The Only Winning Move

Probably THE thing I’m most interested in in my hobby field of Economics at the moment is Deflation - which most economists think of as a general fall in prices (probably owing to waning demand), and which Austrian and Monetarist Economists think of as a drop in the money supply (the amount of money and available credit floating about). Obviously these two things are related, and in light of the current situation it’s interesting to compare the two definitions. By the standard definition, we’re definitely in a deflation. Prices are falling (the CPI is down 0.1%, and it almost never drops), and it seems to have to do with a drop in demand (people just aren’t spending as much). By the Austrian definition the situation is interesting because the Federal Reserve is trying desperately to cause inflation. Interest rates are as low as they’ve pretty much ever been, and of course the government is handing out money left and right.

There are two reasons I’m so interested in Deflation. The first is the sort of natural curiosity that everyone has for forbidden fruit. Deflation is the big bugbear of almost every school of Economics - to be avoided at nearly any cost. (Even for some Austrian economists it’s an evil - though no Austrian economist would advocate avoiding it “at any cost.”) The second is that it seems to me an inevitable consequence of a certain kind of gold standard. Imagine that there is a fixed amount of gold (or whatever commodity it is) in Fort Knox, and that’s just it - a frozen money supply. Dollars are defined at some fixed weight, and so there are only ever so many dollars floating about. It seems that in this kind of situation (which no one is advocating or will likely ever advocate) deflation would actually be an inevitable consequence of prosperity as competition and ever-increasing supply means there is always the same amount of money chasing ever greater quantities of goods and services. Prices in general would have to drop. Since I can imagine a situation in a totally alien economy where deflation would thus be a good thing, I’m curious whether anyone more knowledgable about these things than me has worked out all the implications.

So I was pleased to discover that the Mises Institute had made a copy of a book on the subject available as a free podcast download (also available in pdf form). The book is Jörg Guido Hülsmann’s Deflation and Liberty, and it tries to make the case that deflation is not only necessary but socially desireable. Since it’s so far from the standard script on the subject, I downloaded and listened to it this week.

The argument in a nutshell is that deflation and inflation are best understood in terms of the price of money, or else the size of the money supply. Inflation is when the amount of money “out there” grows relative to the amount of goods and services available. Deflation is when it shrinks. Hülsmann argues plausibly that for this reason inflation and deflation are best understood as redistributive mechanisms. Since that’s always the way I’ve thought about them too, it was nice to get some confirmation! To show how it works, let’s take an inflation example. This means that the money supply (the amount of paper dollars and available credit) grows relative to the number of goods and services. So you have the same total amount of “value out there” in the form of goods and services, what’s changed is that there’s more money available to exchange for these goods and services. OK - so clearly since the amount of value has not changed, what will have changed is who commands how much of that value. The people who get more of the new money obviously benefit from the redistribution, the people who didn’t get as much (or any) of the new money are harmed. What cannot be doubted, really, is that a redistribution of some kind has taken place. The interesting question is then who benefits and who is harmed, generally speaking? The answer seems to be that in general people who go into debt benefit from inflation and those who save are made worse off.

There are two ways to convince yourself of this. First, consider that inflation means that each dollar bill is worth a little bit less. Remember, there is exactly the same amount of value, what’s changed is that there are more dollars “out there” to spend on that value. So each dollar is a little bit weaker than it used to be. It’s sort of like if you’re measuring something in inches and are suddenly told to change to centimeters. The length of the thing that you’re measuring hasn’t changed, but it now takes more individual units of length to account for it. Second, consider that the consequence of more money being “out there” is that prices will have to rise. Since there’s more money to be had, people who make things will need more of it to maintain their position. Either way you think of it, it’s easy to see that inflation steals from people who save. Your money in the bank is now worth less than it was, whether you think of this in terms of it being a smaller portion of the overall money supply, or whether you think of it as buying less at the newly higher prices than it did before inflation. People who borrow do comparatively better, however. They buy things without having first saved for them, and if the inflation continues, they can work off their debts at inflated wages relative to the amount they borrowed, making it easier to pay off the accumulated debt.

It stands to reason, then, that deflation redistributes in favor of the savers. Money in the bank buys more than it did the day you put it in - whether you think of this in terms of it being a bigger part of a shrinking money pie, or in terms of the general price level decreasing. By contrast, people who are in debt are worse off, because they borrowed money when prices and wages were higher, and now they have to pay it off at lower wages, or by selling off things they own at lower prices.

I hadn’t ever thought of deflation in terms of helping savers, so this book really helped me see how that works. By the same token, I’d never really thought of deflation as a good thing for liberty. That’s a more complicated argument that I’ll leave it to the book to make - but the nutshell version is that since the people who print the inflated new money get to decide where it goes but don’t find it as easy to control things when they shrink the money supply, that inflation more than deflation is a tool for economic manipulation by the central bank/government.

The book was really useful to me for clearing up these issues, and so I recommend it. However, I had a few lingering questions.

1. I’m frankly a little uncomfortable with the ATB praise for deflation in the current situation. I agree that a general deflation is necessary and therefore probably welcome. However, a freefall deflation seems a bit unfair given the extent to which people have been encouraged to go into debt. Taking myself as an example, I’ve accumulated some student loan debts here in graduate school, which seemed more rational than going to work for a year and postponing graduation. I’m fully willing to take responsibility for my choice, and I’m not therefore seeking to avoid my debts. Quite the contrary - I’ve been very careful to take out these loans only from private sources, at higher interest rates, so that I am not asking anyone I don’t know (i.e. the general taxpayers) to finance my education. I consider myself a responsible borrow responding to the incentives that were placed before me, and it seems a bit unfair for the amount of my debt to suddenly inflate should prices be allowed to go into freefall. Since most people are in much worse situations than I am (from housing loans, larger quantities of student loans, etc.), the problem only compounds. A lot of innocent people will be hurt by a general deflation.
2. Related to the first reason, most people currently in debt simply won’t be able to pay under a general deflation. This will lead to lots of defaults and bankrupcies, which will dry up a lot of the capital stock for recovery. I suppose the answer to this question is that that’s to a large degree money that was never there to begin with (i.e. money the Fed pulled out of thin air), so no harm no foul. I buy that to a large extent - but surely there is some residual damage?
3. I wonder if there is a sense in which inflation is a nature’s response to central bankers trying to game the system. I’m thinking in particular here of the labor unions. They negotiate their wages higher with government backing, which has the effect of causing more inflation. Which means that some of their gains then vanish as general price levels go higher. Push the economy, and it pushes back! Of course, I suppose the answer to this one is to point to all those other workers who aren’t union members and have to deal with higher prices even though their wages haven’t necessarily gone up - in which case the unions really do gain, even if not by as much as they planned.

At any rate, an interesting book. It won’t answer all your questions by a long shot, but as food for thought on deflation (which, at a manageable hour and fifteen minutes you can easily digest during commutes), it’s a good place to start.

One of my frustrations with political discourse from the left involves the use of the following trick. First, point out that some government institution has been helpful in the current crisis. Then, invite everyone to imagine how much worse the crisis would have been without that institution. Finally, stop short of openly wondering whether the current crisis might have been in part caused by a general overestimation of said institution’s power to save us should exactly this kind of thing happen.

Of course I’m talking about Paul Krugman’s latest column - titled (appropriately, though with some unintentional irony) “Franklin Delano Obama.”

About the New Deal’s long-run achievements: the institutions F.D.R. built have proved both durable and essential. Indeed, those institutions remain the bedrock of our nation’s economic stability. Imagine how much worse the financial crisis would be if the New Deal hadn’t insured most bank deposits.

Yes, it seems plausible that the crisis would be a lot worse without the FDIC’s guarantee (there wasn’t a run on the banks like there was in ‘29 and ‘32, after all). But it seems equally plausible that there just wouldn’t have been a crisis at all without the FDIC’s guarantee. Consider it this way: it’s 1932 and over half the banks fail, wiping out a lot of savings overnight. That’s a catastrophe, and indeed, a lot of people lost their jobs. Now let’s imagine that instead of guaranteeing bank deposits, the federal government had just let people sort it all out themselves. Well, in that case the banks would’ve had to do some serious convincing to get people to trust them again. Chief among this would no doubt be upping the “fractional” part of “fractional reserve” such that they guaranteed that for every account, a certain (very high) percentage of that account would always be there on hand. That is, instead of keeping only 20% of deposits on tap (or even less - I understand that in recent years this number has sunk to well below 10%), banks would start writing into their deposit contracts that their loans would only be made on, say, 20% of the money on balance. The result would be that even in a run on the bank, people would get 80% (or whatever) back. Now - imagining that this had happened rather than the government stepping in to do the banks’ primary job for them, what do you think the current crisis would look like? Right - it wouldn’t even be happening, because contractural obligations would’ve prevented the banks from exposing themselves to the tune of 90+% of their assets in the first place.

Imagine how insecure older Americans would feel right now if Republicans had managed to dismantle Social Security.

Well, right - no doubt older Americans would feel pretty insecure right now if the Republicans had dismantled Social Security. Of course, no Republican has ever proposed actually dismantling Social Security. The proposal, as Krugman well knows, was to allow people to opt out of a certain portion of it, and to deposit their payroll taxes into IRAs instead. Either way, the government would have been forcing people to save, just that some people would’ve been allowed to manage their own funds if they so desired. So this is Krugman indulging in fantasy yet again - but that’s fine with me because I’m about to use my imagination too. Let’s imagine that Social Security had never even existed. In that case, it again seems hugely unlikely that the current financial mess would have ever happened because the American household savings rate would be much higher than it is right now. Rather than counting on the government to take care of them in their old age, people would have been saving for themselves, which would mean a lot more money on deposit in banks, and again a much greater capital base in the country as a whole. Rather than living on $70trillion in loans of money that doesn’t actually exist, Americans would be living off of their savings and buying houses honestly.

What saved the economy, and the New Deal, was the enormous public works project known as World War II, which finally provided a fiscal stimulus adequate to the economy’s needs.

This one, of course, is just a lie. The economy didn’t recover until 1952 - which if Dr. Krugman will check his history books was 7 years after WWII. Immediately after the war, we fell back into recession.

The economic lesson is the importance of doing enough. F.D.R. thought he was being prudent by reining in his spending plans; in reality, he was taking big risks with the economy and with his legacy. My advice to the Obama people is to figure out how much help they think the economy needs, then add 50 percent. It’s much better, in a depressed economy, to err on the side of too much stimulus than on the side of too little.

Um, no. It’s much better in a depressed economy to get the goverment out of everyone’s way and let production get back to normal. A lot of capital has been misallocated, in large part because the amount of existing capital has been overstated. Getting the government in the business of misallocating even more staggering amounts of imaginary capital isn’t going to help anything.

The glaring omission in all of this, of course, is that part of FDR’s New Deal was the nationalization of the mortgage market. For years after the 1930s, the mortgage market was actually in the government’s hands and strictly regulated. In the late 60s and early 70s, the industry was semi-privatized, with Fannie Mae and Freddie Mac remaining largely under the government’s control, the government’s “man on the inside” to insure that the whole industry follows its dictates. Officially, there was only a government credit line to bail out the industry should mass foreclosures of the kind we saw during the New Deal return. But in reality, this ammounted to an implicit guarantee that the institutions would never be allowed to fail. Now, it doesn’t take an MIT economist to tell you what happens when you wink at someone and tell him you’ve got his back. It’s the same thing that always comes from having powerful friends: you take more risks ’cause you know they’ve got your back. And sure enough, that’s what caused the mess we’re in now. Freddie and Fannie basically threw out the book on how to evaluate the creditworthiness of people applying for mortgages, they made a lot of stupid loans (under, I hasten to add, a lot of political pressure from Congress to make housing “more affordable”), many of which they were able to sell on the basis of everyone’s understanding that the government would bail them out if it ever came to that. It did come to that, and the government did bail them out, and that, ladies and gentlemen, is the real legacy of the New Deal. Far from being a model for what to do in the current crisis, FDR should stand as a stark warning of the kind of moral hazard trouble that you get yourself into when you let the government go and tell the financial sector how to run its business.

So once again, Krugman is not only cherry-picking his data, he’s also mischaracterizing the cherries he picks. Well, no one’s ever accused him of playing fair…

A headline: As Verasun (VSE) Goes Chapter 11, The Ethanol Industry Faces Serial Failures.

Best goddamned news I’ve heard all day. Good riddance. Those leeches deserve their fate. If you have a competitive non-oil fuel source, I’m more than happy to buy it. But when you have a fuel source that not only is not competitive but actually destructive and only gets sold because the government makes people buy it, you are officially doing more harm than good. I understand that farmers like government handouts, and I understand that they like ethanol because it makes their corn more expensive. There are about 2million farmers in the US - which means 298million non-farmers. By any economically rational point of view, consumer savings to 298million people trumps increased profits for 2million. That is, 0.0000006% of the population should not get free money at the expense of the rest of the 99.99999% of us. ESPECIALLY not when that subsidy crowds out investment in other energy alternatives.

So - ethanol farmers: Go. Fuck. Yourselves. Very little could make me happier than seeing you assholes go out of business.

Of course, the biggest irony of the fact that Obama seems poised to win the election is that it means that we’re essentially giving our stamp of approval to a subsidy that is entirely the fault of Bush and the Republican Congress. The Republicans in Congress were every bit as guilty as the Democrats of larding up that bill with more pork than the Republic had ever seen. And Bush’s dumb ass signed it. It’s one of the many, many things that the Republicans need punishing for, and yet it’s the Republican candidate for president who’s calling them out on it. McCain isn’t exactly promising to repeal the bill (how could he?), but he IS promising to lower tariffs on foreign ethanol quite significantly (by more than 50%), saving us all a metric assload of money that we can now spend ourselves rather than handing out to greedy rent-seekers in Iowa for free. I say it again - McCain is the sane choice on economic policy. At the very least - even if we can’t necessarily count on him to get a hostile Congress to pass his bill - we can count on him to veto any measures to bail these bloodsuckers out. How do I know I can count on him? Because in addition to voting against the original bill, he also had the balls to say so in Iowa during the primary when that primary was still crowded. Obama, by contrast, will be all too happy to sign anything that “spreads the wealth around.” (Yes, voting for HR6 was one of Obama’s few non-abstentions.)

Vote McCain.

Here’s why I’m not too worried about this. The link will take you to a chart (I’m speaking here about figure 1.1 - there are three, selectable through tabs on the bottom) on Robert Shiller’s homepage. It purports to show a disturbing widening in the gap in the Price-to-Earnings-Ratio of stocks and the actual earnings of the companies they represent.

I think this data is spurious. The scary bits in the chart for me are regions like that in the 1960s and 1970s, where the P/E ratio grows in contrast to a relatively steady state for corporate incomes. Periods like those are a pretty stark demonstration that stock prices were doing a bad job tracking corporate incomes. By contrast, periods like the one in the 2000s don’t bother me so much. True, the P/E ratio is sky-high compared to corporate earnings - dramatically so. But it’s exactly this kind of thing that a statistical charlatan exploits to sell books. When you consider what the P/E ratio represents, it’s pretty easy to convince yourself that what it actually is matters not a whit, so long as it generally trends in the same direction as corporate profits.

The P/E ratio is simplicity itself. All you do is take the stock price (P) and divide it by the company’s earnings (E). The P is easy to calculate - you simply look up the stock’s value on the NYSE index (or whatever market it’s traded on). E is a bit harder. For that, you take the dollar amount of the company’s earnings and divide it by the number of shares (a “share” is, after all, just what it sounds like: your own private piece of the company). But no matter - if you own the stock, it’s usually easy to get that number too, and P/E ratios typically posted somewhere public to save you the trouble.

Now, since this is a simple fraction, it’s easy to puzzle out what it would mean if company earnings drop, but the P/E ratio for a stock rises. Since the P - the price of the stock - is in the numerator, and the E - the company earnings - is in the denominator, then for the P/E ratio to rise while E falls it would have to be that at best corporate earnings are falling faster than the price of the stock, but more likely that the price of the stock either holds flat or even rises as company earnings fall. Same thing for the situation where corporate earnings rise but the P/E ratio falls. For that to happen, it means that E is growing faster than P - which is to say, corporate profits are either (a) growing faster than the price of the stock, (b) growing while the price of the stock holds steady or (c) growing while the price of the stock falls. In either case, it means that the price of the stock is probably not tracking corporate earnings - which is to say, probably not reflecting economic reality. THAT’s the sort of thing that we should worry about - when the stock market is tracking essentially nothing but the machinations of traders.

By contrast - consider the situation where P/E is growing faster than E, or falling faster than E, but in the same direction. That simply means that stock prices are more dramatic than corporate earnings (they rise or fall faster than earnings) maybe, but they are still basically tracking them. It’s impossible for the P/E ratio to rise while corporate earnings rise if P is falling, and likewise impossible for the P/E ratio to fall while E is falling if P is rising.

I won’t say this is exactly what we want. In the utopian world where the Efficient Market Hypothesis were transparently true without qualification, then I suppose the P/E ratio would be less volatile than E itself, and that P/E would stay close to 1. But that’s a world of total transparency in both reporting and prediction. I really do think the future holds something like that, but probably not in my lifetime. Right now, the world economy remains uncertain enough that what tomorrow holds is still guesswork, to a large degree. That means that P/E is both volatile and a long way from unity. But that’s OK with me so long as it generally tracks the real economy.

What Shiller’s graph says to me, actually, is that the stock market is doing a better job than ever tracking the real economy. Because even though it’s true that the P/E ratio has a wider gap with E than ever before, notice how closely it tracks E. Starting in the late 90s, it’s actually just a REALLY EXAGGERATED proxy for E. It rises when E rises, falls when E falls, which is to say that E is doing the real heavy lifting of explaining where stocks prices go. P rises faster than E and falls faster than E, but always in the same direction. In other words, the market is working, and the direction stock prices take in general gives us a good idea where the market is headed. Better still - P/E isn’t just tracking E, it’s correctly predicting it. P/E seems to rise just before E does, and fall just before E falls. It’s a good demonstration of the wisdom of crowds. Prices are volatile, so that means that individual traders have no clue which direction the market is headed. However, traders as a whole seem to be getting it more right than ever. Which is to say, as a group they’re doing their jobs.

Why is the gap between P/E and E so stark all of a sudden, then? No clue - but here’s my stab at it. I would say that it coincides with a massive expansion in stock speculation. That is, back in the 70s there weren’t so many traders; these days, nearly everyone with a job is a trader. The amount of fodder traders have to play with is much larger, so of course there’s some drama. It’s sort of like the difference between shooting someone with a .45 and shooting them with an AK. Dead is dead either way, but it’s a messier kill the more firepower you have. Traders are playing with larger volumes of money than ever (what with the existence of 401Ks and such), but if Shiller’s chart is to be believed, this has only made them more precise in their predictions recently.

Now - one fear that probably still needs calming is the idea that with stock prices in general being higher than ever, isn’t a lot of that money “not real?” Well, no - all it means is that there’s a higher barrier to entry into the market than before. A good way to think of it is to imagine a poker game. You can’t play without first paying for your chips. Likewise - in the stock market, you can’t play without first paying for your stocks. Once you start playing, you’re mostly trading chips for chips (stocks for stocks), but the total amount of money in the stock market can’t grow without someone first playing in. Granted that there’s a caveat here - some of these purchases may be made with borrowed money, and if these traders go bust and can’t repay their loans then yes, some of the volatility they caused was based on money that turns out not to be real. Dispelling this worry takes a longer post - but the general idea is that so long as they never become the majority of traders we’re probably OK, the noise comes out in the wash (some of them, after all, make back what they borrowed and pay back their creditors). That caveat aside, it’s just like a poker game. When you take your chips out, all you’re claiming is money that’s already been deposited. And if there’s more money total on the table than there was when you started, then that’s because others have been buying in with more (real) money to stave off their losses. Either that, or more players have joined the game since you did. (In fact, I think this analogy probably works for the widening of the gap in P/E and E too. The more total money there is at the table in a poker game, the bigger the bets - and especially pots - tend to be. The underlying reality of how you win and lose hasn’t changed, but the stakes have is all.)

So I’m not too impressed with Shiller’s scary graph. I think as long as P/E tracks E, then E is doing the real explaining, and that means the market is working. P/E holding relatively flat would be even better. What’s REALLY scary is when P/E goes in the opposite direction as E. Then the stock market is only tracking its own wankery and has effectively ceased to function as an economic indicator. It shouldn’t surprise anyone that this happened at the height of Socialism in this country in the late 1960s/early 1970s. “We” (meaning the Johnson and Nixon Administrations) adopted an anti-market policy, and the market therefore stopped telling us much that was useful, just as Ludwig von Mises warned it would.

Here’s a question with an easy answer. When you’re in a desperate situation, and you know someone else who has been in a similar situation and made some bad choices as to how to get out of it, do you (a) do exactly what he did or (b) cast about for some other solution?

Amazingly, Paul Krugman and Ben Bernanke advocate choosing (a).

First, some clarity. The situations in question, as you may have guessed, are the Japanese “lost decade” of the 1990s and the current American “credit crunch.” The similarities between the two are striking. On December 29, 1989, the Japanese stock market hit an all-time high of 38,957.44. Not only has it never even come close to duplicating that performance, it’s currently valued at 7,162.90 - about what it was worth in 1982. Throughout 1990, the Nikkei posted near-constant losses. There was a reprieve in 1991-1992, but it dropped some more in the following years and bounced around but generally declined until 2003. This was the consequence of the infamous “bubble economy.” Like with the Great Depression, the initial collapse was probably unavoidable, given the financial and regulatory environment of the time. It was very much a case of irrational exuberance, caused by almost exactly the same thing that is casuing the current problems in America (irresponsible lending based on overvalued mortgage assets), and there wasn’t much anyone could’ve done in 1990 but let the Nikkei fall. What WAS, in all probability, avoidable was the so-called “lost decade.” That was a problem created entirely by the unwillingness of Japan’s political class to accept some pain in exchange for later gain. The banks continued making bad loans because the central bank kept cutting interest rates until they were literally zero (1998), and the government kept stepping in to hand out cash every time this scheme failed to work. The downward spiral was eventually broken under the stewardship of reformist prime minister Junichiro Koizumi - probably the only postwar Japanese leader to understand “no pain no gain.”

Let’s start with Dr. Krugman, since his intellectual dishonesty is well known. An October 25 post on Krugman’s blog suggests that the problem with the bailout is that it isn’t expensive enough.

Japan’s bank bailout in 1998 was more than $500 billion, in an economy whose dollar GDP was only about 1/4 that of the United States today. Do the math. And the just-announced IMF loan to Iceland is $2.1 billion — that’s for a country with only 300,000 people. Both of these numbers seem to suggest that an eventual outlay of $2 trillion is in the realm of possibility.

Yes, that’s all very convincing until you bother to remember that Japan didn’t start recovering until 2003. There is NO EVIDENCE WHATEVER that the $500billion that the Japanese government spent on that bailout did any good at all. In other words, at best Japan just put $500billion in an empty oil drum and lit it on fire. At worst, it used this money to prop up bad loans and crowd out the kind of prudent investment necessary to restart its economy. On either interpretation, why the HELL does Krugman think it’s a good idea to throw MORE money at a bailout that we have historical reasons to believe WON’T WORK??? Thanks, but I’ll pass. The data point about Iceland is, of course, completely irrelevant. Iceland may well be asking for proportionally much more money than we are, but (a) Iceland’s entire economy is a banking economy (aside from some fish here and there, it doesn’t have any industry or exports) and (b) we don’t know whether the Iceland bailout is going to be successful, i.e. the most generous thing we can say about this citation of it as evidence that financial prudence is more expensive is that the jury’s still out (the trial hasn’t even happened). Notice also that Krugman’s hallmark dishonesty is on full display here. When we’re talking about Japan, it’s the sensible “size-of-economy” that’s the standard of comparison. When we’re talking about Iceland, we’ve inexplicably switched to “size-of-population,” which of course has nothing to do with anything. But what’s especially galling about the whole thing, as if it needed pointing out, is that Krugman is citing a case of known failure as a recipe for success. The Nobel Committee was really engaging in self-parody when it gave this man a bus pass, let alone an award.

Now here’s Bernanke. He wants to cut interst rates to 1%. Again, does no one remember that Japan did exactly this in the 1990s to no effect? It’s as though, instead of a simple inability to learn from history, there’s a stubborn refusal to do so. I understand the logic here, and it’s not wrong so much as uninformed. Bernanke is operating under the assumption that the problem is that banks are holding on to their loan capital. So, to stimulate new lending, you want to make loan capital “cheap” by lowering the prime interest rates. That seems to make sense. But - just as with Japan in the 90s - the problem has been misdiagnosed. The problem isn’t that banks aren’t lending. In fact, the dollar amount of loans is still growing by as much as 10%. They only call it a “slowdown” because the rate of growth in lending is down. But note that in absolute terms, more loans were made this year than last. The problem is more likely that there’s too much lending going on. (After all, many of those loans that accounted for lending last year were mortgage investments - neither prudent nor economically productive. It is NOT a bad thing if we write fewer of those this year!) Now, a slowdown in lending WILL mean more unemployment and it WILL mean recession and it WILL therefore mean pain. But this is all unavoidable. If the whole problem is that loans are coming in bad (rather than that loans aren’t happening), then obviously you want loan money to be harder to get in the hope that the dwindling supply of loan money gets better-allocated. It is never - that’s NEVER - a good idea to throw value at investments that don’t return value. It was when Japan finally got around to learning that the hard way that winds started to blow in their favor again. When your problem is a mass of bad loans, the solution is not to lend more than ever! The solution is to lend less and more prudently, and to let the unprofitable businesses fail. This is a simple allocation problem: we want money going to those parts of the economy that are most productive. By cutting interest rates even further when there is no evidence that lending has seized up (failed to grow as quickly as last year is NOT the same thing as seized up! Repeat after me: “there is no credit crunch.”), he’s inviting more bad loans, more misallocation of resources, and inflation. Brilliant.

Look - this isn’t that hard. Japan at least had the excuse that its situation was new. We don’t. We saw what happened to Japan - so I suggest we learn from it rather than aping solutions we know aren’t helpful.

I suppose the upshot is that it means there won’t be a second term for President Obama. The downshot is that we may be in for a “lost decade” of our own. And the down-down-shot is that it was all completely avoidable. Ben Bernanke has done all he can do. He needs to take his finger off the trigger and let events play out. It isn’t his job to prevent recessions - just to soften them. He’s done that, and it’s enough. Please, please, let’s now leave the interest rate alone! (I wouldn’t actually mind if he raised it.) And for the sake of God in Heaven NO MORE BAILOUT MONEY! As for Paul Krugman, the only thing that seems likely help him at this point is an arsenic pill in his coffee.

One thing that seems to be surprising a lot of pundits is how much oil prices have fallen. Not only that, but that they continue to fall ever after OPEC repeatedly imposes output cuts (designed to drive prices back up).

It doesn’t surprise me.

It has been obvious since the beginning of the oil price rises that commentators don’t know what an inelastic demand curve is. Note - I didn’t say they are unfamiliar with it. One sees these and similar words in print almost constantly - “demand for gas is highly inelastic” and such. They are familiar enough with the term to use it in the proper contexts, I’m just not sure they really know what it means.

Here’s something it doesn’t mean: “the demand for the product in question never changes, no matter what the price.”

An “inelastic demand curve” for a given just means that changes in demand aren’t all that sensitive to changes in price. So yes, things like oil and water and food come to mind here. You can’t refuse to eat and expect to live, so if there were a sudden spike in food prices, you would have to simply pay the increase. And yes, low elasticity is good for producers, where high elasticity is good for consumers. When elasticity is low (that is, changes in price don’t really affect demand), then the producers can afford to raise their prices without worrying too much about chasing off buyers. You chase off some buyers maybe, but the people who continute to buy from you are paying such higher prices that it more than makes up for it. You come out better. By contrast, high elasticity works the other way. If demand is highly sensitive to changes in price, then it’s usually a good idea to lower your price - so as to increase demand. Since demand is highly sensitive to price changes, then lowering the price brings in lots more people, and the increase in customer base makes up for the lost revenue-per-unit-sold (more stuff gets bought overall, so it doesn’t matter that the price is lower).

What there really isn’t such a thing as is a perfectly inelastic demand curve. That is, there is no such product such that you can just raise the price forever without chasing buyers away … as oil companies (and hopefully Congress) are now discovering. Why? It seems almost counterintuitive. After all, the lion’s share of the transportation and energy economies depend on oil - and surely “the” Economy can’t function without these two crucial pillars! Well, right - it’s true that it wouldn’t be economical to just ditch oil at the moment. But it’s still a mistake to assume that there are no alternatives to oil. There are plenty of alternatives - it’s just that they’re all highly inefficient (and therefore expensive) at the moment. More importantly, there are ways to economize on oil - and that’s what people are currently doing. You can walk to the store rather than drive (or take fewer overall trips to the store if walking is not an option), cut down on your electricity use, go with a more fuel-efficient choice when you buy a new car, spend that extra dollar on better insulation, put up solar panels, etc. etc. If you can’t exactly get oil out of your life, you can certainly opt to use less of it. And “using less of it” is a drop in demand just like any other.

Why are gas prices dropping faster than output drops? It’s simple: demand for oil is dropping faster than the supply. The Department of Transportation reports, for example, that Americans drove 15billion highway miles less this August than last, the largest ever yearly decline (at 5.6%). If that isn’t impressive enough, consider that there hasn’t even BEEN a yearly decline since 1979. That’s right - for almost 30 years straight, Americans drove more each year than the year before. This year is different - and mostly because of gas prices.

So “inelastic demand” doesn’t mean oil companies can raise prices as and when they like and still expect to profit. Clearly, or they wouldn’t be having as much trouble as they’re having now. I think what it’s more likely to mean - at least in the case of oil - is that there’s a certain price range within which they can raise prices without worrying about killing off demand, but that above a certain point, they’re in real trouble. In other words, the public can put up with a certain amount of punishment, but after that point it just snaps. And that’s in fact what we observed. For me, the tipping point comes when it’s economical to buy a bicycle. That is, if a bike would “pay for itself” with the savings in gas, then we’ve hit the point for me personally where my “inelastic” demand for oil snaps. So, when I first came to Bloomington in 2003, I was paying $1.40/gallon or so for premium. By 2007 that had more than doubled - and I was used to $3.10-3.30. Was it painful? You betcha. But consider - by not driving at all, how long would it take me to buy a bicycle? If I use about 4 gallons a week, I only save $12 a week. At that rate, it takes about 30 weeks, or the better part of a year, of no driving at all to recoup the cost of a bike. Not really worth it when considered as a tradeoff in convenience. However, what when gas is $4.40/gallon, which it was until recently? Why then it’s $4/week more for gas - which is to say that every three weeks I’ve added another $12 gas week. It’s like paying for 4 weeks of gas at the old price and getting three weeks of use. And in terms of buying a bike - it pays for itself 10 weeks sooner than it used to. That’s significant! And so when gas was in the $4-range I was seriously considering biking. It was worth it all of the sudden, given the level of savings potential I’d hit. My demand for oil was just as “inelastic” as ever - but I’d hit my snapping point in terms of tradeoffs. That point will be different for everyone according to his own situation, of course, but the point is that the higher they let prices go, the bigger risk oil companies take that significant numbers of people will hit such snapping points. That’s because the higher oil prices are, the more there is to be gained by economizing on it, which is to say the more incentive people have to think of ways to do that.

I think the main thing about inelastic demand curves that people don’t appreciate is how much buyers resent them. No one likes to be in a situation where they depend on a product so much that there isn’t much they can do about price increases. So once you hit their snapping point, whereever that is, and induce them to actually make the painful changes that will reduce their dependence, they dont’ have a lot of motivation to come back to the fold once you lower your prices again. It’s true that some of the drop in demand for gas will have to do with the slowing of the economy. Fewer new businesses and jobs means less consumption overall - of anything. But a lot more of it will have to do with the fact that people are unwilling to go back to using a product as price-volatile as oil if they can possibly help it. It isn’t just that oil was expensive in living memory, you see, it’s that the price was unpredictable. It’s hard to manage a household budget, let alone run a competitive business, when you can’t really predict from month-to-month how much you’ll be spending. Price stability matters.

A useful analogy here for computer people is “vendor lock-in.” In the early days of Linux and open-source software, most of this stuff was not economical. Buying the Microsoft product cost more, sure, but it saved you a LOT of time over Linux just because it was so much easier to use. No matter what kind of salary you were earning - from $500/hour to $10/hour - the savings in time from using Microsoft were worth it. Nevertheless, many people (me included) reasoned that avoiding vendor lock-in was worth the tradeoff. Rather than allow Microsoft to set the standards for everything, we prefered to spend the extra time learning how to use Linux et al just to keep the standards open, even though in 2003 making that decision amounted to something like a charitable donation of one’s time. Of course, now Linux has become so user-friendly that even this tradeoff is no longer really there - so this point is probably moot these days (these days if you’re using Microsoft products you’ve sort of failed an IQ test). But I would argue that even back then the switch to Linux was worth it for the same reasons that “economizing” on oil by paying more for something else is probably worth it now. Maybe you buy yourself more frustration in the short term, but you buy long-term stability at the same time - by not having to shell out with each new Microsoft release, or gas price increase - and that’s worth a lot. Just as the ease of use is guaranteed to grow with time in a way that Microsoft is not, prices for alternative sources of energy are guaranteed to come down for the forseeable future, whereas oil prices will bounce up and down and all over the place, probably always ending a bit higher than they were the year previously from now on.

The political lesson here is obvious. Just a few months ago, Congress was talking about taxing “windfall” profits on oil companies - that is, those profits that oil companies make as a result of the inelasticity of demand. The idea is that since oil companies can charge “whatever they want” for gas, the goverment should take away their incentive to do so by looting their “excess” profits (that is, profits that are accounted for simply by increasing the price without a comensurate lowering in supply or demand). If the companies know that whatever they make in excess will just go to the government, they should decide just to leave prices where they are - was the thinking. I trust now that everyone in Congress will have seen how foolish this line of reasoning is? First of all - because there simply isn’t such a thing as a product where the demand is so inelastic that the suppliers never have to worry about chasing off buyers. Second of all (and more importantly) - because WHEN we have products like oil for which it SEEMS like the demand is completely inelastic, it is generally more efficient if people learn to economize on these things - something they’re not going to do if the government is artificially holding prices low. Remember the dynamics of this: I can tolerate a DOUBLING in the price of oil - which is HUGE! It’s when you’re approaching triple that I start to think seriously about using it more efficiently. The government coming along and threatening the oil companies would’ve meant that I never got to that point. I would have continued to pay double without any change in lifestyle. The oil companies would’ve pocketed the extra money, the government maybe some extra tax revenue - all of which is to say that the economy would’ve missed an opportunity to get more efficient.

Of course, I hit my snapping point just as prices started coming back down, so I never actually snapped. So I’m not the best example. But you don’t have to look just at me. Highway miles are down almost 6% from last year, even with the recent drop in gas prices. And prices continue to drop, even though oil companies are bringing less oil to market than they did this time last year. Which means that demand for oil is STILL DROPPING. Even if I didn’t really make cutbacks, it means a lot of people did - significant ones. Those people aren’t going to go back to using oil until the price comes down a lot more than it already has. The situation with the high gas prices has not only been “corrected” by market forces without any help from Congress, the correction brought with it the side bonus that the US is now less dependent on foreign oil.

Capitalism works.

Via Samizdata, a bailout reading list from the Mises Institute. This is an organization that promotes an alternative, free-market economics that has been heretical in economic circles since the 1920s but is now starting to come into vogue. I intend to follow the suggestion and “read every word.”

Unbelievable. As if we hadn’t already aped Japan’s mistakes enough by allowing a housing asset bubble to form and then pop, people are now honestly suggesting we also adopt their “solution” to it: public works employment schemes.

First of all, the authors of the piece seem to be unaware what public works schemes are supposed to do. They are primarily employment vehicles. Someone please point me to any unemployment crisis in the US? It’s true that employment has dropped off a bit and likely will a bit more before all this is over. Notwithstanding, at 6% or so, the current level of unemployment is reasonable by US historical standards, low by industrial world standards, and low indeed compared to the last major recession we had (1980-81, in which unemployment reached 11%).

Second, it’s doubtful that investment in infrastructure would fix the capital problems that underly the current maybe-maybe-not “recession.” The problem at the moment is mostly that a lot of loans are likely to come in bad, meaning that there’s a lot less capital out there for new investment than people thought or were counting on. This will cause the economy to slow. Now, while investment in infrastructure surely counts as “investment,” it doesn’t address the real problem, which isn’t so much a lack of entrepreneurs willing to start businesses and employ people as it is the fact that they don’t have easy access to credit anymore. How, exactly, is drawing these people into highway building going to help anything? Highway projects are not permanent jobs, nor do they introduce sustainable product lines, nor, more importantly, do they tend to stimulate other kinds of investment. The problem is getting credit in general flowing again. Having the government contract a bunch of new businesses stimulates investment without stimulating the investment market. It allows companies to form without going to banks. It shouldn’t have to be explained, but that means that banks aren’t getting these “good” loans, which means no new capital on their books to back new loans, which means fewer overall loans, which means the interbank lending rates will stay high longer, which means … you see where this is going. Investment in infrastructure is investment, but it isn’t the kind of investment that’s necessary. At best, it will do little for the financial structure of the nation, at worst it would crowd out bank loans, actually prolonging the problem rather than solving it.

It may well be the case that the US infrastructure needs updating. It’s clearly the case that the power grid needs updating - I don’t know about the highway system. Be that as it may, infrastructure investment is NOT a panacea that will solve our economic problems. It’s not even a good suggestion for something that might help solve our economic problems. In fact, it’s so totally unrelated to the current economic problem that it’s hard to believe there’s any serious discussion about it in that context. Public works investment failed to get us out of the Depression, failed to get Japan out of its decade-long recession, and it will fail to solve any of our current problems. So kindly shut up about it as an economic fix. We can talk about it as something that’s overdue on its own merits, but as an economic fix it’s a dead end.

Are stock market prices “real money?”

That’s the question AP article is seeking to clarify. Their answer? Well, let’s just say it gives me a big insight into why there is Socialism.

The article is titled - charmingly - “All that money you’ve lost? — where did it go?” And the line-item answer they give is correct by a for-mass-consumption benchmark:

If you’re looking to track down your missing money — figure out who has it now, maybe ask to have it back — you might be disappointed to learn that is was never really money in the first place.

By more serious standards, though, this answer’s subtly wrong, and in a kind of dangerous way. It would have been more accurate to say that it “was never really there in the first place.” It was always “money,” it’s just that it’s in the nature of “money” - certainly money as we know and use it today - that it’s always an estimate and never an absolute value. Roughly speaking, if we overestimate how much money there is around, then money “disappears” (in one of two ways - explanation to follow). If we underestimate how much there is, then you find out you had more money than you thought.

The AP gets its stuff from one Robert Shiller, Yale Economics Professor and author of the prescient bestseller Irrational Exuberance.

“It’s in people’s minds,” Shiller explains. “We’re just recording a measure of what people think the stock market is worth. What the people who are willing to trade today — who are very, very few people — are actually trading at. So we’re just extrapolating that and thinking, well, maybe that’s what everyone thinks it’s worth.”

Which begs the question: how would one go about finding out what the stock market is “really worth,” independent of anyone’s estimate thereof? Simple answer: there isn’t a way. Complicated answer: not only isn’t there a way, but the very fact that there isn’t a way leads us to conclude that the stock just is worth whatever the traders say it is, end of story. There is no such thing as a price “in isolation,” independent of anyone’s value judgement. Just the opposite, in fact: a thing is only ever worth as much as people value it.

For the Linguists in the crowd, there’s a straightforward analogy with prescriptivism - the idea that there is a “correct” way to speak independent of how people do speak. The idea that Omaha English is “right” and Southern English is “illiterate,” in a popular example. It seems plausible when you go to school and people make it clear to you that if you say “ya’ll” too many times in a job interview you’ll not get hired. But if you stop to think about it, there is nothing in language that is “right” or “wrong” except by convention. Why is it ungrammatical to say “Jack Jill hit” in English? Why does the verb go before the object? Because that’s the way people speak. There is no set of divinely inspired rules of English grammar that tell us this apart from “because that’s just what people do.”

So it is with price value. People who believe in a gold standard like to talk about gold as “real money” with “real value,” but the truth is that even with gold, gold is only worth something because people want to have it (coupled with the fact that it is scarce, of course). As far as the Cosmos is concerned, gold is just a collection of poorly-catalogued subatomic particles like everything else. As Ayn Rand was fond of saying, The concept ‘value’ is not a primary; it presupposes an answer to the question: of value to whom and for what?. The Universe doesn’t care one way or the other about gold; people do, and that’s why it’s worth anything.

Now, of course it would be folly to suggest that people can simply pull prices out of thin air when they’re estimating what the stock market is worth. Far from it - these value judgements are only useful insofar as people gain (or, more accurately, perceieve themselves to gain) something by holding the item in question. So Ayn Rand is right: there is only value from a personal point of view, and there is only value to some purpose. I want oil because it heats my house, powers my car and generates electricity. I want food because it tastes good and I anyway can’t live without it. If there is a sense in which something has an “objective” value, then that is because the fact of someone else wanting it is an objective fact. That’s sorta how it is with gold for me. I’m not really all that impressed with the stuff myself - but I want it all the same because other people want it, and I can trade it with those people for things I, in turn, would like to have. It’s sorta like finding a rare baseball card on the ground. Means fuck-all to me: baseball bores me to tears, and I wouldn’t know enough about it to recognize the face on the picture in any case. But there are people out there who really value these things, and so I value it too, if only because I know I gain something by trading it to them. And cash money, of course, is the same way. There’s nothing “intrinsically” valuable about the funny green pieces of paper we trade back and forth. What would it even mean to say that? I only care about dollar bills I find on the ground because everyone else agrees to trade them for things I want/need. It certainly isn’t the pretty paper itself that makes it all happen!

“Money,” to answer the question above, is nothing other than a measuring system for (economic) value. The same way we measure length in inches and volume in gallons, we attempt to measure value in dollars. The key word here is attempt - and that is because, as noted, “value” isn’t an objective thing in the same way that length is. We can only get at “value” indirectly, and even so it is the kind of thing that is, by its nature, always in flux. Food is “more valuable” around mealtimes than otherwise, people who are goofy enough to pay tens of thousands of dollars for baseball cards today may lose interest in sports of any kind next year, and so on. More importantly to a modern economy, value is in flux because we’re never totaly certain how many products and services there are “out there” and how much it is that people want them. Portable CD players are somewhat less useful in this age of iPods than they were in 1990, for example. And for this reason there can never be a fixed answer to the question of how many dollars a Sony Discman is worth. That’s a question that only ever has a contingent answer - and is contingent on a great many things. It isn’t just “how much people want it,” it also depends on how many dollars those people have to trade for it, what other things they want, how many Sony Discmans there are available for purchase, what the alternatives are, how many dollars are in general floating about, etc. etc. etc.

So Robert Shiller is right that stock market prices are an “estimate” of what the stock market is worth. He’s wrong that there is any sense in which there is a value to the stock market over and above that estimate. The value is the estimate - and it changes only then when the estimate changes. The difference in the price of the stock market of a week ago and the price of the stock market today was real money. It didn’t “vanish.” It’s just that we took a new measure and got a new result.

Just as we measure length in length (an inch is a length, after all), we measure value in value. It’s circular, but there you have it. I value gold because someone out there will pay me $35/oz for it. And I know that’s a good reason to value it because they also value their dollars. It isn’t the gold I value so much as the dollars. And it isn’t even the dollars I value so much as the things I can trade them for.

There’s a key distinction here: While the money in your pocket is unlikely to just vanish into thin air, the money you could have had, if only you’d sold your house or drained your stock-heavy mutual funds a year ago, most certainly can.

Wrong. A lot of people suffer from this illusion, but that’s because they’re fooled by small change. It’s true that a $20 bill buys me more or less today what it did a couple of months ago. So from my short-term small-potatoes perspective of making purchases in supermarkets, then yeah, cash money seems more solid than asset or investment money. But that’s an illusion no different from the well-known Physics illusion that time passes at the same rate for all observers. As it turns out, if one of a pair of observers is travelling a lot faster than the other one, then time isn’t constant at all (and neither is length, for that matter). And if you’re holding a lot of cash, then you’ll soon become aware that the value of cash isn’t stable at all. Try going into the supermarket with $5,200 once a year rather than $100 once a week and tally up what you can buy with your $5,200 every year and you’ll see what I mean. Prices are always changing - you just don’t really notice it because you’re typically buying small quantities of things with small portions of your total cash-on-hand. The point being: cash is also “only an estimate.” It’s just a less efficient estimate, because it’s a bit difficult to destroy and create cash as and when we need to to revise our estimate of how much value there is “out there.” So what happens instead is price inflation (and, more rarely, deflation). If there’s more cash out there than our collective estimate would warrant, prices in general rise to soak up the difference. If there’s less, they fall. Since our estimates in the United States are pretty good these days, there isn’t as much inflation as there used to be. But as recently as 30 years ago it wasn’t unusual for the cash in your hand - that supposedly stable “money in your pocket” that you can count on not to “vanish into thin air” - to lose 20% or more of its value in a single year. The dollar bill itself doesn’t “vanish into thin air” maybe, but its purchasing power (the ONLY relevant measure of its worth) can and often does. So it is simply wrong to think of cash money as somehow different from asset or investment money. Paper dollars and real assets each gain and lose value in exactly the same way: you either can or can not trade them for quantities of other things you want.

The reason people say goofy things like this about the stock market is because there’s some suspicion that stock prices don’t actually represent anything. And it’s certainly true that they’re decoupled in some sense from the things they’re supposed to represent: shares of corporate earnings. There was a time way back when when buying a stock meant buying a share in a company hoping to earn money off of the actual dividends - that is, the percentage of the profit that belongs to you when they’re paid out. Those times are long gone, and these days dividends, if they’re paid at all, are such a small portion of the total value of the stock as to be almost completely unimportant. Nevertheless, a stock still represents an ownership share in a company, and for that reason it is tied to how well the company performs. One cannot escape this because of the possibility of two very real situations: the company gets sold or the company folds. If the company folds, then you’ve lost (most of) what you paid for the stock. Sorry. That real money that you traded for that real stock is really gone since no one can buy a nonexistent stock from you. (You do, of course, get to offset this a bit by your claim on whatever assets are divided up at closing, but that’s generally much less than the value of the stock.) And if the company gets sold, then you will be paid real money for your stake in the ownership - sometimes at huge markup, sometimes at a loss. But the point is that stocks actually are tied to reality. Though it’s difficult to see at a cursory glance, traders do have a real incentive to get their estimates of these prices right. If you buy GM stock and GM suddenly folds (something that at the moment seems far from impossible), then you lost whatever money you paid the original holder for his stake. If you buy GM today and GM suddenly takes off, then you’ve just bought a share in an important company that’s making real things that people really use, and that’s of real value to other traders.

And when confidence is drained out of a financial system, a lot of investors will decide to sell at any price, and a big chunk of that money you thought your investments were worth simply goes away.

If you once thought your investment portfolio was as good as a suitcase full of twenties, you might suddenly suspect that it’s not.

It’s as though people just can’t remember what inflation is. A “suitcase full of twenties” is an investment too! It’s a bet that prices will hold stable or go down. If you suspect that prices will rise, then the shoe is on the other foot, and the AP might as well have said “If you once thought your suitcase full of twenties was as good as an investment portfolio, you might suddenly suspect that it’s not.”

Here’s the bottom line. Money is not “disappearing” from the economy. That is merely a manner of speaking. What’s really happening is that people are revising their estimates of how much stuff is “out there” to buy, sell or consume. As it turns out, a great deal of the value we thought was there was accounted for by the promises of shady borrowers to pay the banks back for homes they bought and expected to appreciate. Since we now know that a lot of those loans are never going to be repaid, then the investments that were made on the expectation of profits from those loans cannot be covered. Which means: there is actually less stuff “out there” than our indicators were indicating. The fact that stock markets are plummeting simply reflects this correction of the estimate. To put it bluntly, in 2007 we thought that 14,000 “Dow points” was a good estimate of how much coporate America was worth, but today we have new facts that lead us to believe it’s much, much lower than that. Money didn’t “disappear,” and neither did value. We got our estimate wrong, and now we are correcting it.

Now, these are humans doing this estimating and correcting, and they do not have access to all or even most of the relevant data. So right now, it’s likely that we’ve already slipped back into underestimating how much stuff is out there. People have a tendency to overcompensate for mistakes (think of yourself hugging the toilet promising yourself that you’ll never, ever touch another drop of whiskey ever) when they’re pointed out. They soon leave off their extreme behavior for a more measured response. The market will recover, but it’s going to take a bit of time first. And it’s not going back to 14,000 any time soon because that estimate was based on faulty data. There are a lot more cars to make and cows to milk and ore to extract before we can make that claim again!

One thing that’s patently NOT going to help - and this point is obvious only to a painfully small number of people, it seems - is having the government step in to muddy the waters by handing out $700billion in free funnypaper. Because no money “disappeared” from the stock market (remember, it’s just a change in estimate), it’s silly in the extreme to think that plugging it all up with more money will make that value suddenly reappear. Again - paper dollars are just paper unless there is something to trade them for and someone willing to trade. Handing out more of them to try to help there be more stuff for them to measure is a bit like measuring your penis in centimeters and calling them inches. It might fool someone at the bar enough to go home with you, but it won’t prop up a marriage.

When the dust settles, I expect the story historians will tell about this bailout will go something like this. People trading in bundled mortgage securities were massively overstating how big a share of the total world economic pie they commanded. Once their paper came due, it was discovered that they were, as a class, to some degree massively mistaken, and to some degree outright lying. Rather than realizing the twin truths that (a) the world economic pie was actually somewhat smaller than generally thought thanks to this mistake/fraud and (b) that in any case however big the pie was these investors’ piece of it was smaller than previously believed - what instead happened was that the government decided to give them a bigger piece of the total pie than they really deserved anyway. It’s a bit like what happens when you go to buy a used car, and they tell you it’s going to be $11,000, and then on the day of it’s suddenly $15,000, and you huff and storm and “talk them down” to $13,000 instead. So they commit fraud to the tune of $2,000 rather than $4,000 - it’s still fraud.

This bailout is deceptive, corrupt, and immoral. And the worst part of it is that it isn’t even going to work. In fact, it should be obvious to everyone that it’s NOT working. The Dow has lost considerably more since the bailout was approved than it did before. The government’s magic ability to “restore confidence” - or however it is they phrase whatever it is they’re proposing to do - is a sham. In reality, they’re just going to end up claiming credit for something that was happening anyway. We’ve all seen how this works. If the markets continue to fall after the bailout, then politicians will say that it would’ve been worse had the bailout never happened. If markets rise at any point after the bailout, then politicians will say that all credit is owed them for saving us from the abyss. What few people stop to consider is that the stock market and commercial paper and All that Jazz is only ever valued at what the wisdom of crowds says the economy is worth. Robbing Peter to pay Paul doesn’t make our group any better off. The fallacy of the bailout is in this mistaken belief that stock market indices and lending rates and things like that can be tinkered with because they’re “not as real as cash.” But they’re every bit as real as cash.

In times past (and, in some undercivilized places, still even today), governments DID used to print cash to buy their way out of economic crises. It was soon discovered (see, Germany, Weimar Republic for the most prominent example) that printing more money got you nowhere because prices simply shot up to compensate. Printing more money, as explained, doesn’t make goods any less scarce, after all. I suspect that what’s going on now is that we’re beginning our object lesson in how the exact same thing is true of securities. Hoepfully, there are enough people out there who understand that money is just money whether it’s cash or assets, and that the proper amount of money is ALWAYS an estimate, that there won’t be any Weimar Republics to add to history books for this learning exercise.

Well, well. After having its worst day ever, in which it lost 777 points, the Dow is up 485 today. That’s all by itself and with no help from Congress. To put that in perspective, the Dow’s down a net 2.6% or so from opening yesterday. (If it lost 777 and then gained 485 of that back, it’s down 292 points, which is 2.6% of the 11149.66 it must’ve been at at opening yesterday if it closed at 10850.66 today.) And 2.6% is not such an unusual loss. Large to be sure, but what would be weird would be to post no loss at all this early in the correction.

And guess who led the pack? Yup - financials. They’re up 13.1% from yesterday.

The point being that the correction IS happening - just like anyone who’s economically literate and not a corrupt banker or politician knew it would. The biggest gains are in financials because that was also the source of the panic. They fell the furthest and had the most distance to climb back to normalcy. This is natural.

What needs to happen now is for financial gurus to trade these securities back and forth until they settle on prices for them. The whole problem is that no one knows what they’re worth, and the sooner people get back to bidding on them in the normal way, the sooner we’ll know what “the market” in general thinks they’re worth. Then, once prices have adjusted and it’s clear who owns them all and to what extent, the loans they’re based on will either default or not, and cash will flow to the people who predicted correctly and away from those who didn’t. Nothing about this requires Congress’ assistance. In fact, Congress getting involved can only retard the process. If Congress and the holders agree on prices that have nothing to do with anticipated profits and everything to do with “saving the economy,” it’s difficult to see how anyone is going to know what’s a good investment and what’s not. The prices will continue to be “wrong” in the important sense, and since the pressure will generally be in the direction of keeping them higher than they should be, all it seems likely to do on average is continue to attract money - i.e. real value - into money pits to be destroyed. Sure, some of these investments will work out, but it’s an even surer thing that many of them will fail. That’s a bad thing in the short term - but in the long term it’s right that they should do so. Bad investments, after all, are bad investments. It is never a sound financial policy to direct value toward things that don’t return it.

So let’s please, please, please not bail out the financial sector. Let it sort out its own mess. Yes, that means pain for the rest of us. But it’s the kind of pain that you can take in one sharp dose now, or spend the rest of your life working out in smaller fits. Like setting your nose as soon as it’s broken. Hurts like hell, but it does have the advantage of leaving you more or less back where you started. There’s GOING to be a correction, so let’s go ahead and let it happen. The good news is that it seems to be underway.