the Freeman

Gold and Money, II

Warren Gibson Economics, Liberty , , , , , ,

Last [blog post], we examined some propositions about gold as money, drawing from theory and history. [In] this [blog post] we ask whether and how gold might once again serve a monetary function.

Money of any sort, commodity-based or not, derives its value in large part from what economists call a “network effect.” Like a fax machine, whose value depends largely on how many other people have fax machines, we value money because other people value it. We feel confident our money will buy us what we need tomorrow. A strong network effect means that something drastic has to happen before people will give up their familiar form of money.

Something drastic was happening when U.S. Rep. Ron Paul’s Gold Commission was set up in 1979. By the time the commission’s report was issued in 1980, inflation had reached alarming levels: The consumer price index was at 14 percent and rising. The prime rate was over 20 percent, and in 1980 silver exploded to $50 an ounce and gold surpassed $800 (about $2,300 in today’s dollars). Bestselling books urged people to buy gold, silver, diamonds, firearms, and rural hideouts.

We now know that inflation was peaking and that the silver price spike was a fluke caused by a failed attempt to corner the silver market. But none of this was apparent at the time, so it was reasonable to wonder whether our monetary system would survive. What did happen, of course, was that the new Fed chairman, Paul Volcker, stepped on the monetary brakes hard enough to break the back of inflation. Two back-to-back recessions resulted but were followed by a long period of recovery in which both inflation and interest rates dropped steadily. The Gold Commission was largely forgotten, though the U.S. Mint did get into the business of producing gold coins in a big way. Continue reading →

Boombustology: A Review

Warren Gibson Books, Economics , , , , , , , , , , ,

These days commentators near and far are announcing booms and bubbles in Treasury securities, gold, China – perhaps even a bubbles. Vikram Mansharamani is in the China camp, but his arguments stand out from the others. If you can get past the title of his book – Boombustology – you will be rewarded with a thorough, well-documented, yet mercifully brief and readable exposition of a theory of booms and busts applied to past events and China’s future.

Most macroeconomists see the boom-bust cycle as an unsolved problem. Like physicists in search of a Grand Unified Theory, they long for a model that accounts for all the major aspects of the business cycle. Perhaps they are hampered by looking through the wrong end of a telescope. Mansharamani uses not just one but five “lenses” to examine the subject. In addition to micro- and macroeconomics, they include psychology, politics, and biology. He is not the first economist to invade these fields. Rather his accomplishment lies in assembling ideas from each of those areas, applying them to past boom-bust cycles, and putting his ideas on the line by issuing a brave prediction of a forthcoming Chinese economic train wreck.

Austrian Business Cycle Theory

The author’s macro lens includes Austrian business cycle theory. That theory says inflation of the money supply causes a drop in interest rates, which is misinterpreted as an increased aggregate preference for saving over consumption, leading to investments in more roundabout means of production. When it becomes clear that there has been no such preference shift, these undertakings are seen to be at least partial mistakes, requiring write-offs and retrenchment – a bust. The boom is the problem, not the bust, which is the market’s attempt to realign itself to the realities of time preference. Austrian business cycle theory has great merit but leaves some things unexplained.

Mansharamani’s micro lens includes the concept of reflexivity. Market participants don’t just observe prices but also influence them. Reflexive dynamics occasionally give rise to instabilities in which rising prices lead to increased demand.  A simpler term would be a “bandwagon effect.” I recall an office party in 1980 where one of the secretaries asked about buying gold – precisely at the peak, as it turned out. All she knew about gold was that it was way up and therefore must be going higher. I should have realized that when you see financially unsophisticated people like her climbing on a bandwagon, you can be pretty sure there’s no one left to sell to and nowhere for prices to go but down, which is where gold and silver prices went in 1980, and in a big hurry.

From psychology Dr. M. borrows ideas and data about cognitive biases. For example, subjects asked to guess some bland statistic, like the number of African countries that belong to the UN, are influenced by the spin of a wheel of fortune: When the wheel lands on a high number, they guess higher. He translates this and a dozen other cognitive biases into irrational market behavior that can foster booms and busts.

He introduces his biology lens with an analogy to the spread of an infectious disease. When the prevalence of a disease reaches a high level, the infection rate necessarily slows and the disease begins to wane, just like the 1980 gold market.  But it is devilishly difficult to “inoculate” oneself against infectious ideas. Individual investors who can do so have a decent chance to beat the market averages over time, I believe. (Those who would pursue these ideas in greater depth would do well to find James Dines’s quirky and expensive but worthwhile book, Mass Psychology.) Continue reading →

The Mystique of Hedge Funds

Warren Gibson Economics, History , , , , , , ,

Hedge funds are controversial these days. Though it’s unlikely that the average citizen or the average congressman could say just what hedge funds do, many are certain they must be reined in by additional regulation because they can—and do—cause widespread damage to our financial system. Almost everyone takes it for granted that regulation of some sort is the solution, ignoring the possibility that at least some of the problems are actually caused by regulation.

What is a hedge fund? The name implies hedging, a strategy that reduces risk. If you bet on several horses in a race, you are hedging your bets—spreading your risk. You can buy gold to hedge against inflation. You can sell interest-rate futures to hedge the risk that rising interest rates would pose to your bond portfolio.

The first hedge fund was created in 1949 by Alfred Jones. He believed he could pick stocks that would outperform and those that would underperform the overall market. But Jones didn’t know where the overall market was going, so he would buy his expected outperformers and sell short the expected underperformers. He thereby insulated his portfolio from general market moves, which would affect about half his holding positively and half negatively.

Most present-day hedge funds don’t do much hedging, but the name persists. Instead, they engage in a bewildering variety of trading methods, including buying on margin (using borrowed funds) and selling short (selling borrowed assets so as to profit from a price drop). They trade stocks, bonds, options, currencies, commodity futures, and sophisticated derivatives thereof. Some try to anticipate global political or economic events, while others seek opportunities in specific industries or companies. Continue reading →

Around the Web

Brandon Christensen Links , , , , , , , , , ,
  1. How Government Sort Of Created the Internet. Fascinating read from the Freeman.
  2. What Happened? Will Wilkinson asks the tough question in the aftermath of a debate which I missed, but heard that Romney roundly is perceived to have won.
  3. The Next Industrial Revolution (it’s going to be in goods and services). Arnold Kling has written about this before. (h/t Tyler Cowen)
  4. Beirut: Security, Surveillance, and Navigation. As I’ve gotten deeper and deeper into anthropology, I’ve found that many anthropologists never get past the glorified journalism aspect of the discipline associated with introductory courses. This is a good example of that, but still worth a gander.

Native American Property Rights and European Contact

Brandon Christensen History, Law, Liberty , , , ,

Despite the claim to rights based on discovery, British colonists often acquired land by contract. For example, almost all of Massachusetts was acquired by purchase from local tribes. The primary exceptions there, Salem and Boston, were uninhabited areas, having been depopulated earlier by the diseases the colonists unwittingly brought with them. Although the British crown claimed the sole right to negotiate transfer of land rights from the Native Americans, many colonists thought otherwise and regularly made individual arrangements with various tribes to secure land.

This is from Europe Meets America, a heavy post in the Freeman.

From the Comments: the Unemployment Rate

Brandon Christensen Current Events, Economics , , , , , , , ,

Dr. Gibson has won the much-cherished gold star I had offered in a previous comment. My question had to do with the green dot in this graph, and Dr. Gibson explained it to perfection. He writes:

The widely followed U3 unemployment rate, as shown in the figure, is the number of unemployed divided by the labor force. The labor force excludes discouraged workers. The labor force participation rate is the labor force size (employed & unemployed) divided by the population. The green dot shows what the U3 rate would be if that ratio had stayed the same since Jan. 2009.

The U6 statistic counts discouraged workers as unemployed. That rate is currently around 15%.

See also: Unemployment: What It Is

From the article Dr. Gibson directs us towards comes some other important information:

Government policies contribute to unemployment above and beyond natural unemployment. The most notorious of these policies are minimum wage laws. These laws make it illegal, effectively, for low-skilled workers to accept employment. Anyone who cannot generate $8 worth of production per hour cannot expect to be paid more than $8. Such unfortunate people might be productive at $6 per hour but are forbidden to accept employment at this rate and are instead condemned to joblessness and all its attendant miseries. This burden falls most heavily on black teenagers, whose unemployment rate (based on those seeking work and excluding those who are in school) is well over 40 percent. The benefits accrue mainly to slightly higher-skilled workers, who have climbed onto the metaphorical ladder leading to better jobs and who are shielded from competition from those excluded by minimum-wage laws […]

Labor unions, as voluntary associations bargaining freely with employers, are unobjectionable. They did a lot of good in the past when working conditions in many places were pretty bad. But now they are granted special privileges by law—basically the privilege to engage in violent or coercive activities. The result is often wage agreements that are above market-clearing levels. Those left out are of course unemployed.

While labor unions can boost their members’ compensation at the expense of non-union workers, higher wages generally and higher living standards are due mainly to increased productivity, which in turn depends on high levels of capital investment. People are more willing to save and invest when they have confidence in the future, and that confidence comes from respect for property rights.

For more on minimum wage laws, see Bad Idea of the Year.

Glass-Steagall and Deregulation: What Went Wrong?

Brandon Christensen History, Law , , , , ,

Nothing, really. Consortium members Warren Gibson and Jeffrey Rogers Hummel write in the Freeman on Glass-Steagall and what its repeal in the 1990’s meant for the economic crisis that began in 2008:

The timing of the repeal of Glass-Steagall makes this deregulatory move a convenient scapegoat for the financial crisis. But the crisis began with the housing collapse, a result of government encouragement of unsound lending practices. Financial firms took too much risk with mortgage-backed securities, in part because of moral hazard engendered by government guarantees and partly because bond rating firms were not as independent as was once thought. The limited liability that the investment banks gained when they became corporations may also have amplified moral hazard. There is no good reason to believe that Glass-Steagall, had it remained in effect, would have prevented any of these problems.

I highly recommend this piece. Lots of good history behind the law as well as a very clear explanation of the different types of banking services, what they do, and how they are created.

Around the Web: Consortium Edition

Brandon Christensen Links , , , , , , , , , , , , ,

Co-editor Fred Foldvary points out that slavery is alive and well today.

Historian Michael Adamson compares the debacle in Iraq to South Vietnam rather than Germany or Japan.

Mark Brady gives us a well-written, brief biography of a little-known (and hence important) individual in the liberty movement.

Ninos Malek explains how property rights are the key to environmental conservation efforts.

Jeffrey Rogers Hummel takes on anthropologist David Graeber.

“Stocks Slammed as Dow Erases 2012 Gains”

Brandon Christensen Current Events, Economics , , , , , , , , , , ,

That’s the title to a headline piece over at CNN.

The Dow Jones industrial average (INDU) plunged 275 points, or 2.2%, the biggest one-day drop since November. The blue-chip index gave up all its gains for the year, and is now 99 points below where it finished 2011. The S&P 500 (SPX) lost 32 points, or 2.5%, and the Nasdaq (COMP) dropped 80 points, or 2.8%.

Ouch. The cause of the plunge?

“The U.S. employment report was simply terrible,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

The May jobs report showed only 69,000 jobs were added to payrolls, less than half the 150,000 jobs forecast by economists surveyed by CNNMoney. The unemployment rate ticked higher for the first time in a year, rising to 8.2%.

I take three things away from this: Continue reading →

Links From Around the Web

Brandon Christensen Links , , , , , , , , , , ,

Co-editor Fred Foldvary on the destruction of the Libertarian Party.

Newest member of the consortium, Warren Gibson, writes in the Freeman about GDP.

Ninos Malek on associating in peace.

Jacques Delacroix questions Ron Paul’s credibility.

And writing over in the Atlantic, Conor Friedersdorf celebrates the failed boycott attempts of Rush Limbaugh’s show.

I just started school today, so if you don’t hear from me for a while, you now know why.  Have a great spring!

Links From Around the Consortium

Brandon Christensen Liberty, Links , , , , , , , , , , , ,

Over at the Progress Report, Dr. Fred Foldvary writes on how we can extirpate poverty from the world.

Jacques Delacroix calls out Ron Paul’s statement about Iran being surrounded by the U.S. government.

Professor Jeffrey Rogers Hummel tackles the issue of slavery head-on in a Freeman article.

Brian Gothberg writes about the potential technology has to start protecting the ocean’s resources through property rights.

And our newest blogger, Dr. Ninos Malek, defends stereotyping (defending the undefendable is why I love being a libertarian!).