A freemarket of fools

May 30, 2009

So I’m switched on to the McAlvany podcast which makes for really good and easy listening since I found it through the InvestmentPostcards blog. My late father, Jos Gerson, who got his PhD in Economics under Professor Harold Demsetz, would have I’m sure enjoyed this kind of Chicago Economics style programming. It’s especially interesting for me as it fills in some areas missing from my limited economics education. Most of what I learned in my 2 years of undergraduate economics at the University of Cape Town came from my dad ranting about how outdated the Keynsian textbook was. In fact I’m both a little embarrassed and proud to admit that I only went to one lecture in my entire 2nd year course. I didn’t see any point wasting my time when I knew that the exams would all be set out of the textbook material. Although my dad went on at length about the work of Milton Friedman, he never mentioned the likes of Hayek to me. Well nothing that Wikipedia can’t fix… 🙂

I do have an issue though with the two recent podcasts I have been listening to, interviewing Thomas Woods Jr. and Walter Block. The theme of both episodes is how the US Central Bank’s tampering of the money supply is largely responsible for the current recession.  Thomas, siting Hayek, stating that the Fed is responsible for the whole boom and bust cycle and Walter saying largely the same thing advocating that a gold standard would be a more responsible system. Although I think that they might have valid points overall, I think that their arguments are overly simplistic and to blame the Fed entirely is unfair.

First off, bubbles have occurred under the gold standard since it was formalized in the early 1700s. The railway speculation around the world in the 19th century was very real and ultimately very painful for a lot of people who didn’t get out at the right time. To deny the gravy train phenomenon as part of human make up is to be very naive. People want in on the action they perceive others to be enjoying. It’s why McDonalds would pay 1000 people to stand in line for a new product line release. I’ve also heard of experiments of people joining bogus queues simply because they existed without knowing what they were for but I can’t find the links. Unless detractors of the Fed are going to make claims that the gold standard wasn’t enforced properly during these periods, which I’d like to see evidence for, I can’t see how a completely slanted view of the Fed is justified. It’s not true when Mr Wood says there is no reason for stating the Free Market comes part and parcel with boom and bust cycles.

Here in South Africa, the Reserve Bank (Fed equivalent) has a policy of inflation targeting given that they’d like to ideally keep the price of bread constant for the masses of predominantly poorer population. This means that although there are pressures that would influence the Reserve bank otherwise, usually the way rates move are quite predictable to the private sector in theory. So how is this then reconciled with Mr Woods’s idea that people don’t know the true value of their own wealth? The McAlvany podcast spoke of inflationary pressures in the bond market and the housing market. The fundamental formulae that tie bond pricing to interest rates and longer term trends in terms of both the housing market and the bond market are public knowledge. So unless the Fed/Reserve bank moves rates in ways that come as a surprise to the market, I don’t understand how one can blame the Fed entirely when the market over-inflates these asset classes. The analogy about giving a builder more alcohol tries to blame the would be barman for the fact that the builder actually drinks the alcohol. This is separate from government stimulus which is the barman drinking his own alcohol.

Having said this, I do potentially agree with Mr Block’s assessment that the Fed may do more harm than good. Mr Block more obviously acknowledges that the boom and bust cycles exist but could be shorter lived. I actually do believe that in theory the Fed could help to smooth out the boom and bust cycle, but in practise it is unlikely to ever work. The incentives not to spoil the party during good times are simply too strong for any politically appointed body. Standing stead fast to a policy of price stabilization is just too hard.  However the gold standard brings the risk of deflation if gold is not dug out of the ground at the same rate as legitimate production increases. Mr Block mentions that deflation is not a bad thing for computers and cars. In fact it’s a brilliant thing when deflation happens with consumable asset classes and those involved in the means of production. The population expects this and it means that everyone is richer in real terms and can produce more. The problem is when deflation happens in those asset classes used by the population for the preservation of wealth. This is not a happy thing as it means everyone is poorer in real terms. To fully convince me, Mr Block would have to present a model which shows that the potential gold standard deflation in wealth preservation asset classes is less of a problem than what would be caused by the exacerbated cycles the Fed causes over and above regular cycles. All this specifically in terms of matching peoples expectations… although the evidence does make me lean in favour of the gold standard as the lesser of two evils.

This gets me to the subject of this piece. As far as I can see it doesn’t matter what system you have to change the money supply as long as the majority of the population understands fully how it affects their wealth. The incentive to be foolish, whether it’s from ignoring fundamentals and wanting to get in on the action during bubbles, or whether it’s the fed not wanting to spoil the party, or whether it’s people not willing to put in the effort to understand the complex asset they are buying, all makes for a bad end. There will always be investors, like Grantham last year, who saw the bubble for what it was and didn’t allocate his resources to it. The problem is that he is in the minority and will probably always be. If the population is not willing to do the homework to evaluate which bank will best protect their money then you need systems like the depositor insurance program, which shouldn’t be a necessary tool in a market of perfect information. Likewise the ideal system for controlling the money supply should be one that the majority of people can cope with intellectually for protecting their wealth.

To leave you with something to think about. I propose a system where the money supply is linked to the size of the population, which I’d imagine probably better correlates to a country’s production than the gold standard which is arbitrarly the rarity of the precious metal on the planet in human hands. Fat chance though that any adopted system won’t be suspended towards a fiat currency when the political pressure becomes too great, just as the gold standard was in order to solve the funding problem of/after WWII.

Anyone who thinks I’m pro Keysian government spending has misunderstood this blog. The question is how do we best allocate the size of the money supply which is a necessary but not naturally occuring part of the free market economy.


…but I want to be a poet.

April 25, 2009

A friend thought I should copyright this statment. Not sure it’s a quotable quote but I thought I’d put it out there anyway. If it does become popular you saw it here first 🙂 Let me know if there’s already something similar out there.

An expectation fulfilled can never beat the same experience unexpected.

That’s just too much to conceive!

April 3, 2009

Humanity seems to have a fear of big numbers. Here are a couple of examples. The first time programmers see a software respository system and find out that the system can quite easily store a copy of every modification they’ve ever made to a program without running out of space. Seeing the pyramids and not believing that it’s possible for this to be made using human labour. Not believing that every image on the internet could be labelled accurately by only a few people in the world in a matter of months without paying them. Finding it amazing that google can search for your results on every web page on the internet in split seconds. Not believing that every species on the planet can evolve from mutation and repeating the process multiple generations. Folding a piece of paper 70 times over will take us out of our solar system a number of times over.

I’ll add more examples to the list later, but the common thread here is that each example involves a quantity that it’s difficult for the human mind to take in at once. It becomes, just a inconceivable number. It’s possible to know that one number is bigger than another on paper, but when confronted with it in front of us, the mind just boggles. So our intuition tells us unfortunately that it’s not possible, but scientific enquiry and particular mathematics often tells us that it is.

The moral here is: Don’t be scared of big numbers! Don’t trust your intuition, find a formula.

Learning to live as inferior

April 3, 2009

In today’s world we’ve successfully (more or less) learned to live with people that are different. Different skin colour, different culture, different language, different religion. The challenge that humanity still struggles with is to live with people that are superior. Even the words superior and inferior most readers of this entry will dislike, because they read into it something more fundamental. The fact of the matter is many of our neighbours are better looking, better spoken, better educated and wealthier than we are. Usually to varying degrees, but occasionally the whole shabang and let’s throw in better sense of humour just for good measure.

Trying to be egalitarian about it does not go to the heart of the problem. It’s easiest to try and tax the wealthier because they have the most tangible assets that can be redistributed. But really the problem is not in the world. The problem is in us. We should be working on ourselves to “not and let this bother us”. We should be comfortable enough in our own skins that we don’t mind that others are better, and if possible if the quality is attainable, then we should endeavour to attain it. Some things aren’t attainable, but then part of being an adult is the maturity to live with this. To shy away to remote regions where this “isn’t in your face” is a hack and really means that you haven’t learned the skills to really not give a damn.

..will probably expand this a little later.


April 2, 2009

Seems to me that lots of people confuse poverty with overpopulation. They are related, but just because you see lots of people in poverty doesn’t necessarily mean that there are too many people in the world. Poverty has been successfully tackled in lots of countries by education, the market and infrastructure (neither of which is really possible without good governance and the rule of law). Just look at the transformation of South Korea over a 40 year period, and even the transformation of China even despite not being democratic. Actually China now faces an obesity problem and only 8% of children are underweight and I bet this figure is dropping.

To assume though, that poverty is caused by too many people that the earth can’t cope and that we’re headed for a malthusian disaster (although the actual works of Thomas Malthus may not be so extreme), you have to have a model that predicts this. I’m writing this specifically with respect to agriculture. Here’s at least one theory which predicts something different by Ester Boserup. There are indeed some clever people that do believe in this catastrophe and are worth reading but as with any complex problem determining policy before a consensus of a science (which requires a model back by strong evidence, both passed data and it’s ability to predict) is a bad idea. Actually I don’t really have to say much more on this, as it’s said by following the criticism section on the Malthusian Catastrophe page. Happy reading.

Additionally in response to the comments on the page. What I haven’t addressed so far is

  1. the fear that more people mean exponentially higher costs.
  2. the fear that more people means less opportunity (aside from agriculture), jobs, housing. Also sited parking.
  3. A fear that the absolute numbers are just too big.
  4. Not recognizing that with wealth comes population decline.
  5. An irritation at having to share the planet with other people.

Well (1) is definitely false. The whole point about production is that it works because of the phenomenon known as economies of scale. Can you think of a single product we consume that as they produce more of it the generic product has become more expensive (where branding and patents aren’t involved)? I can’t. As my dad would point out this process applies to the plant and not to the firm, as when then plant gets too big, you either invent new tech or just create another one. So the firm has no theoretical maximum size. This applies to activities like governments collecting of taxes. I’m willing to bet that with a little more digging I’d find data to show that as population increases income tax lowers (although comparing income tax formulas are difficult) in countries without socialist agendas.

No (2) is also not rational with everything except space. Again my dad would say that if there were a finite number of jobs in the cities then as cities grew, everyone would move out to the countyside. This empirically isn’t the case. People move to cities to find work, and the more they move to the cities, the more work there is. This isn’t just true in Cape Town, but in the biggest cities in the world (London, New York etc). It is true that as more space is taken up the value goes up. However the amount of the earths surface where this has reached some kind of equilibrium saturation point is tiny. In each of the major cities we’re talking Manhattan in New York, Inner tokyo, Zone 1 in London etc. Yes this would affect things like parking space too, the challenge in big cities is to create public transport systems to cater.

Regarding (3): I’m sure that some of the models describing how many people will actually be in the world in the future are correct. But I don’t care. Human beings naturally have a fear of big numbers even when they are legitimately sustainable.

The good news (4) is that as people get wealthier, even the potential threat of of overpopulation becomes a mute point. So really the only issue is actually tackling poverty.

The issues raised in (5) I don’t have any time for. The issues to do with sharing the world are the same with 2 trillion as they are with 2. This is a human nature issue.

The bottom line for me is that if one really feels that overpopulation is a legitimate threat, then I think one should be supporting policies like China’s One Child policy as when we’re faced with threats to humanity, civil liberties need to be suspended for the good of the group, just as in war time. Although I’m in favour of family planning because of quality of life arguments (don’t have more children than you can support) I think that China’s solution is a disgusting infringement on the liberties of the individual and because I don’t believe that overpopulation is actually a threat.

Hello world!

April 2, 2009

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