China vs. U.S. Savings Rates

I was going to include an extensive write-up with this. But I think the charts pretty much do the talking. And what they say is not encouraging. That's savings as a percent of GDP for the United States and China. Guess which is which.

The Big CON, Healthcare Edition

That is to say, "certificates of need." I recently learned about these, among other things, from reading an old John Cochrane blog post, and I am now inspired. I have seen the light. Seen the light in the sense that pretty much all of our national conversation on healthcare misses the point entirely, and by focusing on health insurance and the government pays-what-for-whom-when (Medicare for all! No, Medicare for none!) we're missing the mark by focusing on shifting the demand-curve for healthcare, when all the bodies are (literally in some cases) buried on the supply side.

Which brings me to the Certificates Of Need. A CON is a certificate that hospitals must submit for approval by the state government before they can purchase large-scale new equipment or expand physical operations, or build a new hospital at all. To be approved to expand operations, the hospital must demonstrate that its expansion will not impede the profitabilty of existing hospitals in the area or infringe on their market share.

Think about that, and imagine if that kind of rule were put in place in any other industry. Imagine if Verizon had to submit a form to the Federal government before developing a new cellphone and prove that it would not reduce AT&T's profits. Or Ford was prevented from building a new plant because it would harm GM's market share. We'd have a limited supply of cars and cellphones at higher prices. When you prohibit the expansion of production, that shifts the supply curve to the left. When you shift the supply curve to the left you get less output at higher prices. That's healthcare. It's not cellphones and cars because firms that provide these products are not LEGALLY PREVENTED from expanding plant and equipment; indeed it's encouraged. So prices continaully come down as quality and quantity grow. But not so with healthcare, so we instead get an endless series of schemes to expand "coverage" and reduce costs, when healthcare firms are legally prohibited from organically doing both on their own.

"Whoa, CONS are COOL."  

Bernanke Is Not to Blame for Low Rates #387

Thought I'd hammer away at this again because I hadn't in a while. But it bears repeating because of the enormous policy implications and the political lobbying power of people who don't like low rates. Anyways, with the knowledge that "the" real interest rate will adjust and remain at an equilibrium that balances savings and investment in an economy, we expect the interest rate to fall when saving increases relative to investment. Bear in mind, this is the natural operation of a secular market, with no policy interference; simply a price changing to clear a market. Well check out the graph:

Ben Bernanke needs to throw this graph right in Paul Ryan's face next time he starts complaining about the "financial repression" caused by "artificially" low rates. Serisouly, look at that: in 2010, the American economy funded ALL the private investment firms wanted to make out of domestic savings and had over a trillion dollars left over. Of course, that was more than absorbed by the Federal budget deficit, which is why we still ran a current account deficit. But with inflation expections running so low and the private sector flooding the economy with net savings, low rates are the result of the market system, not an act of policy or choice.

P.S. as luck would have it David Glasner just made a new post with exactly this theme, but of course a lot better. Here's an exerpt and a link:
"First, it can’t be emphasized too strongly that low real interest rates are not caused by Fed “intervention” in the market. The Fed can buy up all the Treasuries it wants to, but doing so could not force down interest rates if those low interest rates were inconsistent with expected rates of return on investment and the marginal rate of time preference of households."

A Very Discount Christmas: Mises and Hayek are Dead part deaux

So what is wrong with the Austrian theory of the business cycle?

For one thing, the entire theory is predicated on the assumption that economic agents not only don't possess perfect information and foresight about the future, but cannot and do not react to events occuring around them in real time. To believe that real interest rates will be suppressed by inflation for a prolonged period of time comprising the "boom" you have to believe lenders don't notice rising prices around them and readjust nominal interest rates upward to keep the real rate constant.

For another, in the theory the mechanism by which the "boom" ends and the "bust" begins is a rise in real interest rates as they return to their equilibrium, making low-returning investment projects suddenly unprofitable on margin. This represents a misunderstanding of how finace works and what forms of liabilities are used to do what. Short-term debt like commercial paper is used to meet payroll and fund daily operations and basically allows for firms to consumption-smooth, because operating revenue flucuates more than operating costs. But no self-respecting firm would dream of building a factory or any large, long term project and financing it with short-term money. The market for long-term bonds exists to prevent exactly the thing Austrians say causes the business cycle.

Inflation drives nominal interest rates because bond markets
are forward looking;the monetary authority has
little to no ability to peg a real magnitude

A world that operated on the lines of the Austrian theory would be chaos. It is a great irony that the school of economic thought that claims to place the most faith in the market is predicated on the assumption that market paricipants are myopic to a fatal extent. A form of capitalism where lenders don't respond to expected inflation, firms make long-term investments with short-term variable rate debt, and the governmnet can fool everyone time and time again would be a hellish nightmare; indeed state-run communism would be preferable! Thankfully, its the not world we live in. Long-term bonds do exists, as does the Fisher effect. Lenders and businessmen are more savy and less easily outsmarted by government bureaucrats than Hayek of Mises gave them credit for.

A Very Discount Christmas Special: Mises and Hayek are Dead

Austrian economics dominates online amateur economics blogging and commentary. Their views go largely unchallenged because most people who read their stuff agree with it or have better things to do than worry about it. Yes, I have nothing better to do on Christmas Eve than try to start a war with libertarians.

This is actually a rather charming picture and makes the
headline seem morbid and untactful.

The Austrian business cycle theory posits that the business cylce is caused by the monetary authority. So far, so good. As I understand it, the theory is based around the analysis of the so called "boom and bust cycle," with booms preceding and causing the inevitable bust. The monetary authority increases the money supply which in short-order causes an increase in prices (inflation) and a fall in real interest rates. These artificially low interest rates are below the equilibrium real interest rate that would prevail in an "unmanipulated" market, and remain so for an extended period. Firms borrow funds at these interest rates and use the loans to invest in capital projects, which because they are financed at low interest rates are low-quality projects. Later, at some unspecified point in time, real interest rates are revised upward to their equilibrium value and the investment projects, which were undertaken to the point where their rates of return equalled the previous, low, interest rate, are now unprofitable. A recession ensues as firms cancel their "malinvestments," banks write off bad loans made with the initial increased money stock, and workers and capital are reallocated away from investment, which was made excessive, and toward consumption or other sectors. 

To Review:

1. Money Supply Increases 2. Interest Rates Fall 3. Firms Borrow and Make "Malinvestments" 4. Rates Rise Again 4. Malinvestments are liquidated 5. A Reallocative Recession Ensues 6. Rinse Repeat

This all sounds reasonable enough; but as we'll see in part 2, there are fatal flaws that need to be addressed.

The Fed Takes Another Step in the Right Direction

How I love printing money.

But seriously, the Fed just announced a new set of actual RULES it intends to use as guidelines to set monetary policy for the next several years. Basically, its a committment to keep the Fed funds rate at zero and continue the $40 billion a month in asset purchases until unemployment falls below 6.5% or inflation rises above 2.5%. Its not targeting the TIPs spread, or NGDP, but its something- and a sign of good things to come. Check it.

"To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. The Committee views these thresholds as consistent with its earlier date-based guidance. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments."

From here: http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm

I've Performed and Invaluable Public Service

Behold, a time series illustrating one of the more elusive economic indicators, the real interest rate. The blue line is the real rate on corporate AAA bonds, the red on 10 year Treasuries. Useful stuff. FRED data transformations are the miracle of the age.