Sunday, September 27, 2009

Energy As Currency: Cat Is Out Of The bag.

What follows is a response of mine to an article that I'm about to post over on one of my favorite blogs, The Oil Drum . I posted my response here, first, simply to ensure that I'm credited with my own work (indeed, I have an enormous amount of work into this idea). The time stamps should evidence that what follow is my post, my idea, and, incidentally, reveal my identity on the blogosphere as GreenPlease (you'll find me posting on The Oil Drum, GreenCarCongress, TreeHugger, e90post, and facebook under that name). The only difference in the posts will be that my TOD post will include a link to this post. Enough of marking my own territory. Here it goes:
Is 'trust' subject to laws of thermodynamics?
What a great question, one that I plan on giving a lot of thought. Tons of thought. Possibly a thesis. Seriously, great question. In response to your questions:

1) Can you articulate a concerted policy response that would indeed lead to 'strong', 'sustainable', and 'balanced' growth?

I'm not going to go against the tide and say that "sustainable" and "growth" are compatible but I would say that we need to redefine "growth." Too many people view growth as using larger and larger amounts of resources (e.g. more wood, water, oil, land, etc.) and very few think of efficiency when they think about growth. If the entire world were to start using state-of-the-art LEDs tomorrow, we would use significantly fewer resources (coal and water primarily), though the end benefit to society (lighting) would remain the same. Would this not be growth in a sense? Unfortunately, this would not be seen as growth by most in the field of economics. This mindset has to change.

1a) If not, what sort of 'economic triage' policy would you recommend? Think bold.

The following is the boldest policy I've got (I'm an economist mind you): move the entire world to an energy denominated currency (either the kw/h or btu) I've been working on this idea for a little over two years now and have compiled quite a thesis to back it. Guess this is as good of a time as any to let the cat out of the bag. The summary of the ideas/pros/cons follows: Society would instantly be more aware of how important energy is in day to day life. Hopefully/possibly they will act more responsibly accordingly. Information is such an important aspect of economics. People's ability to choose correctly is largely dependent on them having the correct information. Our current fiat currency system accompanied by government subsidies masks the true costs of goods and results in poor choices. -The intrinsic interest rate would be negative This is due to entropy. People's currency would thus literally "disappear" over time. Huge consequences ensue: --Spending driven recessions would be a thing of the past. Economists have been dancing around this idea for years. Krugman frequently cites the idea of a negative interest rate in his work (going back to the early 80s) as a cure-all for spending driven recessions. --Inflation and deflation would cease to exist in the aggregate: market forces would still allow for inflation and deflation in localized instances (such as a "hot" product) but the nature of an energy currency, that it is finite, would cause deflation to materialize elsewhere in the economy. Inflation and deflation would balance each other out. --Our monetary system would fall in line with the real economy. If we are less productive (for whatever reason), less money is available. If we are more productive, more money is available. Further, carrying costs would be realized. The Austrians seem to believe that money should have a constant value. The fallacy in this idea is the concept of carrying costs. Imagine we live in a two person economy: you and me. Let's say you grow carrots and let's say I have a piece of currency that allows me to purchase your carrots (a call). If I don't buy your carrots the first year your carrots rot and you have to grow new carrots the next year and incur a cost in the process. My "austrian" money has not depreciated, however and I incur no additional cost for you to grow said carrots. Constant value money puts an undue burden on producers. An energy currency, with its intrinsic negative interest rate, would account for your carrying cost. As your carrots rot so does my money. --A negative interest rate on currency would cause people to invest in flows instead of stocks. That is, they would try to own producing goods (solar panels, farmland, etc.) rather than hoard money in hopes it will accumulate greater money (CDs, bonds, etc.) --Many would argue that inflation already does this with fiat currency but fluctuations in currency markets and monetary policy don't always allow the negative value mechanism to work. Recent cases of wealth destruction, such as the credit bubble, cause currency to appreciate (fewer claims on the same number of physical goods) give people the idea that currency can appreciate in value, thus giving them incentive to bet (hoard) currency instead of using it to buy/produce a producing asset. Pricing would be more efficient With appropriate information, people would better be able to price goods. Transport and holding costs would be contextually apparent and rational decisions would be more likely. In the long term, everyone would benefit (no guarantees everyone lives to see the long term but we can't be all things to all people here). The importance of efficiency in resource utilization would become apparent The idea of utility would be clear. A more efficient engine would be seen as an economic gain We would be able to price environmental goods The value of water and oxygen would become apparent. To this end, we could effectively price the value of wetlands that filter water, the value of the water itself, the value of trees (need oxygen to burn stuff).... the list goes on. As a side note here, water itself would be priced in terms of energy. Highly saline/contaminated water would have a high energy cost as it would have to be filtered, as would distant or deep water as it would have to be transported. Clean surface waters would be cheap and thus of a comparative value in the market place. Example: growing carrots in Saudi Arabia vs. Michigan. In SA, water has a cost of say 100,000btu/m^3, whereas in Michigan it has a cost of only 1,000btu/m^3. If we assume that all the carrots grown get sold and that SA carrots are not sold at a loss, then the Michigan carrots will reap an economic benefit of at least 99,000btu/however many carrots are grown with a cubic meter of water. We would be able to measure our growth relative to our environmental impact I'm getting a little bit tire here so I'm going to just start lumping stuff together. Our economic condition could be measured by 1. raw output 2. efficiency in utilization 3. impact on the environment. I have details on these measures in my thesis Many of the classical ideas of economics would re-emerge No point in expounding on this but I will say that, in my opinion, many of the classical ideas regarding economics have better logic behind them and are more in touch with the real world Countries would not be able to manipulate their currency to gain an advantage Instead they would only be able to institute policies that would allow them to expand their productive base or become more efficient in using said base. I've designed and modeled (technically, I'm modeling) a transitionary framework. This is not trivial work but it appears if the right countries picked up the flame a universal energy currency would spread quickly enough. The importance of resource utilization would become instantly apparent At least a few TOD readers have had the thought "my gosh, Saudi Arabia would become even more disproportionately wealthy for no real reason" by now. At first glance, an energy currency seems to benefit energy rich countries (which it does to a point) but this energy is essentially just a savings, a stock, not a flow. What matters in the quality of our lives is flows. The actual quality of life of Saudis would not change immediately due to an energy currency (likewise for most countries). Saudi Arabia could very well increase their flow rate of oil and gas, burn more of it to produce "work" but if this work doesn't somehow better their citizens lives (by providing lighting, climate control, water, food, etc) then their resource utilization will be low and their resulting measured economic well being would also be low. In order to better themselves, SA would have to ship its oil/gas to a region with fertile land which would ship back food. Think gains due to specialization and trade here. Entropy and enthalapy would become immediately important think quality vs. quantity Fractional reserve banking would come to an endYay!!! I don't think I need to explain why this is such a great thing. I've come up with some counter arguments that indicate that fractional reserve banking would still be possible though they are too complex and too esoteric for here (plus, I'm getting really tired). FWIW, my initial models indicate that a bank practicing fractional reserve banking with an energy currency would quickly become insolvent. Economics (and finance as an associated branch) would finally have a link to the other sciences Many of the other sciences can communicate and share ideas because of shared and fixed units of measure. Economics, up until now, has not had this. In my opinion, the biggest problem plaguing economics at the moment is the problem of measuring. There is a great deal of literature about the importance of measuring in science and the consensus is that improvements in the ability to measure result in step changes in the capabilities of science. I hope this proves to be the case in economics. For years I've kept one of Einstein's quotes in the back of my head "Not everything that can be counted counts, and not everything that counts can be counted." Brain is fried, I know I'm missing 2-3 points here. There's a lot more to this (165 pages and counting :D ), such as transition mechanisms, currency issuance, but this isn't the right venue. I'm just trying to convey the general concept. Nate, it appears you seem to be thinking along the same lines as me regarding our current monetary system. If you think that some of my work on this idea is worthy of a guest post, I'd be honored (not to get a big head, just saying). If you want to contact me directly (this applies to any of you as well) try one of my emails:
- cornelius x carroll at yahoo dot com (this is the one I check most frequently) or -ccarroll at rollins dot edu P.S. Nate, note that much of the $400-700trillion of debt you cite is in the form of derivatives. Inherently, most (>90% off the top of my head) cannot actually enter the economy in order to claim a physical good. This is because most options (calls/puts) expire worthless, and most credit default swaps cancel out (and simply tie the entire financial system together/create systemic risk, think AIG). Also don't forget that some debt can also cancel out (theoretically, two banks could issue debt and use the resulting currency to purchase said debt). This does not instantly cancel out, however, as the debt has a time value. The result is a build in M3, though in reality this money cannot enter the system to purchase physical goods. This is one of the reasons that the Fed stopped publishing M3 data (not to mention it was pretty darn convenient for them to stop when they did). What is important are the flows (interest rates) as they determine the amount of money that can actually enter the system to purchase goods. The Austrians/gold bugs totally miss these points though I give them credit for at least acknowledging that our current fiat currency system is bunk.

Thursday, September 24, 2009

Food for Thought: Unemployment Irony

I think it is safe to say that just about everyone sees unemployment as a bad thing. I'm going to go out on a limb here and say that unemployment is actually a good thing and that it is a sign of progress.

Consider the case of yourself being stranded alone on an island. In order to survive, you must perform quite a bit of work: you have to gather fresh water, gather food, gather firewood, cook the food, build a shelter, and maintain said shelter. This would take a considerable amount of time and effort. Any reduction in the amount of time and effort that you expend on these tasks would certainly be to your benefit (an economic benefit if you will).

Let's say that you change the location of your shelter from the beach to an inland stream. Now you don't have to travel as far or for as long to gather water for the day. Then you invent a stick that allows you to gather fruit without having to shimmy up trees. Once again, you'd no longer have to work as hard or as long to gather your fruit. Finally, after engineering your way to more free time in a day, you build a more robust structure which requires less maintenance and consequently reduces your labor load even further.

Take a second to think about all of this. Through innovation, you, a lone island dweller, have innovated your way to more free time. You have innovated your way into unemployment. Simply put, you no longer have to do as much work to survive and maintain a decent standard of living. So, in this case, unemployment is clearly a good thing.

Going from an island of one to a world of many changes nothing. Indeed, the portion of man-hours necessary to gather water, food, and maintain shelter has dropped dramatically in the last hundred years. Simply put, there is less work to be done and that's a very good thing as we just demonstrated. Yet without employment people lack income which is clearly a bad thing and a problem. Therefore, we should reason that lack of income is the problem and not unemployment.

How can we have income without employment? How do we separate the two?

Income has many forms. In this context, I do not mean monetary income (a paycheck) but instead "real" income in the form of goods and services. A self sufficient farmer has no monetary income but has some (indeed enough) "real" income. I have theorized over the past couple of years that people will eventually de-urbanize and enter in agriculture in an attempt to employ themselves, gain income, and be self sufficient in a sense. Coincidentally, this was the precise view the founding fathers had for our country: a nation of self-sufficient farmers.

This thought goes against the economic tide of specialization and increasing economies of scale. Indeed, by proposing self-sufficiency I am proposing the direct opposite of specialization and increasing economies of scale. I would argue, however, that specialization now lies within our technology and not within our labor force. For the time being, certain fields such as law, medicine, and engineering are undoubtedly specialized but it is clear to me that the internet is changing that by making such information accessible, interpretable, and operable to all.

I don't have an appropriate way to conclude this at the moment as it I have just made these observations though I will revisit this at a later date. As the title said, it's just food for thought.

Sunday, September 20, 2009

Who Loses? Who Wins?

I had an interesting conversation today with a fellow academic about the U.S./China dynamic. It went like this:

Friend: We (the U.S.) are regulating ourselves into poverty with all of these environmental restrictions
Me: Really? How?
Friend: First we can't use DDT, we lose all of our citrus to South America, then we have water quality regulations and we lose all of our manufacturing to China. Next, we'll regulate greenhouse gases and then we REALLY won't be able to compete. We've regulated ourselves out of manufacturing anything. All we can do is borrow money and buy stuff from China. China has all the money and we have all the debt!
Me: So pollution carries no cost?
Friend: What do you mean?
Me: Well, pollution certainly can't be a positive thing. I find it rather undesirable.
Friend: Like the dollar cost? I don't know...
Me: No, not the dollar cost. That would be nearly impossible to calculate. I'm talking about the real cost, the human cost. Have you seen pictures of China? Have you seen how bad the air is? The water? That doesn't just go away. That's going to be with them for decades. People are going to get sick. People are going to die of cancer. Millions of people. We could default on our debt tomorrow and it wouldn't have a material impact on your life. After all, it's just paper. But if we default, the Chinese won't be able to give us all that pollution back. They're stuck with it. So it's a little bit of a pompous, maybe even nihilistic, view but the reality is that if the Chinese are willing to pollute their country into oblivion while we kick back, enjoy clean air, and buy the fruit of their labour with their money.... that's a pretty sweet deal! I don't really see how we lose!

Tuesday, September 15, 2009

Personal Note: Qualifying My Attack On The Left

I just thought I'd fill my readers in on something: I'm a huge fan of the free market system. Throughout my blog, I'll frequently attack the left (almost exclusively) for their attacks on the market system. I should qualify and explain these attacks:

I believe (though I cannot yet prove)

  • that the market is the way of nature
  • that a market system is the most efficient economic system obtainable by humans
  • that large scale government intervention results in economic losses due to queuing losses
  • that the price discovery function of the market is the single largest creator of wealth since fire.
  • that, absent the constraint of income imposed by a market system, economic participants would have no incentive to communicate proper information to the economy (thus killing the idea of central planning)
  • that the inequality imposed on market participants by the market system facilitates greater aggregate and discrete well being
  • that said inequality would be greatly reduced and more productive (and therefore tolerable) if we had a proper currency system
While it is easy to attribute my magnanimous view of the market as attributable to the fact that I have benefited greatly (read: disproportionately) from it, the reality is that my defense of the market is much like my defense of nature. I see it for its beauty and elegance. I see it in everyday life, I see how individuals engaging in discrete processes of bidding and offering manage to price and allocate goods and services throughout the entire economy in an almost quantum manner. I defend the market because, much like Adam Smith, I stand in awe of the market

Monday, September 14, 2009

Economic Theory: Efficient Markets, Leverage, and Rational Market Participants

It seems that it is in vogue to question the fundamentals of market economies these days. Understandable. While driving back from breakfast this morning, I was listening to Marc Faber being interviewed by Tom Keene on Bloomberg. They were discussing the idea of leverage in efficient markets with the innuendo being that efficient markets shouldn't need leverage (Faber flatly denied this saying, correctly, that efficient market theory says nothing of leverage). It was a great interview and it brought me to the conclusion that we need to redefine certain axioms in the market economy such as:

-The idea that market participants always act in a rational manner

This is clearly not true. Simply put, few are educated well enough to make such rational decisions. Consider my post from a few days ago regarding a simple profit and loss word problem. The vast majority of those that I polled failed to answer it properly. So where does this leave us? The assumption of rational participants is very convenient for modeling purposes and for logic experiments. What we can assume, safely, is that market participants will always act in a manner that they THINK maximizes their own economic condition. It is obvious that this has large implications. Greater discussion on this point will follow in later posts.

-The idea that markets are efficient

It has always truly stunned me that when people refer to efficient market theory they speak of "perfect markets" as in 100% efficient. The typical attack for academics on the left is to point out that if markets are not "perfect" then the idea of efficient markets is busted. From there they go on to reason that a greater role should be played by the government. What these academic fail to realize is that there are degrees of efficiency. It is lunacy to think that beings as imperfect as humans could ever price goods perfectly. Further, it is also lunacy to think that a government composed of imperfect humans could ever price goods perfectly. The market is an engine. Instead of saying that the engine is doomed because it is inefficient and it broke down we should try to better understand why it broke down and how it can be made more efficient.

Edit: one more
-The idea of an ever growing economic pie

For the foreseeable past and future and for our purposes here, we will consider the idea of an ever growing economic pie to be a reality. Will it grow forever? That gets into the idea of the sustainable-growth contradiction which we will avoid here but visit in a later post.

Over the long term, we have managed to steadily increase our production of goods and services. Every year, we are capable of manufacturing more steel, building more buildings, cars, appliances, televisions, computers, cell phones, clothes, etc. Our agricultural system manages to produce more and more food. People are willing and able to work. Even in this recession, the deepest and most dire since the Great Depression, our capacity to produce probably rose. Ours is not a plague of locusts. It is not a problem of actually working, of actually producing, and of actually consuming. We are very good at all three and become better as each year passes. We are just not very good at paying for things.

While the theory of an ever growing economic pie is a reality, there is a substantial disconnect in that the monetary pie is not ever growing (our ability to pay for things). Our fiat currency system is very fickle and very vulnerable to swings in investor sentiment and human emotions. Animal spirits as Keynes would say. This isn't the appropriate place to detail the mechanisms behind money, debt, and changes in the supply of the two (that will be a later post). Instead, I'll just say that in times of investor panic, a sudden contraction in the money supply will halt commerce and trigger bankruptcies (see this post for a visual representation of the money/debt cycle). Therefore, when economists, investors, or financiers speak of an ever-growing economic pie they should make sure that they delineate this from the idea of an ever-growing monetary pie.

Friday, September 11, 2009

Markets and Information: Left vs. Right

Sorry this post was a little late today but I guess better late than never. Unless we're talking about delivering anti-venom. Then never is probably better because if the anti-venom arrived too late it would be like "hey, you could have lived if it wasn't for that red light" and it would be the worst tease ever. Anywho....

One of my classes today (Income and Wealth Distribution) focused on market outcomes and the idea of a perfect market. My professor (who is on the left) referenced the Austrian school of thought saying that
The Austrian school, which is on the far right, believes that market transactions result in the best possible outcomes. The idea of imperfect, incomplete, manipulated, or asymmetrical information is inconvenient to them. They are out of touch with the real world.
I found it very ironic that this professor was making a point about information with incomplete and erroneous information. Whether this was done intentionally or unintentionally was not immediately clear. I chimed up, having once purused Mises' Human Action, saying
Actually, the Austrian school of thought does not assume perfect and symmetrical information in transactions. Instead, it assumes pervasive imperfect and asymmetrical information and simply reasons that the market outcome produces the best possible outcome from said imperfect and asymmetrical information.
The professor was perturbed at this, brushing it off as a semantics argument. I could clearly see, however, that he had never actually read any of the works of Austrian economists. Instead, he had merely read leftist critiques thereof.

Supposedly, I'm making a point here and not just bashing a professor that I don't particularly like, right? Right. Let's pretend for a moment that my interaction with my professor was a market transaction. The left would have the government (let's say the economics department) intervene to adjust for asymmetries in information in market transactions (correct the professor for his mistake). The right would just argue for better information (the professor wouldn't have made the mistake in the first place). Both sides have merit as the idea of having perfect information is quite clearly utopian and, some would argue, contrary to the idea of incentives driving the market*. However, getting the government (econ dept.) to intervene involves transactions costs (I have to email them, they have to discuss and agree). Further, such intervention in the context of real world monetary transactions simply redistributes wealth whereas better information invariably leads to greater wealth in the aggregate.

As it is said, knowledge is power.

Wednesday, September 9, 2009

The Debt Cycle: Loan Duration and Credit Crisis

I'll be honest. I'm pretty proud of this one. After flipping through all of my economics books and numerous google searches I can confidently say that I've devised an original visual representation of debt in the business cycle. If any of my readers have seen such a representation elsewhere, feel free to burst my bubble in the comments section.

What prompted this maddening exercise in MS Paint was a bit of an epiphany: the asset bubble didn't have to pop because of price alone.

An entire plethora of reasons has been named for the asset bubble of 2008. Among these are lying, lack or government regulation, and irrational market expectations. These are all very large reasons for the market to have collapsed but why does the reason have to be large? What about the proverbial hair that broke the camel's? The pebble that triggered the avalanche? What I'm saying is that, at the heart of the cause of the crisis, somebody didn't pay.

Timing is very important to businesses. It is of little consolation to a restaurant owner to have people line up for breakfast the day after her business was taken over by the bank. In the above diagram you can see three businesses, their own debt cycles, and the interaction between these cycles (note that > is forward in time). Assuming an interest rate of 0%, this economy is at equilibrium. As an interesting side note, one can see that what banks really do is facilitate commerce by creating open contracts amongst businesses.

Think of the above cycle of transactions as gears. I've sized them all the same meaning that the maturity on the debt for all three businesses is of the same duration. Thus the gears mesh well and the machine turns. What would happen, however, if one of those gears were to be smaller and the corresponding business's debt maturity shorter? If the time horizon for business 3 to sell to business 2 were shorter such that business 3 had to sell its good prior to business 2 being ready to buy, it would go bankrupt. The gears wouldn't turn and, if enough events such as this one occured, the whole system would grind to a halt.

I don't fully grasp the realizations of this approach but I'd be willing to make the following bet. Prior to the crisis two things happened in the morgtage backed security market: average loan duration fell and time remaining to maturity also fell.

Tuesday, September 8, 2009

The Dollar: Up Or Down?

This is going to be a quick post.

The value of any currency moves with changes in the relationship between productive capacity and currency supply. Faith plays a huge role but, for simplicity, we'll do away with faith here. Many pundits have been calling for the dollar to crash citing the large monetary expansion undertaken by the Federal Reserve in an attempt to combat the recession/depression. Simple economics: more dollars competing for the same resources equals higher prices causing the buying power of each individual dollar to fall. Simple stuff.

What most of these pundits fail to mention is the absolutely MASSIVE wealth destruction that took place last year (at least on paper). Further, they fail to mention that the private sector is de-leveraging through an increase in the savings rate. This is very important because one has to now consider that different entities in the credit markets are moving in different directions: the public sector is leveraging (effectively) while the private sector is de-leveraging.

So, to truly know which way the dollar is headed, we have to ask ourselves what is happening faster: public borrowing or private savings?

I'll provide some data in a later post but for now my observational data tells me that we are in a deflationary environment, that the savers have the day, and that (excluding faith) the dollar should head higher in the short term.

Sunday, September 6, 2009

Long Term Solution: Education as a Market Force 1.0

Economics is unique in comparison to the other sciences in that the way we observe the world has a very large impact on how the world actually works. If an astronomer improperly observes the movement of stars it doesn't actually change the way those stars move. If a physicist theorizes some physical constant, it doesn't alter whether or not that constant exists or what the metrics of that constant are. If a biologist theorizes an evolutionary path it doesn't alter the actual course of evolution. If an economist, however, theorizes that communism or capitalism is the best course of action.... well then that is how things shake out.

You get the idea. The behavior of the economy is almost entirely dependent on how we perceive the economy. To this end, the education of market participants (all of us) is a very important factor in the functioning of the economy.

Until very recently (today) I was of the view that education didn't have that much of an impact on the movements of markets. I was of the view that such incongruences were of minimal impact at the macro level. My revelation came in the form of a very simple problem:
"A man buys a horse for $50 and then sells it for $60. He then buys the same horse for $70 and then sells it for $80. What is his total profit?"
The answer is $20.

The person who gave me this problem is in college studying to be a teacher. She is a senior, already teaches in the class room, and I generally regard her as bright and studious. The above problem was given to her class (all seniors) which was divided on the answer: half of the class said $10, half of the class said $20 (aforementioned teacher was split between the two answers). I cannot tell you how disturbing this was to me. I was shocked. I couldn't believe it. Such a simple problem yet well educated people, educators mind you, couldn't manage to consistently answer it correctly.

I didn't know what to make of this, so, like any good economist, I conducted some real world research. I presented the problem to everyone in my immediate vicinity, to my friends, to the cashier at Publix.... essentially everyone I came in contact with for the rest of the day. The results were shocking. I heard a variety of answers including $10, $20, $30, and $130 along with a slew of numbers that were clearly gross arithmetic errors. All told, I probably surveyed twenty people. Of those twenty only six answered the question correctly. Six.

This was a very basic profit/loss problem. How would these people have done if I had asked them the difference between nominal and real wages? I don't need to drag this out. Any economist or skilled investor can see where I'm going. Simply put, the assumption of rational market participants is bunk as is the assumption of symmetrical and perfect information.

Now let's consider the investment community. The principles that these investors preach/practice vary wildly. Some adhere to the concept of value investing. Some trade short term volatility others adhere to Buffett like principles such as "buy and hold." Of particular interest to me are the turtle traders (also known as momentum traders or trend traders). This form of trading, made famous by the legendary CBOT trader Richard Dennis, is essentially a form of bet management with rules for when to buy, when to sell, when to double down, and when to take part of a position off. There are many arguments in favor of trend trading which usually sound something like "the information is already priced into the market...the technicals/chart is a reflection of that information...the trade itself has no meaningful impact on the direction of the market or it simply reinforces the market consensus."

Many of the arguments in favor of trading trends are very elaborate and very correct (if by correct you mean history of success). But what happens when every trader (market participant) is a trend trader? What happens when a large portion of traders are trained to trend trade? Is such activity not conducive to "bubbles"? The question of trend trading doesn't just apply to equity, bond, futures, and forex markets. It also applies to real estate markets and government spending. Humans are educated, it seems, to assume that trends, however irrational, will continue.

It turns out that I'm not the first economist to consider the rationality of market participants (not by a long shot). Indeed, most economics curricula focus on policy based economics in order to compensate for irrational market participants. The University of Chicago is a shining example in this shift of thought. Once home to the free-market luminary Milton Friedman, the Chicago school is now noted for policy centric economists such as Austan Goolsbee a member of Barack Obama's Council of Economic Advisors.

Notice that I put "1.0" in the title. I did that because I intend to revisit this theme several times in the future. For now, I'll leave you with a closing thought. Instead of compensating for irrational market participants, as "new social" economists seek to do, we should give serious thought to better educating market participants starting from the elementary level. At the very least we'll achieve a world in which a grocery store cashier doesn't have to endure a P/L word problem from a crazy customer.

Currency: An Alternate View to a Collapse

The Chinese have approximately $2,000,000,000,000 (that's trillion) in foreign exchange reserves. About half of that is held in U.S. government bonds with the remainder held in other currencies (euros, rubbles, etc.). The popular theory goes that China cannot afford either the default or a significant weakening of the U.S. dollar as it would batter it's own currency, the renminbi, and the savings of its citizens. One of my own professors, who will remain nameless, taught his students that the U.S. and China were reliant on each other and that China simply could not afford to de-couple from the United States because of the resulting damage to renminbi. He told us that we were trapped in a spiral of U.S. trade deficits and foreign direct investment by China that would never end. Americans could keep buying cheap Chinese manufactured goods with money lent to us by the Chinese themselves. The party will never stop. 

I'm not trying to fault the professor. Far from it. What he taught us was, and still is, the prevailing wisdom by a long shot both on Capitol Hill (where he worked) and on Wall Street. Only the morally upright Austrian School economists, such as Peter Schiff, think that China will "pull the punch bowl" and that this will be done for moral, not monetary, reasons. I have an alternative view.

Let's run a quick theoretical scenario: the U.S dollar plunges by 25% over the course of a month. What happens to renminbi? Conventional wisdom says that, because the Chinese do not float the renminbi and the renminbi is backed by large dollar denominated assets, the renminbi will fall in concert with the dollar. This mode of thinking, however, does not take into account what the Chinese might do in reaction to the dollar's decline. If the Chinese were to float the renminbi, make it fully convertible, and relax capital controls.... the renminbi would soar. Or at the very least retain its value. This would happen because investors would seek the renminbi as a safe haven, as a reserve currency, and possibly as a currency of settlement. Capital inflows from foreign governments and private investors would likely counter any decline in Chinese owned U.S. government debt. 

The counter argument to this is that the Chinese government could not afford such appreciation of the renminbi because it would obviate one of its advantages in trade, an artificially weak currency, and the resulting unemployment from such currency appreciation would be politically unacceptable. The point that is missed here is that, under the prior scenario, the renminbi would only appreciate against the dollar, not (necessarily) other currencies as the prevailing wisdom suggests. Just as capital would seek the renminbi, it would also seek currencies of China's trade partners (Euro, Yen, etc.) Thus only a portion of China's exports, perhaps $80 billion, would be affected. The domestic economy, which would suddenly find itself richer, could soak this up easily. There might be a short term spike in Chinese unemployment but would not be long lived. 

The result? China would suddenly find itself a lot richer and the U.S. would suddenly find itself a lot poorer. Economic justice I suppose, for it is productive capacity that backs one's currency and determines the wealth of one's nation and nobody can argue with China's productive supremacy in today's economy. 

Edit: I stumbled upon this article on the Financial Times' website . What would China need if it were to float the renminbi? Swap lines with other foreign central banks and a stock of commodities to tide it over until the dollar was no longer the primary settlement/pricing currency. Turns out I don't have such an "alternative" view after all. It has begun.

Saturday, September 5, 2009

Unemployment: We Don't Need You Anymore

The goal of this post is to investigate the necessary employment of the United States. That is to say, the number of people that actually have to work in order for all of us to survive. For the sake of this post, survival will constitute the availability of food, water, shelter, and energy. My methods are a bit shady but will suffice for a quick post and to convey my message: we really don't need to employ that many people.

So what's the result? We only have to employ ~11,800,000 people, just 3.9% of our population here in the United States, in order to meet our basic needs. Data breakdown below. Why is this significant? Just a few hundred years ago, upwards of 30% of the population would have been employed in such tasks. People will argue that the farmer needs the banker and that we all need a police force and doctors... but those jobs exist solely to deal with problems generated by humans. When it comes to beating nature, surviving, we've become very efficient which presents a very real problem to economists and politicians alike: structural unemployment.

Note to the unemployed: in order to survive, we don't need you anymore. In fact, in order for you to survive, you don't need you anymore either. Bittersweet I suppose.

Here's the data breakdown:
-Food (agriculture): ~1,400,000
-Energy (oil, gas, coal): ~820,000
-Shelter (construction): ~9,500,000
-Water (water districts): unknown, highball guess of 80,000, that's 1600 per state
-Total: 11,800,000
-Total U.S. Population: 304,059,724
Sources: BLS  and Google PublicData
Methods: number of unemployed persons was divided by the unemployment rate for both 2008 and 2009. The resulting workforces were averaged. The number of people working for water districts and related services was a complete guess but I sure hope 1,600 people would be sufficient for a state considering that our water collection and distribution systems are almost entirely automated.

Friday, September 4, 2009

Healthcare: Whatever Happened to General Equilibrium?

Economists seem to love general equilibrium. For those non-technocrats, general equilibrium is the state sought by the forces of supply and demand. General equilibrium tells us that doctors, and health-care services in general, command such a high price because (1.) they are in short supply relative to demand and/or (2.) their price is commensurate to the amount they have invested in developing their skills/services.

An overview of general equilibrium on wikipedia

My next statement is pretty obvious. Why isn't anyone talking about increasing the supply of doctors, pharmacists, bio-chemists, nurses, etc? I'm really shocked that no one on the hill has proposed such an idea and even more shocked that such an idea hasn't been floated in the media (consider McGraw-Hill's ties to mainstream media and one of their businesses: education).

A very simple and non-controversial policy measure for the current administration would be to extend (substantial) financial aid to those wishing to enter medical-service related fields.


"Please allow me to introduce myself...

My name is Cornelius X. Carroll. That's me, on the left, laying on a sheet of glass cantilevered off the side of the Sear's Tower. I'm a senior at Rollins College and am an economics major. I'm originally from Chicago and hope to return there to attend graduate school at The University of Chicago. For as long as I can remember, I've been exposed to economic ideas through contact with my family and my family's friends.

I genuinely have a passion for economics. I love talking about it and I love sharing my ideas as well as hearing the ideas of others. My focus on economics, however, is rather recent. While I've always had a keen understanding of economic issues, mostly due to the tutelage of my father and grandfather, my obsession is rather recent. Up until my second year of undergraduate studies I was quite convinced that I would become some sort of an engineer.

Machines have fascinated me for as long as I can remember.  One of my great accomplishments in life thus far has been figuring out the workings of a car engine on my own at the age of six. I just love taking machines apart, seeing their inner-workings, and putting them back together. A couple of years ago it dawned on me that the global economy was the largest and most complex machine one could ever hope to deal with. Entrepreneurs, consumers, workers, and machines themselves all work and mesh together in the global economy to make modern civilized life what it is.

With this realization, I embarked on a journey in the pursuit of knowledge regarding the global economy and the economic principals that underpin it. This blog is one part of that journey. I intend to use this blog as a blank canvass to convey my insights, inquiries, and opinions regarding the economy and the financial markets. Enjoy!