Section I: After expounding his own theory, in this next chapter, as well as in the Appendix that follows it, Keynes criticizes what he calls the classical theory of interest. This theory he has trouble stately precisely, for lack of "an explicit account of it in the leading treatises of the modern classical school." Not the adjective "modern": Keynes is referring mainly to Marshall and Pigou, whose works I have not read.
Still, Keynes manages a summary:
It is fairly clear, however, that this tradition has regarded the rate of interest as the factor which brings the demand for investment and the willingness to save into equilibrium with one another. Investment represents the demand for investable resources and saving represents the supply, whilst the rate of interest is the “price” of investable resources at which the two are equated. Just as the price of a commodity is necessarily fixed at that point where the demand for it is equal to the supply, so the rate of interest necessarily comes to rest under the play of market forces at the point where the amount of investment at that rate of interest is equal to the amount of saving at that rate.
He notes that "the ordinary man", who was "brought up on the traditional theory" believes: "that whenever an individual performs an act of saving he has done something which automatically brings down the rate of interest, that this automatically stimulates the output of capital." He also believes that this "takes place without the necessity for any special intervention or grandmotherly care on the part of the monetary authority." Yet: "the analysis of the previous chapters will have made it plain that this account of the matter must be erroneous."
Let's try to unpack this paragraph a bit. First, it's characteristic of Keynes to criticize a common sense approach to economics. Clearly common sense is not infallible, but it is curious how often Keynes's thought tends toward paradoxes. In this case, the man in the street is correct: an increase in savings will have the tendency to lower the rate of interest, thereby increasing investment, which assists in the output of capital. As savings increases, lenders have a larger pool from which to borrow; this competition among savers drives down the rate of interest. In addition, this competition occurs--or would occur--on the open market. The grandmotherly care of the central bank, on the other hand, distorts the rate of interest by increasing the money supply. This lowers the rate of interest, true, but it does so without demanding an increase in savings; hence it leads to malinvestment in certain sectors of the economy.
Returning to Keynes: "The independent variables of the classical theory of the rate of interest are the demand curve for capital and the influence of the rate of interest on the amount saved out of a given income; and when (e.g.) the demand curve for capital shifts, the new rate of interest, according to this theory, is given by the point of intersection between the new demand curve for capital and the curve relating the rate of interest to the amounts which will be saved out of the given income." We are told that this is nonsense. For a shift in either curve will necessarily cause income to change. He then walks us through an example to demonstrate that the classical theory must be corrected to account for changes in income. The chart he uses can be seen here.
The general idea is that the rate of interest is determined by the income: "The traditional analysis has been aware that saving depends on income but it has overlooked the fact that income depends on investment, in such fashion that, when investment changes, income must necessarily change in just that degree which is necessary to make the change in saving equal to the change in investment." Even having read this far along in his book, I confess confusion as to this aspect of his theory.
Granted that a change in income could alter the rate of savings, and therefore alter the interest rate, it does not follow that, if I increase my savings out of my unchanged stream of income, I will somehow see my salary reduce--or vice versa. If the investment proves propitious, and allows business to produce more goods at a lower cost, I can purchase these; this redounds to my benefit, but it has no effect on my income. And, in fact, the increased purchasing power is not a short-term benefit.
I have glanced over a matter of some importance. When faced with the notion that the money supply ought to remain constant, so that lending and borrowing can be properly coordinated by the market, Keynes notes: "The wild duck has dived down to the bottom — as deep as she can get — and bitten fast hold of the weed and tangle and all the rubbish that is down there, and it would need an extraordinarily clever dog to dive after and fish her up again.” Unfortunately, this is hardly an argument. It would have been more interesting for him to analyze what would happen if the money supply was kept constant.
The conclusion of this section--the only one in this chapter--is very important, so I will quote it at some length:
For the economic principle, on which the practical advice of economists has been almost invariably based, has assumed, in effect, that, cet. par., a decrease in spending will tend to lower the rate of interest and an increase in investment to raise it. But if what these two quantities determine is, not the rate of interest, but the aggregate volume of employment, then our outlook on the mechanism of the economic system will be profoundly changed. A decreased readiness to spend will be looked on in quite a different light if, instead of being regarded as a factor which will, cet. par., increase investment, it is seen as a factor which will, cet. par., diminish employment.
Here we have Keynesianism in a nutshell. Consumption is the engine which drives the economy. Reducing one's consumption leads to diminishing employment. As George W. Bush explained after 9/11, Americans ought to go to malls to spend money so as to stimulate the economy. Denigrated is the role played by the saver, who allocates funds for capital investment so as to extend the productive process, which provides the things we then consume.
Appendix: Since most of this section deals with extended quotations from Marshall, Pigou and Ricardo--as well as commentary from Keynes--I will refrain from commenting on this section. I did notice, however, that our author was familiar with the theory of interest of Ludwig von Mises as well as F. A. Hayek, who was a good friend of Keynes.
We've made far too many digressions into the realm of Austrian theory to pardon another one, but interested parties can discover the time-preference theory of interest in Mises's Theory of Money and Credit, which was restated in his magnum opus, Human Action, particularly in Chapter XIX.
Saturday, February 19, 2011
Tuesday, February 15, 2011
Timorous Tyrants
The Gitche Gummee Gamut is shutting down. I had sent in one additional column to my editor, so I'll post it here. It's unfortunate that the website didn't last very long. Selfishly, I appreciated the wider audience; and as an exceptionally lazy writer, a weekly deadline proved useful to my productivity.
But there's another reason the event is unfortunate. All politics is and ought to be local. We like to obsess over whichever bozo will take over the executive branch, but aside from ruining everything, a president is mostly useless. On the other hand the local school board can influence the education of the children who reside in the district--at least in theory. Anyone can write editorials about national politics--I know, because I do it. But to cover the minutiae requires diligence and a drive I can only vaguely fathom.
To a large extent, newspapers have abdicated their responsibility to the local communities; their inevitable destruction is well merited. Still, we'll miss something when the newspapers have gone away; it remains far from clear whether or not the Internet can and will fill this void--though my pessimistic prognostication is that it will fail to do so.
Anyway, here's a rosy column to warm your hearts:
"There are three basic ways to win obedience: by force, by buying consent with wealth, and by persuasion. Each of these three leads us to another level (military, economic, or intellectual) outside the political level." - Carroll Quigley, Tragedy and Hope
It should always be remembered, both by the rulers as well as the ruled, that all government depends on the consent of the governed. As our philosophers tell it, this does not require the threat of force, but in the real world, the implicit danger of violence is ever lurking, cajoling the citizenry into handing over consent. If this be doubted, try avoiding paying one's taxes. Unless one is politically well-connected, the government will force the taxpayer to consent to pay every last penny.
Good government tries to rule by persuasion. In the long-run, any other foundation is unstable. This is especially so when it comes to government by force. Maintaining a semblance of order requires drastic action without regard to ethical sensibilities. Thus Robespierre guillotined his fellow countrymen with impunity, and Stalin imprisoned millions of unfortunate "wreckers". Buying consent with wealth may seem a better option, but this too has its drawbacks. The main problem with this approach is that the government has no wealth of its own; anything it attains must be appropriated from the citizenry. Therefore, only a small portion thereof—what Angelo Codevilla dubbed the ruling class—can benefit from the pilfering. Consent bought can only come at the expense of content stolen from someone else. A witty saying of Frederic Bastiat's is relevant here: "The state is that great fiction by which everyone tries to live at the expense of everyone else."
For a good, which is to say, limited, government, persuasion is not terribly difficult. But if government intends to grow, it must depend on the people remaining ignorant of the harm being done to them. Thus trusting souls may have believed that the bailout of the bankers was for the good of the republic. But while the executives of Goldman-Sachs will no doubt consent to legislation from which they benefit so handsomely, it takes only a little bit of skepticism for the commoner to see that he is no better off than he was before--rather the opposite, probably. From the prospective of those in power, it would have made more sense to have paid off everyone's mortgage. It would also have been cheaper. But the complexities of our fraudulent banking system prevented those who wished to maintain the charade from taking this step. In return for the postponement of a greater recession, the elites gave up an opportunity to reinforce the always shaky consent of the governed.
While we should not discount the prospect of a demagogue rising to give hope to the masses—or, I should say, an effective one, since Obama lacks the gravitas to be a competent demagogue—I want to examine a less obvious route. So long as the people remain insensible to the harm caused to them by their own government, the elites may continue to rule, however tenuously. Hence the need for propaganda, to ensure that the truth must compete against the noble lies of the government. Previously in this space we've examined how the metrics used by the government to gauge the health of the economy have been willfully distorted over time to understate inflation and unemployment and to boost GDP. This is an excellent example of the sort of propaganda which benefits the government.
This approach works well, but for one thing. The Internet has leveled the playing field, reducing the influence of propaganda. These distortions of which I speak have been thoroughly documented on the web. Not for nothing, then, was there talk of an Internet kill switch, recently put into practice, with some success, by the Egyptian authorities during their recent revolution. Hence legislation is again being introduced into the U.S. Senate to inhibit the free exchange of ideas over the web. The supporters of the legislation will no doubt insist that they would only shut down the Internet for reasons of national security. At this point, terrorism is invoked to justify the fondling of children, the torturing of prisoners, the invasion of foreign countries, the indefinite detainment of suspects, as well as other violations of our Constitution, so I'd suggest taking the reasoning with a sizable grain of salt.
As Gary North has pointed out, shutting off the Internet will severely cripple economic productivity. This will cause even more unrest in the masses, so if the Internet is shut off, it will only happen temporarily. Moreover, once the Internet is restored, the threat, such that it is, will reemerge. From the perspective of the rulers, it would be more helpful if the government could simply whisk away a few of the leaders of any potential revolts—PATRIOT ACT them, so to speak, indefinitely. But, as we saw when the government went after Julian Assange of Wikileaks, even this does nothing to obstruct the dissemination of information; that of his organization become readily available on mirror sites all across the world.
I remain very much the pessimist about the future of our country. Conventional wisdom insists that, since the truth is more readily available on the Internet, it will help restore the lost liberty of the people. Yet there is no evidence that people care much for liberty—or truth. There is more than enough information available now to demonstrate the wretchedness of our government. Still, the people remain insensible.
However, in a sense, the revival of the legislation to shut down the Internet is a good sign for libertarians. This is true, not simply because, cut off from a steady supply of pornography and celebrity gossip, the rabble may become roused from its stupor. It is also because the leaders are revealing the extent of their fear of the people. While this may not restrain them from acting against us, it may cause them to overreach. The prospect of a third American revolution is not altogether dim.
But there's another reason the event is unfortunate. All politics is and ought to be local. We like to obsess over whichever bozo will take over the executive branch, but aside from ruining everything, a president is mostly useless. On the other hand the local school board can influence the education of the children who reside in the district--at least in theory. Anyone can write editorials about national politics--I know, because I do it. But to cover the minutiae requires diligence and a drive I can only vaguely fathom.
To a large extent, newspapers have abdicated their responsibility to the local communities; their inevitable destruction is well merited. Still, we'll miss something when the newspapers have gone away; it remains far from clear whether or not the Internet can and will fill this void--though my pessimistic prognostication is that it will fail to do so.
Anyway, here's a rosy column to warm your hearts:
"There are three basic ways to win obedience: by force, by buying consent with wealth, and by persuasion. Each of these three leads us to another level (military, economic, or intellectual) outside the political level." - Carroll Quigley, Tragedy and Hope
It should always be remembered, both by the rulers as well as the ruled, that all government depends on the consent of the governed. As our philosophers tell it, this does not require the threat of force, but in the real world, the implicit danger of violence is ever lurking, cajoling the citizenry into handing over consent. If this be doubted, try avoiding paying one's taxes. Unless one is politically well-connected, the government will force the taxpayer to consent to pay every last penny.
Good government tries to rule by persuasion. In the long-run, any other foundation is unstable. This is especially so when it comes to government by force. Maintaining a semblance of order requires drastic action without regard to ethical sensibilities. Thus Robespierre guillotined his fellow countrymen with impunity, and Stalin imprisoned millions of unfortunate "wreckers". Buying consent with wealth may seem a better option, but this too has its drawbacks. The main problem with this approach is that the government has no wealth of its own; anything it attains must be appropriated from the citizenry. Therefore, only a small portion thereof—what Angelo Codevilla dubbed the ruling class—can benefit from the pilfering. Consent bought can only come at the expense of content stolen from someone else. A witty saying of Frederic Bastiat's is relevant here: "The state is that great fiction by which everyone tries to live at the expense of everyone else."
For a good, which is to say, limited, government, persuasion is not terribly difficult. But if government intends to grow, it must depend on the people remaining ignorant of the harm being done to them. Thus trusting souls may have believed that the bailout of the bankers was for the good of the republic. But while the executives of Goldman-Sachs will no doubt consent to legislation from which they benefit so handsomely, it takes only a little bit of skepticism for the commoner to see that he is no better off than he was before--rather the opposite, probably. From the prospective of those in power, it would have made more sense to have paid off everyone's mortgage. It would also have been cheaper. But the complexities of our fraudulent banking system prevented those who wished to maintain the charade from taking this step. In return for the postponement of a greater recession, the elites gave up an opportunity to reinforce the always shaky consent of the governed.
While we should not discount the prospect of a demagogue rising to give hope to the masses—or, I should say, an effective one, since Obama lacks the gravitas to be a competent demagogue—I want to examine a less obvious route. So long as the people remain insensible to the harm caused to them by their own government, the elites may continue to rule, however tenuously. Hence the need for propaganda, to ensure that the truth must compete against the noble lies of the government. Previously in this space we've examined how the metrics used by the government to gauge the health of the economy have been willfully distorted over time to understate inflation and unemployment and to boost GDP. This is an excellent example of the sort of propaganda which benefits the government.
This approach works well, but for one thing. The Internet has leveled the playing field, reducing the influence of propaganda. These distortions of which I speak have been thoroughly documented on the web. Not for nothing, then, was there talk of an Internet kill switch, recently put into practice, with some success, by the Egyptian authorities during their recent revolution. Hence legislation is again being introduced into the U.S. Senate to inhibit the free exchange of ideas over the web. The supporters of the legislation will no doubt insist that they would only shut down the Internet for reasons of national security. At this point, terrorism is invoked to justify the fondling of children, the torturing of prisoners, the invasion of foreign countries, the indefinite detainment of suspects, as well as other violations of our Constitution, so I'd suggest taking the reasoning with a sizable grain of salt.
As Gary North has pointed out, shutting off the Internet will severely cripple economic productivity. This will cause even more unrest in the masses, so if the Internet is shut off, it will only happen temporarily. Moreover, once the Internet is restored, the threat, such that it is, will reemerge. From the perspective of the rulers, it would be more helpful if the government could simply whisk away a few of the leaders of any potential revolts—PATRIOT ACT them, so to speak, indefinitely. But, as we saw when the government went after Julian Assange of Wikileaks, even this does nothing to obstruct the dissemination of information; that of his organization become readily available on mirror sites all across the world.
I remain very much the pessimist about the future of our country. Conventional wisdom insists that, since the truth is more readily available on the Internet, it will help restore the lost liberty of the people. Yet there is no evidence that people care much for liberty—or truth. There is more than enough information available now to demonstrate the wretchedness of our government. Still, the people remain insensible.
However, in a sense, the revival of the legislation to shut down the Internet is a good sign for libertarians. This is true, not simply because, cut off from a steady supply of pornography and celebrity gossip, the rabble may become roused from its stupor. It is also because the leaders are revealing the extent of their fear of the people. While this may not restrain them from acting against us, it may cause them to overreach. The prospect of a third American revolution is not altogether dim.
Monday, February 14, 2011
Keynes - The General Theory - Chapter XIII
Using some of the conclusions he made in the previous chapters, Keynes attempts to explain his interest theory.
Section I: Keynes begins by stating that the rate of interest depends on the schedule of the marginal efficiency of capital and the psychological propensity to save. He continues that it is wrong to conclude that, "the rate of interest is the balancing factor which brings the demand for saving in the shape of new investment forthcoming at a given rate of interest into equality with the supply of saving which results at that rate of interest from the community’s psychological propensity to save." Essentially, there is some other factor - that has been glossed over by other economists - that properly explains interest theory.
Section II: Here Keynes introduces us to this other factor, liquidity-preference. Keynes argues that when an individual decides how much of his income to consume now rather than later we are dealing with the propensity to consume. After this decision, an individual must decide what to do with this income for future consumption. Liquidity-preference is the schedule that shows how much of that income should be held as money, and what should be invested. Keynes continues that the rate of interest is not the "price" which brings into equilibrium the "demand for resources to invest with the readiness to abstain from present consumption." Rather, it is the reward for parting with liquidity.
Here Keynes makes the mistake of assuming that humans are incapable of thinking in terms of three margins. Why must a person decide between consumption and saving, and then after determine what to do with the savings? It is much more likely that people decide to consume, invest, and hoard at the same time. Thus, liquidity-preference has no real value in economic analysis. We once again conclude that interest rates are determined by individual time preferences, no more, no less.
Liquidity-preference does have its uses to Keynes, because from his conclusion Keynes deduces that the other factor affecting the interest rate must be the money supply. For if the rate of interest is lowered significantly, the amount of cash the public wishes to hold would exceed the available supply of money. To prove this point, Keynes turns to his trusted mathematical equations. Keynes writes, "Liquidity-preference fixes the quantity of money which the public will hold when the rate of interest is given; so that if r is the rate of interest, M the quantity of money and L the function of liquidity-preference, we have M = L(r)."
Here again, Keynes' analysis fails a thorough examination. As any student of Austrian Economics - or even someone familiar with their theories - knows, Economics is an a priori science. Disregarding this fact, Keynes uses mutual determination to deduce the influence of the money supply on interest rates. When originally discussing liquidity-preference Keynes wrote that the mistake of accepted interest theories lies in their attempts to deduce the rate of interest while neglecting liquidity-preference. Then, as I quoted above, he writes how changes in the interest rate change a person's desire to hold cash, or simply change their liquidity preference. The interest rate can not both be determining and determined by liquidity preference. That completely contradicts the idea that Economics follows cause-and-effect relationships.
Keynes end this section with a gem worth quoting. "Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ." Interpreted: Ideally, we should be able to predict the future, but since we cannot we should control the money supply to drive the economy. If that fails, blame everyone for having the same opinions.
Section III: This section is essentially the fine print for his interest theory. For example, Keynes writes, "an increase in the quantity of money may be expected, cet. par., to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money." He then follows this same formula for several different scenarios.
Section IV: A simple disclaimer that liquidity-preference as mentioned in this text is not the same thing as the "state of bearishness" in his Treatise on Money. Since I have not read that text, nor do I have any interest in reading it, I will withhold comment.
Section V: Keynes finishes this chapter by introducing us to hoarding. He does not say much on the subject for now, with his main point being the rate of interest is not the reward for not-spending, but not-hoarding. The fallacy of this conclusion has already been demonstrated above.
Section I: Keynes begins by stating that the rate of interest depends on the schedule of the marginal efficiency of capital and the psychological propensity to save. He continues that it is wrong to conclude that, "the rate of interest is the balancing factor which brings the demand for saving in the shape of new investment forthcoming at a given rate of interest into equality with the supply of saving which results at that rate of interest from the community’s psychological propensity to save." Essentially, there is some other factor - that has been glossed over by other economists - that properly explains interest theory.
Section II: Here Keynes introduces us to this other factor, liquidity-preference. Keynes argues that when an individual decides how much of his income to consume now rather than later we are dealing with the propensity to consume. After this decision, an individual must decide what to do with this income for future consumption. Liquidity-preference is the schedule that shows how much of that income should be held as money, and what should be invested. Keynes continues that the rate of interest is not the "price" which brings into equilibrium the "demand for resources to invest with the readiness to abstain from present consumption." Rather, it is the reward for parting with liquidity.
Here Keynes makes the mistake of assuming that humans are incapable of thinking in terms of three margins. Why must a person decide between consumption and saving, and then after determine what to do with the savings? It is much more likely that people decide to consume, invest, and hoard at the same time. Thus, liquidity-preference has no real value in economic analysis. We once again conclude that interest rates are determined by individual time preferences, no more, no less.
Liquidity-preference does have its uses to Keynes, because from his conclusion Keynes deduces that the other factor affecting the interest rate must be the money supply. For if the rate of interest is lowered significantly, the amount of cash the public wishes to hold would exceed the available supply of money. To prove this point, Keynes turns to his trusted mathematical equations. Keynes writes, "Liquidity-preference fixes the quantity of money which the public will hold when the rate of interest is given; so that if r is the rate of interest, M the quantity of money and L the function of liquidity-preference, we have M = L(r)."
Here again, Keynes' analysis fails a thorough examination. As any student of Austrian Economics - or even someone familiar with their theories - knows, Economics is an a priori science. Disregarding this fact, Keynes uses mutual determination to deduce the influence of the money supply on interest rates. When originally discussing liquidity-preference Keynes wrote that the mistake of accepted interest theories lies in their attempts to deduce the rate of interest while neglecting liquidity-preference. Then, as I quoted above, he writes how changes in the interest rate change a person's desire to hold cash, or simply change their liquidity preference. The interest rate can not both be determining and determined by liquidity preference. That completely contradicts the idea that Economics follows cause-and-effect relationships.
Keynes end this section with a gem worth quoting. "Best of all that we should know the future. But if not, then, if we are to control the activity of the economic system by changing the quantity of money, it is important that opinions should differ." Interpreted: Ideally, we should be able to predict the future, but since we cannot we should control the money supply to drive the economy. If that fails, blame everyone for having the same opinions.
Section III: This section is essentially the fine print for his interest theory. For example, Keynes writes, "an increase in the quantity of money may be expected, cet. par., to reduce the rate of interest, this will not happen if the liquidity-preferences of the public are increasing more than the quantity of money." He then follows this same formula for several different scenarios.
Section IV: A simple disclaimer that liquidity-preference as mentioned in this text is not the same thing as the "state of bearishness" in his Treatise on Money. Since I have not read that text, nor do I have any interest in reading it, I will withhold comment.
Section V: Keynes finishes this chapter by introducing us to hoarding. He does not say much on the subject for now, with his main point being the rate of interest is not the reward for not-spending, but not-hoarding. The fallacy of this conclusion has already been demonstrated above.
Wednesday, January 26, 2011
Weekly Column - 01/26/2011
This week's column comes early:
"Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t." – President Barack Obama
Attempts to draw parallels can sometimes be more instructive when the comparison is inapt. For while cash-strapped families must reduce expenditures to make a budget, the government merely has to raise the debt ceiling and have the chairmen of the Federal Reserve fire up his printing press. The federal government is not constrained by budgets, and will never be, so long as it has recourse to an endless supply of cash.
It’s true that the government, like the American family, must borrow at interest to meet its budget. It’s also true that these interest rates will climb as the American government goes deeper and deeper into debt. But the comparison ends there. An American who falls into debt may declare bankruptcy—though certain debts, such as students loans, can never be escaped. He thereupon incurs all that bankruptcy entails. To avoid this, he must pay back all that he owes. Congress, meanwhile has no intention of ever paying off its debt; its members know that they will not be held responsible for the decisions of previous Congresses. And the bankruptcy of the nation is certainly of no concern to the congresscritters. So the orgy of spending continues.
"Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t." – President Barack Obama
Attempts to draw parallels can sometimes be more instructive when the comparison is inapt. For while cash-strapped families must reduce expenditures to make a budget, the government merely has to raise the debt ceiling and have the chairmen of the Federal Reserve fire up his printing press. The federal government is not constrained by budgets, and will never be, so long as it has recourse to an endless supply of cash.
It’s true that the government, like the American family, must borrow at interest to meet its budget. It’s also true that these interest rates will climb as the American government goes deeper and deeper into debt. But the comparison ends there. An American who falls into debt may declare bankruptcy—though certain debts, such as students loans, can never be escaped. He thereupon incurs all that bankruptcy entails. To avoid this, he must pay back all that he owes. Congress, meanwhile has no intention of ever paying off its debt; its members know that they will not be held responsible for the decisions of previous Congresses. And the bankruptcy of the nation is certainly of no concern to the congresscritters. So the orgy of spending continues.
The Power of Narrative
The advantage of having a regular column is that I actually bother to do some writing, as opposed to sitting on my couch reading books. The disadvantage is that in the unlikely event that I write about something timely, it's not always relevant by the time my column is published. So it is with this one, which seems to have gotten lost, but which, having already been written, will be posted here.
"With many similar parables Jesus spoke the word to them, as much as they could understand." Mark 4:33
"With many similar parables Jesus spoke the word to them, as much as they could understand." Mark 4:33
Just as Jesus taught the crowds using parables, so modern American political discourse involves narratives. The parables were constructed to illustrate a truth which was hidden behind tangled reality. The people were better able to see how one ought to love one's neighbor after hearing of the good Samaritan. Political narratives operate differently: they serve to reinforce an ideology, by ensuring that any facts which may occur can be carefully woven into the narrative. In this way, no event can possibly upset the faithful; any conceivable action only serves to demonstrate the infallibility of the unquestioned ideology.
In the real world, politics is comprised of fallen human beings seeking to enact policies which reflect ideals; in this they often fail because other people possess opposing ideals which reflect apposite ends. The desire to allow the middle class family to retain most of its wealth is inconsistent with the desire to redistribute wealth among impoverished members of the same society. Hence politics is—and must necessarily be—something of a messy affair.
The narrative allows the populace to pretend that things are neat and tidy. On the one side are the forces of good, on the other, the forces of evil; think of Bush channeling his supposed Savior in insisting that anyone is either for or against America. Since this country—and, indeed, any country—is divided against itself, the dichotomy is false. It is easy to pick on Bush, but the left possesses a similar narrative, likewise neat and tidy, and similarly incompatible with the vicissitudes of reality.
To take a recent example: no sooner had the story of the Arizona shooter broke than the journalists insinuated that the act must have been the work of right-wing extremists. The theory was not without plausibility: after all, one of the woman shot was Representative Gabrielle Giffords, a Democrat. Ergo it must have been a crazy Republican, probably one of those Tea Partiers, the craziest of the bunch. That the criminal could fail to possess political motivation, or that a single incident could be insufficient to reinforce the superiority of the leftist position, was utterly beyond consideration.
Alas, the real story is that Loughner is a lunatic. In a piece by Nick Baumann in Mother Jones, a friend recounts that Loughner was angry that Giffords had failed to answer satisfactorily a question which he had posed to her during a 2007 campaign event. The question: "What is government if words have no meaning?" It proved impossible to intelligibly extract political implications from such palpable nonsense. This was unfortunate because the fabricated story fit perfectly into the narrative—compiled in advance for consumption by denizens of the left.
Yet, as is so often the case, the narrative is more important than the facts. The former, which is a creation of man, and therefore mutable, cannot be allowed to change; whereas the latter, having been settled in history, can be misrepresented to conform to the narrative. In short, things are precisely backwards. In this case, both sides—left and right—were compelled to contort themselves, trying to explain how this nut belonged to the other political camp. From the liberal point of view, that this particular incident had no connection whatsoever to the Tea Party did not imply that a specter of right-wing radicalism wasn't haunting America. Paradoxically, it proved it. The lack of Tea Party connection only meant that the next incident would surely evince the piece of missing evidence. Everyone knows that the Tea Party means to kill all the democrats. Why, Sarah Palin, even had targets over the heads of democratic members of Congress. Quod erat demonstratum.
The reality is that members of both the far right and the far left—whatever we mean by these terms—are capable of acts of violence. Of considerably greater importance, despite the vehemence of the rhetoric emanating from all points along the political spectrum, the American people are seldom motivated to commit acts of violence for political reasons. This is unfortunate for the fearmongers in television news, but the facts speak for themselves. We are constantly told that we are more divided than ever, and that the extremists will surely erupt in violence against those who have the temerity to disagree with them. Yet these eruptions remain extraordinary.
When the Lougher story blows over, we will return to our status quo of mutual distrust and paranoia. Eventually, another act of violence will occur, one which may even have political motivation. But while an isolated act will no doubt fuel the fires of antagonism which drives what passes for political discourse, it's hard to see what a single act is capable of proving. If a tea partier shoots up a Democrat's campaign office tomorrow, or someone who listens to NPR does the same, nothing will change, except for the unfortunate few who were personally involved in the hypothetical incident. Liberals recoil at the comparison, but it should be noted that tea partiers have utilized their ideology to attempt the same number of crimes as those who listen to public radio. Any inclination to be concerned over one group more than the other is a result of prejudice in favor of one's narrative. Neither adequately reflects reality.
And yet this is the test of a narrative. When Jesus crafted his parables, he was concerning himself with something true in the human condition. The whole purpose of the story was to make clear this truth. A testament to his success is that these stories are still read today. According to this metric, the political narratives fail. They do not aid us in our attempts to better interpret reality. Instead, they obfuscate facts, which are the only things upon which all parties should be able to agree. Intellectually honest individuals of all political persuasions should be wary of those who wield the narrative as a cover to avoid meaningful thought.
In the real world, politics is comprised of fallen human beings seeking to enact policies which reflect ideals; in this they often fail because other people possess opposing ideals which reflect apposite ends. The desire to allow the middle class family to retain most of its wealth is inconsistent with the desire to redistribute wealth among impoverished members of the same society. Hence politics is—and must necessarily be—something of a messy affair.
The narrative allows the populace to pretend that things are neat and tidy. On the one side are the forces of good, on the other, the forces of evil; think of Bush channeling his supposed Savior in insisting that anyone is either for or against America. Since this country—and, indeed, any country—is divided against itself, the dichotomy is false. It is easy to pick on Bush, but the left possesses a similar narrative, likewise neat and tidy, and similarly incompatible with the vicissitudes of reality.
To take a recent example: no sooner had the story of the Arizona shooter broke than the journalists insinuated that the act must have been the work of right-wing extremists. The theory was not without plausibility: after all, one of the woman shot was Representative Gabrielle Giffords, a Democrat. Ergo it must have been a crazy Republican, probably one of those Tea Partiers, the craziest of the bunch. That the criminal could fail to possess political motivation, or that a single incident could be insufficient to reinforce the superiority of the leftist position, was utterly beyond consideration.
Alas, the real story is that Loughner is a lunatic. In a piece by Nick Baumann in Mother Jones, a friend recounts that Loughner was angry that Giffords had failed to answer satisfactorily a question which he had posed to her during a 2007 campaign event. The question: "What is government if words have no meaning?" It proved impossible to intelligibly extract political implications from such palpable nonsense. This was unfortunate because the fabricated story fit perfectly into the narrative—compiled in advance for consumption by denizens of the left.
Yet, as is so often the case, the narrative is more important than the facts. The former, which is a creation of man, and therefore mutable, cannot be allowed to change; whereas the latter, having been settled in history, can be misrepresented to conform to the narrative. In short, things are precisely backwards. In this case, both sides—left and right—were compelled to contort themselves, trying to explain how this nut belonged to the other political camp. From the liberal point of view, that this particular incident had no connection whatsoever to the Tea Party did not imply that a specter of right-wing radicalism wasn't haunting America. Paradoxically, it proved it. The lack of Tea Party connection only meant that the next incident would surely evince the piece of missing evidence. Everyone knows that the Tea Party means to kill all the democrats. Why, Sarah Palin, even had targets over the heads of democratic members of Congress. Quod erat demonstratum.
The reality is that members of both the far right and the far left—whatever we mean by these terms—are capable of acts of violence. Of considerably greater importance, despite the vehemence of the rhetoric emanating from all points along the political spectrum, the American people are seldom motivated to commit acts of violence for political reasons. This is unfortunate for the fearmongers in television news, but the facts speak for themselves. We are constantly told that we are more divided than ever, and that the extremists will surely erupt in violence against those who have the temerity to disagree with them. Yet these eruptions remain extraordinary.
When the Lougher story blows over, we will return to our status quo of mutual distrust and paranoia. Eventually, another act of violence will occur, one which may even have political motivation. But while an isolated act will no doubt fuel the fires of antagonism which drives what passes for political discourse, it's hard to see what a single act is capable of proving. If a tea partier shoots up a Democrat's campaign office tomorrow, or someone who listens to NPR does the same, nothing will change, except for the unfortunate few who were personally involved in the hypothetical incident. Liberals recoil at the comparison, but it should be noted that tea partiers have utilized their ideology to attempt the same number of crimes as those who listen to public radio. Any inclination to be concerned over one group more than the other is a result of prejudice in favor of one's narrative. Neither adequately reflects reality.
And yet this is the test of a narrative. When Jesus crafted his parables, he was concerning himself with something true in the human condition. The whole purpose of the story was to make clear this truth. A testament to his success is that these stories are still read today. According to this metric, the political narratives fail. They do not aid us in our attempts to better interpret reality. Instead, they obfuscate facts, which are the only things upon which all parties should be able to agree. Intellectually honest individuals of all political persuasions should be wary of those who wield the narrative as a cover to avoid meaningful thought.
Tuesday, January 25, 2011
Weekly Column - 01/25/11
This week's column:
"Knowledge is capable of being its own end." – John Henry Cardinal Newman, The Idea of a University
This was intended to be an essay examining the pros and cons of pursuing a college education. Our political leaders continue to insist that it is imperative that every American obtain a college degree, just as they insisted that every American become a homeowner. This parallel is chosen deliberately, both because it is distinctly possible that the ever-rising cost of a college education is indicative of another bubble—one never knows until it pops—but also because it demonstrates the superficiality of our policy recommendations. Politicians had heard that those who owned homes were more likely to be good members of their respective communities. What better way to improve the livelihood of all and sundry than ensuring that everyone could own his own home? Alas, as it turns out, the importance of home ownership is in the habits instilled during the process; the same characteristics of those who prove capable of working hard so as to save to buy a home redound to the benefit of the community. There is no shortcut to virtue. Attempting to circumvent the mean by which virtue was instilled was exceedingly foolish, even by the standards of American politicians.
So it is with the attempt to bestow college degrees upon everyone. As President Obama notes: "We expect all our children not only to graduate from high school but to graduate from college and get a good-paying job." The reasons for this are clear. Using old data, Obama insists: "On average during your lifetime you will earn a million dollars more if you get a bachelor’s degree." If Helicopter Ben causes the currency to hyperinflate, this may well be true. Yet the purpose of a college is not to churn our graduates who can make more money.
"Knowledge is capable of being its own end." – John Henry Cardinal Newman, The Idea of a University
This was intended to be an essay examining the pros and cons of pursuing a college education. Our political leaders continue to insist that it is imperative that every American obtain a college degree, just as they insisted that every American become a homeowner. This parallel is chosen deliberately, both because it is distinctly possible that the ever-rising cost of a college education is indicative of another bubble—one never knows until it pops—but also because it demonstrates the superficiality of our policy recommendations. Politicians had heard that those who owned homes were more likely to be good members of their respective communities. What better way to improve the livelihood of all and sundry than ensuring that everyone could own his own home? Alas, as it turns out, the importance of home ownership is in the habits instilled during the process; the same characteristics of those who prove capable of working hard so as to save to buy a home redound to the benefit of the community. There is no shortcut to virtue. Attempting to circumvent the mean by which virtue was instilled was exceedingly foolish, even by the standards of American politicians.
So it is with the attempt to bestow college degrees upon everyone. As President Obama notes: "We expect all our children not only to graduate from high school but to graduate from college and get a good-paying job." The reasons for this are clear. Using old data, Obama insists: "On average during your lifetime you will earn a million dollars more if you get a bachelor’s degree." If Helicopter Ben causes the currency to hyperinflate, this may well be true. Yet the purpose of a college is not to churn our graduates who can make more money.
Monday, January 24, 2011
Keynes - The General Theory - Chapter XII
Since this chapter, The State of Long-Term Expectation, has little to do with economics, Keynes's writing is clearer than usual. Unfortunately, this clarity is devoted to little more than an ad hominem attack on the free market.
Section I: Keynes notes that the entrepreneur must concern himself with "future events which can only be forecasted with more or less confidence." Long-term expectation is then defined as "the state of psychological expectation which covers" these future events.
Section II: After noting that future events are uncertain, he explains that the state of confidence is very important in bringing these about. "But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms." This is attempt at profundity is typical of Keynes; the reason economists deal with it so little is not that is if of no importance, but that it cannot be measured. Indeed, while the American "state of confidence" is probably very weak presently, this hasn't hurt the sale of gold--or iPads. Keynes is once again guilty of aggregating disparate things.
He also points out: "There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule."
Section III: Keynes rhetoric is very revealing. For instance, he categorizes successful entrepreneurship as a lottery. Certainly luck plays a role, but an entrepreneur anticipates and responds to consumer demand. It is uncharitable to pretend that his only role is to be blessed by fortune.
Section IV: This can be skipped over without loss.
Section V: Keynes, looking back at The Great Depression, lampoons the role of "speculators" on the stock market. He gives five reasons why the stock market is especially precarious.
He devotes most of his space to the fourth reason. The speculators have ruined things for everyone: "It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise."
This focus on short-term expectation is somehow believed to foil long-term expectations. The former lack, apparently, a basis in reality, to which the latter are preferable. Yet the greater the liquidity, the less likely that the market will over value a particular stock--though, especially in the case of overt fraud, this will still happen from time to time. Keynes insisted that his was a general theory, but his concerns about speculation were devoted purely to the realm of the most recent bubble, namely, the stock market.
Section VI: Keynes writes: "If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise." Again, notice the rhetoric. Certain trading is bad, while other trading is good; we are not given a reason for this.
Most illuminating is Keynes insistence that the people, who obviously have no idea what they are doing, be prevented from using their money as they see fit: "The only radical cure for the crises of confidence which afflict the economic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital-asset which, even though it be on precarious evidence, impresses him as the most promising investment available to him."
Earlier, Keynes had written: "That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmorton Street is, compared with Wall Street to the average American, inaccessible and very expensive." So the problem is not merely with speculators so much as it is with, well, poor people. Keynes has much less of a problem with allowing the rich to invest their money.
Section VII: Here we come to Keynes's famous "animal spirits":
"Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.
This comes in a chapter diametrically opposed to any notion of rationality in the markets. Since it is all a game, it is important that the confidence of man be stimulated so as to keep the charade going. Obscured is an economic reality, which can be recognized by man.
Moreover, an irrational optimism is more dangerous than pessimism. If people are overly optimistic, they will, for instance, build houses where none are needed; this wastes scarce resources. On the other hand, if the government refrains from distorting the market, a fall in prices will eventually bring forth investment. Since man must consume in order to live, the animal spirits must eventually revive.
Section VIII: Having demonstrated his lack of faith in the ability of people to handle their own economic affairs, Keynes turns to omnipotent government to save us from ourselves:
"I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest." Coming at the end of this chapter, I can only call this implicit approval.
Surely the government, investing other people's money, will only do so with the most perfect of intentions. Even bridges to nowhere are evidence of the brilliance of our masters, who would never focus on the next election at the expense of the long-term. Keynesianism is often seen as a moderate path between capitalism and socialism, but we see here that it was far closer to the latter.
UPDATE: One of the recent Planet Money podcasts dealt with one of the examples from this section of the book. Interested parties ought to check it out.
Section I: Keynes notes that the entrepreneur must concern himself with "future events which can only be forecasted with more or less confidence." Long-term expectation is then defined as "the state of psychological expectation which covers" these future events.
Section II: After noting that future events are uncertain, he explains that the state of confidence is very important in bringing these about. "But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms." This is attempt at profundity is typical of Keynes; the reason economists deal with it so little is not that is if of no importance, but that it cannot be measured. Indeed, while the American "state of confidence" is probably very weak presently, this hasn't hurt the sale of gold--or iPads. Keynes is once again guilty of aggregating disparate things.
He also points out: "There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same thing as the investment demand-schedule."
Section III: Keynes rhetoric is very revealing. For instance, he categorizes successful entrepreneurship as a lottery. Certainly luck plays a role, but an entrepreneur anticipates and responds to consumer demand. It is uncharitable to pretend that his only role is to be blessed by fortune.
Section IV: This can be skipped over without loss.
Section V: Keynes, looking back at The Great Depression, lampoons the role of "speculators" on the stock market. He gives five reasons why the stock market is especially precarious.
He devotes most of his space to the fourth reason. The speculators have ruined things for everyone: "It might have been supposed that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, would correct the vagaries of the ignorant individual left to himself. It happens, however, that the energies and skill of the professional investor and speculator are mainly occupied otherwise."
This focus on short-term expectation is somehow believed to foil long-term expectations. The former lack, apparently, a basis in reality, to which the latter are preferable. Yet the greater the liquidity, the less likely that the market will over value a particular stock--though, especially in the case of overt fraud, this will still happen from time to time. Keynes insisted that his was a general theory, but his concerns about speculation were devoted purely to the realm of the most recent bubble, namely, the stock market.
Section VI: Keynes writes: "If I may be allowed to appropriate the term speculation for the activity of forecasting the psychology of the market, and the term enterprise for the activity of forecasting the prospective yield of assets over their whole life, it is by no means always the case that speculation predominates over enterprise." Again, notice the rhetoric. Certain trading is bad, while other trading is good; we are not given a reason for this.
Most illuminating is Keynes insistence that the people, who obviously have no idea what they are doing, be prevented from using their money as they see fit: "The only radical cure for the crises of confidence which afflict the economic life of the modern world would be to allow the individual no choice between consuming his income and ordering the production of the specific capital-asset which, even though it be on precarious evidence, impresses him as the most promising investment available to him."
Earlier, Keynes had written: "That the sins of the London Stock Exchange are less than those of Wall Street may be due, not so much to differences in national character, as to the fact that to the average Englishman Throgmorton Street is, compared with Wall Street to the average American, inaccessible and very expensive." So the problem is not merely with speculators so much as it is with, well, poor people. Keynes has much less of a problem with allowing the rich to invest their money.
Section VII: Here we come to Keynes's famous "animal spirits":
"Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.
This comes in a chapter diametrically opposed to any notion of rationality in the markets. Since it is all a game, it is important that the confidence of man be stimulated so as to keep the charade going. Obscured is an economic reality, which can be recognized by man.
Moreover, an irrational optimism is more dangerous than pessimism. If people are overly optimistic, they will, for instance, build houses where none are needed; this wastes scarce resources. On the other hand, if the government refrains from distorting the market, a fall in prices will eventually bring forth investment. Since man must consume in order to live, the animal spirits must eventually revive.
Section VIII: Having demonstrated his lack of faith in the ability of people to handle their own economic affairs, Keynes turns to omnipotent government to save us from ourselves:
"I expect to see the State, which is in a position to calculate the marginal efficiency of capital-goods on long views and on the basis of the general social advantage, taking an ever greater responsibility for directly organising investment; since it seems likely that the fluctuations in the market estimation of the marginal efficiency of different types of capital, calculated on the principles I have described above, will be too great to be offset by any practicable changes in the rate of interest." Coming at the end of this chapter, I can only call this implicit approval.
Surely the government, investing other people's money, will only do so with the most perfect of intentions. Even bridges to nowhere are evidence of the brilliance of our masters, who would never focus on the next election at the expense of the long-term. Keynesianism is often seen as a moderate path between capitalism and socialism, but we see here that it was far closer to the latter.
UPDATE: One of the recent Planet Money podcasts dealt with one of the examples from this section of the book. Interested parties ought to check it out.
Monday, January 17, 2011
Keynes - The General Theory - Chapter XI
Chapter XI is the first in a series of chapters on the subject of investment, and this section is the longest in the General Theory. Hopefully Keynes will wrap up some of his loose ends and present his theory in an understandable fashion.
Section I: Keynes begins Chapter XI by attempting to define the marginal efficiency of capital as, "being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price." He then continues with a simple deduction from the principle of supply and demand that when investment increases in a certain type of capital the marginal efficiency will decrease. This will continue until the marginal efficiency of capital is equal to the market rate of interest.
This seems like a fairly trivial concept, but allow me to delve deeper. We can think of the supply price as what a firm would buy the capital goods for, and the expected returns as what it receives for selling either the finished good to the consumers or a higher order capital good to another firm. Thus, the marginal efficiency of capital is the rate of price spreads in the stages of production. From Austrian economic theory, we know that this is precisely equal to the rate of interest. Thus, Keynes misses a crucial aspect of interest theory - that his marginal efficiency is the rate of interest.
Section II: Keynes continues by outlining three ambiguities surrounding the marginal efficiency of capital. None of these ambiguities are of critical importance to his discussion of the marginal efficiency of capital so I will leave them be. If I missed anything of importance in this section please feel free to comment.
Section III: Keynes notes the distinction between the current yield and the prospective yield of a given capital stock is routinely overlooked, which results in confusion surrounding the marginal efficiency of capital. I have not read enough of the literature that was available at the time to know if this is true, but I agree that using current yield in the place of prospective yield will often result in erroneous conclusions. One of the main purposes of an entrepreneur is to foresee future changes, which are accounted for in the prospective yield.
Keynes continues by noting that changes in the value of money will affect the marginal efficiency of capital. He spends a decent amount of time outlining the different situations that will arise when the change in value of money is foreseen or unforeseen. The important point, which Keynes fails to note, is that changes in the value of money are usually foreseen when money is derived from a commodity - say silver or gold. A fiat money system with a controlling central bank is far more likely to affect the value of money, and coincidental the marginal efficiency of capital. One would think that limiting any unforeseen changes in the value of money would be beneficial for the economy as entrepreneurs would be less likely to make errors in forecasting. Keynes neglects to note this point.
Section IV: Here Keynes describes the risks associated with investment. The first being the risk taken by a man when he invests his money in capital. If he incorrectly forecasts the prospective yield of his investment, he will lose money (unless he assumes he will make less money than what actually transpires, in which case he would earn a profit). The second being the risk taken by person A when he lends money to person B or firm C to invest as the individual or firm seems fit. Keynes claims that because both the lender and the borrower are incurring a risk in this case, it is added twice to the pure rate of interest, making investments more costly. I believe Keynes is misguided in that he assumes the borrowing and investment to be one transaction.
For example, if I borrow a friend $100 for a year and charge 5% interest, I expect to receive $105 a year from now. If my friend in turn takes the $100 to buy a lawnmower to start a lawn mowing service, that is a separate transaction. The risk he incurs by investing in the capital to start his business is separate from the risk I take borrowing money to my friend. Thus, the duplication of the risk is not true as two transactions are taking place.
Keynes claims that this doubling of risk is important for understanding trade cycle (business cycle) theory so we will have to wait until he reaches that point in his analysis to see how this so called doubling of risk affects his views of the business cycle.
Section V: Keynes concludes this chapter by arguing that the marginal efficiency of capital is of significant importance because it accounts for future changes, as we have seen through its reliance on prospective yields. He then makes an egregious error by claiming the rate of interest is, "virtually, a current phenomenon." I am not entirely sure on what reasoning he bases this claim, but considering the rate of interest in determined on the time market it must be based on both present and future considerations. Thus, Keynes ends this chapter in a similar manner to how it began, by making crucial mistakes regarding the connection between the marginal efficiency of capital and the interest rate.
Section I: Keynes begins Chapter XI by attempting to define the marginal efficiency of capital as, "being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price." He then continues with a simple deduction from the principle of supply and demand that when investment increases in a certain type of capital the marginal efficiency will decrease. This will continue until the marginal efficiency of capital is equal to the market rate of interest.
This seems like a fairly trivial concept, but allow me to delve deeper. We can think of the supply price as what a firm would buy the capital goods for, and the expected returns as what it receives for selling either the finished good to the consumers or a higher order capital good to another firm. Thus, the marginal efficiency of capital is the rate of price spreads in the stages of production. From Austrian economic theory, we know that this is precisely equal to the rate of interest. Thus, Keynes misses a crucial aspect of interest theory - that his marginal efficiency is the rate of interest.
Section II: Keynes continues by outlining three ambiguities surrounding the marginal efficiency of capital. None of these ambiguities are of critical importance to his discussion of the marginal efficiency of capital so I will leave them be. If I missed anything of importance in this section please feel free to comment.
Section III: Keynes notes the distinction between the current yield and the prospective yield of a given capital stock is routinely overlooked, which results in confusion surrounding the marginal efficiency of capital. I have not read enough of the literature that was available at the time to know if this is true, but I agree that using current yield in the place of prospective yield will often result in erroneous conclusions. One of the main purposes of an entrepreneur is to foresee future changes, which are accounted for in the prospective yield.
Keynes continues by noting that changes in the value of money will affect the marginal efficiency of capital. He spends a decent amount of time outlining the different situations that will arise when the change in value of money is foreseen or unforeseen. The important point, which Keynes fails to note, is that changes in the value of money are usually foreseen when money is derived from a commodity - say silver or gold. A fiat money system with a controlling central bank is far more likely to affect the value of money, and coincidental the marginal efficiency of capital. One would think that limiting any unforeseen changes in the value of money would be beneficial for the economy as entrepreneurs would be less likely to make errors in forecasting. Keynes neglects to note this point.
Section IV: Here Keynes describes the risks associated with investment. The first being the risk taken by a man when he invests his money in capital. If he incorrectly forecasts the prospective yield of his investment, he will lose money (unless he assumes he will make less money than what actually transpires, in which case he would earn a profit). The second being the risk taken by person A when he lends money to person B or firm C to invest as the individual or firm seems fit. Keynes claims that because both the lender and the borrower are incurring a risk in this case, it is added twice to the pure rate of interest, making investments more costly. I believe Keynes is misguided in that he assumes the borrowing and investment to be one transaction.
For example, if I borrow a friend $100 for a year and charge 5% interest, I expect to receive $105 a year from now. If my friend in turn takes the $100 to buy a lawnmower to start a lawn mowing service, that is a separate transaction. The risk he incurs by investing in the capital to start his business is separate from the risk I take borrowing money to my friend. Thus, the duplication of the risk is not true as two transactions are taking place.
Keynes claims that this doubling of risk is important for understanding trade cycle (business cycle) theory so we will have to wait until he reaches that point in his analysis to see how this so called doubling of risk affects his views of the business cycle.
Section V: Keynes concludes this chapter by arguing that the marginal efficiency of capital is of significant importance because it accounts for future changes, as we have seen through its reliance on prospective yields. He then makes an egregious error by claiming the rate of interest is, "virtually, a current phenomenon." I am not entirely sure on what reasoning he bases this claim, but considering the rate of interest in determined on the time market it must be based on both present and future considerations. Thus, Keynes ends this chapter in a similar manner to how it began, by making crucial mistakes regarding the connection between the marginal efficiency of capital and the interest rate.
Monday, January 10, 2011
Weekly Column - 01/10/11
This week's column:
"Upon the mount that highest o’er the wave / Rises was I, in life or pure or sinful,
From the first hour to that which is the second, / As the sun changes quadrant, to the sixth." – Dante, Paradiso: Canto XXVI
As Dante makes his way through heaven, he meets Adam, the first man, who thus recounts that he remained in the earthly paradise until his sin caused him to be expelled forever. Thereafter, man was cursed to labor by the sweat of his brow, woman, to bring forth children in pain; humanity cursed Adam and Eve for the frailty they evinced and which we all share.
The frailty was on display on Wednesday, when the new Congress, including triumphant tea party candidates, took the house floor. As Karl Denniger points out, just as, in Dante’s telling, it took Adam from dawn to noon to commit his first sin, so the tea party capitulated in precisely six hours. This is nothing more than a coincidence, of course, but it is an amusing one. As Adam’s fall provides the archetype for human frailty, the great tea party betrayal demonstrates the untrustworthiness of politicians.
"Upon the mount that highest o’er the wave / Rises was I, in life or pure or sinful,
From the first hour to that which is the second, / As the sun changes quadrant, to the sixth." – Dante, Paradiso: Canto XXVI
As Dante makes his way through heaven, he meets Adam, the first man, who thus recounts that he remained in the earthly paradise until his sin caused him to be expelled forever. Thereafter, man was cursed to labor by the sweat of his brow, woman, to bring forth children in pain; humanity cursed Adam and Eve for the frailty they evinced and which we all share.
The frailty was on display on Wednesday, when the new Congress, including triumphant tea party candidates, took the house floor. As Karl Denniger points out, just as, in Dante’s telling, it took Adam from dawn to noon to commit his first sin, so the tea party capitulated in precisely six hours. This is nothing more than a coincidence, of course, but it is an amusing one. As Adam’s fall provides the archetype for human frailty, the great tea party betrayal demonstrates the untrustworthiness of politicians.
Tuesday, January 04, 2011
Ethical Chaos
This was intended to be a column, but was unpublished for some reason, so I'll post it here.
“Deprive the taboo rules of their original context and they at once are apt to appear as a set of arbitrary prohibitions, as indeed they characteristically do appear when the initial context is lost, when those background beliefs in the light of which the taboo rules had originally been understood have not only been abandoned but forgotten.” - Alasdair MacIntyre, After Virtue
The slippery slope is a well known logical fallacy. Utilizing it anyway, opponents of gay “marriage” insist that this is a step toward bestiality. Proponents claim that this is ridiculous; the extension of the institution of marriage to homosexuals can be undertaken in isolation. Logically, this seems correct, but it misfires for two reasons. First, while it is true that homosexual relationships had a positive connotation in many western societies—most obviously in ancient Greece—the western conception of marriage confines the covenant to one man and one woman. Gay marriage thus requires a radical reinterpretation of the institution. The second point follows from the first. The moral edifice which made gay marriage unthinkable has crumbled; in MacIntyre's terminology, the initial context has been lost—though not completely—and homosexual relations remain, if anything, a taboo. The implications of this deserve our careful consideration.
Economic issues continue to dominate our politics, so it might seem unusual to devote any time to the issue of gay marriage. Yet there is value in trying to calmly examine an issue before the talking heads have spun it to suit their political biases. Moreover, a high profile incest case has offered us an insight into what may occur when taboos prove insufficient. Columbia University professor and Huffington Post blogger David Epstein has been caught having sex with his daughter. The charge is one felony incest account; if convicted, he will spend four years in prison. Since his daughter was not a minor while the incidents occurred, there is speculation as to whether the charge will stick. As Tracy Clark-Flory points out in a Salon column: “It isn't a clear-cut case of child abuse, and there are no allegations that the three-year-long relationship carried on without the daughter's consent.”
A commenter at the Huffington Post, channeling the Zeitgeist, writes: “I don’t understand how it is a crime.” That it is possible to not understand why communities would wish to prohibit incestuous relations, consensual or otherwise, reveals that, for many in our culture, incest remains merely taboo. The reasons society condemned this behavior cannot be conceived. This is astounding.
Briefly, I think it incumbent on me to explain the libertarian position: consensual relations—sexual or otherwise—between adults should be legal. There are times when the implications of libertarianism can be quite shocking, and this is certainly one of those times. Yet even if incest were not prohibited by law, there would be a very simple way for the community to restrain this type of activity without resorting to government force. To wit, those who have committed incest could be restricted from taking part in the community: shopkeepers could ban them from their stores, neighbors could refuse to associate with them, employers could refuse to hire them, and so on and so forth. That this would be deemed discriminatory reveals the inconsistency of our application of libertarian principles. Deviancy becomes acceptable since the law prohibits intolerance.
If the community were sufficiently sickened by the behavior in question, shunning would produce the intended effects. Like Cain, Epstein would be condemned to be wander restlessly. That this will assuredly not happen does not invalidate the point; it is precisely to build up voluntary associations that the libertarian insists that the State should be rolled back, even in areas, such as this, where it is difficult to see downsides to prohibition.
The Epstein case will be fascinating to follow because it will allow corroboration of my suspicions that the Judeo-Christian ethical edifice has crumbled, leaving us to reap the whirlwind. In the meantime, it's worthwhile to point out, for our lost contemporaries, why the prohibition against incest exists.
In the Summa Theologica (II-II, Q. 154, A. 9), Thomas Aquinas gives four reasons why incest is contrary to reason. First, “because man naturally owes a certain respect to his parents and therefore to his other blood relations”; this respect can no longer exist once the relationship becomes incestuous. Second, since blood relations “live in close touch with one another... opportunities of venereal intercourse would be very frequent and thus men's minds would be enervated by lust.” Third, by marrying someone to whom one is not related, one thereby gains friendships with one's wife's kin; this would be frustrated if one did not marry outside one's family. And fourth, courtesy of Aristotle, a man will have a liking for his kinswoman; it is not good for this affection to become too ardent, which would occur if he had sexual relations with her. It is worth pointing out that, for Thomas, prohibiting incest does not require biblical quotation.
The family is the fundamental social unit upon which all civilization is based. The bonds it inculcates are unlike any others formed in society. Moreover the bond between a husband and wife is substantially different from that formed between mother and son or father and daughter. Incest irrevocably distorts this bond, to the detriment of the family, and, by extension, society. Recall that Oedipus is horrified when he finds out that he has committed incest, even though he had no awareness that he was doing wrong. We've come a long way when one of the most important western texts is becoming incomprehensible to those of us living today. Unless we find and restore the Judeo-Christian context, the taboos will fail. If we have not yet reached it, at this point, we shall find ourselves confronted by complete chaos in sexual relations.
“Deprive the taboo rules of their original context and they at once are apt to appear as a set of arbitrary prohibitions, as indeed they characteristically do appear when the initial context is lost, when those background beliefs in the light of which the taboo rules had originally been understood have not only been abandoned but forgotten.” - Alasdair MacIntyre, After Virtue
The slippery slope is a well known logical fallacy. Utilizing it anyway, opponents of gay “marriage” insist that this is a step toward bestiality. Proponents claim that this is ridiculous; the extension of the institution of marriage to homosexuals can be undertaken in isolation. Logically, this seems correct, but it misfires for two reasons. First, while it is true that homosexual relationships had a positive connotation in many western societies—most obviously in ancient Greece—the western conception of marriage confines the covenant to one man and one woman. Gay marriage thus requires a radical reinterpretation of the institution. The second point follows from the first. The moral edifice which made gay marriage unthinkable has crumbled; in MacIntyre's terminology, the initial context has been lost—though not completely—and homosexual relations remain, if anything, a taboo. The implications of this deserve our careful consideration.
Economic issues continue to dominate our politics, so it might seem unusual to devote any time to the issue of gay marriage. Yet there is value in trying to calmly examine an issue before the talking heads have spun it to suit their political biases. Moreover, a high profile incest case has offered us an insight into what may occur when taboos prove insufficient. Columbia University professor and Huffington Post blogger David Epstein has been caught having sex with his daughter. The charge is one felony incest account; if convicted, he will spend four years in prison. Since his daughter was not a minor while the incidents occurred, there is speculation as to whether the charge will stick. As Tracy Clark-Flory points out in a Salon column: “It isn't a clear-cut case of child abuse, and there are no allegations that the three-year-long relationship carried on without the daughter's consent.”
A commenter at the Huffington Post, channeling the Zeitgeist, writes: “I don’t understand how it is a crime.” That it is possible to not understand why communities would wish to prohibit incestuous relations, consensual or otherwise, reveals that, for many in our culture, incest remains merely taboo. The reasons society condemned this behavior cannot be conceived. This is astounding.
Briefly, I think it incumbent on me to explain the libertarian position: consensual relations—sexual or otherwise—between adults should be legal. There are times when the implications of libertarianism can be quite shocking, and this is certainly one of those times. Yet even if incest were not prohibited by law, there would be a very simple way for the community to restrain this type of activity without resorting to government force. To wit, those who have committed incest could be restricted from taking part in the community: shopkeepers could ban them from their stores, neighbors could refuse to associate with them, employers could refuse to hire them, and so on and so forth. That this would be deemed discriminatory reveals the inconsistency of our application of libertarian principles. Deviancy becomes acceptable since the law prohibits intolerance.
If the community were sufficiently sickened by the behavior in question, shunning would produce the intended effects. Like Cain, Epstein would be condemned to be wander restlessly. That this will assuredly not happen does not invalidate the point; it is precisely to build up voluntary associations that the libertarian insists that the State should be rolled back, even in areas, such as this, where it is difficult to see downsides to prohibition.
The Epstein case will be fascinating to follow because it will allow corroboration of my suspicions that the Judeo-Christian ethical edifice has crumbled, leaving us to reap the whirlwind. In the meantime, it's worthwhile to point out, for our lost contemporaries, why the prohibition against incest exists.
In the Summa Theologica (II-II, Q. 154, A. 9), Thomas Aquinas gives four reasons why incest is contrary to reason. First, “because man naturally owes a certain respect to his parents and therefore to his other blood relations”; this respect can no longer exist once the relationship becomes incestuous. Second, since blood relations “live in close touch with one another... opportunities of venereal intercourse would be very frequent and thus men's minds would be enervated by lust.” Third, by marrying someone to whom one is not related, one thereby gains friendships with one's wife's kin; this would be frustrated if one did not marry outside one's family. And fourth, courtesy of Aristotle, a man will have a liking for his kinswoman; it is not good for this affection to become too ardent, which would occur if he had sexual relations with her. It is worth pointing out that, for Thomas, prohibiting incest does not require biblical quotation.
The family is the fundamental social unit upon which all civilization is based. The bonds it inculcates are unlike any others formed in society. Moreover the bond between a husband and wife is substantially different from that formed between mother and son or father and daughter. Incest irrevocably distorts this bond, to the detriment of the family, and, by extension, society. Recall that Oedipus is horrified when he finds out that he has committed incest, even though he had no awareness that he was doing wrong. We've come a long way when one of the most important western texts is becoming incomprehensible to those of us living today. Unless we find and restore the Judeo-Christian context, the taboos will fail. If we have not yet reached it, at this point, we shall find ourselves confronted by complete chaos in sexual relations.
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