By Simon Grey, on January 24th, 2012
In many ways the monetary policy issue is even more important, simply because we are running out of rope on our national debt-addiction rappelling adventure and the floor is still 100′ down. That’s a serious problem — and “gold standards” do not (in fact cannot!) fix it. The only fix that works is to demand and enforce a zero-CPI standard with honest statistics, along with an end to federal government borrowing — period. “Hard money” .vs. “Fiat money” is immaterial; if you permit fraud in the monetary and credit system, as we have, the rest simply does not matter and yet if you put a cork in the frauds and lock up the scammers then you quickly come to the conclusion that allowing a handful of producers of some metal, the majority of which are foreign entities, is the last group you want running your monetary policy!
The Paulites get this wrong and so does Ron Paul himself despite the historical fact that the United States had massive inflationary bubbles and detonations of them during the time it was on the Gold Standard. 1873 anyone (as just one example.)
The real problem in 1873 as with all other similar blowups was the issuance of bogus debt instruments unbacked by anything. In the case of 1873 concentration was in railroads and related construction all financed by long-duration bonds (and therefore subject to high degrees of price risk due to their duration) but which were entirely-speculative and in fact for which there was no actual demand in the economy for the services (transportation to be provided by said railroads) at a level sufficient to meet the intended expense. It didn’t help that we were playing games with our exports (and Europe with its imports) much as China and the US are today, effectively hiding the bubble’s impact for a period of time and allowing it to inflate to ridiculous size. When the over-leveraged positions became exposed the game collapsed and the Long Depression followed. [Emphasis original.]
Denninger correctly notes that a gold standard, in and of itself, is not enough to prevent a bubble of any sort. He also correctly notes that enforcing a zero-CPI standard would fix the current currency mess. However, what he seems to neglect in his analysis is that the real problem is not with the proposed solutions, but the fact that the government has to enact and enforce them.
This then begs the obvious question: given the government’s obvious failures to prevent bubbles by keeping money honest, regardless of the money is metal or digital, why then even bother to put the government in charge of the money supply? They can’t manage it properly when gold is money, and they certainly can’t manage it properly when paper is used as money. Why then trust them with it?
The better solution is to simply allow currencies to freely compete with each other, which will have a strong tendency to ensure that currencies remain sound, strong, and free from inflation. By the way, there is one presidential candidate who has proposed legislation that would do exactly this. We all know who he is.
By Simon Grey, on December 30th, 2011
In Academically Adrift, Arum and Roksa paint a chilling portrait of what the university curriculum has become. The central evidence that the authors deploy comes from the performance of 2,322 students on the Collegiate Learning Assessment, a standardized test administered to students in their first semester at university and again at the end of their second year: not a multiple-choice exam, but an ingenious exercise that requires students to read a set of documents on a fictional problem in business or politics and write a memo advising an official on how to respond to it. Data from the National Survey of Student Engagement, a self-assessment of student learning filled out by millions each year, and recent ethnographies of student life provide a rich background.
Their results are sobering. The Collegiate Learning Assessment reveals that some 45 percent of students in the sample had made effectively no progress in critical thinking, complex reasoning, and writing in their first two years. And a look at their academic experience helps to explain why. Students reported spending twelve hours a week, on average, studying—down from twenty-five hours per week in 1961 and twenty in 1981. Half the students in the sample had not taken a course that required more than twenty pages of writing in the previous semester, while a third had not even taken a course that required as much as forty pages a week of reading.
One of the subtle cultural shifts arising from the education bubble has been how people are inclined to view college. It used to be that people went to college for an education. Now people go to college in order to ensure having a good job later on.* In essence, the role of college has shifted from education to credentials.
As such, it should not be surprising that colleges dumb down both their admission requirements and their curriculum, for the goal is not education. Rather, the goal is giving students customers a piece of paper that says they are smart. This claim doesn’t have to reflect reality in any meaningful way because most students don’t bear the direct costs of their “education.” Therefore, students are considerably more willing to spend their parents’ money and their future income on degrees that become less and less valuable.
Basically, then, the dumbing down of academic standards is proof of the education bubble because the free and cheap money subsidizes marginal students who would otherwise have no business being in college. This subsidy is then seen in the dumbed-down curriculum, for students expect to have something to show for the time and money they’ve put into college, and it’s easier to satisfy customers by giving them a degree regardless of their actual accomplishments.
*One thing that always puzzles me is how parents think that four to six years of extended adolescence is better for their children’s future than having an actual full time job is. But that’s for another post.
By Ajay Shah, on December 27th, 2011
Patrick Chovanec has a fascinating article in Foreign Affairs, titled China’s Real Estate Bubble May Have Just Popped. This is interesting and important from two points of view.
First, bad news for China is bad news for the world economy. We are already in a bleak environment, with difficulties in Europe, Japan, the US, and India. It will not be pretty if China runs into trouble as well. I am reminded of the feeling of carefully watching real
estate in the United States in 2006, with a sense that the future of the world economy was going to turn on how it turned out.
Second, it made me think about real estate in India. As with China, one often sees buyers of real estate in India have the notion that
this is a safe financial asset. This is a questionable proposition. Real estate is perhaps not an asset
class with a positive expected return in the first place; and it is certainly not a convenient asset class with features like liquidity,
transparency, diversification and easy formation of low-volatility diversified portfolios. I find it hard to explain the prominence of
real estate in the portfolios of even educated people in India.
In the article, Chovanec says:
For more than a decade, they have bet on longer-term demand trends by buying up multiple units — often dozens at a time — which they then leave empty with the belief that prices will rise. Estimates of such idle holdings range anywhere from 10 million to 65 million homes; no one really knows the exact number, but the visual impression created by vast `ghost’ districts, filled with row upon row of uninhabited villas and apartment complexes, leaves one with a sense of investments with, literally, nothing inside.
This has not happened in India. So in this sense, the situation in India is not as dire. But his second key message seems uncomfortably
close:
As 2011 progressed, developers scrambled for new lines of financing to keep their overstocked inventories. They first relied on bank loans (until they were cut off), then high-yield bonds in Hong Kong (until the market soured), then private investment vehicles (sponsored by banks as an end run around lending constraints), and finally, in some
cases, loan sharks. By the end of last summer, many Chinese developers had run out of options and were forced to begin liquidating inventory. Hence, the price slashing: 30, 40, and even 50 percent discounts.
Part of this looks familiar. There is a lot of leverage in Indian real estate development and speculation. Real estate speculators and
developers are finding themselves in a bit of a scramble hunting for credit. One hears about very high interest rates being paid by
developers. Other sources of financing are also weak. This reminds me of the dark days before the global crisis, when borrowing by real estate companies was the canary in the coal mine.
If business cycle conditions and financial conditions worsen, the problems of borrowing by real estate developers and speculators will get worse. How might this turn out? Perhaps the borrowers will merely get uncomfortable. Or, a few firms could really get into trouble, and start liquidating inventory. That would have substantial repercussions.
Suppose there is a situation where there are many people who have speculative positions in real estate, but significant selling of
inventory has not yet begun. The longs would then be nervously looking at each other, wondering who would be the first one to sell, to take a better price and exit his position. The ones who sell late would get an inferior price. In such a situation, conditions could change sharply in a short time.
On a longer horizon, I would, of course, be delighted if real estate prices are lower. This would help shift the supply function of
labour, reduce the cost of setting up new businesses, etc. But that’s more about the long-term policy changes, which would remove barriers for converting land into built-up housing, while rising vertically into the sky with FSI in Indian cities ranging from 5 to 25.
By Simon Grey, on December 5th, 2011
From Bryan Caplan:
Many educators sooth their consciences by insisting that “I teach my students how to think, not what to think.” But this platitude goes against a hundred years of educational psychology. Education is very narrow; students learn the material you specifically teach them… if you’re lucky.
Other educators claim they’re teaching good work habits. But especially at the college level, this doesn’t pass the laugh test. How many jobs tolerate a 50% attendance rate – or let you skate by with twelve hours of work a week? School probably builds character relative to playing videogames. But it’s hard to see how school could build character relative to a full-time job in the Real World.
At this point, you may be thinking: If professors don’t teach a lot of job skills, don’t teach their students how to think, and don’t instill constructive work habits, why do employers so heavily reward educational success? The best answer comes straight out of the ivory tower itself. It’s called the signaling model of education – the subject of my book in progress, The Case Against Education.
According to the signaling model, employers reward educational success because of what it shows (”signals”) about the student. Good students tend to be smart, hard-working, and conformist – three crucial traits for almost any job. When a student excels in school, then, employers correctly infer that he’s likely to be a good worker. What precisely did he study? What did he learn how to do? Mere details. As long as you were a good student, employers surmise that you’ll quickly learn what you need to know on the job.
In the signaling story, what matters is how much education you have compared to competing workers. When education levels rise, employers respond with higher standards; when education levels fall, employers respond with lower standards. We’re on a treadmill. If voters took this idea seriously, my close friends and I could easily lose our jobs. As a professor, it is in my interest for the public to continue to believe in the magic of education: To imagine that the ivory tower transforms student lead into worker gold.
What makes the college bubble so problematic is that it is essentially inflationary. College degrees can be considered a form of currency in the labor market, wherein one purchases a salary with not only one’s labor but one’s college education as well. Obviously, this mechanism is not as direct as, say, buying milk at a grocery store, but the effect is similar.
The labor market, then, relies on college degrees to indicate a prospective employee’s fitness for the salary being offered. Certain types of degrees generally pay better than others, certain colleges’ degrees pay better than others, certain grade point averages are worth more than others, etc. Someone who receives an MBA from Harvard while maintaining a GPA of 4.0 will generally earn more than someone who receives an Associate’s degree from ITT Tech while maintaining a 2.0 GPA. This should make sense, as the quality of student varies by institution, degree, and grade, and there are ways to sort this. The college bubble, then, serves as a form of inflation because it distorts the signal that a college has in the labor market.
Basically, as is well known, the college bubble is the result of massive governmental interference in the post-secondary education market. The federal government offers direct subsidies of education costs (e.g. the Pell Grant), and also makes college loans a very enticing offer to lenders by guaranteeing the loans. With direct subsidies and easy credit, prospective students have a very strong incentive to go to college. Furthermore, with this much money on the line, colleges have a very strong incentive to accept more students.
The effects of this bubble, as noted before, are seen primarily in signal distortion. This occurs because employers now have a larger labor from which to select workers. This generally seems like a good thing, since employers can now offer lower wages, but this is not always the case because some potential workers are perhaps not as well-qualified for their position as others. The problem with using college degrees as a qualification is that, at this point, there isn’t enough data to sort the good from the bad. When there were a limited number of college-educated labor candidates, the quality was considerably better since colleges had an incentive to maintain quality control. This is no longer the case because the federal government is paying colleges, indirectly, to simply pass out degrees to young adults with no regards for their qualification.
Thus, the lower wages that have resulted from the increased pool of labor applicants can be thought of as a risk premium. Because there are more college-educated people in the labor supply coupled with increased variance of abilities without there being an increase in the sharpness of the signal generally associated with a college education, and because American labor is tightly regulated with regards to discrimination (particularly as it pertains to firing employees), there is consequently more risk associated with hiring someone because the chance that person a company hires turns out to be a bust, as it were, is considerably greater. Given the costs associated with firing incompetent workers, particularly if they are in a union or minority, employers have an increased incentive to mitigate that risk by offering lower wages.
As such, the most problematic aspect of the college bubble is the consequences that come with signal distortion. Because the supply of college educated labor has increased with a matching increase in demand for said labor, and because a college degree isn’t nuanced enough as a single, there will be an increase in the number of people who are overpaid and an increase in the number of people who are underpaid. This happens because the signal sent by a college degree is roughly the same for everyone who has one.*
Some people will be underpaid because their aptitude is such that they would ordinarily deserve more pay than they are currently receiving but, because it is now more difficult to tell who has what levels of aptitude, they must take a pay cut. The reverse is true for those who are overpaid. Basically, the inflation in the number of students undermines meritocracy, thereby distorting the pay scale. Thus, the current bubble has introduced not only distortion, but market failure on a large scale.
The irony of the current college bubble is that its existence is largely predicated on the belief that a college education makes one more intelligent. This claim is laughable on its face because it does not begin to account for the self-selection bias inherent in this sort of activity. Do students learn because they go to college or do they go to college because they like to learn? This is a crucial question because if the answer is the latter, then it seems likely that those who do go to college would become just as knowledgeable if they lived in a library for four years.
At any rate, the college bubble has had the nasty effect of giving diplomas to those who have no desire to learn, and have undermined the meritocracy that once was a college education, thereby depriving those who are truly above average from an income that would properly reflect this fact. This, then, is the lamentable effect of the college bubble: The attempt to make everyone equal in education has only led to a diminution of standards. We are all idiots now.
* Obviously, a Harvard diploma is still more valuable than an ITT Tech diploma. However, if Harvard’s business school doubles the number of graduates, year over year, the value of a Harvard degree will decline assuming that there is not a corresponding increase in demand for Harvard grads.
By Winton Bates, on July 2nd, 2009
“Reflexivity can be interpreted as a circularity, or two way feedback loop, between the participants’ views and the actual state of affairs. People base their decisions not on the actual situation that confronts them but on their perception or interpretation of that situation. Their decisions make an impact on the situation … and changes in the situation are liable to change their perceptions … . The two functions operate concurrently, not sequentially” (George Soros, “The New Paradigm for Financial Markets”, 2008, p 10).
“Many critics of reflexivity claimed that I was merely belabouring the obvious, namely that the participants’ biased expectations influence market prices. But the crux of the theory of reflexivity is not so obvious; it asserts that market prices can influence the fundamentals. The illusion that markets are always right is caused by their ability to affect the fundamentals that they are supposed to reflect. The change in the fundamentals may then reinforce the biased expectations in an initially self-reinforcing but eventually self-defeating process” (Soros, op cit, p 57-8).
Does George Soros know what he is talking about? The fact that he has operated successfully in financial markets for a long time suggests to me that he might have a few clues about how they work. But I struggle to understand him.
As is the case with many other problems of understanding, I think my problem in this instance relates to definition of terms. What does Soros mean by fundamentals? If a process is eventually self-defeating then it seems to me that this means that it is inconsistent with the fundamentals of the real world – i.e. it is inconsistent with what we know to be true about such things as resource availability, technology or human nature.
When Soros suggests that market prices can influence the fundamentals he may have something less fundamental in mind such as widely accepted perceptions of investors and credit providers about particular markets or the wider economic situation. It seems plausible that a widespread view that housing was a very safe investment, for example, could be reinforced if house prices began to increase more rapidly and if credit providers perceived that this made lending more secure. Under some circumstances that might, perhaps, result in a self-reinforcing process of increases in house prices that would eventually become self-defeating, for example because increasing numbers of people might decide that they would be better off renting rather than owning a house.
If this is what Soros means by reflexivity, does it help to explain the current financial turmoil? In explaining his super-bubble hypothesis Soros writes:
“The belief that markets tend toward equilibrium is directly responsible for the current turmoil; it encouraged the regulators to … rely on the market mechanism to correct its own excesses. The idea that prices, although they may take random walks, tend to revert to the mean served as the guiding principle for the synthetic financial instruments and investment practices which are currently unravelling” (Soros, op cit, p 102).
It seems to me that the second part of that statement, relating to synthetic financial instruments, may help to explain the current financial turmoil. With the benefit of hindsight it is apparent that the world economy is suffering from, among other things, the development of a self-reinforcing belief system which led many financial firms to over-value synthetic financial instruments.
However, the first part of Soros’ statement doesn’t make sense. Regulators have not relied on the market mechanism to correct its own excesses. The current turmoil is partly a consequence of a history of financial firms being bailed out by regulators on the grounds that they were too big to be allowed to fail. George Soros is on much firmer ground when he recognizes that most reflexive processes involve an interplay between market participants and regulators (p77).
Hopefully, the regulatory environment that emerges from the current turmoil will recognise that participants in financial markets are human. It should not surprise anyone that when financiers are given incentives to behave imprudently they tend to act accordingly.
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