauser replies:

 This is an interesting question. The first question is the impact on the money supply. If Siemens were actually a bank and its deposit at the ECB represented bank funds, they would be excess reserves. The commercial bank would get a corresponding amount of reserves because of an ECB loan. If the commercial bank lends out the money or invests it, it would result in a corresponding increase in deposits held by others. In that case money would be unchanged. But if the commercial bank having raised the funds by selling assets or reducing outstanding loans decides to keep those ECB loans as excess reserves, money as measured would be reduced. But while Siemens may have a banking license, in practice I assume those of liquidity reserves of an industrial company to be used for its own purposes.

The idea behind money measurement is to view balances in the hands of those who might be influenced to make purchases of goods, services or securities with those funds, namely consumers and businesses other than banks. So while the Siemens deposit might not be counted in the traditional M1 type definition, for practical analytical purposes, it probably should be counted. In that case, if the commercial bank does not keep the reserves it gets from the ECB but relends or reinvests them, de facto if not de jure money supply would be increased. In that case the reserves Siemens keeps at the ECB would practically be the same as if it kept those balances unused at a commercial bank.

Whether the commercial bank is better or worse off depends on what it has to pay for its funds- the amount charged by the ECB versus that it effectively paid Siemens for those same funds. Whether the commercial bank is less worthy as a risk depends on its assets not whether the liability is to the ECB or to Siemens. In a way it was greater when it was to Siemens as Siemens could withdraw those funds forcing the bankt to sell assets at distressed prices whereas the ECB has no reason to do that as long as it still guarantees the commercial bank. If the commercial bank liquidated not so great assets to accommodate the withdrawal and keeps the funds from the ECB as excess reserves, it is actually safer than before.

Stefan Jovanovich comments:

 "Out" is the key word. In fact, the First Bank of the United States lent most of its money "in" - to the Treasury - during its early years. By 1796 60% of the bank's loan balances were to the Treasury. The Treasury bailed itself out by selling its 20% interest in the bank to private investors and using the proceeds to pay off some of its debt. By 1802 the bank was entirely in private hands. All the histories of the First Bank discuss how successful it was in acting as a central bank - like the Bank of England - but its actual history was very different. The bank acted mostly as a broker, not a taker of deposits; and its activities never included being a lender of last resort. When William Duer got into trouble in 1792, the bank did nothing to reassure the markets or support Duer; his collapse produced the first numbered "Panic" in U.S. history - the Panic of 1792. Hamilton, as Treasury Secretary, did intervene in the markets but he did it to reassure the European investors in Treasury debt, not to "save" the economy. When Jefferson decided to take Napoleon's offer, the First Bank was in position to "fund" the purchase. Its only involvement was to be the U.S. correspondent for Barings and Hope & Co. who were the actual underwriters.

The mechanics of the deal are representative. In 1803 Francis Barings got the French to agree upon a price of FF80 million (the equivalent of US$15 million). FF20 million (US$3.75 million) would be paid by having the U.S. Treasury assume the French government debts owed to US citizens. The balance - FF60 million (S$11.25 million) - would be paid in U.S. Treasury bonds - the first every issued by the U.S. Federal government. The bonds had a 6% coupon with interest payable half yearly installments in Amsterdam, London or Paris, with an exchange rate of 4 shillings 6 pence (22.5p) to the dollar and were to be redeemed between 1819 and 1822. Barings and Hope & Co. agreed to buy the bonds for FF52 million - a 13.3 per cent discount - with payment to be made in installments of FF6m up front and 23 monthly installments each of FF2m. A year later Napoleon - who was always desperate for money - pressed for immediate payment. The full balance was paid off by Barings and Hope & Co. in April 1804 at the cost of an additional FF1.65m commission. Most of the actual money for the loan was raised by Barings and Hope & Co. in Holland; their contemporaries said that "Francis Barings owned the Dutch market."

It is doubtful that any real comparisons can be made with either the First or the Second Bank of the United States and modern central banks. The ECB and the Fed hold gold as part of their reserves, but, unlike the U.S. Banks, they have no obligation to pay it out. Their paper is legal tender simply because they say it is, not because it is payable in Coin. And that one fact makes all the difference no matter what the speed of modern money.




Aversion to risk hinders medical innovation:

"Now, experts say, there is an often-unspoken fear of risk that threatens to kill the spirit of biomedical innovation. Whether it's avoiding the risk of spending money on possible breakthrough treatments or trying to screen out risk by extending regulatory reviews of new drugs or vaccines, society has responded to that fear in ways that may keep innovation sidelined."

An article in "Innovation News Daily" suggests that we are not taking enough risk to move away from established approaches that worked in the past to produce only more slight improvements to more entirely new ways if we wish to keep finding ways to really extent good health and life expectancy.



 One has to wonder why this whole "college is a waste of time" meme has suddenly become so prevalent. Is it because so many people have trouble with college loans? Too many writers who have nothing more to say about O's birth certificate?

Thinking one can predict the future based on what one does in the present is a persistent human foible. For sure a lot of kids go to college who don't need to. But is this truly something new? Would anyone sensible make a decision based on what they read about this subject? Unfortunately some probably will.

It remains to be seen how employers of the future will react to resumes that state "I am really smart but I didn't go to college because I read online that it was BS; but I really am smart."

One of my kids is 1/2 way through college and the other is just entering this fall– and I don't spend any time at all thinking it's a waste of time or money; it's been a path to prosperity in my family where none of the previous generation had any education past high-school (if indeed they finished that at all).

On the other hand my wife and I went to CUNY at a time where the cost was $35/semester. That's not a typo.

But I still wonder what's behind the impetus to discredit higher education?

Ken Drees writes:

I get the vibe that the intent is more of a cost justification issue. You don't send a kid to college who gets middle of the road grades and majors in marketing anymore. The job market out of college is poor and will continue to be poor. College now will set you back serious money as a percentage of household income and there will be serious debt burdens on the student and parents upon graduation. You can't put the college payments on the credit card or the home equity loan anymore.

I believe that a college bound child needs serious career planning up front, which is tough to do since kids sometimes do not know what they want to do prior to going off to the higher education arena. Like the union bubble which is feeling the backlash from the debt riddled state pockets empty reality, colleges need to step back, cut back, stop the pay raises–else enrollment is going to crater and the pie shrinks.

Victor Niederhoffer comments:

 A college education will always serve as a signaling device to employers and partners and parents that one is capable of being admitted under highly competitive circumstances and then has the fortitude to stick with the program, and finish the requirements, and the moral fiber not to have been kicked out. The signaling will always be of value and the rate of return from college should stay relatively constant.

Russ Sears comments:

Very similar qualifications could be said about homeownerships, commitment to paying a mortgage and good citizenship of being a good neighbor. When a persons limit to leverage has no bearing to what they could reasonably expect… many with nothing to loss will gamble with somebody else's money. This of course creates a bubble in some areas where there will be large oversupply of X degrees. For instance everybody will think in 2022, "what were they thinking taking forensic science and $100 grand of loans?"

The problem is when you use the argument that is it "should" be worth it to argue that everybody has a "right" to upgrade there lives. Further when you grant this "right" to any 18 year old capable of getting a high school degree you are bound to get many that should not have been given this privilege without working a few years and tasting responsibility. I still believe orginially there was a segment of responsible people that were granted sub-prime loans. These people however, proved to be the exception to the rule when everybody was given this right.The difference may be that those youth that are the sharpest will see the "bubble" within these areas and avoid them.

Could we be looking at the class of 2011? on a resume and subconsciously think what a deadbeat?

James Goldcamp writes: 

 I agree with chair's analysis of the signaling value of education, but one also wonders at what cost. I would find it hard to believe the return on invested capital has not gone down with both greater real costs and general degree (volume) inflation over time. It occurs to me that a rigorous self study program with standardized tests against which one could be compared might provide some lesser but nonetheless valuable signaling vehicle at 1/20th the cost of the current college education. Interestingly, one hire we had years ago was more known for his perfect SAT than his multiple Ivy degrees.

Thomas Miller writes:

This anti college education and anti home ownership "debate", seem to reflect a negative attitude that is growing in this country. The theme seems to be "dont even bother to go to college or strive to own your own home. it's not "worth it." just give up and settle for less." Of course college education or home ownership is not for everyone, but those that propagate these defeatist platitudes, (especially the ones that do it on internet blogs read by a large audience), are doing a great disservice to young people. "just settle for less" is not the attitude that made this country great. A generation ago, many that chose not to pursue college could get a decent job with benefits and be fairly sure of being able to retire from that job. There are very few of those jobs available now. The gap between those with a college degree and those without will continue to widen.

Russ Sears comments:

 I believe those that are "anti" college are saying take more risks start a business instead.

And for those that it will not turn out for the better, it's not good government to guarantee the loan. More responsible decisions will be made if they have to compete for access to loans like anyone else.

Ralph Vince replies:

I cannot speak for others, but I am not advocating a "give up," or defeatist attitude here. I speak with those who have children of college age frequently, as well those who ARE of college age frequently too. One of these day, I'm going to stop speaking to people who don;t take my advice (most people are incapable of taking advice, we simply have to learn things the hard way, and usually more than once)

I hear an awful lot of talk from all of these people that a college education is necessary to enter the American job market, as though it were a ticket to the dance, a means to an end as it were.

(I should point out in full disclosure I do not have a college education. I am self taught. When I decided I should learn math, I started with algebra, geometry, trig, analytic geometry, calculus, topology…..eventually stochastic differential equations, which is used (with near exclusivity) to model prices with (a nice target for a math track for someone interested in the markets, but I find these methods model prices with a degree of reality akin to Oz modeling Kansas). When I wanted to learn literature, I started with Homer, then Virgil….through to the 1950s. Of course one cannot study everything and anything, you have to make selective, intelligent decisions (which is where talking with others comes in) and someone must WANT to dispal their ignorance (and this is the key attribute, the acknowledgement of our ignorance and a desire to overcome that — whether formally educated or not).

The last time anyone ever asked me about my educational background was probably when Reagan was running against Carter.

So when I look at what people are learning, and WHY they are learning it, I DO come away in MOST cases with a "Why bother with that?" attitude.

So once we acknowledge that there are two reasons for edication:
1. To dispel our ignorance, and ultimately, to study material we are passionate about, should have such good fortune, and
2. To make ourselves, personally, a marketable product (i.e. posses a marketable "trade," be it electrician, brain surgeon, or truck driving certificate)

people can make better decisions. Unless they are fortunate enough to be a trust fund kid, they need #2. A mere college degree does NOT provide that — this is a wives tale that floats about America wherein a lot of money is being wasted in its pursuit.

#1 is a luxury — one must have the good fortune of finding what fires their jets at a young age, aside from pornography, and find a way to pursue it. If they have the resources and time, college is the way to go. If not, anyone with a spark and a modicum of resourcefulness will find a way to pursue it.

I've spoken of this before. The number of persons from the 2000 census to the 2010 census is up 20%, the number of households, nowhere near that amount. Clearly, in the not-so-distant future, either much housing must be created or much work must be done to convert the "cul-de-sac development" McMansions into 2 and three household homes. What young person is a yeoman plumber out there, or plasterer? Not many, certainly not many over the past 10 years — but it is the fastest track to acquiring #2, above, for most.

And most need #2. Not everyone needs #1, and if they have that luxury, nothing will stop them from pursuing it. But the notion of borrowing a lot of money for a ticket to a dance based on some parent's misguided model of reality (Oz!) is something the educational institutions feed on, benefit by and play to.

Jim Lackey writes:

 College is the time to meet your mate, your equal. For the fortunate men, it's  the better half you spend life with.

In your college years, there is only so far you will go…. Either to fake it, to fit in/get ahead or rebel against, to get off easy and/or explore the adventures of danger. The gist is how you act when no one you know is looking. Sin may resurface later in life. For certain people, the hypocrisy of life will rear its ugly head. If a married couple knew each other during these years of growth and uncertainty it's near impossible to argue later the lack of full disclosure prior to marriage.

A grievance can always be resolved. A slight, an imaginary hurt, the lack of full disclosure–the "I thought I knew that person". That person will hate you til the day they die.

My guess that is how/why bitter divorces ruin families… vs the much higher than average success rate of current marriages from my anecdotal evidence of family, friends and cohorts that married some one they knew from school.

Jeff Sasmor writes:

Good article on "What's a Degree Worth" :

What Are You Going to Do With That?

For the first time, researchers analyze earnings based on 171 college majors

By Beckie Supiano

Tuition is rising, the job market is weak, and everyone seems to be debating the value of a college degree. But Anthony P. Carnevale thinks these arguments are missing an important point. Mr. Carnevale, director of the Georgetown University Center on Education and the Workforce, has argued that talking about the bachelor's degree in general doesn't make a whole lot of sense, because its financial payoff is heavily affected by what that degree is in and which college it is from.

Now, new data from the U.S. Census Bureau sheds light on one big piece of Mr. Carnevale's assertion: the importance of the undergraduate major. In 2009, the American Community Survey, the tool the bureau uses to collect annual estimates of population characteristics, included a new question asking respondents with a bachelor's degree to give their undergraduate major.

After combing through the data, Mr. Carnevale says, it's clear: "It does matter what you major in."

Laurence Glazier writes:

After the signalling provided by college qualifications, the deliberate undertaking of full-time employment may signal the willingness to allow creative fruit to wither on the vine. A shibboleth of perspective. So many wait for retirement (which may not come) to allow vent to such aspirations, but the law of the farm dictates regular irrigiation throughout a lifetime.

To this end there would be much benefit to all if full-time work became less the norm. The end of government subsidy of unsound housing loans would reduce the pressure on people to suppress their finest qualities.

The Harry Potter books emerged not in spite of the writer's modest circumstances, but aided by them.

David Hillman writes:

Very astute observations.

A laborer can be trained to dig a ditch to a certain depth. A monkey can be trained to dance to the organ grinder's tune. Even a plant can be 'trained' to grow in the desired fashion. But few of the former are, nor neither of the latter can be, trained to *think* and creatively problem solve.

One might speculate that emphasizing skills, specialization and technology in educational curricula and employment qualifications may be the culprits.

While a college education being increasingly available only to the affluent because of financial considerations is, indeed, an issue, perhaps another of our chief concerns should be that we are creating a nation of people who are trained, rather than educated.

Kim Zussman writes:

The "education ruins thinking" argument has value, but simply looking at dollars a college degree pays more than just HS diploma. BLS stats below shows increasing income with formal education: about $400/week more for college grads - which of course does not include harder to value assets like volume of learning, tutored critical thinking, facility of life-long learning, status, access to better mates, good memories, signalling, etc.

One would need about 10 years of the additional (median) college grad salary to pay for 4-year private degree (ignoring taxes). Would the degree be worth it if it took 20 years to pay off?

Unemployment rate     Education attained        Median weekly earnings
in 2010 (Percent)                     in 2010 (Dollars)

1.9%            Doctoral degree            $1,550
2.4            Professional degree         1,610
4.0            Master's degree             1,272
5.4            Bachelor's degree         1,038
7.0            Associate degree           767
9.2            Some college, no degree           712
10.3            High-school graduate           626
14.9            Less than a high school diploma       444

8.2                     All Workers                        782

Note: Data are 2010 annual averages for persons age 25 and over.

Earnings are for full-time wage and salary workers.

Source: Bureau of Labor Statistics, Current Population Survey

Rudolf Hauser writes:

The question of a rate of return on a college education is not that easy to measure. For one, it will vary greatly on the college attended both by cost and quality of education. It would also vary greatly by the course of study and how much a person actually learned as opposed to just getting by and having fun. Even taking account of these variables, it is not an easy question to answer. The math is a simple discounted present value calculation, but the inputs are something else. For one, the attributes of those attending college and those not attending will differ. Those with an interest in learning and working hard, more personal discipline and more ambitious are more likely to be attending college than those who are not. Those people are more likely to earn more than the group that does not go to college even if they had not gone to college. So while the value of the education is the difference in what they earn in the future compared to what they could have earned had they not gone to college, one cannot just assume the latter is what those without a college education currently earn. In addition what is actually earned will not be a single average or medium figure but will have a wide distribution around it based on good or bad fortune, who you know, and countless factors beyond one's control. Costs while being educated in addition to direct costs of tuition ,books include difference in living costs relative to what they would be had one not gone to college and opportunity costs of lost potential earnings from working rather than going to school. Then there is the question of how much of the difference is due to signaling as opposed to the value of what was learned and contacts made during school. That is real but could change if the marketplace found alternatives to such signaling. If lower education had more strict criteria for graduation and grades the signaling value of a college education might lessen as employers had more confidence in that and prior work experience. The cost of loans may also vary, so that how the education is financed will matter a great deal.

In addition to monetary economic measurement, there are other benefits that might be gained. Meeting a spouse has been mentioned by list members as one such benefit. Learning about many areas and learning how to learn, may enrich one's life as a person, contributing to the value one has to society and family and to one's personal richness of life and happiness. But if prospects do not turn out as one hoped, it can also lead to unhappiness. The question then is how much one wishes to pay for these other potential benefits or negatives (i.e., the probability of disappointment). Some areas of study such as general liberal arts, might be expected to have a higher risk of low or negative economic returns than more specialized fields, but specialization runs risks if those skills become of less use to society.

On a personal level, I do not believe it make sense to send a kid to college unless they are actually going to work hard to learn. If not, it might be best for them to work for a time and see how difficult life can be without a college education. Often they may then go to college and actually make the most of it rather than going at a younger age and goofing off.

I might also add that education need not be in the classroom. The time spent learning on one's own is also education. One need not attend college to learn. It might not have much signaling value but it certainly helps in many areas. The cost is the value of the time spent either in terms of the value of one's leisure or economic opportunity cost.
The ability to learn might be enhanced by a formal education. One of the things I would advise a person attending college to learn is how different disciplines think. The way a lawyer thinks about problems, the way a scientist does, the way a creative writer thinks , the way an economist thinks differ and are specialized in some ways that takes a time to learn. The first course in microeconomics is difficult for many students, for example. The more ways of thinking one understands, the broader ones ways of understanding the world, understanding other people and in solving problems. Some of the great innovations come from taking of advantages in knowing something about other areas of learning that provide insights into the problems in your area of interest.

David Hillman writes:

Ok, then, I meant the focus to be on the point of training versus education. If it requires more updated or timeless references than those to the 20th Century, so be it, and I beg pardon.

(1) Backhoe operators are *trained* to operate them, but there are many instances of heavy equipment being stuck because the operator failed to *think* about the application.

(2) Musicians can be *trained* to play an instrument, but without a proper foundation, i.e., *education* in music theory, history, etc., while the music may be technically correct, it is often dry and mechanical, uninspired and with an 'off-the-shelf' feel.

(3) An air traffic controller can be *trained* to direct aircraft, but when an emergency arises, he/she must *think* of how to resolve it, not unlike,

(4) A 9-1-1 operator being *trained* to follow protocol, but when that protocol does not apply, hopefully, that individual may be capable of *thinking* of a way to prevent loss of life.

And, what of entrepreneurs like you and me? How can one be *trained* to brainstorm an idea out of thin air, then take it from the drawing board to reality? But, one can certainly be educated broadly enough to think creatively, make connections, take calculated risks and solve problems. Even in strategic planning, one can follow a plan, but the successful execution of it requires feedback from the real world and adjustment, which requires the ability to think, not just the ability to follow an SOP manual.

Clearly, a liberal arts education is not for everyone and the rise of tech schools and alternative forms of education and training should be applauded. For those who require training, the more well-trained they are, the better off will be all of us who depend upon their services. But, one should not necessarily depend upon them to do anything other than the job for which they've been trained, nor to be able to *think* creatively when faced with a situation or event for which they have not been trained. Trained mechanics may depend upon a diagnostic computer and trained line cooks upon a recipe, whereas a great mechanic might 'feel' a rough idle and a great chef might improvise a dish. The latter two have the ability to think and create, some of which is natural, but a good deal of which may also come from an education.

Nor is a college education always the right thing for someone at any given time. There are plenty of examples of individuals who failed to perform well in college as a recent high school grad, but did stellar work 'going back to school', my own being one of them.

Some eschew those who are 'too educated' as being 'troublesome' precisely because they can think. However, if I knew nothing of one's natural intelligence, and had to choose, I'd probably go with the educated over the trained.

That said, neither education nor training has much to do with 'smarts.' For that, you either are, or you are not. Some of the dumbest guys I've known have had PhD's, but so have some of the smartest. Likewise, some of the least educated have been the smartest and most capable, but there have been many that are dumb as a box of rocks.

As someone once told me, "it's better to healthy and rich, than to be sick and poor." I'm kinda thinking it might also be better in the long run to be smart and educated, than to be dumb and trained.

Stefan Jovanovich writes:

David is right. If there is any fault to his argument, it would lie in his optimism about the capacities of higher education. But, then, my cynicism about schooling comes from having literally grown up in the business and from being a 2nd generation academic bum. (There are not many fathers and sons who share the distinction of having gone to graduate school in English literature solely because they had no better idea of what to do and the GI Bill would pay for it.) School, like most things, is what you make of it. My difficulty is that "education" is now what "national defense" was in the 50s and beyond; an open-ended appeal for more money that is always justified in the name of some higher good that is incapable of being questioned.

Jeff Rollert writes:

I concur with Ralph, and if you believe in the concept of singularity, then a repetitive answer method is most likely to be replaced by a machine.

For me, I believe that standard problems will have standard solutions already applied to them before I'm even aware of the problem. So if one were to find employees who where good at sensing/finding the "unknown-unknowns" then they would have to have a non-standardized approach - in other words a non-academic approach.

Lastly, in a logic sense, how can something be a "value" but still be "expensive"? Aren't these mutually exclusive?

Tim Melvin writes: 

We have dealt with both sides of the college issue here in the past few years. My daughter on her quest to be the world only libertarian teacher had no choice. To teach you must have three degrees and credentials. She has on semester left and has pulled a 4.0 throughout. She may have learned some basic teaching techniques she did not know but the general education element was lost on one who reads like her. When I look at the top 10 majors in US colleges I have a hard time seeing what we are producing except middle managers. Teaching and nursing are the only to that offer a truce vocational choice. I would love to have had four years to study literature, but I question the employment value of the degree itself. The top tier schools may be different but is seems to me that our universities are teaching fixed values and information, not how to think. How to think has to be either installed by your parents or learned on your own. I cannot see where this can possibly be worth the cost today. Perhaps Colonel Depew can add a though on this but I think teaching the young to read the Great Books Curriculum would go farther than the current middle management factory that are most schools today.

I never went to college. Truth be told I dropped out of high school at the enthusiastic recommendation of the local authorities. What education I have I obtained from between two covers in the style of Louis L'Amour– I suggest that book as a manual on learning to think by the way. I read constantly when I was a kid. My mother was wise enough to let us read anything we wanted regardless of content. If there was something we didn't understand she made us find the source material to explain it..and this was back in the day when Encyclopedia Britannica was still the source of knowledge not the internet. I have continued to read ravenously all my life. I read anything and everything. I have found that even fiction often contains lessons for life and can be a source of knowledge. As an example, I read two or three of Robert Parker's excellent Spenser series. Great detective books, but read a few and you will learn two or three good quick dinner recipes, several literary quotes worthy of further research and how to win a fight. Many of us on the list have followed the chair's lead and studied the great lessons of Monte Walsh, Don Quixote and Patrick O' Brian. Randy Wayne Whites Doc Ford novels often contain insights into the biology of floridian waterways and the everglades. Knowledge is everywhere if you know how to think. I fear today's world of standardized testing and assembly line universities may not be teaching that valuable skill.

Think about this. The two greatest innovators and business men of the past thirty years both dropped out of college. Some schools may be worth the price tag. I suspect most are not.

My son on the other eschewed school in favor of making a few bucks. He discovered he had a real talent for and love of business. Within six months or so of going to work at Boater's Worlds he was managing one of the top producing stores in the company…at the age of 20. We talked about school and he told me flat out "I can't see the value of spending the money. I have two MBAs working for me now because they can't find jobs that pay enough, and my part time staff includes a phd in English." He moved on when the Ritz family folded the chain. His former district manager brought him over to his new company and he is moving up the rank there. He just undersands the art of working hard and making money. He may need a few accounting classes some day but four years at some state university would have been a waste of time and money.

We need more thinkers who have a passion for knowledge and more curious explorers and fewer managers and chair holders. That's on us as parents as much as the schoools. If our children go onto college make sure they know how to think and the univerisity allows them to do so.

Stefan Jovanovich writes:

Dropping out can be useful even for scholars. Peter Green (the #1 biographer of Alexander the Great) did it.

So did Eddy's favorite professor who didn't teach art history.

Eddy's most treasured legacy from 4 years at Cal was giving Professor Jacobson the recording of her version of the Super Mario tune. He had heard her play it on the UC Carillon and wanted it for the ring tone on his phone.

Dan Grossman writes: 

Found this interesting blog post by Steve Sailer proving the value of higher education:

 A column on a new Gallup Poll asking "Just your best guess, what percentage of Americans today are gay or lesbian?"

"The mean guess was a ridiculous 24.6%. Only 4% said less than 5%, which is probably the best guess.

Polling companies seldom ask questions on which people can make obvious fools of themselves, since those can raise questions about the value of opinion polls.

Looking at the demographic crosstabs, it's evident that low intelligence people were most likely to wildly overestimate the percentage of homosexuals: 53% of people making under $30,000 annually said that at least 25% of the population was gay, and 47% of those with no more than a high school education. 43% of Democrats versus 24% of Republicans got the question wildly wrong.

In general, people are terrible at estimating or remembering demographic statistics. A 2001 Gallup survey, right after the release of 2000 Census results, found that the average American estimated that 33% of the population was black and 29% were Hispanic. That adds up to 62%, but who's counting? Not most people.

In that 2001 survey, nonwhites estimated that 40% of the population was black and 35% was Hispanic (adding up to 75%). In contrast, people claiming postgraduate degrees estimated that 25% were black and 24% Hispanic (only about double the Census numbers), which proves the value of advanced education."



The term savings can be a bit confusing because it applies to both a stock and a flow concept. On the individual level, savings on a balance sheet concept is the amount of income one has set aside for possible future consumption. It's level will change with price changes of assets held. Stock savings can either be thought of as changes in the balance sheet value of savings (marked to market) or as the portion of earnings from production and profits not consumed but set aside for future consumption. This includes investments made directly in addition to financial assets. The term stock used in this context is not to be confused with equities. It refers to the balance sheet value of assets, that is the value of outstanding amounts.

From a flow standpoint, savings refers to valued added (amounts earned) not consumed. For business this value added is wages, interest payments and earnings based on economic depreciation not an accounting definition of depreciation. Economic depreciation refers to the amount of an invested asset that in effect is consumed in the production process and as such is a cost factor. Earnings the person as an individual it includes the amounts earned on capital by business paid out in interest and dividends. For corporations the amounts not paid out to providers of capital is called retained earnings. These savings have to be invested. Investment can be made by individuals by purchases of homes and durable goods, the value of which is consumed over the life of the items in question. Consumption includes the economic depreciation on those items. The amounts invested in financial assets represent purchasing power passed on to other entities. They can be used for consumption as is the case with consumer credit. For the economy as a whole this reduces savings as some people are dissaving. Part allows other consumers to make investments in residential housing and durable goods. Part goes to finance government, which uses proceeds for consumption, transfers that mainly result in consumption and some actual investment in such things as military weapons and highways. We treat spending on human capital (education and training) as consumption, although one can argue that this is really investment in large part. It is in the investment in plant and equipment, R&D, education that we increase the future productive power of our work effort. That is what we need to grow on a per capita basis and also on a total basis and new workers have to be supported by capital investment if overall productivity is not to be dragged down. Changes in asset values are not savings in a macro-stock sense. They add nothing to real savings, which are physical assets not financial values.

Changes in the value of equities represent changes in the discount rate of expected future cash flows to stockholders and changes in expected future cash flows. Changes in expected cash flows in part represent differences in actual retained earnings from anticipated amounts, unanticipated issuance and retirement of capital and the required rate of return (cost of capital) not paid out in dividends or stock repurchase, where we are taking in aggregate not per share terms. (Transaction prices in stock issuance or repurchase that differ from economic book value will influence per share figures.) Changes in fixed income securities represent changes in interest rates. Both interest rates and equity discount rates reflect the real non-risk rate of interest, risk premiums, inflation premiums and time preference premiums. All of these can change over time. Since these are determined on the margin, changes in the marginal investor can cause such changes.

Productive investment is made to facilitate the production of other capital assets and goods for final consumption. As capital assets are ultimately designed to produce consumer goods, one could envision a case in which present and future consumption is less than productive capacity and additional capital investment is not economical. Under such circumstances, cost of capital would be driven down to negligible levels, but it cannot go below zero in nominal terms. What often happens is that all sorts of crazy speculative investments may occur that will go down in failure. A key question is what risk premiums will remain and to the extent they deter productive investment. If investment demand is less than the savings not all labor resources will be able to be utilized until lower national income levels again equate savings and investment. Fortunately, consumer demands in most societies are such that such a problem does not represent itself except over more limited time periods. Labor may be idle for other reasons such when the productive value of the worker is below that of some prevailing minimum wage limit. The latter can be set by law or in the absence of legal restrictions by the amounts below which the workers would become ill or starve. That was never much of a problem in more primitive economics but is a greater possibility in current modern society.



 What is the geophysics of thinking that more natural disasters are more likely now that the earth quake has occurred?

Kim Zussman shares:

Read this article.

Rudolf Hauser writes:

Another factor to consider is the shifting of the magnetic poles. This is reportedly associated with violent swings in weather and more earthquakes and volcanic explosions. Apparently there has been a marked acceleration in the rate of shifting in the past few years. Some question whether this might be the cause of recent weather extremes and geological activity. Since such shifts occur only every half million years or so we obviously have little idea of how they progress. If this is a real reason for concern it is an issue far more immediate and important that the global warming fears.

Pitt T. Maner III writes: 

There have been suggestions of a connection with renewed (regional?) vulcanism.

The last eruption of Mt. Fuji , for instance, occurred 49 days after the previous largest earthquake in Japanese history.

Another Japanese volcano has resumed activity but cause/effect from the March 11 quake may be tenuous.

The volcano, Shinmoedake, is famous for standing in as the villain's secret rocket base in the 1967 James Bond film, "You Only Live Twice". 

Bill Rafter comments: 

Earthquakes and volcanism are simply different manifestations of the goings on of plate tectonics.

Read this article from New Sceintist: "The megaquake connection: Are huge earthquakes linked?".



I'd like to share this thought provoking article, "It's Time to Make Insider Trading Fully Legal":

The newspapers in recent months have been full of bombshell stories about insider trading on Wall Street. According to an account in the Wall Street Journal, "the investigations, if they bear fruit, have the potential to expose a culture of pervasive insider trading in US financial markets, including new ways nonpublic information is passed to traders through experts tied to specific industries or companies." The basic argument made against what its detractors call "insider trading" is that the ability to act on nonpublic information creates an unlevel playing field that decreases faith in the stock markets themselves. If access to information is made equal, small investors will allegedly feel more comfortable placing their savings in the markets.

One problem with the above theorizing is that what most deem "insider trading" has never been defined by lawmakers or the courts. Worse, not considered enough is how both the economy and investors are harmed when necessary information is obscured, thereby perpetuating unrealistic share valuations.

Ultimately, it should be said that to ban insider trading is to block use of the very information necessary for markets to function properly. The better solution is to cease prosecution of what is already vague, and in the process reward market sleuths whose efforts will ensure properly priced shares, and in the case of poorly run firms, no further waste of capital.

Read the full article here

Dylan Distasio replies: 

I would assume the author of this article is attempting to ignite a controversy, but I will go a head and take the bait… He writes:

One problem with the above theorizing is that what most deem "insider trading" has never been defined by lawmakers or the courts. Worse, not considered enough is how both the economy and investors are harmed when necessary information is obscured, thereby perpetuating unrealistic share valuations.

To this I would reply: "When I see a bird that walks like a duck and swims like a duck and quacks like a duck, I call that bird a duck." or perhaps in the vein of Stewart "I know it when I see it."

Here's an example of what I'm referring to, although in this case, it's a goose not a duck:

Insider trading is an economic plus. Arguably the greatest reason that governments should encourage insider trading has to do with economic growth. To put it very simply, we live in a world of limited capital, and insider trading ensures that share prices will reach fully informed levels as quickly as possible.

To encourage the opposite, as in making insider trading a crime, is to delay the happy process whereby companies achieve a fair price. To the extent that market altering information is kept from reaching the marketplace, companies doing what investors want will necessarily not receive as much capital as they otherwise might. Poorly run companies will receive more capital than they can efficiently use.

This is a laughable justification…Insider trading doesn't help share prices to "reach fully informed levels as quickly as possible." It helps the few with privileged information line their pockets in an unethical manner. The fact that it is insider information by definition dictates that it is not being disclosed publicly and thus does little to allow share prices to quickly reach a new equilibrium. A public news release that a company didn't get expected FDA approval for a new drug, as in the recent case of MNKD helps the stock reach a new equilibrium rapidly.

Hypothetical insiders quietly dumping their shares and trying to cover their tracks as best as possible ahead of a news release serves no one other than themselves (This comment is not in reference to MNKD).

I thought I had seen everything until I read this article, I apologize in advance for feeding the troll.

Rudolf Hauser writes:

An officer or director of a company has a fiduciary duty to represent the interests of the company's shareholders. As such they should not be allowed to use material information about their companies that has not yet been reported to the public and shareholders for their personal advantage in changing their position ahead of shareholders in response to either good or adverse developments. Such insider trading should be subject to breach of fiduciary duty legal actions to reclaim an any advantage plus punitive damages. Given that a company with many small shareholders might not find it advantageous on an individual basis to sue the SEC should have the power to sue on their behalf. Those involved in arranging deals, etc. likewise have a fiduciary duty to the companies involved as their clients not to act on such information. This is what the law would look like if I were writing it.

When it comes to others who are not in a position of fiduciary duty, I too would not make such use of non-public information illegal. If the news is positive it provides the seller with a better price than he or she would otherwise have–which helps rather than hurts them. Likewise, with regard to such selling on non-public information, the investor intent on buying receives a lower price–which again is to his or her benefit, not detriment. The only ones who might be hurt are those who might decide to act based on the new price before the full impacts of the developments in question are reflected in the stock price. I would guess that the former are more likely than the latter instances. The wider the scope of what is called insider information, the more nebulous the concept and the more it discourages analysis. For example, if one has many industry contacts who can provide a feel for industry trends without any providing what would be considered information in itself, at what point does the interpretation of the law become so broad that having such a information network is itself considered inside information? The regulators have a tendency to try to keep expanding the reach of the rules they impose.

But of course, I am not the one writing the laws. So whether good or bad, the law is what it is and should be followed until such time as it is changed by proper legal process.



 "The stock market is the type of beauty contest [apparently common in England at the time] in which you choose the girl that most others will find most beautiful, not the girl you find most beautiful." –Keynes

Not sure about Maynard's proclivities, but those afflicted with affinity for the opposite sex may find such judgements most difficult.

Rudolf Hauser writes:

This points to a key difference between long-term investing using fundamental analysis and trading. In essence the trader/speculator skill's lies in seeing how others will view events and makes his bets accordingly. This is the case even if someone with an intermediate term horizon relies on fundamentals in their analysis. In contrast the long-term investor (horizon measured in next few years) implicitly trusts not in his or her ability to anticipate how others will react but assumes superior knowledge in anticipating the future fundamentals of a company will enfold and considers if the security is likely to provide a superior return over that longer horizon given how the market usually perceives such a future state on the assumption that the usual influences on a stock short-term will at some point reflect the future values perceived by such an investor. To the extent that the market is driven by the former, opportunities can occur. For example, in a market downturn long-term opportunities may arise but the market could continue falling because of a near-term focus of most market participants. Accumulating a position over time would allow one to avoid buying the possibility of buying at even better future prices while avoiding the possibility of not taking advantage of current prices entirely should the market have reached bottom. Naturally a long-term investor has to be prepared to hold (avoid leveraging) his or her position and for periods of low or negative returns. Naturally that same fundamental investor will improve his or her performance to the extent that he or she can predict how traders will react and impact near to intermediate term price movements to time their own transactions.



The distribution of income is bounded on the low end by zero, but unbounded on the high end. This resembles the distribution of stock returns, and is better described by log-normal distribution.

Presumably humans evolved to anticipate something like normal distributions bounded by zero and bounded on the high end; height or weight for example. If heights were distributed like income, most of the time you would encounter normal-looking people, but occasional 20 footers. Of course tribes of average folk would to try hard to befriend the big guys.

Phil McDonnell writes:

I think there is a statistical quirk. Namely the quintiles are reconstructed every year with new individual members. Thus the 2009 top quintile contains different people than the 2010 top quintile. To understand how this creates a bias we need to look at how new people enter and leave the top quintile and what that process does to the 'average' of the quintile. To enter the top quintile the individual can only come from below. Thus he lowers the average of the quintile below and possibly raises the one above. No one can leave the top quintile by rising out of it. Thus there is an upward bias in the sense that they are retained no matter how high they go. On the other hand they are eliminated if they fall in income.

In the bottom quintile the reverse is true You cannot leave by going to zero, you are still in the bottom quintile. But if you make too much you will move up to the next quintile and thus reduce the average in the bottom quintile.

The middle three quintiles have less bias in this sense because individuals who leave can either go up or down to the next quintile resulting in more of a wash. In the same fashion new entrants to a given quintile can come either from above or below again resulting in more a a net wash effect.

The comparison of the top quintile to the bottom inevitably results in a biased and distorted comparison because of this effect. It would be better if they compared the second from the top and second from the bottom quintiles to reduce the bias. Reducing the bias is probably not the goal of those who calculate such statistics.

Rudy Hauser comments:

This is a different question that relates to what the statistics represent and will be used for. What Phil writes is certainly correct. What the quintiles show is the income distribution at any one point in time. It does not tell you anything about lifetime income or the ability to better one's self over time, that is upward mobility in the quintiles, or the fact that some of the well off become less so over time. For that you would need other measures. The movements between the groups will create the biases described. But to say that the bottom fifth only earn so much over time x and the top fifth earn so much need not have an upward bias to what these statistics actually measure as such movement happens all the time to varying degrees over time and by country. The top fifth are still the best off and the bottom fifth the worst off. Were they stand an any one time is what it is and that is all this statistical approach shows. There is no need to correct this bias but one does have to develop other measures to answer the sort of questions that seem to concern those who point to bias. There is no statistical reason why the growth rates have to favor the top group. That tendency to the extent it exists is due to political economic factors, cultural factors, social factors, etc.




 This article on income mobility will put in perspective the malaise affecting our economy. It's the 40 % from each of the lower 2 quintiles who moves to the top 2 quintile that has made us beautiful and created the jobs and responded to the past incentives, and dolorously "prefers not to" create jobs and value now.

Australian Nick White comments: 

This is a great country. Being back here the last few weeks just reinforces to me how lucky America is– even if you're in a perceived funk right now. This is the country where anything can get done…that's not the case in any other western nation. You have freedoms that you take for granted every day (even post legislative amendments that may have eroded them more than trivially). You have every type of geography and lifestyle. You have 36 different choices of one brand of orange juice fer crissakes! (which you can drink while watching one of thousands of tv channels).

I don't know much, but I know that if America continues to focus on the the things that got them to here– without trying to reinvent the wheel– you will all be just fine. The only danger I see is increasing reliance on form rather than substance– but this is a malaise of the world in general, not just the US. 

Rudolf Hauser writes:

This data on income mobility does not give us a complete picture. Large gains or losses from realized capital gains/losses, special bonuses payments, decisions to take long breaks from work, etc. can all influence results for any one year. One would also expect income from most careers to advance with experience and age. What would be interesting to see but probably very difficult data to obtain would be an average of five years of data say at age 50 with those relative income positions of those households income compared with that in the same period in the lives of their parents. I suspect that there would be a good deal of upward income mobility demonstrated by such an analysis, but it would nonetheless be most interesting to have that evidence.

Russ Sears writes:

Isn't this the premise of the sitcom "The Big Bang Theory"?

A group of nerdy physicists meet their neighbor, a beautiful blond girl waiting tables at the cheesecake shop… but even she is hoping to become an actress.

But you miss the point– from the Will Smiths to the nerds in physics to the marathon runners to the Saints QB, they are all incredibly talented, even the WS geeks, not just the WS geeks.

And as someone seen how letting a small business owners put the money back into a sport can revitalize: it can change how everybody developed talent. In 1992 The US marathon trials were a joke, but these guys changed it.

The world will never know the talents that were not developed for lack of a few dollars, but I have seen first hand how thin the pie can be sliced at the top, and how a few centimeters thicker can change everything. 

Jordan Neuman comments:

It is interesting that you mention the varieties of orange juice. I just read The Paradox of Choice which argues that our lives would be better if we did not have so many choices. The varieties of grocery items was the author's starting point.

It would not matter unless such ideas had support in this Administration. The references to health insurance in the book are illustrative. And I found the interview with the author in the afterword absolutely chilling. This professor was sure he and his "expert" friends knew better.

Larry Williams writes:

Living in the US Virgin Islands means giving up many choices in foods, clothes, cars, etc. I have found that a wonderful thing; it causes one to focus on what is really desired (that can be ordered from off island). It makes for a simpler life style and turns ones attention from man made consumables to the ocean, the trade winds, local markets and such.

Sam Marx comments:

I remember one of the escaped English spies then living in Moscow, when asked what he missed most about England, he replied Lea & Perrins Steak Sauce.



This article about how the current behavior of the global financial system cannot be explained by "normal" models of economics or finance is an example of fallacy of composition in that it assumes what would be true for an individual is true for the economy as a whole. In this case it is not. GDP is a measure of what an economy produces in the course of a year. It is defined on a gross basis in that it does not account for depreciation of the existing asset base, but one can also look at it on a net of depreciation basis. Aggregate demand can exceed production to the extent that we import more than we export. But that is not what this author of the article was talking about. Each entity that produces either keeps what it produces as inventory or sells it. The resulting purchasing power can now be distributed to pay its employees, bondholders and shareholders or invested back in the entity in the form of investments in plant, equipment, etc. Those who were paid can then in turn can either consume, invest in their own entities, hoard currency, purchase existing or new physical assets or save using financial markets . Amounts saved as either debt or equity then provide the means for other entities to consume, purchase existing assets, make investments. It also can provide governments the financial means to engage in purchases or transfer payments. The recipients of transfer payments can then, consume, etc. Purchase of existing assets just exchanges assets some hold for purchasing power with which to purchase consumer goods, etc. or save via financial instruments (including equity). It switches ownership of goods such as housing but does not increase aggregate demand that allows for increased consumption and investment beyond what is produced (GDP) plus net imports. Looked at from a different perspective, the sale and purchase of an existing asset such as a house does not create any jobs beyond that of the middle men (realtors, etc.) whose contribution is included as part of GDP.

This is not to say that the distribution of ability to buy in excess of amounts earned is without any macro implications. In an economy with specialization we have to be able to produce something that someone else is willing to buy. Investments are made in order to be able to increase future production of consumer goods. Those investments include physical plant and equipment but also R&D, education and training (development of human capital), etc. For the most part in our modern economy the ability to put sheer labor to use it must be combined with capital that someone was willing and able to provide. When people are not able to find something to which they can apply their productive talents that someone else will buy they do not produce or consume except to the extent that someone or some entity is willing to help them out. When producers miscalculate where the future demand will be at prices that exceed costs of production (including necessary return on capital) certain physical capital and human capital will become wasted and those who invested in them will sustain losses. It also means that labor has to be redeployed. That may mean accepting lower payments as one's acquired skills are no longer valued or necessitate more human capital investment to be able to qualify for available jobs. Note that the return on human capital is dependent on the amount of time left in a working career and the premium over what their labor is worth without having that human capital. This makes it more difficult to redeploy older workers. When consumers go on a spending spree based on credit provided by savers they create more demand in industries that produce what they wish to consume. When they have to cut back capital and labor in those sectors will face lower demand and have to be reduced. When investors become more risk adverse because of bad experiences, etc. what happens is that some sectors will face higher risk premiums which may exceed the rates of return they can expect to earn or not be able to obtain capital at all. Those risk adverse investors will just drive the interest rate on low risk assets to very low levels. That can result in an economy in which government transfer payments increase resulting in higher taxes which will work to discourage even more investment and provide a place for risk adverse investors to place they savings in the form of more government debt issuance. That translates into a lower level of GDP. For an economy to maximize its prosperity one needs efficient capital markets that can move capital to where it is needed most, entrepreneurs and managers who correctly anticipate where profitable demand will be, the development of better technology and methods of production and distribution through research, trial and error, etc. and the willingness to accept innovation, flexibility in moving the means of production to where it can be used most efficiently, trust developed through ethics and culture reinforced by adequate legal systems and policing of crime, savers willing to take an appropriate degree of risk (that is prudent risk to allow innovation and new enterprise but without going into pure speculation), etc. It also requires providing the needed amount of transaction and near transaction means (i.e., money and near money) without causing a change in the overall price level (i.e., inflation or deflation).

Tyler McClellan comments:

What a magisterial post, such deep but sensible knowledge.

I think you might have gone slightly further however and elaborated how much of our economic activity does in point of fact depend on expectations of the future, the Keynesian convention of certainty, when none such exists.

I think your lay explanation of how expectations of the future affect both the demand to save and the demand to invest is very good. Hence the complex interest rate outcome. Much better than my own attempts at driving at this fundamental problem.



sheep giving birthEvery 6 months the BLS performs an exercise in hindsight. It looks over its surveys from the prior half-year and adjusts its extrapolation of the total number of employed. Then it goes back to making birth-death adjustments based on its estimate of how many people were employed by new businesses and how many were laid off by businesses that had failed in the prior month. In January of this year the BLS removed nearly half a million jobs that it had added in 2nd half of 2009. It decided that its cumulative birth-death adjustments for August through December overestimated actual employment during the period by 427,000. Starting in February the BLS began adding jobs again; its birth-death adjustments for the first half-year of 2010 totaled 728,000. June's gain in private jobs - 83,000 - depended on one of those monthly adjustments; without it, the gain in June would have been a loss of 64,000 jobs. The unemployment rate for June improved through a similar sleight of hand. In May the BLS survey showed 14,973,000 Unemployed out of a total Labor Force of 154,393.000 Labor Force; that produced the UE Rate of 9.7% For June the numbers were 14,623,000 Unemployed out of a total Labor Force of 153,741,000 (UE Rate = 9.5%). But for the magical disappearance of roughly 650,000 people (where, one wonders, did they go?) the Unemployment Rate would have remained the same as it was in May.

Rudy Hauser comments:

The payroll series after those adjustments are made is a very accurate survey as it is based on payroll reports which all employers, even if you only employ one person, have to file at least quarterly. That full information is not available on a timely basis but is reflected when the numbers are revised to incorporate that information. Those reports are used to determine what employers have to pay for unemployment insurance and as such it is illegal not to file them as required. The immediate numbers are based on voluntary reporting to the BLS by firms. New firms are not likely to be included and it is not always known why a firm stops reporting, hence the need for the initial birth/death of firm adjustment.

The household survey on which the unemployment rate is based is just that- a survey of households. A decline in the labor force could just reflect the usual variation for any survey, even a large one such as the household survey or it could reflect an actual decline of people actively looking for work or some combination of the two.



Richard RollThe annual meeting of the IAFE in New York on 2010/06/18 featured UCLA's Prof. Richard Roll , who was a colleague of Chair at the University of Chicago many years ago. He started out by warning the audience that his explanation is different from everybody else's, cannot really be considered proven, and may be hard to accept. Nevertheless he urged the audience to keep an open mind, if only because if this explanation is correct then the current remedies may actually be harmful.

First he dismissed the popular idea that inappropriately low interest rates caused a bubble in real estate prices, which then crashed. Although nominal interest rates were low, the more relevant real interest rates (as shown by the yield on TIPS) were actually rising during the period 2004 to 2007.

Also, defaults in the debt or derivatives markets cannot have been at the root of the crisis, contrary to common opinion. The net amount of debt in the economy is zero (someone owns each debt and someone else owes it) as is the net amount of derivatives (for every long there is a short). Default on debt simply involves a redistribution of wealth, not a destruction of wealth. For example if a borrower defaults on a $300,000 mortgage, and the house is now worth 200,000, the result is essentially as if the bank had given a $100,000 "gift" to the borrower. One is better off and the other is worse off, but the net national wealth is unchanged. These are just redistributions with no (or little) system wide effect.

So what happened? Roll believes that the root of the crisis was a reduction in wealth, and specifically a drop in the value of human capital. Recall that human capital is the present value of all future labor income streams for all persons. It is very difficult to measure because it requires knowledge (or estimates) of the future; but it must be a very large number, perhaps the largest component of national wealth. Roll believes that the value of human capital is correlated with the value of real estate and, to a lesser extent to the value of the stock market. The correlation can be seen, for example, in the fact that people who expect to have a high income in the future live in expensive houses; the value of someone's house is to some extent an estimate of that person's future income.

According to Roll a sharp drop in the value of human capital took place in 2007-2008. This immediately, or perhaps with a short lag, caused a drop in the value of real estate and (to a lesser extent) a drop in stocks (because if the people's future income is expected to be lower, the revenues of corporations will also be lower). We cannot measure the drop in human capital directly, but the drop in real estate and stocks is a clue that (according to Roll) the value of human capital dropped.

The only remaining question is why the value of human capital fell. Roll's controversial explanation is that the market correctly anticipated that government intervention would greatly increase in the years ahead, and that his would cause a permanent lowering of the rate of growth of labor income. Economists have found that past a certain point, a decrease in the share of GDP generated in the private sector leads to lower growth; conversely "liberalization" or an increase in the private share typically leads to higher growth.

This explanation was contested by a member of the audience, who said he had worked in the mortgage securities field and who felt that enormous problems developed in the mortgage market which the Professor was leaving out and which were essential to understaning the crisis.

Another member of the audience pointed out that the professor's explanation is similar to the theory of Amity Shlaes as to why the Great Depression lasted a long time.

Another critique was made by derivatives textbook author John Hull, who felt that the human capital explanation was on the right track, but disagreed about the cause. He felt that the markets began to realize that the US was increasingly unable to compete with China and could not easily restructure itself because of weaknesses in education and skills of the US population. Roll replied that this explanation was too specific to the Us, and did not account for the fact that other countries, for ex. Great Britain, also experienced a severe financial crisis.

Steve Ellison writes:

One possible reason for a decline in human capital is the aging of the population. As the average age of the population increases, the value of future income decreases.

Rocky Humbert writes:

Roll says, "Default on debt simply involves a redistribution of wealth, not a destruction of wealth. And that wide-spread defaults have no system-wide effects."

His argument is like saying "Muggers and bank robbers simply involve a redistribution of wealth, not a destruction of wealth." He ignores the costs and consequences that wide-spread mugging and bank robbing would have on behavior and economic activity. He also ignores that bankruptcy and reorganization imposes significant costs on all of the stakeholders (and by extension, society as a whole.) That's one reason why the value of an enterprise declines as it enters bankruptcy protection. Defaults is not a zero sum game with the value moving from shareholders to creditors. It's a negative sum game.

Professor Roll's argument falls down when one considers that "human capital" is a balance sheet item, but "human income" is on the cashflow statement. A country, company and individual with a negative net worth (negative human capital) can function without any problems — but it's when the cash flow cannot support the expenses that the problem causes a crisis. Hence, human capital is like goodwill on a corporate balance sheet. It's an accounting fiction. It's the human cash flow that matters.

Gibbons Burke writes:

Abortion and contraception have taken a heavy toll on human capital. Since Roe v. Wade was decided, over 50 million potentially productive human beings have been murdered in the womb in the U.S. alone.

Kim Zussman adds:

You wrote "the drop in real estate and stocks is a clue that (according to Roll) the value of human capital dropped."

Then it must have been true that human capital (anomalously) increased, causing the housing bubble in the first place.

In the attached chart (Case-Shiller real house-price data, 1890-2010), the bubble peaking in 2006 DWARFS all other housing price peaks over 120 years.

Perhaps a surreptitious rally in human capital occurred, manifested by the unprecedented housing bubble?

Rudolf  Hauser comments:

It is not quite fair to criticize Prof. Richard Roll without having heard his presentation, but based on Alex's summary thereof, I will do so nonetheless. I agree with some of what he has to say but differ in many respects. The main failure is to make any reference to the discount rate. Wealth may be the present value of future income but that is both a function of those future income streams and the rate by which they are discounted. I also find the focus on the value of human capital a strange form of analysis which ignores some market realities as to what actually happened.

Let me start by a very simplified explanation. Real wealth in the capital stock is created when someone labors to produce it. That includes amounts spend in developing human capital via education and training. That labor means that consumption will be less than the amount of production by the amount of that capital investment. But that tells us nothing about how existing wealth is valued. Assume A is moving from NY to LA and B is moving from LA to NY. Both purchased their homes for $100,000. They now decide that their homes are worth $500,000. They trade homes. All they have is capital transfer. It hardly matters what the actual value is in that it is an even exchange. Now in reality A will sell his home for that amount to someone, just a B will, and they will both buy their respective homes from others. The ignoring the intermediate transactions, that is in effect what you have. Now in the past people and lenders would base their decisions largely on their expected future incomes. But in the sort of bubble situation we had in housing, people were expecting home price appreciation to bail them out. In essence, expected future appreciation was part of their anticipated income stream. Now when it was finally realized that this assumption was a chimera that it was decided that the two homes were only worth $300,000. Now wealth has declined in value. The only question is who bears the loss. Given the mortgage amounts the lenders might well find that they must bear some of that loss. There is no reason to refer to "gifts" to the borrower. It is the decline in the value of the property, of wealth that causes the loss. It makes no sense to call that loss a gift.

Then we get to what brings about the additional losses of real wealth. That happens when capital, either physical or human, becomes useless in producing future income. That can happen when lenders refuse to renew loans and/or revenue declines cause bankruptcies. Long periods of unemployment destroy human capital. Physical capital decays from neglect. And that can happen because firms are driven into bankruptcy because of debt defaults and their ability to refinance themselves.

As to the argument that this was a drop in the value of human capital, it is first of all something that cannot be measured. The wealth we can measure has cyclical tendencies. While the recent recession was one that might logically influence future expectations, for the most part recessions are and should be expected as they have always happened from time to time. There is no reason why they should change long-term expectations other than emotions. What does happen is that there is a need in the time of crisis to have more liquidity. That increases the risk premium on longer-term and less liquid assets. Part of that increase in returns is an expectation of capital gains when the liquidity crisis/recession ends. That is why we often see an inverted yield curve leading into such declines. Logically, the yield curve should become more positive, not turn negative, because risk premiums should rise more on the longer term assets. But what matters is total return and that included anticipated capital gains. When those are not great enough the yield curve does not invert, as was the case in the 1930s. Well if the declines in wealth were due to changes in future expectations that is not what you would see. Rather it is because of what I would call risk liquidity premiums rising. If Roll's argument were valid with regard to government intervention, how does he explain the increase in stock values of the past two years-a period when by all logic the changes in government should be increasing fears of greater intervention?

What happened was that the markets finally realized that with all the complicated debt and derivate structures that depended on counterparties many transactions away to deliver was in doubt and that no one's balance sheets could be trusted anymore. With that lending dried up and all values where put into question. That cause a large increase in risk liquidity premiums that was only mitigated by the Fed belatedly pouring in large amounts of liquidity and the government offering guarantees for parts of the financial system.

Another point, although a bit more trivial. When Alex writes that Roll said that "The net amount of debt in the economy is zero." he ignores the fact that some of that debt is owed to foreigners. That is the statement is only true in an international sense.

What you had in this period was an increase in the foreign inflow of savings. Net fixed non-residential investment by business relative to GDP was significantly lower than it had been in the 1990s. In essence there was too much savings wanting to earn higher returns relative to the business investment opportunities leading investors to finance a housing boom instead.



There is a very big "shoot the moon" increase in the Base.

Bud Conrad comments:

Here is a chart from St Louis Fed of Monetary base

Bill Rafter adds:

Terse: a big increase in money stock (money supply). That would normally tend to be inflationary, but BSB just yesterday told us there is no inflation. (And he was correct.) Typically the Base tends to grow at an exponential rate in the low single digits. However with the banking rescue programs there was an astounding 100+ percent increase from Sept 08 to Jan 09, and another big increase from Aug 09 to Dec 09, and now we are at it again.

The reason there has not been inflation is that this expansion has not gone anywhere beyond the (big) banks. If you look at other versions of the money stock such as M2, you see that there has been no such increase. In fact, M2 has been showing contraction relative to its long-term target. It will be most interesting to see the M2 numbers to be released today. A big increase in M2 would make the case that inflation is finally coming. No increase in M2 would state that we are just getting more of the same, specifically that the Fed has been putting money out to the big banks (at zero interest) and then allowing them to simply leave that money on deposit with the Fed (at interest). This process is just a subsidy to the banks.

The important question to me now is why the latest increase? Are the banks in further trouble? Does this anticipate more trouble, say with commercial real estate?

Given the colossal increase in the Base, some of it will bleed through to M2, which probably explains the current increase. However note that M2 is still below its long-term growth rate (what I call the fit or target), so effectively practice (as opposed to policy) continues to be restrictive.

At some point "somethin's gotta give": The Fed could start taking down the Base. They probably will just reverse the policy of paying interest on deposits left with the Fed. At that point the banks will return much of their borrowings back to the Fed. Some of them may not, and choose to start pushing commercial loans out the door. Then you will start to see increases in M2 and the earlier increase in the Base will become inflation. That at present is the only reason why I watch this data.

Mick St. Amour comments:

Bill, this proves my theory that fed is fighting deflationary forces given contraction in lending and collapse in monetary velocity. Given we are in balance sheet recession, reflation of assets/collateral values is main goal of central banks everywhere. It is key to stoking animal spirits in the markets and in real economy. I suspect this provides tailwind for asset classes such as equities and commodities.

Rudolf Hauser comments:

It might be worthwhile to remind readers of what the demand for money is in a non-inflationary economy. It is the amount of money people in the aggregate wish to hold (emphasis on hold, not spend) plus that needed for transition in transactions (the amount involved that is held up by the clearing process) in an environment of just real growth or decline. That applies to both high-powered money (the monetary base) and measures such as M2. If that amount is not provided banks will attempt to increase reserves by reducing investments and loans. Paying interest on reserves increases the banks demand for reserves (excess reserves), as does increased caution on their part. You will only get M2 to grow if banks are more aggressive in investing and lending. Since there are no longer reserve requirements on (M2-M1) all of the reserves related to this are excess reserves. If the Fed were to stop paying interest on reserves a bank could profit from such reserves by buying 3 month or probably even 1 month Treasury bills as long as the return were in excess of their processing costs since the reserves used to buy those securities is zero percent financing. But to buy treasures they have to pay the buyer, which increases bank deposits, i.e., M2 (and M3). The banks cannot drain total reserves from the system– only the Fed can do that. If the Fed wants to keep excess reserves from being used it can discourage that use by raising the interest rate it pays on excess reserves. To repeat, lowering that interest rate only leads to more rapid monetary creation-something that I suggested would be desirable here to accelerate M2 growth to a rate that does not drive us into another economic down-leg in a few quarters from now.



 I cannot count the number of times my trading was going along really well, then all of the sudden, wham… all my profits were erased in one fell swoop, one bad trade. In retrospect, I got arrogant, and decided, because of my invulnerability, to assume extra risk which became my undoing.

Despite many decades of trading, I still occasionally get a b**ch-slap from the mistress of the market when I get excessively confident. In my own case, this seems to happen when I have many trades on and all are solidly in the black, or I've had a real good run. I get a sense of invulnerability, hubris, and that's my own personal kryptonite. At least I can recognize this flaw, and it hasn't reared its ugly head in a few months. Usually when my normal balance between my offensive and defensive game goes out of whack is when I get killed. Now I have a system in place that identifies when I'm about ready to go on tilt. The system hasn't kicked in yet, so maybe I'm learning something.

When I was coming up, an old grain trader told me that "Hope" is for losers. I used to get stuck in a position, and hope it would come back, and it usually would not. In fact, my friends saw me hoping for an improvement and were fading me all the way down. It took awhile, but I learned that hope won't bring the market to your favor, but hope will make you go bankrupt. Finding people full of hope can be a gold mine for you, provided you play it right. Seeing a person "Hope" for his position to improve enables another person to get additional clarity on what the market is going to do….at least in my case…..but I like fading losers. The converse is that I don't mind or take it personally when people fade me when I'm wrong.

Luck is just wrong. I don't believe in luck, and if it were to exist it would be a zero sum game. Is a person who wins the lottery lucky, or is he just part of the statistical distribution? I like to think of luck as an offspring of statistics and probabilities. There is a probability for every possible occurrence in the universe, and things just happen without any mysticism involved..Some gamblers like to have lucky rabbit's feet, or other talismans. I like to sit in position to those guys in table games. Some guys like to brag about their lucky streaks and I listen carefully. I like to observe their streak, and at some point, start to fade them, a little at first before I really press. Sometimes this works, sometimes I get my butt handed to me on a silver platter, it depends.

My favorite are the superstitious, as they believe that some mystic power controls their destiny. Evidence of any kind of lucky charm raises my curiosity and I try to observe that person for any fade clue. It's tough enough to pull money out of the markets. The emotions of hubris, hope, and luck make it near impossible to make money. These emotions are akin to having a horse player bet the his idea of an overlay, only to lose, and hear the lament, "Boy, I wish there were just one more furlong." In horses, as in the market, and life, there is not one more furlong and do-overs aren't allowed.

Kim Zussman replies:

How about this definition of luck: 

From Merriam-Webster:

1 a : a force that brings good fortune or adversity b : the events or circumstances that operate for or against an individual

2 : favoring chance

3. Favorable or unfavorable outcome which was not caused by skill, effort, or actions taken.

I purposely left out "ability", since some large fraction of ability is genetic, and one can only obtain good parents by luck.

Janice Dorn writes:

Self attribution bias applied to trading posits that traders attribute good results to skill and bad results to bad luck. This is a common bias that underlies the inability of many to admit they made a mistake.

Rudolf Hauser writes:

Kim's definition of luck is a good one but I disagree when he writes "I don't believe in luck, and if it were to exist it would be a zero sum game." There is no question that ability, persistence, preparation and work in general are needed to take advantage of opportunity, but luck also plays a part. So much of what we do involves interaction with other people and some depends on being in the right place at the right time. The geologist or anthropologist who is traveling somewhere and happens to notice some clues that will lead to a significant discovery is the beneficiary of both his or her skill and good the good fortune of being alert (not luck –or is it if you were just doing something else at that time and so missed what you otherwise would have notice so you had bad luck) and the luck of being in the right place at a time they had the experience to take advantage of the opportunity.

Or what about the person who takes a job in a local company that just has a product about to take off and ends up making a super salary and seeing the stock he purchased in the company rise and make him rich whereas if he had done the same in another town with the same skills and hard work doing much less well because the people running the company in and industry with no such product line and whom he had never meet were bad managers and ran the company into the ground? Sure he or she did not have perfect foresight and the ability to evaluate the thousands of people one interact with and predict how will interact with them over a lifetime–but then who does?

There is no question in my mind that a person who does not fully apply themselves is not likely to be able to take advantage of what good fortune of opportunity presents itself but there is also no question that luck plays a major part in life. And it's not just genetic– if you were born in a country in perpetual war and poverty your changes of a good life are much less than if you were born in the U.S.A. Or what about the Jewish children born in the 1930's in Germany or central Europe rather than the U.S.A. or being born in either place in the 1960's? Was that there bad luck or a failure of keen judgment and hard work on their part if they died in Hitler's gas chamber? What about the person who contracts a disease and dies from it when a cure would have been available had he gotten the disease a decade later? Was that something he or she could have prevented or just bad luck?

Kim Zussman adds:

I know a guy who is a retired contractor/developer, who "came from Germany with $20 in his pocket" and is now very wealthy. He developed a number of commercial and residential properties.

Why so successful?

1. He happened to like to work outdoors, was good with building, and good at commanding laborers
2. Was born charming
3. Was lucky to have lived through three decades of atypically high appreciation in real estate

Had any of the above three been missing, especially #3, he would not been as successful — maybe even a failure. I call that luck.

You can say the same about stock bulls in the 90s, oils and railroads in the past — all kinds of bull markets and bubbles, without which the great moguls and flops would not be. Not to mention war heroes who survived to tell the story, as opposed to those who took equal action but were silenced.

Economic society is pretty much zero sum over short periods, if you add all the give and take together.

Russ Sears writes:

Much of what we call luck is really the skill, effort and actions taken by others and given to us by the generosity of those most successful.

This would include living in a free country.

Further, much of this skill, is willingness to take actions and give effort where the difference between success and failure often hinges on the smallest thread. A thread so small, that even the most skilled, those putting the most effort can not be assured that any fruit will be borne. But one where the skill lies only in putting the edge in their favor.

This would include parenting and trading.

Finally, much of what looks like incredible luck is compounding of these skills over time and history.

However, to anecdotal throw a wrench into the "no such thing as luck" I have a relative by marriage, that won 2 lotteries. One a $4.3 million jackpot in MO state lottery, by entering one ticket a week. The other a half million Reader Digest sweep-stake, by answering the junk mailer. But she would like to remain anonymous.

The untold story however, is how the money tore apart her family. Luck or curse, I leave it to the reader.

Jim Sogi writes:

 Chinese proverb

Good Luck Bad Luck!

There is a Chinese story of a farmer who used an old horse to till his fields. One day, the horse escaped into the hills and when the farmer's neighbors sympathized with the old man over his bad luck, the farmer replied, "Bad luck? Good luck? Who knows?" A week later, the horse returned with a herd of horses from the hills and this time the neighbors congratulated the farmer on his good luck. His reply was, "Good luck? Bad luck? Who knows?"

Then, when the farmer's son was attempting to tame one of the wild horses, he fell off its back and broke his leg. Everyone thought this very bad luck. Not the farmer, whose only reaction was, "Bad luck? Good luck? Who knows?"

Some weeks later, the army marched into the village and conscripted every able-bodied youth they found there. When they saw the farmer's son with his broken leg, they let him off. Now was that good luck or bad luck?

Who knows?



Alexander HamiltonI had invited a good acquaintance, Dick Sylla of NYU, to the Junto meeting this past week. Dick, who is an economist specializing in economic history, is working on a book on Alexander Hamilton focusing on his economic and financial contributions. I though his presence might elicit a more interesting discussion. But it turned out that he was unable to attend. He had asked me to comment on the meeting. I sent him the response below, and he then responded to what I had written. With his permission I am publishing it. (It appears below my e-mail contents to him and his initial e-mail to me.) Also linked is his published article on the financial crisis of 1792 and Hamilton's role in stabilizing the situation that he sent me and that readers will find interesting on both it account of the crisis and for a different view of Hamilton:

Dear Dick,

I am really sorry that you were not able to make it. We really could have used you there. Unfortunately there was no one there who really contested his views. There were a whole number of questions but very little in the way of defense of Hamilton. Aside from asking him how the world would have differed with regard to industrial development in the U.S. had Jefferson rather than Hamilton prevailed, I kept quiet because unfortunately my knowledge of the period and of Hamilton is too weak for me to have stood my ground. His response to my question was that for that Jefferson was not really against manufacturing or banks just on subsidies thereto. He noted that for the first decades of the Republic tariffs were low and Jefferson repaid much of the debt so that the results on industrial development would not really have differed. He claimed that the Bank of the U.S. was responsible for very high inflation in its first five years. I just have no idea what the facts are. I had thought our inflation problem came in the pre-Constitution days but would really have to go and look at the data. His suggestion was really that Hamilton introduced the concepts of the lack of limits on government power and the expansive view of the commerce clause–his overall view of the constitution — was what has allowed the government to expand its power in the past 150 years. Had I wanted to just be argumentative I might have been more direct in noting that his attack on Hamilton buying and owning slaves was hardly as anti-freedom as Jefferson favor of the Southern agrarian economy that depended on slave labor. Some question was raised as to how honest and or rich Hamilton really was, with Di Lorenzo noting that he believed that Hamilton buying up millions face value of government debt at a small fraction of its face value in the knowledge of plan to have the federal government pay it off in full allegedly for his brother-in-law in fact must have benefited Hamilton also. His dislike of the Supreme Court asserting the right to determine what the Constitution meant under Justice Marshall, whom he claims did so under Hamilton's influence ignores the fact that the other two branches are even more likely to decide based on the pressure of the democratic vote and it was that Court that initially resisted the efforts of FDR to expand the role of government and only relented under the pressure of president to pack the court to get his way or that it did not really use that right again for a long time after that initial critical precedent setting decision. But I did not believe much would be served by bringing up that point since it was not central to his arguments against Hamilton. He claims that Jefferson read "The Wealth of Nations" but doubts that Hamilton did or that he believed in the arguments of Adam Smith on the market. But as I recall Jefferson's plantations lost money over the years and he also died bankrupt making me doubt how astute Jefferson really was on economics– but unfortunately I do not really know the facts. He claims Hamilton was the one who favored the views of the Jacobites in France with regard to the public good, but I thought Jefferson never wavered in his support of the French Revolution and frankly do not know what view Hamilton held in this regard. It's time for me to do some reading on the early days of our republic.

Best wishes,


Dear Rudolf,

Thanks for this good account. I'm surprised there wasn't more contesting of his views–I guess he was preaching to the (libertarian) converted! His book argues that AH is responsible for almost everything he doesn't like about the US; he has an earlier book where he says almost the same thing about Lincoln–that one must have established the pattern! I suppose books such as these, when one stands back and says why were these written long after the subjects died of their wounds, are really in a sense tributes to how influential the two historical figures have been.

On some specifics, yes, there was some inflation in the early 1790s, mostly from 1793 to 1796. Since the BUS [Ed.: First Bank of the United States] started at the end of 1791, it is a weak candidate as a cause, and from the 1796 peak prices were fairly level, maybe a slight downtrend, to 1810, when the BUS continued. Consumer prices rose only 4.5% from 1790 to 1792, and then 38% from 1792 to 1796. Two better explanations, I think, are (1) that the outbreak of war between France and Britain in 1793 either disrupted trade/imports and raised prices or led to large increases in demand (and perhaps money/specie inflows) on the part of the belligerents for American products and shipping services (an old story told by economic historians), and (2) wheat was an important commodity and seems to have risen in price a lot in 1795 and 1796 because a pest called the Hessian fly did a lot of damage to wheat crops. We also know that foreigners were buying a lot of American securities (US debt and BUS stock in particular) in these years, leading me to wonder whether capital inflows pumped up prices, just as they do in emerging markets today. Anyway, the issue of the early 1790s inflation could use more research.

AH certainly did push for more federal power, but at a time when the gov't was brand new, weak, and very much needing to establish its authority and respectability. I and others consider this one of his and the Federalists' greatest achievements. Maybe that power was misused and abused later in history, but that can hardly be blamed on the 1790s generation. The alternative might have been British or French invasions, breaking up the country, or even a break up of the country without such invasions (as in 1861). We forget that these were real concerns at the time.

The evidence for Hamilton owning slaves is quite weak, although as an agent he may well have purchased or sold them for others. We know he detested slavery from his West Indies days and did throughout his life. The definitive Papers of AH (27 volumes with extensive notes) has just one letter from around 1781 or 1782 when he says he is sending someone, maybe John Jay, money "for the woman", which might have been a slave he bought to help out at home where his wife had just had a kid or two, but it might have been a rental as well. The editors of the papers say that one comment is the only evidence there is that AH might have owned a slave. A person such as Di Lorenzo has to make a big thing of this because of Jefferson's vulnerability on slavery–we know he owned 200 of them, and probably fathered a few!

There is no evidence that AH speculated in gov't debt before, during, or after his term at Treasury. He was determined to pay our debts honorably, and so it's likely that those who knew him and had confidence in him would speculate in the way Di L describes. But I think I can use information on securities prices (see our recent article "AH, Central Banker", showing some of our price evidence, used in the article for another purpose) that I've gathered to show that those prices fluctuated a lot from 1788 to 1792, and any speculator could easily have gotten burned by the fluctuations. We know that AH succeeded, but a person living in 1789, 1790, and 1791 could not be sure of that. This illustrates a major problem of historical interpretation.

Di L is right that AH was an early and strong proponent of judicial review (in Federalist 78), and that Marshall, his disciple, carried on in that tradition after AH was gone (or even before, since a key case, Marbury , was in 1803). Your misgivings about Di L on this are well taken–the Supreme Court often constrains presidents and Congress from doing unconstitutional things, even if a democratic majority favors them. Hamilton and Madison worried about the tyranny of the majority; they were not so fond of democracy, but were extremely fond of constitutional government.

Hamilton and all the other top guys certainly read Adam Smith. Hamilton's famous Report on Manufactures (1791) is in fact one of the earliest extended commentaries on Smith–he doesn't cite Smith specifically but says things like 'some writers contend….' after which he quotes Smith almost verbatim! And then agrees with some of Smith and disagrees with other parts of Smith.

It's altogether wrong to say AH favored the views of the Jacobins (not Jacobites) in France. That was Jefferson. Jefferson and his allies taunted Hamilton and the Federalists as "monarchists", and the latter responded by calling the former "Jacobins." You are right that TJ hardly ever wavered in his support of the French Revolution. AH saw it spelled trouble from the start (in a letter warning Lafayette to be careful not long after the storming of the Bastille), and he even predicted the bloodbath that was to occur in France shortly. Both France and Britain, much larger states and powers, caused a lot of trouble for the 4 million Americans living in the early 1790s.

Gordon Wood, a distinguished historian, has a new history of the years 1788-1815 just out, called Empire of Liberty . He cites some of my stuff, but I think he doesn't entirely understand Hamilton because of some of his own blinders (which are much smaller that Di Lorenzo's blinders). Maybe even better is The Age of Federalism , covering 1788-1800, by S. Elkins and E. McKitrick, published in the 1990s and now available in paperback. Both of these are 'big' books. So is Chernow's 2004 biography of Hamilton, also worth reading, although my favorite is still the one by Forrest McDonald (a conservative, but not a libertarian bloody-shirt-waver such as Di L).

Best, Dick



the st. louis fedThe latest release of the bi-weekly velocity of money multiplier series at the St. Louis Fed shows that the velocity has fallen to an all time historic low. The current reading is .811 and means that a dollar of money supply only produces 81 cents worth of GDP in a year. Another way to look at it is that the Fed needs to print $1.23 of new money to produce $1 of GDP in the next 12 months.

Part of economic impetus driving this situation is extremely low interest rates. At short term rates under 1% there is little urgency to invest. Putting your money under the mattress results in little in the way of lost interest. But it does save one from the savings account counter party risk and hypothetical failure of the FDIC program. The mattress strategy might even yield a net real return if deflation is the future.

The following link is to the St. Louis Fed site with a chart of the velocity of money and the most recent numbers.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Stefan Jovanovich replies:

Dr. Phil's statistical expertise dwarfs my poor abilities to add and subtract, but we Hayekian arithmeticians remain stubbornly skeptical about the relationship between official monies and wealth. If all the Fed really needs to do is print $xx.xx of new money to produce $yy.yy of GDP aka the sum of private and public incomes, then those in charge are clearly derelict in not immediately printing 2, 3 or 4 times $xx.xx.

Could it be that the evil capitalists are huddling at zero maturities, no matter what the price being paid for their lending the government back its official money, because the risks of (a) 2,3, and 4 times $xx.xx being printed or (b) the collapse of the carry trade in world commodities priced in U.S. dollars are BOTH best hedged by having the shortest possible terms on their official IOUs?

Those of us who dream of a return to the stupidities of Austrian and 19th century American gold standard economics fantasize that there will be that magic day when some impeccably credentialed Dr. of Economics stands up at the Emperor's testimonial dinner and asks why the accounting tautology of MV=GDP is any more meaningful than the one that says Equity=Assets-Liabilities.

MULT: The M1 multiplier is the ratio of M1 to the St. Louis Adjusted Monetary Base.

M1: The sum of currency held outside the vaults of depository institutions, Federal Reserve Banks, and the U.S. Treasury; travelers checks; and demand and other checkable deposits issued by financial institutions (except demand deposits due to the Treasury and depository institutions), minus cash items in process of collection and Federal Reserve float.

Adjusted Monetary Base: The sum of currency in circulation outside Federal Reserve Banks and the U.S. Treasury, deposits of depository financial institutions at Federal Reserve Banks, and an adjustment for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.

Rudolf Hauser writes:

 We do not live in a barter economy but rely on money instead. Anything that is convenient to use, that is very widely accepted in transactions and that retains it worth can be used as money. As with all goods and services, humanity is served by efficiency. Gold has the advantage that it is a limited commodity in nature, which keeps it relatively scarce and hence helps it to retain value, but one major disadvantage in that it is very costly to produce, making it an inefficient use of human resources. Paper money is cheap to produce but retaining value depends on the will of the producing authorities to provide an amount sufficient to meet demand for liquidity without exceeding it such as to neither increase or decrease its value (and the lesser problem of avoiding counterfeiting).

A decline in velocity indicates an increase in the demand for money relative to available supply. To measure velocity against economic activity (GDP) one most consider the lags typically involved. I prefer to use a two quarter lag. On that basis velocity was still declining for M1, M2 and MZM in the third quarter. But given the performance of financial markets I believe that the present monetary growth, while not that rapid of M2 and MZM, but more rapid for what I call liquid M2 (M2 less CD's, without institutional money market funds included in MZM), is adequate because of the increasing confidence which should be reducing the demand for money. Hence, the decline in income velocity is a reflection of the lags. Monetary growth was clearly inadequate earlier in 2008 given the rising demand for liquidity until the Fed finally panicked in the autumn.

Money creation does not increase real economic activity from a stable state level, although an erratic or inflationary monetary policy will probably decrease real growth potential. If money is inadequate to supply the effort to restore liquidity will drive down other financial asset prices and reduce economic activity. In such cases the supply of more money will meet that liquidity demand and result in an increase in financial asset prices and real economic activity. This is just a restoration from a prior inadequate supply of money. An increase in money from a starting state in which the demand for liquidity in a non-inflationary environment might increase real economic activity temporarily if there is money illusion, that is nominal demand increases are mistaken for real demand increases. Otherwise it will just cause inflation, with the lag depending on the state of the general view on monetary policy. In an inflationary environment the lag to an inflationary impact would be minimal to non-existent, but in a world with much confidence in the monetary authorities it is likely to be longer.

Stefan Jovanovich adds:

The arguments against the gold standard always come down to the "inefficiency" of having to carry around a heavy bag full of sovereigns or Double Eagles. This has, of course, absolutely nothing to do with the history of coinage or official money; but, given how few good arguments there are in favor of fiat money, it should not be surprising that it is the standard explanation for why our paper currency is no longer exchangeable for specie. One should never underestimate the determined historicisms of the monopoly academic mind. What is ironic is that the "inefficiency" explanation is made by people who depend on the credit records of the 19th century to establish their certainties about the relations between "money" (sic) and GDP (sic).

The gold standard, as adopted by the United States of America at its founding, and by the United Kingdom, France, Germany, Belgium, Netherlands, Italy, Spain - the list is too long to continue - in the last third of the 19th century did not require people to carry bags of coins. What is remarkable is that it did not even require people to a particular money. All the gold standard said is that the sovereign government would mint coin in gold of a standard purity and that, on demand, the government would redeem its debts in such coin. You can find that pledge in the American constitution and, for that matter, in the constitution of the Confederacy. The gold standard did not require people to demand bags of coin as payment for the Treasury bonds, and even at times of financial distress, very few people did actually demand specie from the government. But the gold standard gave them that choice. "Ordinary" (sic) people could demand that the government meet its promises according to a standard that the government itself could not manipulate. Now, as Rudolph points out, the measure and weight of money is dependent on "the will of the producing authorities".

As Hayek kept reminding us, with elegance and without intemperateness, the notion that the government "supplies" money is the fallacy. Governments have minted coins from the beginning of recorded history, but they have not supplied that wealth; they have only collected it. Governments insisted on an official money because they could not live with private money. The idea that, before governments, people lived only by barter is truly fantastic; there is evidence of private money in every literate culture in history. As soon as people figured out how to write, they started issuing IOUs to each other. But, the promise of Fred the grain merchant of Tigris to pay Harry the wheat farmer two goats and a dowry for Gharry's daughter was not going to be very useful in paying the hill tribesmen pay/bribes/rewards for serving in the king's own regiment. The hill tribesmen did not know Fred or speak his dialect; they wanted something of tangible value. Official money developed out of the need/desire/vanity for armies and the necessity of paying them. That is still official money's ultimate rationale; the state needs to be able to pay its minions with a money that they will accept.

But why, as Hayek asked, does official money have to be a monopoly? Why are our most "progressive" thinkers in favor of a world currency, for example? The inefficiency argument hardly applies in this case; having 3, 5 or even 50 different sovereign currencies is no more difficult to manage in the age of computers than a single currency. The answer is obvious: with competing monies there is still a means for people to accumulate and hold their own wealth. That liberty may only be available to the very rich but it is still a freedom that exists and that could possibly be expanded to include "ordinary" (sic) people; and that movable private wealth represents a very real threat to official power.

The one valid argument that defenders of the Confederacy have is that Lincoln did want to impose a Federal monopoly on money and that, once the Civil War started, he did just that. What the defenders of States rights do not acknowledge is that state governments had been as eager monopolists as Lincoln. They had also, like Lincoln, been willing to default on specie redemption for their borrowings.

The reason that you have a period of rare political unanimity on the question of the gold standard for the 4 decades between the Resumption Act and the closing of the New York Stock Exchange at the beginning of World War I is that Northerners and Southerners, Democrats and Republicans, of any sense all understood the monetary lesson of the Civil War: if government is allowed to exempt itself from a Constitutional standard for money, then ruin follows. When governments can literally manipulate the weights and standards of money itself, the currency becomes a mechanism for theft by those who sit closest to the King.

But, there is no point in quarreling with the true believers in the money supply. It is part of the same theology that has as an article of faith the certainty that, without compulsory government schooling, none of us would ever learn how to read. One can only laugh at the irony that it is the true believers who have the most at risk. The contingent payments to the civil servants themselves - those glorious pensions - are the promises most likely to fail. The coins cannot be clipped, and competing monies do represent a restraint on hyper-devaluation. All that is left is default. Given a choice between defaulting on Social Security/Medicare and public employee and school teacher pensions, there seems little doubt what the electorate will vote for ten or twenty years from now - assuming, of course, that the issue is even put to a vote.

Alex Forshaw replies:

But, there is no point in quarreling with the true believers in the money supply. It is part of the same theology that has as an article of faith the certainty that, without compulsory government schooling, none of us would ever learn how to read.

I'd go even further than this.

In my (thus far brief) speculative experience, for every one brilliantly complex idea which spectacularly vindicates the prophet lost in the wilderness, there are 99 "brilliantly complex" ideas whose complexity proves nothing more than a refuge for the proponent's ego, for him to delay admitting he's been wrong all along. Such is the case with the academic mumbo-jumbo that belabors arguments on monetary policy, among others.

Arguments about money supply, liquidity provision, bubbles and the gold standard revolve around some very basic presuppositions.

Can bureaucrats be trusted to Do The Right Thing when specialized constituencies' interests, and bureaucratic institutional self-interest, unite on the other side of the argument?

Or do they–under the cover of complex esoterica completely foreign beyond their own constituencies–generally convince themselves that The Right Thing happens to align perfectly with their own institutional self interest?

I do not understand how anybody can look at the history of money, and the history of human nature in general, different from "hell no."

In my opinion, if you take the other side of that question, as Rudolf has, you will find yourself justifying the most brazen monetary manipulations any of us has ever seen. The rest is just pedantry. How does anyone have the arrogance to set the cost of capital for an entire planet? How does anyone else sucker themselves into believing any one individual ever has that kind of "edge," on any kind of ongoing, predictable basis?

Theses that can't be explained simply, should not be trusted. There is a lot more egotism than truth in complexity. No amount of academic mumbo jumbo will help contemporary, "how D A R E you suggest our tripling M1 in 1 year was anything other than saving the economy from Armageddon?" Keynesianism pass the bullshit test; and that's where the line in the sand should be drawn.

If you accept the terminology and the givens of the monetary clergy, you tacitly concede intellectual honesty on their part. For someone not invested in the status quo (or invested beyond that), all debate beyond that point is a waste of time. You aren't going to change anything, so why not just find something better to do?.

Rudolf Hauser counters:

I am not going to persuade Stefan to abandon his love of gold, so I would not even waste my time trying. He like our sometime contributor Larry Parks are staunch advocates. But other members of the list might be open to alternative viewpoints. First of all, I do not advocate a government mandated monopoly on money. I believe individuals should be able to hold whatever assets they wish, gold included, and contract to deal in whatever medium of exchange they prefer. I like Stefan object to efforts to restrict such as was done when the gold standard was abolished under the FDR administration. The inefficiency I am thinking off is not people carrying bags of gold around but the human costs of mining the stuff. How many work under absolutely miserable conditions digging through mounds of dirt for a few grams to buy them a meager subsistence in Central Africa? How many work under extremely hot, unpleasant and I suspect not without danger depths of South African mines? How many wasted their lives digging for gold without most finding much in the gold field booms of California, Alaska, etc.? Digging for the stuff costs lives and ruins lives. People would still do so for the non-monetary uses of gold, but the price would be lower and the resulting activity less. The use of IOUs etc. in early human activity not expressed in a common medium of exchange is still a form of barter. Only when you have a substance widely accepted by a large group of people in which the value of all other goods and services are expressed do you have something that can be called money. A near money, like the non-M1 components of M2 are not transactional money, but may be considered as money for analysis if they can readily be converted to a transactional money without any or most minimal cost. Transactions in international trade involving two or more currencies represent additional risks and costs. Not only is your competitive position determined by what happens to the demand and supply of your products but also by the overall balance between the countries in question which will impact the exchange value of the currencies. Hedging will reduce the risk somewhat but not without cost. I am not advocating a single currency as that also creates even greater problems with regions growing at different rates, etc.-just pointing out there is both advantages as well as disadvantages to having to deal only in a single currency. A gold standard will not prevent a government from defaulting. It only changes the form that the default might take. A fiat standard makes it easier to do so without being so overt about it, but in extreme situations it will not prevent that from happening. For an economy to function most efficiently, it needs to have an adequate but not excessive medium of exchange. Gold is limited by the amount in the ground. Any currency, etc. backed by gold at a constant amount would still be limited by the available quantity of gold. Major gold discoveries have lead to inflation, albeit very modest compared to what happens with inflated fiat money. A shortage of gold leads to deflation. As the experience of the latter half of the 18th century in the U.S. showed you can still have good real growth with modest deflation. But there is a problem here. Most people rely in others to make investments in real ventures (that is, capital spending, etc. as opposed to financial investments). But since the nominal return on money practically go below zero (storage costs, etc. might reduce it slightly below zero), the amount of deflation will set the risk free interest rate floor. As that rate rises higher and higher, fewer and fewer investments will offer enough of a return to attract saver's dollars. As such, investment and real economic growth, with resulting improvement in living standards, would lag behind potential. Efforts to accommodate this by reducing gold backing, changing conversion rates get you right back to the issue of government discretion that Stefan was talking about in the first place. You could end up with a monetary shortage as people hoarded available money. Alternative private forms of money might develop, but as they would represent more inflation prone forms of exchange than would private money such as gold under current conditions, they do not strike me a first glance as an attractive alternative to a sound fiat standard.

Alex, M1 did treble-relative to Feb. 1985. It has increased 22.9% in the past two years. M2 was up 13.2% over those two years. On a continuing basis that would surely be inflationary. But given the financial uncertainty, it resulted in that time, it has probably been desirable. I am very concerned that it might not be reversed when the demand for money decreases again and then we might have an inflationary result.

Efficient societies depend on trust. Remove trust and the ability to make progress is greatly limited. But the biggest problem in modern society is indeed the need to restrict and control the power of government. We have different view on how that should be done and what government should be allowed to do.

Also, Alex, M1 did treble-relative to Feb. 1985. It has increased 22.9% in the past two years. M2 was up 13.2% over those two years. On a continuing basis that would surely be inflationary. But given the financial uncertainty, it resulted in that time, it has probably been desirable. I am very concerned that it might not be reversed when the demand for money decreases again and then we might have an inflationary result.

Efficient societies depend on trust. Remove trust and the ability to make progress is greatly limited. But the biggest problem in modern society is indeed the need to restrict and control the power of government. We have different view on how that should be done and what government should be allowed to do.

Jack Tierney comments:

 The arguments against mining (not just of gold but most other "raw materials") has become extremely popular. Much of the case made against the practice include elements similar to those put forth by Rudy (the larger and more revealing reason is that the government in general and the leeches in particular, want a bigger piece of the action, i.e., higher royalties).

Unfortunately, most are convinced that the maintenance and continued health of our "way of life" is dependent on computerized technology. It is not - not now and not ever. Our way of life began when individuals, so sympathetically described by Rudy, began digging holes. Our development as a country and our continued successes are wholly dependent on the mining, refining, fabricating, and moulding of raw materials. Autos exist because poor people dug holes in the ground in Michigan. The iron ore produced was useless without a refining process that called for other poor souls to harvest the coal beneath the soil of Appalachia. And what use is the auto without a group of speculators and rough necks drilling the world for oil?

The specialty steels used by defense contractors is insufficient without the necessary rare earths which greatly enhance its strength. Solar panels and longer enduring batteries are inconceivable without silicon & lithium (among others) which also must be mined and refined.

And all the miners, fabricators, designers, innovators, developers, and speculators still depend on someone digging a hole in the ground, dropping in a seed, adding a little (mined & refined) fertilizer, watering it (pumped from an underground aquifer), and, eventually, producing a crop which after further milling, purifying, packaging, and shipping is available as food.

Make any case you wish for or against gold, but we cannot do without hole diggers and those processes which follow the raw material in the production process. Yet we have abandoned all those incremental steps and continue to believe we can somehow maintain our standard of living. We are left to purchase many required finished products which, at one time, we produced in such abundance that we exported the raw materials (e.g., copper & iron ore) necessary for their manufacture (and, whether measured in dollars or ounces of gold, paying an increasingly higher price). We face a situation in which these manufacturing countries are still creating the end products but now, due to their internal growth, are consuming much of what they produce. Understandably, our need does not trump theirs.

I can accept that a great deal of the industrial transformations we have experienced can be related to global labor arbitrage. However, it behooves any country which pictures itself as an "international power" to continually monitor the world production of those raw materials (from origination to end product) which are essential to its continued health. We already have strategic petroleum reserves - but that reserve is exactly that: petroleum. It is not gasoline, diesel, or kerosene -products which can be used immediately. It must be refined; yet, in spite of no new refineries in 40 years, Valero just closed down another operation within the past week.

We not only need to consider strategic reserves of a wide variety of raw materials, but also the means to produce those essential end items. But we must keep digging holes.

Rudolf Hauser responds:

I agree with almost everything you write with regard to mining. My point was that I rather have people engaged in other productive activities, mining of those other minerals included, instead of doing unpleasant work digging for something that serves a function that could be served with much less human effort or cost. Much of mining has always been somewhat dangerous and hazardous to health, just as building railroads and canals was in the 19th century. People took those jobs because the need for the income and the available income was judged better than the alternatives. Keeping their families alive here and now was worth more to them than longevity. As overall living standards improved, so did mine safety. It is still difficult work but vastly improved over what it once was. Because living standards are lower, safety standards still lag ours in places like China. And yes, we are still dependent on the rare materials produced and the processing of such. The cost of externalities such as resulting water pollution still have to be allocated to the producers in some cases .

But while my main point was that it is more efficient to use paper money than gold or silver when possible to do so responsibly, I also made note of the human misery associated with gold. Just as people will gamble when they think that the odds of winning big are great but at the same time be reluctant to undertake a risky investment that is likely to yield a superior return with much less risk of loss than those activities and investments designed to make giant killings for the very few (like lotteries), so to it was with gold discoveries. Some made millions, but many more made little. Those with the best prospects were the merchants and others who serviced the miners. Digging for coal, oil or copper will not do the same. That takes larger operations. Even wildcatting is expensive. It's not like taking a few simple tools and looking for gold. Gold you measure in ounces, the other minerals in tons. Today there are dictators and war lords in central Africa who exploit people desperate to make a living by having them dig in unsatisfactory conditions for diamonds and gold. And the South African gold mines are some of the deepest mines in existence, and it gets hotter the further down you go. There have got to be better ways to earn a living.

Stefan Jovanovich replies:

I can't argue with Rudolph about the nastiness of mining. Grandfather Jovanovich was a miner; he dug for coal in Pennsylvania and Southern Illinois and Colorado and for copper in New Mexico, and his stories of those days were never, ever about the ease or safety of the work even though he loved it. But, using the particular barbarousness of finding and smelting the monetary metal seems to me a very weak argument to make against the lessons of several millennia. Lead mining and smelting are far more nasty, brutish and toxic; and that "near-gold" element is - so far - the unavoidable technological foundation for our brave, new Green world full of batteries. It is equally improbable that the gold miners in South Africa would be willing to trade places with the coal miners in China. The sociological argument against gold is, at base, pretty weak.

Gold's virtues are simple: it has been accepted throughout history as genuinely precious and scarce, it is not easily counterfeited (unlike, for example, diamonds and silver), and its costs of production seem to have a remarkably consistent relationship to the real costs of doing things when measured over centuries and even millennia.

The only argument that has even half-succeeded against the gold standard is the one that Rudolph makes. It is the one that was made in favor of the adoption of the Federal Reserve Act - namely, that a massive new discovery of gold - like the one then happening in South Africa - would unbalance the price structure of that newly discovered thing called "the economy" by increasing the quantity of money. But that argument only wins if one accepts the strict monetarist premise that prices change only because of the fluctuations in bank reserves. One had to believe that innovation, enterprise and science AND the varying animal spirits of the people getting and giving credit had no significant effects on prices.

What has worked to defeat the gold standard is the theological argument that Money and Credit are really one and the same. Given how bitterly we Christians have argued over the mysteries of the Trinity, it should hardly be shocking that the young science of economics has fallen into the snares that captured Church Councils, but one wishes that somehow, as a science, economics could avoid the mystical notion measure of Credit and Credit itself are both separate and one. To the rationalist Deists who voted for our Federal Constitution the endless analyses about M's 1 through pick a number would have seemed like the very doctrinal arguments they wanted their new country to set aside. The delegates who suffered through the true global warming of the summer of 1787 in Philadelphia formally adopted Article I. Section 8. for the same reason they insisted that there be no establishment of religion even in this nation formed under God. The delegates adopted a gold standard for the United States of America to prevent the Congress from extending its monopoly power over Money (which was granted by the Constitution) to a monopoly power over credit.

The original Constitutionalists would not have found Ron Paul's arguments any more persuasive than Rudolph's. In their demand for a gold-backed currency the Paulistas are not arguing for a restoration of the Constitutional gold standard; they are insisting that gold to be the sword that will slay the dragon of fractional reserve banking itself. To the delegates in Philadelphia in 1787, that would have seemed as lunatic as our present fiat Money system. Abolishing the ability of banks to deal in their own credit would have been as crazy as requiring all businesses to deal only in cash.

Having lived through a war, and its destructions, the original Constitutionalists were not in a mood to accept either Rudolph's monetary extremism or Ron Paul's. The country had lost its primary banker - the United Kingdom - and had destroyed its own currency - "not worth a Continental". What the Constitutionalists understood - and what we moderns still do not understand - is that thinking about money as a "medium of exchange" puts the cart before the horse. People will exchange things whether or not they have an official "medium"; what they cannot do, without money, is have savings whose future value is under their and not the government's control. That is, of course, the root of the problem we face now. If money itself is nothing but an IOU, then the government can resort to the form of cheating that had been a universal constant throughout history: the government can demand payment of its taxes in something real - grain, for example - and pay its obligations in something mostly false - adulterated coinage or paper like John Law's.

For better or worse, the original Constitutionalists gave the Federal government an extraordinary monopoly power; Congress alone, of all the governments in the United States, had the power to create Money in all its forms. See Article I. Section 10. "No State shall …coin Money, emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts". Only Congress had the power "coin Money". To assure that the Federal government would not abuse its monopoly power over Money, the Constitution required that Congress "regulate the Value thereof". (Article I. Section 8.) Morris' words need a careful reading. If one uses our current understanding of the word "regulate", one fails completely to understand the sense of what was written. In 1787 the word "regulate" was a technical term of science; it meant "to make regular" - i.e. to make uniform and consistent, in this case, in the assay. No other interpretation makes sense of why the founders then gave Congress the authority and obligation to "regulate the Value" of U.S. Money and also foreign Coin. Both were part of Congress' more general authority and obligation to "fix the Standard of Weights and Measures". Congress would have sole authority over Money, but that authority could only be exercised by fixing Money's Weight and Measure - i.e. purity.

The Constitutionalists took it for granted that the price of Money - what it would buy now and what it would be worth in future credit - would fluctuate. That was in the nature of credit itself. What should not fluctuate was the Value - i.e. the assay - of Money. If Congress wanted to add a further Measure - to define a particular weight and purity as a "dollar", that was certainly within their authority. What was not within their authority and certainly not within the President's Executive authority was to abolish their Constitutional obligation to regulate the Value of Money.

I don't really expect to convince Rudolph or anyone else who has been schooled in the modern Temples of Erewhon that Morris, Washington and Franklin had a greater understanding of money and credit than Paul Samuelson. But, the evidence seems overwhelming. The difficulties of arbitrage that Rudolph makes such a fuss over are precisely the difficulties that the original Constitutionalists expected the citizens to endure. No government on earth could make Money "safe" in the sense of guaranteeing its future purchasing power and assuring that its price in Credit would not suffer. Holding Money by itself was not enterprise; the citizens would have to take the daily risk inherent in either spending or keeping their Money. What they could be promised is that the Money itself would be true and "regular".

Alston Mabry writes:

Just by the way, I was thinking the Treasury and Fed kept separate gold accounts, but it appears they each list the same 261M oz, with the Treasury using market price and the Fed using $42/oz. The "gold stock" line on this Fed report dated today, shows the Federal Reserve Banks having ~$11B in gold, which, @ $42, equals 261M oz.




 I have a dumb question that everyone on television seems to understand but I don't:

If we lost 13,000 jobs in November, how come the unemployment rate declined from 10.2% to 10%?

Stefan Jovanovich replies: 

Base14 counting. The unemployment rate is not based on the number of people who are physically capable of working but do not have jobs; it is based on the official count of the people who qualify to be considered "unemployed". If your unemployment benefits have run out, you are no longer "unemployed" by the BLS's count. Senator Moynihan once said that before you can solve a social problem, you have to be able to quantify it. As the new science of climate change has shown, once you have a political agenda, your data have to match. And, if the facts are stubbornly resistant, you have to change the plain meaning of words until the facts comply. So, early winter snow storms and severe cold become further proof of global warming; and a stock market rally becomes proof of an economic recovery even though the increased corporate earnings are almost entirely the result of cost-cutting by laying off employees and capital subsidies to the people who deal in credit (the Federal bailouts are the carry trade).

Rudolf Hauser notes:

Stefan is incorrect when he writes "If your unemployment benefits have run out, you are no longer "unemployed" by the BLS count." The BLS definition of unemployed has nothing to do with whether or not you are collecting unemployment insurance. You are counted as employed if you worked at all during the past week, were self-employed, or are employed but did not work because of such things as vacation, sick leave, a strike, bad weather, etc. You are counted as unemployed if you have actively looked for work in the past four weeks. Actively looking includes job interviews, contacting an employer, contacting a public or private employment agency, contacting friends or relatives for job leads, using an employment center such as that of a university, sending out resumes or filing out job applications, placing or answering ads, checking union or professional job registers or any other active means of job search. Getting or not getting unemployment insurance is never a consideration. You are also counted as unemployed if you do not look for a job but are on a layoff and expect to be recalled within the next six months. To see questions asked and more details go to the BLS web site.

Dan,  your question is one that is often asked when the two series produce somewhat different results. Stefan's explanation is way off base. The decline in employment you refer to is the number from the payroll series which is based on report to the BLS from firm's reporting that information to the IRS. It is known as the establishment survey. It is benchmarked by the quarterly reports all employers, no matter who small (I filed reports for the people who cared for my mother) for purposes of unemployment insurance premiums. The reported numbers are revised annually based on that benchmark.

The unemployment number is obtained from a different survey. It is based on a survey of households by the BLS. Employment on that series actually increased by 275 thousand by that measure. It is based on the number of people who worked at all during the survey week. It is divided by those people who have been employed or actively looking for work. Naturally, the unemployment rate could decline with a decline in the number of employed (numerator) if the civilian labor force (denominator) declined even more, but of course that is not what happened in November.

Stefan Jovanovich responds:

But, that assumption (that the methodology is sound) is the very problem. The statistical methods can be completely sound and the outputs can be garbage because what is being counted are categorical abstractions that do not match up well to actual human activity. What the BLS has never done –as far as I have discovered– is test its own sampling techniques against data that cannot easily be fudged where enterprise is concerned. I have not found anything from the BLS that makes a comparison between the 1.5 million jobs that were supposedly created by new businesses started in the past year and a half and the actual data for incorporations, fictitious business name filings, and resale number applications– the usual indices for new business formations. Rudolph knows infinitely more about the details of how the BLS works; my point is simply that the tools of statistics can be used to build sand castles if "norms" are accepted at face value. It is like the Romers' presumption that government spending has an implicit multiplier that is greater than 1. That is certainly true– if you are a government employee. What the BLS is increasingly counting is "work" that is itself government employment; and its surveying is missing not only the "black" economy but also the "grey" one of legally-permissible activity that no longer fits the "standard" categories. My personal, non-statistical observation is that the shrinkage of activity in the black and grey markets here in California continues unabated.



BudThere is something missing in the article from, "Correlation Of S&P 500 Performance With Fed Monetization". The Quantitative Easing of buying $917b more securities went nowhere as shown by the big increase in deposits ($886b) at the Fed by the same institutions that sold the securities. They just left the newly created money sitting on the Fed's balance sheet, earning the modest interest that the Fed now pays. They didn't go buy stocks with it. Yes they could have, but the Fed balance sheet doesn't suggest that as a likely action. Furthermore, the Fed didn't really create new money for QE because many of their direct loans were paid down. The Fed balance sheet has been flat during this time frame. The banks, who had been paying interest on their borrowing, sold MBS and Treasuries to the Fed, and now are collecting interest rather than paying it. It would have to be some back channel of additional off Fed balance sheet funding to claim that the Fed is the source of money for the stock market rally IMO. Yes, it does seem that the QE lines up with the increase in stocks. Zerohedge suggests there is a multiplier on Fed money, and that could be the case. Then the big financial institutions would have to be borrowing, perhaps pointing to their big deposits at the Fed to justify big loans, to invest in the stock market. Maybe, but I haven't seen evidence of that either. I'd be delighted if the proposed relationship were valid as then that would explain the surprisingly big jump in stocks as being Fed monetization induced, since I still see great weakness in the overall economy that doesn't justify stocks rising. But the proposed link doesn't hold from what I see. Anybody else see how the link would work?

Dr. Conrad is chief economist of Casey Research and a professor at Golden Gate University.

Rocky Humbert offers:

Another possible explanation:

As part of QE, the Fed bought MBS securities from the open market, which reduced their supply and increased their price. This caused some marginal participants to purchase other, less expensive fixed income assets. In this case, corporate bonds.

The Vanguard Short-Term Investment Grade Bond Fund (VFSTX) has returned 12% year-to-date and the Vanguard Intermediate Investment Grade Bond Fund (VFICX) has returned 15% year-to-date. These are huge moves.

As the cost of corporate debt financing declines, it’s logical equity valuations should benefit.

Dr. Humbert is a quantitative analyst and speculator who blogs as OneHonestMan.

Our money and credit expert Rudolf Hauser writes:

From the Zerohedge article "And instead of this excess money hitting broader aggregates such as M2 or MZM, it is held by the banks, who proceed to buy securities outright on their own, either Treasuries or Equities."

When banks purchase securities they pay for them with those Fed created reserves. The person or institution selling those securities now has a bank deposit. The impact on M2 is the same as if the bank had made a loan. But if the high-powered money created by the Fed is kept at the Fed M2 is not expanded. In short the article is incorrect.



 What would the impact of a strong economic employment report be? One dares to contemplate.

James Lackey answers:

The DC fear trade. I'd like to believe that another round of foreclosures or the always predicted disaster in commercial real estate is factored like GM vs LEH, but god forbid if the men get cut off from DC and have to go it alone. Just the fear of abandonment will cause the blizzard of double dip recession stories in the hopper to be front page news.

Rudolf Hauser replies:

I have no idea how the market would react to a favorable employment report this Friday both because I do not know what overall market expectations are or the question regarding recovery potential vs. inflation issues. However, with regard to your comment on inflation and the quantity theory of money, my view is a bit more complex. What is inflationary is the creation of money in excess of the demand therefor at a non-inflationary economy. The demand reflects not only the level of real output, the existence of near money substitutes and their degree of moneyness, inflation expectations and general fear levels, etc. Those fear levels probably are an important factor here. When fear diminishes the higher level of the quantity of money outstanding, which might have been consistent with no or negative inflation during the crisis, could become inflationary. An additional factor to consider is that the pressure to get rid of inventory and to bring in revenues to avoid making difficult decisions such as laying off long-term employees might drive prices below the point of long-term profitability. There would have to be a rebound in such price declines to levels of real profitability before real output potential could be realized. What is the more serious risk is that the government's policies might reduce the real growth potential of the economy with the result that the same growth in money that might have been non-inflationary in an economy with the prior incentive structure and level of impediments to economic growth and full employment would now become inflationary.



On the topic of the role of individuals in history, I read a pretty interesting book called Ubiquity recently (reviewed on my blog ) that addresses this issue as part of its investigation into critical systems (earthquakes, forest fires, markets, etc). Towards the end, the author compares the roles of individuals in history to the grains of sand that cause mini avalanches on a sand pile:

'… the largest avalanches are far and away the most influential in terms of the effects they have on the pile. … how should some historian explain these movements?

Our historian will be sorely tempted to identify certain individual grains as having been massively influential. After all, colleagues will point out that in 1942, an individual grain of immense courage named Granular Columbus triggered an avalanche that ultimately carried grains all the way from the East to the West, and so altered the face of the world and its future. … For each great event, they can identify some extraordinary grain that touched it off, and perhaps a few others that kept it going at crucial stages. And these grains, they might conclude, are the real agents of history.

Despite being tempted to agree, our historian (a subtle observer of individual character) will have noticed that in the sand world every grain is identical to every other, so there really can be no question of any one being a Great Grain. … By understanding that the pile is always on the edge of radical change, our historian comes to realise that there are always places in the pile at which the falling of a single grain can trigger world-changing effects. These grains are only special, however, because they happened to fall in the right place at the right time. In a critical world, there are necessarily a few great roles and some grains by necessity fall into them.

Might the same be true of human history? There is no denying that some people, by virtue of their personality or intelligence, are more influential than others. And yet it is at least a theoretical possibility that our world exists in something very much like a critical state. In such a world, even if human being were identical in their abilities, a few would nevertheless find themselves in situations in which their ordinary actions would have truly staggering consequences. They might not even be aware of it, as the potential for their actions to propagate might only become apparent as history unfolded. Such individuals might come to be known as great men or great women, as creators of vast social movements of tremendous import. Many of them might indeed be exceptional. But this need not imply that their greatness accounts for the greatness of the events they sparked off.

Just as it is almost irresistibly tempting to seek great causes behind the great earthquakes or the mass extinctions, it is also tempting to see great persons behind the great events in history. But the sand-pile historian comes down firmly against the ‘great grain’ theory of history … Our historian might agree with Georg Wilhel Friedrich Hegel, who concluded that:

‘The great man of the age is one who can out into words the will of his age, tell his age what its will is, and accomplish it. What he does is the heart and essence of his age; he actualises his age.’

Rudolf Hauser comments:

For a fire to start one needs something that will burn and oxygen. Without either there will be no fire. With them there will still not be a fire without a spark, or more precisely enough heat to start the process. It is the same with history. No individual can change the course of history if the necessary conditions are not present. Sometimes a fire is more difficult to start and it takes greater skill on the part of someone trying to light it than when conditions are more favorable. The same with history. Sometimes a very unique person can make changes happen if conditions are only slightly favorable to such changes. At other times, conditions are so clear that almost anyone can push history in a certain direction. In short, individuals do matter in the direction history takes but more will be likely to push history in a particular direction at times so that the individual who does so matters little and at other times it takes a unique person to do so. Even if change seems inevitable, the exact direction events take can depend on individuals.

Jeff Watson writes:

Sometimes, wrong or false ideas get put into the mainstream and become accepted as fact. Consider the old axiom that fire always needs oxygen or an oxidizer to occur. Nothing could be further from the truth. There are examples of fire occurring in the absence of oxygen, such as lithium burning in the presence of a pure nitrogen atmosphere at high temperatures, forming lithium nitride. I consider this reaction to be fire as there's a visible flame, but some might dispute the fact that it is really a fire because of the lack of an oxygen component. Since it is ingrained in our heads from an early age that combustion requires four components (oxygen, fuel, heat, and chemical interaction to start a chain reaction), many will scratch their heads with disbelief at the idea of fire without oxygen. People who scoffed at the truths of Copernicus, Galileo Galilei, and Newton and were found to be proven wrong. Some market participants hold similar wrong ideas that get put into the mainstream. The benefit of the economic policies promulgated by John Maynard Keynes comes to mind. It will take time to get the mainstream to prove these ideas wrong, much like it took generations for the ideas of Copernicus to become accepted.

Stefan Jovanovich responds:

Riz Din mentioned Columbus. He became important in late 19th century American eyes because Italian-Americans (but, interestingly, not the descendants of his bosses, the Spanish) celebrated his discovery of the West Indies as a holiday. Before then he was no more important a figure than Vespucci and far, far less important to Americans own view of themselves than the Pilgrims. To his contemporaries the Genoese sea captain was simply one of the literally hundreds of explorers who were doing VC start-ups - looking for ways to break the Ottoman-Venetian monopoly on the spice and silk trade. When other explorers found what Columbus did not - gold and then silver - the focus of Europeans shifted somewhat from East to West; but it was not really until the sugar boom (the one commodity that could not be profitably grown in Asia) that our New World became as important as the Indies. And, even then, North America was very, very unimportant. It is always helpful (and properly humbling to us Americans who think we are truly the center of everything) to remember that after what we Inglese call the French and Indian War, the French peace treaty negotiators thought that keeping Guadalupe was more important than retaining Canada and for half a century thereafter the Brits thought they had gotten the worse part of the deal.

That is the most plausible story of what the Europeans did. But that, or any other story of how Europeans dealt with America, cannot tell us anything about the relative causal importance of individuals. The story is not an equation or an scientific test; there is no empirical answer. After enjoying and wasting half a century reading millions of words of written "history" and dragging my dear wife to old buildings, museums, and shrines, I have come to the same conclusion Hayek came to about "macroeconomics". The idea of "history" is an interesting construct, but it is an aggregationist illusion. Human action does not have a course or a moral or a lesson or a burning point; it is not a river, a sermon, a lecture or a fire. A good history is a plausible story about the past that is honest about the known records, is properly skeptical about our human capacity to tell stories that say "hooray for our side", and views the events from all sides. Not surprisingly, for every good history there are a hundred bad ones. What the bad ones all have in common is the same thing that Hayek found so dispiriting about Keynes as much as he enjoyed and respected the man: the ease with which inconvenient facts can be discarded in favor of a causal theory.

The book Guns, Germs and Steel is the most notorious recent example of really rotten history, but just about everything on PBS will do. But, to be fair, if you mute the narrations and turn off the closed captioning, the photographs have considerable interest. Or, they did, until documentaries decided to become awful dramas of "reenactment". If you want examples of the other kind of history, J.S. Holliday's history of the California gold rush, The World Rushed In, remains a classic; and his later work, Rush for Riches, is an even better story.



VictorThere has been much talk recently about the many bear markets that have been achieved. The way it's usually defined is that a market has declined 20% from a recent peak. There are many ways of quantifying that, but let's say the definition is that the current month's close is less than a monthly close in the last five years by more than 20%, and is also not more than 10% above a close preceding it in the last five years by 10%.

In November 1968 the S&P 500 closed at 108 and in January 1970 it closed at 85. Subsequently the S&P 500 rose, to 118 on December 1972, then fell continously to 64 in September 1974. It then rose continously to 1400 in December 1999 and then fell to 815 in September 2002.

During 1929 the market rose to 31 in August, then fell to 4.8 in June 1932. In June of 1921 there was a 40% drom from tge high of 10.2 in 1916. Those are the only major drops.

There are many questions. There were three declines of more than 40%. Were these offset by the many drops of 20% that bounced back? Have conditions changed since 1929 when the market dropped by 83%? What would proper exit and entry points be? What happens when the market drops by 20% within various periods? How does the interest rate environment affect it? Have declines associated with big drops in real estate been any different? is there such a thing as a bear market?

Rudolf Hauser adds:

Rudy HauserI have always looked at the bear markets that ended in 1970 and 1974 as two distinct bear markets. What characterized both the major periods of down markets in the 1930s and 1970s were inappropriate monetary and other government policies. This is what appears to turn modest periods of market and economic setback into major ones. In the 1930s monetary policy was too restrictive and other government policies were also the absolute wrong way to go. Because these mistakes were on the downside of economic policy decision making, I have tended to view that as one protracted bear market interrupted by a rally. Following the 1970 episode the Fed was much too expansive, which compounded the underlying inflation problem. That in turn led to the 1973-1974 debacle and subsequent ones until this stop-go policy finally ended under Volcker and Reagan. The lesson seems to be that market downturns caused either by market (not just equity markets) imbalances and/or mistaken government policies may remain moderate unless further government mistakes in reacting to the events are badly mistaken ones. One just has to hope that the government and central bank have learned from past mistakes and do not stumble into some new variation of mistaken policies. If they can do that the prospects for the equity markets are much better. The low probability major downside risk I see here is the whole structure of derivatives and other new products that spread out risk to those willing to bear it. The problem comes if enough of those ultimate risk takers are not able to bear it and take down those who lent to them and those who were counting on their ability to pay up when the time comes. If this goes into major financial institutions that are not just short of liquidity but suffering from major negative equity positions that cannot be baled out without special government legislation, we could have a new version of mistake — one that perhaps cannot be blamed on government actions as opposed to inaction, unless one wants to place the blame on monetary policy that too expansive in the past for asset markets.

Jim Sogi remarks:

Jim SogiThere are many ways of quantifying a bear market.

For the sake of argument, let's call it a one or more down months. Looking at Dow monthly from 2/1945 to 11/2006, 309 months were down and 424 were up.

If we say two or more down months in a row is a bear market then we have the following count of consecutive up and down months. Under this definition we are 40% of the time in a bear market. Three down months are close to 40%.

Months in a row, down, up

2 39 50
3 21 32
4  4 11
5  2  3
6  4  6

If we look at first 360 months the situation is much darker with close to 50% of the time in a down market.

2 20 20
3 11 17
4  2  6
5  2  0
6  2  3
7  0  1
8  0  1
11  0  1
12  0  1

The last half is brighter, but there are a number of downdrafts.

2 19 30
3 10 15
4  2  5
5  0  3
6  2  3
7  0  1
8  0  1

So yes, there are bear markets. Lots of them.

As to magnitude: mean down month is -80.8, mean up is +84.2

This shows the drift, but also that the downs months can be bad. This study highlights the skew in the data.



I once drove Milton Friedman from San Francisco to the Hoover Institute while he talked to my dad about his book Free To Choose. (Being dad's unofficial chauffeur for things he wanted keep secret - principally his visits to the hospital and meetings with, as yet, unsigned authors - was my penance for being the black sheep elder son.) Like any sensible author, Friedman spent most of the time talking about royalties, but I do remember a brief exchange on the subject of money. Since the subject of money supply was one of the book's themes, shouldn't there be a glossary or some definition of what it was? It could be put in the back, said dad. Friedman's response was to laugh. That would, he said, make the appendix ten times the size of the book.

C. Kin adds:

Central bank forecasting Published: January 30 2007 11:47 | Last updated: January 30 2007 20:57

Milton Friedman, in one of his final interviews, suggested that monetary policy should be run by a computer. Since the future is uncertain, any interest rate mechanism will make wrong decisions. But humans add another flaw. Monetary policy requires managing expectations of future inflation and interest rates. Policymakers must be able to communicate effectively. Ben Bernanke's initial difficulties and the Bank of England's current woes reflect this challenge. The problem is not policymakers' views but rather that few can understand what those views actually are.

Sweden's Riksbank, the world's oldest central bank, has just joined a small group of institutions with a no-nonsense solution: policymakers publish a forecast of where they expect to set interest rates in the future. This is not as radical as it sounds. If they are competent, they should have a view. And it forms another step towards transparency. Europe's central banks once made inflation forecasts on the assumption of constant interest rates - a pretty silly premise. Now the European Central Bank and BoE assume a more realistic market yield curve. But they expend an inordinate amount of energy hinting at how plausible they believe that curve is. Far better just to say, explicitly, what they think.

Why do most central bankers see forecasts as the last taboo? Partly, self interest - they would frequently be revealed as being wrong. Yet there are two credible objections. First, while financial markets are grown up enough to understand forecasts are uncertain, the general public might not be. Second, making explicit numerical rate forecasts by committee is difficult. Pioneering New Zealand, Norway and Sweden in effect have either a single dominant decision maker or small groups of bank insiders. The ECB's 19 rate-setters and the BoE's nine look unwieldy by comparison. Reformers can forget the Federal Reserve. It is not so long ago that a congressman told Alan Greenspan that he finally understood what the chairman had been saying. "I must have misspoken," was Mr Greenspan's famous reply.

Copyright The Financial Times Limited 2007

Rudolf Hauser adds:

The most important problem with central bank discretion is not the lack of transparency, although that certainly does not help, but rather, it's that central bankers might take actions that make the problems worse rather than better. The problem with a computer program is that it has to make some static assumption about some key variables that might in effect change over time. However, it is possible for a perceptive central banker to anticipate those changes and adjust central bank policy accordingly. It might be much less costly to adjust monetary policy than to force the market to adjust to a predetermined monetary policy.

Forgetting the many specific ways of implementation, there are basically two guides to monetary policy. One is to target high-powered money (the monetary base or in other words the sum of reserves held at the central bank and currency) or a definition of money selected that the Fed could reasonably control through the use of the monetary base adjustments. There are a number of problems here, including changes in the demand for money, the fact that other financial instruments aside from the chosen definition of money are quasi-money and could substitute for the chosen definition (which could itself be fully money - such as an IRA savings deposit), and effectively controlling that definition just by manipulating the monetary base. The other approach is to target the interest rate for high-powered money (the Fed funds rate) or some other interest rate relative to an equilibrium real interest rate. The main problem here is determining what that real equilibrium interest rate is, which includes being able to determine the market's inflation expectations included in the nominal interest rate. The advantage is that changes in the demand for money might not present a problem, and that real equilibrium rate might change over time with shifts in the savings/investment balance and changes in time preference of consumption. Discretionary central bank policy has often just focused on perceptions of the economic outlook and attempted to react to those forecasts by changing interest rates or other targets to moderate the impact of undesired directions in inflation or unemployment. Given that stable prices should be a central bank's key objective in its monetary policy, inflation targeting is a third alternative, with adjustments to interest rate, or money supply targets to be used more directly. Although standard assumption can be made for the demand for money (income velocity) and for the real equilibrium interest rate, setting up an automatic computer program for a policy aimed at inflation is more difficult. It need not be the case if one has a market forecast of future inflation based on an efficient market for inflation-indexed securities to plug into a program that then specifies what adjustments should me made to the more direct targets.

When one has an astute central banker such as Alan Greenspan, discretionary policy might work better. The more stable the environment, the more effective a computer program might be. I favored Friedman's computer approach of targeting M2 until the turbulent times of the 1990s when there appeared to have been significant changes in the demand for money. Until that time, monetary growth had been extremely stable under the Greenspan Fed. After that, monetary growth accelerated to accommodate increases in the demand for money related to various financial crises, etc. Relying on an arbitrary computer program might not have been as effective. In the past, discretionary policy often made economic performance much worse, as was particularly the case in the depression of the 1930s and inflation of the 1970s. Focus on recent performance often created a worse pattern of boom and bust. The Fed has learned something from those past mistakes, so it is possible that those mistakes are less likely to be repeated in the future. But one never knows, and reacting to new circumstances is not the same as avoiding exact repeats of past mistakes. Also, as new people come to the positions, those past lessons might not be as well remembered as they should be. At this point, I am reluctant to rely on a computer program, but I realize that relying on discretionary policies also has considerable risks. What should be the case is that a stable price environment with either no inflation or a predictable minimum rate of inflation should be the standard by which the Fed is judged.



I am indebted once again to the best eye for economics in the 20th century, James Lorie, for introducing me to the cliometrician Robert Fogel, with the comment ” His work is brilliant and important”. Thus, when I saw a reference to Robert Fogel’s 111 page work, The Escape from Hunger and Premature Death, 1700-2100, published in 2004, I was predisposed to give it a read. It is one of the most rewarding and mind boggling short works I have ever read, and I would recommend it to all as a startling shooting star of light on the subject of the records, causes and prospects for longevity, as a beacon of proper methodology for historical studies, a debunker of numerous market fallacies, and a guide for proper thinking of about the industries most likely to prosper in the coming decades.

The main point of the book is that there has been an unprecedented increase of 15 years of life span per person in the last 100 years, for all countries, and that the gains have been much greater for the poor and underdeveloped, mostly coming from the combined co-evolution of better technology and better nutrition.

Fogel has the ideal background to be a cliometrician. He started out as a science major at Stuyvesant, then went into physical sciences at Cornell and History at John Hopkins, where he learned everything then known about economic time series. After 10 years working for his dad’s meat packing business, (his dad was a frustrated engineer — having emigrated penniless from Czarist Russia and having started out below the minimum wage as a janitor), he thought he could solve the problems of why the economy was not at full employment. Then he figured he better study smaller things first, like railroads and steel’s contribution to human progress. Along the way, he fought the battle with traditional statisticians and began to study the rate of return from slavery, based on discussions deriving from a classic paper by John Myers. In the course of studying it, he had to figure out what was known about life expectancies in the 18th and 19th centuries. He found several data bases in Union Army annals, and in Norway, that enabled him to construct time series to shed light on these life expectancies. Strangely he found cycles of increasing and decreasing life expectancy in the 19th century; just a temporary decline from various famines, a slight increase from the beginning of mankind to the end of the 18th century, and then a massive increase in the 20th century.

Fogel describes the central message of the book as technophysio evolution — the synergistic interaction between advances in the technology of production and improvements in human physiology. This evolution led to about a 30 year increase in life expectancy in the 20th century, 13 years in the 19th century and hardly any increase in the thousands of years before that.

whatever contributions the technological and scientific advances of the eighteenth and 19th centuries may have made, escape from hunger and high mortality did not become a reality for most ordinary people until the twentieth century.

Fogel attributes this to the improved productivity of agriculture which gave humans more calories to consume, and thus energy available for work. He places much reliance on global balance sheets of energy available as calories, less the amount needed for metabolism. There was not much left, on average, before the 19th and 20th century improvements in mechanization and transportation, refrigeration and communication.

Fogel believe that the increase in calories gives people a better change of having the right height relative to weight, the body mass index, which is height squared divided by weight. There are many interesting cross sectional tables that show that mortality is greater when the body mass or proper height is not reached.

There are several great leaps of faith in making this argument of causation of the decrease in mortality from these factors. I do not believe that the alternative explanation of better hygiene, and better antibiotics , i.e. better medicine, is adequately tested nor that longitudinal comparisons of causes over time can be based on cross sectional differences at any given time.

The second chapter of the book is devoted to why the twentieth century was so remarkable. Fogel notes that during our first 20,000 years, humans population increased at an exceedingly slow rate. The move from hunting to agriculture 11,000 years ago “made it possible to relieve 15% of the labor force from the direct production of food and gave rise to the first cities”, yet the advances in the technology of food production after the second agricultural revolution of 1700 were far more dramatic than in the first. The new technology’s breakthroughs in manufacturing, transportation, trade, communications ,energy production ,leisure time services and medical services, were in many respect even more striking than those in agriculture. Fogel in chapter 2 gives a beautiful chart of all the improvements of the 20th century, including airplanes, automobiles, penicillin, the discovery of DNA, nuclear energy, computers, cloning, the war on malaria, the man on moon, the genome project, and stem cell research, to prove that the 20th century had a much greater string of advances than other centuries (which look relatively lack luster with just 2 or 3 advances a century at most). But as in so much of chart work, the qualitative enumeration is subject to much debate as others could argue that the the 19th and 18th century were equally important and adduce charts that would look just as convincing.

The second chart in chapter two is crucial to the author’s argument. It shows that the relative mortality risk of Union Army Veterans at 64, 68 and 72 inches is 1.3 to 1 to 0.5 respectively. Similar, but not as strong results apply to relative mortality risk by body mass index, but here a BMI near the middle is very good, with a 0.9 relative risk — and as you get up to 30 or down to 20 the relative risk goes up by some 100%.

At this point Fogel’s training in mechanical drawing at Cornell comes into play and he lovingly presents and describes a Waaler diagram of Iso-Mortality Curves of Relative Risk for Height and Weight among Norwegian males aged 50-64 with a Plot of the Estimated French Height and Weight at four dates superimposed. Such a diagram is a nice example of visual statistics, but it is so crowded and hard to read and based on so few observations at the sharply up sloping points, that it is easy to be mislead. As always, I prefer the raw numbers to the three dimensional chart. Various tables in the rest of Chapter 2 show how specific diseases are getting much less common, and this militates against the main causal explanation for the declining mortality that Fogel gives as being due to nutrition, as for each disease modern medical procedures are associated with the cure.

Despite this, the ending part of chapter two is a tour de force where he presents his ideas on the Thermodynamic and Physiological factors in economic growth. The gist is that in the bad old days, workers lacked energy to work. When they had more calories due to better seeds and fertilizers, workers were able to work longer and at greater intensity.

Changes in health, in the compositions of diet, and in clothing and shelter can significantly affect efficiency. Reductions in the prevalence of infectious diseases increase the proportion of ingested energy available for work because of savings in the energy required to mobilize the immune system, and because the capacity of the gut to absorb nutrients is improved”

He also believes that Thermodynamic efficiency has increased because we eat more meats and sugars, an increase in the Atwater Factors, to use the language of nutritionists.

After summarizing qualitative factors like this, each one of which is highly controversial, Fogel is given to statements like “The average efficiency of the human engine increased in Britain by 53% between 1790 and 1980″, and yet, incentives, incentives, incentives. Without private property, without being able to keep the fruits of your own effort, none of this matters. People who have served as employers and employees know this.

The major contribution of the second chapter is to show that the lower classes gained much more than the upper classes since 1900, but that the upper classes gained more in the time before that:

From the beginning of the Industrial revolution to the end of the nineteenth century, the gap in life expectancy between the upper and lower classes increased by 10 years.

But after this, new variables like increased leisure time, the quality of hospitals and public health, more widespread education, and better water supply take effect, and the gains in standards of living and life expectancy are much greater for the poor and the lower classes from this point.

Despite the doubling of the Asian population in just a few decades, advances in seeds, dry farming techniques, improved fertilizer, new crops, and the expansion of arable land have permitted a vast increase in the world’s food supply. Not only has agricultural production kept pace with the population explosion for the past half century but the world’s per capita production of food has actually increased, rising by about 0.6 % per annum.

A related theme of these chapters is that inequality has been reduced considerably by the fantastic relative improvements in leisure time and life expectancy, and health and ease of living of the lower and middle classes relative to the upper.

The fourth chapter of the book talks about prospects for the future. He forecasts that leisure will increase from today to 2040 from 6 to 7 hours a day and that we will work about 60% as many hours in 2040 as we do today. In the final postscript he forecasts that life expectancy will increase by 2.4 years per decade for women and 2.2 year per decade for me. These equations lead to the prediction that by 2070, female life expectancy will be between 92.5 years, and 101.5 years.

In the society that Fogel sees, leisure activities will be the best to invest in, and durable goods and manufactured goods in general will be stagnating fields. In what I consider the most important investment conclusion of the book he states that:

The point is that leisure care activities, including lifelong learning and health care, are the growth industries of the twenty first century. They will will spark economic expansion during our age, just as agriculture did in the eighteenth and early nineteenth centuries, and as manufacturing, transportation, and utilities did in the late nineteenth and much of the twentieth century..

In total, this is a magnificent and thought provoking book. Almost every page gives you a foundation for understanding economic and social trends better. It will get you thinking about the incredible dynamism of the world economy, the resilience and innovativeness of it all, and the diffusion of material goods and improvements in quality of life that it provides. Never again will you believe the agrarian propaganda that the gains of the last century or the most recent decades have been concentrated in the financial sector or the upper classes. Never again will you believe such shibboleths as ‘manufacturing is the key to our prosperity’ or that the pace of innovation is slower now than before.

This is one book that you will want to read over the dinner table, be sure that is in every library, and that all of your kids and their teachers are exposed to.

Dr. Rudolf Hauser adds:

Having just recently read Fogel’s book myself, I concur with Vic’s favorable view of this work. I might note that it was written for a general audience so you do not have to be an economist to be able to understand it.

Recently we have seen increasing speculation about extending longevity by reducing calorific intake. It is my impression that this work was perhaps based on laboratory rats who live in nice sheltered conditions and do not have to avoid predators or the exposure to diseases that their free ranging relatives face. These are hardly the conditions of ordinary life. We have lots of examples of people with reduced caloric intake in places like Africa who do not seem to have better life expectancy. It should be stressed that I am talking about the idea of people who are not overweight to start with reducing their food intake. The evidence that being fat is not good for you seems clear enough and is not what is at question. (Do people who have faced starvation, say in concentration camps, live longer after they return to normal life than others? I knew one person who had faced food deprivation in a Russian prisoner of war camp who tended to eat too much afterwards because of that experience, so those who do that should perhaps be excluded from such a statistical examination.) In any case, Fogel’s historical data seem to raise additional questions about such a conclusion. In short, his book adds to my skepticism about any such conclusion, and I for one am not about to starve myself into becoming underweight. (As an aside, Fogel’s book has statistics that show that longevity has a positive correlation to height and that the ideal BMI for a tall person is lower than for a short person.)

Fogel’s work also shows the much better nutritional levels in America than in the UK or France at the time of the American Revolution. It resulted in dramatically higher longevity experience in the U.S. even with its risks of the frontier than were found in Europe. As Vic notes in referring to some of Fogel’s points better nutritional intake is related in part to better sanitation and such advances as antibiotics. To me his evidence suggests that nutritional intake (into the body not just intestines) is very important but made possible by many of these other advances. Vic neglected to note that higher BMI’s (up to the ideal point which is exceeded in only a few societies such as in the U.S. today) also result in major improvements in morbidity and that since nutrition of the mother during pregnancy and in the early life of the infant are particularly critical, we should continue to see improvements from those born later in the 19th century as they age compared to their ancestors.

Fogel’s work also gave me a totally different impression of the social changes of the industrial revolution. Clearly Dickens’s concerns about the conditions of the lower classes were not just those of a better-off society being able to care more about the poor who were always with them but also the actual conditions of life. It suggests that in a major period of innovation disparities between the elite and lower working classes might actually increase for some time. (Fogel argues that higher wages were just an offset to worse mortality and living conditions in crowded cities more susceptible to disease than living in less crowded country conditions for much of the 19th century.) This situation should not be as pronounced in developing countries today because of advances in public health (particularly sanitation) and medicine, but it might still be present. That suggests that the social nature of rapid advancement might have difficult transition periods before the full advantages of the advance are really felt at the lower levels of society.

In short, this book is a very impressive summary of much interesting research by Fogel and others that I would also recommend highly for a better understanding of past economic history and present day problems.

Stefan Jovanovich contributes:

As Vic noted, Fogel learned from Kuznets that “the central statistical problem in economics was not random error but systematic biases in the data”. Escape from Hunger is a masterwork, but I think its own data has the bias of relying too heavily on the experience of the British Isles in assessing whether the period of the Industrial Revolution created any actual improvement in nutrition and mortality for the average person.

The data for the British Isles is skewed by the effects of (1) the last great European famine not caused by war - the failure of the Irish potato crop - and (2) urbanization being forced on people by the enclosures of the commons. Even at the time of the Napoleonic War the enclosures were still putting pressure on the villagers in Jack Aubrey’s home district, and he was making trouble for himself by opposing the gentry who wanted to “improve” the common land for their own benefit.

The data for industrialization and urbanization in continental Europe gives a far kinder verdict to the effects of steam power, railroads, coal and steel. Using Dickens for testimony is equally problematic. He was, like so many geniuses, a terrible snob, and he nursed a grievance against having had to work in the blacking factory — not because the work was so arduous but because the experience itself marked him as someone who had actually spend time with the common people. He endured the far more arduous labor of being a “reporter” at Westminster without complaint, and his fright at the conditions of the factory and the city was matched by his horror at the slovenliness of pastoral America. In all Dickens’ comedies the happy ending comes with the good people securing their proper fortunes not from jobs or occupations but with income from unnamed but reliable sources of dividends.



In times like this isn’t it only prudent to consider taking some profits, or at least getting off margin so that one can have ample buying power for when there is a downturn (as in May), and we can remind ourselves of the drift while the world around talks of doom.

Victor Niederhoffer responds:

Such an idea would be right most of the time, but I think it would have a negative expectation. For example, it would miss most of the 1950s and 1990s while waiting for the pullback.

Dr. Rudolf Hauser replies:

There is a very important consideration in deciding how much one should pull back to a less leveraged, less invested position, namely what one has to take out each year to meet regular living costs. If one does not have another source of income than trading, the percentage of one’s net worth that one has to spend for such living purposes increases as net worth declines. That means your net worth will not recover its loss when the market recovers to it prior high. That might not be a significant problem is your required drawdown at the prior peak was less than 1% and/or much of the drawdown is for discretionary spending you can easily cut back on, but could be a major problem if it is a much higher figure such as 10% and most of that is for necessities. Another advantage of cutting back in times of what one believes is temporarily too high is that one is less likely to make stupid mistakes because of panic if one feels one is not in over his or her head. I agree with Vic that going short is a risky position as you are betting against the long-term trend.

GM Nigel Davies adds:

One thing I’ve noticed about good attacking players is that they constantly strive for the initiative they are often happy to make light material sacrifices (for example a pawn, or rook for bishop and pawn). Bit they will tend not throw in the kitchen sink too early, instead holding back reserves. And often they will take time to pick up a pawn or two in the midst of their onslaught.

This contrasts with weaker players, or those less skilled in the attack, for whom nothing less than checkmate is good enough. They appear to be very insecure being material down without a clear means of forcing a win. But by setting their goal so high they reject many good moves along the way and often fall flat on their faces.

So one thing to look for when you are preparing to play someone is how comfortable they are in the attack and with material imbalance. Against players not adept at this it’s often good to snatch material and watch them ruin their positions in their attempts to punish you.



It is necessary to separate profits from trading for oneself from those managing other people’s money. Those proceeds derived from fees and percentages of profits from trading other people’s money where those other people bear the risk of loss do not count.Trading is a way of earning a living. The investments are starting capital and time and effort spent trading, with the latter measured against opportunity costs of not have engaged in alternative activities. Results include not only net worth but also the income taken out over the years for personal needs, alternative investments, gifts, etc. The question from a personal view is whether the returns on time/effort and capital have been adequate to justify the risk and emotional impact of such risk.

Extraordinary returns cannot be achieved without taking extraordinary risks as a general rule. Sometimes a small bet like in a lottery that can easily result in a 100% loss but is insignificant relative to total net worth/ income can result in a huge killing, but the odds of that are very small. But for larger sums and as a general rule it means taking major risks to one’s entire net worth in that to make such gains one has to place most to well in excess of one’s net worth at risk. The only shelter is to use legal means to shelter some assets, such as doing one’s trading in limited liability corporate forms. By such risk one not only means that the incompetent will lose. Such risks consist of factors difficult to know in advance, to unknowable. Skill and ability will give one an edge on the former but not on the latter. A certain amount of diversification and skill at cutting and hedging against losses will also help. But given the risks talked about, it means even the best will fail at times either because of a lapse in the skills (mistakes that could possibly have been avoided) or pure bad luck with regard to the unknowable.

Some have developed great skills and abilities and have been able to make those amazing profits over time. Reversals will happen and results have to be judged over a career. One should compare not to the peaks when one really lived well but to what life would have been like had a different less risky course been followed from the start. Better to have lived well for a time than not at all, unless the final result is so much worse than it would have been with the less risky course. (This ignores the possible psychological costs such as the negative effect of letdown vs. a steadier path even if less on average, which have to be considered as the overall criteria should be one’s happiness properly defined. When considering psychological costs one also has to consider the psychological benefits from riding high etc. and utility values placed on different outcomes and timing impact. These will vary with the person, so that only the person himself can really judge, not the outsiders. This is because only the person him or herself will know their preferences and utility values and state of mind, and then only upon much reflection.)

The best course is to know when one has enough, and to focus on keeping that rather than getting much richer. That is if one has gotten rich, know when to stop taking such risks and getting out while one is ahead. As to having someone invest for one, you can only hope to get super rich doing so if the person doing the investments is able to deliver such results for prolonged periods. One time results, mixed track records or no prior success means the odds of the person having the right skills is less and the odds of success are lower. The odds are higher with someone like Vic or Krisrock who have shown evidence of such skills. But one can never know when the risk will catch up with them. So do not place all one’s assets with any one trader over one time. It may just turn out to be when the skilled turn unlucky. Diversify over time and traders. Returns could be higher by concentrating or they can also be a total wipeout. My guess is that chess is mostly skill and not luck, but trading, which is not governed by fixed rules like chess, has a much greater element of luck. Even a chess player turned loser because of personal distractions could come back when those distractions are removed. A skilled traded turned unlucky just has to get lucky. To the extent that losses were due to the avoidable, the lessons learned might have made them a better trader. On the other side, there might be negative emotional scars from the experience that will reduce trading ability (which requires ability to restrain emotions). And new mistakes are always possible. But the odds of one who has shown skills over time doing well again are probably higher than those of one who has never demonstrated such skills convincingly in the first place.



A phrase that comes to mind when looking at the fate of the original Jack Schwager’s Market Wizards, is ‘A pat on the back is a few small vertebrae away from a kick in the rear end.’ Countless times no one sees the ass whoopin’ coming due to the warm feeling they feel for being on top or the taste of success, resting on laurels.Every time someone is mentioned in an article, book, or put up on a pedestal for the World to emulate and trade after, the edge vanishes, the trader goes bust or has his first down year, standard deviation increases dramatically, his wife leaves him with half of his wealth. When does Vic suggest to Count or test those strategies of our colleagues? After the pat on the back or the kick in the rear?

Do these things happen simply due to the fact that they happen to everyone in life and we are just forcing a correlation? Maybe. Is it because a pat on the back is the magic formula to hoodoo someone, the abracadabra of forced failure?

I do not know, but I do know that one of the most powerful principles that Mr. Bill espoused was anonymity. It is a word in the namesake of A.A.. Anonymity keeps one out of the light and focused on current affairs, wax still clinging to wings. Want to quit smoking, do not tell a single soul! The more people you tell you are going to quit, the more people you will have asking you if you are thinking about a cigarette, which triggers a craving. It is the same thing with positions taken during the day, week, month or quarter. You know the significance points, the edge, but if you share your new found trade with everyone then they call you on the down ticks, adverse headlines and such and once again trigger your ’switching’ cravings.

I would just rather keep my name and face out of the books, TV, award ceremonies and stadiums and stick to doing what got me there anyways. It is easy for me because I suffer from fear of success, but anonymity is powerful in so many ways. Principles before personalities.

How many CTAs, Hedge PMs or Speculators do you know that run from the press, keep below the radar, do not accept awards, and donate and give anonymously or without fanfare? Are they always doing it to conceal and protect positions, net worth, personal information and liberties? No. I say they know and fear a little bit, the fear that comes from that ‘kick in the butt’ after the ‘pat on the back.’ There is no upside from being a part of financial pornography, but discretely sharing and learning amongst friends who practice the same principles as you do is priceless. That way we grow as speculators and individuals and maintain our edges for the most efficient amount of time.

Rudolf Hauser adds:

Part of the problem is the tendency to engage in grand projects or take greater risks to keep up the reputation established by publicity, but I suspect that to a greater extent this is just a symptom of overconfidence in one’s ability as a result of great success. This leads to exaggerated expectations of what one can get away with in terms of risks, grand assumptions, and a reduction in the fear that keeps one sharp and trying harder. These attitudes can exist without the publicity as well, and of course, it is a natural human tendency to attribute success mainly to one’s abilities and insufficiently to luck when one is doing well, and the reverse when one is doing poorly.

Dr. Janice Dorn comments:

It is posts such as this one that elevate the spirit, give pause, put so much into perspective, and remind us to be, always, in gratitude and humility. Thank you, J.T..

In his early writings on market psychology, circa 1912, Selden said that the man with a million dollars is a silent individual, the time when it was necessary for him to talk is past, and now, his money does the talking. The one thousand men with one thousand dollars each however, are conversational, fluent, verbose to the last degree.

Steve Leslie offers:

Here are my two cents:

I heard Lou Holtz the great football coach once say “Things are never as good as they might seem, nor as bad, they are always somewhere in between.”

‘Pride Goeth before a Fall.’ Pride is considered by Pope Gregory to be the the most severe of the Seven Deadly Sins.

I saw an interview with Greg Raymer WSOP Champion of 2004. He said that when he won the WSOP bracelet he did not let it go to his head. He realized that it was more a reflection of great fortune and luck for one week, than the fact that he was that much better than the field. He did not want to be one of those who won the title and then went broke the following year, so he plays within himself.


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