The Angry Economist

There is much to disagree with in David Morse's May Friends Journal article on globalization. Let me say only three things. First, that the condition of mankind for hundreds of thousands of years has been poverty, starvation, an early death, and pestilence. Three hundred years ago, capitalism was invented. Some cultures have adopted capitalism, and they have largely escaped those ill effects. One of these is America, where you can own a house with electricity and indoor plumbing, own a car, and two color televisions, and STILL live on public charity because you are poor. Other cultures have adopted capitalism only in part, and they still suffer some. Other cultures know nothing about capitalism either by ignorance or by choice, and they still suffer. I absolutely cannot decry capitalism, and would certainly not seek to deny its benefits to the entire world, as David seems to want. "Ye shall know them by their fruits." It's a quote from a book about some guy. Yes, I mean to call David a false profit.

Second, David makes the case for America being wealthy on the backs of the entire world, and he thinks that's horrible. And yet as I write this, the hottest topic of conversation is offshoring -- a transfer of wealth from America to third world countries through the export of jobs -- and everybody thinks that's horrible. I, myself, accept neither problem definition, and so David's proposed solutions are completely beside the point.

Third, David arrives at several conclusions about economics which if presented to economists would provoke howling laughter. For example, he claims that the WTO is run by capitalists for the benefit of capitalists (which fails to explain the WTO's ruling against the Bush steel tariffs). If he were to propose similar conclusions about physics, say, that all objects fell at different speeds, or cosmology, say, that the earth is flat, or that the sun rotates around the earth, surely everyone would laugh at him. Why can he say these kinds of things about economics and still be taken seriously?

How can an earnest, sincere, and honest Friend like David make these kinds of errors? It seems to me that he is operating on faith not science. Yes, of course, faith is a central element of any religion. However, there are two kinds of faith: faith that something which is unprovable, right or wrong, is right; and faith that something which is provably wrong, is right. We cannot prove whether God exists or does not exist using the scientific method. It is only right to rely on faith in this matter. In other matters of which science can speak, evidence must override faith. The earth is not flat, objects fall at the same speed, the WTO is not in the pocket of capitalists, and capitalism is a good thing for all free people.

Inflation is not widely understood. A Friend explained it thusly: "Inflation is when people demand raises, get paid too much, and compete for goods and services, driving the price up, which causes people to demand raises." The cause in that scenario is the demand for higher pay, and the solution is to impose wage and price controls, ala Nixon (God help us when politicians think they understand economics, .... or economists politics!)

That explanation is complete doo-doo. The way to understand money is to think of it as a good unto itself. The fiat currency (the dollar is not backed by anything other than people's willingness to accept it) we use now has no other use than as money. You shouldn't dwell on the arbitrariness of the value of money, though. You should think of it as if it were gold, or silver, or cigarettes, or something else with an intrinsic use. Money evolved from the use of a good of some sort.

If money is a good, then money will have a value which is only partly related to its exchange value. Gold is made into jewelry, silver is made into photographic film, cigarettes get smoked. But the exchange value is itself also something desirable to have. If you have a painting which is worth $200 (to the right buyer), that's not the same as actually having $200. Money, both in its intrinsic value and its exchange value, is a good that has value beyond what you can exchange it for. As a good, it has a value, a supply, and a demand, like any other good.

Yes, the value of money changes. A dollar is not always worth a dollar. In uncertain times, people value exchangability. If you don't know that you can sell your $200 painting for $200, you might just sell it now for $190 and hold onto the $190. That $190 is worth more to you because you have it now, than the $200 might be worth to you later. The demand for money has risen.

Money also has a supply. Only the US Mint can legally issue US dollars. There are also counterfeiters, of course, but the only difference between a counterfeiter and the Mint on the supply of money is who gets to spend the dollar first. And the fact that the Mint exercises some restraint on printing excess dollars. The same goes for private currencies, such as the Ithaca Hour.

In order for money to have a stable value, the supply and the demand should be matched. The Mint prints dollars, but the Federal Reserve controls the supply of money through the interest rate at which it loans money to banks. It has no control over the demand for dollars. It will be reasonably stable and predictable in a peaceful free-market society. If the Fed did nothing or didn't exist, prices and wages would slowly drop as the economy grew. Because of productivity gains caused by capital investment, prices would drop faster than wages and everybody would be richer. However, nobody but nobody wants to see their wages go down, even if prices are going down faster. Therefore, we have the Federal Reserve.

To avoid the unattractiveness of falling wages the Fed is always increasing the amount of dollars. If they increase them too quickly, the supply of money exceeds the demand, and the value of dollars drops. The thing is, though, that when you inflate the currency, you get to spend the money first. That's the attractiveness of counterfeiting. It also explains why inflation is so common and deflation so rare. To deflate the currency, you need to buy dollars with hard goods, and then destroy them. It makes almost zero sense. Governments use inflation as a source of income.

Why dollar inflation is not likely any time soon

People who loan money are concerned about inflation. If they loan $1K, and the government prints up a matching $1K, they'll effectively get paid back only $500. That's why interest rates rise in the face of inflation. Lenders want to be paid back the same value that they loaned even if it has a different number on it. Lenders do whatever it takes to avoid inflation.

The Federal Government raises funds by taxing, selling bonds, and inflating the currency. To a very large extent, foreigners are buying the bonds. That's because they have a lot of dollars because they sold things to us in exchange for dollars. They are holding dollars because they expect that dollars will be worth more in the future. If the Federal Government tries to raise funds by inflation, these dollar-holders will sell off their bonds and buy something else that they expect will hold its value. If they try to convert those dollars into their own currency, the demand for their currency will rise and dollars fall. This is precisely where you see the value of the dollar changing: in the foreign exchange markets.

The trouble with a falling value of dollars is that it makes foreign goods more expensive. Because we buy so much products from abroad, expensive, not cheap dollars, are important. The Federal Government wants to continue this flow of cheap goods into the US, so it will refrain from activities which cause the dollar to fall in value.

Continued from a previous posting on The Price of Gasoline.

Went to David Isenberg's WTF!?! retreat last weekend. The retreat was held at Edith Macy conference center, owned by the Girl Scouts. It showed, too. Isabel Walcott pointed out, with far too much glee, that the women's room had 7 stalls while the men's room had only 2 stalls. Since WTF was male-heavy we got a taste of the common problem women face in buildings designed by idiotsmen.

Heard from many interesting people. One of them was Kenneth S. Defeyes, geologist and author of Hubbard's Peak. He is fervently pointing out to everyone who will listen that we're really, really not discovering any more oil this time. He's using the same method which predicted the peak of oil production in the USA, a prediction which history has supported. He's even going so far as to put forth the specific date of November 29, 2005, plus or minus a few weeks.

So, are we going to run out of oil? The answer is that no, we're never going to run out of oil. Oil is used for many things: it's cracked into various densities, and each one has its own use. As long as there are uses for any one of those densities, oil will sell for the price of the substitute for that use. If there is no substitute at all, then the oil will sell at the price of doing without it. If the price of extracting oil exceeds the price it can be sold at, then the oil will be left in the ground, hence the statement that we are never going to run out of oil.

Kenneth is saying that we have a problem, because the demand (which has always increased and may be expected to increase in the future) and the supply (which has always increased) are soon to be headed in opposite directions. What he wants is for people to realize that oil is going to becomes several times more expensive (he estimates $7/gallon), and unless people start doing something about it now, people are going to suffer.

I told him, in the Q/A session after his talk, that I couldn't dispute his geology, not being a geologist, and that while I agree that there are a bunch of quack economists out there, I had to disagree with his economics. (BTW, Isen gave me grief for not being angry enough, particularly given the way I savaged Eli Noam, who also spoke at WTF. If you want to change people's minds, you can't get them into their lizard mind.)

The way that the world changes is that people go along, doing stuff. The level of stuff-doing may go up and down a little, or there may be a trend towards expansion or contraction. If there is some predicted problem with stuff-doing, people do not immediately change, no matter how reliable the prediction. That is simply because the future is uncertain, and people are inherently conservative. This conservativism comes from the first year of life, where babies learn object conservation, and learn that when they put one foot out, the floor is there when they put their foot back down. The world doesn't change that quickly, and neither do people. It takes a crisis for people to change. Kenneth is being a poor economist but a good geologist when he says "Hey! If you don't prepare for a lack of oil, you're going to suffer!" I had to tell him "There's going to be a crisis no matter what you say." After I returned to my seat, Sara Wedeman said "you're right!" She's a behavioral psychologist with an MBA.

The price of gasoline will rise long before we actually "run out of oil." What is happening, and what should be happening is that the shortage will be brought from the future into the present by people creating stockpiles of oil against its future scarcity. Some will no doubt be accused of hoarding. But what's the difference between a hoarder and a salesman? Simply that the hoarder refuses to sell at the current price whereas the salesman is willing.

The technical term for this is speculation. You see it on the commodity exchanges all the time. People buy a commodity because they think it will be worth more later, or sell a commodity they have now because they think it will be cheaper later. It's even possible to sell things which don't exist yet--that's called a "future". Someone agrees to provide a commodity for a given price on a certain date, and they'll sell that future to someone else. They no longer care how much the future is worth, because they know how much they're getting paid. That lack of uncertainty is worth a lot to them, so they sell the future at a discount relative to the price an omniscient being would sell it for.

The trouble with speculation is that people see it as an offense against society. The speculator is holding onto something that is desperately needed by people, "just cuz". The "just cuz" shows a profound ignorance of economics. The speculator is actually helping society by preserving something from being used prematurely. For example, a speculator might purchase land from a logging operation because they anticipate that in twenty years the land will be in demand for recreational uses. In the meantime they keep people out because people will harm the growing trees. Once the trees have regrown, and the land is worth more, the speculator will want to sell it for a much higher price. This will cover any effort they put into improving the land, the taxes they spent to hold the land, and the foregone value of the money spent to purchase the land. However, from a non-economist's point of view, the speculator didn't "do anything" worth paying for.

An ethicist on 4/4's Sunday All Things Considered make a similar mistake. I would never presume to judge an ethicist's ethics, but I feel competent to comment on his economics. He said, in relation to the ticket prices "you haven't contributed anything to the production of the value of the ticket." That's wrong. First, he paid for the ticket in the past and plans to sell it in the future. In the meantime he's giving up the value of anything else he could have bought with the same money. Second, the ticket is worth more later, as more tickets are sold to people who value them higher.

Long before gasoline actually becomes scarce, it will become expensive. The price of gasoline has risen lately, but it's still cheaper in real (inflation-adjusted) dollars, than it was twenty years ago. You'll still be able to drive to the store when gas costs $3/gallon, you'll just think about it before you go. As a recent political cartoon put it, gasoline is cheaper at $2/gallon than most other fluids that people buy.

Interested in interest? Good! It seems that every major religion is interested in interest as well. They call interest usury, and condemn it. Some religions only condemn excessive interest; some continue to condemn any interest at all. The trouble with doing this is that a desire to be compensated for a loan seems to be a part of human nature.

Economists assume that if all other things are equal, people value an economic good (that is, a scarce product or service) now rather than later. If you want to use something that someone else owns, they will want something from you. In the case of neighbors, this will most likely simply be goodwill, or an expectation of a similar lending in the reverse direction. In market transactions, this is called originary interest.

Interest and rent are the same thing. I'll only talk about interest here, but all the aspects pertain to rent as well.

When you pay "Interest", you're paying for more than just originary interest. Interest also covers other costs. It covers the risk that the good willl not be returned. It covers any damage to the good, or, if money, it covers the possibility that the value of money will change over the course of the transaction. There are some types of loans where those risks are so small as to be inconsequential. Originary interest remains.

What about zero-interest loans, such as have been made in Japan in recent years? These loans still have originary interest. Their currency was deflating at the time, so the lenders were willing to be paid back less money plus originary interest, which added up to the same amount they were loaning.

What about a zero-interest loan such as one Muslim might make to another when selling a house? The loan still has originary interest, but it's being forsaken by the first Muslim, just as it was forsaken by the person who sold it to him. The person who built the house originally got screwed. They had to save their money while simultaneously paying interest in the form of rent (no, it doesn't make any sense).

Von Mises, in Human Action, pointed out that people take action to change the future. The past is fixed and cannot be changed. Any action must be in response to a dislike or unease with the anticipated future. This unease exists because a person is applying a value judgement to the anticipated future. What is expected to happen is bad, and what they want to have happen is good. Or, succinctly, people take actions for a reason.

Obviously, individual actions and reasons are always considered by the individual to be for the benefit of the individual. Nobody deliberately harms themselves. Even though the action and reason may be judged by other people to be good or bad for that individual, the individual himself always considers both the action and reason to be beneficial to himself. Altruism is seen by the individual as enhancing her reputation. There are no exceptions to this rule. Even insane people consider what they do to be good.

So, the only time someone is going to judge an action or reason as bad is when they're judging someone else's actions (or if they're judging their own past actions, but I don't want to talk about that here).

You may have noticed that I keep talking about both actions and reasons. That's because I want to consider them separately. It's interesting that some people refuse to consider them separately. Sometimes people criticize free markets because the participants do not have the goal of improving society even though that is exactly what happens. Some people praise actions which are bad for society, such as fair trade, or minimum wage laws, because those actions are taken for a good reason.

These people are poor economists. Even worse, they take that as a compliment. I believe that this is mostly because they do not understand what constitutes good economics. A good economist will not allow the reason for doing something to override the effects of the action itself. I'm not alone in saying this: "Ye shall know them by their fruits" and "The road to hell is paved with good intentions."

Not all economists are worthy of the name. Imagine if anybody in the following set of people called themselves physicists: perpetual motion kooks, flat earthers, Velikovskians, and finally, the intellectual sons and daughters of Newton, Einstein, etc. Unfortunately, there's a lot of pseudo-scientists in the field of economics, and some of them graduated from Harvard, Princeton, and Yale, so a storied college degree is no help.

Criticize economics if you must, but at least take the time to understand that which you criticize!

A primary goal of any two nations at war is to stop the other's international trade. This is without dispute, as there are innumerable instances of naval blockades, or trade sanctions, or sieges. During WWII, Japan did not attack the USA out of the blue; we were blockading them. We currently maintain trade sanctions against various countries that we consider our enemies: at least Cuba, Libya, and (formerly) Iraq.

What does this say about people who want to limit, control, or reduce America's trade with other countries? Without meaning to, they would cause us to treat all countries as our enemies. Even though some of these people are our citizens. Even though some of these people work in our government. Even though some of them have been elected as our representatives. Even though some of them ... are us.

Since I'm too lazy to change my blogging software so it supports a blogroll, consider visiting this Marginal Revolution posting.

Everybody has surely noticed that the price of gasoline has risen by about ten cents in the USA. As one commentator put it, "Still sounds like a rip off to me djf". Hopefully I can explain why the free market is acting the way it does.

When prices are stable, you see certain aspects of the station's pricing policy. Martin's Citgo here in Potsdam will take personal credit. Their prices are accordingly much higher, by about twelve cents per gallon. The Stewart's is usually two cents cheaper than the Mobil across the street. They don't let you pay at the pump. They hope that when you come in to the store, you'll purchase enough to make up for the lower cost of the gasoline.

The first effect you see is a rippling of price increases throughout the community. Different gas stations will adjust to the increase at different times. Nobody wants to gratuitiously raise their prices, because that will send their customers elsewhere. Gasoline is a commodity, and retail sales of gasoline are very competitive. Everyone who raises the price of gasoline has a good reason for doing so.

When a gas station buys a tanker of gas, they pay the same price for every gallon of it. Once they've bought it, the cost is immaterial. That price is history. The price they want to charge for that gasoline is the cost of the next tanker of gasoline. That's why prices in a community will rise quickly, even before the next tanker comes. If a gas station has sold most of their gas at the lower price, they'll have to dig deep to pay for the new tanker at the higher price.

Prices will rise on bad news. No gas station wants to sell cheap and buy dear. If they anticipate that the price that they pay will rise in the future, they'll raise their own prices. The worse the news, the higher the increase. The more uncertainty, the more likely any news will be interpreted as bad news. Even rumors will then cause the price to increase.

Prices fall more slowly. First, a company would prefer to make as much money as possible on every tanker they purchase. Second, the only thing forcing the prices down is their desire to sell more gas at a lower price thereby generating more profit. The fall in prices is a process of discovery: how much will you lower your prices by? Nobody wants to lower them too far too fast. That causes a price war, and lowered profits.

Price-setting is always a gamble, a risk, a guess. You have to buy in the past and sell in the future. Anything can happen in the meantime. Everyone who sets prices takes that into account, and adds a little to cover for it. The more uncertainty, the more they have to add. When there's a war in Iraq, when refineries are having trouble, when Venezuelans are up in arms over their national banking policy, when pipelines burst, they add more. Sometimes a lot more.

I haven't said a word yet about demand. The demand for gasoline always rises in August. For whatever reason people take their road trips during August. Probably trying to get in a vacation before school starts, or trying to take advantage of what is usually the warmest weather of the summer. Demand is going to push the price up as well.

Transportation also plays a part in the price of gasoline. Gas is heavy and needs to be transported. If there's a pipeline, that can keep the cost down substantially. The teamsters used to charge $3 to haul a barrel of oil from Pithole, PA to the railhead a century and a half ago. A pipeline could carry it for $1 per barrel. The teamsters didn't like that and sabotaged the pipeline. The pipeline owners hired armed guards to protect it. If a pipeline serving your area breaks, that's going to substantially drive up the cost of gasoline.

Do you think the price of gasoline is too high? You can do your part to lower it by refusing to buy it at those prices. You can (in essence) pay companies to lower their prices by buying gas from companies that lower their prices first. Frequent a website such as Gas Buddy, which keeps real-time local gas prices.

Continued in The Price of Gasoline 2