"Wherefore We must interrupt a silence which it would be criminal to prolong, that We may point out...as they really are, men who are badly disguised." Pope St. Pius X, September 8, 1907, Pascendi Dominici Gregis


Friday, April 1, 2011

An Easier Way to Think About Bubbles

If you're not interested in an intellectual preface of the basic logic of the Austrian theory of the business cycle, skip to the second paragraph.

As Austrians so forthrightly explain, the boom-bust business cycle occurs when artificially low interests rates indicate more capital is available than really exists. Entrepreneurs, totally dependent upon this incorrect market signal, adjust their behavior by taking on new and more round-about production processes (e.g., building a ton of houses). But because the new capital is in actuality mere fiat currency, un-backed as it were by actual resources (i.e., savings) eventually inflation or otherwise an adjustment in prices reveals that the boom is unsustainable. We must then readjust our behavior to a state that cause us to be less well-off than when we started because real savings (read effort) made in the meantime were diverted into unrealizable projects, and it is costly to properly rearrange or salvage it.

But there is a much more personal way to think about how a bubble works and the problems it causes. Let me use myself as an example. I recently obtained a new job. This job pays a significantly higher salary than my previous job. And I do not start until April 25th. I have known this since mid-March. During this intervening time period (from mid-March to April 25th) I have already adjusted my behavior in anticipation of my higher income.

Expenses that I have been putting off (e.g., making a superficial repair to my car) I have now made. I have shifted some of my savings into riskier assets like stocks because, no longer being unemployed, guaranteeing the level of my savings does not fluctuate wildly is less of a concern. I realize most people would not do such a thing, but I nonetheless have. And let me ask, when we apply this analogy to the wider economy, would not a billionaire investor do similarly?

And I have made a hundred dollar plus deposit in order to guarantee me an apartment I otherwise would not have rented. Now, let's assume April 25th arrives and the job is eliminated. Chalk it up to whatever you want:  the company went bankrupt, the hiring manager changed his mind, etc. What does this do to my mis-informed actions? I will lose the hundred-plus dollar deposit, as I no longer need the apartment and being unemployed, don't actually want to rent it. I may need to sell some of the stocks I bought sooner and at lower prices than I would have if I actually got the job. I dearly wish I would've retained the money spent on superficial car repair. This is the equivalent of a bust for me.

Notice, I did not actually have to receive my new salary for it to have an effect my actions, investments, and current standard of living. I am now poorer, at least by the amount of the deposit and the time wasted preparing for a job that does not exist. So too do lower interest rates caused by Federal Reserve "money printing" (or digit creation) lead entrepreneurs to make misinformed decisions which ultimately lead to everyone's impoverishment when it turns out they can't be carried all the way through.

NB: I made my decisions with at least a partial realization that I may never actually see my paycheck. Entrepreneurs, however, are entirely dependent upon the market interest rate and cannot determine whether the particular lot of money they receive is newly created or representative of actual savings-capital. Thus, if anything, the Fed's actions are to that extent even more impoverishing.

Wednesday, February 16, 2011

Can Tech Outrun the Regulatory State?

A while back, I became aware of something called a Mobile Ad-Hoc Network. For those not tech savvy, this basically consists of a computer network that functions via individual connections from one computer to the next. As computers are turned off and on or moved, these connections rearrange themselves such that a given computer is always connected to the closest computers around it and this true for all of the computers in the network. It is wireless, and so as we mentioned mobile, and is constantly changing in the aforementioned pattern, and thus, ad-hoc. The significance of such a network struck me immediately. If there were ever a move to shut down the internet by unplugging the centralized servers, such Mobile Ad-Hoc Networks, or MANets, would spring up as an alternative means of networking without the central servers. The only way to kill a MANet is to take out every computer individually, one at a time.

Fast forward to today, and between the machinations of the Obama administration and the recent events in Egypt, we are all well aware of the imminent danger of government control over centralized servers.  Technological evolution, which has the possibility to become the guarantor of human freedom, is moving ever closer to making MANets a reality. Enter the FreedomBox Foundation. The goal of the foundation is to create a cheap, personal server that will store all of your information, doing an end run around centralized sites like Facebook, in a decentralized, secure manner, safe from the prying eyes of private-public partnerships. His goal is very Fullerite in that it aims to make the solution to our collective social problem so clearly advantageous that everyone will adopt it voluntarily: the device will produce all the benefits we currently enjoy online, with none of the “free spying” that the founder of FreedomBox decries in his very intriguing lecture. I encourage you to become aware of these issues and perhaps contribute monetarily or otherwise to this effort.

Thursday, February 10, 2011

Whac-A-Stat

There’s a lot of talk about the need for the Federal Reserve's dual mandate of low unemployment and price stability. But as we all intuitively know, and as John Thompson points out, like a game of whack-a-mole, the suppressing or forced stability of one variable may merely cause a natural disruption to pop up somewhere else. That is, to use a recent example, suppressing the price swing mole may lead to large upward movements in the supply of houses mole.

Now let us forget for a moment that the fed has consistently failed in its price stability goal. Not only is the dollar worth less than 5% of its original value when the Fed was founded, but instead of price stability we have, as this chart clearly indicates, some sort of unidirectionality in price fluctuation. Instead of price fluctuations that sometimes reward creditors (i.e., deflation), sometimes debtors (i.e., inflation) that tend to equal out over time as the market participants see fit, since Fed policy really got underway in the twentieth century we have only inflation that constantly rewards the politically well connected receivers of freshly printed dollars at the expense of savers and all other dollar holders. This new phenomena of unidirectionality in long-term price movements has attendant deleterious cultural effects that have recently come to dominate our economy. On the one hand, many are now averse to hard work and saving because in an inflation-only world the rewards of these are diminished. On the other hand, in an effort to overcome the effects of purchasing power erosion many people are now unnecessarily career obsessed, and this is especially true in the case of women and the rise of the two-income household.

By the way, if deflation truly creates an economic death spiral into the abyss of economic collapse, how do mainstream economists account for the consistent re-emergence of inflation following periods of deflation in early American history when we were on the gold standard? Just a question.

And as at least nine percent of the population is currently painfully aware, the Fed really hasn’t been able to maintain low unemployment either.  

So, even if the Fed could somehow smooth out fluctuations in the employment rate and prices, it is almost certain that the adjustments that would otherwise play themselves out through prices or changes in employment will instead manifest elsewhere in the economy. Or, moreover, as our current predicament tends to suggest, the very adjustments in prices and employment that the Fed attempts to smooth out, may indeed be shallower, viz., lesser in magnitude, but also become more chronic, viz., longer in duration. In short, there is no free lunch. The Fed cannot magically fix the natural adjustment process of the market economy. It can only shift the adjustments in ways that are, given its incentives, favorable to political insiders or deleterious to the wealth creating tendencies of the market.

Wednesday, February 9, 2011

Why aren’t you as rich as you should be?

I really can’t sit quietly after watching an academic, whose biggest achievement admittedly is taking out a mortgage during the housing boom, try to trump the assertion of Peter Thiel, who co-founded PayPal and was one of the ground level investors in Facebook, that given our technological advancement America really should be far better off today than we are. A typical, superficial observer, the academic wants to label Thiel’s argument a pessimistic or paranoid one, when it is quite clear that effective optimism and evaluation of incentives of the type it takes to create world-bettering businesses involves evaluating how a situation was lacking in the past and devising a remedy.

Peter asserts that the thesis of the book, The American Challenge by J. Servan-Schreiber, that Americans should by now have sufficient incomes to maintain our standard of living by working only four days per week, seven hours per day, and taking thirteen weeks of vacation per year was by and large realizable and an accurate extrapolation of trends from the late 1960s. However, as a nation we have put many stumbling blocks in our way that have prevented us from its actual realization. In a fit of academic cluelessness, the host attempts to demonstrate statistically that we are actually as well off as we can expect to be, even though it is clear that the qualitative changes predicted in the American Challenge have not come to pass. While Mr. Thiel appears to have reality on his side, does accurately recognize that there is indeed “something wrong with the real economy,” and puts forward education as an area that needs some improvement, he does not put forth as effective an argument as he could if he understood the Austrian theory of the business cycle and particularly the insidious role of inflation. I will try to supplement Mr. Thiel in this effort.

Mr. Thiel addresses the phenomenon of bubbles and its recent manifestations in the housing and tech sectors by claiming that such booms could have progressed apace if underlying growth had actually lived up to expectations. Perhaps, but this it seems begs the very question, why did underlying growth not actually live up to expectations? The Austrian business cycle theory accounts for this clearly. An artificially lowered interest rate by the central bank’s creation of new money via the printing press indicates to entrepreneurs and consumers alike that there are more loanable funds and their attendant resources  available than actually exists. Because buffers exist in the economy, and there is a certain amount of available capital to put into any particular project at a given time, entrepreneurs begin building more and different new capital goods and consumers begin consuming more goods than they would in absence of the improper interest rate signal. This is sustainable for a time but only in the way that building a new structure that requires one hundred bricks can be built with bricks limited in availability to fifty. We will build a too large a foundation, realizing half-way through the process that we cannot complete the structure, and indeed we should have drawn plans for building a structure with only fifty bricks. The grasping for any remaining available bricks to actually complete our misinformed plan leads to rampant inflation, it becomes clear consumers and businesses cannot complete their plans and the bust ensues.

We know why booms lead to busts and wealth destruction. In our example, after inflation, we realize that the foundation for our hundred brick home must be tore down and our plans adjusted not only to account for the availability of only fifty bricks, but indeed fewer than, because no doubt some bricks will be destroyed in the process of rearranging the foundation, not to mention the attendant waste of time and effort. But let us take this one step further and attempt to flesh out exactly how living standards would be better in absence of such waste.

A boom it seems, in agreement with Thiel, is an attempt to have all of the gains of future progress now.  In these short-sighted forays, we set ourselves back through our waste of time, effort and scarce physical resources. Reality cannot yet live up to expectations. A key point is how the bubble ends. Prices for the remaining scarce resources are bid up to unnatural levels that match and compensate for the unnaturally low interest rates set by the central bank. Inflation eats away our remaining savings. Can inflation really account for the difference between the American Challenge’s prediction of four day work weeks and thirteen weeks of vacation and today’s reality of decreasing incomes, equally long work weeks and two-income households?   My instinct tells me it can.

This is one area I really think has been lacking from the standpoint of research put forth by leading Austrians.  Austrians widely acknowledge that inflation has a redistributing effect from the holders of the previously printed dollar bills, particularly those who are to be paid at a set nominal dollar amount in the future (e.g., pensioners, creditors) to the spenders of the freshly printed dollars. It thereby distorts the constellation of naturally occurring market prices and also during the business cycle reveals that there are actually too few resources currently available to sustain the boom, leading to the bust. But often the line in the discussion is drawn here, saying inflation interferes with the normal functioning marketplace and this is not good. But I think this line of thought can and should be taken a step further.  Like Hayek said, before we can understand what has gone wrong, we must understand how things can go right. Austrians sort of set the theory out there, substantially demonstrate how inflation interferes and then vaguely say, we would all be wealthier if inflation hadn’t occurred.  Fine, but how would we be wealthier? To what extent? Is this just a slight set back, or is this the reason for the future’s failure to live up to expectations?  Can we provide some definite examples?

I realize we are now dealing with questions that can be variously styled as hypothetically historical, thymological, empirical and subjective, but if we really want to convince people that the boom and bust cycle is substantially impoverishing, we will have to grope towards an answer. The objection has even occurred to me:  What if the process of the creation of excess capacity during the boom actually leads to the invention of valuable technology that otherwise would not have been created or created much later? There are two immediate ways to address this issue that spring to mind. There is the moral objection that if we can establish an undeniable moral justification for the institution of private property (subject matter appropriate to another paper), then the central bank is in fact one way or another committing an act of fraud in the creation of dollar bills out of thin air. There is also the related epistemological argument that it is quite literally impossible to concretely differentiate between the actual results of the boom and what actually would have happened in absence of one.  This is not so much an argument against the boom, as it is an argument that we ought to default to the preference of a non-boom situation for perhaps the aforementioned or other justifications, since we can make no valid case for a boom. But I am curious if we can put forward a third objection:  The boom is so substantially impoverishing that any possible technological advantages it provides are overwhelmed.

Superficially this argument already seems plausible, for if the booms weren’t substantially impoverishing or the technology created during the boom somehow compensated for this impoverishment, then why do we still have a clearly recognizable bust? Indeed, technology first used during a boom may appear in that way superficially beneficial, but in a vague attempt to abstract the scientific process from short term fluctuations in larger economic conditions, we could say that the new technology may have been created or deployed sooner without the wealth misallocation of the boom because the current trends in science would’ve been there anyway and would’ve had more resources available to use towards their progress. Moreover, technology as an idea, per se, is useless. We only make use of the actual physical embodiments of technology, and Austrians have shown indisputably that this capital embodiment of our technological progress is clearly wasted during a boom.

Still even more to the point, I believe this ‘technological progress’ argument in favor of booms is really a historical anomaly. It was born, I think, out of the tech boom. Indeed, in the case of our most recent boom the ‘technological progress’ argument not only can barely be made, but almost works in the opposite direction. If interest rates indicate that there are plenty of resources available to build our next swath of suburban housing developments as a nation, why implement technology that would save these resources?  Indeed, the incentive structure suggests that fewer technological innovations would be implemented during the boom than without a boom, because there appears to be a far lesser need to conserve scarce resources. And ultimately, we can apply this argument back to the case of the tech boom; it is just semantically awkward, because how could a tech boom lead to a lessening use of technology?  But as any Austrian could tell you, economic progress is not solely about the amount of technology available, but about how effectively it is used, embodied and distributed in capital throughout time in order to satisfy human wants. And as Mr. Thiel shrewdly points out, 'really how much technological benefit did the hundredth online pet food company provide to the economy overall?'

Let us return, then, to inflation. It is true, as is mentioned in the video, that great productivity gains were made in recent decades both through the advancement and implementation of new technology and the expansion of the division of labor to emerging economies. As Austrians have pointed out, such productivity gains are normally embodied in the market process by benign deflation. We get a hint of this in the tech sector, where every year new computers are not only more productive but also monetarily less expensive. This is in fact a phenomenon that should apply to a lesser extent to the economy as a whole. The 1990s, far from being a period of low two to three percent inflation, in absence of the central bank’s use of the printing press should’ve been a period of substantial, perhaps five percent, deflation.  Two to three percent headline inflation, then, was actually seven to eight percent real inflation.  In this scenario, then, eight percent of real productivity gains disappear.  Where does this time and energy and these resources go?

Indeed, they go to the holders of the newly printed dollars, who in fact do not produce anything of real value to exchange for these dollar holdings. This is a class of parasites that live off of the productivity of the real economy. Not only do these entities siphon off real economic growth, but often the efforts that are undertaken by those enabled with newly printed money attack or hinder the remainder of the real economy. As Peter Thiel points out this includes public schools, who receive newly printed dollars when the Fed prints money to buy U.S. Treasuries, but it also includes defense contractors, regulatory agencies like the FCC, SEC, and FDA and large and well connected banking institutions. Indeed, these predatory banking institutions are given newly printed money that eat up your own productivity gains that they turn around and lend to you. They are effectively using an institutional gimmick to lend you funds representing time, effort and resources that are rightfully yours. The interest paid on these loans, which is substantial, is in effect a theft of your wealth used to support a class of parasitic bankers that pretend to have a legitimate role to play in our capitalistic system. In absence of money printing, however, such bankers would have to find real jobs that actual expand the productivity of the economy by creating something of real value, instead of charging you interest to use productivity gains that are rightfully yours.

In absence of such corruption, would the real economy have provided the productivity gains necessary to achieve the four day work week in the year 2000?  Something tells me yes.  But we need more research that indicates this.