Posts
Triffin's Dilemma, identified by economist Robert Triffin, highlights a fundamental imbalance caused by a national currency acting simultaneously as a global reserve currency. Specifically it refers to the US dollar's role under the Bretton Woods agreement.
It states that the use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. Triffin noticed that the US had two competing and incompatible goals while maintaining the Bretton Woods system:
If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.
If U.S. deficits continued, a steady stream of dollars would continue to fuel world economic growth. However, excessive U.S. deficits (dollar glut) would erode confidence in the value of the U.S. dollar. Without confidence in the dollar, it would no longer be accepted as the world's reserve currency. The fixed exchange rate system could break down, leading to instability.
Obviously, the US was faced with a dilemma because it is not possible to run a balance of payments current account deficit and surplus at the same time.
Wednesday, March 25, 2009
Triffin's Dilemma
Tuesday, March 24, 2009
Key Concept - Quantitative Easing
Quantitative easing is basically a term for "printing money". It refers to a central bank essentially creating new money and using it to reduce interest rates and thus encourage lending. It can accomplish this "easing" by: buying debt in the form of government bonds, buying assets from banks, directly lending to deposit-taking institutions, or any combination thereof.
Central banks normally use interest rate cuts to stimulate lending. Quantitative easing can be used when this strategy is not working or interest rates have already been cut to 0%. It can be used to combat deflation, but if the money supply is increased too much, it can create inflationary pressures. The ultimate risk is hyperinflation.
Saturday, March 7, 2009
Key Concept - Ricardian Equivalence
Ricardian Equivalence is an economic theory that postulates debt-financed government spending will leave demand unchanged. It suggests that it does not matter whether a government finances its spending with debt or a tax increase, the effect on total level of demand in an economy will be the same.
According to the theory, the public will save any excess money received to pay for the inevitable future tax increases. In an extreme case, current generations will save the money and bequeath it to future generations to pay the bill.
The theory, developed by the 19th century political economist David Ricardo (who also was a pioneer in the description of comparative advantage), rests on several key assumptions:
1. A perfect capital market - all players can borrow or save as much as is required at a fixed rate which is the same for all persons at a given date
2. Fixed government spending path
3. Inter-generational concern - The increased taxes may not be paid by the current generation. Current individuals would need to have concern for their descendants.
4. Rational citizens
Obviously these are assumptions that are on shaky footing in our current world, which tends to cause the theory to lose some validity. Since the theory doesn't hold up completely, government stimulus plans can affect the economy, and may explain standard Keynesian theory where bond financed spending has a bigger effect than tax financed spending.
However, while perhaps not perfect, it certainly can explain some behavior that will temper the effectiveness of government stimulus programs. Many people use their stimulus checks to pay down debts, thus leaving more ability for payment of future tax increases.
It also brings up moral issues about financing current spending by writing debt to be paid by future generations that have no say in the process. Even if issuing debt does give an increase in demand for the economy, the recipient of the benefit and the payer of the debt should both be willing participants.
Refs:
wikipedia, investopedia
Wednesday, March 4, 2009
The Defense of Howard Roark
“Degrees of ability vary, but the basic principle remains the same: the degree of a man’s independence, initiative and personal love for his work determines his talent as a worker and his worth as a man. Independence is the only gauge of human virtue and value. What a man is and makes of himself; not what he has or hasn’t done for others. There is no substitute for personal dignity. There is no standard of personal dignity except independence.Excerpt from The Fountainhead, by Ayn Rand
“In all proper relationships there is no sacrifice of anyone to anyone. An architect needs clients, but he does not subordinate his work to their wishes. They need him, but they do not order a house just to give him a commission. Men exchange their work by free, mutual consent to mutual advantage when their personal interests agree and they both desire the exchange. If they do not desire it, they are not forced to deal with each other. They seek further. This is the only possible form of relationship between equals. Anything else is a relation of slave to master, or victim to executioner.
“No work is ever done collectively, by a majority decision. Every creative job is achieved under the guidance of a single individual thought. An architect requires a great many men to erect his building. But he does not ask them to vote on his design. They work together by free agreement and each is free in his proper function. An architect uses steel, glass, concrete, produced by others. But the materials remain just so much steel, glass and concrete until he touches them. What he does with them is his individual product and his individual property. This is the only pattern for proper co-operation among men.
...
“Now observe the results of a society built on the principle of individualism. This, our country. The noblest country in the history of men. The country of greatest achievement, greatest prosperity, greatest freedom. This country was not based on selfless service, sacrifice, renunciation or any precept of altruism. It was based on a man’s right to the pursuit of happiness. His own happiness. Not anyone else’s. A private, personal, selfish motive. Look at the results. Look into your own conscience.
“It is an ancient conflict. Men have come close to the truth, but it was destroyed each time and one civilization fell after another. Civilization is the progress toward a society of privacy. The savage’s whole existence is public, ruled by the laws of his tribe. Civilization is the process of setting man free from men.
“Now, in our age, collectivism, the rule of the second-hander and second-rater, the ancient monster, has broken loose and is running amuck. It has brought men to a level of intellectual indecency never equaled on earth. It has reached a scale of horror without precedent. It has poisoned every mind. It has swallowed most of Europe. It is engulfing our country.
Tuesday, February 17, 2009
Word of the Day
Pyrrhic victory 
(pĭr'ĭk)
1. A victory that is offset by staggering losses
2. A victory or goal achieved at too great a cost
This expression alludes to Kind Pyrrhus of Epirus, who defeated the Romans at Asculum in a.d. 279, but lost his best officers and many of his troops. Pyrrhus then said: "Another such victory and we are lost."
Sunday, February 15, 2009
Personal Savings Rate
As I noted in 'Paradox of Thrift' and is highlighted in this article, the personal savings rate has gotten a lot of attention lately. So how exactly is the personal savings rate calculated?
There are two main sources for the calculation of the personal savings rate (PSR); the U.S. Bureau of Economic Analysis (BEA) estimates it from the National Income and Product Account (NIPA) data, and the Board of Governors (BOG) of the Federal Reserve System estimates the changes in personal net wealth that can be computed from their flow of funds (FoF) accounts.
The PSR value from the BEA is the one most commonly used and quoted in the press. It is calculated by first finding personal savings:
(personal income) - (personal outlays + personal current taxes) = personal savings
This value is then divided by personal income to get the rate.
What exactly is personal income? According to the BEA glossary it is: Income received by persons from all sources. It includes income received from participation in production as well as from government and business transfer payments. It is the sum of compensation of employees (received), supplements to wages and salaries, proprietors' income with inventory valuation adjustment and capital consumption adjustment (CCAdj), rental income of persons with CCAdj, personal income receipts on assets, and personal current transfer receipts, less contributions for government social insurance.
What are personal outlays? From the BEA: The sum of personal consumption expenditures (e.g. the goods and services purchased by persons), personal interest payments, and personal current transfer payments.
Personal current transfer payments are payments consisting of transfer payments by persons to government and to the rest of the world. Payments to government include donations, fees, and fines paid to Federal, state, and local governments, formerly classified as "personal nontax payments."
What about personal taxes? These include taxes paid by persons on income, including realized net capital gains, and on personal property.
The NIPA tables can be found here.
Thursday, February 12, 2009
Argumentum Ad Consequentiam
Argumentum Ad Consequentiam - a logical fallacy which concludes a certain premise is either true of false based on the (un)desirability of the outcome.
Forms:
- If P, then Q will occur.
- Q is desirable.
- Therefore, P is true.
- If P, then Q will occur.
- Q is undesirable.
- Therefore, P is false.
- This fallacy also falls under the broader "appeal to emotion"
Sunday, February 8, 2009
Word of the Day
schadenfreude [shahd-n-froi-duh]
1. enjoyment obtained from the troubles of others
See also: Roman Holiday
Wednesday, February 4, 2009
Key Concept - VIX
VIX is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index. It describes the expected volatility for the market over the next 30 days, and is known as the "fear index". There are three variations: VIX, VXN, and VXD which describe the S&P 500, NASDAQ and Dow, respectively.
Generally, a VIX value over 30 represents high volatility, while one less than 20 corresponds to calm times in the market. Note that high volatility can occur during a bull or bear market.
The VIX reached an intra-day high of 98.53 on Oct 24, 2008. For perspective: between 1990 and Oct 08, the VIX averaged around 19.
Tuesday, February 3, 2009
Paradox of Thrift
'Thriftiness, while a virtue for the individual, is disastrous for an economy.’
I've noticed several articles in the past few days describing the "Paradox of Thrift". It is a construction of Keynesian economic thought: in times of recession it is in the best interest of the individual to save - however the greater economy suffers from lack of demand. This ultimately harms all individual consumers - in a form of prisoner's dilemma. The worry is that this behavior can extend the recession or even cause deflation and depression.
Keep in mind I'm not an economist, but I see several problems with this line of thought. First, it would seem that "saved" money is not (normally) hoarded away under a mattress. As long as the saved money is not held in actual bills, it is returned to the economy through banks or stocks or bonds or other investments. This increases the money supply to be loaned out to buy new things or used to create new businesses, etc.
Second, if our economy is based upon consumers spending more than they earn, it is inherently unsustainable. This would lead me to believe that our current problems will take quite some time to work themselves out. I also do not see how borrowing large amounts of more money will fix things, if the original cause of the crisis was too much cheap, easy credit. Perhaps someone can explain this to me.
Friday, January 16, 2009
Key Concept - Moral Hazard
Moral Hazard is the tendency for a party that is shielded from risk to behave differently than if he was exposed to said risk. It can also occur when a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.
Moral Hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.
While the concept has been around since the 1600s, the phrase was first used in a modern context in 1963 by economist Ken Arrow. It has been employed in finance to describe the dilemma that arises when a government helps a financial institution rebound after a self-inflicted failure. The unfortunate consequence is that the government assistance could be interpreted as a new precedent - rather than a one-time occurrence - and lead to increased risky behavior by multiple parties.
The concept has been commonly applied in the fields of finance, insurance, management, and in the social sciences.
Monday, January 12, 2009
Key Concept - Comparative Advantage
While an absolute advantage in an endeavor refers to the ability to produce at the lowest cost or using the least amount of resources; a comparative advantage is the ability to produce at a lower opportunity cost.
An example: Suppose that two castaways on a desert island gather both fruit and grain, which they then share equally between them. Suppose that Castaway A can gather more fruit per hour than Castaway B, and therefore has an absolute advantage in this good. Nonetheless, it may well make sense for A to leave some fruit-gathering to B. This is because it is possible that B gathers fruit slightly slower than A, but gathers grain extremely slowly.
One needs to look at comparative advantage rather than absolute advantage, to discover how A and B can each best allocate their effort. If A's initial advantage over B in grain-gathering is greater than his or her advantage in fruit-gathering, then fruit-effort should be transferred from A to B, to the point where A's comparative advantages in the two goods are equal. Thus it may be rational for fruit to flow from B to A, despite A's absolute advantage.
Thursday, January 8, 2009
Word of the Day
contango [kuh
n-tang-goh]
1. In futures or options trading, a market in which longer-term contracts carry a higher price than near-term contracts.
2. The premium accorded to longer maturities is a normal condition of the market and reflects the cost of carrying the commodity for future delivery.
3. (on the London stock exchange) a fee paid by a buyer of securities to the seller for the privilege of deferring payment.
See also Backwardation.
Sunday, January 4, 2009
Key Concept - Tragedy of the Commons
I am beginning a semi-recurring series of interesting (to me) topics to further explore and consolidate certain "Key Concepts". Up first is the namesake of this blog: "The Tragedy of the Commons".
The term and concept was first officially coined by Garrett Hardin in a 1968 Science magazine article, which I highly recommend. (article here) It describes the inclination for multiple rational individuals to act in their own self-interest in the short-term, even at the detriment of all over the long-term.
The article raises some very interesting and sometimes rather controversial ideas, the most outstanding being the call to relinquish the freedom to procreate. I'd prefer to highlight some of the other, perhaps less extreme, points:
The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy.
As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, "What is the utility to me of adding one more animal to my herd?" This utility has one negative and one positive component.
1) The positive component is a function of the increment of one animal. Since the herdsman receives all the proceeds from the sale of the additional animal, the positive utility is nearly +1.
2) The negative component is a function of the additional overgrazing created by one more animal. Since, however, the effects of overgrazing are shared by all the herdsmen, the negative utility for any particular decision-making herdsman is only a fraction of -1.
Adding together the component partial utilities, the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another.... But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit--in a world that is limited.
- There are problems that do not have technical solutions
- It is not mathematically possible to maximize for two (or more) variables at the same time
- Optimal human population is below the maximum population
- The morality of an act is a function of the state of the system at the time it is performed
- An alternative to the commons need not be perfect just to be preferable
While the article is mainly concerned with population growth, the author does mention pollution as an example. In current events, Global Warming certainly fits squarely in the category of a 'Tragedy of the Commons'. The author places global population in the "no technical solution" category; unfortunately, I am more and more inclined to do the same for climate change. Certain parallels are quite striking: as the author cautions against the appeal to conscience, most anti-global warming appeals are decidedly guilt-based. The article posits that these calls are not productive in the long- or short-term.
My fear is that a solution that is effective, equitable, and enforceable is simply beyond the global community's technical and political ability. This is the true tragedy - "the solemnity of the remorseless working of things".
The long-term disadvantage of an appeal to conscience should be enough to condemn it; but has serious short-term disadvantages as well. If we ask a man who is exploiting a commons to desist "in the name of conscience," what are we saying to him? What does he hear?--not only at the moment but also in the wee small hours of the night when, half asleep, he remembers not merely the words we used but also the nonverbal communication cues we gave him unawares? Sooner or later, consciously or subconsciously, he senses that he has received two communications, and that they are contradictory: (i) (intended communication) "If you don't do as we ask, we will openly condemn you for not acting like a responsible citizen"; (ii) (the unintended communication) "If you do behave as we ask, we will secretly condemn you for a simpleton who can be shamed into standing aside while the rest of us exploit the commons."
Wednesday, December 17, 2008
Word of the Day
anthropogenic (
n
thr
-p-j
n
k)
1. Caused or influenced by humans.
2. Pertaining to the effect of human beings on the natural world.
Tuesday, November 11, 2008
The Dark Side of Lower Prices
I am certainly enjoying the plummeting price of oil and gasoline. However, as with anything, there may be a catch. As I noted here, it is not just oil that is dropping, but many other commodities and goods. While this sounds great from a consumer perspective, this article examines why most economists think - if it continues - it is not good at all.
"When prices start to fall because of lack of demand, they can go well below the cost it takes to produce products," said Bernard Baumohl, executive director of the Economic Outlook Group. "Companies have no alternative than to cut back production and lay off a lot of workers. That cuts demand more. You get this vicious downward spiral in prices."
Most economists point out that the current economic conditions do not yet suggest that deflation is present, or even imminent.