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.

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 agenda...how 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 line...is 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

"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.

More Housing

USA Today provides an interesting story and graphic on the concentration of mortgage foreclosures and defaults.  The graphic below is from the Economix blog from the New York Times, but the USA Today article breaks it down by counties and shows that 35 counties accounted for roughly half of all foreclosures in 2008.  Amazing that such a few geographic areas are responsible for such a mess.

Historical Timeline on Housing Crisis

This link to a Fox News video on You Tube actually comes out of Canada, so it has a little ancillary material at front and back, but it is useful to watch as a means of understanding the obfuscation that is taking place in Congress today about who is really behind some of the key mistakes in the lead up to this crisis.

GM Bankruptcy

As reported in the Wall Street Journal, GM auditors question the firm's ability to continue to operate. This smacks of political blackmail for more bailout money. I have no doubt that they need additional funds to continue to operate. I just question the need to keep them afloat. Many companies file for Chapter 11 protection and come out of bankruptcy in much better shape. I would predict that GM will go bankrupt. The only question is how much money are we going to put into the company before it happens.

Interesting Question: If the government loans significant money to GM and GM files for Chapter 11 bankruptcy, is GM "protected" from its major creditor...the U.S. taxpayer?

Probability of a 'Depression'

Robert Barro in a Wall Street Journal editorial provides some evidence to formulate the probability of a mild "depression" as defined as real GDP decline of over 10%. Based on his data, he estimates the probability at around 20%. The probability of a major depression (real GDP decline more than 25%) at around 9%. The last statement he makes deserves repeating here:

I wish I could be confident that the array of U.S. policies already in place and those likely forthcoming will be helpful. But I think it more likely that the economy will eventually recover despite these policies, rather than because of them.

Unfortunately, I am afraid I agree with him. I hope we are wrong and our recovery is more rapid, but it increasingly seems the structural adjustments the economy is progressing through are deeper than anticipated.

Government Contracting Future???

An Associated Press story outlines plans by the Obama administration to overhaul government contracting at a savings of $40 billion per year. Sounds good, but details are scant. Here are a few quotes from the story worth mentioning.

Those new rules, officials said, would make it more difficult for contractors to bilk taxpayers and make some half-trillion dollars in federal contracts each year more accessible to independent contractors.

OK. That sounds good. But, what do they mean by "independent contractors?" Or what about:

Obama will say that his administration will stop outsourcing to private contractors many services that should be performed by government employees. He also pledged to open contracts to small businesses and eliminate "unnecessary" no-bid contracts that allow preferred contractors to take assignments even though they might not be the least expensive option.

The first sentence sounds suspiciously like more government expansion. There are certainly jobs that should be performed by government for a variety of reasons, but most of the time it is more costly and inefficient. Equally important is that the first sentence in this quote appears to contradict the previous quote.

The administration official said Obama would not, however, sacrifice national security to save pennies. The official also said the administration plans to increase transparency and accountability provisions in contracts -- a major theme of Obama's young administration. [my emphasis added]

OK. The rest was sounding OK, but the highlighted statement runs counter to our experience so far with this administration. This is just another issue to watch closely in the future.

Mortgage Pig

The guys at CalculatedRisk have an amusing technical interpretation of the S&P 500:

It helps to find some humor in the current economic environment...

Ugly Picture

Here is another ugly picture from dshort.com:


The accelerating pace of this is quite scary. But, all markets are new. So we shall see where we go from here.

Opportunity Costs and Budgeting

The core principle of economics is a concept called opportunity costs. Basically, opportunity cost is the value of an alternative course of action given the choice to do something else. You give up current income to go to college (the opportunity cost) in the hopes of achieving a higher lifetime income. We live in a world of scarce resources, so choosing one use of those resources necessarily means that we are giving up the opportunity to do something else. Every freshman economics student is taught this concept.

Now that the President's budget "blueprint" has been released, we get a glimpse of how he does opportunity cost calculus (or doesn't). Let's start with a media "darling"...agriculture. Farm subsidies have been a favorite political target of developing countries as well as the Wall Street Journal editorial board, among others. First, a little perspective is in order. The total cost of farm subsidies in current dollars over the last 40 years is somewhere in the neighborhood of $140 billion. Compare this to the TARP and"stimulus" packages of the past several months. But, are there opportunity costs associated with farm subsidies? Of course there are costs. The money could have been used elsewhere in the economy. The subsidies have distorted resource use away from the allocation of resources that would have resulted in the absence of government intervention (how much, of course, is a relevant question).

We have to compare this, though, with what we get in return. In the 1940s, as much as 50% of U.S. household disposable income was spent on food. Today, it's less than 10%. This relative decline means we have had more money to spend on DVD players and cars, thereby fueling economic growth. We have arguably maintained or improved the standard of living in rural areas and promoted a sector that is the only industry that has consistently fed the U.S. population uninterrupted through two world wars and countless other conflicts and economic crises.

Platitudes aside, the question is whether the benefits to society outweigh the opportunity and cash costs of the programs? Well, society, since 1933, has consistently said "yes." Now, we find in the President's budget that for some reason that calculus has changed dramatically. Why? Surely it is not cost. He argued for a $600+ billion "reserve fund" for some future undefined nationalized health care system. What is the opportunity cost of that $600 billion? What is the future economic growth drag of a system like that?

I have never been a proponent of farm programs. But, I recognize that there are social, political, and other non-economic reasons for their existence. I also recognize that our trading partners will continue to subsidize their production even if we do not (and do not be fooled; even developing countries are subsidizing their agriculture). In years past, government budget and deficit spending levels were such that we economists were concerned with the social tradeoffs between agricultural and other government spending. But today, I am not sure the opportunity cost arguments implicit in the President's budget are genuine. If we are to spend $600+ billion per year on health care, what's another $15 billion on food?

Currency Manipulation "Message"

Greg Mankiw has an interesting take on the inconsistency of the message coming from Washington to China about currency and debt. It is worth a read.

Bank 'Nationalization'

This editorial in the Wall Street Journal points to some semantic differences when people use 'nationalization.' Quite correctly, the author points out that the Federal Deposit Insurance Corporation (FDIC) quite regularly 'nationalizes' failed banks. But this is potentially quite different than what is being proposed by some. The devil is in the details. But, so far, very few details have been forthcoming. By being purposely vague, the Obama administration can hide their agenda is something that resembles common sense. Or, maybe they just do not know what they are doing.

Policy Stability

Jeffrey Sachs has an interesting piece on the need for policy stability, not stimulus, in the Scientific American.

Stimulus Humor

A bit of stimulus humor:

What Does "Create or Save" Jobs Really Mean??

Greg Mankiw has a useful political commentary on President Obama's "creating or saving" jobs with the stimulus bill. I agree with him that this phrasing is politically genius because it is not provable and virtually any outcome can be justified by the statement...ludicrous.

"Green Payments" in Agriculture

The Southwest Farm Press reported on a discussion by Secretary of Agriculture Vilsack about green payments in agriculture. In a nutshell, Vilsack is discussing the potential that agriculture receive payments for environmental amenities (for example, carbon sequestration) produced on farms. This would, theoretically, be in place of traditional farm income support payments (I say "theoretically" because existing programs rarely disappear when new programs are introduced; but may have to now given the financial mess we are in). Although I have long argued that this was the direction we were headed with farm programs, I do think two questions are relevant before embarking down this road:

1. Current payments are related to factors such as farm size, crops, etc., that lead to a certain distribution of these payments across the country. Land values, equipment loans, etc., are tied to the existence of those payments. Changing payments to be based on environmental amenities is likely to result in a distribution of payments that is at least somewhat different than the current distribution, which could have impacts on land values, cropping patterns, etc. Do we understand this process well enough? Are we ready to accept the consequences of those changes?
2. Green payments are presumably not tied to farm revenue, prices, production, or any other historical variable related to the farm. As such, the revenue these payments would provide are not counter-cyclical to farm revenue. Do we care if farm policy does not provide income risk protection?
   

These are but a couple of questions relevant to the debate that is likely to begin soon.