Category Archives: Economic theory and policy

The rising price of houses

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The RBA is worried about rising house prices in Australia. But at the end of the article, Kelly O’Dwyer MHR, the chair of a parliamentary inquiry into foreign investment in residential real estate, put her finger right on the problem:

There was evidence to suggest current foreign investment restrictions were not being enforced by the Foreign Investment Review Board (FIRB), she said.

We used to pay for our balance of payments deficits through increased investment and the revenues that previous investments had caused. Now we pay for our imports by selling off the farm. The first could go on for ever and made us prosperous. The second will be a disaster but no one is willing to stop the inbound flow of funds.

The trick to picking winners is not to pick losers – how easy is that!

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It is a big part of what I try to teach – that the future is unknown and all decisions are made before the consequences of those decisions can be known. So people take inferences wherever they can, and in this case the inference is that McDonald’s tells us why the market will collapse. It seems to tell us more than just what is happening to the market:

We had, essentially, very poor sales from McDonald’s. Now, McDonald’s is a very good indicator of the global economy. If McDonald’s doesn’t increase its sales, it tells you that the monetary policies have largely failed in the sense that prices are going up more than disposable income, and so people have less purchasing power.”

Faber has long argued that the policies of the Federal Reserve and other central banks simply increase asset prices and create inflation rather than actually stimulating the economy. But while the long-predicted inflation has not come to pass, Faber says that the McDonald’s results reflect the fact that inflation is rising faster than income, reducing the amount that individuals can spend.

Who can be in any doubt that the cost of living is rising around us? But whatever else, very few of us are able to maintain our living standards, with plenty of shifts in expenditure patterns to accommodate the harder going. I was reading The Senior the other day and its front page was on “Living in ‘energy poverty'” with the subhead, “Disconnections up: more seeking hardship plans”. The example given was of a 77-year old woman who received a $1500 gas bill. Not that long ago such a notion would have been impossible. Now we are all being careful of this and so many other things.

Our living standards are being chiselled at in countless ways, only some of which show up as a rise in the price level. It’s not just monetary policies that are failing but the entire range of policies which divert resources away from value adding production and into the usual low-productivity nonsense aimed at by governments. The wonderfully whimsical headline in this morning’s AFR captured it all:

Abbott to pick winners not losers

No doubt this will appeal to everyone, a political winner. One can only hope that those who are promoting the policy understand it can never do anything but waste money so will be very restrained in following up on this:

Federal cabinet has approved a “competitiveness agenda” that will lead to government support for parts of the economy where Australia is strongest and require greater collaboration between businesses, schools, universities and training colleges.

Mercantilists all.

A farrago of vacuous ideas and empty nonsense

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I came across a book in one of the still remaining second hand book shops I frequent by two Nobel Prize winners, George Akerlof and Robert Shiller. It’s title was Animal Spirits with the basic premise stated on the cover, that “human psychology drives the economy and why it matters for global capitalism”. So far, so ordinary but since this is all part of the new direction in economics, I thought I would give it a go.

Well, what a farrago of vacuous ideas and empty nonsense. I had always thought it was ridiculous that Keynes had made such a fetish about “animal spirits” himself, seeing as how every classical economist was perfectly aware of how crucial business confidence is to economic outcomes. If nothing else, Frank Knight had published his Risk, Uncertainty and Profit in 1921, a book I am pretty certain Keynes raided in writing the General Theory published in 1936. That Akerlof and Shiller write as if they have introduced some new conceptions into economics was astonishing, but given the low level of historical knowledge within the profession, you can just about get away with anything.

But what really did get to me was this book, published in 2009 at the height of the GFC and as the stimulus programs were getting into full swing, were not just advocating such public spending but made it clear how much economists had learned from Keynes and how fortunate we lot were that economists such as themselves were now on the watch and in control of policy.

A repeat of the Great Depression is now a possibility because economists, the government and the general public have in recent years grown complacent. They have forgotten the lessons of the 1930s. In those hard times we learned how the economy really works. . . .

In the middle of the Great Depression John Maynard Keynes published The General Theory of Employment, Interest and Money. In this 1936 masterwork, Keynes described how creditworthy governments like those of the United States and Great Britain could borrow and spend, and thus put the unemployed back to work. [My bolding]

I have an article on this book at Quadrant Online, Phlogiston with a Keynsian Twist. I think of it as a contender for the worst book on economics ever written. Lots of bad books on the subject, of course, but you don’t normally find two people at the highest level of the profession conspiring to write such stuff. Read the review, but spare yourself the trouble of reading the book, unless you would like to see just how empty economics can be in this day and age.

Is this the dumbest book on economics ever written?

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There will have to be a wall of shame for economists who endorsed Keynesian solutions back in 2009 who will need to have their beliefs brought back to haunt them. Picked up in a secondhand bookshop a particularly pathetic version of what had been quite common back in those heady days of the stimulus, this being a book titled, Animal Spirits, written by two Nobel Prize winners, George Akerlof and Robert Shiller. If these types were ever capable of shame they would be buying up every copy in print and have them consigned to the flames. Instead and no doubt, they continue in the delusion that we have been saved from far worse by the timely actions taken to stimulate demand.

Mind you, I had been just as certain that the entire attempt to diminish the impact of the recession and return us to reasonable rates of growth would turn out the disaster it has been. But for myself, I can now run the told-you-so as much and as far as I like. There is not a shred of evidence, outside their own nonsense-Keynesian models, that the stimulus did anything but harm. But since they are incapable of even having a glimmer of a notion that the economic models they have devoted their lives to understanding are about as useful as the theory of phlogiston was in physics, they just carry on. It is only we critics who go back to those books and try to remind others that Keynesian economic policy has been an unmitigated disaster. So far are we now from a robust recovery, a ten year pause will turn out to be the best we can hope for. This is from the Preface, and recall that this is from 2009 just as the stimulus programs were getting under way:

“A repeat of the Great Depression is now a possibility because economists, the government and the general public have in recent years grown complacent. They have forgotten the lessons of the 1930s. In those hard times we learned how the economy really works. . . .

“In the middle of the Great Depression John Maynard Keynes published The General Theory of Employment, Interest and Money. In this 1936 masterwork, Keynes described how creditworthy governments like those of the United States and Great Britain could borrow and spend, and thus put the unemployed back to work.”

That was 2009. Is the world in 2014 the one they expected, the outcome they foresaw? I suspect not. Yet there is hardly another ripple of any other kind they could blame the deeply depressed nature of the American economy on other than the policies of the past five years. The one certainty is that no one is any longer telling us now about the great “masterwork” written by Keynes.

Almost as nonsensical is the potted history of economic thought they provide. Can they actually be as ignorant of pre-Keynesian economic thought as they suggest by these words:

“According to traditional economics, free market capitalism will be essentially perfect and stable. There is little, if any, need for government interference. On the contrary, the only risk of major depression today, or in the future, comes from government intervention.

“This line of reasoning goes back to Adam Smith.” (p. 2)

The notion that Adam Smith, or any other economist of the classical tradition, expected a ripple-free economy with no depressions and that no government interference was ever necessary is so lacking in historical accuracy that I would barely accept such ignorance from a first year student. That they could believe and commit to print such obviously untrue statements – obvious, that is, to anyone who has taken the trouble to learn even the rudiments of the classical theory of the cycle or what Adam Smith had actually written – is a disgrace.

But if I have to choose the least sensible statement they made in this startling superficial and inane book, it is their attribution of the cause of the Global Financial Crisis to an excess of saving, the precise issue raised by Keynes:

“In the short run, an exogenous increase in the demand for desired saving rate of just a couple of percentage points may be enough to tip the economy into recession, as indeed seems to be happening in the current financial crisis.” (p. 116)

The entire financial world held its breath as the banking system teetered on the edge of collapse, with every lender profoundly unsure of the safety of lending to others, and this is reduced to decisions to save. It is embarrassing to have to read such thoughts from two of the most respected economists in the world. This is more of the Keynes the master, but though no one any longer would write any such thing given how events have turned out, it makes one despair whether economic theory can ever again provide serious guidance to those who make economic policy. It is a frightening book lacking even the rudiments of depth or common sense.

Imputed rents for housing

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In a previous post I mentioned the following:

The national accounts imputes the rising value of the houses we live in as a real increase in GDP so that we home owners are contributing to GDP by simply living in the places we bought years ago whose value has now gone up.

This seemed to come as a revelation to some. But it is worth dwelling on this along with much else that is faulty about the national accounts as a measure of anything. This is from a U.S. Bureau of Economic Analysis paper, Housing Services in the National Economic Accounts:

Housing services are a component of personal consumption expenditures (PCE), and consequently part of GDP, in the national income and product accounts (NIPAs). The rental value of tenant-occupied housing and the imputed rental value of owner-occupied housing are both part of PCE housing services, reflecting the amount of money tenants spend for the service of shelter and the amount of money owner occupants would have spent had they been renting. Owner-occupied housing is included in PCE because the NIPAs treat the owner-occupant as if it were a rental business, or in other words, a landlord renting to him or herself. That is, BEA imputes a value for the services of owner-occupied housing (space rent) based on the rents charged for similar tenant-occupied housing, and this value is included in GDP as part of personal consumption expenditures. This imputation is necessary in order for GDP to be invariant when housing units shift between tenant occupancy and owner occupancy.

Everybody does it the same (here is the Australian version although I don’t think it’s as clear). How the statistician adjusts the value of the houses we live in for national accounting purposes as its real value rises I am less sure about and would have been happy for some guidance. But if the rental-equivalent value of a house rises by 20%, it does seem that merely living in the place must show an upturn in the real value of consumption irrespective of whether anything at all has changed. Or so I understand. Something to keep in mind the next time you hear that consumption expenditure has gone up.

Bringing ruin to the USA

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You do have to wonder when there is going to be reaction against Y=C+I+G amongst economists. How do they explain this?

Record 92,269,000 Not in Labor Force; Participation Rate Matches 36-Year Low

The two theories of the Obama presidency remain intact: either he is an incompetent fool, or he has deliberately set out to ruin the United States. But whichever it is, he is certainly bringing ruin through every major decision he has made.

Value added and economic growth

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I wrote about modern economics is such junk and then went out and picked up the AFR only to find across its front page that living standards in Australia are falling. The story opens:

The national income generated by each Australian has fallen for a second straight year, the first such slump since the early 1990s recession as the economy wears a sharp pay cut from the rest of the world.

Does anyone any longer base policy on the understanding that growth only occurs if what is poduced is greater than the value of the resources that are used up? The ALP set about killing off our most value adding industry through the mining tax and promoted such imbicilities as the NBN which will always be a drain on national productivity, now and forever as far into the future as you care to look. The only thing that is strange to relate is that the national accounts are even able to pick up that living standards actually are falling given what a faulty measure GDP intrinsically is. My son is astounded, as he hunts around for a place to buy, at the difference between the ratio of house prices to income in my day compared with his. The national accounts imputes the rising value of the houses we live in as a real increase in GDP so that we home owners are contributing to GDP by simply living in the places we bought years ago whose value has now gone up. That most of us could not afford our own homes today is neither here nor there.

Yet for all of the obstacles put in the way of the government by the Senate and Labor’s legacy, we are actually making progress. That the Government has been able to reverse the increases in compulsory superannuation is all to the good. These are very difficult times, but how difficult they will be when the US Fed finally does begin to raise rates is still to be seen.

Modern economics is such junk

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I was once again reminded about the multitudinous things that are wrong with economics today by two stories this morning. The first: Fed: US consumers have decided to ‘hoard money’. And then there was this: Cramped seats and angry passengers lead to diverted flights. Let me start with the first.

“Hoarding money” amongst all of the Keynesian idiocies is the most idiotic. Q: Why are people not spending? A: Because they are hoarding money. Q: What does it mean to “hoard money”? A: People are literally hanging onto cash rather than spend. And literally means literally. It means keeping money on hand and not even putting it into a bank.

It was idiocy in the 1930s when Keynes said it even though bank failures were not uncommon in the US. It has been a stupidity ever since as a cause of anything, and so far as I know, most textbooks tend to overlook this notion because it is so stupid. But not the Federal Reserve of St Louis:

One of the great mysteries of the post-financial crisis world is why the U.S. has lacked inflation despite all the money being pumped into the economy.

The St. Louis Federal Reserve thinks it has the answer: A paper the central bank branch published this week blames the low level of money movement in large part on consumers and their “willingness to hoard money.” The paper also cites the Fed’s own policies as a reason for consumers’ unwillingness to spend. . . .

“Why did the monetary base increase not cause a proportionate increase in either the general price level or (gross domestic product)?” economist Yi Wen and associate Maria A. Arias asked in the St. Louis Fed paper. “The answer lies in the private sector’s dramatic increase in their willingness to hoard money instead of spend it. Such an unprecedented increase in money demand has slowed down the velocity of money.”

These people are clueless about what’s going on, absolutely clueless. The lack of real income is crushing the American economy as the ersatz version driven by government spending has replaced the real kinds of income that are based on value adding production.

So what’s this got to do with the cramped seating on planes? Inflation means that what a unit of currency will buy diminishes. The same things cost more money, or the same amount of money will buy you fewer things. If you think of an airplane seat as a specific amount of room on an aircraft as you go from place to place, the inflation is coming in the form of less legroom and reduced space. On a cost per inch basis, prices have rocketed, but the CPI will never pick such things up.

The other way that the suppressed inflation is affecting things is in the way out capital structure is being run down. Again invisible using the national accounts or the CPI, but if you have travelled on an airplane in the US, just to give you one example, you can see just how decrepit the stock of capital in the US is becoming. The US, along with the rest of us, are finding our living standards declining because we are drawing down rather than building up.

Economic theory is such junk! But on a brighter note, the 2nd ed of my Free Market Economics will be released at the end of the month.

There but for the Grace of God

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I have just reached home and happy I am to be here but I must say seldom has any trip of mine been so complete. All my interests – economic, political and historical – came together so seamlessly that I only wish life was always like this.

Economically, the meeting on J.-B. Say and the Entrepreneur was an outstanding success. This being the first such meeting, it is of major significance that there is a casting about for some kind of successor paradigm to the fault-ridden neo-classical synthesis so accurately represented by Paul Krugman and Joe Stiglitz. As just a minor point, what became evident is that economists are useless at predicting the future so have substituted GDP estimates for actually knowing anything at all about the economy. If I tell you that Australia over the past twenty years grew by 50% and China by 150%, you would not have any idea about what either was really like, the kinds of economy each is or what is actually going on. Economists have substituted statistics for actual knowledge. It is all pretty useless, but if your aim is to pull wool over people’s eyes about what is taking place, GDP is a great number since it is almost meaningless as a statement about anything of significance.

Politically, it has been amazing to be here for the transition to a more market-oriented socialist Prime Minister. Every country is a hopeless case since the freeloaders have now overrun the productive. But if you are trying to manage the place, even the most dense political leader trying to re-engineer a recovery cannot help noticing that only those who make a net contribution to output actually create more value than they use up. A tremendous amount of capital to run through in our Western economies, but we are managing to do it. Fascinating to see it all in action in a place you would not normally expect it.

Historically, there are two sides to it. In relation to why I am here, I am part of a group that is trying to save Jean-Baptiste Say’s factory in Auchy-les-Hesdins for posterity. There are not many – any – places in the world that are actually historical sites in which economic issues are at the forefront. Auchy is astonishing in that it combines an ancient cotton mill – where the waterfall that ran the mill can still be seen – with the writings of one of the greatest economists of all time. If you are in France in the north-west around Calais or Normandy, and you have any interest in these things at all, you must come visit. The website I am told is coming but you should see it for yourself. The best way to describe the positioning of Auchy is to note that it is half way between Azincourt and Crecy. See all three, but if you have an interest in economics and its history, this place will astonish you. There is nothing like it on the planet and, as with everything related to Say, is only now in the process of being rediscovered.

Lastly there has been my following the trail of historical battles, with the last few days on the WWI battle fronts. Went to Villers-Brettoneaux yesterday which is the Australian Vimy Ridge. Very moving places both of them. Two things I found particularly noteworthy. The first was the direction finder in the tower pointing out various places of significance on the Somme battle grounds. But amongst the 20 miles to this and 30 miles to that was the arrow that pointed to 14,235 miles to Canberra. It was a long way from home for those young Australians who lie buried in the fields of France.

The other was a grave to some young lad who died on this battlefield in 1918. His name was S. Keates. It was quite a strange moment. It is truly the case that there but for the grace of God go we all.

Words have consequences

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Theodore Dalrymple on an unfamiliar topic for him, how the meaning of words applies to “austerity”:

I was irritated rather by the fact that the author of the article accepted that the policy of the present British government can properly be described as one of austerity. What the alleged austerity amounts to is this: that in the current year the government will borrow only one in six of the pounds it spends instead of one in five, as it did last year. As to the reasons for this less than startling decline in its borrowing requirements, it was not because the government was spending less but because it was receiving more taxes, from the speculative housing bubble which it has done much to fuel. . . .

One would not say of a man who passed from smoking sixty cigarettes a day to fifty that he had given up smoking, or that he had exercised great self-denial. And one would not, or rather should not, say of an organization that had balanced its budget once in fifty years (the British government) that it was practicing austerity merely because it had to borrow a slightly lower percentage of what it spent than it did the year before. This is to deprive words of their meaning.

But the word “austerity” is not used by those who support balanced budgets but by its enemies. Why anyone still believes high levels of public spending can do anything but harm for the nation overall remains a mystery.