Keynes vs. Hayek (stimulus vs. austerity)

A summary of Hayek's work, in case you are interested in the Keynes vs. Hayek debate (aka stimulus vs. austerity) (my previous posts in the subject here, here, here, and here)
"The discussion was very similar to the modern austerity versus stimulus debate, although at the time the major players were still busy fully developing their theories.  Keynes favored temporary and limited government socialization of investment as a means of using unspent money to recover the “gap” in aggregate demand, as well as general monetary stimulus.  He believed that banks do not do an adequate or complete job in financial intermediation through the loanable funds market — a form of disconnect between savings and consumption.  More specifically, he did not see a reason as to why savings are necessarily invested, seeing this as a natural fault in the capitalist system.

Hayek essentially agreed that the business cycle was characterized by a massive loss in investment and productive capabilities.  It was in his identification of the causes for this loss where he differed with Keynes.  The differences in business cycle theory also led Hayek to radically different ideas on the nature of the recovery.

In short, Hayek borrowed from Mises the idea that an increase in the supply of money distributed through the loanable funds market could distort the prices of capital goods relative to consumer goods. This would lead to an investment boom which would gradually spread up the structure of production — this facet formed the crux of Hayek’s work on business cycle theory in Prices and Production.  However, investments require capital goods, and by distorting prices what occurs is an increase in the quantity demanded without a previous increase in their supply.  The insufficient quantity of capital goods leads to the necessary liquidation of impossible investments, once prices increase enough to reveal their unprofitability — what Mises and Hayek term “malinvestments.”

While the recession is characterized by the mass liquidation of malinvestment, what this really entails is a capital restructuring.  The different processes of production that make up an economy must be reorganized in accordance with consumer preferences, including intertemporal preferences (the relationship between savings and consumption).  This process of reorganization is carried about by the individual capital-controlling entrepreneurs, each of which uses her best judgment in economizing her stock of capital goods.

Mises and Hayek saw government expenditure as counter-productive, because it negatively intervenes in the process of economization.  In other words, on average, government socialization of investment — whether it manifests through forced wealth redistribution or actual public investment (e.g. public works) — leads to less productive outcomes than what the alternative would have been had those resources been only been economized in the market process.  More elementarily, since government acts outside of the profit and loss jurisdiction, government cannot accurately calculate the net (un)profitability of its investments."

No, they are not 99%

An interesting review of several recent Gallup surveys (you may want to visit the Gallup site for the original statistics):

Less and less Americans think that they are poor ("have nots"):
"Let me start with a Gallup survey released on December 15, which showed that the number of Americans who see American society as divided into haves and have-nots has decreased significantly since the 2008 election. Back then, 49 percent saw the country as divided along those lines, and 49 percent didn’t. As of this week, only 41 percent see the country as divided between haves and have-nots, while 58 percent do not. (The share of Americans who consider themselves to be “haves” hasn’t budged: 59 percent in 2008, 58 percent today.)"

Most Americans do not think that the inequality gap is the major problem facing their country:
"Now consider another Gallup survey, this one released on the 16th. Respondents were asked to categorize three economic objectives as extremely important, very important, somewhat important, or not important. Here’s what they said:
                                                Extremely/very important          Somewhat/not important
Grow and expand
the economy                                         82                                            18
Increase equality of
opportunity for people to
get ahead                                               70                                            30
Reduce the income and
wealth gap between the
rich and the poor                                  46                                            54
 
Regardless of partisanship, substantial majorities of Americans saw expanding the economy and increasing equality of opportunity as extremely or very important. Not so for reducing income and wealth gaps—21 percent of Republicans and 43 percent of independents. Only Democrats gave this goal a high priority, by a margin of 72 to 27."

Majority of Americans think that "Big Business" is a lesser evil than the "Bog Government":
"A third Gallup survey asked Americans to state whether they saw big business, big government, or big labor as the biggest threat to the country in the future. In March of 2009, 55 percent felt most threatened by big government, and 32 percent by big business.  As of December 2011, a near-record 64 percent saw big government as the greatest threat, versus on 26 percent for big business. As Obama nears the end of his third year in office, the people are more likely to fear government, and less likely to fear business, than they were at the beginning of his administration."

"Either/or" vs. "both/and"

A typical figure of speech, which, in my opinion, displays the very root of the European economic problems:
"The package, which aims to generate €20 billion ($26 billion) in cost savings through a combination of tax increases and spending cuts, is designed by the government to reassure European authorities that Italy is serious about shoring up its finances and restoring investor confidence in the country."

In short, most of the economic measures nowadays are directed at "reassuring" and "restoring investor confidence" rather than on actually shoring up the finances. Politicians naturally evade undertaking the real austerity measures, which are bound to be unpopular among their voters (reducing benefits, raising retirement age, cutting the number of state employees, etc.). Yet, I doubt that any investors are encouraged by such a half-hearted approach. 

This is a clear example of Thatcher-esque "either/or" situation:
"Optimism had always been part of Mrs. Thatcher's appeal, too, but it was of a more rigorist kind. Gain comes because of pain, she believed. Nothing can be done without personal effort. Hard truths must be told, dragons slain. Hers was the politics of "either/or." As Peter Mandelson, Mr. Blair's chief strategist, liked to put it, theirs was the politics of "both/and.""


One will not be able to keep both investors and voters happy.

A case for austerity: Margaret Thatcher

Wall Street Journal reviews the political life of Margaret Thatcher. If we are to learn from the history, she is one of the main figures to look at in connection to the European debt crisis: on the one hand, she successfully championed the austerity policies, which the Europe is trying to adopt nowadays... on the other hand, she vehemently opposed the European integration. (Also, I posted earlier this video where she expresses her views on the socialist welfare.)
 
Thatcher on fiscal discipline:
"What did she tell them? In essence, Margaret Thatcher's views about the relationship between money and politics are simple—her critics would say reductive. In 1949, when, as a 23-year-old, unmarried woman, Margaret Roberts was adopted as a Conservative parliamentary candidate for the first time, she said: "In wartime there was a slogan 'It all depends on me.' People seem to have forgotten that, and they think it all depends on the other person."

"Don't be scared by the high language of economists and Cabinet ministers," she went on, "but think of politics at our own household level."
She wasn't scared, and she never really deviated from such doctrines. They acquired great resonance in the 1970s, when inflation and excessive government borrowing and spending had become the norm. Indeed, they won her the general election of 1979. She preached that a household—and, most particularly, the woman who runs its weekly budget—knows that you cannot ultimately spend more than you earn and that you must "provide for a rainy day.

The same mythical housewife, Mrs. Thatcher asserted, also knows that if you do not provide you cannot be certain that anyone else will. Living beyond your means leads to dependency instead of independence, and dependency leads to degradation."

Thatcher on Keynes and "Keynesians"
"This was as true for nations, Mrs. Thatcher maintained, as for individuals. She was quite sophisticated enough to understand that nations can and sometimes must borrow and spend on a huge scale. She respected the teachings of John Maynard Keynes, while being highly suspicious of the subsequent generations of left-wing "Keynesians.""

Thatcher on the role of the government
"It would be hard to deny that Mrs. Thatcher succeeded in bringing some of this about. The top rate of income tax was 98% in 1979 and 40% by 1988. In 1979, Britain lost 29.5 million working days to strikes; by 1986, the figure was 1.9 million. When she started, Mrs. Thatcher had to deal with the most deficit-laden nationalized industries in the developed world. When she finished, the idea of privatization had become the most profitable piece of intellectual property ever exported by a politician."

Thatcher against European Union:
"Her most controversial remark was her attack on both statism and super-statism: "We have not successfully rolled back the frontiers of the state in Britain, only to see them reimposed at a European level with a European super-state exercising a new dominance from Brussels." She was fiercely opposed to European economic and monetary union.

Last week's summit in Brussels took place exactly 20 years after the Maastricht Treaty, by which the EU agreed to establish a single currency (with Britain securing an opt-out). Today, the answer in Brussels to the problems caused by centralization is to centralize some more."

Francois Hollande enters austerity vs. ECB intervention debate

Francois Hollande, the candidate for the French presidency from the Socialist party, is among the highest pofile Europeans calling for the European Central Bank intervention:
"Speaking in an interview at his campaign's headquarters in central Paris, Mr. Hollande, 57 years old, said only the ECB has enough credibility and financial firepower to restore investor confidence and unravel the debt crisis that has been roiling the euro zone for two years."

As I said previously, my opposition to such proposals, first of all, from the impossibility to realize them in practice over the opposition of German chancellor Angela Merkel and the ECB head Mario Draghi. This means that any talk about the ECB intervention, the Eurobonds and printing of more money has everything to do with politics and nothing to do with reality.

 Mr. Holland, however, may be excused: he is running for the French presidency against Nicholas Sarkozy, who so far has teamed with Merkel and Draghi. In addition, Hollande's position is consistent with the general socialist views that he is supposed to represent, and he is honest about the low likelihood of such policies being implemented:
"Mr. Hollande said he was well aware that Germany would staunchly oppose any attempt to amend the ECB's core mandate: to keep inflation in check. He said that were he to be elected president next year, however, he would still ask that the ECB play a bigger role in stemming the crisis within the framework of current bylaws."

Krugman about inflation and the liquidity trap

Some food for thought about inflation from the Paul Krugman's column:
"OK, strictly speaking the time hasn’t run out — we could, I guess, see an explosion of inflation next year. But with commodity prices down, wages going nowhere, and the dollar actually strengthening against other currencies, it’s kind of hard to see where that’s supposed to come from.

Look, the Austrian/Ron Paul types made some very strong predictions about inflation — and rightly, given their model of how the world works. In their version of reality, it really isn’t possible to triple the monetary base without dire effects on the price level. In my version of reality, of course, that’s not only possible but what the model predicts in a liquidity trap.

So since we did indeed triple the monetary base with nothing much happening to inflation, the right lesson to draw is that their model is all wrong. Unfortunately, I see no hint that anyone in that camp is prepared to consider that possibility."

Neuroscience versus Psychology

Here is an article about Neuroeconomcis - the mixture of neuroscience and economics. Neuroscience is becoming increasingly popular nowadays, although this term is frequently used as a politically correct substitute for "psychology" - the subject that is inevitably associated with Sigmund Freud, sexuality, and the dark forces in our mind.

A few words about Freud - subject that I have been interested in for some time, but has not written about so far at length. (although by saying "Freud" I will refer not only to him, but to the host of people who worked in the same time with him, as well as to those who have developed the psychology throughout the XXth century.)

Sexuality
People feel wary at the only mentioning of the Freud's name - allegedly because our impluses obviously cannot be reduced to sexuality only. In my opinion, the word "obviously" should make a scientist shrug his/her shoulders, and Freud himself later added "aggression" as another driving force for our behavior - he was motivated to do so by witnessing the mass slaughter during the World War 1 - something that we still attribute to the faulty actions of a few people, but what Freud himself saw as millions of people voluntarily taking part in these actions.

More than sexuality
In reality, the opposition to Freud stems from more than just the displeasure with his ideas about sexuality. His research showed too conclusively the dark side of the human nature. He exposed how we use the pretenses of "goodness", "morality", "social justice", "fairness", etc. to achieve our selfish goals. He did not shy from directly attacking the religion, the state and the society - no surprise that nowadays, a hundred years later, he still has so many enemies.

Subconscious
Some of the breakthroughs made by Freud and co-workers have been so firmly internalized by the modern culture that they are not anymore attributed to him. For example, we freely and casually speak of subconscious. However, a hundred years ago the idea, that our thinking is not limited by our consciousness and that our decisions are not always rational, met a lot of opposition and scepticism. Freud would be greatly amused by the fact that in the beginning of the XXI irrationality of human behavior comes as a surprize to some very educated people: here is the statement from the article that I linked above

"Much of modern economic and financial theory is based on the assumption that people are rational, and thus that they systematically maximize their own happiness, or as economists call it, their “utility.” When Samuelson took on the subject in his 1947 book, he did not look into the brain, but relied instead on “revealed preference.” People’s objectives are revealed only by observing their economic activities. Under Samuelson’s guidance, generations of economists have based their research not on any physical structure underlying thought and behavior, but only on the assumption of rationality."

However, Keynes, who himself lived in the times of Freud and was possibly familiar with the Freud's ideas, was more cautious:
"John Maynard Keynes thought that most economic decision-making occurs in ambiguous situations in which probabilities are not known. He concluded that much of our business cycle is driven by fluctuations in “animal spirits,” something in the mind – and not understood by economists."

Neurology versus psychology
The ideas about suconscious and other features of the mind functioning were however grounded in a much more basic fact demonstrated by Freud: many psychological conditions resulted from the "software" rather than from the "hardware" mulfunctioning. The evidence of that was totally scientific - one of the examples, studied by Freud himself, was that of the "glove amnesia" - the complete loss of sensation from the wrist down. Freud, who himself was trained as a neurologist, was quick to point out that this phenomenon could not be explained as a physical mulfunctioning of the brain, since the receptors of the neuron cells extend all the way from the brain to the wrist, and the mechanical damage somwehere in between would paralize the whole arm, rather than only the wrist. Another example was the heavy psychological conditions common during World War 1 among the people who survived a shock, but were physically unharmed.

You can now imagine with how much dismay would he learn that in XXI century we are still trying to explain our complex behaviors and motivations by comparing our brain cells to transistors and discussing how these transistors are "wired":
"Yet it is likely that one day we will know much more about how economies work – or fail to work – by understanding better the physical structures that underlie brain functioning. Those structures – networks of neurons that communicate with each other via axons and dendrites – underlie the familiar analogy of the brain to a computer – networks of transistors that communicate with each other via electric wires. The economy is the next analogy: a network of people who communicate with each other via electronic and other connections.
The brain, the computer, and the economy: all three are devices whose purpose is to solve fundamental information problems in coordinating the activities of individual units – the neurons, the transistors, or individual people. As we improve our understanding of the problems that any one of these devices solves – and how it overcomes obstacles in doing so – we learn something valuable about all three." 


Disclaimer: I am not aware of how much Paul Glimcher, whose research is described in the article, and Robert Schiller, who wrote it, know about psychology. It might be that they know it much better than me, but the article is deliberately written for the benefit of the average reader... or with the goal of not mentioning the toxic words "Freud" and "psychology". It is the lack of knowledge among the average public that bothers me.

Economics Nobel lectures

This year Economy Nobel prize lectures (action begins at about 10:00)
The lecture by Thomas Sargent is particularly interesting in connection to the sovereign debt crisis and the analogy between the European Union today and the United States in its beginning. Nicely, Sargent goes into great pains in order to distance himself from either Republican or Democrat ideology when discussing the role of the government debt and the bailouts of states and companies by the Federal government.

The lecture by Christopher Sims is more technical, but will probably ring a few bells with those who are familiar with statistics or Monte-Carlo methods.

Eurobonds and ECB intervention

I pointed recenly the strange logic of the advocates of creating eurobonds and the European Central Bank direct intervention - they keep having this discussion, despite its total irrelevance in view of the strong opposition from Germany and perhaps from some economically smaller contries that are still doing well (such as Austria, Finland, Netherlands.) (And Britain has just demonstrated that how one country's opposition can block any initiatives.)
Yet, they insist:
"The ECB has a strong rationale to act: to ensure the smooth transmission of monetary policy, to prevent a depression that would lead to deflation, and to avoid the breakup of the euro. Yet it has so far refused to do so, hiding behind a legal fig leaf.

Granted, Article 123 of the Lisbon Treaty prohibits the ECB from purchasing bonds directly from public bodies, but intervening in the secondary market is permitted. The ECB has long been doing so through its Securities Market Program. Where in the treaty does it say that extending the SMP is prohibited? Indeed, a credible open-ended commitment to contain interest-rate spreads would actually require fewer purchases than the ECB’s current limited and temporary program does."

and also:
"Eurozone leaders could also set out a roadmap towards Eurobonds, subject to strict conditionality, and tied to a credible mechanism for ensuring fiscal prudence. This would provide an additional incentive for governments that wish to qualify to introduce the necessary reforms, while reassuring the ECB and markets that governments remain committed to making the euro work."

Strangest of all is lecturing to Germans why their understanding of their own history is incorrect:
"Unfortunately, many Germans, notably at the Bundesbank, loathe the idea of central-bank intervention, because it conjures up memories of 1923, when the Reichsbank printed money to fund government borrowing, the resulting hyperinflation destroyed middle-class savings, and a decade later Hitler came to power. Yet Germans ought to remember that it was in fact the financial panic provoked by the collapse of the Austrian bank Creditanstalt, the resulting slump, and misjudgment by the German political establishment that cleared the Nazis’ path.

Far from precluding action, history justifies it. Besides, there is no reason to panic about inflation when monetary growth is low, bank credit is contracting, and people are hoarding money rather than spending it. Moreover, any ECB purchases could continue to be sterilized."

This might be true... but one also ought to remember that the above-mentioned "misjudgment by the German political establishment that cleared the Nazis’ path" was in fact the mijudgement by the Weimar Socialist Democrats, not so different from the socialists governments, whose misjudgement has brought about the European debt crisis.

Washington Post's political cartoons

Since my random selection of old Soviet political cartoons turned out unexpectedly  and undeservingly popular - here are more of the modern American ones (admittedly with anti-Republican bias - just count how many of them make fun of GOP - but still funny.)

Why socialism is so popular?

Von Mises Blog on socialism:
"One may wonder whether Sir William Harcourt was right when, more than 60 years ago, he proclaimed: We are all socialists now. But today governments, political parties, teachers and writers, militant antitheists as well as Christian theologians are almost unanimous in passionately rejecting the market economy and praising the alleged benefits of state omnipotence. The rising generation is brought up in an environment that is engrossed in socialist ideas.

The influence of the pro-socialist ideology comes to light in the way in which public opinion, almost without any exception, explains the reasons that induce people to join the socialist or communist parties. In dealing with domestic politics, one assumes that, "naturally and necessarily," those who are not rich favor the radical programs — planning, socialism, communism — while only the rich have reason to vote for the preservation of the market economy. This assumption takes for granted the fundamental socialist idea that the economic interests of the masses are hurt by the operation of capitalism for the sole benefit of the "exploiters" and that socialism will improve the common man's standard of living.

However, people do not ask for socialism because they know that socialism will improve their conditions, and they do not reject capitalism because they know that it is a system prejudicial to their interests. They are socialists because they believe that socialism will improve their conditions, and they hate capitalism because they believe that it harms them. They are socialists because they are blinded by envy and ignorance. They stubbornly refuse to study economics and spurn the economists' devastating critique of the socialist plans because, in their eyes, economics, being an abstract theory, is simply nonsense. They pretend to trust only in experience. But they no less stubbornly refuse to take cognizance of the undeniable facts of experience, viz., that the common man's standard of living is incomparably higher in capitalistic American than in the socialist paradise of the Soviets."

Mugrabi Bridge

There is a passionate debate about the closure for repairs of the wooden bridge, connecting the Old City of Jerusalem and the al-Aqsa mosque on the Temple mountain.

The related statement by Hamas clearly belongs to my "Theatre of the absurd" section, even though the Muslim riots in Jerusalem are often more dangerous than absurd jokes:
"Hamas warned Monday that the Israeli closure of the Mugrabi Bridge is tantamount to a "declaration of war" on Muslim holy sites. “This is a serious step that shows the Zionist scheme of aggression against the al-Aqsa mosque,” said Hamas spokesman Fawzi Barhum in an interview with AFP. “This is a violent act that amounts to a declaration of religious war on the Muslim holy places in Jerusalem.”"
 

Middle-East re-alighnment

Alain Juppe has made some strong statements about Syria and Hezbollah:
"French foreign minister says he believes roadside bomb which injured 5 French UNIFIL peacekeepers in southern Lebanon carried out by Hezbollah at Syria's urging."

There are two reasons why traditionally pro-Arab French come forward with such sharp criticism:
1. They believe that the Assad's days are counted and prepare the ground for military or, at least, diplomatic (for example, in the form of strong sanctions and recognizing alternative government) intervention a la Libya, which would guarantee France a greater diplomatic and economic role in post-Assad Syria.

2. This is part of the re-alignment in the Middle East that I believe has been happening for some time: the Arab-Israeli conflict is superseded by pro-Iranian and anti-Iranian coalitions. The pro-Iranian force has been already well defined: Iran, Syria, Hamas, Hezbollah, enabled by political backing from Russia and China. On the other hand, the anti-Iranian force is forming slowly due to the traditional antagonism among its partners: Israel and Saudi Arabia with other oil-rich states wary of the Iranian interference. In addition, the anti-Iranian coalition lacks the necessary political backing from the nowadays passive United States. The last circumstance gives France and other European states a good opportunity for a greater role in the Middle East (such as: cheaper and more secure oil supply, more contracts for oil-exploring European companies, broader markets for European companies, particularly where it comes to the arms sales... and more arms sales. All of these, by the way, are very useful for overcoming the economic crisis.)

UPDATE 12/12/11: No less harsh condemnation of Syria from the German foreign minister:
""I am really shocked about what I heard about the atrocities in Syria. Five thousand people were killed, civilians, people who ask for their freedom and civil and human rights," he told reporters."