Sunday, November 30, 2008

drama in Ottawa

I might well have voted Liberal in the federal election last month had I been in Canada. I like Dion's corporate tax proposals and his remarks about opposing the NDP on this count. I like Dion's willingness to present policy initiatives like the "Green Shift" even if it had problems; at least it's a step better than the cynical populism of the Tories. I also like Iggy's background (it's not a liability to be educated, despite what Sarah Palin supporters might think) and even some of Bob Rae's remarks, like what Bob said about Georgia vs Russia. Of course, there's a lot I don't like about the Liberals, like their immigration policy, but in a number of respect the Liberals seemed the party of ideas in contrast to the party of the angry and pugnacious.

But I can't help but notice the Globe and Mail announcement that "Jack Mintz defends the Harper approach" [to stimulus]. I've referred to Mintz before; - I consider him Canada's top fiscal policy expert. If the opposition takes down the government on this issue (the public financing of political parties issue having been taken off the table), I will be off the fence in terms of Liberal vs Conservative. It would be a huge mistake for the Liberals to get on the wrong side of sound policy, and that's where you are if you are on the wrong side of Jack Mintz.

I don't entirely agree with Mintz re public financing of political parties, but on that count it is not really much of an economic issue. I see little fundamental difference beeen tax privileging political donations and outright subsidies, either way you are steering economic resources towards political parties. Does anyone think cutting tax credits for political donations would be a good idea? I see a vibrant marketplace of ideas as something of a positive externality. That said, the sums do matter. $30 million is a mere drop in bucket budget wise but $300 million is questionable. $30 million would help get messages out, whereas $300 million would get them out and market them in a big way, which shouldn't be necessary since the punditocracy will "market" the messages if they have merit. They just need enough help to get on the radar screen, in my view (of course, in Alberta it works the opposite: the bigger the party, the bigger the taxpayer support).

Saturday, November 29, 2008

Financial Crisis '08: attack of the parasites

How did this happen?

In a nutshell, consumption, especially in the US, of housing was at an unsustainable level, driven as it was by mispriced credit (too cheap). Government policies such as the deductiblity of interest on money borrowed to purchase a home aggravated the mispricing.

In general you support laissez faire policy on the grounds that government interventions, however well intentioned, typically create mispricings that undermine their objectives. But when you suggest here that government policy "aggravated" the mispricing, are you suggesting that the free market mispriced?

Yes. To begin with, free markets are subject to panics, manias, and bubbles, and these are mispricings. The "bubble" in US mortgage lending has been followed by a global credit panic.

It is important to understand here that panics and bubbles are symptoms of a problem, however, as opposed to the problem themselves. The problem is a lack of transparency. If it is clear to everyone what the "true" price should be, prices wouldn't soar far beyond that or crash far below.

Financial intermediation is critical to economic development. It puts people with ideas about how to produce more for less together with people with the capital to enable that idea. Unfortunately for capital suppliers, they have less information about the value of potential investment opportunities than the capital seeking entrepreneurs. Economists call this "information asymmetry", a concept at the core of financial market theory.

There are various things governments and regulators can do to try to address this problem, such as mandating disclosure and prohibiting trading on non-public information (lest the pool of willing capital suppliers shrink to insiders). Especially important is creating an investor friendly tax and legal system in the background. One of the lessons of this crisis, however, is that there was, in the end, still a significant shortage of information, or, more precisely a shortage of meaningful information in a sea of complex data.

So price discovery cannot be left to the private sector?

The wrong lesson from this crisis is that government should discover prices (i.e. determine how much of any given good or service should be produced). The right lesson is that private actors discover prices best and what happened is that these actors were overwhelmed by other private actors who obscured prices.

Who obscured prices here?

The guilty parties are legion, ranging from mortgage applicants who misrepresented their incomes to uninformed retail traders who exacerbated any mania or panic, but the prime culprits here are investment bankers. Investment bankers are financial innovators. And for a long time this financial innovation was economically useful. For example, whoever invented the common share made a very useful contribution by creating a product that represents a residual claim on a firm's assets instead of a fixed claim (like a bond or a bank loan). But with the explosion of progressively more complex derivatives, the generally useful process of spreading risk by slicing and splicing various payoffs and exposures became dominated by the harmful process of of obscuring just what the risks were.

Is there an example of when spreading risk is not useful?

Yes. Consider a bank originating a mortgage. It knows the borrower if it has a first hand relationship and has every incentive to monitor that borrower. If the default risk is spread, the bank will lend more and monitor less. Indeed, this financial crisis brings us back to the typically ignored policy fact which is that overinvestment is as much a problem as underinvestment per se, overinvestment in a particular sector implying mispriced investment (which in turn implies underinvestment in some other area). When investment bankers step in to slice and dice the risk across a chain of parties, they create another chain of information asymmetries and the duty to monitor suffers from a "tragedy of the commons".

How does it serve these investment bankers to obscure?

The more complex the valuation process is, the more these people leverage their comparative advantage. Markets move money from the uninformed to the informed. To a large extent, this is what policy makers want, because it is central to the idea of efficient price discovery. But in this case, "informed" people were making money who were not, in fact, more informed about the fundamental economic (as opposed to financial) values, they were rather more informed about the operations of things like derivatives, which do not further price discovery.

Why do you call derivatives parasites?

Because the value of a derivative is entirely derived from the value of the underlying. Resources diverted to pricing derivatives are resources diverted away from price discovery of the underlying.

Had the investment bankers really understood the nature of the beast they created, they would have kept the host alive. But in the end the beast was so big it completely obscured any view of the host.

GST cut clever and timely after all?

When the federal Tories cut the GST, it was widely panned by academic economists since it encourages consumption instead of investment.

Yet today the consensus seems close to universal that governments worldwide need to stimulate consumption by running deficits or otherwise pursuing policies that stimulate spending as opposed to saving. Never mind that borrowing to consume is what got the developed world into its present crisis...!


"[The favorite go-to economist for the Canadian media, Don Drummond, said] "the government should consider cutting taxes on lower income Canadians [who are] more likely to spend the money than those more affluent who might be tempted to bank it."

This is EXACTLY what was trotted as the reason why NOT to cut the GST (the tax savings would get spent instead of "banked").

Tuesday, November 25, 2008

comments on financial crisis in development

Kunming, the capital of Yunnan province and the only city with international flights to northern Burma, is forecast to be cold, relative to Dali, so I expect to be here in Dali until Sunday. I'll thus head to the Burmese consulate first thing next Monday morning with the idea of flying to Mandalay as soon as possible next week. Hot and humind southern Myanmar (Burma), including the capital Yangon (Rangoon), has little appeal to me, so unless I want to book an extra flight from Yangon north, the time to go is when I'll be in Kunming anyway. There is also a Burmese consulate in Kunming, so if I were to go to Burma later, I'd have to route through a city that has one, which might be out of my way.

I was thinking of getting to northern Thailand via Laos, but entering Thailand from Burma would be rather more unique, and I may go through Laos anyway to return to Kunming next month. There is apparently a two week wait to get a Burmese permit to exit overland, but applying and waiting in Burma where I'd probably be for 2 weeks anyway is reportedly easier than trying to enter Burma and go far into the country from Thailand.

All this to say that I've got some time on my hands this week and I've started putting together some thoughts about the financial crisis and its policy implications.

Monday, November 24, 2008

in China

I ended up rather busy while in Hong Kong, but now have some time in Old Dali, a city in China's southwestern Yunnan province.

My #1 pet peeve about China is the spitting. Closely followed by the smoking. Every station in an internet cafe will have an ashtray. On the plus side are the prices, which are typically listed, and when they aren't the locals will invariably give you change back just as if you were a local.

Tuesday, November 4, 2008

Dems lose white vote... again

The Democrat candidate for the White House hasn't won a majority of the white vote since 1964, and Barack Obama hasn't won it either, according to exit polls. In fact, he didn't even win a majority of white women.

For all the optimism about what this election represents, I think it should be tempered with some sober reflection on just how limited the extent was to which Obama "won the argument". Winning an election based on demographic changes alone is not "winning the argument". This isn't to deny that Obama did not win some thoughtful people over as opposed to just winning because of identity politics. But regress the wins in Virginia (and possibly NC) to the demographic changes there and then consider Ronald Reagan's 1984 landsilde. The number of people who changed their minds in how they voted betweeen 2000, 2004, and 2008 is dwarfed by, say, the people who changed their minds between 1976, 1980, and 1984.

Lest anyone think I'm simply being ungracious, keep in mind that my overriding interest is simply seeing more policy debates, more sophisticated policy debates, introduced into the campaign process. When people are celebrating the victory of "one of their own", it suggests that that the policy debate fell out as irrelevant; all those voters needed to know was which candidate looked more like them. I'm not at all sure how it illustrates the triumph of what's great about democracy if the most sober lessson is that the best way to get yourself elected is to find a constituency where you match up best demographically.

On another note, the election of Obama has evidently done nothing to improve Moscow's opinion of America.


Gay marriage ban defeated in California if only whites had voted... "What carried it over the top was enormous support from black voters, with about 70 percent of them backing it."

Monday, November 3, 2008

President Obama...

In the recent Canadian election, had I been in the country to vote it wouldn't have been an easy decision for me. As a youth I was down-the-line "conservative", but as I approach middle age I've become increasingly frustrated with the anti-intellectual strain that runs through cultural conservatism. What one person sees as an appeal to the values of the patriotic and hardworking man in the street is another person's rabble-rousing populism, retarding rather than advancing informed policy discussion. And the federal Canadian Tories have become master populists. A productivity agenda? If there was one, I'd suspect it was coming from the civil servants in Ottawa, not the Conservative Party. Perhaps if they had a coherent climate change strategy, or, in the alternative, the courage to simply deny the need for any government role in mitigating climate change, I could see them as the party of superior policy. But of course the Tories have been purely reactive on that file and my time on the inside of Flaherty's Finance Department occasionally made me nostaligic for John Manley, someone who, by the way, has been fighting the good fight for North American economic integration instead of just picking fights with other politicians....

The US election, however, is clearer. Make no mistake: I would vote Obama Prom King any day of the week. I like his cerebral style, his graciousness, the inspiration he provides to people of colour. But when it comes to policy, there is limited evidence for the thesis that Obama takes growth friendly policies as his starting point. It seems that he takes a conception of social and/or economic "justice" as his starting point, and then mitigates any damage to economic growth as a second step. This is a recipe for poor policy, in my view. Yes, growth only policy needs adjustment; - gross inquality can result and this can and should be mitigated. But McCain seems more likely to have the steps in the policy process in the right order. Yes, McCain doesn't know much about economics (as Joe Klein of TIME insists on pointing out), but McCain seems more inclined to defer free market economists than Obama. Obama respects expertise, of course, but explain to me how that respect actually means something in the end if, for example, he votes for rent controls as he did while a state senator?

Obama is a genuine expert in constitutional law. I'll grant that. But as someone with a degree in both law and business, I believe that business expertise and/or experience is far more valuable in a politician than legal expertise. Suppose that foreign policy is a more pressing issue than the economy. On that count we've already seen McCain exhibit better judgment on issues ranging from the surge to Georgia. Yes, Obama was right on Iraq, however one has to ask whether Obama's decision wasn't based on his sense of justice as opposed to a prescient appreciation of the subsequent practical problems; i.e. an ideological approach that happened to be proved right as opposed to a savvy pragmatic approach. The man TIME magazine called Obama's top foreign policy advisor, Tony Lake, has claimed that the guilt of Alger Hiss is not settled. Yet John Ehrman notes that "The basic question — whether Alger Hiss was a spy for the Soviet Union during the 1930s and 1940s — was finally settled during the 1990s". The bipartisan Moynihan Commission concluded that "The complicity of Alger Hiss of the State Department seems settled" and Moynihan (D-NY) himself said there is "conclusive evidence of his guilt". Stanley Kutler has observed that "In the end, the publication of the Venona intercepts of wartime Soviet espionage referring to "Ales" settled the matter". Scholar David Oshinsky says that the "vast majority of historians” accept Whittaker Chambers' overall version of events and "[t]o accept the guilt of Alger Hiss is to admit the bitter truth about a small but sinister part of America's "progressive" past". Intelligence expert Thomas Powers notes that "...much additional evidence about Hiss's involvement with the Soviets has turned up since the voluminous and explicit claims by Whittaker Chambers and Elizabeth Bentley in the 1940s, claims which no serious scholar of the subject any longer dismisses". See also Robert Beisner, Mark Kramer, David Greenberg, Allen Weinstein, John Earl Haynes, Harvey Klehr ("Outside the ranks of Nation readers and a dwindling coterie of academic leftists, there are few people still willing to claim that Alger Hiss and Harry Dexter White were not Soviet agents"), Vasili Mitrokhin, Ronald Radosh ("Except for a dwindling group — mostly Nation magazine readers and editors ... the consensus has solidified: Hiss was undoubtedly a Soviet spy"), Sam Tanenhaus, G. Edward White etc. etc. Leftist academic Ellen Schrecker concedes that "There is now too much evidence from too many different sources for anyone but the most die-hard loyalists to argue convincingly for the innocence of Hiss" as does Maurice Isserman ("Let's face it, the debate just ended" (in Isserman's review of Weinstein's Haunted Wood)). Even at the self-described "flagship of the left", Nation contributor Athan Theoharis grants that the "conventional assessment" is that Hiss was "an unreconstructed Soviet spy" and editor Victor Navasky himself allows that he's not with the "consensus historians". If that isn't enough, one could cite the New York Times, the Washington Post, TIME, PBS NOVA ("Venona also helps to settle the case of Alger Hiss") etc. And this is Obama's top foreign policy advisor?

When did the media call attention to the fact this Obama advisor is offside all but the most dogmatically leftist of experts on at least this one issue? In the mean time, you've got the running media narrative that questioning Obama's assocations amounts to dirty campaigning.

A review of this substantive editorial in the Times of India indicates the international enthusiasm for Obama is less than universal. The Wall Street Journal has distinguished itself in its coverage of this election (unlike the vast majority of the media), and one asks oneself why other papers aren't carrying the observations of, to take one example, Nobel Prize winning economist Vernon Smith, who writes, "it is entirely likely that Mr. Obama will succeed in going for higher business, capital gains and income taxes, but it is an economic illusion to think for a minute that this will benefit the poor." Then there's others, like the (incidentally black) economist Thomas Sowell, who suggests that tomorrow's election will provide "all the ingredients for a historic meltdown".

Obama's support for the Farm Bill, and McCain's opposition to that egregious legislation, is probably my single biggest problem with Obama, closely followed by Obama's ties to anti-trade interest groups like unions "("...I owe those unions" - "Audacity of Hope", paperback, p. 142). McCain's is far more emotional than Obama, and that goes to judgement, but that detractor for McCain is somewhat tempered by the fact I see that as a greater inclination to have greater affection for and sympathy for his enemies. Obama's post-partisanship might well be entirely rhetorical.

If the generally accepted narrative about Obama was skeptical, I'd be more comfortable with the idea of President Obama. But it isn't, and I'm not.