Goldman Sachs, Market Makers and standard economic theory

I wish I had the time to work through this more systematically but I do not. But can anyone watching the US senate grilling of G&S execs believe in the micro-foundations of orthodox economics (scientific liberalism)? What I liked was Sen. Levin’s interpretation of a Market Maker (MM) and G&S’s interpretation of MM. The G&S position is thus: we can sell anything to anybody without divulging what we think it is worth; in fact our obligation is to sell shit, if it is shit, it is just that shit, and we have no obligation to divulge our position about its quality.

This is simply buyer beware all trussed up. I am kind of sympathetic to this position as far as it applies to capitalism. The job of a capitalist enterprise is to make a profit: Some profit by selling quality and some profit by selling fake versions of Viagra. To paraphrase Marx: “capitalists seek profits; that in the process real or imagined needs get satisfied, satisfied well, or not is of secondary importance to the capitalist.” People sell lemons all the time in the attempt to lay-off their risk. In for the penny into the pound.

The community sets the standards on what is fraud and what is not. Now of course it is clear that firms like G&S bought the regulator (or in more polite form captured the regulator). So all of this is a bit of a smoke screen: political theatre. The real question is about how the state came to give these firms such latitude to determine what is fraud and what is not: or what is a lemon what is not?

Standard micro economic theory has a highly transparent view of information. Between the rational expectations and the implied substance of the efficient market hypothesis G&S should never have been able to push junk onto a market and find buyers in a sustained fashion over a prolonged period of time. But the G&S defence wants it both ways: we can sell shit because buyers should know they are buying shit. And they want to say we can sell shit because nothing obliges us to divulge the fact we are selling and saying shit.

And this is not much different from standard economic theory. Standard economic theory is want to say that shit can be sold because the market will almost instantly recognize that it is shit and that is the natural limit thus we do not need regulation to define shit. But G&S’s actions prove that market makers have an informational advantage that will not necessarily disappear by the discovery processes of market agents; at least not any meaningful sense of what is meant by this. The EMH boyz now want to redefine colossal market failure (the failure for good information to drive out bad) as the financial crisis. The crisis, the market pancaking thus becomes the rectifying process, the proof of real information discovery. That is like saying nautical engineers are successful because when ships sink they really sink.

What the sad story of G&S actually indicates is that market makers really make markets and that information is, by design, and in the absence of regulation, asymmetrical and consciously so. In a more revolutionary direction G&S, along with the entire private financial sector, indicates that private entities, if they have the financial wherewithal, will thwart, to the best of their abilities, the capacity for public oversight and regulation. This being the case it would seem to suggest that some activities ought to be brought under the public domain.

Styalised facts being what they are: CD Howe, the Fraser and CCPA

Some things just pass as fact when further scrutiny turns things around a bit…or at least requires a couple of qualifications. When I see words like *always* and *never* my bullshit sensor goes off the scale.  As for example in this passage from the good cop bad cop of Canadian economics blogs:

One can predict with a remarkable degree of precision the conclusions of such think-tanks as the Fraser Institute (‘markets always work’) or the Canadian Centre for Policy Alternatives (‘markets never work’). With the notable – and laudable – exception of the work of the CD Howe Institute (disclaimer: I have nothing to do with the CD Howe Institute)…

I will grant this much, the Fraser has never made an argument that I am aware of that argues for more, bigger, etc.,  government (although I stand to be corrected can one of readers find some contradictory evidence).  Does such a claim stick to the CCPA?  Last time I checked, the CCPA was in favour of *market based* approaches to climate change.  Not only that they have shown interest in a VAT tax progressive income tax trade-off.

So what gives here?  I dunno perhaps just misplaced centre of the road “ho hum we are the only ones who are balanced around here.”  Yet my suspicions get narrowed when I focus in on the statement:  “(disclaimer: I have nothing to do with the CD Howe Institute) .”  There is that absolute *nothing*.  Hard sell brother.  Word of advice: leave the absolutes for God.  However, the point is, your blogging comrade in arms, and arguably the majority contributor to said blog’s traffic going by comments (110-8 is hard to deny), is an economist affiliated with the the CD Howe.  I link him not because I think I have uncovered some mysterious conspiracy.  Your CD how affiliated economist has been quite open about this. Why, indeed, hide it?   Ah schucks *nothing*.  Forgive me, but your blog is not sub-titled “where I square off against the left, middle and right of the public debate on economic policy, but leave 75% of the floor to the CD Howe.”

But where is the evidence that the CD Howe is balanced: as in neither for or against markets (to stay with a worthless solipsism)?  Some young beaver should do a little qualitative research and see just how many times the CD Howe has come out in favour of more market based solutions rather than less.  If I had to wager I would put at somewhere around 20-25% gov and the rest to the putative markets.  But your unflinching belief that 25 (gov)-75 is the 50-50 scientific balance betrays more than nothing and less than everything.

Economic Historians and Kiln Design: Another just so ho hum story

Sometimes I wish academics would take the time to know what they were talking about before they attempted to cram a real world example into a predetermined paradigm.  Case in point Robert C. Allen,” The British industrial revolution a global perspective.

Pottery, for instance, was manufactured in both England and China. The design of the kilns differed greatly, however. English kilns were cheap to build but very fuel inefficient; much of the energy from the burning fuel was lost through the vent hole on the top (Figure 4). The typical Chinese kiln, on the other hand, was more expensive to construct and, indeed, required more labour to operate. Figure 5 shows how heat was drawn into the chamber on the left and then forced out a hole at floor level into a second chamber. The process continued through many chambers until the air, by then denuded of most of its heat, finally exited up a chimney. In England, it was not worth spending a lot of money to build a thermally efficient kiln since energy was so cheap. In China, however, where energy was expensive, it was cost effective to build thermally efficient kilns. The technologies that were used reflected the relative prices of capital, labour, and energy. Since it was costly to invent technology, invention also responded to the same incentives.

I call bullsheet! As someone who built kilns and fired them for years and who has intimate knowledge of kiln design history I must concur that this is yet another just so story by another just so economic “historian”.

It is true that downdraught kilns are more efficient than updraught kilns for the reason already cited in the excerpt. In the simple updraught (that is where the flame enters in at the floor of kiln and exits at the top) less heat work is done,i.e., the actual heat that gets transferred to the ware (think about the difference between horse power and torque). In the downdraught design heat is once again introduced at the floor of the kiln and then directed up the side walls into the arch where it is sent back down into holes at the bottom of the kiln and travels out through a flu exit on the floor. Here much more heat work is done so it is more efficient regardless of how many chambers there are.

The Chinese kiln is essentially a series of downdraught kilns strung together which are staggered along a hill. This is a clever innovation because it eliminates the need for a tall chimney which is necessary for most down draught designs. Now the Chinese Climbing kiln as it is known is special not only because it eliminates the need for a tall chimney but also because each ware chamber can be individually stoked. So the way it works is this. Say you have a ten chamber hill climbing kiln. You fire chamber one to temperature aprx 1315 degrees centigrade and then you fire the next to temperature and so on. Yes fuel is conserved because one is using the exhaust from the preceding chamber to pre heat the next chamber. So on the face of it the story holds.

But there are four other issues which the author fails to mention.

Significantly not all Chinese climbing kilns were of the multi-chamber variety some were single chamber climbing kilns similar to the Japanese Anagama (in fact the Japanese Anagama is a derivative of the Chinese). And while technically a downdraught it is really a cross-draught (the exhaust flue is slightly higher than the inlet). So not all kilns were of the multi chamber energy scavenging variety in Asia!

The second significant issue is temperature. Asians were firing their kilns to cone 10 (stoneware 1315 and higher for porcelains). Stoneware starts in the 1400s BC in China and began in Europe during the 1700s and 1800s as the Europeans sought to emulate the wares they were importing. But the point is this, achieving stoneware temperatures is difficult, costly and thus inefficient. It is a complex story but the difference between 1100 degrees centigrade and 1300 is not trivial and requires a lot of extra fuel. For example if you fire a modern IFB brick kiln of 20 cubic feet to 1300 you need between 2-4 extra hours of firing time @ a min of 1 million BTUs per hour. Now imagine the extra energy needed if wood is your fuel, your bricks are of the dense non-insulating refractory type, and your kiln is 10 chambers X 40 cubic feet. And this was the design of the Chinese kiln in question! Hardly an energy efficient model of production. All of which suggests fuel costs were not a significant factor or at least not a manipulatable factor.

The next issue is timing. Once the Europeans figured out how to find, refine and manufacture both the clay for porcelains and stoneware and the bricks for the kilns they almost immediately started developing downdraught two to three chamber kilns. In 1873 Mr Minto would actually take out a paten on his Minton Oven design: A downdraught two chamber kiln where the second chamber was used to pre-fire wares (bisque). However, in Germany they were already by 1858 using continuous firing kilns for bricks and this type of kiln is considered to be the basis of all modern industrial type kilns.

All of which brings me to the third issue: SCALE. Once you take into account the different types of fuels and the temperature at which the wares are being fired the issue that seems most relevant is economies of scale and specialization. The Chinese, Korean and Japanese, multi chamber climbing kilns made sense because pottery was made at the scale of the village. That is, whole villages were dedicated to the making of pottery. Such a scale required large multi-chamber kilns capable of producing large volumes of wares. This is why, I think we see an approximation of the Chinese kiln in the German continuous firing brick kiln: because brick construction was ubiquitous in Germany and the demand was huge such that kiln design was and still is dictated by the volume of demand rather than the relative scarcity of inputs.

Updraught industrial scale kilns are *more* expensive to build, not nearly as reliable, and the quality of the firing is poor (the difference in temperature between the top and bottom on a small kiln can be 100 degree centigrade!  Once large volume, high temperatures  and consistent results are required we see the Europeans switching over to down draft multiple or continuous chamber kilns.  Relative factor endowments do not play much if any of a role.

I suppose if I had Ricardo in the back of my head I would have reached the same conclusion as Mr. Allen.  Fortunately there is more between heaven and earth.

The left and Cash Transfers to the Poor: A Rejoinder to Slander

This seems so elementary that it should not have to be pointed out. Lately it has not been in my nature to get in the way of an over the top, gross generalization founded on spurious sampling techniques paired with the terrorism of gotcha journalism, however, today I am feeling frisky.

Some Guy (SG) has a blog post up about how lefties hate direct cash transfers to the poor. I can’t make heads or tails of this claim including the two random citations of lefties provided: one an individual the other a think tank (now there is rigour if I ever saw it). Unfortunately even the random citations provided were poor choice because in the one case SG failed to read the article—I suspect he is hoping you will too.

But alas we all now know that economists are to be debated not trusted. Inter alia, Duncan Cameron argued for an increase in direct cash transfers to the working, unemployed and non working poor:

“By any measure, minimum wages, welfare payments, unemployment assistance have all declined since at least the inflationary period of the 1970s. All these programs need dramatic improvements.”

There is then some irony that SG should have given his post the title: “An overlooked anti-poverty strategy: giving money to poor people.” Seemingly for SG, an increase in the cash benefits to the poor, working poor and unemployed do not quality as “giving money to the poor” (I will explain why below). And unintended irony of all irony the research reported on SG”s blog on minimum wages concludes that increases in minimum wages under a 40-45% of an average hourly wages threshold has little to a positive effect on employment. Although having an indeterminate effect on poverty.

Hence, I suppose the need for direct cash transfers of one form or another. Like uhm maybe an increase in cash benefits for welfare and EI recipients as Duncan argued? No No No No! Shrieked the vanilla economist! I will explain why further on.

In order to solve this murder mystery we will have to return to the scene of the crime. What seems to have stuck in the quick of SG was this offending remark by Duncan on EITCs as a generalized strategy for poverty reduction:

“Not even the Toronto Star editorial board seems to have noticed the problem is much wider than the working poor, and the solution greater than an earned income tax credit — aka a handout — so that lousy employers can continue to pay poverty wages.”

Clearly EITCs are SG’s preferred poverty reduction strategy—no matter that EITC’s do not have robust evidence to support the claim that they reduce poverty. In the US for example, where the program is much more robust than in Canada, the maximum benefit is around 2,700$ per year for a family with two children and around 500$ for a family without kids. And here is the kicker the EITC is phased out fully at 37,000$ for a two child two working parent family and 24,000$ for two individual no children family. I find some irony in the fact that my middle class baby manual tells me that children cost around 10,000$ a year. Therefore the idea that a 1,300$ (max) a year per child EITC in the US could be held up as major strategy to combat poverty is well simply farcical—albeit better than a kick in the ass I suppose. In any case, this is clearly where the unintended irony of a virgin gives way to self-satirisation—hardly edifying.

But the more important question is why would an economist be flogging EITCs as (a) the only form direct cash transfers should take; and (b), at the same time misrepresent the scheme as a poverty reduction scheme? The second is easier (i.e., more simple) to explain than the first. Classic misdirection—the first learned trick of magicians, pick pockets and con-artists (all of which I have infinite respect for outside of the academy).

However, the first question is more painfully answered. You see back in some early graduate seminar vanilla economists (well actually all economists because all economists have to be able to converse with vanilla economists but the reverse is not true—although some vanilla economist are capable of cross paradigm conversations) are given a tutorial on welfare policy analysis. The problem is that traditional cash transfers from say welfare or EI create an incentive for poor people not to work. All things being equal, why work if your welfare benefits will be clawed back and your earned income will be taxed? The basic thrust of the EITC is that it makes it so that work pays. And this is the real thrust of the EITC—making sure the incentive structure is designed so that the poor have an incentive to work and not layabout on the dole. It is about getting people off of welfare—which may or may not be a good thing—but it is not about poverty alleviation.

As an aside it was this I think Duncan was reacting to. Somewhat perversely, EITC’s act as a subsidy to minimum wage employers in two ways. On the one hand, they increase the labour supply of minimum wage workers thereby ensuring increased slack in their labour markets and thus downward pressure on average minimum wages. And on the other hand, they provide a subsidy to employers because the tax credit mitigates workers demand for higher wages. Perhaps this is why the program enjoys such bi-partisan support in the US.

In sum, EITCs are politically palatable because they “reward hard work” and shun the welfare system while giving the appearance of a concern about poverty. they keep in tact and rejuvenate that old Victorian separation between deserving and undeserving poor (never mind that the welfare system already reproduces this logic through extensive monitoring and what has been over the last twenty years increasing paltry benefit rates with increasingly restrictive qualification criteria).  They are, if taken in isolation as the only tool, a politically expedient, ideologically driven, and an ineffective poverty alleviation strategy sometimes garbed up in progressive rhetoric.

I welcome an honest conversation about a robust poverty alleviation strategy for Canada.  If only vanilla economists would try to meaningfully participate by jettisoning their predetermined policy preferences and erroneous characterizations of other members of the policy community. I for one am ready for a new conversation on poverty reduction in which everything is on the table–and not just facile ideological preferences masquerading as the new true social science.

Bank of Canada Beats a Retreat on Optimism

Well I do not mean to brag but I did argue at the time, along with others, that Mark Carney and the BOC were being overly optimistic to which the usual suspects countered that the BOC had super superior models and modelling acumen. So it was, as it is now that Super Mark and the BOC are beating a hasty retreat from their rosy optimism. The globe reports:

The Bank of Canada cut its benchmark lending rate to the lowest possible, and promised to leave it there for as long as a year in order to fight a recession that is deeper and will last longer than previously thought……

The central bank now predicts that Canada’s gross domestic product will shrink by 3 per cent in 2009, compared with a January estimate for a 1.2-per-cent contraction.

The Bank of Canada also abandoned its relatively optimistic estimate that the economy would rebound to expand 3.8 per cent in 2010. The recovery will be far more muted, with an expansion of 2.5 per cent in 2010, the central bank said.

Mr. Carney and his chief advisers on the governing council are trying to restore confidence amid Canada’s first recession since 1992. Employers have shed more than 270,000 jobs since the country fell into a recession in the fourth quarter, a period during which factories produced at only 75 per cent of their capacities, the lowest rate on record…..

Hmm…maybe we start taking fiscal policy a little bit more seriously now and not its faux ami tax cuts?


Erin Weir on BoC rate cut.  Better Late Than Never

Delong is Wrong Again

What is up with Brad Delong?  It is like he is itching for a job in the Obama administration.  By his own admission he is no macro-economist but surely he knows the difference between effective demand at the level of the grass roots and supply push.  Then again maybe he is a macro-economists…of the fresh water variety.  Just read the following:

Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it, and that this will directly pull people out of joblessness and into employment.

Here is a rather old fashioned idea: temporarily beef-up both the number of those covered by UI and the level of the replacement wage so that unemployed workers will have cash to spend on things like mortgages, rents, food and transportation.  Surely this seems better than hoping those who already have pockets full of cash will spend more of it and pull people out of employment.  And while unemployed workers are spending their UI, the Obama administration can find a little bit of breathing room to come up with a coherent plan to the financial mess instead of playing hanky panky ad hocery with the Fed, the Treasury and Wall street.

Dude trickle down is so like…the eighties.

Krugman is getting closer

In his latest Op-ed Krugman seems to be getting closer to the nub of it.  Just a little further Paul you are almost home.

Much discussion of the toxic-asset plan has focused on the details and the arithmetic, and rightly so. Beyond that, however, what’s striking is the vision expressed both in the content of the financial plan and in statements by administration officials. In essence, the administration seems to believe that once investors calm down, securitization — and the business of finance — can resume where it left off a year or two ago.

To be fair, officials are calling for more regulation. Indeed, on Thursday Tim Geithner, the Treasury secretary, laid out plans for enhanced regulation that would have been considered radical not long ago.

But the underlying vision remains that of a financial system more or less the same as it was two years ago, albeit somewhat tamed by new rules.

As you can guess, I don’t share that vision. I don’t think this is just a financial panic; I believe that it represents the failure of a whole model of banking, of an overgrown financial sector that did more harm than good. I don’t think the Obama administration can bring securitization back to life, and I don’t believe it should try.

Once krugman integrates some notion of stagnant wages and the privatization of debt via the massive extension of consumer credit he will arrive at an indictment of a growth model that goes well beyond a bloated financial sector.  He will, in short, end up indicting the very neoliberal growth model he once so proudly shilled for.

On Credit and Crisis

From old whiskers

The two characteristics immanent in the credit system are, on the one hand, to develop the incentive of capitalist production, enrichment through exploitation of the labour of others, to the purest and most colossal form of gambling and swindling, and to reduce more and more the number of the few who exploit the social wealth; on the other hand, to constitute the form of transition to a new mode of production. It is this ambiguous nature, which endows the principal spokesmen of credit from Law to Isaac Péreire with the pleasant character mixture of swindler and prophet.

OECD: More of the Last Thiry Years-that’s the Ticket

Someday some bright chap over at the OECD is going to draw a line between flexible labour markets (stagnant wages in the US), deregulation of finance and financial flows, free trade, global imbalances and this crisis. Until then we get more of the same. Interesting how the very same policies that created the crisis are its solution. Well, to be fair there is a nod to public infrastructure spending. Hardly a paradigm breaker. But then we know that the OECD is really PSA service for official policy. So there is no use howling at them for this ill-smelling wind.

OECD urges rich countries to strive for flexibility

By Chris Giles, Economics Editor

Published: March 3 2009 09:00 | Last updated: March 3 2009 09:00

Rich countries should redouble efforts to increase flexibility in labour markets and boost competition even though they are suffering the worst recession since the second world war, the Organisation for Economic Co-operation and Development said on Tuesday.

Arguing that liberalisation was the surest route to a speedy recovery, the Paris-based international organisation locked horns with a vocal group of European economists, who have been extolling the virtues of labour market rigidities as a way of preventing deflation and depression.
Klaus Schmidt-Hebbel, OECD chief economist argued: “More flexible product and labour markets are likely to strengthen country resilience to weather future downturns with less disruption to output and employment.”…
It also identified higher spending on infrastructure, increased spending on training and reduction of personal income taxes for low earners as policies that gave a “double-dividend” of limiting the depth of the recession and boosting longer-term growth prospects.

The list will please the new US administration of Barack Obama since it reflects much of the thinking behind Washington’s stimulus plan.