ProfessorBainbridge.com

The Democrat's Economic Policy

John Carney's been watching the DNC and concludes:

The Democrats seem to be completely sold on the narrative that Clinton-era tax hikes and budget surpluses produced low interest rates and widespread prosperity that was later squandered by the Bush administration's deficits, with the end result of the financial crisis and "The Worst Recession Since the Great Depression." (Read more: Want The Truth? Every Politician Wants To Raise Your Taxes)

There’s not really any reputable economic theory that supports the idea that the combination of higher taxes and government budget surpluses leads to greater prosperity. It’s more like a shadow of a theory, something Democratic policy makers created from crib notes from respectable economic theory.

Carney concludes that the Democrat's policy requires one to assume not the proverbial can opener, but rather a free lunch. And there ain't no such thing.

Are we doomed to permanent deficits?

Buttonwood observes:

America has run a deficit for 40 of the last 44 years; Britain for 51 out of 60 and Spain for 45 out of 49. France has not balanced its budget since 1978; Italy since 1960.

I get the theory that in recessions one ought to run a deficit so as to stimulate the economy. But we haven't been in a recession for "40 of the last 44 years." The deficit is not about fiscal policy, it is about trying to have both a military hyperpower and a pervasive nanny state set of entitlements. It's long past time we tried austerity for a while.

Personally, I'm starting to believe that getting Paul Ryan into ever-increasing seats of power may be our last shot at sensible fiscal policy. Certainly, there's no reason to think the incumbent will make any progress. Obama's solution--to the extent he has one--depends on increasing taxes on the 1%. The troubel with solving the deficit with tax increases, of course, is obvious. As Milton Friedman explained:

... postwar experience has demonstrated two things. First, that Congress will spend whatever the tax system will raise—plus a little (and recently, a lot) more.  Second, that, surprising as it seems, it has proved difficult to get taxes down once they are raised.  The special interests created by government spending have proved more potent than the general interest in tax reduction.

If taxes are raised in order to keep down the deficit, the result is likely to be a higher norm for government spending. Deficits will again mount and the process will be repeated.

The solution remains a combination of starving the beast and cutting spending.

The continuing global impact of central bank policy on savings

Buttonwood notes some shocking facts:

As Deutsche Bank points out in its long-term asset return study, the longest series of bond yield data is for the Netherlands dating back all the way to 1517. In June, those yields reached a record low. Not just any old record, then, but a 500-year nadir. In America, yields go back only to 1790 but they too have been at all-time lows.

In other words, the developed world's central banks have (a) failed to stimulate the economy and (b) created an environment in which saving essentially is pointless because returns have been so low for so long. Maybe it's time to try some new central bankers and some new ideas.

The lesson of LIBOR: If we can't trust regulators to enforce current law, why would more regulation be a good idea?

Schumpeter makes a point I've been emphasizing in discussing the LIBOR scandal:

BOOSTERS of financial regulation are making hay from the widening scandal over allegations that LIBOR, a key interest rate, was rigged repeatedly for at least five years since 2005. Yet the trove of documents that have emerged also reveal the very flawed nature of regulation, in which government bureaucrats are asked to keep tabs on high-flying financial sorts. Transcripts of calls between officials at the Federal Reserve Bank of New York and traders at Barclays show that regulators didn’t really pick up on cues, even when they spelled out misbehaviour.

LIBOR, of course, is not the only pertinent example. Also in current news are the regulator failures at Peregrine Financial Group:

The Wall Street Journal reviewed the letters, which a person familiar with the situation said were left by Peregrine Chief Executive Russell Wasendorf Sr. They offer the first account of where Peregrine's missing money might have gone in a case that has left holders of thousands of accounts facing possible losses and fueled new concern over regulation of the futures-trading industry.

One of the notes, which was a general statement describing Mr. Wasendorf's alleged fraud and signed by him, says regulators first examined Peregrine's use of client funds as far back as 1993, triggering Mr. Wasendorf to start his alleged fraud. Deceiving the regulators was "relatively simple," said the statement. ...

The statement indicates a potentially closer involvement by the CFTC in overseeing Peregrine, commonly known as PFGBest, than previously thought. The CFTC has said it left the day-to-day regulation of Peregrine to the National Futures Association, an industry self-regulatory body. Thus, the note could put further pressure by investors and lawmakers on the CFTC for missing the scandal, particularly given the intense scrutiny alleged in the note.

If we can't trust regulators to capably enforce the laws on the books, why would we remotely think that more regulation is the right answer?

Favorite all-time TV shows

YMMV, but here's my list:

Is Venture Capital in Crisis?

The recent financial crisis cannot totally be blamed for the marked drops in venture capital fundraising, reduced venture investment and the hindrance of successful exits around the world, but it may have exacerbated the existing problems. Poor returns over the past decade indicate most fund managers do not earn their fees, and investors have been increasingly wary of taking on added risk without getting the reward. Structural changes are inevitable to the venture capital marketplace to preserve an essential source of funding for nascent high-growth companies.

--Cumming, Douglas J. and Johan, Sofia A., Is Venture Capital in Crisis? (June 11, 2012). World Economic Review, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2082062

via papers.ssrn.com

Chicago Economist Luigi Zingales on Crony Capitalism and the Crisis of the West

Musing on the implications of the Eurozone crisis:

Americans should be concerned for a deeper reason. High deficits, high debt and unsustainable entitlements are symptoms of a common disease infecting Southern Europe and the U.S. That's crony capitalism, a problem with which I, having lived in Italy, am unfortunately familiar. ...

For the U.S., the moment to act is now, before the cancer of crony capitalism metastasizes. The tax code needs an overhaul that eliminates special treatment and bans any form of corporate subsidy—starting with too-big-to-fail banks. We must find ways to introduce more competition into sectors such as education and health care, while expanding economic opportunity for those at the lower end of the income spectrum. And we must curb the political power that large industry incumbents have over legislation. Not only does it distort legislation, it also forces new entrants to compete on lobbying instead of concentrating on making more innovative and cheaper products.

It is not too late for the United States, but the clock is ticking. We have already begun to look like Italy. If we don't do something to stop that soon, we will end up like Greece.

via online.wsj.com

Let's just suck it up and take our medicine

I'm reluctantly coming around to the idea that stalemate might be a good thing:

As Ezra Klein explains:

The “extended baseline scenario” means we let the Bush tax cuts expire, the spending sequester take effect, etc. The “alternative” scenario means we extend everything.

In the “extended baseline scenario,” which is the one currently written into law, we don’t have a debt problem, but we have much higher taxes and, in the short-term, a likely recession. In the “alternative” scenario, we’ve got a huge debt problem, but lower taxes and less short-term austerity.

We can only go on kicking the can down the road so long. So maybe we ought to just go ahead and take our medicine now.

"Only a pessimist owns gold, and pessimists who do not also own guns are laughable"

The title of our post comes from a wonderful essay entitled Fool's Gold: Why Ordinary American Citizens Ought Not to Invest in Gold.

I don't own either, FWIW.

"Civilized People Don't Buy Gold" (Updated)

CNBC reports:

Warren Buffett's right-hand man, Charlie Munger, agrees with his boss on most things but there's one area they disagree — gold."

"Gold is a great thing to sew into your garments if you’re a Jewish family in Vienna in 1939," the Berkshire vice chairman said, "but I think civilized people don’t buy gold, they invest in productive businesses."

I'm reminded here of Terry Pratchett's wonderful Discworld novel Making Money, in which Lord Vetinari maneuvers reformed criminal and current Ankh-Morpork Postmaster General Moist von Lipwig into taking on the job of running the Bank of Ankh-Morpock and the Royal Mint. Lipwig eventually discovers that the 10 tons of gold supposedly in the bank's vaults is now longer there. Panic almost ensues. Naturally, however, Lipwig saves the day, gets the girl, and persuades the citizens of Ankh-Morpock to abandon the gold standard.

In doing so, Lipwig is interviewed by The Ankh-Morpork Times' crack reporter Sacharissa Cripslock, in the course of which Lipwig comes up with what I have always regarded as a compelling argument against the gold standard:

"The world is full of things worth more than gold. But we dig the damn stuff up and then bury it in a different hole. Where's the sense in that? What are we, magpies? Is it all about the gleam? Good heavens, potatoes are worth more than gold!"

"Surely not!," [said Ms. Cripslock]

"If you were shipwrecked on a desert island, what would you prefer, a bag of potatoes or a bag of gold?," [replied Moist]

"Yes, but a desert island isn't Ankh-Morpork!"

"And that proves gold is only valuable because we agree it is, right? It's just a dream. But a potato is always worth a potato, anywhere. A knob of butter and a pinch of salt and you've got a meal, anywhere . Bury gold in the ground and you'll be worrying about thieves for ever. Bury a potato and in due season you could be looking at a dividend of a thousand per cent."

"Can I assume for a moment that you don't intend to put us on the potato standard?" said Sacharissa sharply.

Update: A comment over at Walter Jacobson's blog opines that:

I think that we are in the same situation as the Jews in Vienna in 1939. In other words, it is going to hit the fan in the next few years.

Which calls to mind a passage from Edward McQuarrie's essay Fool's Gold:

In making a rational decision about whether to invest in gold, two possible outcome scenarios must be considered:

1. Society does not collapse
2. Society does collapse

Gold can only be a winning investment under the second scenario. If society does not collapse-if we continue to muddle through, as we more or less have in the United States for several centuries now-then gold is a losing investment. To see why, we have to explore what it means to be a "store of value."

I'm going to skip his explanation of why gold makes a lousy store of value. Instead, I want to go on to the survivalist argument for gold:

Please run the following movie in your head: society has just collapsed and you, whistling cheerfully, tossing your gold coins in hand, stroll down to the store, shouldering ahead of those wretches with their wheelbarrows of worthless paper currency, to buy a loaf of bread …

What's wrong with this picture? Two things: either you will be beaten bloody, and your gold robbed, before you ever get to the store; or, you will be followed home and murdered in your sleep-and your gold robbed.

First moral: if you are going to buy gold, you have to buy a shotgun too. Under precisely those conditions where gold will finally pay for itself, it will be far too dangerous for an unarmed person to carry gold. If you truly believe that you need to own gold, then it follows directly that you need to own a shotgun too. Bars on the windows and a Doberman wouldn't hurt either. ...

Second moral: under precisely those circumstances where gold would pay off as an investment, you can't possibly trust anyone else to hold your gold for you. And if you are thinking that you will keep your gold in a repository just until things start to look grim…have you ever seen pictures of a run on a bank…it isn't very pretty. Besides, how are you going to get that gold home, without a shotgun-do you really think the repository employees are going to keep mum about this guy in the red Camry, now heading West on Main Street, with thousands of dollars of gold in the trunk? ...

If you are going to buy gold, you must think and act like a survivalist.

Paul Ryan's take on Catholic social teaching

Daniel Henninger quotes Paul Ryan's explanation of how Catholic social teaching influenced his budget proposal:

"A person's faith is central to how they conduct themselves in public and in private. So to me, using my Catholic faith, we call it the social magisterium, which is how do you apply the doctrine of your teaching into your everyday life as a lay person?

"To me, the principle of subsidiarity . . . meaning government closest to the people governs best . . . where we, through our civic organizations, through our churches, through our charities, through all of our different groups where we interact with people as a community, that's how we advance the common good. By not having big government crowd out civic society, but by having enough space in our communities so that we can interact with each other, and take care of people who are down and out in our communities.

"Those principles are very, very important, and the preferential option for the poor, which is one of the primary tenets of Catholic social teaching, means don't keep people poor, don't make people dependent on government so that they stay stuck at their station in life. Help people get out of poverty out onto a life of independence."

Predictably this has outraged the Catholic left, which basically equates CST with the Democrat Party platform.

Personally, I agree with Rob Vischer that CST is incapable of "easy categorization."

Having said that, however, I think it is essential that Catholic conservatives like Ryan articulate an alternative interpretation of CST that departs from the left-liberal conventional wisdom. 

As with all of the Church’s ordinary teaching, the faithful “are to adhere to [the social teaching] with religious assent.” United States Catholic Conference, Catechism of the Catholic Church ¶ 892 (2d ed. 1997). Yet, the church encourages lay initiative “especially when the matter involves discovering or inventing the means for permeating social, political, and economic realities with the demands of Christian doctrine and life.” Id. at  899.

Mark Sargent observed that “the Catholic university—and hence, the Catholic law school—is where the Church does its thinking.” Mark A. Sargent, An Alternative to the Sectarian Vision: The Role of the Dean in an Inclusive Catholic Law School, 33 Univ. Toledo L. Rev. 171, 181 (2001). In my view, one properly may generalize Sargent’s proposition to the believing laity as a whole. Hence, it is the task of Catholic intellectuals to exercise critical reflective judgment with respect to society, the Church, and the relationship between the two.

An active and critical role for the laity seems especially important with respect to economic life. To be sure, when it comes to issues such as the degree of state intervention in the economy, for example, the Church outlines basic principles but recognizes substantial latitude with respect to their translation into public policy. Nowhere, for example, does the Church state what percentage of the economy should by controlled by the state, thus leaving a great deal of room for prudential judgment by Catholics.

Nevertheless, as Michael Novak has noted, the Catholic hierarchy tends to be poorly trained in economics and inexperienced with the business world. They “are likely to inherit either a pre-capitalist or a frankly socialist set of ideals about political economy.” Michael Novak, Toward a Theology of the Corporation 59 (rev. ed.1990). Consequently, the hierarchy is “more likely to err in this territory [i.e., economic justice] than in most others.” Id. at 12.

Thoughtful and faithful applications and critiques of the social teaching from Catholics like Paul Ryan are thus essential to ensure that that teaching remains resistant to “easy characterization.”

Gingrich touts Chilean pension system as Social Security reform

Politico reports that:

Newt Gingrich Sunday said that he'd like to see the United States adopt a 'Chilean model' for Social Security — a pension system that is reliant on a government mandated purchase of a private investment account. ...

The idea of personal savings accounts was first raised in a September GOP debate by then-presidential candidate Herman Cain. Conservatives are in the midst of a battle against President Barack Obama's health care law, citing the individual mandate as a violation of personal liberty. But the Chilean pension model relies on a similar regulatory scheme, forcing workers to contribute at least 10 percent of their pre-tax wages into a private investment account.

If the idea got traction, I'd be quite leery of the mandate aspect of the Chilean system. Of course, I'm not all that crazy about the current tax-based system. I'm quite confident that the money I pay into Social Security would earn a significantly greater rate of return if I could put it into an IRA-type vehicle instead of a government program.

In any case, it's not clear that the Chilean system is superior to our Social Security system. A NBER report found that:

The Chilean reform gets high marks for defending the system from political risk and for its effects on capital accumulation and on the functioning of the capital market. The Chilean reform gets low marks for the provision of insurance and for administrative cost. Perhaps the most surprising aspect of the Chilean reform is the high cost of running a privatized social security system, higher than the 'inefficient' system that it replaced. Valdes-Prieto has estimated that the average administrative charge per effective affiliate while active is U.S. $89.10 per year (for 1991) which is 2.94% of average taxable earnings. This is close to 30% of the 10% mandatory savings rate. The cost per person is not far from costs observed in other privately-managed pension systems, such as defined-benefit private pensions in the U.S. However, it compares unfavorably with administrative costs in well-run unified government managed systems.

High admninsitative costs translate into a substantial reduction in effective yield. But I wonder if we could significantly reduce those costs by giving people a limited array of choices emphasizing low-fee index funds rather than actively managed funds.

Matthew Bishop's new ebook on money and gold

The Economist's Matthew Bishop sent along this email:

I just wanted to let you know that my first ebook (again written with Michael Green) has now been published. It is a look at the history, current crisis, and future of money, through the lens of the rise, fall, and rise again of gold. We learnt a lot writing it, and I think you will enjoy it. This fun animation sets the scene: http://www.youtube.com/watch?v=oAJLY93g6WQ

It provides a lively analysis of the big economic questions currently facing America, such as the danger to the dollar posed by gridlock in DC, especially over deficit reduction, the euro crisis, the growing risk of inflation and the changing attitude of China towards America.

Amazon somehow persuaded us to agree to let them sell it for the absurdly low price of $2.99, so I do hope you will buy a copy, encourage your friends to do so, and give it a shout out on twitter, facebook or whatever other social media you use.

It is called "In Gold We Trust? The Future of Money in an Age of Uncertainty"

"the blame for [Fannie and Freddie] rests on the United States' economic policies covering homeownership"

The unprecedented growth, eventual take-over of half the mortgage market and ultimate failure of Fannie Mae and Freddie Mac stems from the decision-making strategies of the companies’ managers. Using a three-period backwards-induction analysis, this article first explores the history and unilateral benefits the government conferred upon the two government-sponsored enterprises (GSEs), and then explains, through the lens of opportunistic managers, why and how Fannie and Freddie engaged in systemically risky activity that ensured their bailouts. I show that although both the decisions and methods of the GSEs' expansions were fraught with moral hazard problems and created a giant burden on taxpayers, the managers acted in a logical manner to maximize shareholder wealth while simultaneously mitigating risk. Therefore, the blame for the GSEs rests on the United States' economic policies covering homeownership, which lacked the appropriate mechanisms to monitor and measure the potential harm of Fannie and Freddie.

Abrams, Charles J., Fannie and Freddie Flipped: A Backward Induction Analysis of the GSEs’ Meltdown (May 1, 2011). William & Mary Policy Review, Vol. 3, No. 1, p. 157, 2011. Available at SSRN: http://ssrn.com/abstract=1970381

via papers.ssrn.com

"In spite of what you may heave heard, the Senate just effectively killed crowdfunding"

This last week, the Senate passed the “JOBS Act,” leaving it one step away from final passage by Congress and Signature by President Obama.  The JOBS Act contains a number of provisions which are aimed at reducing the securities compliance burdens of small companies and startups.  One of the major provisions within the JOBS Act is the so-called “crowdfunding” provision.

via www.strictlybusinesslawblog.com

Thereby proving that Democrats really aren't serious about promoting capital formation. Instead, they cling to the belief that jobs will spring from Obama's forehead sort of the way Athena sprang from that of Zeus, without the need for business men and women to raise capital for expansion and growth.