The following content is from my first website, which I created while at the University of Michigan . . . sometime in 2003 or 2004. They are taking the web hosting offline as of October 30, 2015, so I’m posting the content here to save it.
Climbing in Nevada between time at the poker tables.
From the page of the website titled, “GOLF THOUGHTS”:
I started golfing when I was nine years old. My dad took me to the local junior golf lesson camp and I was instantly hooked. The next year I played in a few nine hole tournaments, which was fun except for having to talk to the other kids in the group. Eventually, the interest grew into obsession and throughout high school I ate, breathed and played golf. Golf is more casual now, though I plan to play in a few tournaments this upcoming summer.
January 7, 2004
Tomorrow is the beginning of another exciting PGA tour season. The thirty or so winners from last years’ tournaments are teeing it up at the Mercedes Championships at Kapalua, Maui, Hawaii. I had the wonderful opportunity to play the Kapalua Plantation course a few years ago, so watching this tournament is especially exciting.
From the page of the website titled, “BOOK REVIEWS”:
Currently Reading: A Heartbreaking Work of Staggering Genius by Dave Eggers
Buffettology by Mary Buffett
Dumbed down advice for at home investors. You would need a million dollars to get anywhere with this book. The second half has some semi-relevant advice, though most of it is common knowledge for anyone who has taken a college class in financial economics, etc. The main idea I took from it is that the more work you put into researching your investments, the more likely you are to have a profitable adventure in the stock market.
The Biggest Game in Town by A. Alverez
Eh. This is a popular gambling book, though I was less than impressed. I read it in a day because I like the setting of Vegas. Its glitz and glam are alluring. However, for anyone who is less than obsessed with gambling, this book will quickly become boring. Good history of poker, however.
Less than Zero by Bret Easton Ellis
Less than Zero is by the same author that wrote American Psycho and The Rules of Attraction. I read this book in one sitting. It doesn’t go anywhere, which usually wouldn’t be a plus, but in this case that is the main draw. I captures the drug saturated lives of rich SoCal teens perfectly.
Bringing Down the House
This is the story of the MIT blackjack team. It has become popular in the last couple months on TV and in the major book stores. This was the first “gambling” book I read. It was well written, though maybe a little strung out.
Bobos* In Paradise by David Brooks
Poker Nation by Andy Bellin
Considering my recent obsession with poker, this book was a complete pleasure to read. Bellin weaves insightful poker strategy into gambling tales that would seduce anyone to the edge of the green felt table.
Nickel and Dimed by Barbara Ehrenreich
The later part of the title to the book is On (Not) Getting By in America. The author means to show that it is not possible to get by on minimum wage. Ehrenreich disclaims in the beginning that her goal is to show that her income can’t possibly cover her living expenses. However, the point of book is lost in tedious repition of the same struggle in each city to which she moves.
Positively Fifth Street by James McManus
The author takes a trip to Las Vegas to report on women playing in the World Series of Poker and turns out doing quite well in the tournament himself. For anyone who has been caught up in the poker craze in the last year, this is a must read.
Brush with the Law
The two authors describe their experiences at Harvard and Stanford Law Schools through alternating chapters of drugs, gambling, and biking.
The Davinci Code, Deception Point, Digital Fortress, and Angels & Deamons all by Dan Brown
I loved all four of these books. I would rank them from best to worst in the following order: A&D, Davinci Code, Deception Point, Digital Fortress. Each one has a very similar format, but that does not lessen the need to read each of them. Where as the ending to Davinci Code clicks shut, A&D is insane and over the top. Easily the most theatrical.
From the page of the website titled, “ECONOMIC PAPERS”:
November 30, 2003 – Number Portability
“The Big Switch” of cell phones began November 24th in America’s 100 largest cities. The new legislation allows consumers take their phone numbers from one phone company to another, saving consumers the hassle of alerting friends, clients, and others of their number switch. Once in full effect, the change in Federal rules will have a significant effect on the private and corporate phone use. Many businesses “had been loath to risk losing business by changing numbers that were printed on business cards and stored in their contact’s address books. Shopping around for a better plan could yield typical companies savings between 17% and 44%.” Personal consumers will be prone to convert their phone number from their home land line to a wireless service to save money and simplify their lives. The implications of shifts of customers, labor and capital from the landline industry to the cellular industry and within the cellular industry will be significant in increasing both the productive capacity of phone companies and the entire economy.
Transferring phone numbers is not specifically new technology, though it will behave like a technology shock. Current unused technology is being instituted to allow number portability. Also, Professor Kimball argues that shifts are often mistaken for technology shocks because they have similar exogenous effects on the economy. Kimball writes that “on impact, when technology improves, input use falls sharply, and output may fall slightly. With a lag of several years, inputs return to normal and output rises strongly.” Sector shifts and technology shocks are analogous. The number portability shock on cell phone industry and to a lesser degree, the economy, will follow the behavior described by Kimball. Number portability is in fact a significant technology shock that will affect the economy slightly in the short run and on a larger scale in the medium run.
Assuming an economy with increasing returns to scale, imperfect measurements of output (Y), capital (K), and labor (N), and different degrees of imperfect competition between industries allows a realistic and accurate model of the real economy. A final assumption is that the markup for durable goods is significantly greater than the markup for non-durable goods. During a boom, not only are there more durable goods, but it also appears that there are less non-durable goods and services.
Applying this theory to number portability, there will be an increase in durable sales in the form of handsets and a reallocation of consumers from company to company and from the landline industry to the cellular phone industry. Essentially, one dollar of labor input will produce more durable goods output than non-durable goods output. Or, in phone terms, labor and capital will be reallocated from the landline industry to the cellular phone industry both to accommodate more cellular phone users and to realize headset demand in the short run and in the long run as “sales should plateau at a new, higher level.” All the while, it will appear that the economy is more productive because of an increase in phone technology when realistically the increase in production will be due to reallocation of labor and capital to industries that have a larger profit margin.
Number portability is a technology shock, which is a real shock in economic terms that effects full employment output, the full employment interest rate, and the NRR curve in the NRR-LM model. The technology shock must be analyzed separate from a labor supply shock to clearly illustrate its effects. To allow for this, assume that wealth and interest rate effects cancel.
Looking at the graph on page 2, note that time T is when the technology becomes productive, not when the technology is implemented. Number portability has just reached T as it was just implemented a week ago and the complications are still being fixed. However, assuming that number portability will live up to its estimated usefulness, productivity will improve.
Assuming number portability will positively affect firms’ ability to more efficiently do business, the following effects will be seen in the economy. The LM curve will shift to the left to LM’ immediately upon the information that technology is going to improve. This shift corresponds with time zero on the previous graph. When number portability is announced, consumers’ anticipation of switching cellular service providers will spike. Uncertainty caused a decrease in investment in the telephone industry represented by the jump in the interest rate from point “a” to point “b” on the graph. Consequently, the uncertainty in the short term behavior of cellular communications is represented by high interest rates that will cause phone investment to decrease in the short run. Output will decrease as consumers wait for the technology to become effective at time T. Currently, we are just past point “T.” The confusion that results from imperfect number portability and the fact that number portability is not available to everyone is causing interruptions in service. In turn, business’ and individuals’ phone service is being interrupted by the new technology where their old phones worked well before. Ultimately, when the problems with large scale number portability are worked out, output in the phone industry and in the entire economy should increase significantly to Y’ from Y. Further, number portability will increase business communications and lead to further technological improvements. “Business users stand to benefit from more than pricing [plan improvements]. Portability should spur carriers to roll out more data services with an eye toward keeping business users.” Though it is optimistic that number portability will have as far reaching an effect as described in the essay, the positive economic ramifications are undoubtedly significant beyond our current expectations.
November 23, 2003
Steve Liesman addresses the ever present question; what is the Federal Reserve’s next rate move going to be? More specifically, Liesman is trying to establish when the Federal Reserve is going to raise the federal funds rate. The Fed rate has been cut for the last three years to its present low of 1%. However, as a result of the recent surge in GDP growth to 7.2%, discussion is stirring about when the right time for a rate increase will be. It must be accurately positioned as to not slow the much needed growth.
The article, “A Missing Phrase Shows It’s Time to Ask the Fed for Some Clarity,” emphasizes the absence of the term, “a considerable period,” in Alan Greenspan’s most recent speech regarding when the Federal Reserve planes to increase the Fed rate. It is almost certain that the Federal Reserve is not going to increase the Fed rate in the immediate future; though, if the economy continues to see increases in business investment and strong GDP growth, there will be an increase within a year. Evidence of this is that “the Fed-funds futures market has priced in virtually a 100% chance of a rate hike.”
The Federal Reserve’s recent lack of a clear objective with policy spurned discussion regarding the Fed rate, though the recurring topic is inflation. The Federal Reserve is not required to target a specific inflation rate. The Federal Reserve is currently thinking about adopting policy that would keep inflation at 1%. It is questionable why the Fed would pick such a low target, although they might foresee the fact that inflation is inevitably going to increase with increases in the federal funds rate in the future.
Liesman is correct in writing that 1% inflation is too low. By keeping inflation exceptionally low, the Fed must keep deflation in mind. Regardless of how effective monetary policy is, it may be difficult for the Fed to counter a large negative shock and prevent inflation from turning to deflation in the short run. If the Fed is intent on keeping inflation exceptionally low, they should make it a long term goal and be more concerned with encouraging growth and raising the federal funds rate in the short run.
Knowing that the economy must remain strong in order to allow the Federal Reserve to increase the federal funds rate, the issue of how to keep the economy strong must now be addressed. According to the article, to assure continued economic improvement, the following are necessary: two or more quarters of strong growth, continued improvement in unemployment, and higher commodity prices. Notice that the last requirement listed is higher prices, or inflation. The Fed’s goal of 1% inflation will not satisfy this. There needs to be significant expansionary monetary policy in the short run. Then, in a year the Fed can increase rates.
An immediate increase in the money supply leads to a very predictable stimulus for the economy. The medium run steady state will not change as a result of expansionary monetary policy, which is what the Fed wants. It will remain possible for inflation to return to the Fed’s stated goal of 1% in the medium run, while in the short run inflation will increase enough to feed the economy’s growth. Initially, inflation will jump to “b” before gradually returning to the original steady state “a.” This process should take about a year, the usual duration of the short run. During that time, assuming no unforeseeable negative real shocks, the Fed can justifiable raise the federal funds rate.
As a result of the expansionary monetary policy, real interest rates will increase above the real rental rate and investment will decrease. However, while this may theoretically be true, investment is not likely to decline significantly because output will be strong. Three years of decreasing inventories, lagging demand, and high unemployment are now turning around. Businesses are in the process of rebuilding inventories and growth is strong. There is no foreseeable weakness in the economy at the moment.
The focus should not be on how the Federal Reserve can stimulate the economy, but instead on what policy they can adopt that does not hurt the economy. It is apparent that the Fed has forgotten the lessons learned from the Great Depression regarding an economy that is flirting with deflation. In 1929, leading to the Great Depression, the Federal Reserve was overly concerned about inflation. As a result, they failed to increase the money supply enough and deflation ensued.
Just recently in June of 2002, the United States had an inflation rate of 1%. The current inflation rate is a healthy 2%, though it has fallen from a two year high of 3%. Inflation is certainly not a concern, yet the Fed is focused on keeping it low. Currently, the Federal Reserve is restricted because it can’t cut the federal funds rate any lower, which is why it should increase the money supply to encourage the current growth. After solid growth is established, the Federal Reserve can then focus on maintaining a constant rate of inflation – though, it should be higher than 1%.
November 12, 2003 – The Obsolescence of Inventory as an Economic Variable
The following few pages take on the most optimistic view of increasing inventories as can be assumed. This is justified, however, because there are many positive leading and lagging indicators that result from an increase in business inventory after a prolonged depletion period. Not the least of which is increases in production. Despite suspect returns in the stock market in a time when the public’s fear of terrorism and uneasiness regarding the war in Iraq are justifiable being dragged out, the economy is ready to support growth and investment when the public notices that the fundamentals are in order. Regarding inventories, consumer and business spending soared in the most recent quarter. This “growth was achieved with a minimal increase in hours worked.” Finally, as output increased at an astounding rate of “7.2% — the best showing in nearly two decades – business inventories fell by $35 billion.” In summation, a fall in inventories accompanied by an increase in GDP growth is a strong indication that the economic growth is sustainable.
More recently, it has been reported that inventories rose in September “by a seasonally adjusted $3.6 billion.” The recent predictions that if GDP continues to show moderate to strong growth and consumer and business spending continues to be strong, we should see inventories increase to meet expected future demand have been realized. Looking at the graph on the next page, it is visible that after a long period of inventory decline, there has been a slight increase.
The principle of holding inventories is to smooth production, which recently meant inventories were depleted as firms were facing uncertain demand in the future. Conversely, firms hold inventories for “stock-out avoidance,” in order to prevent the loss of sales and profit in the case that they can not meet demand. Inventory size is therefore related to the amount of output a firm can produce and inventory and production / output are driven by demand. When demand is high, inventories and production will increase. Most recently, observing the chronological order of economic news, it is correctly apparent that solid GDP growth is a leading indicator that inventories will increase.
The Accelerator model for inventories relates the stock of inventories as a fraction of output. N is the stock of inventories, β is inventories as a fraction of output, and Y is output. Investment is equal to the change in the stock of inventories. While β is slowly decreasing because increases in technology allow for smaller inventories through programs such as just-in-time, the decrease is not significant enough to explain the recent decrease in inventories. Instead, we must look to the change in output to explain inventory decreases and recent increases. GDP growth has been weak during the last two years. Correspondingly, referring to the graph above, inventories as a fraction of sales have fallen consistently. Only recently, when GDP growth was robustly reported to be 7.2% did we see an increase in inventories of .03%.
High interest rates increase the cost of holding inventories for firms. However, attributing inventory depletion to high interest rates can be excused because real interest rates are currently exceptionally low.
The key thing is what firms “must do” in the near future. If inventories run low, they need to produce more goods to meet any level of demand that is greater than zero. To produce more goods, firms will need to hire more workers. The process seems quite simple, and is simple as long as the public believes that GDP growth is strong. Considering that as the economy grows stronger the Federal Reserve will be lead to increase interest rates, it would be wise for firms to stock up now expecting the economy to continue to grow at its current pace.
There is no doubt that inventory as a fraction of output will be permanently lower “because executives are focused on operating more efficiently, with as little inventory as possible.” If that is the case, the significance of inventory levels for future predictions should be discounted. Where “past inventory swings have been very powerful engines,” meaning that inventory depletion [was] a valid motive for production to increase and spark an economy to recover, firms fear of decreased demand and their ability to meet increasing demand with more technologically advanced production methods may eliminate the need for inventories. And, along with the elimination of inventories will be the elimination of the tendency for economists to look towards inventories for signs of economic recovery; hence, the obsolescence of an economic variable.
November 5, 2003 – An Untamable Debt
Paul Krugman writes in his Op-ed column of the New York Times that “the federal government is in no immediate danger of running out of money, just as our forces in Iraq are in no danger of outright defeat.” However, “… in both cases, current policies appear to be unsustainable.” Apparently, his short term outlook is better than his long term outlook. I would like to thank Mr. Krugman for noting that if the short run problems persist, those problems will become long run problems – brilliant. He isn’t very certain on either the long or the short run and is most likely wrong on both accounts. Alan Greenspan has also pointlessly been criticizing the federal budget of late. Granted, there is a point when short term troubles become detrimental to the long term forecast. However, the United States need not be concerned of falling into an abyss of debt from which they will be unable to recover.
The argument here is not that the United States can ignore government debt. Instead, the argument is that the debt burden will remain stable, despite negative shocks. As historical evidence shows, there are bound to be upswings whose endurance is much greater than the duration of the recession we have just experienced. The concern that the United States economy will not be able to outgrow the debt is unfounded if the debt remains reasonable and we have positive inflation. The vital factor is that the growth rate of the debt remains below the rate of inflation, a ratio that often looks dire in periods of low inflation and high government spending.
The negative shock from the Iraq war added to an already weak economy. At a time when another negative shock could have crippled the US economy, the economy held constant. The grandeur of the US economy dwarfs even large expenses such as the recent $87 billion dollar allotment by Congress to the Iraqi war effort. $87 billion dollars is less than one percent of the US GDP. Considering that the “real gross domestic product increased at an annual rate of 7.2 percent in the third quarter of 2003,” there is little concern of losing the argument that the economy is strong on that note, even after a recession.
The inflation rate is more important to the issue of whether the United States economy can outgrow the government debt. In the last ten years, inflation has hovered around 2%. This moderately positive number seems to be what the Federal Reserve desires. If inflation is to remain at 2%, the Fed must accept the possibility of deflation as well as inflation. It is inevitable that the actual inflation rate will jump both above and below the natural rate of inflation.
By stabilizing inflation, deflation is no longer a valid concern. Two or three years ago, when the economy was booming – unemployment was very low and production was high – the inflation rate was extremely low and there was little indication that it would increase. The Federal Reserve has less ammunition to prevent inflation from dropping below zero with interest rates at an all time low; however, there are two reasons why deflation will not be a concern. Monetary policy will keep inflation in check and the improving economy will soon give the Federal Reserve room to maneuver rates up slightly from where they are at. We are already seeing this behavior in England and Australia.
Additionally, the goal of the Federal Reserve may be changing slightly from before, especially in times of modest economic standings. Instead of allowing large variations in inflation, they might find that stability is more beneficial. This concept is similar to the trade off between stabilization and closing Okun Gaps regarding GDP. We have a target inflation rate that lies at the current steady state point of inflation on the phase diagrams. Inflation continuously jumps up and down the saddle path as constant positive and negative shocks rearrange the relevant information to the phase diagram. This is to say, there is a natural level of inflation. Inevitably, if the natural rate of inflation is low enough, deflation is bound to occur from time to time. There should be little concern considering deflation, however, because there will be an equal time spent above the natural rate of inflation as below it. Therefore, high and low inflation should be given little consideration when relating inflation to the growth rate of the government debt.
By stabilizing inflation, the United States is given a bound for the growth rate of the debt. The burden of the debt cannot grow at a rate that exceeds that of inflation. If the growth rate of the debt were to exceed inflation, then it would be impossible for the natural growth of the economy to erode the debt over time. The federal budged can be kept in control by realizing there will be shocks to the numerator (debt burden), though ultimately they will be less than steady inflation in the denominator. Krugman’s worries about the federal budged getting out of control, as well as those of Greenspan, should be swiftly swept out the door and set on fire. Instead we should focus on the strength of the economy and worry about issues that actually have an effect on our future.
November 2, 2003 – Money Supply
Jesse Eisinger’s article, “Clear Eye on Money Supply,” concludes with concern about the slowing growth of the money-supply in the 13 weeks from July 8, 2003 to present as compared to a 15% rise from June 1 to July 7. The Federal Reserve’s expansionary monetary policy from June 1to July 7 was partially a counter movement to the negative shock caused by the Iraq war. The influx of money was meant to stimulate consumption to avoid worsening the recession we were currently in at a time when consumer confidence was at its lowest point in several years. The need to stimulate the economy did not decrease with the conclusion of the Iraq war. GDP growth is doing well this quarter at 6.1%, improving on a less impressive 3.3% in the second quarter of this year. Also, the combination of the shopping season, a lack of foreseeable shocks, and a stabilized unemployment rate create an opportune time to jump start the economy with continued aggressive monetary policy. The Federal Reserve should capitalize on the favorable economic conditions by continuing to increase the money supply in the present and by convincing the public that they will continue to increase it in the future.
The Federal Reserve does not have the option of lowering the federal funds rate, as it remains close to an all time low. Instead they are forced to increase the money supply, usually sought as a secondary investment stimulant to the FFR . If the Federal Reserve does not increase the money supply, the combined effect of a low FFR with a stagnant money supply will greatly worsen the economy. The Federal Reserve can not effectively lower the FFR without risking getting stuck at zero percent. If the flat growth of the money supply continues in the United States as it has in the last thirteen weeks, the US could end up in a similar situation as Japan is currently in, whose interest rates are at zero and are not responding to increases in the money supply. The mistake Japan has made has been the method in which they have increased their money supply. Instead of doing it aggressively to instill confidence in consumers and businesses that everything is under control, they have done it with less conviction. To avoid future concern regarding the FFR and other interest rates in the United States, the Federal Reserve should increase the money supply now aggressively to spark consumption, investment and to eventually allow the Federal Reserve to maneuver the FFR higher.
Increasing the money supply would decrease interest rates in the ultra short run. As a result, investment would increase because the return on new investment (R – δ) would be greater than the real interest rate (r). Increased investment would increase output in the short run, but it would also increase the real interest rate. Businesses will invest when (R – δ) > r and until (R – δ) = r, increasing output along the way.
If the Federal Reserve effectively convinces consumers and businesses that it will continue to increase the money supply in the near future and production is increased, money demand should also rise as a result of higher wages and job growth. Money demand lags increases in money supply enough to allow the lower interest rates that result from an increase in the money supply to stimulate investment. Consequently, the Federal Reserve can increase the money supply without fearing inflation because increasing money demand will counter the falling real interest rate. When unemployment stabilizes and wages are stagnant, money demand will no longer be strong enough to raise the real interest rate in response to increase in the money supply. At that point in time, the Federal Reserve will be justified in slowing monetary expansion or even in practicing some monetary contraction to keep the real interest rate in check. The moment to worry about contraction is a few years off, though we will reach it faster with aggressive expansionary monetary policy.
While it is true that excessive inflation is no help to economic recovery, there is no immediate inflationary concern that could result from increases in the money supply. The real interest rate moves opposite inflation. That is, if the Federal Reserve is overly aggressive in increasing the money supply and spurs inflation unnecessarily, it will cause the real interest rate to decrease. (r = i – π) In turn, investment would decrease. It should be noted that as the economy improves, it makes sense to slow the growth of money. If the money supply continued to grow with a robust economy, inflation would be a threat.
“The question that has dominated since it became clear that the economy was strengthening is whether the expansion is sustainable.” Expansion is not only sustainable, but also likely if the Federal Reserve takes a proactive stance towards increasing the money supply. Contractionary policy has proven in the past to be an effective tool against slumping economies. As I said earlier, with the Federal Funds Rate excessively low, the Federal Reserve has little choice but to increase the money supply. Also, knowing that the economy will return to the original full employment steady state there is no long term effect of increasing the money supply. However, in the short term, it will help to jump start investment and production. Corporate profits are up – “That means they have more money to hire and invest.” That alone, combined with aggressive monetary policy allows for a very positive outlook over the next few years.
October 19, 2003 – China is Following in Japan’s Footsteps
Krugman’s The Return of Depression Economics explains the downfall of the economies of Thailand and Japan. Those economies collapsed partially because substantial amounts of risky loans were being given out to maintain rapid growth. Both and Thailand saw estimated growth rates of 8 or 9% at one point that were being maintained by heavy investment without technological advance. As we saw in Japan during the 1990’s, the growth was not justified. Buildings and factories were being erected under the assumption that the massive increase in demand could be maintained. Then, when demand fell, investor sentiment shifted and the economy collapsed.
David Wessel’s article, “Speed and Courage: Banks in China Must Get Lending Right,” highlights three critical elements of China’s economy that are strikingly similar to those of Thailand in 1987 and Japan throughout the1990’s. They are as follows: one, the close relationship between the Chinese government and their banking system; two, reckless lending to support growth; and three, high growth rates that are arguably unjustified. Also, Kathy Chen highlights relevant parallels between China and Japan in her article, “Chinese Regulator Promises to Turn around Ailing Banks.” China is trying to fix a “bad-loan problem” while financial fraud is rising. Combining bad loans with China’s “red-hot property sector” creates a significant risk of for a “potential bubble.” The Chinese economy is not in a poor situation yet, but if they continue “lending wildly to keep the economy going” they will start facing the consequences of bad investment. Expanding on each weak point of the Chinese economy will strengthen the argument that China must proceed with caution.
Firstly, China is a communist nation. Although it is given that there is a close relationship between the government and banks, this cannot be overlooked. The degree of control the Chinese government has over its banks is greater than the influence the Japanese government had on businesses in Japan. There are “four big state-owned banks [in China that] have 120,000 branches and 1.4 million employees. Chinese people save…about 35% to 40% of their annual incomes because they have no alternative and because…they trust that the government will guarantee their savings.” The people of China lend their money to these state-owned banks because of their “secure” backing. If the banks fault, the Chinese government is there to offer insurance similar to the FDIC in the United States. However, as we have seen before, there are limits to the amount of protection any government can offer. As I argued in my last paper, economic policy is limited in its ability to compensate for policy mistakes.
Secondly, the possible severity of the increasing amount of “nonperforming” loans is magnified by the large savings rate. The Chinese government is granting loans with increasing recklessness everyday to “state-owned enterprises.” Citizens have little choice but to keep their money in state-banks that lend to state-owned enterprises, all of which is backed by the State. As inbred as the system is, its genetics are bound to implode. “Rapid lending is essential to sustaining China’s rapid growth … [and] growth is needed to leave [China] room to maneuver for reforming the state-owned enterprises. [They] need growth of 8% or 9%. Otherwise, the hurdles to the government policy to take reforms will be huge.”” The problem is that the rapid lending is inflating the government debt. China is also looking to increase international investment, which has the potential to increase nonperforming loans.
Wessel notes that many of the loans are being used for investment that may never yield returns. “Beijing has claimed 7%-8% annual growth in recent years, and while many observers believe the official figures over the past two decades overstated China’s real economic growth by 2 to 3 percentage points, China’s official national growth rates of the past two years are fairly close to actual GDP growth.” While it is understandable that growth is necessary, the banks should not “be lending wildly to keep the economy going.” Eventually, the capacity need will slow, if it hasn’t already, and China will be the same situation as Thailand in 1987. China will be investing to maintain growth, not expecting a return. And, when an outside shock causes investment to slow and the state-owned banks begin to call-in loans, state-owned enterprises will not have the money to repay their loans. The Government will be able to help to a certain extent, but they are bearing the brunt of the risk. They real loss will be on the shoulders of the Chinese people who look to the state-owned banks for security. To no one’s surprise, the intimate relationship between government and business will have deceived the citizens and frivolously invested their money while they were hard at work.
China’s state is less dire than Wessel’s article makes it appear, though that does not mean it is out of harms way. Government ties to the banks, large amounts of risky loans, and frivolous investment in any country indicate there is trouble in the future. The Chinese government must respect its current economic situation. External government debt was 2.62% of GDP in 2002. That is much lower than the 8 or 9% ratio seen in Thailand or Latin America in the critical moments before their economies’ collapse. However, China’s large GDP can’t be used as an excuse, but it does offer the country the benefit of the doubt when it comes to foreign investment. Through deregulation of the state-owned banks, China’s economy is emerging as a First World quality economy. “Beijing plans to raise the stake [foreign investors] can acquire in Chinese banks to 20% from 15%,” in the near future. This will allow it the benefit of the doubt, as Krugman says First World countries are granted, though it could worsen a pending problem by allowing short term investments to grow further out of control.
October 13, 2003 – Economic Tipping Point
I. Introduction
A “tipping point” has the following three main characteristics – “one, contagiousness; two, the fact that little causes can have big effects; and three, that change happens not gradually but at one dramatic moment.” In each of the economies in Krugman’s The Return of Depression Economics, there is a specific time at which they turned for the worse. Thailand, who devalued the baht on July 2, 1997, is a prime example of a tipping point. The devaluation of the currency was not the cause of the tipping point. Rather, it was the tipping point of an economy ready to implode because of an accumulation of other causes. Contagion, as termed by both Krugman and Malcolm Goldwell, was the root of both the build up in investor confidence and the far reaching collapse. The Asian economies were “only modestly linked in terms of physical flows of goods,” however, “they were linked in the minds of investors, who regarded the troubles of one Asian economy as bad news about the others.” Devaluing the baht – a small decision by a country facing large obstacles – is evidence of how a small policy can have a large and sudden effect on an economy or economies.
Similar faults to those of Thailand were exposed in the remains of the slumping economies of Japan, Asia, and Brazil. The point of introducing the tipping point concept is to show that there is an explanation for the behavior of these economies that encompasses the economic policies that were instituted. The first cause is mistaking economics for duct tape in thinking that it will fix all crises in an economy. Secondly, booms resulting from overinvestment in new technology are unavoidable, though that doesn’t mean they should be complacently accepted. Booms relate to, and are directly caused by, the over reliance on economic policy combined with brash investors. (However, in relation of the United States, the cause of booms is slightly different, and I get to this in the conclusion.) Finally, currency management plays a large role in each of the economies ability to stabilize and receive support in turbulent times. Although each of these three factors is small, they accumulated to a tipping point in Japan, Asia, and Brazil.
II. Economics Can’t Conquer All
Krugman says that we cannot blame the victims in each of the cases he presents because there are inherent glitches in all economies. I agree. There is a proper way to run an economy, determined by the desired long run goals, which extends beyond pure application of economic policy. As we saw, many of the factors that affected each of the economies were not uniquely economic. Instead, the economic problems arose in trying to compensate for poor government policy, such as the Japanese government’s close relationship with private businesses; or, maintaining an economy worth investing in (as Brazil tried to do with high interest rates). This is seen in the NRR-LM model when the net rental rate curve becomes steeper than the LM curve. It is at this point where the equilibrium is abolished and monetary policy is not longer able to compensate for high levels of investment.
Ultimately, it was not poor economic strategies that lead each of the economies into crisis. “A good economic system should not require perfect policies of its denizens,” and I am not saying it should. Rather, it is apparent economic policy is inadequate to deal with artificially large imminent catastrophes that are created by irrational information.
III. Investor Sentiment
The fundamental strength of the economy is closely tied to the confidence of its investors. Investors will offer praise to an economy that is flourishing by trusting it with their money. A solid economy should not fall into the “vicious cycles of financial crisis.” However, inflated confidence deceived by overextended loans that finance investment that appears profitable creates the cycles from which economic policy cannot rescue an economy.
An example of this is the Japanese stock market during the late 1980’s. Its market capitalization was greater than that of the United States. In Japan’s case, investors kept inferring that positive past investments meant profitable future investments were more likely. For example, they weighted recent stock market growth very heavily in their expectation of future growth. Such investment is justified as long as the fundamentals support it, however prices must inevitably return to a lagging true price. When one consumer becomes complacent, the slippery slope will begin and a collapse of the market will take place. This return to normal is exaggerated when, as in Japan’s case, investment is funded by risky loans.
IV. Currency
Finally, currency policy is not the direct cause of a tipping point, as are overextension of economic policy and investor sentiment. As seen with the devaluation of the baht, it was the tipping point. Thailand fought the increase in price of the baht by continually increasing the money supply. (See Graph 2 on page
5.) Because you had both an increasing demand and an increasing supply, output continued to increase while the interest and exchange rates remained constant.
Prices increase as demand increases because of diminishing returns to capital. Thailand’s case was stable until demand could no longer outpace supply. When demand fell, the swelling price of the baht imploded. The money supply was too high for a devaluation to be effective. In Japan’s case, their interest rates were already at zero and could not be cut to encourage investment. In both situations, each country ruled out rescue options in their boom economic policies.
V. America’s Outlook
As we have seen with Brazil, Japan, and Asia, all economies that were believed to be justified at their peaks, one cannot reach a definite conclusion as to the security of the long run outlook; or, even the short run outlook. However, compared to the other economies discussed, the United States is doing correctly what the others did wrong. Firstly, we are a strong First World country, meaning we have the benefit of the doubt according to Krugman. Secondly, the United States possesses the first two of the three keys to success listed by Krugman, those being: one, discretion in monetary policy; two, stable exchange rates; and three, free international business exchange. Finally, a floating exchange rate is preferred because it allows monetary policy to be effective in countering booms and busts, and the US has this. As seen earlier, Thailand and Brazil were limited by fixed exchange rates. They had to do this to encourage investment, whereas the United States is fundamentally strong enough to maintain investor confidence without a fixed exchange rate. Overall, the United States does not have the tendencies of the smaller countries and can fare booms and busts more easily than less sound economies.
October 5, 2003 – Iraq’s Economic Plan is Not Extreme…Just Optimistic
Iraq is in disarray at the moment with a GDP real growth rate of
-3% and unemployment pushing the 50 to 60% range. Also, their oil production is impaired, though the war could have stunted output much more severely. Investment is tentative as a result of lack of stability, which is constantly in question in the Middle East. The good news is that Iraq’s economy is a blank slate and is just now being reintroduced to private investment and an influx of technological possibility. Recently, “Iraq’s new finance minister, Kamel al Gailani, announced a sweeping liberalization of his country’s economy.” The “stunning” plan includes top tax rates of 15% and tariffs on imports as low as 5%.
Critics are extremely pessimistic, arguing that the low barrier on imports will crowd out production within the state and the low tax rates, like other instances of supply side thinking, will fail to spark investment. Plans for other countries in the past similar to the one being instituted in Iraq have failed miserably. The goal of Iraq’s “spontaneously freeing markets from price controls, reducing taxes and suddenly privatizing business are supposed…to create a thriving economy.” I feel there is great potential in Iraq if wise decisions are made in the near future.
Firstly, their oil infrastructure needs to be rebuilt and maximized. This is a short term investment project that will pay off immediately. Currently, they are producing 2.2 million barrels of oil a day. Though oil production was hurt in the last three years by lower oil prices, turbulence in the Iraqi government, and a war, there is significant potential. The estimated potential is three million barrels per day, nearly 50% greater than the current output. Estimates for oil revenue in the next three years range from $10 to $35 billion. If oil production can be steadily increased over the next few years, Iraq will significantly improve the base of its economy.
The immediate concern is not to protect industry within Iraq. Low tariffs will help not hurt the Iraqi economy by allowing aggressive investment, especially in repairing the oil infrastructure. Only five 5% of Iraq’s revenue comes from sources other than oil, so Iraq needs all the help it can get to encourage investment in non-oil sectors of their economy. At least in the short run, low tariffs will attract investment from sources that would otherwise shy away from Iraq due to suspect security regarding the possible returns of those investments.
In Iraq’s situation, the use of tariffs is opposite of how they are usually intended to work. Instead of aiming to make domestic goods competitive by raising the price of imported goods, Iraq wants to encourage competition of domestic goods with imported goods. Because imported goods face little competition within Iraq, their cheap access to demand has little or no negative effect on the price level. More available goods, whether domestic or imported, will encourage investment and consumption. Outsiders are being rewarded for investment and Iraqi’s are chasing the carrot of investment and capitalist profit.
Generally, taxes are a significant part of national income. However, Iraq is not going to be able to rebuild with tax revenue in the near future. With the current plan, Iraq is willing to forego such revenue in favor of freeing up its citizens ability to purchase goods. The low tax rates will be integral in the rebuilding of Iraq. In country with 50% unemployment, those who can create a niche in business and capitalize on it will aid the country in the short a long run with lower taxes because they will be able to invest in their business and hire more workers.
The positive effects of the low tax rates may look jumbled. It will take longer for the cuts to increase supply of domestic goods and improve labor. However, in the short run, there should be an increase in demand of all goods, especially readily available imported goods. The increased demand for imported goods, as was stated above, will have more of a psychological effect than a material effect. Iraqi’s will be encouraged to work harder to attain or develop similar assets. As a result, the GDP should improve and unemployment will decrease. The immediate point of the tax cut in Iraq is to increase slumping demand. If that is done, everything else should fall into place more easily.
The Iraqi employment situation has never been worse, but this should improve as GDP improves. They fear that more jobs will be lost as a result of the low tariffs. I would argue that outside investment will provide the thousands of jobs Iraq needs. Rebuilding of the infrastructure and clean-up will provide a significant number of jobs in the short run and “pave” the way for long term business investments to become effective. Foreign investors should capitalize on the abundance of over qualified labor in Iraq willing to work for as little as $4.00 American per day.
When evaluating Iraq, we should be looking ahead ten to fifteen years. Their unemployment rate and GDP growth will not respond to investment or tax cuts immediately. The primary concern regarding Iraq is establishing a dependable oil infrastructure. When that is accomplished, oil output will be greatly increased and the momentum towards general economic improvement will increase. I think firms will find that Iraq’s open economy possesses abundant possibilities for business. With increased investment and internal competition, Iraq’s GDP should stop sliding and lead unemployment down from its current rate.
September 28, 2003 – Re: Labor v. Capital
Two weeks ago I addressed the inconsistency between production and unemployment rates in the current economy. With production increasing steadily, unemployment is remaining stagnant. In this paper I will excuse technology increases as exogenous and look more closely at several other policy changes that are biased toward capital. The combination of more favorable dividend tax rates, depreciation changes on capital, and low inflation cheapen the relative cost of capital with respect to labor. Steve Liesman highlights these factors in his article, “Washington Needs to Decide If It Favors Capital or Labor.” The current state of the economy, while not wholly attributable to recent policy changes, is an anomaly worsened by them. Firms are taking advantage of favorable investment conditions created by such policies and procrastinating on hiring new workers.
Firstly, business investment is strong at the moment because of favorable depreciation and dividend tax rates. Firms are eager to produce more of a good at any given price and will therefore be looking to maximize their use of labor and capital. This usually leads to a call for more workers as the prices of goods are bid down and output increases. However, hiring has not yet overcome the lag created by consistently strong investment. “We have done a lot of restructuring in terms of businesses that expanded a lot in the ‘90s and then contracted…but in their place, there doesn’t seem to be a hot new industry or a hot sector that’s generating excitement.” This makes sense if you do not take into consideration previous investment. While capital is fixed in the short run, there has been significant business investment due to favorable conditions in the last six quarters. The lag effect will eventually overcome the significant gap between cheap capital and labor demand. Accounting for this recent strong investment, indicates that we should soon see decreased unemployment if business investment continues to be a leading indicator in the market.
Firms are investing instead of saving because of low interest rates. There is a greater return in investing in an asset that they can write off against income within the year than saving money and earning minimal interest. Low inflation is also accountable for favorable capital investment and high unemployment. And, considering the drop in durable goods of 0.9%, there is no risk of demand-pull inflation in the near future. There is simply not enough demand to entice firms to raise prices. According to the Phillips curve, “in the short run, inflation and unemployment are negatively related. At any point in time, a policymaker who controls aggregate demand can choose a combination of inflation and unemployment.” We are in a point of the unemployment cycle where the unemployment rate is just beginning to come back to the natural rate of unemployment. I wouldn’t be surprised to see inflation increase slightly as unemployment continues to steady itself.
Currently, we are in a state where the marginal cost of labor relative to the marginal cost of capital is greater than the ratio of wage over the real rental rate. This means it is cheaper to buy capital relative to wage and the economy will do so until it reaches equilibrium where the marginal cost of labor relative to the marginal cost of capital is equal to the ratio of wage over the real interest rate. Looking at the graph to the right, E is the equilibrium between the iso-cost line and Kθ (ZN)1-θ = Ώ. The economy’s output (Y) is equal to the combined input measure (Ώ) minus fixed costs. Typically, it follows that in imperfect competition you have increasing returns to scale. Firms in the current market are increasing returns without hiring labor. Generally, capital is a stand in for fixed costs of production. I am arguing that investment has been “flowing” long enough to effect capital. This means that an increase in capital just ads to the combined input and fixed costs equally. The growth in the economy must be coming from either increases in Z or N. If we want more growth, then the only remaining thing to do is stimulate N, considering Z is exogenous.
If we continue to see investment without an effect on labor levels, the question arises of whether or not hiring should be stimulated through decreased payroll taxation. If the payroll tax were cut enough, the marginal cost of labor would draw equal to or become more favorable than the marginal cost of investing in capital. The Keynesian approach applies here. “Tax cuts expand aggregate demand by raising households’ disposable income.” Hence, the Bush administration is moving in the right direction with regard to tax cuts. “At this phase in the business cycle, the household employment figure is typically a four-month indicator for the payroll numbers…but, the problem is it’s been terribly lagged.” Cutting the payroll tax will require patience. If a tax were effective, we would see a decrease in capital investment as we pull further out of the recession and depart from a war that unsettled consumer confidence. Demand will increase if current output can be maintained and employment can be improved.
It seems that several factors are working with each other and against each other in the economy. Depreciation rates, inflation, and tax rates on capital gains, while providing incentive for business investment, are wrecking the job market. Tax cuts are insufficient to fully compensate for the degree to which current firms favor capital. There needs to be a revision on either the labor side or the capital side of the marker to bring down unemployment. When that occurs the economy will not only be moving along its production possibility frontier (PPF), but also expanding it. New technology attributing to more efficient means of production and reduced excess will allow more goods to be produced with fewer workers per unit of capital. If labor supply and capital stock both move out, the PPF will expand.
September 21, 2003 – The Share Economy
I. Introduction
Martin Weitzman argues for a share economy throughout his book, but as Professor Kimball directed, this paper will focus on what it is like to live in an economy where price is greater than marginal cost. “As an economic system, monopolistic competition exerts steady pressure on output markets, in good times and bad, because at any given moment firms are actively seeking to expand production and sales. Our very way of life is shaped by this asymmetric bias.” While firms try to increase output, the economy tends toward equilibrium where demand is equal to supply. If the economy were to reach equilibrium, the market would be “indifferent as to whether customers came or went.” Essentially, Adam Smith’s invisible hand would not only be visible, but also dead. There would be no incentive to produce more, as everyone would be getting what they want and the market would be indifferent.
“Under perfect competition the firm has very limited ability to choose its price and is, in effect, a price taker.” However, monopolistic competition with sticky prices allows price not equal to marginal cost in the short run.
II. Consumption
The anticipation and expectation on the parts of consumers and producers is what allows price above marginal cost in the short run. A new good is introduced that is differentiated from other goods and therefore more appealing to consumers. Those consumers who display a high utility for the new good will consume at a higher price in the short run. Others will wait for the price to be bid down as substitute goods are introduced to the market.
A good example of technology turnover is the computer sector because of its high obsolescence rate. Firms hold pricing power for a limited amount of time because competitors quickly flood the market. Consumers on the cutting edge demand the latest product, and will pay dearly for it. Those consumers who do not immediately benefit from increased technology (processing power, larger memory, etc.) will wait for prices to drop, but will eventually be forced to upgrade due to obsolescence. That is, cutting edge consumers maintain the economy’s ability to have price above marginal cost in the short run because they are impatient. If price remains greater than the market clearing price until after “secondary” consumers reach obsolescence, then there will be extended profit. Hence, a constant cycle dependent on the economy’s (or a firm’s) ability to consistently produce new technology or goods is created and maintained by consumers willing to pay higher prices for new products.
III. Labor
“Demand-pull inflation is present in an economy at full employment.” A monopolistically competitive economy creates “artificial” inflation as a result of constant rationing. However, a wage increase should be in proportion to a marginal cost increase so that real purchasing power remains the same. Firms are reluctant to lower the price, but will always sell more at the current price (See graph 1). If more consumers buy at the current price, then the monopoly can again raise the price.
The question is what happens at full employment, when all job seekers are employed? A decrease in demand is the weakness of keeping price above marginal cost. When demand slumps, either labor will be released or prices will be cut. If demand slumps indefinitely, unemployment will increase. As Weitzman posits, keeping price above marginal cost ensures that firms want to produce more and hire more labor. However, if price equal to marginal cost is met before full employment is met, there will be no need to hire more workers as there will be no extra demand for goods at that price and goods will not be produced below price equal to marginal cost.
IV. Conclusion
There cannot be profit in the long run for monopolistically competitive firms because it is inevitable that other firms will flood the market and dilute their pricing power. However, due to monopoly pricing, rationing does extend the good’s marketable life. Prices will always be converging towards equilibrium of price equal to marginal cost. By the time prices fall equal to marginal cost the goods to which the prices apply are obsolete. Therefore, while the economy may be striving for, and reach, equilibrium, it is a historical equilibrium that is no longer relevant to the current market. This lag applies more readily to industries that have quicker technology turnover and high investment, but in principle it should apply to firms and industries with all investment rates and short run pricing power.
September 14, 2003
I. Introduction
The Wall Street Journal article, “Payroll Slump Has Economists Rethinking Ideas on Job Creation,” alleges that the productivity potential of the economy may be much higher than previously estimated. Firms have not yet maximized their production with current labor and capital levels. Job seekers anticipating employment opportunities are consequently misled by productivity and become discouraged. The unemployment rate decreased to 6.1 percent in August due to a contraction of the labor force. Like the unemployed workers, I want to know what factors are causing the economy to buck normal historical trends in favor of less impressive employment trends and positive, though underestimated, productivity growth.
The economy is currently opposing the historical correlation between output and unemployment. Typically, as production increases, the unemployment rate falls. However, the GDP is increasing while unemployment continues to increase (graph ). Total non-farm payroll is down 93,000, which is the seventh consecutive decline in employed workers. The contradictory behavior may be attributable to several factors, including: increases in technology, changing employment characteristics in response to increases in technology, and lags in investment. I argue that employment is not behaving artificially, but is instead in line with the present levels of investment and employment indicators.
II. Technology
“In real business cycle theory, the analogous variable is technology, which determines our ability to turn inputs (capital and labor) into output (goods and services). The theory assumes that our economy experiences fluctuations in technology and that these fluctuations in technology cause fluctuations in output and employment. When the available production technology improves, the economy produces more output, and real wages rise. ”
Coming out of the recent technological recession magnifies technological advances. Production is increasing as the growth in technology investment is being realized. However, the incongruity present between production and unemployment is a result of firms using current capital and labor more efficiently, especially when applied to new technology.
Using the Solow growth model to examine the technological progress in labor, we look at output (Y) as a function of labor (L), the efficiency of labor (E), and the level of capital (K). That is, Y = F (K, L*E). L*E is the number of effective workers in the economy growing at the rate n+g. Increases in technology increase E. Despite the declining labor force (-n), the efficiency of labor is increasing (g). As a result, g is greater than n and positive, meaning L*E is increasing causing output to increase. This labor augmentation is improving production efficiency and decreases the demand for labor in the short run.
III. Employment Trends
In the article it is argued that frictional unemployment is now more permanent due to sectoral shifts. Labor supply is remaining fairly constant, while investments in technology are decreasing the demand for labor. This is attributed to investments in technology that allow companies to train employees more efficiently, leading to more productivity.
Temporary help, regarded as a leading indicator of employment trends, has increased for the fourth consecutive month (See Graph 1 in back). Optimism towards the economy based on Temporary employment increases is misleading because the net change from month to month is decreasingly positive. Observing the Temporary help data for the last four months indicates that, while there is positive growth in the ultra short run, we may see slower growth or a reduction of temporary jobs in the short to medium run. Mankiw states that “the labor market is often viewed as a lagging indicator of conditions,” and thinks that “we’ll have employment growing by the end of the year.” Reflecting on the tendency towards longer durations of unemployment and decreasingly positive Temporary employment trends, I am reluctant to agree with Mankiw that employment will pick up by the end of the year.
IV. Technology Investment Lag
Firms are discovering that by continuing to apply the methods used when demand was low they can more efficiently use their current labor with the new capitol to increase productivity. The time required to plan, obtain, and install new investment, in conjunction with more efficient use of current capital and labor levels, is creating a vacuum of jobs. When technology is in place and demand production has been strong for a long period of time will we see a ceiling on productivity. When this ceiling is met firms will be forced to hire to meet new demands.
V. Conclusion
The current state of unemployment is explained by a lag in technology, more efficient use of present technology, and a changing labor force. Firms investing today that have been pinned down by poor economic conditions during recent years will not see returns in the ultra short run and perhaps not even in the short run. The lag on investment leads to a lag in the application of new technology. Technology lags will result in a subsequent lag in output and higher unemployment. If a production ceiling can be found in the near future, employment should increase as firms will be required to expand current investment and hire new labor to run present technology. Until then, we will remain in a state of wavering unemployment and uncertain production increases.