The yield on corporate bonds can be thought of as the "cost of credit" for large corporations. Here is a graph of the last 50 years:

( cut in case big image breaks friends pages )
Bob Murphy writes:

I grant you, there is a pretty sharp spike in the Baa yields. Even so, the absolute level isn't anything shocking.

And check out the Aaa yields. Neglecting the period 2001-2007--when all parties agree there were much-too-low yields that encouraged overleveraging and caused the current mess--the yield right now on Aaa is lower than it has been since the late 1960s. (Caveat, we should adjust all of this for expected inflation. Even so, the above chart hardly tells the story DeLong wants to spin.)

Remember folks, the "credit crunch" really means, "Credit markets returning to their conditions before the criminally insane state during the housing bubble."

Look at that graph. Yes, there was a big spike. Does that look like a disaster requiring over $1T in taxpayer money to immediately fix or else armageddon will happen?

All I know about this book is a review from Tyler Cowen that Phil Whittington shared, but it sounded like something some of y'all might like:

The subtitle is "A No-Nonsense, Nonpartisan Guide to Today's Global Economic Debates" and it is by Nariman Behravesh.

I was shocked by how much I liked this book. I think of it as a kind of contemporary Capitalism and Freedom, although it comes across as less partisan and the coverage is much more global. I agreed with almost everything the author said and I thought the framing was effective and spot on just about all the time.

A nice whiteboard explanation of CDS, and how they result in massive bank entanglement.

One of the more plausible explanations for the root cause of the credit crisis (what caused all those bad mortgages to be issued) was Greenspan's 1% interest rates after the dot com bubble. This week, the Fed again lowered interest rates to 1%. Bob Murphy says:

Let me say it once again, for the record: Suppose that Ludwig von Mises and Friedrich Hayek were right, and that really low interest rates (caused by the central bank flooding the market with artificial credit) screw up the market's coordination over time. Then that means we are now sowing the seeds for an even bigger crisis four or five years from now.

It's true, many people would say, "That's irrelevant. Right now the pain is so bad, we need to stop the bleeding and deal with future problems down the road."

However, that's exactly what people were saying in light of the "unacceptable" pain that would have occurred due to the dot-com crash and 9/11 attacks. It never occurred to people back then, how bad the housing boom would end up being.

This is not a good idea!

Arnold Kling on Warren Buffett favoring the bailout:

Without in any way impugning his motives, let me state the impact on Warren Buffett personally if the bailout is enacted.

Think of the mortgage securities market as the World Series of Poker...The best players in this World Series of Poker are the folks at Goldman. They hired Fischer Black and other geniuses back when the markets were first getting going. They have typically had the best squad of geeks around.

Buffett just bought a stake in Goldman. That stake would be a lot more valuable if there were actually a poker game--that is, if mortgage securities were still trading. Right now, they're not trading. So Goldman is sitting there ready to play and no one is ready to play with them.

Along comes Uncle Sam, who wants to take a one-hour lesson in poker and then sit down and play in the World Series with $700 billion in chips. And whaddaya know? Warren Buffett thinks Uncle Sam really has to get in the game.

I love it! All the banks clamoring for the bailout are like poker sharks hoping some sucker wins a big tournament, and gets their hands on lots of lovely money to lose at the tables.

Do you really want the government playing against the pros with your money? Buying securities that the geniuses at Goldman, and every hedge fund in the country could buy - but don't want at current prices?

On Distributed Republic.

I find it a little baffling that people blame the current financial crisis on deregulation and laissez faire when it is occurring in a financial system built on top of fiat currency - arguably the greatest swindle of all time, and one perpetrated by the government.

This is not to say that the current crisis couldn't have been avoided by additional regulation. It is complex enough that proponents of both more and less regulation can reasonably imagine alternative approaches which fit their model and would have made things better. Thus each side can see, in the crisis, validation of their own beliefs. But it strikes me as insane to characterize any system built on top of fiat currency as a free market.

Rothbard's "What has the government done with our money?" is a good introductory read on the subject of money. While I don't agree with his views on the fraudulent nature of fractional reserve banking and he (of course) overstates the case against government / for the market, money is a topic where I believe there is some deep, basic truth to some of the strongest allegations of libertarians about the fraudulent and coercive nature of government.

It blows my mind that we live in a world where most people don't know that for a long time, money consisted of notes redeemable for gold or silver, until suddenly one day, the government (here & elsewhere) said "You must continue accepting these notes, but you can no longer trade them for metal - and we're keeping all the metal we had been using to guarantee the notes." In many cases, this was accompanied by a ban on the private ownership of the metal, or on taking it out of the country. People accepted the unbacked notes because it was illegal to do otherwise.

It was theft on a colossal, mind-boggling scale, but it's behind us and so we've forgotten about it.

The history of money is a sordid history of legalized theft. It will be interesting to see what alternatives arise in the coming decades, and whether fiat money survives. I would guess that it won't, because of the advantages of digital cash, except that the arguments which say digital cash will win in the future also say it should already have won, which it hasn't, so perhaps those arguments are wrong.

I've said it before, I'll say it again. Banning short-selling is the financial market equivalent of making it illegal to argue on one side of a debate. It promotes a disconnect between price and value, which is what got us into this mess in the first place!

This is a fitting time for IOUSA to come out, eh? With the US piling on debt like there's no tomorrow.

"If you could steal all the money you wanted and print all the money you wanted, don't you think you could stay out of debt?"

Long or Short Capital's take on the US "drinking the Zimbabwaid":

Today the US treasury announced they are bailing out the federal reserve bank. They are concerned that the federal reserve bank - after taking over the debt of Bear Stearns, Fannie, Freddie, AIG et al. is “over-leveraged”. The obvious question is, who will bail out the Treasury? The answer is paper. More specifically the “Bureau of Engraving and Printing”. We are so long the Bureau of Engraving and Printing as we see it as the only financial institution in the country that will always “find” enough liquidity to fund itself. If you’d like to get long them we recommend you check out www.moneyfactory.gov. Yes that’s the real name of their government website. Money doesn’t grow on trees, but you can cut the trees down send them to a money factory and presto pronto prego DINERO!

K, back to work on alternatives...

Will Wilkinson on the local-food movement:

Local food is often better-tasting and more nutritious. That's a pretty good reason to pay more for it. Maybe you want to support small local farms. Go ahead, if that's your bag. But don't think going local does much to reduce your carbon footprint. And it shouldn't do much to ease your conscience.

How far your food travels matters a lot less than what kind of food it is, or how it was produced. According to a recent study out of Carnegie Mellon University, the distance traveled by the average American's dinner rose about 25 percent from 1997 to 2004, due to increasing global trade. But carbon emissions from food transport saw only a 5 percent bump, thanks to the efficiencies of vast cargo container ships.

A tomato raised in a heated greenhouse next door can be more carbon-intensive than one shipped halfway across the globe. And cows spew a lot more greenhouse gas than hens, or kumquats, so eating just a bit less beef can do more carbon-wise than going completely local. It's complicated.

But one thing is clear enough: the farmers in Mexico, China, and Brazil, who produce a lot of the imported food Americans eat, are poorer than the farmers here in Iowa. A lot poorer. The corollary of "eat local" is "don't eat Mexican," so to speak. But the way poor people get less poor is to do business with people who have a lot of money, like us.

As is so often the case, those with soft hearts who think they are righteously doing the good thing to make the world a better place are actually contributing to inequality. Normally, I would just say "hey, if they care more about supporting local farmers than reducing global poverty, that's fine".

But because the local food movement has an explicit component of self-righteousness: "We do this because it makes the world a better place relative to other eating choices", it is open to criticisms about whether that is the case. And to me, it's pretty clear that supporting rich farmers instead of poor ones, at the price of slightly more CO2 emissions from the transportation, is worse for the world.

Heck, I suspect that this is true even if your only metric for good/bad is CO2 emissions! If I pay $1 for 3 apples from Mexico and you pay $1.50 for the same 3 apples from California, I bet that your $1.50 turns into more CO2 than my $1. Sure, my Mexican apples require a little more transport, but transport is such a tiny fraction of the total cost that it is overwhelmed by the extra 50c you paid. Since everything in the economy uses gasoline and transportation and thus generates CO2, the extra 50c implies significantly more CO2 used elsewhere. For example, consider the profit. Suppose in both cases the farmers make 5%. That means either a Mexican farmer makes 5c or a California farmer makes 7.5c. The latter will lead to more resource and CO2 usage.

Put more simply: By eating local, you are rewarding those who don't transport goods...but also rewarding those who live extremely resource-intensive lifestyles relative to the global norm (ie Americans). If you instead buy things from poor people far away, you are supporting those who live low-resource lifestyles (pretty much by definition, being poor means not using many resources).

That those with soft hearts get this simple idea so utterly backwards seems like strong evidence of their soft heads. Prices are signals about resource usage - if you want to save resources, buy cheap things! Anytime you are buying something more expensive while thinking you are saving resources, you are probably deluding yourself. Local food is no exception. Buy it if you want - but stop pretending that you are saving the environment.

From distrep_front, In Praise of Low Wages:

I think supporters of free markets too often defend low wages in an almost apologetic fashion: "You know, Wal-Mart's wages really aren't that low," or "Yeah, it would be great if cashiers could make $25 per hour, but it would drive prices through the roof." But there's nothing to apologize for. Low wages are good. Wages are prices, and prices are signals. Just as an above-market price for milk will give inaccurate signals to dairy farmers and result in a misallocation of farmland, paying above-market wages will give inaccurate signals to workers and result in a misallocation of human capital.

Manning a checkout line is a low-skill job. It requires minimal training and can be done by virtually anyone*. As such, it's a good part-time job for students, and maybe a good full-time job for someone with a mild mental handicap. But it's really not a valid career choice for an adult of normal intelligence. The fact that it pays low wages is the market's way of telling would-be career cashiers to learn a marketable skill and get a real job that creates more value. At $25 per hour, that signal would be lost, and many people would be content to spend their lives scanning groceries or working in some other low-skill job rather than put in the effort necessary to learn a more valuable skill.

If relative wages in different professions reflect the relative value those professions produce for the world, people will be properly incented to learn the right professions. If we boost the wages in low-wage professions relative to other professions, that changes the incentives. Specifically, it reduces the benefits of training and education.

This is no accident. Interfering in the market always produces distortions. I'm not saying these distortions are always bad, but they always exist.

via perspectivism here is a piece about how consumption is not what gets us out of recessions. Consumption is better than hoarding, but worse than investement.

Says Arnold Kling, dissing macro:

In real economics, work is a "bad." There is no such thing as a shortage of jobs. Instead, there are unlimited wants. We should be rooting for high productivity that enables people to choose a mix of consumption goods and leisure that they prefer.

In real economics, saving does not hurt the economy. Saving allows individuals to smooth their consumption. It allows businesses to accumulate capital, raising worker productivity. We should be rooting for high saving, rather than worrying about consumers being in the mood to spend.

In real economics, government spending that is financed by borrowing is typically not a good thing. We should be rooting against deficit spending.

In real economics, borders and currencies do not matter. We should not be rooting for a weak dollar to give us a "trade surplus." Instead, we should be rooting for unimpeded trade, in order to gain from specialization and comparative advantage.

Making fun of naive macro...it just never gets old.

I'm reading Tim Harford's _Logic of Life_, which has lots of interesting bits of econ. For example, I hadn't realized the extent to which high incarceration rates for black males led to low marriage rates. The argument is pretty simple: by removing men from the marriage market (by putting them in jail), there is a supply/demand imbalance which gives the men who are still free much greater bargaining power[1]. They use this power to have less committed relationships. So there is an amplification effect, and it's pretty big.

Using data from different times and states, the estimate is that every 1% increase in the number of young black men in prison leads to a 3% decrease in the number of young black women who have ever been married. And there are 32 (!) states where > 10% of young black males are in prison, so this is not a small effect!

This is really fucked up, for several reasons:
1) It's an example of the indirect harm caused by the War On (some) Drugs. The effects of the low black marriage rate in the past few decades are very serious - the perpetuation of poverty for a large group of people.
2) It's an example of how the government (in actuality, not in the redistributionist's fantasy world) usually fucks over those who need help the most. This is why those of us who think the government that governs least governs best are actually friends of the poor, even though we are often caricatured as only caring about the rich.
3) Those with the least to lose are most likely to do risky things, both moral (sell drugs) and immoral (rob stores). Risky activities are asymmetrically distributed (males are much more likely to do them). And marriage matters - it decreases poverty both directly (through the economies of scale in households) and indirectly (by increasing the income of children who grow up w/ 2 parents). Put these together and you get a vicious positive feedback loop for poverty. Sure, not everyone falls into this trap. Sure, the more foolish and risk-seeking people are more likely to get caught in it. So? Without the trap, more people would be out of jail, married, working productively, and raising kids who would do even better.

[1] You can see that small differences in number of men/women can lead to large differences in a simple model where there are 100 men and 100 women, and the surplus from marrying is $100. Every couple will split the surplus $50/$50. Add a single woman, and the rational split becomes $99/$1, or whatever the smallest increment is. Obviously this is more extreme than reality, but there is some empirical evidence for the effects being large, as described above.

Bryan Caplan reports on Singapore's genius policy for reducing unemployment. Standard methods are increasing spending (so-called economic stimulus, which it's not clear to me actually helps) or decreasing general taxes (which is always a good thing, but not very specific to unemployment). Instead, they specifically decrease the employer's share of payroll tax (what would be SocSec in the US).

This is perfect, because it hits exactly what matters most: the cost to an employer of hiring employees. By reducing this cost, they will directly increase employment without the side-effects of the other methods.

This makes a good example of how I understand micro a lot better than macro: this method makes deep intuitive sense to me, whereas "stimulating aggregate demand" or whatever they call increasing spending makes little sense to me. (I don't just mean that I'm skeptical that it works, but also that I don't feel like I understand the system well enough to be very confident either way.)

If you're interested in these subjects, go check out the long thread on prock's post about the broken window fallacy fallacy where I try to explain the difference between money and wealth. It's important, and many people find it non-intuitive.

While I'm pretty sure I understand that distinction, there is something I don't understand, which is why deflation is bad, and how something like the Great Depression happened. In my resource-centric view of the world, money is just a counter for keeping track of value. If there is deflation, each dollar is worth more. But I don't see why this dries up the supply of credit or causes other problems. Shouldn't wages and prices just adjust downward, and everything go on as before?

I know this efficient market/rational people view is wrong (history has clearly demonstrated that), but I don't understand exactly how. Someone please enlighten me (with less words than this).

Arnold Kling writes:

"The point is important that the typical investor should act as if the efficient markets hypothesis is true. One of the most widespread biases in finance is hubris. I could not believe it when Mike Moffat sided with Patri Friedman's argument to use mortgage leverage to buy stocks. In an efficient market, that is just plain incorrect."

Brandon Berg gave my counterargument before I got there:

Efficient or not, isn't it generally acknowledged that an equity premium does exist? And with mortgage interest deductible at a higher rate than capital gains are taxed, the government is essentially subsidizing homeowners who arbitrage the equity premium.

The EMH simply does not apply to what I recommend (keep minimal equity in your house, put your money in the stock market instead), because it depends on the tax-advantaged nature of mortgages. That is not an inefficiency that can be arbitraged away by a hedge fund or whatever.

Does anyone else think it is bogus to criticize a project that makes, say, oil from natural gas, because of its energy balance? If natural gas is cheap, and oil is expensive, then turning one into the other is a win, regardless of whether you use up some extra BTUs while doing it. If I could open a wormhole to the sun, and use up 10 BTUs of its fusion energy to make 0.1 BTUs of oil, that would be fucking sweet. It's about cost, not energy balance.

Essentially, energy balance accounting is trying to replicate the actual economic accounting of cost, using a different currency and leaving out a different set of things. I'm all for getting more accurate estimates of cost than current prices, by factoring in national security costs, pollution, etc., but energy balance is just a different arbitrary subset of true costs than price. Which I guess makes it sort of useful as a cross-check, but not any better as a single metric.

A great example of this is the time a Mudd engineer once expressed surprise/sadness that power companies will use excess nighttime power to pump water up, and then run it through a turbine during the day. He found this silly, since it is not 100% efficient and thus must cost them power, on net. I was flabbergasted to hear this opinion expressed by an intelligent person.

Um...I think the power company knows that. And I think they do it because it saves them money. And I think it saving them money means, in this case, it saving the world some resources. Because power plants have fixed costs and variable costs, and very irregular demands, which means they have to build for high peak capacity rather than lower average capacity, which means taking some "loss" to smooth things out is actually a win. Which is really obvious if you stop and consider something besides short-term energy balances, and treat prices as genuine signals about costs.

It was once thought that humans are born as "blank slates" to be programmed by our families, culture and society. While those forces play an important role, evolutionary psychology teaches us that human behavior is also the product of the environment in which humanity evolved -- that many of our intuitions are ingrained because they contributed to our primitive ancestors' survival.

Public policy pays surprisingly little attention to evolutionary psychology. Yet there are many human intuitions and behaviors that influence contemporary policy issues -- sometimes in ways that are no longer useful or perhaps even harmful to humans flourishing. These intuitions are sometimes referred to as "folk economics," and one area in which they often emerge is the international economy.

Our primitive ancestors lived in a world that was essentially static; there was little societal or technological change from one generation to the next. This meant that our ancestors lived in a world that was zero sum -- if a particular gain happened to one group of humans, it came at the expense of another.

This is the world our minds evolved to understand. To this day, we often see the gain of some people and assume it has come at the expense of others. Economists have argued for more than two centuries that voluntary trade, whether domestic or international, is positive sum: it benefits both parties, or else the exchange wouldn't occur. Economists have also long argued that the economics of immigration -- immigrants coming here to exchange their labor for money that they then exchange for the products of other people's labor -- is positive sum. Yet our evolutionary intuition is that, because foreign workers gain from trade and immigrant workers gain from joining the U.S. economy, native-born workers must lose. This zero-sum thinking leads us to see trade and immigration as conflict ("trade wars," "immigrant invaders") when trade and immigration actually produce cooperation and mutual benefit, the exact opposite of conflict.

[Washington Post]

The link comes from Bryan Caplan, whose new book makes the simple but somehow contentious point that when voters are consistently biased about basic economics, a democracy will have dumb policies - even if one grants that a democracy produces the results the demos wants and not those that benefit politicians. And whaddaya know, we have trade and immigration barriers.

I previously posted an opinion from a libertarian economist on what economists think about climate change. Here is a less biased study, where randomly selected members of the AEA were polled. Less this group be criticized for being libertarians too, note that while AEA members are more conservative then the general population, they are, like most academics, liberal on average. The results:

The most popular response is that rising greenhouse gas levels will have virtually no impact on income per person (less than 1 percent lower or higher). The vast majority (73.2%) predict that the impact will be less than 5 percent one way or the other. (Here are the complete responses: a) more than 10 percent lower = 12.5%; b) about 5 to 10 percent lower = 7.1%; c) about 1 to 5 percent lower = 21.4%; d) less than 1 percent lower or higher = 35.7%; e) about 1 to 5 percent higher = 16.1%; f) more than 5 percent higher = 7.1%.)

Assuming that "more than 10" = 15, "more than 5" = 10, and taking the midpoint of the other intervals, this averages to -1.86%. Since the end of World War II, inflation-adjusted GDP has risen by about 2 percent per year on average. Thus, the collective wisdom of these economists is that greenhouse gas emissions will shave about one year of economic growth off the economy over the next century.

If this estimate is anything like correct, then proposals to spend a percent or two of GDP to stop greenhouse warming is a huge net loss. On the other hand, one might regard it as a reasonable price to insure against catastrophe.

The results of two actual runs of the game described here are in. The experiment was performed with a Mensa group and a non-Mensa group. Each group knew of their own status (ie the Mensa members knew they were playing against other Mensa members). The results:

Non-Mensa. Mean=26.9 Winning number 18.
Mensa Mean=21.18 Winning number 14.

The experimenter's theory is that this difference reflects the different IQ's of the two groups. The smarter group is closer to the game theoretic result. Rob, however, made the excellent point that it could be entirely due to a difference in expectations. If you expect others to be more rational, you will adjust your guess downward. It might be that with two subsets of the same group, we'd get this same phenomenon merely from telling one half they were playing against average intelligence and the other that they were playing against high intelligence.

In fact, the guy's model specifically says "In general as the fraction of irrational players increases from 0 to 100% the optimum submission moves from 1 to 33." And "I made it clear that each group was playing against their peers. Mensa understood their peer group to be much more intelligent than average but the same did not hold for banking staff." Based on these two ideas, my default assumption would be that the difference was due to expectations of opponent intelligence, not individual intelligence. If you told Mensa members they were playing against bank tellers, they might well have the same average as bank tellers playing against bank tellers (or at least close).

It would be fascinating to re-run the experiment in this fashion. Alternatively (or additionally), choose two groups with different IQ's, but tell them the same thing about what sort of opponents they have. This would tell us whether the variation is due to intelligence or expectations.

( Here are the experimenter's detailed comments )