Monthly Archives: August 2008

Recommended Listening

Bloomberg’s On the Economy podcast with Tom Keene. The podcast is always enlightening, but the Aug. 21 podcast on the credit crisis is particularly worthwhile. Here is a description:

Bloomberg’s Tom Keene talks about the credit crisis with Nassim Taleb, author of “The Black Swan: The Impact of the Highly Improbable,’ investor David P. Goldman, Martin Feldstein of Harvard University, Allan Meltzer of Carnegie Mellon University, James Poterba of the National Bureau of Economic Research, Peter Fisher of BlackRock Inc., Mohamed El-Erian of Pacific Investment Management Co., David Malpass of Encima Global and Thomas Mayer of Deutsche Bank AG.

Cowen on ABCT

Tyler Cowen remains reluctant to embrace the Austrian Business Cycle Theory despite the remarkably accurate predictions he made on the basis of the ABCT back in 2005.

Who Is Barack Obama?

Frequent readers know that I try to avoid the topic of politics. However, the recent piece in the New York Times on Obama’s views on economics have prompted me to put on my political pundit hat an offer a few points before summarizing my overall view:

  • Prior to reading the piece I could not have summarized Obama’s views on the economy. I am still unable to do so, but I do have a more favorable opinion of the Senator.
  • Can we please stop making ridiculous arguments based on mere evidence of correlation? Both sides are guilty of this type of argument and perhaps it works on voters, but it irritates me to no end. Let me offer an example:

    The second criticism is that Obama’s tax increases would send an already-weak economy into a tailspin. The problem with this argument is that it’s been made before, fairly recently, and it proved to be spectacularly wrong. When Bill Clinton raised taxes on upper-income families in 1993, his supply-side critics insisted that he would ruin the economy. As we now know, Clinton presided over the longest economic expansion on record, the fastest income growth most workers had experienced in a generation and the disappearance of the federal-budget deficit. His successor, Bush, then did exactly what the supply-siders wanted, cutting upper-income tax rates, and the results were much worse. Economic growth wasn’t quite as strong or nearly as widespread, and the deficit returned. At the very least, Clinton’s increases did no discernible economic damage.

    This is precisely the insane analysis that I have grown tired of in the media. Both Republicans and Democrats each have their own story about how their particular policy led to the boom of the 1990s. Can anyone simply acknowledge that there were secular forces that likely had a much more prominent effect on the economy than policy? Similarly, separating business cycles by the elections of presidents has no fundamental theoretical basis. To do so is to assume that business cycles begin anew with each election.

  • Another quote from the article:

    He said it made him think of Warren Buffett, an Obama supporter, who, if anything, might argue that he wasn’t going far enough to change the tax code. “If you talk to Warren, he’ll tell you his preference is not to meddle in the economy at all — let the market work, however way it’s going to work, and then just tax the heck out of people at the end and just redistribute it,” Obama said. “That way you’re not impeding efficiency, and you’re achieving equity on the back end.” He continued by saying that he thought there was some merit in Buffett’s argument. But, he said: “I do think that what the argument may miss is the sense of control that we want individuals to have in determining their own career paths, making their own life choices and so forth. And I also think you want to instill that sense of self-reliance and that what you do will help determine outcomes.”

    First, please tell me that Buffett does not sincerely believe this. If you want to redistribute, fine. However, let’s not presume that the market functions the same in the presence of a redistribution program as it would without. One could make the argument that the benefit is worth the distortion, but certainly one cannot argue that no distortion would be created.

    I like Obama’s response.

  • One final quote:

    Yet laissez-faire capitalism hasn’t delivered nearly what its proponents promised. It has created big budget deficits…

    I simply do not understand this statement.

Upon reading the piece, I found that there is much to like (and dislike) about Obamanomics. Fundamentally, I think that Obama seems to understand that the government can play a crucial role in providing the social institutions that allow markets to function — although there are cases in which I think that he is overly pessimistic. Also, I like the fact that he has surrounded himself with many intelligent economists and seems genuinely interested in research and ideas.

On the negative side, his health care plan seems extremely complicated and, more importantly, expensive. I am not quite sure his plan does anything to bring the cost of health care down. We have heard the same tired arguments about pharmaceuticals selling to other countries at lower prices, etc. His recent comments regarding windfall profits taxes as well as much of the populist rhetoric involved in the campaign are similarly disheartening.

I am not enthused about the election, but I grown to look at Obama more favorably.

Quote of the Day

“OK, so a bunch of people got their panties in a twist because of the proposed Milton Friedman Institute… I’m sorry for them, but, anyway, I just thought that it’s worth pointing out that there exist such as thing as the Becker Center on Chicago Price Theory…”  — Gabriel Mihalache

Economics Humor

Justin Wolfers: “The list is hilarious [Ed. note: particularly if you are an economist; if not, perhaps not so much].” He is correct.

Strategic Reserves and Oil Prices

I was fortunate enough to receive an advanced copy of Paul Davidson’s article on oil speculation prior to its publication in the July/August issue of CHALLENGE (here is a non-gated version). Davidson shares my view that speculation coupled with low interest rates are causing rising oil prices and offers a solution.

As I have previously expressed, the rise in oil prices cannot be fully attributed to supply and demand because interest rates are at historically low levels (short-term real interest rates are negative). Thus there is little incentive to extract oil from the ground when the rate of interest is below the rate of growth in the price of oil. As Davidson points out, Keynes explained this phenomenon using the Marshallian idea of the user costs. He explains:

…if oil prices are expected to rise tomorrow then producing a barrel of oil today involves the cost of foregone larger profits that could be obtained by holding the oil underground to produce tomorrow in order to sell at an expected higher price. Clearly such expectations of future oil prices should affect the oil producers’s decision of how much oil to produce today if they are interested in maximizing the return on already existing investments. In other words, the recognition of a user costs factor means that both Krugman’s argument that higher prices due to speculation will induce an “excess supply” and The Economist’s assertion that producers will not hold oil reserves underground because this always means a lower return on investment already undertaken are not correct. The concept of user costs suggests that leaving more oil underground may enhance total profits on the producer’s investment if prices are expected to rise in the future (more rapidly than the current rate of interest). And what better indicator of future prices exists today, then the benchmark oil price determined in the NYMEX and ICE futures market?

So how can the price be brought in line with market fundamentals? Davidson suggests selling between 70 and 105 million barrels of oil from the Strategic Petroleum Reserve (SPR). Doing so would significantly reduce the price of oil, squeeze speculators, and alleviate some of the government’s current budget deficit. Also, since the SPR can pump up to 4 million barrels per day, the government could pursue such a policy for a couple months without significantly reducing the reserves. Barack Obama has recently signed on to this idea (as well as changing his position on offshore drilling).

If my hypothesis regarding oil prices is correct, offshore drilling will not be enough to reduce the price of oil because significant changes in supply are unlikely to take place absent higher interest rates. The Fed has signaled that it will not help in this regard as it announced today that the federal funds rate will remain unchanged. Thus, if the government really wants to “do something” about the problem, this is likely the best scenario. It is certainly better than Obama’s previously floated idea of offering a $1000 energy rebate check or the Clinton-McCain gas tax holiday.