State of the Rose: not addressing the problem

Since I blogged a few weeks ago about "the marshmellow test", I've looked for bloggers who have linked the concept with macroeconomics and I've come across a column by Christopher Meyer that puts the point rather succinctly:

The US doesn't need to match Vietnam's 42% of GDP invested. Just getting to the level of a Singapore (21%) or Switzerland (22%) would be a huge improvement. But it won't be easy. This quote, of disputed origin, expresses the problem:

A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefits....

If you were running for office in a country of marshmallow addicts, what would you do?

A good question. In 2005 David Frum defined a "brokerage party" as "a political entity without fixed principles or policies that exploits the power of the central state to bribe or bully incompatible constituencies to join together to share the spoils of government." Perhaps a political party cannot grow large enough to form a government without becoming a brokerage party.

I believe a starting point on the way to a solution may be to first address policy matters that deal with the mix of national income components as opposed to the expenditure-side mix of consumption and investment. China's undervaluing of its currency, for example, is more than just a consumption versus investment issue: the undervaluation allows the Chinese government to extract a substantial slice of the value of China's exports without distorting the incentives that encourage its people to work so hard and make Chinese labour so productive. Does this remind anyone of the "tax what is inelastic" argument that has been advanced in support of land value taxation? It should.

Naturally-occurring goods such as water, air, soil, minerals, flora and fauna are used in the creation of products. Economists call the payments received by the owners of these primary factors of production, which can be generalized as "land", rent.

An unfortunate tendency of influential people in the Wildrose party is to prioritize protection of the interests of "land" owners under the rubric of protecting property rights. Prior to the 2009 AGM, the party platform included a plank that called for "deeded landowners to receive up to 1% of the provincial royalty income generated on their land." I spoke out against the plank, noting that the policy created a "windfall," with the key point being that any cheques written under this policy "would be totally unrelated to any work or capital contribution by the surface owner." Although the plank was deleted after a close vote, the sentiment remains, and we see it in things like Wildrose's obsession with bills 19, 36, and 50, a focus we've seen from candidates like Link Byfield in addition to the leader.

Granted the issue is not directly a taxation issue, but besides unhelpfully encouraging a NIMBY culture, there seems to be little appreciation for the fact that land owners make no contribution to the production process. They instead just prevent others from using that which would otherwise be useful.

National statistical agencies typically break down broad income and expenditure estimates in order to show how the various sectors of the economy interact in their transactions with one another to produce national output. These agencies (and economists) identify more income categories than just employee wages and business profits. As an economy generates wealth, the price of land and other natural resources increases. Because the gifts of nature cannot be produced by human effort and supply cannot be increased to meet demand, holders of land and natural resources are in a position to capture the surplus - economic rent - generated by labor and capital. This rental income is a distinguishable income category of its own, and there is little call to be especially concerned about protecting its share of national income on either a moral or economic basis given that it is a socially generated surplus that is being privately captured. Besides being bad economics to defend this externality-consuming profiteering, it creates a backlash against profit in general, making it that more politically difficult to provide policy relief to productive labour and industry.

I've gone on something of an extended tirade about the state of the Wildrose Alliance here with today's triple post but in fairness it is not clear that the party leadership is offside with the membership. One of the critical issues both in terms of economics and social justice that the province is facing concerns the far weaker pension benefits that private sector workers can expect relative to their public sector counterparts. The solution is not enriching the Canadian Pension Plan, which would mean public sector retirees with Cadillac pension plans get even more, but creation of a non-universal program that acts as a supplementary plan for private sector workers. The Alberta government, to its credit, has explored a "made in the west" solution along these lines in partnership with British Columbia. The Canadian Union of Public Employees (CUPE) has, no surprise, come out in favour of greater CPP benefits. Who supports CUPE's view? Apparently just as many Wildrosers as non-Wildrosers: "[t]wo-thirds of respondents who support Stelmach’s Conservative Party back an increase [in CPP benefits], as do a similar number of supporters of the Wildrose Alliance Party."

UPDATE Tuesday, October 12:

As if on cue, Wildrose leader Danielle Smith is meeting with the Warburg-Pembina Surface Rights Group tonight to speak about the "Wildrose vision" on "property rights issues" while the OECD has published a study that finds that "recurrent taxes on immovable property" are the "most growth friendly" taxes. Corporate income taxes, which Wildrose circa 2010 has been silent about (unlike Wildrose circa 2008), "have the most negative effect on GDP per capita."

Siding with rural landowners, many of whom simply inherited their land, may make a lot of political sense but on a policy front it is completely wrong-headed.

UPDATE Wednesday, October 13:

"Cancelled Power Plant boosts Oakville Real Estate" makes explicit the connection between the market value of privately held property and public policy. Adam Radwanski then makes explicit the connection to business investment: "In terms of energy policy, the Oakville decision raises all sorts of questions... to what extent will such a reactive decision scare off investment by an industry that sees fewer risks elsewhere?"

Earlier today someone tweeted me saying there isn't a parallel to Alberta's power lines debate, but several months ago Wildrose's leader reportedly said, "Landowners must be fully and fairly compensated for the loss of value in their property and nuisance these new lines will cause."

See MLA Doug Griffiths' remarks after 14:25 of this AlbertaVenture interview for why it's difficult to have a substantive discussion about Alberta's fiscal policy.

the Ottawa card: will an Alberta political party support the Economic Charter of Rights initiative?

What about the dreaded Ottawa card?

The Macdonald Laurier Institute (hereafter, MLI) has called "on the federal government to use its constitutional authority to strike down internal barriers to free trade and mobility within Canada" through an Economic Charter of Rights and then set up a commission that would deal with non-compliance.

An Ontario poli sci professor writing in the Toronto Star has attacked the proposal as "enshrining free market dogma" and the usual suspects over at "Progressive Economists" have agreed that the left's monopoly on the use of the courts to advance their agenda should be preserved. In light of this hostility from the left one would think that "right wing" or "centrist" parties like Alberta's Wildrose and Progressive Conservative parties would consider coming out in support of such a charter. But in fact an endorsement is unlikely to emerge from either party, even (or especially) from the grassroots. One of the members of the MLI's Advisory Council is Purdy Crawford, who chaired the "Crawford Panel" calling for a single national securities regulator, a notion that Wildrose MLA Rob Anderson has slammed. Purdy Crawford has also been described as "dean emeritus of Canada's corporate bar", something that sounds precariously like "eastern establishment" to prairie ears. MLI founder Brian Lee Crowley co-wrote "The Canadian Century" with Neils Veldhuis and James Clemens and that book speaks well of the federal Liberal regime circa 1993 to 2003, surely a cardinal sin in "Conservative" Alberta. Crowley is also a Maritimer who has worked in Ottawa. Veldhuis, Crowley's co-author, is pro-HST, another taboo for the cowboy set.

Can "Conservative" Albertans truly not get past these nominal associations with the "eastern elite" and get behind the MLI's call for an Economic Charter of Rights? The blurb for Crowley's book "Fearful Symmetry: The Fall and Rise of Canada's Founding Values" is solidly conservative:

In the 1960s, Canada began a seismic shift away from the core policies and values upon which the country had been built. A nation of “makers” transformed itself into a nation of “takers.” Crowley argues that the time has come for the pendulum to swing back—back to a time when Canadians were less willing to rely on the state for support; when people went where the work was rather than waiting for the work to come to them.

Just a few weeks ago Western Standard contributor JJ McCullough had little quibble with the good things "The Canadian Century" had to say about the Chretien/Martin regime. In fact, in a must-read review McCullough provides as an "important fact" the book's contention that "[t]he 1993-2003 Liberal government of Jean Chretien embarked on a remarkable agenda of fiscal conservatism..." and quotes, apparently approvingly, the book authors' opinion that "[t]here is substantial risk that current federal [Conservative] policy will undo the fiscal reforms of the Redemptive Decade [1993 - 2003]". Most relevantly for Alberta firsters, "Canadian Century" co-authors Clemens and Veldhuis are, in addition to working for the Fraser Institute, authors of "Beyond Equalization", which critiqued Canada's system of interprovincial transfers and had a chapter on why the equalization program may be illegal.

On this Western Standard page, however, you can see Clemens speaking with the word "Liberal" featured prominently in the background. The unfortunate reality remains: an anti-establishment sentiment is at work on the prairies such that "Liberal" is equated with eastern elites and all things nefarious. The BC Liberals gets high marks from many in the "public policy establishment" for their stance on unions ("the obvious pro-union-pro-worker bias of the [Obama] government has contributed to a slower recovery, especially in labor markets" - Gary Becker, 1992 Nobel Prize for Economics recipient), trade, a carbon tax, the HST, etc. The BC Conservatives are rightly seen as cranks, and Tim Hudak in Ontario has pulled a variety of populist stunts that have failed to whet the appetite of the pundit class, including denunciations of the HST, broadsides against "elitist special interests”, etc. Thus does the Liberal brand retain as much shine in BC and Ontario as "Conservative", if not more.

The Alberta Liberals ought to have a tremendous opportunity to follow in the steps of the BC Liberals by staking out a position as the party of the sophisticated businessperson. The party's support is already skewed towards more educated voters, so why not run with that and reposition as the party for the Economist reader?

I must have my weekly issue of The Economist, or I risk de-evolving into the sort of mouth-breathing rabble by which I am surrounded daily!

- The Onion, Point/Counterpoint

There are four major political parties in Alberta (five if the Alberta Party is included), yet none of the them can be expected to support this national Economic Charter idea, the Liberals because leader David Swann is too resolutely left, the PCs and Wildrose because they are too provincial. That this vacuum in political options should exist is ultimately a failure of the conservative elite, if one can call them that.

US "conservative elites", are, of course, at least as frustrated with nominally conservative American politicians as they are in Canada (where they are not frustrated enough, IMO). Reihan Salam of the National Review was left scratching his head last month after Senate Minority Mitch McConnell asserted that tax cuts pay for themselves. The 20-something liberal bloggers Ezra Klein and Matthew Yglesias both chimed on in the "failure of conservative elites", with Klein writing that "[t]o a degree that people don't quite appreciate, conservative economic elites have attempted to... make people ashamed of... wacky views [in particular the view that tax cuts don't increase deficits]." The result is the absence of a political option for real fiscal responsibility.

the sorry state of the US healthcare debate

After almost two decades of holding a subscription to TIME newsmagazine, I've decided not to renew. I don't have a problem with left leaning publications; indeed, I probably read more material from "left" sources than "right". But what is insidious about TIME is that its agenda is not apparent (aside from the fact that Joe Klein is unabashedly the biggest Obama partisan amongst MSM columnists, a remarkable feat given the intensity of the competition for this distinction). I could take a number of examples, but TIME's July 28 article "Taxing Pricey Insurance: No Health-Care Cure" will readily do. Despite the fact the whole focus of the article is the tax exclusion for employer provided health care, at no point is there any reference to the consensus of expert opinion on the subject. We instead just get

- the claim that "very few [nonelderly Americans] would look kindly on reforming the system" by removing the exclusion

- a few quotes from union lobbyists

- the argument that "Cadillac health plan" is somehow "misleading" terminology because these plans are more often enjoyed by union and public sector employees than CEOs:

many more of the most expensive employer-based health-insurance plans cover people like the families of New Hampshire state employees who, according to the Boston Globe, have policies worth $20,400 per year

- the title's conclusion that there is "no cure" to be found here

Contrast this with more openly leftist The New Republic, where their healthcare writers Jonathan Cohn ("most economists will tell you ... [t]he exclusion distorts the market") and Harold Pollack have both acknowledged where expert opinion lies. As Pollack writes

[re the] Taxation of health benefits... A large and influential group of policy experts--not least among them,Congressional Budget Office Director Doug Elmendorf--believe that this is the surest way to pay for reform and curb health spending in the future.

So why is Pollack not calling unequivocally for removal of the exclusion? He's frank: "For reasons of coalition politics, I don't go as far as ... many economists would." Pollack acknowledges that "Unions provided boots on the ground by the thousands in various canvassing efforts [for Obama]."

It's not like the economic argument is so abstruse mass market readers could not follow it. Of the measures that are uniquely tax exempt in America, the two most significant are income spent on servicing a residential mortgage and income spent on health care services. What is so special about these particular services that consumers should be able to pay for them with pre-tax income instead of after-tax income?

It should be obvious that when the taxman is not taking a cut from a particular sector of the economy that sector's share of the economy is going to grow, and we've already seen the consequences of retail overconsumption of mortgage origination. You accordingly don't have to be an expert CBO analyst to appreciate that raising taxes just on the non-healthcare economy in order to pay for broader health insurance coverage is more likely to "bend the curve" of spiraling healthcare costs up than down.

Although healthcare benefits are also not taxed in single payer systems like Canada, consumers here have to "bargain" with government and thus ultimately themselves as taxpayers for their level of healthcare service. In the US, employees bargain with their employers, and it is all too easy for them to agree to an inflated, inefficient level of service because, to get technically precise for a moment, the deadweight loss created by the externality is borne by third parties (the self-employed and the uninsured underclass).

To make the point with an example, suppose the employment compensation your household earns consists of $50 000 in wages and $10 000 in healthcare insurance. In negotiations for another $5000 in compensation, you could either get, on an aftertax basis, another $3500 in wages or another $5000 in healthcare value. The employer, of course, is indifferent between the two as both would create a $5000 tax deduction for the employer. What are you going to choose? Now, in practice, most individuals are not as familiar with the way the system works as professional union negotiators such that it is typically union members (as opposed to individual bargainers) who end up with "Cadillac" health plans. And so it is that the unions are quite happy with the status quo, such that if there is to be any expansion of healthcare insurance coverage, they want it paid for by taxing the non-unionized (a group which includes the über-rich and the self-employed). Even if not taxed directly, the non-unionized working outside the healthcare sector pay an opportunity cost because unionized employees chose not to take their compensation increase as wages that could be spent in the non-healthcare economy.

On top of this is the fact that removing the exclusion would facilitate labour mobility and make costs more transparent to consumers.

I've been spending a fair amount of time on the US healthcare debate, and the prime reason why is because this is a critical test of whether the United States will get its fiscal house in order. With respect to soaking the rich, "You can only go to the same well so many times": if you can't tax the "middle class" here in order to rein in the deficits, when the policy argument for doing so is so clearcut (any absence of clarity being attributable to the sorry state of the current debate), the United States is highly unlikely to ever do so short of a California style fiscal crisis (or worse).

UPDATE August 4:

It appears that a couple of wonkier left wing pundits have finally broken from the herd. J. Lester Feder, a former "steward of the United Auto Workers" notes in a Salon piece that "[t]he employer exclusion is a backdoor health insurance subsidy that gives the most help to the wealthiest workers with the best benefits while fully taxing the income of uninsured low-wage workers" and defends the reforming efforts of Senate Finance Committee Chairman Max Baucus (D-Mont.) against Obama's union coddling policy. Today Jonathan Cohn at TNR joined Feder in calling for a partial rollback of the tax exclusion for group health insurance by supporting a cap regardless of what organized labour thinks.

Paul Krugman increasingly shrill

Krugman is now lamenting that there are "wingnuts everywhere". Apparently what these wingnuts have in common is a skepticism of Keynesianism. Yet from a purely sociological perspective, if deviants are "everywhere", isn't deviation the new norm?
Last summer, Krugman labelled "Republicans ... the party of stupid". But if that's true, how is it that Krugman's professional colleague, Harvard prof Greg Mankiw, should be sending "kudos" to a lengthly list of politicians, every last one of whom has an "R" behind his or her name?
Methinks the Nobel laureate writing for the NYT should dial it down a notch. Not because he doesn't have a valid point about influential elements of the 21st century GOP being overly hostile to the intelligentsia, but because his charges of widespread wingnuttery suggest as fact something that simply isn't, namely, that those who disagree with him subscribe to fringe theories not to be taken seriously by educated people.
Acccording to David Brooks,

About a third of economists that I was talking to really hate this bill. They think it will cause inflation, really screw up our long-term fiscal situation. Republicans are arguing out of principle, I think.

Part of the problem here with finding a consensus is that there isn't a textbook economic answer like there is to questions like rent control or free trade. It is generally agreed that the long term objective must be to move out the long run aggregate supply curve. But that doesn't say anything about what to do about the short run aggregate demand curve. Most of the serious stimulus skepticism is not directed at Keynesianism as a theoretical model so much as at the efficacy of any particular government effort to manage demand and the political difficulties of reversing in the future deficit spending that is supposed to be reversed.
The Economist's Feb 7 edition notes that a "main conflict lies between the need to spend quickly and the desire to spend well." My own view, and I suspect that of most of my fellow stimulus skeptics, is that in the presence of uncertainty, one should err in favour of spending well. Having said that, there's no denying that whatever the merits of Schumpeter's "creative destruction", the Great Depression wasn't worth it. There does come a point where the risk of a devasting collapse in demand is so great that massive spending is called for. Whether we have reached that point, or could even ever reach that point when monetary (as opposed to fiscal) policy is running flat out expansionary (something that was not the case in the 30s), is another question.

You knew conservatism and fiscal prudence had gone the way of the Edsel when the promoters of Montreal's Just for Laughs festival praised the Flaherty budget for lavishing money on festivals. Comedians no longer exist just to give us the giggles: now they're economic stimulus.
- Derek DeCloet, G&M ROB, Feb 7

Krugman's broken windows

In his Feb 1 post re the "Buy American" provisions in the US stimulus bill, Paul Krugman argues that not only is fiscal demand management good policy, it is good even when it is admitted that the spending is inefficient.

Krugman makes a large concession when he grants the validity of the comparative advantage argument that's at the root of the economic consensus supporting free trade. It follows that he would have to concede that national stimulus packages which stimulate production of goods in which those nations have comparative disadvantages (i.e. have buy domestic provisions) would also be inefficient. Krugman essentially concedes that even if Doug Irwin's examples of inefficiency obtained, in other words, the need for spending now is so great it is necessary even if the same spending some time later (when domestic suppliers to government did not have a monopoly) would buy more. The need for more global stimulus is so great that apparently it would make "the world as a whole better off" even if Canada's government was using taxpayer money to develop a domestic banana industry while Singapore subsidized domestic softwood logging! Special times call for special measures... even broken windows!

For an economist, an appeal to efficiency is the trump. Yet Krugman seems to believe that trump can be trumped by an appeal to Keynesianism.

As for the empirical (evidence based, as opposed to theory/logic based) argument, perhaps Krugman will comment on the findings of the centrist Peterson Institute that "Buy American" would likely cost more jobs than it creates.

"I just hope they know what they're doing."

It's just a gigantic scale.... It's the entire economic consensus in this country, including the academic economists, the Treasury people.... We're just taking such big moves. As I say, I just hope they know what they're doing.
- David Brooks, The Newshour with Jim Lehrer, November 28

I also hope they know what they're doing.

And I have major doubts that they do.

Let's start with the contradictions. "The entire economic consensus" used to be that cutting consumption taxes, like Canada's GST, which was just cut another 1% earlier this year, was the worst possible tax cut. Yet Britain cuts its VAT 2.5% and "Jonathan Loynes, chief UK economist at Capital Economics, said: 'This would be a bold, high-impact way of putting money straight into consumers’ pockets.'" Another source says that "[Britain's] economists seem united by a single opinion over the Government's immediate move to slash VAT from 17.5% to 15%. ... The move was, broadly, welcomed, and [even] criticised as not on its own being enough..."

So what was formerly out of fashion, to put it charitably, is now "bold" and "high impact"?

Auto sector bailout? Joseph Stiglitz is opposed, which wouldn't be especially surprising were it not for the fact that Stiglitz has been the most prominent economist to repeatedly jab an accusing finger at the Washington Consensus and free markets generally. Apparently Stiglitz doesn't think the decisions of private finance re the allocation of capital should be second-guessed... except when they should.

The incongruities increase: Germany's Social Democratic finance minister, Peer Steinbrück, said:

All this will do is raise Britain's debt to a level that will take a whole generation to work off. The same people who would never touch deficit spending are now tossing around billions. The switch from decades of supply-side politics all the way to a crass Keynesianism is breathtaking. When I ask about the origins of the crisis, economists I respect tell me it is the credit-financed growth of recent years and decades. Isn’t this the same mistake everyone is suddenly making again, under all the public pressure?

A supposedly left wing politician, and a Continental one at that, is the voice speaking out against a deficit-financed government spending spree? I'm reminded of when the NDP criticized Alberta's "Conservative" government for its spending. Considering the source, perhaps they have a point?

It is true that there are economists like Greg Mankiw who consider themselves stimulus skeptics, but Mankiw is (1) apparently very much in the minority ("Only one outside economist contacted by Obama aides, Harvard's Greg Mankiw, voiced skepticism") and (2) Mankiw is careful to call himself a skeptic and not an opposer.

There was a time when I put a lot of stock in what academics hold as true with respect to finance and economics. But my experience of the real world of finance disabused me of notions that are still considered gospel for professors, like market efficiency. Markets are not efficient with respect to pricing; they are inevitably subject to manias, panics, and crashes (unless (and even then this is just a theoretical unless) there is total transparency and simplicity with respect to how to determine fundamental values). Indeed, this is at the very core of what got us into this mess: the idea that market-determined prices reflect economic fundamentals. Financial engineers were given free reign to innovate ever more exotic financial products that worked AGAINST efficiency instead of for it by reducing transparency and simplicity. You didn't get better capital pricing with more financial market development, you got worse. Things got further and further away from fundamentals because the trial of bread crumbs became so long and convoluted nobody could understand it.

Now, as an aside, when I speak of market development I speak of the number and complexity of financial instruments (in particular second and third order instruments, aka derivatives) as opposed to liquidity. If I were pointing the finger at liquidity or trading levels, I'd be pointing the finger at capitalism itself.

These academics, in conjunction with the Wall Street veterans who have a conflict of interest with respect to bringing the sort of transparency to capital pricing that would allow non-Ivy League MBAs to figure out what was going on, are supposed to be now be deferred to with respect to a gi-normous dump of future generation financed government spending?

Germany's social democrats are questioning the wisdom of a massive expansion of government, while the Anglo-Saxon world is gung-ho. May you live in interesting times.

Financial Crisis '08: attack of the parasites

How did this happen?

In a nutshell, consumption, especially in the US, of housing was at an unsustainable level, driven as it was by mispriced credit (too cheap). Government policies such as the deductiblity of interest on money borrowed to purchase a home aggravated the mispricing.

In general you support laissez faire policy on the grounds that government interventions, however well intentioned, typically create mispricings that undermine their objectives. But when you suggest here that government policy "aggravated" the mispricing, are you suggesting that the free market mispriced?

Yes. To begin with, free markets are subject to panics, manias, and bubbles, and these are mispricings. The "bubble" in US mortgage lending has been followed by a global credit panic.

It is important to understand here that panics and bubbles are symptoms of a problem, however, as opposed to the problem themselves. The problem is a lack of transparency. If it is clear to everyone what the "true" price should be, prices wouldn't soar far beyond that or crash far below.

Financial intermediation is critical to economic development. It puts people with ideas about how to produce more for less together with people with the capital to enable that idea. Unfortunately for capital suppliers, they have less information about the value of potential investment opportunities than the capital seeking entrepreneurs. Economists call this "information asymmetry", a concept at the core of financial market theory.

There are various things governments and regulators can do to try to address this problem, such as mandating disclosure and prohibiting trading on non-public information (lest the pool of willing capital suppliers shrink to insiders). Especially important is creating an investor friendly tax and legal system in the background. One of the lessons of this crisis, however, is that there was, in the end, still a significant shortage of information, or, more precisely a shortage of meaningful information in a sea of complex data.

So price discovery cannot be left to the private sector?

The wrong lesson from this crisis is that government should discover prices (i.e. determine how much of any given good or service should be produced). The right lesson is that private actors discover prices best and what happened is that these actors were overwhelmed by other private actors who obscured prices.

Who obscured prices here?

The guilty parties are legion, ranging from mortgage applicants who misrepresented their incomes to uninformed retail traders who exacerbated any mania or panic, but the prime culprits here are investment bankers. Investment bankers are financial innovators. And for a long time this financial innovation was economically useful. For example, whoever invented the common share made a very useful contribution by creating a product that represents a residual claim on a firm's assets instead of a fixed claim (like a bond or a bank loan). But with the explosion of progressively more complex derivatives, the generally useful process of spreading risk by slicing and splicing various payoffs and exposures became dominated by the harmful process of of obscuring just what the risks were.

Is there an example of when spreading risk is not useful?

Yes. Consider a bank originating a mortgage. It knows the borrower if it has a first hand relationship and has every incentive to monitor that borrower. If the default risk is spread, the bank will lend more and monitor less. Indeed, this financial crisis brings us back to the typically ignored policy fact which is that overinvestment is as much a problem as underinvestment per se, overinvestment in a particular sector implying mispriced investment (which in turn implies underinvestment in some other area). When investment bankers step in to slice and dice the risk across a chain of parties, they create another chain of information asymmetries and the duty to monitor suffers from a "tragedy of the commons".

How does it serve these investment bankers to obscure?

The more complex the valuation process is, the more these people leverage their comparative advantage. Markets move money from the uninformed to the informed. To a large extent, this is what policy makers want, because it is central to the idea of efficient price discovery. But in this case, "informed" people were making money who were not, in fact, more informed about the fundamental economic (as opposed to financial) values, they were rather more informed about the operations of things like derivatives, which do not further price discovery.

Why do you call derivatives parasites?

Because the value of a derivative is entirely derived from the value of the underlying. Resources diverted to pricing derivatives are resources diverted away from price discovery of the underlying.

Had the investment bankers really understood the nature of the beast they created, they would have kept the host alive. But in the end the beast was so big it completely obscured any view of the host.

Tory MLA on the "US Slowdown"

" In the US there is a market correction going on that has been amplified by the sub-prime mortgage mistake. People who couldn't afford a house were given mortgages at below prime..."

As Wikipedia explains, "Subprime lending (also known as B-paper, near-prime, or second chance lending) is lending at a higher rate than the prime rate. ... A subprime loan is offered at a rate higher than A-paper loans due to the perceived increased risk." What's "less than prime" is the credit of the borrower, not the rate!

"they have a devalued/devaluing dollar that is creating subsector inflation (all goods imported will grow more expensive..."

This has the causal relationship backwards. As noted by the Bank of Canada "the value of the Canadian dollar is determined by economic forces (fundamentals), such as the rate of inflation and the level of interest rates in Canada..." not the other way around (aside: that BoC webpage contemplates intervention, but my former boss at the Finance Dept and fellow Edmontonian Mark Carney says that the Bank won't be intervening while he is Governor). I appreciate that the reference here is to "subsector" inflation but I don't see what the problem is if it is necessarily accompanied by "subsector" deflation such that you don't have macro inflation, period.

"the US has a national debt that is growing rapidly ... (and that in turn leads to further depreciation against world currencies.)"

Of relevance for currency level is the fact that the United States has a massive current account deficit. The vast majority of that deficit is accounted for by the merchandise trade deficit, although the flow of greenbacks out of the US is increased by unilateral transfers (US foreign aid or immigrants in the US who send dollars back to their families) and factor income (foreigners who receive interest, dividends, or rent from the assets they own in the US).

As long as foreigners continue to "finance" the current account deficit, the dollar's value will remain stable. Foreigners can use the dollars that arise from their current account surpluses to purchase US assets, whether it be property and plant on US soil (foreign direct investment or FDI), shares in US firms (portfolio investment), or US Treasuries. China and Japan in particular have bought enormous amounts of US government securities.

The mirror image of the massive US current account deficit is thus the massive US capital account surplus.

To what extent does increasing US national debt dissuade foreigners from continuing to finance the current account deficit? One study suggests that a $1.00 reduction in the federal budget deficit would cause the current account deficit to decline less than $0.20. Also, the US current account deficit expanded by about $300 billion between 1996 and 2000, a period during which the US federal budget was in surplus. See also "How I Learned to Stop Worrying and Love the Current Account Deficit".

Besides, if you have a project that will return 10 cents on an invested dollar every period, why stop investing with just the money you have on hand, if someone is willing to lend you more for just 2 cents interest on every additional dollar lent to you? This is to say, the expanding US debt might be the rationally responding variable to international investors who are falling over themselves to finance the US. Indeed, no less a personage than Ben Bernanke says he wishes to:

... take issue with the common view that the recent deterioration in the U.S. current account primarily reflects economic policies and other economic developments within the United States itself.

Non-Americans aren't just the drivers on the capital account, either. If the Chinese weren't happy with their current account situation vis-a-vis the US they'd let their currency float.

Note that while one of Bernanke's predecessors, Paul Volcker, points a worried finger at the fact that "What holds it all together is a massive and growing flow of capital from abroad, running to more than $2 billion every working day, and growing," he acknowledges that "As a nation we don't consciously borrow or beg. We aren't even offering attractive interest rates". In any case, "Bernanke" has declared "Paul Volcker an enemy combatant to the economy" and as for Greenspan, well, evidently he isn't especially worried about the current account deficit.

I certainly agree that spending should slow and the net asset position be improved. But the declining US dollar isn't the US' problem. Rather, it's the solution! Current external imbalances can be unwound either by future trade surpluses or by future favorable returns on the net foreign asset position of the US. A declining greenback increases the dollar value of US assets currently denominated in foreign currencies and helps to increase net exports as well. This study finds that "a 10% depreciation of the dollar represents, ceteris paribus, a transfer of around 5.9% of US GDP from the rest of the world to the US."

"... slow spending, slow borrowing, and encourage savings and debt pay down... [otherwise] ... the only way it will turn around at that point is for interest rates to rise to 15 - 20% for close to a decade..."


It's remarkable that a member of the Alberta government can wag the finger about slowing spending and improving the net asset position with no apparent sense of irony.

As I observed during the campaign: "most absurd of all is [the premier's] contention that a vote for anyone other than Ed is going to lead to '22% interest rates'."

Apparently our MLA here has been or is a member of the Standing Committee on the Alberta Heritage Savings Trust Fund. As I noted a month ago, Jack Mintz told the Calgary Herald on Jan 21 that the Alberta government "needs much more fiscal discipline" and "[t]he most important message that will come out of our report will be why Albertans should save." Why is the government continuing to sit on this report? There was ZERO indication in Tuesday's Throne Speech that the Alberta PCs will be giving any consideration to taking the medicine one of their number is prescribing for another government.

At bottom, I entirely agree with the thesis that government should be moving out the long run supply curve instead of juicing short term demand. But at least the US is contemplating more fiscal stimulus when the economy is far from running at full tilt. If the Alberta government wants to lecture anyone about stoking inflation, they just need to find a mirror!