Oil And Defense Spending

Last spring I was interviewed on our local NPR outlet about energy economics.  Among other things I pointed out the well-established costs of pollution from fossil fuels relating to global warming and health issues from SOX and NOX.  I urged the standard well-known green technologies along with thorium nuclear reactors, noting the irony that the US did not pursue this technology after carrying out the first thorium fission experiments in the 1950s because this could not be used to make nuclear weapons, along with other now desirable features (safer, more thorium around than uranium, etc.).  The show was rebroadcast recently without anybody telling me, and many more apparently heard it and I was bombarded by various comments and inquiries.  One friend asked why I did not note the defense spending costs associated with oil as part of the issue.  Given that my friend George McGovern now lies in a hospice at age 90 no longer responding to the communications from his family, perhaps this is an appropriate time to address this more closely.

I responded to my friend's inquiry (which came through facebook) by noting that in contrast to global warming or health costs of SOX and NOX, it is much harder to determine how much of defense spending is for "protecting our sources of oil."  Indeed, this is a very difficult matter, although thinking about carefully suggests to me that not much really is, which also suggests to me that the position I agreed with and helped support of McGovern's that we did not need nearly as large of a DOD establishment as we had and have remains correct.  Its budget is often justified to the public on precisely these grounds, but the reality is quite another story.

So, let us simply focus on the Gulf wars as an example, and, to sort of simplify things let us focus on the second of these, our recently concluded war in Iraq (although we continue to spend DOD money there with some residual troops, etc.).  For starters there is disagreement on how much it cost.  At the upper end are estimates by Stiglitz and coauthors of as high possibly over the long run as $3 trillion.  This includes all the medical costs of everybody wounded and much else.  The direct military costs appear to be just a bit under $1 trillion, which gives us a reasonable range.  But how much of this was really about "protecting our sources of oil"?

Indeed, my response to my inquirer was that this is a matter of great uncertainty, and the more I think about it, the less I think that it had anything to do with it, even when those running policy thought that it did.  Now indeed it is not a new position of mine that the Iraq war was not "really" about oil, although many people whom I respect think quite the contrary, that it was all about that and nothing else.  Well, I will grant that the real motivation of the first Gulf war under Bush, Sr. was about oil.  When Indonesia invaded and annexed East Timor, nobody did squat, and likewise when India did the same in Sikkim (although there was more noise about that one, given the glamor connections of some of the wives of the Sikkimese royal family).  But Bush Sr. arranged a global alliance to push Saddam Hussein back out of Kuwait, even though it appears that his goals were fairly modest, to grab a small slice of Kuwait, based on old border disputes from the setting of those borders by the British after WW I.  The Saudis and Bush feared Saddam really wanted to run all the way down the Gulf to grab the big prize of al Ghawar in Saudi Arabia out of which nearly 5% of the world's oil supply flows.  And maybe that was his goal, along with conquering Mecca and declaring a new Caliphate as some have argued.  In any case, Bush Sr. succeeded in pushing him back out of Kuwait and wisely listened to the Saudis who said, "Do not go to Baghdad," much to the annoyance of some of his underlings, most significantly, Dick Cheney.

So, when Bush Jr. came in, his VP Cheney played a nasty game with him, playing to his masculine insecurities vis a vis his dad, urging him to be like Reagan and "finish the business and take out Saddam," although Reagan pulled out of Lebanon the minute terrorists attacked our embassy in Beirut and killed a bunch of Marines.  For Bush Jr., this was what the war in Iraq was about, not oil. And for a bunch of his other advisers who pushed the war it was also not about oil, but about Israel, the neocons such as Wolfowitz, given Saddam's ridiculous habit of paying the families of Palestinian suicide bombers $25,000 when they died.  Oil had zip to do with this, indeed, the matter of Israel has always been a contradiction in the story of US Mideast foreign policy, with the US oil companies viewing US support of Israel as an annoying distraction from their love fest with the Saudis and other Arab and Muslim (Iran once upon a time) oil producers.

Of course, Cheney was a different story.  He had personal interests, notably the company that he formerly ran, Halliburton, and it remains a scandal that Halliburton made so much money out of the war in Iraq, whatever Cheney's personal take from that was, although in the end the major portion of this had to do with supplying the US military with all sorts of goodies rather than actually making money out of engaging in oil business in Iraq or elsewhere in the Gulf.  Now, Cheney does appear to have been plotting more generally to be a pinup boy for an old imperialist vision: bring back the major US oil companies in a serious way into the Gulf oil business, or at least at a minimum, into the Iraqi oil business.  And some of the neocons also were under the delusion that the Iraqis would be so grateful to us that they would pay for our invasion of their country from their oil revenues, like the Kuwaitis did for Bush Sr., the main reason the first place to be taken in Baghdad was their Oil Ministry building.

But in the end, this was all for nought, a pathetic farce and delusion. The war is over, and not only have the Iraqis not paid us a penny for our efforts, the US oil companies have been cut out of the action almost entirely in Iraq, where indeed oil production is reviving gradually after the collapse that occurred as a result of our invasion.  Of course, oil production in Iraq is now controlled by two distinct political entities, Iraq and Iraqi Kurdistan, where rising oil production involves a variety of foreign oil companies, although not universally legally recognized.   Most of the companies in Kurdistan are small independents out of Norway and Canada and other such places, with the only US companies involved there being some owned by the Hunt brothers, one of whom sat on Bush Jr.'s Foreign Intelligence Advisory Board.  This created a minor scandal at the time, that he was profiting from inside intel info, but that faded away, leaving them the only US oil companies making money out of the definite gains for the Kurds from our invasion of Iraq.  As for the main oil fields in the rest of Iraq, US companies viewed them as too risky due to ongoing military conflicts to seriously bid, and as a result, the old operators in Iraq got most of the deals, namely the Russians and the French companies, along with the new big player, the Chinese.  To the best of my knowledge, no major US oil company is making any serious money out of Iraq, although I think there a few minor deals going on.

Of course,  there is more controversial issue here. What really is the "US national interest" here?  Most think that it is a matter of keeping the oil flowing so that price of oil in the US for our consumers does not get too high.  Even now, the threat of Iran blocking the Strait of Hormuz, given our nuclear conflict with them, remains an apparent justification in the eyes of many Americans for our humongous defense spending, or at least some of it.  But in terms of Iraq, the main result of our invasion was to cause a decline in oil production in Iraq, something warned of by the major US oil companies in fact, who perhaps wisely foresaw that our intervention there was not going to make them any serious long run profits.  But this decline in oil production did help US companies, their one compensation, in that it led to a rising price of oil, which helped their profits in the short run, even as it sucked money out of the pockets of US consumers.  In terms of the official public traditional view of "protecting our oil sources," if this meant for US consumers enjoying lower prices it was a total flop, although it did lead to gains for Cheney's pals in the oil industry from the higher prices for awhile.

So, the bottom line here is that in fact nearly zero of the spending for the war in Iraq actually "protected our sources of oil," certainly not for consumers, and not even in the longer run for US oil companies.  Anybody trying to defend the scale of US defense spending on the grounds of "protecting our sources of oil" should be run out of town on a rail after being tarred and feathered.

A Simple Example of How Adverse Selection can Lead to Multiple Equilibria

This came up when I was writing homework problems on adverse selection for a money and banking class and without intending to, wrote one that had 2 equilibria.

Take the market for used cars  a la Akerlof. There are 10 potential buyers and 12 potential sellers, 4 each  with cars of Low, Medium and High quality. Buyers reservation prices  are 15, 10 and 5 thousand dollars for High, Medium and Low quality, respectively.  Low Quality sellers need at least 3,  Medium sellers 7, and High sellers 11 thousand dollars. Quality is known to sellers but not to buyers, who know only the distribution.

There is an equilibrium at a price of $7500, in which Medium and Low quality cars sell,  but no High quality. The expected value of  a  car for buyers is is $7500. Excess demand is 2, but at a price above 7500, there is excess supply as no buyers are interested, since it will be above the expected value of $7500. At prices above 11, the expected value of a car will be  $10,000, so no deals will be made at such prices either.

Think about what happens as we drop the price below 7500. 10 buyers are interested and 8 sellers until we hit 7000. At that point , only low quality sellers will be selling, so the buyer reservation price drops to 5000, and we have no buyers therefore until we hit 5000. This is the second equilibrium: there is excess demand of 6 below and at this price, but excess supply of 4 just above it. Only low quality cars are for sale. This second equilibrium is Pareto-dominated by the higher-price equilibrium.

Now imagine that the sellers are workers, with reservation prices representing opportunity costs, and buyers are employers whose reservation prices represent productivity.  And that productivity is private information for the workers. Then we can get an interesting rationalization for a Card-Krueger positive relationship between employment and the minimum wage. The market suppose is in the $5000 wage equilibrium:  imposing  a $7500 minimum wage would put the market in the better equilibrium with higher employment.

With a little hand-waving and mutatis mutandis, it seems one could get a rationalization of anti-usury laws. Here the bad equilibrium would be the high interest rate equilibrium, with only the lowest quality borrowers wanting loans. Then an anti-usury law can produce the low interest rate equilibrium, where the average quality of borrowers is higher.

This is probably old hat to most, and to the extent that I haven't made glaring mistakes, the idea has I'.m sure been developed  with orders of magnitude more sophistication by others. When I google scholared "adverse selection and multiple equilibria" I get lots of hits, including what looks like a seminal paper by Charles Wilson which I printed out and plan to read right now.  But  sometimes simple examples can be helpful at isolating the way a mechanism works, so I thought I would pass this one along.

John Taylor: I’m Right Regardless of What Anyone Else Says

Noah Smith has an excellent discussion of what he calls “Reinhart-Rogoff vs. Bordo-Haubrich (with grandstanding by John Taylor)”. Please read it as it has become part of the Presidential debate about whether we should condemn the Obama Administration for the slowness of this recovery or we should understand that recoveries from financial crisis are often slow unless our politicians have the wisdom to use massive fiscal stimulus (which Obama originally wanted but the Republicans said no). Noah at one point fired off this shot:

First of all, do not listen to John Taylor. He is not being a scientist right now, he is being a politician ... And I think no one should take John Taylor's promotion of B&H's results seriously, since he is part of Team Romney.

Via Greg Mankiw comes another post from John Taylor who is still promoting B&H:

In sum, the weak recovery deniers have not made their case.

While Taylor does link to Paul Krugman, both he and Mankiw ignore Noah’s post. I guess we could point this out in the comment section of their blogs but guess what – they do not allow comments. Hey – that is their right but would it be too much to ask for them to cite the well written posts on this topic from other economist bloggers such as Noah? Oh wait – as members of Team Romney I guess it would be too much to expect them to engage in an honest debate? Never mind! Update: Noah correctly notes that John Taylor's latest was posted before his excellent post. Note, however, Greg Mankiw's list was posted just today and Greg failed to include Noah's post. So Noah is being very kind and fair to John. We shall see if John follows up and includes Noah's discussion on his blog.

One More Rumination on the Burden of Fiscal Deficits

You would think that everything that needs to be said about this topic has been put on the table in the past few weeks.  (I will skip the links; these posts have already been linked to death.)  And you might be right, but I’ll offer a different take anyway.

The debate has been cast in an aggregative framework in which the set of welfare-relevant individuals includes both those who pay taxes tomorrow to repay today’s deficits and those who hold the bonds and receive payments.  Fine, but let’s consider a narrower question, one that most economists apparently think is beneath discussion: what it is the purely fiscal burden of public debt?

Well it’s obvious, isn’t it?  Either you pay off the debt in the future or you roll it over and pay more interest.  Either way you bear a fiscal burden, and they are the same in present value terms.

Well, try this.  In thinking about the fiscal burden, it may help to imagine a country with two types of citizens.  One type pays taxes but owns no financial assets; the other owns financial assets but pays no taxes.  (We’re getting there....)  The government runs a fiscal deficit in period 1.  In subsequent periods will there have to be offsetting transfers from the taxpayers to the bondholders?

First step: I rule out the scenario in which any significant portion of the debt is paid down.  This is not a deduction from theory, just an empirical observation.  Fiscal surpluses are few and far between.  Tomorrow’s taxpayers will no more be paying off the public debt incurred by the current generation than today’s taxpayers are paying off the debt bequeathed to us by our parents and grandparents.

So let’s get to step 2 and consider interest payments on the debt.  Here the critical move is to regard the burden not as a sum of money but a fraction of income, the debt service to GDP ratio.  This goes up if and only if the percentage increase in debt exceeds the corresponding percentage increase in income, given a constant interest rate.  (I abstract from the issue of real versus nominal incomes and interest rates.)

Now, why would anyone think that the incremental effect of a fiscal deficit on future income growth would be positive?  Two reasons.  First, if the deficit finances public investment, and if this investment is more productive than the use to which the money would have otherwise been put, income will grow commensurately.  Second, if the deficit reduces an otherwise stubborn income gap, hysteresis effects are likely to boost potential income in future periods.  The extent to which income growth attributable to deficits offsets debt service obligations and therefore raises or lowers the future fiscal burden is uncertain.

But that’s the point.  I would say it is an open question whether any particular deficit will be burdensome in the most restricted meaning of that term.  The answer is likely to vary from one macroeconomic context to another, from one program of public spending to another, according to the extent of the deficit, and so on.  The bottom line, however, is that, even if all the government bonds are owned by Martians so that taxpayers and bondholders are completely different species and transfers from the first to the second constitute a pure welfare loss, there is still no determinate relationship between more deficits today and more burden tomorrow.

Arrow v. Taylor Debate at Stanford

Aaron Sekhri provides a summary of a discussion at Stanford between Kenneth Arrow and John Taylor. I wish I had attended but based on this summary, Taylor is very confused about the role that fiscal policy plays during a recession even after Arrow stated the standard Keynesian position when the economy gets stuck in a liquidity trap:

He went on to discuss the disadvantages of what Obama opponents see as key fixes, namely, reductions in government spending. “Spending cuts are not productive,” he argued. “The real problem is the underutilization of resources. We can’t cut down what is really an investment in the future.” … Arrow then began a discussion of the need for government spending at a time when interest rates bottom out, as they did after the 2008 financial crisis. “The problem with monetary policy is that when the interest rate gets to zero, you hit a limit. That’s what happened in the Great Depression, and I’m probably the only one in the room who remembers that time,” joked the 91-year-old Arrow. Taylor argued in response that “temporary spending, such as the stimulus program, peter out very quickly and do not give you sustainable growth.”

Sustainable growth is what economists worry about in terms of full employment economies over the longer term. Does Dr. Taylor even get the basic premise that we have deviated from the long-term full employment path? Of course, Dr. Taylor has a simple solution to how we get back to full employment:

Comparing the federal government’s attitude towards change to the intransigence of the stubborn parent-teacher association at his child’s school, he asserted that the best route to economic wellbeing was to remove the incumbent administration and start anew.

In other words, make Mitt Romney President and everything will magically get better by itself. If you were not convinced by now that John Taylor has turned transformed himself from economist to political hack, this statement should make that case.

California’s Doomed-to-Fail Experiment in Carbon Regulation

The New York Times has a piece this morning on California’s new law to regulate carbon emissions, the corporately named Global Warming Solutions Act.  (Here is our new 2012 lineup of global warming solutions; pick the one that’s best for you.)  It is utterly uninformative about what is at stake in this new program and the damage it is likely to cause.

The author of the piece makes what must have been a pleasant journey to a redwood forest in order to talk with the folks who measure tree diameters: tree growth means carbon storage and provides a physical audit of carbon credits for forestry.  Journalists love this visual stuff, but accurate tape readings are almost irrelevant to the true problems predictable under the California law.

There are two huge issues, either one sufficient to sink the entire experiment.  The first is that carbon permits are given away to businesses based on historic emissions.  The second is the gaping loophole of offsets.

Giving away permits is very attractive to politicians.  Overnight they are in a position to grant or withhold vast sums of monetary equivalents, and this is sure to induce correspondingly large campaign contributions.  In other words, the logic of carbon giveaways is the same as the logic of our tax laws: they are convoluted and larded with special exemptions because otherwise there would be nothing to sell.

But worse, giving away carbon permits creates an unsolvable contradiction for policy.  On the one hand, freebie permits transfer money from consumers to businesses to the extent that the permits are scarce.  Issue fewer permits and prices go up, but costs to producers stay the same because the permits are free.  From an economic point of view it is a lot like the supply restriction enforced by cartels, except that here the government is in charge of squeezing the market.

Of course, what these handouts giveth to businesses they taketh away from the rest of us.  Voters don’t like to see the prices they pay go up, especially for highly visible items like gas and home heating.  They are even less likely to appreciate their contribution to the windfall profits of industry.  So here is the conundrum: permit giveaways are justified as the price that has to be paid to get business to go along with a climate plan, but the same system alienates voters and guarantees that serious limitations on carbon emissions will never occur.  You can see the outcome in the European Trading System, which ended up authorizing so many permits that they now have no value at all and no longer trade: the system “restricts” carbon emissions to the level that would occur in its absence.  My fearless forecast is that California will go the same route.

As for the problem of offsets, if accurate tree measurements is the main hurdle, we are in heaven.  Much more likely are two other glitches.  First, the criterion of additionality, that the green investments being subsidized would not have been made without the sweetener of an offset, is impossible to enforce.  How can anyone prove that a forest would or would not have been harvested in a parallel universe, exactly the same as our own, except for not having a Global Warming Solutions Act?  The history of the Clean Development Mechanism, set up under Kyoto to funnel carbon offset money to green investments in less developed countries, demonstrates that to a fault; independent audits have found that improper subsidies are the rule, not the exception.  On top of that, the criteria for offset eligibility are easily gamed, and many “green” projects are anything but, except in one narrow sense that allows the money to flow.  (Imagine how easy it would be to game any formal criteria for forestry offsets—cutting one forest more while collecting money by cutting another less, turning forests into tree plantations that trade sustainability for more rapid short-run growth, permitting practices that release more carbon from forest soils, etc.)

The offset game gets support from those whose noses are buried in the minutiae of carbon accounting.  Trees capture x amount of CO2 equivalent, equal to the combustion of so many barrels of oil or tons of coal, so why not trade one for the other?  Alas, this ignores the underlying logic of climate change.  The last century has seen a dangerous trend toward global warming not because of deforestation (which has been going on since the beginning of settled agriculture), but because of the release of large quantities of carbon that had been sealed away underground for hundreds of millions of years.  The bottom line of forestalling catastrophic climate change is leaving as much of that stuff in the earth as possible.

Specifically, there is enormous, and enormously complex, exchange between atmospheric, terrestrial and marine stores of carbon.  No one can say today how much of the carbon fixed in tree growth will be released over the next century, particularly since environmental conditions are certain to change radically.  For instance, those wonderful redwoods described in the Times article may turn out to be in the wrong latitude as temperatures rise.  This would be reflected in an increase in the frequency and severity of fires, which would send the carbon back up into the atmosphere.  Or people may not wait for fire to do the job; they could change the laws and start cutting the trees themselves.  What happens to carbon after it is extracted from the earth’s mantle is complex, fragile and reversible; it is the rate of extraction that has to change.

The good news is that this is just about California.  Governments in other places can try to do a better job.  Unfortunately, as the leading experiment in the US, the California system will be viewed as casting a verdict on all attempts to forestall climate change by pricing carbon, and its predictable failure will set back policies good and bad.  Those who care about this issue shouldn’t wait until the moment when failure becomes visible.  There is still a limited opportunity to construct an alternative narrative: this plan is so compromised that can’t work and isn’t a test of climate sanity.

The Neutrality of Money and the Supply and Demand Diagram

I just had an epiphany which I’d like to share with you: the neutrality of money is baked into the standard supply and demand diagram that enters the first-year economics brain and never leaves.

Recall the following point: putting together all the factors on which sellers base their preferences, and all the factors on which buyers base their preferences, an equilibrium price is determined.  If the actual price is above this equilibrium, excess supply will generate downward pressure until equilibrium is reached.  If the actual price is below, excess demand does the job.  It doesn’t matter what the price happens to be at the moment; it will gravitate toward the same equilibrium which has been determined by factors other than this price.

That embodies the neutrality of money.  By “money” I mean not simply the price level, but also the full range of effects generated by the financial system.  Financial activity can alter the prices of individual goods: commodities markets influence the price of minerals and agricultural products, markets in mortgages and their derivatives influence the price of homes, and so on.  The financial sector, in a money-neutral world, is determined by but ultimately does not determine the “real” world of production possibilities and preferences.  That is why finance can be an add-on to economic models that can be specified with or without it.  In a money-non-neutral world, everything really does determine everything else, with no distinction between “monetary” and “real”.

For some people the logic of the supply and demand diagram is a reason for accepting this neutrality.  For me it’s a reason to take a closer look at the model and question what subtle, long-lasting mental poisons we are releasing into the environment each time we (economics professors) teach it.

The answer, we know, is locked in those infamous ceteris paribus conditions.  This becomes transparent at the level of general equilibrium, where Sonnenschein-Debreu-Mantel tells us that changes in actual prices have the power to alter their equilibrium levels.  If you really, truly understand this, you see money and finance differently.  The problem is how to convey this same insight at the level of the simpler, more visible models on which introductory economics is based.  It’s hard to repair the damage caused by years of learning “the economic way of thinking”.

Rotwang strikes

http://www.huffingtonpost.com/ca-rotwang/mr-president-tweak-this_b_1954374.html?utm_hp_ref=politics

Read it and weep.

Jack Welch’s Ignorance Regarding Employment Data

Mark Thoma is very upset with the latest from Jack Welch and he should be. But let’s be calm and look at a couple of Welch’s two key claims:

In August, the labor-force participation rate in the U.S. dropped to 63.5%, the lowest since September 1981. By definition, fewer people in the workforce leads to better unemployment numbers. That's why the unemployment rate dropped to 8.1% in August from 8.3% in July. Meanwhile, we're told in the BLS report that in the months of August and September, federal, state and local governments added 602,000 workers to their payrolls, the largest two-month increase in more than 20 years.

The first claim is true – the labor force participation rate did fall from 63.7% to 63.5% but Welch conveniently omits the fact that this same rate rose from 63.5% to 63.6% as of September. And who told Mr. Welch that reported government employment shot up by over 600 thousand workers in just two months? I guess this person may have been Neil Cavuto or perhaps Donald Luskin because when I checked out the same series per FRED, I see an increase of only 55,000 over the past 3 months. As our graph shows, we have seen a very mild reversal of the unfortunate downward drift of government employment (I'm using seasonally adjusted data here - Mr. Welch didn't say what he was using and his claim is not even consistent with the data not seasonally adjusted). In all of his rants, Mr. Welch has proven only one thing – he is utterly clueless per the employment statistics that the professionals at the Bureau of Labor Statistics report. Before he decides to attack their integrity again – might I suggest he actually learn something about what they report?

Could the Recovery from the Great Recession Been Faster?

ABC’s This Week invited Nobel Prize winning economist Mary Matalin to debate known liar Paul Krugman. OK, I think I got this backwards even though Matalin did say:

I don’t make up numbers ... you have lied about every position and every particular of the Ryan plan on Medicare from the efficiency of Medicare administration to calling it a voucher plan ... You are hardly credible on calling somebody else a liar.

Actually - it was established a long time ago that Mary Matalin is a partisan hack but what about this claim:

Has there ever been this not be true in history that the deeper — the deeper the recession, the steeper and stronger the recovery. There is no such thing as a deep recession with a moderate recovery.

Poor Mary had not read this:

Fact-checking financial recessions is a salient issue, especially in a US election year. On the one hand, the incumbent faces criticism that the recovery is slow. In August the Mitt Romney campaign invoked US history to argue that performance has been poor: “The 2007-2009 financial crisis produced a severe recession ... But GDP growth has been anaemic since then, averaging just 2.2% per year since the trough. This pattern is unusual. The past ten recessions have been followed by faster recoveries, and GDP has fairly swiftly recovered to the previous trendline.” On the other hand, none of the last ten US downturns coincided with a financial crisis. In his convention speech nominating Barack Obama a month later, Bill Clinton intimated that the usual pattern in normal recessions was not relevant in this instance: “The difference this time is purely in the circumstances… no president, not me, not any of my predecessors, no one could have fully repaired all the damage that he found in just four years.” ... We reach back into the historical record over 140 years, examining the experiences of 14 advanced countries, to document the pervasive cyclical influence of credit in the economic fortunes of nations … The more excess credit in the preceding expansion, the worse the recession and subsequent recovery appear to be ... By this reckoning the US has done quite well, steering out of the to-be-expected financial recession range based on the inherited level of excess credit, especially if the shadow system is considered. Most importantly a deep financial recession was avoided at the outset, and this level effect remained intact ... To assume that this US recovery would resemble previous “normal recession” is to use the wrong benchmark.

There is a very simple way to think about this using standard IS-LM thinking. The 10 recessions from the late 1940’s to 2001 (see this for the dating of US business cycles) differed from the Great Recession as well as the Great Depression in terms of the ability of conventional monetary policy to quickly reverse these milder recessions. In those 10 situations, we could have and actually did reverse these recessions by allowing interest rates to fall. Some of these recessions (notably the ones from 1969 to 1982) were started by deliberate monetary contractions to “Whip Inflation Now” as President Ford once quipped. The ability to rely on monetary expansion had lead many economists including myself to wonder if we ever really needed fiscal stimulus to manage downturns in the modern business cycle. Yes – more fiscal stimulus would have been called for during the Great Depression but not in the modern US economy – unless we fell victim once again to the liquidity trap. The financial crisis in other nations such as Japan should have warned us that falling into a liquidity trap was a real possibility but I guess we had to relearn the lessons of history on our own. When Barack Obama prevailed in November 2008, he seemed to realize the need for a massive and effective stimulus package but alas didn’t push hard enough for what Christina Romer recommended. And alas, US fiscal policy has recently drifted towards austerity. So while I agree with those who argue that policy responses to severe financial crisis are different than policy responses to garden variety recessions, all this really means is that we may have to look beyond conventional monetary policies to have quick and effective remedies to downturns in aggregate demand. Alas the Republican Party and Team Romney to date has been opposed to fiscal stimulus unless it is of the military Keynesian brand.

Romney Insults Spain as He Shows His Ignorance of Macroeconomics

Bradley Klapper thinks the story is that Mitt Romney insulted Spain during the Presidential debates. Perhaps but let me extract the relevant economic portion of this story:

“I don’t want to go down the path of Spain,” Romney said Wednesday night during the first presidential debate. He argued that government spending under Obama has reached 42 percent of the U.S. economy, a figure comparable with America’s NATO ally. “I want to go down the path of growth that puts Americans to work.” … No one contests that Spain’s situation is dire, its economy in deep recession and unemployment hovering around 25 percent. But Spain’s level of government spending is actually low by European standards, and significantly less than Germany and Scandinavian countries with far healthier economic prospects. Spain’s woes were chiefly caused by the collapse of a property bubble that had fueled more than a decade of booming economic growth.

Klapper is properly noting that the U.S. recession and the Spanish recession were both caused by similar private sector events. The U.S. has fared less badly than some countries because we at least tried a bit of fiscal stimulus for a little while. Romney has been confused whether we should follow the UK’s disastrous austerity or use military Keynesianism. As far as Spain Matt Yglesias provides a nice graph showing how fast the changed in nominal government spending in Spain has declined:

If the entire argument is really over whether or not this Noteworthy Mercatusward Change in Spanish fiscal policy deserves to be called "cuts" rather than "rapid deceleration" then I suppose we've all wasted our time.

This may not have been the headline lie among all of Romney’s lies during the debate. And maybe Romney was less being dishonest than just completely ignorant of the facts in Spain. But it is very evident that he is either completely ignorant of the macroeconomic situation in the U.S. or is being incredibly dishonest. But hey – what else is news?

Modeling a Rational Romney

Sorry, I can’t help it.  Despite all my protestations, in my bones I must be an economist: if I see strategic behavior I have to consider how it could be represented as an outcome of rational calculation.  To be honest, however, I did not actually see the first Romney-Obama debate—I am willing to suffer for The Cause but only up to a point.  Instead, I am relying on hearsay.

What I gather is that Romney interrupted Obama repeatedly, employing an aggressive personal style and confronting his opponent with one egregious misrepresentation after another.  Obama responded with self-discipline to the point of distancing, acting as though he were conducting a calm seminar on politics; he allowed himself to be cut off, and he never confronted Romney with accusations of dishonesty.  Score one for Romney; apparently that’s what all the commentators did.

Now put yourself in the shoes of Romney and his advisers.  Given the political constraints both candidates face, what is the optimal strategy in the debate game?  I think Romney played his cards absolutely right: he provoked Obama to the maximum extent without going so far as to portray himself as a sociopath.  The debate moderator (and especially this particular moderator) was not in a position to challenge him.  The only resistance could come from Obama himself, and Obama faces the profound constraint of being a black man in America.

Look at it this way: what outcome from this debate would have been even better for Romney?  Answer: if Obama had lost his temper, showed personal anger toward Romney and called him a liar.  That would have proved to white America that, despite his post-racial stylings, underneath it all Obama is still the angry black militant that evokes a primal fear.  Romney can hope, of course: he can think up provocations that would really annoy Obama and make it difficult for him to stay on script.  But if Obama draws back from the challenge that’s OK too, as we’ve seen.

If I’m right, we are likely to see more of this in the future.  Can Obama fight back without invoking the racial stereotypes that would destroy him?  Can he be relaxed and smiling and still twist the knife?  That’s a thin line to walk, and if he gets it wrong there would be no recovery.  His whole political career has been based on avoiding white panic over aggressive, and therefore threatening, black males.  Perhaps his best move is to allow Romney to take all of these debates on points and trust that he has enough other resources to pull out a victory in November.  His TV ads can trash Romney without limit, of course, since the voices and images that express anger in them are not black.

None of this has anything to do with political substance, except insofar as racialized judgments regarding acceptable behavior still constitute an important part of American politics in our enlightened year of 2012.

Sesame Street Economics

You’ve likely seen all the documentation you need to know how much Mitt Romney serially lied last night. After all – he never proposed cutting taxes by $5 trillion. And of course he’ll create 12 million new jobs by doing nothing. Actually what offended me more than this was his attempt to deny that part of the Republican agenda was to just sit back and let cash strapped state & local governments lay off public school teachers. But he did admit to one thing - Big Bird should be fired! After all – saving $445 million a year is all we need to do to magically balance the budget if you scribble it on Art Laffer’s cocktail napkin. And we all know austerity is the path to prosperity. Too bad we didn’t have The Count as Romney’s running mate so we can make sure the math all works out just right. But don’t worry about Big Bird as I hear that he is moderating the next debate.

What Was the Value of DoubleClick When Romney Gifted Shares to His Kids?

Jesse Drucker wrote on September 27:

In January 1999, a trust set up by Mitt Romney for his children and grandchildren reaped a 1,000 percent return on the sale of shares in Internet advertising firm DoubleClick Inc. If Romney had given the cash directly, he could have owed a gift tax at a rate as high as 55 percent … Romney or his trust received shares in DoubleClick eight months before the company went public in 1998. The trust sold them less than a year after the IPO … In January 1999, Romney’s trust sold $746,000 worth of DoubleClick shares, for a gain of about $674,000, or an almost 1,000 percent return

Via Brad DeLong we see that Daniel Shaviro claimed:

The extreme undervaluation certainly looks like tax fraud. Key evidence would be the close proximity of the valuation date and the sale date

What was the fair market value of this DoubleClick stock when Romney set up this trust fund? Drucker and Shaviro are certainly arguing that the fair market value was much higher than what was claimed at the time these shares were gifted. We should note, however, that the value of Doubleclick shares has had a controversial history even up to the time that Google purchased the company for over $3 billion during April 2007. About two years earlier, a private equity firm had purchased the company for just over $1 billion:

DoubleClick shareholders will get $8.50 in cash for every common stock share, a 10.6 per cent premium over the average closing price of the company's stock in the last thirty trading days. The valuation is very low compared to DoubleClick's valuation in its hey days.

We should also note that two people commented over at Brad’s place that stock valuations were quite volatile if not exuberant during the late 1990’s. Mind you that I’d be the last to cast doubt on this Drucker-Shaviro claim that Mitt Romney hired some hack appraiser:

But back to the estate attorney who has a Rolodex of appraisers who will give him any whore answer for the right fee. The appraiser/whore that is chosen to evaluate the fair market value of the business has three tricks up his (her) sleeve ... Doesn’t the IRS have their own appraisers that can effectively rebut the bogus valuation reports commissioned by the estate attorney? One would think so – but read most of the Tax Court decisions in this area and realize that even the National Review looks smart and honest by comparison.

Shaviro’s “Key evidence would be the close proximity of the valuation date and the sale date” reminds me of the “expert” testimony in Nestle v. Commissioner of the Internal Revenue Service which involved the value of the various Carnation trademarks and other intangible assets both at the time the U.S. affiliate of Nestle purchased Carnation (January 1985) and when this affiliate sold them to the Swiss parent, which was on April 30, 1985. Nestle had commissioned one appraiser to argue that the value of the intangible assets was approximately $425 million at both dates. The IRS, however, argued that the value of the intangible assets was only $175 million as of January 1985 but accepted the $425 million value for the intercompany sale price as of April 30, 1985. I’m sure if one wished to read the trial court decision which accepted the IRS view one could mock at the quality of analysis by both sides, and the Appeal Court ultimately rejected the IRS position for its own silly reasons. But note that the IRS never bothered to explain why the intangible assets in such a mundane industry could more than double in a period of less than four months. Which is to simply say – both sides often play games when it comes to valuations for tax purposes.

RIP Francis Newton

"Francis Newton" is the pseudonym Eric Hobsbawm employed for his jazz criticism written for The New Statesman and collected in a book called The Jazz Scene.

An extraordinary historian,  a good man, and a decent jazz critic to boot, is dead.. RIP