Wednesday, March 11, 2009

Chinese Exports Fall--Economic Adjustment

According to the Wall Street Journal, Chinese exports have fallen sharply (26% from a year earlier), which has reduced their trade surplus. This is a result of both the economic slowdown as well as exchange rate adjustments (actually, these are linked, but I don't want to be too wonkish here). At first blush, this appears to be a "good thing," and it is part of a necessary adjustment in our economy. The issue to watch is that the trade surplus has given the Chinese cash, which they have reinvested in U.S. Treasuries. As the trade surplus declines, so does their available cash. As the story points out, however, this decline in purchases has been offset by an increase in the U.S. savings rate to 5% of disposable income (again, for economics wonks, this is obvious). So, we are buying more of our own debt. This trade balance will deserve attention in the near term to see if this trend continues.

Tuesday, March 10, 2009

John Nash, Climate Change, and "One World Government"

John Nash, played by Russell Crowe in the movie A Beautiful Mind, was a mathematician awarded the Nobel Prize in Economics. One of his most famous insights was something called a "Nash Equilibrium." Basically, Nash argued that an individual will do what is best for himself given that his "opponent" chooses what is best from them. More generally, I will choose the course of action that is best for me conditional on what you choose.

The classic example of a problem like this is something called a "Prisoner's Dilemma." From the Wikipedia site, here is a description of the problem:
Two suspects are arrested by the police. The police have insufficient evidence for a conviction, and, having separated both prisoners, visit each of them to offer the same deal. If one testifies (defects) for the prosecution against the other and the other remains silent, the betrayer goes free and the silent accomplice receives the full 10-year sentence. If both remain silent, both prisoners are sentenced to only six months in jail for a minor charge. If each betrays the other, each receives a five-year sentence. Each prisoner must choose to betray the other or to remain silent. Each one is assured that the other would not know about the betrayal before the end of the investigation. How should the prisoners act?
Obviously, both suspects would be better off is they each kept their mouth shut (we call this the social optimum). (This is why your momma always separated you and your brother to get to the truth.) But, Nash and others recognized that each had an incentive to rat out the other party. Because I assume that you will do what is in your best interest (rat me out), I act in my own best interest given that assumption (rat you out). So, while the social optimum is to keep quiet, the individual incentives of ratting out are quite powerful.

Roll out climate change (or any common-pool resource problem for that matter). IF climate change is a real man-made issue, and that is very debatable, is has characteristics of a common-pool resource. That is, my actions have an impact on you and vice versa, but we act independently. If neither of us pollute, we will both have positive economic growth with positive health impacts. If one of us pollutes but the other does not, the one that does not will have higher economic growth (hence, the incentive to not adopt pollution controls), while the non-polluter will have lower economic growth. The negative health consequences are affecting both of us. Thus, while we would both be "better off" by not polluting, the incentive is to pollute.

OK, so what does this have to do with "one-world government." Admittedly, that is a bit hyperbolic. But, notice in the original prisoner's dilemma game that there is no in-game communication (no tapping "just keep quiet" in morse code through the prison walls). This means that because we act individually, we will not reach the social optimum without communication. A recent article in the New Yorker Magazine had an interesting quote on this subject.
“We are in an era of creative destruction,” he said. A thin, easygoing man with the look of an Oxford don, Elkington has long been one of the most articulate of those who seek to marry economic prosperity with environmental protection. “What happens when you go into one of these periods is that before you get to the point of reconstruction things have to fall apart. Detroit will fall apart. I think Ford”—a company that Elkington has advised for years—“will fall apart. They have just made too many bets on the wrong things. A bunch of the institutions that we rely on currently will, to some degree, decompose. I believe that much of what we count as democratic politics today will fall apart, because we are simply not going to be able to deal with the scale of change that we are about to face. It will profoundly disable much of the current political class.” [my emphasis added]

Interesting... Basically, this person is arguing that a command-and-control dictatorship, or at least some significant modification to our representative republic (it really irks me when liberals refer to it as a "democracy" because it is NOT) will have to arise because of the prisoner's dilemma problem. Could be, but in-game communication can be accomplished in many ways, which short-circuits the problem. Additionally, economic research suggests that players of the prisoner's dilemma game often choose to "cooperate" as much as 40% of the time even though it runs counter to their individual incentives. Nevertheless, this might explain why the liberal left continue to push the global warming else to get you to accept sacrificing self-government unless there is a "crisis too big to solve" as individual nations.

More on Climate Trend

Using the NASA data charted in a previous post, I have plotted the mean global temperature index and plotted trend lines and a 10-year moving average line.

The yellow line represents a trend created using a 2nd order polynomial (techno-geek talk for a regression with both time and time squared as variables). For convenience, the regression equation and R2 value (a measure of goodness of fit; but only one of many measures) are presented in the bottom right of the graph. Indeed, if I were Al Gore, I would be scared to death of what this means...namely that global temperatures are increasing at an increasing rate. This runaway global warming is enough to scare even the most hearty of constitution.

But a second look at the data reveals a potential problem. The red line represents a 6th order polynomial trend (a 6th order was determined to be optimal on the basis of a number of statistical criteria relating to goodness of fit). The regression equation for this line lies at the top of the graph. Notice that you get a much different interpretation from this model. Namely, global temperatures have peaked and are actually heading down!! The 10-year moving average appears to confirm this trend (note that the 10-year moving average appears to have only declined twice over the entire period when a global cooling stage was not actually beginning).

Does this analysis necessarily mean that global temperatures will continue to decline? Certainly not. But, it should give us serious pause about implementing draconian measures (I am not talking about your everyday recycling and other prudent conservation measures) that could cripple economic growth in a time of global recession.

An Inconvenient Reversal of Trend?

Al Gore's now infamous movie title may have an interesting twist. The truth may be that trends in global temperatures have reversed. From NASA, here are the most recent facts:

This figure has its own set of issues. But, let's take as given that we are warmer today than in 1950 (the base year for this figure). The black line tracks the annual observations of this index while the red line shows the 5-year mean (presumably to measure the longer term trend in the index). What we see is that we peaked several years ago, and the longer-term trend is now moving downward. This, of course, does not mean that the trend has permanently reversed, but calls into question the notion that temperatures are perpetually increasing. On the contrary, there appears to have been relatively steep increases in this index during the 1990s, but the rate of climb fell of sharply in the late 1990s-early 2000s, and now has actually gone negative (temperatures on the decline).

Lest we focus too much on the global picture at the expense of more specific regions, the figure above breaks the data down by latitude bands. Note that the Northern latitudes have experienced the greatest degree of "warming," which may lend some support to man-made causes (the area with the most industrial activity), but note that all areas are experiences the same reversal of trend.

The above figure shows land and sea temperature changes. Note again that both land and sea are reversing course in temperature. Just an interesting observation is that the sea temperature change appears greater in percentage terms as compared to land and also appears to lead temperature changes on land... That might make an interesting testable hypothesis.

Bottom the trend in global temperatures reversing?? Who knows? Not Al Gore. But, these data will not appear in the mainstream media because it runs counter to the goals and objectives of the liberal left. But more disturbing is how the scientific community has abandoned its principles in this debate.

Some may question why we should care whether the issue of global warming is real or fabricated. The answer is that proposed solutions have costs (see Wall Street Journal editorial or Fox News story that summarizes a complex text produced by the EPA). I suspect, but have no direct evidence, that many of the people most pushing the global warming agenda are heavily invested financially (as well as emotionally) in companies that stand to profit from a move to reduce carbon emissions. I guess we will find out what is going on later....

"There are three types of lies. Lies, damned lies, and statistics."

--Benjamin Disraeli

Monday, March 9, 2009

"Too Big"

AIG warns of serious consequences if it does not get more bailout money. This is what happens when regulators are asleep at the wheel. Note that on page two of the document:
AIG's business model - a sprawl of $1 trillion of insurance and financial services businesses, whose AAA (credit rating) was used to backstop $2 trillion dollar financial products trading business - has many inherent risks that are correlated with one another. As the global economy has experienced multi-sector failures, AIG's vast business has been weakened by these multi-sector failures. [my emphasis added]
Well, duh. What did you think would happen when you highly levered correlated risks?? This either points to the extreme arrogance of these people in ignoring the potential for systemic risk or the lack of competence in understanding that risk existed in their "vast business." To be sure, risk exists in all businesses and cannot be eliminated. Nor should we expect that firms will never take risks, otherwise they will never innovate or expand. But, businesses should be prudent in understanding their risks and regulators should be cognizant of the risks that are being taken.

Who Pays for Cap-and-Trade?

The Wall Street Journal editorial on the subject is a rather enlightening example of how costs work their way through the system. Most important is this passage:
Once the government creates a scarce new commodity -- in this case the right to emit carbon -- and then mandates that businesses buy it, the costs would inevitably be passed on to all consumers in the form of higher prices. Stating the obvious, Peter Orszag -- now Mr. Obama's budget director -- told Congress last year that "Those price increases are essential to the success of a cap-and-trade program."
Notice that Mr. Obama's administration quite readily views this as a tax. I wonder if they even view this as a real solution to a "pollution problem" or just a way to generate tax revenue?
We were also pointed to recent comments by Mr. Orszag that he was "sure there will be enough there to finance the things that we have identified" and maybe "additional money" too. In other words, Mr. Obama expects a much larger tax increase than even he is willing to admit.
I guess that means the more revenue side wins... Finally, the editors observe:
Cap and trade, in other words, is a scheme to redistribute income and wealth -- but in a very curious way. It takes from the working class and gives to the affluent; takes from Miami, Ohio, and gives to Miami, Florida; and takes from an industrial America that is already struggling and gives to rich Silicon Valley and Wall Street "green tech" investors who know how to leverage the political class.
Of course, there are arguments for the success of these programs (see another post of mine that outlines these arguments). But, one must be intellectually fair and recognize the potential outcomes of a policy. And, yet again, we will not discuss this for long...only until May of Ms. Pelosi has her way.