You may have heard recently about how an obscure graduate student from UMass debunked a very influential paper from very influential professors at very influential Harvard recently. Indeed, it was a takedown.
Empirical economists Carmen Reinhart and Kenneth Rogoff’s oft-cited paper “showed” that governments reaching or exceeding a debt-to-GDP figure of 90% experience comparatively much lower growth. Turns out the whole thing was riddled with errors. I happen to agree that bad things are coming to countries that over-leverage themselves, but there is simply no way that a study like this was going to be correct, from its very inception.
Put aside for the moment the fact that the word austerity seems to have no useful meaning outside of rigid ideological parameters, meaning those who care more about politics than reality (read: 99% of economists) are talking at cross purposes. The real problem here is methodological. There is simply no way a spreadsheet of math problems based on aggregations of trillions of data points can tell you anything useful about whether a very general fiscal policy, with no set definition anyway, will have particular effects. It is all fantasy.
The most important point, though, is that we learn the right lesson from this. On the one hand, fancy math does not have the ability to tell us whether austerity, as a general matter, is correct. Anyone who thinks so is probably an idiot.
On the other hand, anyone who thinks that errors in fancy math prove the opposite position, is an even bigger idiot.
This is because they make a compounding error – on top of assuming that the methodology could give us useful evidence if it didn’t have its errors, they also assume that the absence of this evidence is evidence of their opposing position. This is a logical fallacy: absence of evidence for position A will never be evidence for position B. (If you’re interested in seeing a prime example of such massive idiocy, feel free to click on this link. I warn you, it isn’t for those with fragile stomachs.)
Ultimately, it is critical not to get caught up in the economic flame war without evaluating first principles. Neither side is right. And neither side seems to know why. In the meantime, I suppose we could just stand back and enjoy the show.
The stench emanating from China’s macroeconomic indicators is getting worse, yet the news from the country’s Ministry of Truth is just as sunny as ever. At some point the funny numbers will collide with reality, and China could be in for a meltdown.
…China’s imports from Japan fell 16.2pc in December. Imports from Taiwan fell 6.2pc.
The Shanghai Container Freight Index fell 1.4pc to a record low of 919.44 in November, after sliding relentlessly for several months. It has picked up slightly since.
The Baltic Dry Index measuring freight rates for ores, grains, and bulk goods, has fallen 44pc over the last year. Kasper Moller from Maersk in Beijing said weak Chinese demand for iron ore was the key culprit.
…[R]ail, road, river and air freight volume for the whole of China fell to 31780m tons in November (latest data), from 32340m tons in October. Not a big fall, but still negative. (National Bureau of Statistics of China.)
Chinese electricity use was flat in over the Autumn, with a sharp fall in the (year-on-year) growth rates from 8.9pc in September, to 8pc in October, and 7.7pc in December.
Residential investment has been contracting on a monthly basis, and of course property prices are now falling in all but two of China’s 70 largest cities.
So how did China pull off an economic growth rate of 8.9pc in the fourth quarter?
Something is rotten in the state of
Evans-Pritchard is correct when he calls the problem “deeply structural,” saying that the “whole economy is massively deformed and tilted toward excess investment.” And where excess investment leads to malinvestments a bubble is sure to follow. The next bubble may be one that China is incapable of papering over.
The usual caveat applies: I do not know when the other shoe will drop. But that it will is, to my mind, beyond question.
I have long been an advocate for the idea that there is no such thing as a “solution.” Realistically, every policy choice involves tradeoffs only – not solutions. However, it is all too common that only one side of an issue is considered, leading to an inaccurate depiction of those critical tradeoffs.
I was lately spurred into thinking about this in the context of trade policy when reading David Malpass’s column in the Wall Street Journal, called “Ron Paul, the Fed and the Need for a Stable Dollar.” In pertinent part:
Dollar weakness doesn’t work at all for economic well-being. The corollary to the Fed’s policy of manipulating interest rates downward at the expense of savers is declining median incomes. It’s no coincidence that inflation-adjusted median incomes rose in the sound-money booms of the Reagan and Clinton administrations and fell in the weak-dollar busts during the Carter, Bush and Obama years. When the currency weakens, the prices of staples rise faster than wages, hurting all but the rich who buy protection.
The economy and median incomes would do much better if the Fed said simply that it would set interest rates as best it could in order to keep the dollar’s value strong and stable in coming decades, with the goal of attracting capital, maintaining price stability and encouraging full employment.
Dollar weakness is very often touted by bad economists as a way for the economy to grow through export, or (far more pernicious) a way for governments to inflate their way out of fiscal mistakes. Both are true enough.
But what good is an increase in exports if we do not examine the correlated tradeoffs? Weak dollars mean propping up export-driven businesses artificially, and this supports some jobs. But as Malpass points out, commodity prices rise faster than wages, reducing real wealth for everyone, including those whose jobs are being supported.
Furthermore, as Malpass notes, manipulating interest rates downward in the service of a weak dollar is an implicit tax on savers. This leads to over-stimulated current demand, and this skewed time preference precludes valuable investment in the economy that would sustain real wealth over the long term.
And speaking of investment, it is worth noting that running a current account deficit requires running a capital account surplus. The dollars that do not come back to this country as payment for what we do export come back as investments. The last few decades have shown that, in times of high current account deficits (importing over exporting), the United States has experienced relatively higher growth than when the current account deficits were low.
This manifests itself in higher GDP growth, a higher stock market, higher job growth, and higher manufacturing output. Consider this last. Those who insist on examining only one side of the equation insist that weaker dollars and export-driven economy lead to more manufacturing employment, since we can ship our products overseas.
What they do not see, or do not acknowledge, is that the capital investment required to sustain manufacturing employment over the long run often comes from foreign investors looking for a place to invest the dollars they received when we imported their goods.
I would argue that the advantages of a stable dollar policy (growth, employment, standard of living) outweigh the advantages of a weak dollar policy (preservation of some preexisting jobs, political talking points). And the downsides to weak dollar policy (bias against savings, bias toward government spending) are disconcerting too. All in all, I do not find this to be a tradeoff worth making.
A broadly critical Congressional report on the nation-building efforts undertaken by American forces in Afghanistan was released today. According to the Washington Post, the report casts doubt on the continuing viability of the country as it is today.
The hugely expensive U.S. attempt at nation-building in Afghanistan has had only limited success and may not survive an American withdrawal, according to the findings of a two-year congressional investigation to be released Wednesday.
I could have told them that. But another interesting concept, mentioned before on this blog, is the curious disconnect between Keynesian metrics and economic realities. Under traditional Keynesian theory, government spending is used to take up the slack from the private sector in a downturn. This fiscal policy (or stimulus) helps nurse the economy back to health, and the simplest metric of its efficacy is the GDP figure. The higher the GDP, the “better” the economy, or so my admittedly bare-bones explanation of the theory goes.
However, as previously mentioned, GDP does not equal wealth. Similar corollaries would include the fact that creating more money does not make the country richer, and having more jobs does not make the country more productive. Although there is a correlation between GDP and wealth under certain circumstances, the correlation is simply not a particularly useful tool in seeking to understand the ultimate effect of broad-reaching policies.
As it happens, Afghanistan provides the perfect example:
The report also warns that the Afghan economy could slide into a depression with the inevitable decline of the foreign military and development spending that now provides 97 percent of the country’s gross domestic product.
Consider a hypothetical economy twice the size of the United States’ (using GDP as a measurement) but with the same population. In absence of any other information, you would assume that the standard of living in this fantasyland would be much higher than that of the United States’ right? Now consider that this country is engaged in total war. How would that affect your assumptions about standards of living?
When we think about the things that increase our standard of living – plentiful food, spacious housing, proper sanitation, clean water, books and arts, effective transportation – we see that none of them are things provided by military spending. Therefore, roughly 97% of Afghanistan’s GDP has nothing to do with the standard of living enjoyed by Afghanis.
Worse than this, spending on military expeditions and vague “nation-building” missions (read: “getting the backwards tribes to act like good ‘mericans”) actually gets in the way of these things. Can we expect widespread availability of food when the means of production are more likely to go to killing each other than to farming? Can we expect decent housing when the means of production go to government buildings and not apartment buildings?
In this country, we are still plagued by the myth that World War II brought us out of the Great Depression, when in reality we never recovered until after the war was over. Being conscripted to be cannon fodder in the South Pacific may have led to low unemployment numbers, but what does it say about the standard of living of Americans stuck in Guadalcanal?
In a vacuum, bringing an end to the military action in Afghanistan would drastically increase citizens’ standards of living by diverting military spending and state-building waste back to productive uses. Of course, the consequences of withdrawal would not be nearly so simple in real life, due to massive corruption, blowback from the Taliban, and the problems endemic to being weaned off of an artificial dependency on foreign aid.
Then again, those problems are wholly synthetic. They are both creations of the vast war machine now sucking up the country’s wealth, as well as impediments to rebuilding decent standards of living after the war machine that created them is gone.
Without more consumers flushing ever larger numbers of devalued dollars down ever greater numbers of drains, the Fed’s bubble-centered growth strategy (or for that matter the Treasury Department’s own trillions in fiscal stimulus) is a bust.
That this is the same pneumatic strategy employed by Bernanke’s predecessor—and by secretaries of the Treasury long before Tim Geithner—does not mean it makes any sense. As Mark Skousen argued last year, economic growth proceeds from value, savings, and investment. Follow a strategy of spurring and riding the American consumer and you’ll just end up continuing a succession of bubbles: from energy to real estate to financial services to dotcoms to real estate again and now (possibly) back to financial services.
…In the Keynesian universe of policy-making, boosting “aggregate demand” is the only goal, and economic activity, no matter how frenzied or nonsensical, is the only tool.
The key question, of course, is not whether economic indicators are rising. Saying the GDP went up by x%, or the S&P 500 index rose by y% is just as irrelevant as saying “the recession is over because I have found a job.” This is the case because, according to the real world if not to macroeconomists, money is not wealth. Money is related to wealth. (Note that I am still thinking in material terms here; I have no idea how to quantify health, happiness, love, etc., and so I am leaving them out of my definition. Nonetheless, the principle still holds.)
Consider a scenario wherein GDP rises by roughly 3% (this may be considered similar to our current situation, but I am taking liberties). If concurrent inflation rates top 3%, the public experiences a real wealth reduction, all else being equal. However, all else may not be equal – although GDP is rising unemployment may not be budging, companies may be sitting on cash due to regime uncertainty and hostile tax policy, and investment may be stagnating. However, if spending in nominal dollars increases the GDP figure, many macroeconomists will simply declare victory and head to happy hour.
Of course, the idea that consumption spending growth “helps” the economy is based on a misreading of what spending means. The shifts between consumption and investment merely indicate time preferences; however if your entire macroeconomic strategy involves goosing spending numbers, you’ll do whatever it takes to shift people’s time preferences to the here and now, even if it means destroying the value of the currency and their savings.
Ultimately, it is easy to lose sight of what wealth is if we allow ourselves to be dazzled by economic indicators that change by the second and often amount to nothing but static in the economic signal. Wealth is rising standards of living, availability of goods and services that previously were not, and yes, falling real prices. It does nobody any good to hand out dollars while cutting the dollar’s value, but a singular focus on aggregate demand, GDP, and other minor indicators obscures the relationship between the dollar and actual, real-life wealth.
It is encouraging to see so many beginning to question this.
True enough. Diana Furchtgott-Roth of the Manhattan Institute, writing in RealClearMarkets, lays out in layman’s terms the general problem with aggregate economic measurements, and it’s an important thing to think about. When confronted with numbers representing something like the “GDP,” or the “employment rate,” strange formulas said to ennumerate the entire economy, what, if anything, can we assume that they mean? In a word, not much.
(The) Congressional Budget Office issued a report showing that the American Recovery and Reinvestment Act of 2009 increased the number of people employed by between 1.4 and 3.3 million people in the second quarter of 2010 and lowered unemployment by 0.7 to 1.8 percentage points.
CBO concludes that without the Recovery Act unemployment, which stood at 9.5% in July, might exceed 10% and possibly be above 11%.
There’s just one problem. CBO’s latest figures are inconsistent with its claims of the effects of the stimulus bill when it was passed in February 2009. If its models failed to accurately predict the effects of the stimulus bill then, why should we believe the models now?
This illustrates a fundamental problem with economic modeling, and as Furchtgott-Roth says, “bad economics does not make good government.” Why is it that when the models fail, we go back to the same model to explain the failure?
By now I assume that many Americans have a instinctive distrust of economic models and the financial voodoo that emanates from CBO, yet there isn’t any internal push to change CBO’s obviously flawed methods. Quite simply, it’s tunnel vision, and it took on its modern form with Keynes. Take Paul Samuelson for example, who literally “wrote the book” on modern Keynesian macroeconomics in that he authored the macro textbooks used for decades in schools all over the country, and consider whether it’s possible to explain the economy with a raft of broad-based equations? Samuelson certainly thought so – “if only the math on my blackboard is correct, I can prove whatever needs proving.” Of course, Samuelson “proved” that the U.S.S.R. was a superior economic model to the United States. I’m sure his math was beyond reproach.
The fact is, mathematics gets us only so far. When we’re speaking in abstracts, it might indicate a direction or a possibility. But to assume that we can mathematically explain an economy, any one part of which is so far beyond our grasp as to be logically out of reach, is an arrogance of highest order. Models, such as the CBO’s, may help with planning or budgeting, but under no circumstances are they sound enough to base policy on.
Don’t think so? Maybe you could ask the millions of unemployed who, according to the models, ought to be working.