Category: Equitablog

The Missouri side of Kansas City produces a great deal in the form of service exports that flow outside of the lower Missouri Valley to the larger world There are the design and marketing services of Hallmark, there is H&R Block, there is Cerner. The Kansas side of Kansas City has no equivalent except for Sprint. In fact, with the decline of its part of aerospace and of manufacturing in general as an employer, the state of Kansas exports pretty much primary products: corn, wheat, soybeans, pork, beef, natural gas, and petroleum–plus, as an exception, transportation services from the rail tracks that bring so much from Long Beach to the United States east of the Mississippi.

All of these–even the petroleum–provide immense use value to their users. The workers of Kansas, blessed by their climate and natural resources, are pulling their fair share and more of the task of making useful commodities for humans.

But the market does not care whether what you produce is very useful. The market cares about two things only:

1. Is it scarce and hard to produce?
2. Do rich people have a substantial Jones for it?

If both of these are satisfied, you are prosperous. If not–well, then if what you make is very useful you have the water-diamond paradox that so exercised the political economists of the Enlightenment. The woman who carries you water from the stream provides you with something that is the most necessary of commodities: you will die in three days without it. The jeweler who sells you a rock is doing nothing but flattering your vanity: life can be lived as fully without as with diamonds. And yet the woman who brings you water from the stream must supplement her earnings by begging on the street for crusts of bread to stay alive, while the jeweler has a handsome house in Mayfair and keeps a coach-and-four.

The state of Kansas is in the position of the water-carrying woman in today’s global economy. The state produces things of enormous used value. But since the start of the 1920s its agricultural products have overwhelmingly been those in relative excess supply for which the marginal utility–and that is what determines the price and the market value–is much less than the use value, the total utility. For a while that pattern of what Raul Prebisch used to call “unequal exchange” was offset by general manufacturing and aerospace. But no longer.

The fact is: If Kansas had to survive on the free-market value of its exports, its total economy would be only half the size that it is. Kansas as we know it is kept afloat by:

• Farm subsidies
• Social Security (and, no, this generation of retirees didn’t pay for all their Social Security benefits)
• Medicare
• Medicaid
• Health Exchange subsidies
• The location of the 1st Infantry Division at Ft. Drum Riley (even though the Comanche are no longer a serious national-security threat)

Why do these money transfers into Kansas exist? They exist because we here in America are social democrats. We in America believe that the citizens of Kansas are Americans. We do not believe that your value is determined, even if you work as hard as you can and no matter how useful what you make is, by whether or not the stuff your region specializes in is scarce and hard to produce and whether or not rich people have a substantial Jones for it. We think that the large redistributional part of Social Security, that the federal government health programs, and that even the farm subsidies are part of the citizen’s share: something that is yours by right as a citizen and a member of the very prosperous American economy. We do not think that people–or at least our citizens–who produce useful commodities should shut up and be poor if it happens that world market forces make the free-market value of what they produce vastly less than the use value.

You would think, given all this, that the good white citizens of Kansas would be the staunchest social democrats around–that they would send politicians to Washington who would strongly argue that a market economy is fine in its place, but that a market society is not; that while it is useful for incentive reasons to pay those who happen to make things that are scarce, the beneficiaries from such a system have no strong moral right to their High Seats in the Temple of Our Civilization; that since days long before the evolution of language in the Sociable East-African Plains Ape we have evolved a strong drive to think not just of the one but of the many who are in our group, and to redistribute to the unlucky.

But not so!

Must-Read: Calling Brad Setser! The argument over whether the IMF should “worry about global demand as well as global balance of payments adjustment” was lost back in 1944, when John Maynard Keynes pushed for symmetry and Harry Dexter White nuked it on the grounds that the U.S. would always be a surplus country and so did not want the IMF having levers it could use to push surplus countries around!

Brad Setser: Why Is The IMF Pushing Fiscal Consolidation in the Eurozone in 2017?:

If the IMF wants to be symmetric and worry about global demand as well as global balance of payments adjustment…

…the IMF needs to be as aggressive in recommending fiscal expansion in surplus countries as it is in recommending fiscal consolidation in deficit countries. Judging by its recommendations in Europe, it still has a way to go…. I also will be watching the IMF’s 2017 fiscal recommendation for Korea—which has a German-sized current account surplus and, broadly speaking, a German fiscal policy…. There is of course a second, more straight forward argument for why the IMF might want to encourage Germany to do a bit more public investment in 2017…. There is ample reason for the IMF to encourage Germany to offset the impact of the drag expected from Brexit… even if that means Germany would need to run small structural fiscal deficits for a time. It would support German growth in the face of an expected external shock… ease the pressure on monetary policy when the ECB is at the zero bound… make it easier for Italy, Spain, and France to offset the demand drag from fiscal consolidation through exports… facilitate the eurozone’s internal rebalancing… help reduce the eurozone’s contribution to global current account imbalances…

Must-Read: George Akerlof (2001): Writing the “The Market for ‘Lemons'”: A Personal Interpretive Essay:

Rejections and Acceptance:By June of 1967 the paper was ready…

…and I sent it to The American Economic Review for publication. I was spending the academic year 1967-68 in India. Fairly shortly into my stay there, I received my first rejection letter from The American Economic Review. The editor explained that the Review did not publish papers on subjects of such triviality. In a case, perhaps, of life reproducing art, no referee reports were included.

Michael Farrell, an editor of The Review of Economic Studies, had visited Berkeley in 1966-67, and had urged me to submit “Lemons” to The Review, but he had also been quite explicit in giving no guarantees. I submitted “Lemons” there, which was again rejected on the grounds that the The Review did not publish papers on topics of such triviality.

The next rejection was more interesting. I sent “Lemons” to the Journal of Political Economy, which sent me two referee reports, carefully argued as to why I was incorrect. After all, eggs of different grades were sorted and sold (I do not believe that this is just my memory confusing it with my original perception of the egg-grader model), as were other agricultural commodities. If this paper was correct, then no goods could be traded (an exaggeration of the claims of the paper). Besides — and this was the killer — if this paper was correct, economics would be different.

I may have despaired, but I did not give up. I sent the paper off to the Quarterly Journal of Economics, where it was accepted.

I had had such a hard time getting this article published, that I was quite surprised, on a trip to England in the fall of 1973, to discover that, not only had it been read, but even with considerable enthusiasm. Since that time many scholars have fleshed out the implications of asymmetric information and its role in markets, especially Michael Spence and Joseph Stiglitz.

I close with three lessons that might be drawn from my tale. First, “Lemons” was much less of a break with the economics of the time than might otherwise be interpreted. It was the natural extension of the on-going intellectual activity at MIT. (I used the analogy of the Galapagan lizards advisedly.) Second, many people were tremendously generous at all stages, in the writing, editing, and refereeing of this paper, and also later, in exploring its further implications — thus illustrating the extraordinary commitment of academics in general, and of economists in particular, to seek truth and to advance knowledge. Finally, economics is a powerful tool, but like a microscope, it focuses attention on some aspects of reality (especially the role of prices in markets), while it also diverts attention from other aspects. The economists of the time felt that it would violate their methodology to consider a problem, such as the role of asymmetric information, that was out of its traditional focus. There are still important areas of economics that are all but uncharted because of this limited focus. It is consistent with this interpretation that Daniel Kahneman, a leader in changing the focus of economics and one of last year’s prize winners, is not only a trained psychologist, but also, has special expertise in human optical illusion.

Must-Read: Gauti Eggertsson and Lawrence Summers: How Secular Stagnation Spreads and How It Can Be Cured:

The secular stagnation hypothesis suggests that low interest rates may be the new normal in years to come….

This prospect should not only lead to a major rethinking of policy from the perspective of individual economies, but also a major rethinking about monetary and fiscal policy in the international context, the role of international capital flows, and the role of policy coordination across borders. In times of secular stagnation, events such as Brexit or the recent turbulence in Turkey have much larger spillover effects than under normal circumstances.

Must-Read: Ricardo Hausmann: Through the Venezuelan Looking Glass:

Venezuela’s crisis is not the result of bad luck…

but the inevitable consequence of government policies… expropriations, price and exchange controls, over-borrowing in good times, anti-business regulations, border closures, and more. Just consider this small absurdity: President Nicolás Maduro has refused, on several occasions, to authorize printing larger-denomination banknotes. The largest bill currently is worth less than $0.10. This has caused havoc in the payment system and in the functioning of banks and ATMs….

Why would a government adopt harmful policies, and why would society go along? The chaos into which Venezuela has fallen may seem to be beyond belief. In fact, it is a product of belief…. The paradigm of Venezuela’s chavismo blamed inflation and recession on devious business behavior that had to be controlled through more regulation, more expropriations, and more managers in jail. The destruction of people and organizations was perceived as a step in the right direction. By getting rid of those witches, the country would be healed…. The fundamental determinant of public policy choices is the public’s beliefs. In countries where people regard the poor as unlucky, they want redistribution; where they regard them as lazy, they don’t. Where people believe that businesses are corrupt, they want more regulation; and, with enough regulation, the only successful businesses are corrupt….

Donald Trump… and his many supporters [think] the US is led by weaklings who are being exploited by savvy foreign powers, masquerading as allies. Free trade is a Mexican invention to take away American jobs. Global warming is a hoax invented by China to destroy American industry…. Much the same may be true of the United Kingdom’s vote to leave the European Union. Were immigrants and EU rules really blocking the country’s progress, implying that Brexit will open a path to greater prosperity? Or is the economic downturn since the vote an indication of how valuable integration and the free movement of Europeans was to the UK’s own vitality?… Venezuela shows how unaffordable such experiments may turn out to be.

Must-Read: Gary Burtless et al.: How Would Investing in Equities Have Affected the Social Security Trust Fund?:

Our simulations suggest that equity investments would have been helpful historically and can be helpful prospectively… 

Investing part of Social Security reserves in equities can reduce the need for future payroll tax hikes and benefit cuts. If equity investment had begun in 1984, for example, and if equity holdings had ramped up to 40 percent of the Trust Fund portfolio, reserves at the end of 2015 would have been $3.8 trillion compared with actual holdings of just $2.8 trillion. 

A more helpful measure of the size of the reserve is the “Trust Fund ratio”—the amount of assets in the Trust Fund at the beginning of the year divided by expected Social Security payouts during the year. If equity investment had been phased in beginning in 1984, the Trust Fund ratio at year-end 2015 would have been 4.1 compared to the actual ratio of 3.1

Must-Read: Joshua Brown: The Paradox of Quant:

Once crowded, there are a few choices for practitioners of a given investing discipline…

• pretend it’s not over
• adapt and move on to the next thing
• LEVERAGE UP
• sell out to a competitor

You will be hearing a lot about the triumph of quant strategies in the hedge fund space, now that almost no one believes in the omniscience of the 90’s era masters anymore. It’s going to be the cool thing to do, Go Algo! You probably want to be selling the picks and shovels here rather than counting on finding an enduring vein of gold as a prospector. Quantopian had the right idea.