16 October 2013

The Silly Season: Why Economists Go Wrong...

While economics started its life as a branch of moral, and some would say managerial, philosophy, it has evolved these days into a somewhat technical, and too often rather narrow, area of specialization that focuses inwardly on itself and its semi-private, academic squabbles.

Not that this is all bad, because it does keep economists employed and out of other mischief, as John Galbraith had observed.

But it sometimes causes them to get things wrong, because they tend to lack the overall vision of how real things fit together. Incorrect assumptions that compress the life out of reality are the Achilles' heel of all models, especially when they become self-referential and self-perpetuating. One has only to look at Eugene Fama's efficient market hypothesis to see how far this can go, and how damaging it can become.  Well, at least he has recently obtained a consolation prize for establishing a 'benchmark.'

Granted, this is a monumental challenge because economics spans so many areas of life and commerce. But when economists weigh in on policy and moral issues, one would think that they might give an extra special effort to rise out of their own deep wells of subjectivity and models, and at least have a go at understanding the impacts that their thoughts may have on the broader discussion, especially if they hold a public platform.

As the regular reader may recall, I picked on Paul Krugman when he dismissed the ability of the futures markets to influence commodity prices, because as he postulated, those prices are really set on a 'spot market' which ignores the futures prices, which are solely about derivatives on the future.

Now anyone who has spent any time at all trading in commodity markets knows this to be utter nonsense. Price discovery is a much broader activity. The price of a commodity today does incorporate some intelligence about what the price might be next week, for example.

And in the specific case of the metals, the prices in the futures front month have an enormous impact on the going price of a metal. Although that does seem to be diminishing a bit these days, with premiums over 'spot' as set by the futures front month hitting all time high premiums of one hundred dollars. But that is a symptom of a long term abusive price rigging and an unfortunate market divergence, and certainly not the norm.  Although it is amazing how many economists cannot see it even as it is unfolding. 

Today James Kwak weighed in with a few thoughts from the liberal economist point of view.
"Why does anyone think that anyone cares about what a rating agency has to say about Treasury debt? Credit ratings matter for obscure companies because they represent new information that is not otherwise available to investors. In the case of the U.S. Treasury, all the information you need to know is plastered across the front page of the world’s newspapers, all the time. Your not going to change your opinion because of something that Fitch says."
The reason for this should be well known to anyone who might have traded in the bond markets. Certain institutions are required to buy only instruments rated at a certain level, by a consensus of a handful of ratings agencies:  Moody's, SP, and Fitch. 

If Moody's or Fitch were to join SP in downgrading US debt, I guarantee you that there were be a significant reaction in bond market prices, without regard to what any economist might think from their reading in the newspapers. Those institutions who are required to hold only AAA rated debt would be prohibited from buying, and might even become forced sellers.

Is the Ratings Agency system sound and efficient? Hardly. But that is not the point. We have to deal with what is, and then change it if it makes no sense. The sad truth is that the Ratings Agencies are not objective and serenely detached computers processing facts without bias, but instruments of people, with biases, that sometimes become instruments of policy and conflicts of interest.

But this is a little example, fairly straightforward, and one can hardly blame someone for getting it wrong. I can get things like this wrong more than I might like, and often depend on the good grace of expert readers to set me right.

In the next bullet point James says that a holder of Treasuries ought not to care if the interest payment is delayed, because the principal is secure. He may not care, but certain institutions have to care quite a bit about this sort of thing.  A missed interest payment is a consequential event.  But again, it is a detail.

The example that stirred me to write is the next one, which goes far beyond knowing some market rules.
"I am probably one of the few liberals who don’t think the Tea Party caucus is engaged in irresponsible hostage-taking. Sure, I disagree with their policy objectives, and they are risking economic catastrophe by trying to force the government into default. But they are also fighting for a principle, misguided as it may be: Obamacare is evil, and should be stopped. The debt ceiling is an absurdity that should not exist. But since it does exist, it is leverage that conservatives can use to try to achieve their policy goals."
This surely sounds like a fine piece of liberal thought. Something exists, and someone is using it 'on principle.'  And while I may not agree, whom am I to judge in my fog of liberal relativism?  I admire their adherence to principle, in the same way that the diffident often admire the forceful.

Here is where I think James Kwak goes wrong in his moral reasoning.

Just because something exists does not mean that any use of it is a moral use, and one cannot blame or object to anyone's use of it as long as it is 'for principle.' I presume James would balk at the use of the debt ceiling to obtain large personal bonuses for the Congressmen for merely doing their jobs. After all, they are not completely like Wall Street, yet.

What if, in his angst over wanting to save the American people the painful experience of the Affordable Healthcare Act, Senator Ted Cruz were to stand on the roof of the Dirksen Senate Office Building, and vow not to get down from it until the ACA was repealed, eschewing all food and drink. We might question his frame of mind and judgement, but that might well be viewed as an act of principle, a symbolic action of great personal consequence and example.  Gandhi used the  principled hunger strike to influence political actions on several occasions and to great effect. 

But what if Senator Cruz used his office and influence to gather a group of hapless tourists, and hold them on the top of the building without food or nourishment, unless the ACA was repealed? And further, what if he set a date of October 17, and threatened to push them over the edge of the roof unless he was given his way?

Would that be an act of admirable adherence to principle?

No, of course it would not be.  

This relates to the long established moral principle that civil disobedience and demonstrations of principle are admirable if they are peaceful, and if those who take that action place themselves in the path of consequence, and accept that consequence for themselves.  More simply, an act that accepts negative consequences for oneself can be a commitment to principle.  An act that visits the negative consequences on an innocent third party is an act of extortion.

This is the difference between a hunger striker, a pepper-sprayed peaceful demonstrator, and a kidnapper or terrorist bomber.   Personal actions might have a broader consequence as well, as in the case of a transit strike, but I think the difference here is apparent.  The union strike is directly related to the activity, and is usually germane and proportionate.  And the strikers endure a shared hardship with the customers.  Although this too can be abused, obviously.

Now I would not want to engage in dark humour, but I will.   I suspect that if certain elements of the Congress or Wall Street were to gather on the tops of their office buildings and threaten to jump if they did not receive outsized personal bonuses and more power for merely doing their jobs, one might suspect that a less than insignificant element of the public would voice their encouragement, and urge them to go ahead. And the media would sell tickets.

This is the silly season. And people are saying lots of silly things. But there is some need to maintain our common sense, and view things as they are, and not where our and political enthusiasms might wish to take them.

I know, this is a bit of schadenfreude, and I do not wish to pick on James Kwak because I like this writings for the most part and often link to them.  And by comparison the 'liberal economists' are like Solons compared the more venal of the so called 'conservative economists' who will say anything for their employers.

But I mean, come on. Being a liberal does not require one to engage in I'm OK You're OK relativism so that we lose sight of the practical foundations of civic duty and moral behaviour.    This might be a difference between a liberal and a progressive but I have never cared enough to think about it much. 

The practice of Wall Street and the Congress in holding the nation hostage to dire economic consequences, just to get their way when they lack a democratic consensus, has gone too far for too long.  

If they wish to protest, they should place themselves at risk, peacefully, in demonstrating their commitment to their beliefs, and not hold the innocent public hostage by furloughing the government and impeding important civic functions while they continue to enjoy their gymnasium, draw their paychecks,  and enjoy their customary perks in comfort.