Wednesday, March 31, 2010

Marron on Unsustainable Budget Deficits in America

Donald B. Marron offers us an excellent description of the fiscal challenges faced by the US in this article in the National Affairs (HT Mankiw). If there are problems of sustainability in our economy, then this is the mother of them all. Here's a summary:
Some try to duck the budget issue by saying that we shouldn't tighten our belts when the economy is so weak. This is true in a limited sense: We do not want major tax increases or spending reductions in 2010 or 2011. But we can — and must — hurry to put our nation on a more sustainable path, so that desperately needed policy reforms can take effect as soon as economic conditions allow. A move to shore up our finances might even help to improve those conditions. World financial markets would certainly welcome signs that the United States recognizes its budgetary challenges and is willing to take hard steps to address them. And families and businesses would appreciate the advance warning about future changes in their taxes and benefits.

Monday, March 29, 2010

Sowell on Intellectuals and Their Mistakes

The video below has an excellent Hoover Institution interview with Thomas Sowell on the problem with intellectuals and the mistakes they frequently make (HT Division of Labour's Carden).

Sunday, March 28, 2010

Health Care: How the US Created a Frankenstein Monster

The WSJ brings us an excellent interview with Gary Becker (HT EconoLog's Henderson). Like Becker, I've said before that we should have taken a closer look at the Swiss health care system, but the US preferred to create a Frankenstein monster of their own. Here's what Becker says:

Drafting a good bill would have been easy, he continues. Health savings accounts could have been expanded. Consumers could have been permitted to purchase insurance across state lines, which would have increased competition among insurers. The tax deductibility of health-care spending could have been extended from employers to individuals, giving the same tax treatment to all consumers. And incentives could have been put in place to prompt consumers to pay a larger portion of their health-care costs out of their own pockets.

"Here in the United States," Mr. Becker says, "we spend about 17% of our GDP on health care, but out-of-pocket expenses make up only about 12% of total health-care spending. In Switzerland, where they spend only 11% of GDP on health care, their out-of-pocket expenses equal about 31% of total spending. The difference between 12% and 31% is huge. Once people begin spending substantial sums from their own pockets, they become willing to shop around. Ordinary market incentives begin to operate. A good bill would have encouraged that."

Saturday, March 27, 2010

Sorman on Stiglitz's Work of Fiction

Guy Sorman offers us a nice review of Stiglitz's "Freefall: America, Free Markets, and the Sinking of the World Economy" in the City Journal. Here's a passage:

Joseph Stiglitz should win a second Nobel Prize, this time for fiction. ...

Stiglitz feels compelled to remind the reader that he is not a socialist: he only advocates a better world. His utopia would replace the failed market fundamentalism by striking the right balance between market and state. What would such an arrangement look like? Stiglitz doesn’t elaborate, but he hints repeatedly that the world would be a better and more ethical place if he were in charge. For those who already fear the Obama administration’s anti-market bias, think how much worse it could be: Stiglitz could be working there! We better keep him writing fiction and basking in the cheers of Greek audiences, to whom he recommends that their country not repay its debt.

One receives the Nobel Prize in economics for research in a specific area, Milton Friedman used to say, but prize winners then tend to believe that they’ve been implicitly granted the right to express their personal, nonscientific opinions about everything. Stiglitz’s Nobel Prize on market asymmetry was well deserved. His opinions on everything else are just opinions and deserve to be treated as such.

Friday, March 26, 2010

IMF Tells Rich Countries to Stop Going Bananas

It's the IMF now that tells us that developed nations have been acting like banana republics, without showing any sign of regret. This WSJ article explains:

BEIJING—The International Monetary Fund on Sunday urged countries, particularly those with advanced economies, to pare their fiscal deficits and debt to prudent levels by carrying out pension and health entitlement reforms.

IMF First Deputy Managing Director John Lipsky said in remarks delivered in Beijing that high public debt and fiscal deficits have already raised the risk premium for several countries, and could lead to higher interest rates and slower economic growth in the medium term. ...

Mr. Lipsky said that unwinding stimulus programs introduced during the financial crisis won't be enough. "Such measures have accounted for only about one-tenth of the projected debt increase," he said. "Merely winding down the stimulus won't come close to bringing deficits and debt ratios back to prudent levels, considering the projected increases in health care and other entitlement spending." He urged governments to strengthen fiscal institutions and carry out entitlement overhauls, such as increases in the retirement age, to help bring down both their debt and their deficits.

Thursday, March 25, 2010

Cab Drivers and Intellectuals

My last article (in Portuguese) is about cab drivers than can articulate more intelligent thoughts than those of most intellectuals. Here is a translated passage:
Like the first cab driver, the second one, near retirement, told me, after knowing that I lived in the US, that his given name was Truman, a name that his father gave him in 1948 after he emigrated from Greece to escape from the communist menace. He also talked about the misery created by the French social welfare state, but went beyond and told me that he was sure that the waste of resources promoted by the system would render his three children incapable of getting a retirement benefit as good as the one he would soon get. He kept repeating furiously: "To the devil with those reds and commies!" I imagine that the victory of the socialist and green parties in the last French regional elections may have affected for worse the mood of these two cab drivers.

Wednesday, March 24, 2010

Our Banana Republic Rulers

Mankiw cites Krugman:
I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that "a fiscal crisis threatens our future standard of living" — investors still can't believe that the leaders of the United States are acting like the rulers of a banana republic. But I've done the math, and reached my own conclusions.
Krugman wrote this passage in 2003, and the point has never been so relevant as it is today. Krugman however appears to have himself a case of cognitive dissonance, as seen in this recent post. As a response to Krugman, Kinsley gives him some basic economic lessons:
I have been waiting for Paul Krugman to tell me how we are going to handle the debt, once we get this recession out of the way. ... Yglesias [for example] apparently believes that we can escape our fiscal dilemma without pain. I would like to know how. And if there is such a way, why have we denied ourselves for so long? Why do we ever bother to show fiscal restraint? Why have taxes at all? Why deny ourselves anything money can buy? If $15 trillion in debt can be a freebie, why not $30 trillion or $60 trillion?

Sunday, March 21, 2010

Sorman on the Greek Tragedy

Wise words by Guy Sorman in this City Journal article regarding the global financial crisis and the lessons from the Greek budget scandal:

The financial crisis of 2008, still far from over, has done severe damage to the reputation of the free market. The crisis, we are assured, was caused by the withdrawal of the state and an excess of deregulation. To get out of it will thus require a massive return to public spending and intervention, which is in fact what we see happening all over Europe and in the United States. However, what we might call the Greek affair should make us question the statist solution. We ought to consider the possibility that public management could prove even more dangerous than private—that state regulation is no less chancy than deregulation.

The duplicity and corruption of Greek public accounting was more than an error of bookkeeping. The concealment of the country’s real budget deficit necessarily involved a gigantic network of complicity that included the whole political class, the state bureaucracy, and the banks. This network was not confined to Greece: it included Greece’s European partners, Europe’s political leaders, the governors of the Eurozone, the directors of the European Central Bank, and the European commission. It’s hard to believe that the European Commission’s Directorate General for economic and Financial Affairs was ignorant of what was really happening in Greece; and it will come as a surprise to some but not others that Eurostat, the statistical institute of the European Commission, has for years been publishing deliberately false numbers that make the phony accounting of the ratings agencies implicated in the 2008 financial crisis pale in comparison.

Tuesday, March 16, 2010

Will the US Lose the Triple-A Bond Rating?

Becoming more possible every day according to Moody's (HT Miron):

Pierre Cailleteau, managing director of sovereign risk at Moody’s, stressed that none of their ratings were “threatened so far.”

But he did differentiate among the top countries, saying that Britain and the United States are in the toughest position.

“The U.K. and the U.S. are more tested than, say, Germany or France,” Mr. Cailleteau said in an e-mailed response to a question.

Monday, March 15, 2010

Shiller and the Butterfly in the Amazon

Shiller's take on the crisis reinforces Hayek's pretense of knowledge argument (HT Mankiw):

Indeed, the crisis knows no end to the list of its causes. For, in a complicated economic system that feeds back on itself in many ways, events that start a vicious cycle might be as seemingly trivial as the proverbial butterfly in the Amazon, which, by flapping its wings, sets off a chain of events that eventually results in a far-away hurricane. Chaos theory in mathematics explains such dependency on remote and seemingly trivial initial conditions, and explains why even the extrapolation of apparently precise planetary motion becomes impossible when taken far enough into the future. ...

The problem for macroeconomics is that the types of causes mentioned for the current crisis are difficult to systematize. The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. ...

This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.

7th Art: Metallica Plays "The Ecstasy of Gold"

Unforgettable Ennio Morricone's The Ecstasy of Gold from Sergio Leone's The Good, The Bad, and the Ugly has a "Metallica" taste in this live clip. Enjoy!

Friday, March 12, 2010

More Evidence on the Mediocre Economic Performance of the Lula da Silva Administration

I've made the point yet in this post comparing the post-stabilization Brazilian economic performance with the performance of peer countries, and in this post explaining why the Lula da Silva socialist administration in Brazil is the darling of foreign investors. Research conducted by Brazilian economist Reinaldo Gonçalves (article in Portuguese) presents additional evidence regarding the mediocre performance of post-stabilization administrations in Brazil, especially the Lula da Silva administration, translation is mine:
The evidence shows that the performance of the Brazilian economy was mediocre from 2003 to 2009 according to international and historical patterns... Compared to the Cardoso administration, the Lula da Silva administration was "equally mediocre". In 2002, the last year of the Cardoso administration, the participation of Brazil in the world GDP was equal to 2.81%, while in 2009 the participation was equal to 2.79%.

Thursday, March 11, 2010

Why Is Socialist Brazil the Darling of Foreign Investors?

The explanation is very simple: seven years of astonishingly high rates of return on each dollar invested, as shown in my latest article (in Portuguese).

The graph below illustrates my point. It compares yearly rates of return in dollar for investments in Brazil paying the Selic rate, the Brazilian equivalent of the fed funds rate (which is also shown on the graph as benchmark), during the previous social democratic administration (1996-2002) and during the current socialist administration of President Lula da Silva (2003-2009).

Rates of return obtained by foreign investors were indeed very high since macroeconomic stabilization in 1994. However, they are even higher during Lula da Silva's socialist administration (an accumulated rate of 451% in seven years!). This is more shocking when considered that those were years of extremely high dollar liquidity, with the lowest possible interest rates observed in most countries.

These incredible rates of return were driven by a combination of high domestic interest rates and continuous appreciation of the Brazilian currency. Given that these rates aren't sustainable, I wonder if the investors' infatuation with Brazil isn't about to end.

The Brazilian rates of return in dollar also offer new puzzles for academic economists to struggle with. In particular, economists need to address the highly unstable behavior of the exchange rate and the high cost of stabilization under the Brazilian inflation targeting regime.

The Marxist and socialist politicians now in government in Brazil are the same ones that passed the last few decades criticizing previous administrations for being overly generous to "greedy international capitalism." Isn't it the greatest irony that they ended up being the ones to throw the most amazing financial carnival party, solely for the enjoyment of those "greedy foreigners"?

Wednesday, March 10, 2010

Kling on Nye and the Extended Clan

Kling provides us with a very interesting summary of an article by John Nye on the New Deal, here's the main passage:
Nye shares, along with folks such as Douglass North, a view that open-access orders are rare and somewhat contrary to human nature. What is in fact more natural are societies based on principles of an extended family. It is more natural to live in a world of Mafia Godfathers than one with fair, open, competitive markets.

Tuesday, March 9, 2010

Government Failure: Brazil Declares Trade War on the US

Repeating costly past mistakes, governments around the world further special interests at the cost of good economics. As a result, protectionism slowly seeps in.

The last step on the road to economic hell is a new trade war between US and Brazil. Once again, populist politicians and special interest groups win, and everybody else loses. File that under "another example of political rational irrationality" in the Twilight Zone.

Sunday, March 7, 2010

Reaching for the Sky: Interest Rates Before 1982

This is a question for those who believe that macroeconomic policy was on a better path before 1982: how do you explain the graph below?

Graph source: latest edition of Mishkin's Money and Banking textbook.

Wednesday, March 3, 2010

The Overappreciated Brazilian Real

We keep jumping from one bubble to another. From the Le Figaro, more evidence that the Brazilian Real is among the latest victims of the Fed's decade-long policy of easy money:

Fair warning: given that inflation in Brazil has remained high while the Central Bank was helped by an appreciating domestic currency, ample capital inflows, high domestic interest rates, and low foreign interest rates, what should we expect to happen once the tide changes against Brazil?

One Image...

Illustration by Ray Gardner (HT Cafe Hayek's Roberts).

Tuesday, March 2, 2010

Unintended Consequences Matter Too

Incentives matter, and unintended consequences matter too. Here's an excellent essay by Steven Horwitz on the subject. The following passage is particularly interesting (HT De Gustibus Non Est Disputandum):

The neglect of unintended consequences and the focus on motives lead us to celebrate the lives and mourn the deaths of politicians, although they may have caused undesirable unintended consequences, while inventors and businesspeople who benefit humanity while pursuing their own ends go unnoticed. As my matrix on the previous page suggests, we simply don’t have a moral category for people who unintentionally benefit others in pursuit of their self-interest. And we also highly overvalue intentions as a measure of moral worth, leading to praise for those whose “hearts were in the right place” even as they have caused incalculable damage to prosperity and freedom.