Does Amity Shlaes Even Know How to Be Honest?

It has been well established that Ms. Shlaes does not know any economics but her latest goes beyond the pale in dishonesty:

The United States has entered the era of the experiment. President-elect Barack Obama is putting forward an infrastructure program whose plans and price tag are unclear. Treasury Secretary Henry Paulson whipped up the Troubled Asset Relief Program to buy up bad mortgage instruments, and, expanding on that experiment, President Bush wants to try extending TARP to autoworkers. The idea that experiments are warranted in current circumstances comes from the New Deal.

No – the logic behind the Troubled Assets Relief Program’s variation that the government make direct equity investment in troubled financial institutions by many economists including Paul Krugman:

Before I explain the apparent logic here, let’s talk about how governments normally respond to financial crisis: namely, they rescue the failing financial institutions, taking temporary ownership while keeping them running. If they don’t want to keep the institutions public, they eventually dispose of bad assets and pay off enough debt to make the institutions viable again, then sell them back to the private sector. But the first step is rescue with ownership. That’s what we did in the S&L crisis; that’s what Sweden did in the early 90s; that’s what was just done with Fannie and Freddie; it’s even what was done just last week with AIG. It’s more or less what would happen with the Dodd plan, which would buy bad debt but get equity warrants that depend on the later losses on that debt.

Paul has been critical with certain aspects of TARP but he notes that not only has the basic idea of equity infusion is what financial economic theory suggests is a viable policy means for addressing the financial crisis but it has also been successfully tried.

The logic behind fiscal stimulus in general was explained in the 1936 General Theory authored by Lord Keynes. Lawrence Summers recently explained the specific logic behind Obama’s call for an acceleration of infrastructure investment. Summers appeals to conventional economic wisdom and not some longing for the New Deal.

While her alleged ties of the current policy proposals to the New Deal falls in its face, Shlaes repeats her debunked claim that the New Deal made the Great Depression worse:

Modern economists, monetarist or Keynesian, have not rejected this story line. The trouble with the 1930s, in their view, is that government did not fiddle enough. Had the Federal Reserve, the Treasury or the White House fiddled more, the Depression might have been shorter or less severe. The New Deal Fed, they say, never got the price level quite right. Or, the New Deal stimulus programs were too little. And so on. But there is significant evidence that the very arbitrariness of the New Deal made the Depression worse.

What is this “significant evidence” you ask? Oh yea – the past writing of one Amity Shlaes! If the Washington Post really wants to make an argument against Obama’s fiscal policy proposals, might I suggest they find an economist rather than a discredited rightwing hack to make that case?

Shoe 2008

Idiot Year

2008 is over. For many global citizens this year may one day be described as the year of revelation. A full century of environmental and economic abuse along with political intrigue and deceit may have finally come into full view. It seems unlikely that we will continue much longer to accept the counsel of those who tell us that we must fill our world with poisonous chemicals and overexploit our natural resources or take senseless and frightening risks with the employment of new technologies. In the world of politics another range of possibilities is apparent. False pretensions and embedded assumptions of national sovereignty and liberal democracy are unlikely to be accepted without serious questioning in western industrialized nations. With the obvious no longer hidden we may not be as easily fooled ever again. This breakdown of assumed ‘norms’ truly represents the end of an era and it’s happening just at the time a positive feedback loop of Arctic warming kicks in to alter the planetary air conditioner of the Northern Hemisphere [1]. Dramatic and unprecedented social and political change portends in the year that Prince Charles warned the world that we had 18 months to stop climate change. [2]

On 10th September last year the Maidstone Crown Court in the UK decided that “the threat of global warming is so great that [environmental] campaigners were justified in causing more than £35,000 worth of damage to a coal-fired power station.” Six Greenpeace activists were cleared of charges of criminal damage [3]. Just as three of these British protesters responded to systemic collapse in the ecosphere (by painting Gordon Brown's name on the British coal plant's chimney as a metaphor for political accountability) Ben Bernanke of the US Federal Reserve responded to another global crisis with a slightly more concrete metaphor of his own. Helicopter drops of money were used to bail the rich out with increasingly worthless fiat money and on an absolutely extraordinary scale. The surviving handful of Wall Street banks hoarded cash and refused to lend to each other as their four-decades-long global ponzi scheme of money and credit manipulation fell apart [4]. In turn this banking collapse was prompted by the oligopoly dynamics of concentrated economic power in a small number of corporate networks and conglomerates generally[5]. Fictitious capital [6] grew at an ever-increasing rate and fomented unbelievable distortions in what we are told is ‘economic development’ across the globe but is actually a well-managed path designed to generate dependency on the global corporations along with the stronger states that sponsor them.

In 2008 it became clear to many more people that ‘globalisation’ was not a spontaneous result of ‘free market’ dynamics as we had been repeatedly told. Rather it was revealed to be “the deeply political result of political choices made by successive governments of one state: The United States” [8]. Both Republican and Democratic administrations have used overt and covert means to topple democratically-elected governments around the world [7] and to tilt the balance of political and economic advantage unfairly towards North America in other ways [9].

2008 was the year when conventional wisdom became obsolete. It did not allow us to perceive the essential nature of things nor adequately anticipate the consequences of our actions. In 2008 everything became open to question. The ‘pluralism’ of the two-party system was found to be a delusion. There were no safeguards in place to protect against one group gaining too much power over the whole of society nor even the whole of the planet. How obvious it was that the private sector was not balanced by the public one as we saw ‘leaders’ in one national government after another working to a corporate narrow interest agenda. There are bad men on the Earth, after all.”...if nothing happens even though we're entering an ecological crisis of historic gravity, it's because those who have power in the world want it to be this way." [10]

The gift of 2008 is the revelation of important and critical truths. Its legacy is to come to terms with everything.



[1] Changes 'amplify Arctic warming'
By Jonathan Amos, Science reporter, BBC News. 16th December 2008
http://news.bbc.co.uk/2/hi/science/nature/7786910.stm

[2] Prince Charles: Eighteen months to stop climate change disaster. By Andrew Pierce
Last updated: 1:08 PM BST 18/05/2008
http://www.telegraph.co.uk/news/newstopics/theroyalfamily/1961719/Prince-Charles-Eighteen-months-to-
stop-climate-change-disaster.html?service=print

[3] Under the defence of "lawful excuse", a legal principle that “allows damage to be caused to property to prevent even greater damage” as quoted in the article:
Cleared: Jury decides that threat of global warming justifies breaking the law
By Michael McCarthy, Environment Editor. Thursday, 11 September 2008
http://www.independent.co.uk/environment/climate-change/cleared-jury-decides-that-threat-of-global-warming-justifies-breaking-the-law-925561.html

[4] A point had been reached where a huge volume of capital was held in such a small number of private hands that were largely outside any regulatory structure. This was accompanied by an even smaller number of trading and banking networks that resulted in a ‘common tilt’ in multinational corporations’ decisions and processes. See: ‘The World’s Money – International banking from Bretton Woods to the brink of insolvency’ by Michael Moffitt. Touchstone Book, Simon and Schuster New York. 1983. ISBN: 0-671-50596-3 Pbk.

[5] Instability in the global economy became inevitable, as global corporations played a zero sum game by combining high-productivity technologies with large, low-wage labour supplies in ‘under-developed’ nations. As economic power concentrated trade became dominated by non-market intra-corporate transactions where multinational corporations arbitrarily set unrealistic prices in exchanges between parent and affiliates in order to reduce taxes and tariffs, avoid currency exchange controls and optimize profits.

[6] paper claims on wealth (in the form of profit, interest and ground rent) in excess of the total available surplus value, plus available loot from primitive accumulation.

[7] The US was involved in coups in the Democratic Republic of the Congo, in Iran (Operation Ajax in 1953) , in Ecuador (Jaime Roldos), Brazil (1964) in Vietnam, in Indonesia (1967), Panama, Guatemala (Operation PBSUCCESS in 1954), Chile (1973) Australia (1975), Somalia. It attempted coups in Cuba in the early 1960s. there were covert CIA operations in Laos. The JFK assassination has all the qualities of a coup.

There's a longer (but incomplete) list at:
http://en.wikipedia.org/wiki/Covert_U.S._regime_change_actions

[8] The Global Gamble: Washington's Faustian Bid for World Dominance by Peter Gowan.

[9] American US dollar hegemony, for instance, that entails other nations having to earn US dollars first in order to purchase critical commodities such as oil or have syndicated loans lent to the third world denominated in US dollars and be subject to unilateral interest rate decisions by the US Federal Reserve. (In 1979 US Fed Chairman Volker’s decision to limit money supply led to catastrophic rises in global interests rates that resulted in third world debt becoming permanently unpayable.)

[10] From Hervé Kempf's "How the Rich Are Destroying the Planet."

END.

Chicago Economist Claims Homeowners Choose to Default on Their Mortgages And Quit Their Jobs

On Christmas eve, Casey Mulligan claimed that the employment decline was due to an inward shift of the labor supply curve to which we noted that he had yet to give us his explanation for WHY the labor supply curve shifted inwards.

Well – it has been a week and Casey Mulligan offers us this explanation:

Though ubiquitous these days, mortgage modification programs create terrible work incentives. This is one reason the current recession is so different from previous ones … Because of the low resale values, foreclosing on any of the homes will not yield lenders their entire principal; lenders in those cases must rely on the good behavior of the borrowers … these “modification programs” encourage lenders to reduce mortgage payments so that each borrower’s housing payments (including principal, interest, taxes and insurance) are 38 percent of the borrower’s gross income. The payments are to be reduced for five years, or when the mortgage is paid off (whichever comes first) ... I do not expect every adult among those in the 12 million underwater households to be without a job because of the modification rules.

Mulligan is essentially saying that those poor saps who have lost their jobs actually quit so they can game the mortgage system. In other words, there is no such thing as involuntary unemployment or being forced to either lose one’s home versus enter into one of these mortgage modification programs. I’m sorry – but Casey Mulligan is clearly writing from some ivory tower and needs to get out into the real world.

IMF Economist Backs Obama’s Fiscal Plan

Olivier Blanchard also seems to disagree with Jeffrey Miron:

Olivier Blanchard, the IMF's chief economist, said "the size corresponds roughly to what we think is needed." He backed the Obama approach of targeted tax cuts, saying the money should go to consumers who are "truly credit constrained." In an accompanying research paper, Mr. Blanchard and three other IMF economists advised against broad cuts in corporate tax rates, dividends and capital gains -- Republican favorites -- which they judge "likely to be ineffective" because profits are low. The changes "are often difficult to reverse," they added. In an interview, Mr. Blanchard said a general tax cut may be less effective than other measures because many consumers would save the money.

If we choose to go the fiscal stimulus route – shouldn’t we be interested in getting some real bang for the buck? I’m glad to see that Olivier Blanchard thinks so!

Zero Is Not A Lower Bound For Interest Rates

In recent days Paul Krugman has been flailing a model of the term structure of interest rates and the liquidity trap based on the idea that there is an absolute lower bound of zero percent for nominal interest rates. This may have been true in the distant past, but it is not true anymore. We have seen numerous episodes of negative interest rates, with several outbreaks in the last few months, including on the actual federal funds rate and on 90 US Treasury bills, as well as on Japanese interbank rates in the late 1990s, when their target rate was at 0%. A not widely known episode that went on off and on between August and November of 2003 was in the repo market, which used to be used by the Fed for open market operations, as reported in a New York Fed study from April 2004 by Fleming and Garbade, accessible at http://www.newyorkfed.org/research/current-issues/ci10-5.html. It has only been convention and a left over belief like the old religious view that negative numbers did not exist that has led so many economists and others to think that zero is some absolute lower bound on interest rates. We may well see that bound breached more seriously and frequently in the months ahead, if the economic crisis continues to deepen.

The prejudice against believing in negative interest rates, sometimes viewed as the "price of time," is not unrelated to the long-held opposition to the idea of negative prices. We see them regularly in real life, but they often get assumed away by defining paying for the removal of something (such as excess water) as a different market with a positive price from providing the same good when we want more of it (water for irrigation), even when the same activity does both things (building a dam with an irrigation system). Negative real estate prices often are associated with environmental problems, such as kaput coal mines leaking toxic waste that the owner is responsible for paying the cleanup of. In some countries, brides have a positive price while in some grooms do, although as Michael Perelman recently reported, Herodotus tells us of bride auctions in ancient Babylon where some are sold for positive and some for negative prices in the same auction. The great efforts by the general equilibrium theorists to avoid negative prices (not a problem for Walras) were a waste of time, as were all the huffings about negative surplus value in the Sraffian debates. Time to get over it, especially if we start seeing widespread negative interest rates.


Hidden conclusion here.

Jeffrey Miron’s Preference for Ineffective Fiscal Policy

Jeffrey Miron claims:

Is a fiscal stimulus good policy? The answer is no if the stimulus consists of increased spending. The stimulus may be good policy, though, if it consists of lower taxes.

We will likely hear this slogan a lot from conservatives over the next few weeks. Miron’s argument against increasing spending goes something like this:

If the new spending is for projects that are beneficial for society overall, and if the private sector cannot or will not undertake these projects, then the expenditure is worthwhile independent of what it does to fight the recession. A standard example might be repair of the interstate highway system ... Even if certain components of the nation's spending are too low, nothing guarantees that new spending will be directed to these areas. Instead, experience suggests that much will be for repairing "bridges to nowhere," especially those located in the districts of influential legislators. The Keynesian argument for a spending stimulus does not, of course, assume this spending is for projects that have economic or social value. The theory, in fact, suggests that digging ditches and then filling them up is effective at stimulating the economy. This cannot make sense in the long run; government spending must be paid for with taxes, so it ultimately comes at the expense of private spending. Projects that do not make economic sense are then pure waste. Yet the history of government spending indicates the stimulus package will include countless zoos, aquariums, museums, parks and other pork barrel projects for which the private demand does not come close to justifying the investment. In many cases, these projects will persist for decades.

If Jeffrey Miron is worried that the new Administration is about to push for a bunch of pork barrel projects, maybe he should talk to Lawrence Summers. So let me address instead Miron’s faith in tax cuts as the cure for our lack of aggregate demand.

Tax cuts also stimulate demand via the standard Keynesian channels of increased disposable income for consumers

The underlying Keynesian premise for short-term fiscal stimulus is that we need to accelerate aggregate demand but eventually aggregate demand will be restored either through more consumption (public or private) or more investment. When Miron talks about government purchases crowding-out private spending, he is referring to the period known as the long-run and not the short-term concerns that will be the dominant macroeconomic theme for 2009. If one is a believer of propositions such as the life cycle model of consumption or the Barro-Ricardo equivalence proposition, one would dismiss out of hand this notion that we can accelerate aggregate demand by passing a tax cut today that will one day have to be financed by a tax surcharge. I should hasten to add there are a couple of ways of addressing this critique of tax cuts – one of which Miron hints at:

For those who advocate smaller government, the case for a tax cut is easier; short-run increases in the deficit are not a major concern if government should be smaller (and can eventually be reduced in size) in the long run. If the level of spending is too high, the U.S. can have its cake and eat it too: cut taxes now to improve efficiency and stimulate the economy and cut spending later to balance the budget.

Of course, this smaller government canard was a rational for the 1981 tax cut and almost every Republican call for tax cuts since. But even when the Republican Party dominated fiscal policy decision making, we never saw any significant reduction in the size of the government.

Some Keynesians would argue that the life cycle or Barro-Ricardo equivalence models of tax cuts and consumption ignore the fact that some households face borrowing constraints. On this score, Miron might consider what Philip Rucker reported yesterday:

President-elect Barack Obama’s economic stimulus plan will include an immediate tax cut for middle-class families

In other words, the plan is to give tax cuts to those who may indeed be facing borrowing constraints. I guess Miron might complain that President Obama intends to make these middle class tax cuts permanent by increasing taxes on the wealthy – who likely do not face borrowing constraints. But the redistribution of the tax burden is not likely to have much of a net effect on aggregate demand. Simply put – I do not see how Miron’s call for tax cuts will have as much bang for the buck in terms of accelerating aggregate demand as the set of fiscal proposals being advanced by the President-elect’s economic team.

The Mexican Recession and Fiscal Policy

Elisabeth Malkin must not have ever heard of Lord Keynes and his General Theory:

But this recession, it is the profligate United States pulling down fiscally disciplined Mexico. Like a host of middle-class countries, from South Africa to Brazil, Mexico is credited by economists with prudent economic policies that reduced debt and tamed inflation, but that has not saved any of them from the pain of a global recession ... When the American economy began to spiral downward, officials here argued that Mexico’s hard-won macroeconomic stability would protect it ... Now, as each week brings more bad news from the United States, those forecasts seem quaintly optimistic. The North American Free Trade Agreement, or Nafta, which so tightly bound Mexico and the United States and turns 15 on Thursday, is helping drag Mexico down with the United States just as it helped bolster it when times were good north of the border. When the American economy was growing, successive governments here counted on foreign investment and exports to generate growth. Exports account for almost a third of Mexico’s gross domestic product. But more than 80 percent of them go to the United States, and when American consumers stop buying, there is no market for Mexican-made big-screen televisions, auto parts or expensive winter fruit.

Well – at least she introduced the open economy aspects. With the peso hovering around 10 pesos per dollar until August 1 of this year (since then it has devalued by about 33 percent), fiscal stimulus in the U.S. led us to import more goods from Mexico which should boost Mexican aggregate demand. As an aside, Dean Baker is not been that impressed with Mexico’s real GDP growth.

Malkin goes onto note that the fall in U.S. aggregate demand has led to a fall in Mexican exports with a concern that Mexico that will also suffer a recession. If that is the case, fiscal restraint is precisely the wrong policy to adopt at this time.



Update: I checked with this source to see if it is true that US imports from Mexico have declined. Our graph shows these imports from January 2007 to October 2008. Maybe economists are forecasting a decline but we had not seen it as of a couple of months ago.

Google Monetizes Public Libraries?

With public libraries reeling under expanded budget cuts, Google's new deal with the publishers seems to threaten public libraries, which offer Internet service.

Karen Coyle's warning about Google's new plan is short enough that I need not summarize it. Google's response seems disingenuous.

Keep in mind that the major university libraries supplied books that were subsidized by public money.

Whatever happened to "do no harm"?

http://www.opencontentalliance.org/2008/12/06/a-raw-deal-for-libraries/

Federalize Medicaid!

There has been much justified concern and talk about the fiscal problems of the state and local governments in the current crisis, most of whom have some form of balanced budget rule in place, forcing them to engage in automatic destabilizing policy in the form of cutting spending or raising tax rates as the recession lowers tax revenues. One of the most significant of rising costs that is hitting all the state governments, and has been even when times have been better, has been Medicaid, the needs-based program to pay for the medical care of poorer people. Unlike non-needs based Medicare and Social Security, this program is partly funded by the states as well as the federal government, which also means that poorer states face a larger burden.

Although I have heard nobody propose this, and it would cost a lot of money at the federal level, there is an obvious move here that would help in both the short term and the longer term. Federalize Medicaid! Besides essentially eliminating the fiscal crises of the states, it would also provide a more level playing field in the longer term between the states.

Do High Income Individuals Have a Lower Marginal Propensity to Consume or a Higher Propensity to Import?

Kevin Drum seems to believe the former:

One way or another, there's really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can't spend more unless they make more … The only sustainable source of consistent growth is rising median wages. The rich just don't spend enough all by themselves.

Kevin seems to be arguing that as income distribution gets more tilted from the poor and middle class towards the rich, consumption as a share of national income will fall. OK, we are currently concerned about an insufficiency of aggregate demand given that the sum of net investment and net exports is barely above zero. During the transitional (perhaps defined as a couple of years) Keynesian period of weak investment demand, we have the paradox of thrift where any upwards shift of the national savings schedule will only deepen the recession.

But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment. And if Kevin is right about the rich having a lower propensity to consume – that is, a higher propensity to save – the old trickle down nonsense about taking from the poor to give to the rich would at least spur more investment demand and long-term growth.

Paul Krugman, however, isn’t buying this assumption:

There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people.

I’m not sure I’m buying this notion that distributing income from the rich to the poor is going to necessarily reduce our national savings rate either. But here’s a related query related to the Keynesian multiplier related to certain open economy musings by Dani Rodrik:

It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care? Being the open economy that it is, I fear that the U.S. will have to confront this dilemma sooner or later. In an environment where the dollar has already appreciated against the Euro and even more significantly against emerging market currencies, fiscal stimulus here will produce an even larger current account deficit. If American consumers decide to spend 40 cents of a dollar of additional income on cheap imports from China and other foreign countries, the multiplier will be a mere 1.3. How long will it take before politicians of all stripes cry foul over the leakage through the trade account and the "gift to foreigners" that this represents? And they will have Keynesian logic on their side.

Let’s postulate for a moment that the rich have a high marginal propensity to consume imported goods than do the poor. Even if redistributing income from the rich to the poor does not increase overall consumption (that is, we as a nation still save the same amount), it might induce less imports and more domestic spending.

Truism and Consequences

by the Sandwichman

"Any cub productivity theorist can upset the idea by a mere reference to long-time effects on wages; but the unionists were blissfully ignorant of such theories..."



The quote is from Raymond Henry Mussey's "Eight-Hour Theory in the American Federation of Labor" (1927). The image is a page from a letter from John Bates Clark to Franklin H. Giddings in which Clark explains the reason for the delay in publication of his productivity theory of wages.

..By the way I want to tell you in confidence that George Gunton
wrote to the Columbia people proposing to write for them an article
in criticism of my Wage theory. They wrote asking whether I would
rather have it come out before or after my article in the [Political
Science] Quarterly. This was then expected in Sept. I said let Mr.
G.'s article come in Sept. and let me reply in Dec. After thinking
the thing over for a while they concluded not to publish the
symposium or friendly melee at all, and asked me then to send the
article for Sept. independently. By that time I had concluded I must
for the reasons stated, defer the article till December. Mr. Gunton
said of me "He seems to have been much impressed by Stuart Wood's
article in the Quarterly Journal of Economics." This is a true
statement or guess -- I was impressed by the article. Mr. Gunton
seemed to me to think I was a trifle more dependent than I supposed
I was on my good friend's paper. I wonder just a little whether Mr.
Gunton's impression, if such as I surmise is his impression, is a
natural one. Bah! This is an illustration of the essential
littleness and selfishness of the human heart. What does it matter
whether A or B discovered the major part of an economic law, if so
be that it is a law and does a work in interpreting facts of life?...

George Gunton -- who formalized the American Federation of Labor's eight-hour philosophy in a 1889 pamphlet, "The Economic and Social Importance of the Eight-Hour Movement" (which was serialized on EconoSpeak a few months ago) -- was not "blissfully ignorant" of John Bates Clark's productivity theory of wages. On the contrary, Gunton was familiar enough with Clark's theory to write published critiques of it and to detect "impressions" in it of Wood's theory that Clark himself was not entirely aware of.

How I Misrepresented Nassim Nicholas Taleb On Barbell Strategies

[long, wonkish, and personal]

If one googles "barbell strategy," one mostly finds discussions of a bond-trading strategy (and a related definition) that involves putting half of funds in long term bonds and half in short term bonds, with no money in intermediate term bonds. The money at both ends makes this a "barbell." Whether or not such a strategy makes more money than the "bullet strategy" of buying only intermediate term bonds (or all time horizon bonds) depends on the shape of the term structure of interest rates and how it changes over time. Another variation is for a takeover raider to buy both very large firms and very small ones, but not mid-sized ones. A more general definition of a barbell strategy is one that combines very safe investments with very risky ones, while not buying ones of intermediate riskiness. In his book, The Black Swan (TBS), Nassim Nicholas Taleb recommends (pp. 205-26) a variation on this in which one puts 85-90% of one's assets in "extremely safe assets, like Treasury bills" and the rest in "extremely speculative bets, as leveraged as possible (like options), preferably venture-style portfolio," with a footnote suggesting that this remaining 10-15% involve "as many of these small bets as possible."

In various blogs, including here, I have described his barbell strategy accurately with regard to the first part, but misrepresented the second part as involving specifically buying puts on major crashes. I then criticized this as a strategy that would lose money in most years (although obviously it would make money this year if properly done) based on a paper by Oleg Bonderenko, "Why are Put Options So Expensive," available at http://tigger.uic.edu/~olegb/research.htm. In a link on his website, http://fooledbyrandomness.com/fake.htm, Taleb has sharply criticized me for this (others dumped on there are Tyler Cowen, Robin Hanson, Alan Greenspan, Robert C. Merton, Kenneth Rogoff, and Paul Seabright, for various alleged sins, some more serious in my eyes than others, some not sins at all). In any case, I have now gone back to his book and see that my frequently repeated description of his barbell strategy was a misrepresentation. For this, I apologize to him publicly.



Needless to say, there is more to this than I have said so far, for those of you who are interested, and I will say that quite a bit of what Taleb says on his website involves serious misrepresentations. I would strongly suggest that he alter the inaccurate parts and publicly apologize, as I altered parts of an original posting back on maxspeak over a year ago at his request that was at the origin of all this. So, for those of you who are curious, here is the rest of the story, at least as I see it.

So, in the summer of 2007 I happened to read TBS. I found it mostly very interesting and stimulating, and in general I was then and remain in agreement with most of the ideas in it. I enjoyed (and still do) many of the tales and neologisms he came up with there, although on my second reading I find much of it more superficial and self-contradictory than I did the first time around, although this may reflect a more critical approach given our bad relations since. Anyway, after reading it, and becoming aware that he had a number of technical papers floating around on substantive aspects of it that were unpublished, I sent him a friendly email, praising his book and inviting him to submit any papers he might wish to the journal I edit, the Journal of Economic Behavior and Organization (JEBO). He has posted part of that email on his site.

What he does not note on his site is that his reply to me, somewhat delayed, was a form email telling me that he was too busy to reply to my email. I was not all that surprised by this as this was the time when TBS was on the bestseller list, and I could understand that indeed he might be very busy. He said nothing about JEBO and did not say anything about my invitation.

Now, there is at this point a crucial event that he did not realize. He argues that what followed was due to my "feeling rebuffed" that he had "refused [my] invitation to submit in his technical journal." Well, he had not refused. He had simply said he was too busy to reply, and I was in fact still awaiting a reply. However, I became aware of this paper by Bondarenko and saw some discussions on some blogs by some other people whom he does not attack and whom I shall not bring up who argued that Bondarenko's results showed that Taleb's barbell strategy was a money loser in most years, even if the losses would not be all that great, which is his ultimate defense of the strategy ("My barbell strategy has nothing to do with making money - although it does OK - but with being robust to model error"). It was after seeing this, and also hearing of some bizarre conduct of his regarding another blogger, whom I shall not mention, that I then put up a post on the old maxspeak, the predecessor of this blog.

In that post I spent most of my time praising TBS, something that Taleb has somehow never noticed or commented on, I guess assuming that everybody should praise his book without any questions or criticisms. I then, as had Tyler Cowen in a review in Slate (the reason Tyler is on his bad list), said that the main weakness of the book was that his barbell strategy would lose money most of the time. I went too far and said that he would probably not be able to make much money personally with it and would do better by writing and selling his successful books.

Well, now within 20 minutes of putting this up, I got an email from this guy who was "too busy" to reply to my friendly earlier email. It warned me in pretty strong language that I did not know how he made his money and that I should be careful what I said, pointing out specific wording mentioned above. So, I altered that wording to make the post not say what he definitely would do or not do in terms of making money, but still criticizing him. He then sent me another email in which he essentially threatened to sue me, which he has done to others who criticize his financial strategies (whatever else he is, he is ridiculously thin-skinned). I then put up his emails in the comments section of the post and ripped him harshly for his hypocrisy.

I now realize that part of what happened here was a miscommunication. He did not realize that I had changed my views somewhat on his book because of something I read after I sent my original email. That was unfortunate, because, as I said to him both on the blog and in an email, he and I are very close in views and admire and respect many of the same people, some of whom we share as friends. We actually ought to get along, but fell into a very unpleasant contretemps. In any case, I have continued to blast him here and there until now on all this.

A few substantive remarks beyond all this soap opera, and I shall let this go. One is that whether or not any barbell strategy either makes money or even succeeds in insuring one against big losses while preserving that option of making big money depends on the details of the strategy. He sells it as insurance against black swans (unforeseen events), but its ability to insure depends on having "safe assets" that will be safe even in the event of a black swan. In the case of his specific recommendation of US T-bills as the safe asset, while all the world has run to them in the last few months, it is now very far from clear how safe they are, at their near zero rates, and with the possibility of a major crash of the dollar sitting out there. Great grandma's old "cash in the cookie jar" may well be better, maybe along with some euros and yen and a couple of other currencies. A crash of US government securities could well be the next Black Swan.

The strategy again only will work if not too many people are doing it. If too many people are doing it, then the generalization of Bondarenko's critique will hold: those endpoint assets will be overpriced and money will be made by buying the intermediately risky ones. Also, if everybody does it, the economy will belly up with no financing of those intermediately risky activities that constitute the majority of the economy.

Furthermore, while it is very popular now to attack "economists" in general, Taleb rather makes a hash of things. On the broader part of his website he says somewhere that the only two economists he respects are dead: Hayek and Shackle. However, in TBS we find him praising Keynes, Knight, Minsky, and Kindleberger, all of whom I also admire. He also cites many living economists at least not critically, and some positively, with Robert Shiller probably most frequently. Yes, Merton and Scholes (and Samuelson) all look bad, and yes, the textbooks should stop pushing models based on Gaussian distributions, but by now most of us, and certainly the contributors to and readers of this blog know better.

Finally, he does remain in contradiction with himself in TBS, although he knows this and sort of acts like it is all very cute and philosophical (p. 296: "Half the time I am intellectual, the other half I am a no-nonsense practitioner... Half the time I am shallow, the other half I want to avoid shallowness," etc.). But he does have major contradictions, which make me less inclined to be so charitable about his slams on so many people over pretty trivial stuff (although not all of his slams are over trivial matters). So, he spends most of the book denouncing Gaussian distributions and those who push them (not very many these days, kind of a straw man). He seems to contrast that "Mediocristan" with "Black Swan" world of "Extremistan." But then, he spends time talking about econophysics and his papers with Mandelbrot on multi-fractal distributions and so forth, which he admits are not really either; they are "grey swans." Yes, he does cover his behind, but after all his rhetoric and carrying on, it looks pretty hypocritical.

A final btw. On his site he states that he did not wish to submit to JEBO because of his "no-nonsense orientation [that] clashes with academic resume building." Hmmm. Well, that might be fine, but I do see him publishing in American Statistician, Quantitative Finance (edited by our mutual friend, Jean-Philippe Bouchaud), and currently in the process of co-editing a special issue of the International Journal of Forecasting. Well, I wish him good luck with all that academic resume building (Oh, and I still think that he is a popularizer, although that is not necessarily a bad thing, but no, he will not get a Nobel for his ideas, sorry).

Employment Decline – Casey Mulligan Blames Inward Shift of Labor Supply

Believe it or not this explanation made it in print:

Because productivity has been rising — almost as much as the Douglas formula predicts — the decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire). Why would some people have fewer incentives to take a job in 2008 than they did in 2006 and 2007 (and employers fewer incentives to create jobs)? I will tackle that question in my next post, but even without a specific answer we learn a lot about today’s recession from the conclusion that labor supply – not labor demand – should be blamed. First of all, it suggests that a fundamental solution to the recession would encourage labor supply (perhaps cutting personal income tax rates, so people can keep more of their wages), rather than tinker with demand.

Actually – Mulligan decides not to tell us what specifically induced people to reduce their offering of labor after all. The key item in his first post was referred to his next post? OK. But if there was some supply-side reason why workers decided to reduce their offerings of labor along an unchanged demand curve – wouldn’t that mean real wages would have gone up? Funny thing – Mulligan also fails to talk about this aspect of his bizarre explanation.

Financial Regulatory Daisy Chain

I read that Marc Mukasey, son of Atty. Gen. Michael Mukasey, who works for Rudolph Giuliani's law firm, is representing Frank DiPascalli, whom the Wall Street Journal reports is suspected as being in the center of the Madoff scheme. Of course, Madoff himself and his family had numerous connections with regulators.

Now just imagine that Madoff had been a poor person cheating on welfare. How long could he have gotten away with it?