Category Archives: Uncategorized

About that Economic Inequality

I address this essay to two groups. One group is those among the liberty movement, who believe that there’s nothing wrong with inequality. These are often Objectivists, who unknowingly defend a regime that artificially suppresses working people. The other group is those among the Left who still call themselves liberals. They say they don’t like inequality, but nevertheless continue to support this regime, and they often demand more of its interventions.

I am talking, of course, about our regime of the Federal Reserve and its zero-interest policy.

I have written before about how falling interest rates have pushed up the prices of stocks, bonds, and real estate (also artwork, antique cars, etc.) This is seemingly good for those who own capital assets (it’s not, but go try to tell someone it’s not good that his house doubled). At the same time, falling interest causes falling wages if not mass layoffs.

In other words, the Fed drives down interest. This drives up asset prices and drives down wages. The minority who own assets seemingly get richer (an illusion) and everyone else suffers.

That is not the only way that falling interest rates cause inequality. Nor is it the only way that it targets certain groups for greater harm than it brings to others. Consider that zero interest makes it impossible to save. I don’t mean hard to save. I don’t mean excuse-making for lazy people who don’t plan for their futures. I mean impossible in the full context. Let me explain.

When I started my career in 1990, the standard advice was to set aside 10% of your salary and put it in the bank. By the time you reached 65, you would have a big nest egg. The key to this strategy was earning interest. Every bank had brochures showing that by age 65 most of your nest egg would be the accumulation of compounded interest.

Let’s put it in human terms. Suppose you’re a young worker, just starting out. You make the median income of $52,000 a year. You set aside 10% of your gross paycheck before tax. Over 45 years, your salary set-aside adds up to $234K.

Back in 1990, a 1-year Certificate of Deposit paid 8.1 percent. At this rate, you would have about $2.4M by the time you retired at age 65. Over 90% of that total is the compounded interest.

However, today, the same 1-year CD yields less than ¼ percent. At this scant rate, you can expect to have only $246K. Over your entire career. Of that sum, just $12,000 is interest. Let that sink in.

Needless to say, $246K is not enough to live in retirement. If you can’t keep working, you’re going to have to go on the dole. And this leads us to an underappreciated point.

Business consultants, writers, deal makers, and many other white-collar professionals can easily continue to work for 10 or 20 years past the conventional retirement age. So long as you’re healthy, why not keep working? Aside from the money, it gives you something to do, keeps your mind engaged, and you’re contributing to society.

However, there are many jobs where you cannot keep working. Think about brick layers, plumbers, and roofers. These jobs both take a toll on the body and demand more than most 75-year olds can give. Whereas a business consultant may continue to grow his network and expertise even as he gets older, a worker in a physical job is slowing down as well as wearing out.

There is never a good reason for government to intervene and attempt to prevent people from experiencing the consequences of their actions (whether good or bad). Many of those crying about income inequality, just use it as a rationalization to move America down the socialist road.

That said, there is an inequality problem. It is not due to lack of government intervention, as the socialists would have you believe. It cannot be cured by yet more taxes and interventions. Its cause is intervention. I refer to the most pernicious and least-appreciated kind of intervention.

Monetary policy.

You Didn’t Build That!

“There is nobody in this country who got rich on his own — nobody.” – Elizabeth Warren, campaign speech 2011

“If you’ve got a business – you didn’t build that. Somebody else made that happen.” – Barack Obama, campaign speech 2012

The Left is clear about their view. You do not get credit, and you do not own your business by right. When the government taxes you, taxes you some more, regulates you, and licenses you, it has the right. Because you didn’t build that.

As with so many issues, the Right seemingly opposes the Left. Certainly, there was outrage at the outright, open expressions of communist ideology from Warren and Obama. But let’s drill a bit deeper. Let’s look at a litmus test to see if conservatives really believe that you own your business. Or perhaps they accept that you are a mere steward of the people’s resources, for the good of the people.

Can you hire or not hire anyone? After all, if you did build that, then it’s yours by right. And as a matter of right, you can decide who to hire. Right?

Not so fast. Here is what President George Bush, considered to be a conservative, said at the signing of the Americans With Disabilities Act in 1990.

“It will guarantee fair and just access to the fruits of American life which we all must be able to enjoy.”

This is a law forcing businesses to do what they did not agree to do. Who built that business again, Mr. Bush? But this conservative does not think that way. He thinks of it as “access” to the “fruits of American life.”. Access to what? Fruits grown by whom, Mr. Bush??

He continued:

“And then, specifically, first the ADA ensures that employers covered by the act cannot discriminate against qualified individuals with disabilities.”

Clearly a mere steward has no right to hire based on his own preferences.

Then he made it even more clear:

“Second, the ADA ensures access to public accommodations such as restaurants, hotels, shopping centers, and offices.”

Who built that? No matter! Mr. Bush declared your business to be “public accommodations.” And in his view, it’s the role of the government to grant people “access”—to force you to give it to them. How far is the view of Mr. Bush from that of Ms. Warren and Mr. Obama?

OK who else, aside from the Conservatives and the Left, thinks you didn’t build that? Consider the following recent dialog:

“If we discriminate on the basis of religion, to me, that’s doing harm to a big class of people.” – politician
“The Jewish baker should have to bake the cake for the Nazi wedding?” – Moderator
“That would be my contention.” – politician

The politician is, of course, Libertarian Gary Johnson. He does not necessarily think that you built that business any more than Bush thinks it or Obama thinks it. Johnson sees the question in terms of whether “we” should discriminate.

Who is this “we”? One is left to conclude that he means those people who really built your business. The public, presumably.

The Left may be more brazen, more willing to go there, more shameless in taking your business away from you. First in theory, morally, by declaring that you are not a creator or hard worker or whatever it takes to build a business. The in practice, by setting no limits to taxation, regulation, permits, and compliance.

However, the Right and even the Libertarians are on board the same boat. They may stick to humanitarian imagery. They typically prefer to couch their desire to control your business in more palatable terms. But government control of your business stinks all the same.

At root, it necessarily comes back to the same principle. The only way to justify coercing you to “grant access”, the only justification to force a Jewish baker to serve a Nazi cake, is on grounds that it’s not really yours.

You didn’t build that, so shut up and let the government manage it for the benefit of others!

 

This essay is a followup to my previous post, Antidiscrimination Law.

Antidiscrimination Law

“We need to make it illegal for companies to discriminate.” This applies to employees, and even customers.

Well, either such discrimination—really bigotry—is good for the company, or it isn’t. Either companies benefit from racial or gender preferences in employees, or they don’t. Either bakers benefit from turning away paying customers who want cakes, or not (without discussing those rare cases where someone wants to force the baker to bake a cake with a hateful message on it).

If you believe that corporate decisions made by bigotry are good for companies, then that would seem to justify laws to ban it. Well, it would justify it if you believe that the proper purpose of law is to force people to act against their own interest for the sake of someone else’s good…

…Wait, why is it in the interest of employers to fire the blacks (to name one legally protected group)? If you want go there, then realize that there is no way to make this case without promoting overt racism. Think about it. Take as long as you need.

Perhaps you believe that corporate decisions made by bigotry are not good for companies. Then why the need for a law at all? Do you seriously argue that people need to be forced to use cars rather than horses, to use computers rather than do their books using paper ledgers, and to live in houses rather than be exposed to the elements? Self-interest is its own motivator.

And if the purpose of this law is to help companies, how do you justify fining them, punishing them, and or even bankrupting them?

Antidiscrimination law is entirely uncontroversial. It’s universally supported by the Left, nearly universally on the Right, and even some Libertarians promote it. Yet it’s based on logic so flawed that in a rational culture that actually taught logic in school, middle school students would all be able to write essays explaining why such law is contradictory.

Everyone supports it, yet it’s simple to show it’s bad. Hmm, think about that for a while.

Regulation, Thy Nature is Flawed

Regulation has several inherent flaws.

1. One agency acts as legislative, judicial, and executive branch. It makes the rules, decides who is breaking them, and punishes offenders.

2. Regulation is based on the doctrine of prior restraint. Instead of retaliating by force against criminals, the government initiates the use of force against innocents–because they might commit a crime. So it criminalizes non-crimes.

3. Regulation forces businesses to prove a negative–often at great expense.

4. It ossifies the status quo. It is easy (well relatively) to get permission to do the same thing that everyone else is doing. Much harder to get permission to change how business is done.

5. It is an engraved invitation for cronies to use regulation and regulators to suppress competitors.

6. It gives the unscrupulous a place to hide. Bernie Madoff was highly regulated. Regulation didn’t stop him.

7. It prevents startups from forming in the first place (doubly so because raising capital is itself highly regulated, and startup founders don’t typically have the capital and legal sophistication to navigate the regulations).

8. Regulation makes it impossible to know in advance what is legal and what is not. This is because regulation attempts to control actions A, B, and C in an indirect way to prevent crime X. So it can make arbitrary distinctions between two essentially similar things–but one is illegal.

9. Regulation makes it illegal for you to do something that someone else can do legally.

Should Government Give Us the Infrastructure?

An argument against absolutely free markets comes up often. What about so called natural monopolies? So called infrastructure (e.g. sewage plants) have high barriers to entry, and are a challenge to true competition. Therefore if left to private companies, they would become bad monopolies. So it is best for government to provide them.

I think there are answers on several levels.

  1. Moral. The argument is saying that men need to be forced, like brutes. Horses will do no work unless harnessed, and led around by a bit in their mouth (if not whipped). Haven’t we proven beyond a shadow of a doubt that this is wrong?
  2. Economic. The question of how men coordinate their actions–how they CAN coordinate–is one of the major questions of economics. The answer is: each must pursue his own interest, which in an economics context means profit. Pursuit of profit and only this pursuit leads men to work together. Adam Smith may have used an unfortunate phrase “the invisible hand”. I describe in my dissertation the mechanics of it. But no matter how you slice it, economics is about people coordinating based on their individual interests and individual knowledge. Central planning is about the negation of coordination, and the destruction of economics as such.
  3. Scope. There is an analogy to when people demand of philosophy to explain the latest observation from astronomy or a particle accelerator. It is outside the scope of philosophy. It is not the job of the philosopher to answer what it means when you see a super massive black hole. Similarly, it is not the job of the economist to envision every business model in a free market. It is the job of a million entrepreneurs, each developing his own unique business model. Indeed, economists often make lousy entrepreneurs.
  4. The 8th grader. I love using the standard of a precocious 13 yr old. “So you’re saying that government is smarter than the people, and only government is smart enough to figure out how to build a sewer!?”

Why Does the Left Support Wall Street?

The rhetoric from the Left is intransigent in its denunciation of wealth. As long as someone is wealthy, there is inequality. This is because there has always been and will always be someone who is poor. So the very existence of a rich man serves as a rebuke to the Left’s worldview, and a fly in the social justice ointment.

However, Leftists in power behave differently than their rhetoric would lead us to expect. They enact legislation and regulation which actually helps enrich crony businesses, such as big banks. The common refrain is that these politicians are corrupt, and on the take. Wall Street is simply buying their favor.

While this is true to some extent—certainly Wall Street spends a lot on lobbying—it’s not a satisfying answer. How do we fully explain the seeming anomaly between ideas and action on the Left?

It is no anomaly at all. To see why, look at it from the Left’s point of view. It has to be frustrating when the voters reject the policies of Marxism. Unlike in many other parts of the world, the American people do not hate wealth—not yet. If you were a Leftist, how would you go about changing this?

Even today, many Americans if not most of them, feel at a basic gut level that if you work hard you can get rich, and you deserve it. The Left has to find a way to undermine this. The Left wants to migrate Americans to the attitude held in socialist countries: the feeling that if someone is rich then he must be on the take.

If you wanted to devise a strategy to get the population on board your socialist agenda, I can think of no better way than to create a class of very rich people who get their riches off the backs of the people. Create thousands of real-life fat cats whose villainy is infamous. Show the people that this is what it means to be rich: to be on the take. That the rich do not produce, but amass a fortune at the expense of others, at your expense. Put that in the public spotlight.

Once the voters believe this, deep down in their hearts, it’s over. The free market is done. Stick a fork in it. Support for the rights of property or contract will fade away. Then, the path is paved for some kind of socialist takeover and totalitarianism.

Efficient Malpractice

Take the notion of the efficient market. What does that mean? Today, hordes of people are coming out of economics and finance majors believing an absurdity. Yes, I said absurdity. They think that, if the market is efficient, it’s impossible to beat the average investor. This is based on the premise that stock prices (or commodity prices, bond prices, etc.) always incorporate all relevant information.

This means that it’s impossible to know something that others don’t know.

If that were true, then entrepreneurs could not exist, and central planning committees should decide how to best spend the collectivized resources. But it’s not so.

What everyone knows is sometimes false. For example, at one time people thought the world was flat. No matter how unpopular it may be, it’s always possible to discover the truth. When this happens in regards to the value of an asset, the discoverer can make money. This fact should be uncontroversial.

So how did it become controversial?

Part of the answer may be that the philosophy departments have long ago defaulted. It is accepted in the mainstream that knowledge is out there, literally in the universe. In this view, prices are right out there with knowledge.

Information, and more importantly understanding, only incurs in here—in your head. It takes an individual mind to process information, and form an understanding. This means that there is no direct transmission process from information to prices. It is a process of each individual mind coming into contact with the information, deciding for itself whether it even agrees and if so, what importance to ascribe to it. And then, and only then, whether to buy or sell.

Case in point, I can say that the information is out there that all fiat paper currencies eventually collapse. I have put some of that information out there myself. Does that mean that all market participants sell their fiat paper currencies and bid up the price of gold to infinity (or permanent backwardation) instantly? They haven’t done so yet.

Some people know how fiat currencies fail, but most people don’t. Price is set at the margin, so we can say that the marginal gold trader doesn’t know about fiat currencies. Or, it could be that he doesn’t care. The marginal seller could be a gold mining company with a lot of dollar-denominated debt. It will not stop selling gold, no matter what the CEO believes. If he does not sell the majority of the mine’s output, the company will be in default and the creditors will take over. Different actors in the markets have different motivations, let alone different knowledge.

So what on earth could efficiency mean? What could the original intent of this word have been?

There was a time, not too long ago, when a commodity could have a different price in different markets within a city. Communication was slow, and transportation even slower. Economists of the day were aware of this, and concerned about it. If wheat could be had for 4 shillings in the north of London, and 3 shillings in the east end, then many people were making an obvious mistake. Buyers in the north were overpaying, and sellers in the east were accepting too little.

Distributors entered the market. They developed ways of knowing the price in different places, and sought to profit by buying where goods were cheaper and selling where they were more expensive. The result of this activity was a price closer to 3 ½ shillings in both north and east London.

Suppose that wheat was trading higher in Scotland, but cheaper in France. This is the same problem, on a larger scale. It’s nothing that can’t be fixed by adding telegraphs, railroads, and boats.

Similarly, one might observe a wide spread in wheat. The bid might be 2 ¼, but at the same time the ask is 3 ¾. The market maker comes into the wheat market, ready to buy at the bid and sell at the ask. In so doing, he and his competitors narrow the spread. It could become a bid of 3 and an ask of 3 ¼.

Another kind of spread occurs across calendar time. Suppose the wheat harvest comes in, on August 1. The price of wheat collapses for a while. But bakers will still want this commodity next month, and every month through July next year. By late Spring, the price of wheat skyrockets. So warehousemen enter the market, able to buy spot wheat and sell forward contracts for future delivery.

Economists of the day might say that the wheat price reflected all available information. This does not mean that 3 ¼ shillings is right in any intrinsic sense. These arbitrageurs are not supposed to be omniscient. In fact, all they are doing is closing the price gaps they find, and earning a small profit to do so.

This is the original idea of efficiency. It had to develop, as these market innovations were occurring. Note that these have nothing to do with the belief that the current price represents the absolute or universally right price for wheat. Perhaps wheat demand will soon drop off due to a new diet. Perhaps the price will rise due to an insect working its way west out of Russia. These vague concerns have nothing to do with the arbitrageurs.

Efficiency in this original sense is a concept pertaining to the losses one will take to trade in and out, to buy at one’s preferred location, to buy when one chooses, etc. Efficiency exists when a variety of arbitrageurs are active in the market, able to close gaps of distance, spread, or even calendar time.

The arbitragers can be said, in an abstract sense, to be using information to impact prices. However, one should look past the abstract idea to the mechanics of where the rubber meets the road. The simple processes of arbitrage cannot provide the sort of guarantees in which today’s efficient market theorist believes.

The modern idea of efficient markets switches to an entirely different kind of actor. The speculator is no arbitrageur. The distinction is important, because arbitrage is a powerful lever than can narrow any spread. Speculation cannot do what arbitrage does. Speculation, subject to uncertainty, overshooting, undershooting, and risk, is a generally weaker and always inconsistent force than the lever of arbitrage.

Suppose Joe the speculator thinks that the price of wheat will collapse, because of the paleo diet. He and his buddies may sell wheat short, taking down the price. At the same time, Jen the speculator thinks that the price will rise due to some insect in Russia which is eating wheat. So when Joe is about done selling wheat down, she and her friends begin buying it up. Perhaps Joe and his buddies get squeezed, and are forced to buy wheat at a higher price, and their buying pushes up the price even further.

The result is that the price moves around chaotically. At no point in this maelstrom can we say that the price incorporates all information. Sure, Joe and his buddies have pushed the price down based on their diet theory. Then Jen and her friends push it up, leading Joe and his friends to (unintentionally!) push it up further. Next, it may be too high and now Bob and company can short wheat once more, to get the price down to what Bob calculates is the point where supply meets demand. Jen and her friends could get stopped out, and so the price undershoots to the downside.

The wheat market is not like a pond coming to equilibrium after you toss in a pebble. It can often be more like a pinball machine, with lots of automatic bumpers and actuators slamming the ball this way and that.

It should be noted that there is an important asymmetry between selling short and buying long. Short sellers have the risk of unlimited price rises, but can only make a finite amount when the price drops. They will therefore tend to be timid, and only enter for short periods of time.

There is no way to say that speculators make prices perfect—or make markets efficient—in according with the information they trade on. Unlike arbitrage, speculation cannot guarantee any particular market outcome. It involves numerous risks (sometimes lopsided), uncertainty, doubt, incomplete understanding, and many other challenges.

When reading any economics work (including mine!) you should strive to understand the meaning, nature, and consequences of the ideas. If something is said to be true, ask how that is so. Who would have to do what in order for it to be so? Look at real markets, and ask yourself is the theory working out in practice, or do you observe the exact opposite of what the theory predicts?

Sometimes a writer may not be as clear as he could be, especially if he thinks a relationship is obvious or takes a word or concept for granted. Other times, the problem may be that his choice of words is imprecise. No matter what, never fail to drill down, ask deeper questions, and look beyond the mere word to the truth of how markets work.

An efficient market is one which maximizes the marketability of the goods or securities traded in it. The higher the marketability, the lower the costs of doing business such as getting into and out of a good. An efficient market is one with the minimum possible spreads: bid-ask, geographic, calendar, brokerage commissions, etc.

An efficient market is not omniscient. The concept is closer to frictionless. A car with frictionless bearings does not guarantee you will drive to the right destination. It simply drives with the lowest possible fuel bill.