Saturday, October 27, 2012

Don Boudreaux on the Keynesian Myth of Debt Totalitarianism

Cafe Hayek's Don Boudreaux echoes James Buchanan and makes an excellent point about the Keynesian myth of debt totalitarianism:
If we regard all humanity as One, then U.S. government debt held by people in China and Finland is debt that, no less than is such debt held by people in California and Florida, debt that “we owe to ourselves.” ... 
It won’t do here, by the way, to object to the previous paragraph by pointing out that Chinese citizens (unlike American citizens) aren’t on the hook to pay the taxes necessary to pay interest or principal on U.S.-government debt.  A central point of Jim Buchanan’s debt-burden case is that even within national boundaries, the individuals whose taxes are raised today to pay interest or principal on a government bond are distinct from the bond holders who receive those payments.  The payer is not the payee, and that the latter might share national citizenship with the former is an economically irrelevant happenstance that cannot possibly make a government-debt burden disappear.

Thursday, October 25, 2012

Native English Is Not the Same as Intelligible Globetrotter English


Browsing through the readers' comments to this The Economist article on English skills across countries I could observe, once again, an interesting phenomenon: that many native English speakers don't realize, from their point of view, that international (globetrotter) English is a language variation in itself, spontaneously developing and adapting according to practical rules of intelligibility. Somebody that speaks Texan or Scottish English, for example, may be well understood in Amarillo or Kirkcaldy, but may also have a significant handicap as a globetrotter English speaker.

Business schools in the US and the UK have not yet, at least to my knowledge, considered international English intelligibility to be a skill that needs to be mastered. In advanced non-English speaking countries, on the other hand, the schools are somewhat aware of the problem, and have been tweaking their globetrotter English training programs accordingly.

Monday, October 15, 2012

Nobel Economics Prize Goes to Roth and Shapley


Their work allows for example for market solutions to be applied in cases where monetary transactions are traditionally considered to be unappealing, like in dating, marriage, education and organ donation. Levitt offers a good explanation of the contribution:
The type of economics [Roth] is best known for is what is called “Market Design.”  Essentially, it means bringing market-type thinking to areas in which historically non-market allocation mechanisms have been used.  A few examples of the areas Roth has explored are matching fledgling doctors to hospitals for their residency, matching students to public schools in school choice programs, and matching kidney donors with those who need a kidney. ... 
An example that we’ve written about here at the blog is Roth’s work on kidney transplants.  As much as economists think we should just have a market for kidneys, the rest of the world hasn’t quite caught up to that idea.  So Roth came up with a different scheme – one that involves barter — that takes into account the real-world constraints that people aren’t allowed to pay for kidneys. So instead he developed a clearinghouse for connecting chains of pairs in which there is both a person who needs a kidney transplant and a person willing to give one, but who is not a good match medically to donate to his or her loved one.  The key is that the potential donor is a good match for someone, just not for the loved one.  But, if you can make a chain in which it all balances out: each donor matches with someone willing to donate, then it works out for everyone.

Friday, October 5, 2012

Tuesday, October 2, 2012

The Neglected Strengths of the Euro

With very few exceptions, the literature about the euro produced outside of Continental Europe, since its inception, suffers from a striking amount of selective bias. The literature also suffers from a tendency to rely heavily on association fallacy, attributing almost automatically to the euro the responsibility for any problem that is common to countries in its area, such as the difficulties created by fiscal excesses of welfare states. Evident strengths of the euro institutions, on the other hand, are simply ignored or waved away as trivial.

The selective bias manifests itself sometimes as the omission of relevant positive information. An example is the recent announcement by the French socialist government that it is now committed to austerity. This is coming from a government that had heavily campaigned against austerity just a few months ago.

Such a political overturn would be an extremely improbable event in countries with national central banks. It is entirely driven by the restrictive framing built into euro institutions, framing that the UK, for example, has always rejected. In my fiscally conservative opinion, this is an incredible social and economic achievement for the euro economies, one that cannot be reproduced, at this moment, in other advanced economies because they remain stuck in the age of monetary nationalism.

Monday, October 1, 2012

TIPS Funds, a Risky Bet

This excellent Vanguard article must be read by anyone investing in TIPS (inflation-protected securities) funds. Here's the deal: investing in TIPS funds isn't the same thing as buying TIPS. Differently from bonds, TIPS funds cannot offer nominally-guaranteed payouts at maturity. And TIPS funds have high duration and are significantly affected by TIPS yields (a proxy for expected real interest rates), as seen in this graph (copied from the article):


By historical standards, TIPS yields are extremely low at this point (graph from Vanguard's article):


Meaning that those who invest in TIPS funds today are exposed to high downward risk and low expected rates of returns for a long period of time. The article concludes with a very clear warning:
Considering that the best long-term predictor of bond returns is the starting yield, with TIPS real yields near zero today, the long-term expected real return of TIPS would also be near zero. From a nominal return standpoint, if current break-even rates of inflation between 10-year TIPS and 10-year nominal Treasuries are about 2%–2.5%, adding that inflation expectation to the zero real-return expectation puts the long-term expected nominal return of TIPS at 2%–2.5%, unless there is a significant upward or downward movement in inflation. Those expectations are much lower than past returns... As with most investments, the short-term performance of TIPS, both positive and negative, is an unreliable basis for long-term return expectations. Given the current low-yield environment, the return outlook for TIPS (as with most U.S. bond investments today) is muted and likely to be more volatile than in the past.
In other words, betting on TIPS funds at this point can only be a winning strategy if you believe that real interest rates will continue to fall deeper into negative territory. Given that nominal rates cannot fall further, this is the same as to believe that inflation will rise and central banks won't respond by increasing nominal rates accordingly. Not impossible, given the extent to which central banks have departed from sound monetary principles since before the crisis, but yet extremely improbable, no matter how reckless they have become.