The Midas Curse

Today is the official launch date of my book on the Great Depression, entitled . . . well . . . do you want the official title (The Midas Paradox) or my preferred title (The Midas Curse)?  The publisher thought the latter title sounded too depressing, and wouldn’t sell.  But in my own mind it will always be The Midas Curse.  The metaphor reflects the fact that attempts to hoard lots of gold ended up impoverishing the countries that got too greedy.  And I’d add that the second theme of the book is that attempts to artificially drive up wages ended up impoverishing workers through high unemployment.

A few observations about the book:

I began research on this subject in 1986.  I was interested in McCloskey and Zecher’s critique of Friedman and Schwartz, and tried to reconcile the two studies on my own terms, by developing a model of discretionary monetary policy under a gold standard.

Then I tried to get empirical estimates of both national and global monetary policy. At that time I defined monetary policy not as expected NGDP growth, but rather changes in the gold currency ratio.  Even today, I would defend that seeming inconsistency as follows: Under a fiat money regime there are no significant constraints on monetary policy, hence it makes sense to think of the stance of policy in terms of the goal variable (NGDP, or something similar).  Under a gold standard, policy is sharply constrained; hence it makes sense to think about the stance of policy in terms of deviations from the rules of the game, i.e. changes in the gold reserve ratio.  That’s what central banks actually controlled, not the money supply or interest rates.

Then I started noticing that private gold hoarding was also an issue.  And finally, I added changes in the price of gold (1933-34) to complete the demand-side model. I noticed that real wages seemed highly (negatively) correlated with output, and thus added New Deal policies aimed at boosting wages as the supply-side of the model. (Based on research with Steve Silver.)  Obviously other factors matter, but I still think these are the key drivers of high frequency fluctuations in output from 1929-39.

I had a lot of frustrations along the way.  Most of my empirical data (on “Minitab”) was eventually lost when Bentley changed it’s computer system. I once lost a notebook with almost a year’s worth of notes on the New York Times I had read from the 1930s.  I read virtually the entire NYT from that decade, on microfilm.  I also read many old dusty volumes at Bentley, Brandeis and Harvard Baker Libraries.

I think I worked far too carefully, trying too hard to be accurate.  At the time I was working on my own (I did not use research assistants) and didn’t know how other economists did research.  I was very careful collecting all sorts of obscure data like the stock of Estonian kroons (monthly) in the 1930s, to make data sets as complete as possible.  (To give you an idea how old this research is, Estonia didn’t exist at the time.) Later I learned that most researchers cut lots of corners, and I doubt that any tiny improvement in accuracy from my painstaking approach was worth all the time I spent.  (I wasn’t thinking like an economist.)  If I had known how difficult the project would be, I probably never would have done it.  And even with all that effort, the book undoubtedly has some mistakes.

By around 2005 the book was done.  After a long period at Cambridge University Press it was rejected.  The reviewer was not at all helpful.  Then I set it aside, before sending it to Princeton after I started blogging in 2009.  Another rejection (at least the reviewer was acceptable—just wasn’t their cup of tea.)  Then Independent Institute, and again more delays.  Unfortunately that means the book is somewhat out of date in terms of the literature review.  Once I started blogging I had no time to keep up with my research.  But the good news is that my work is so out of the mainstream that I doubt anyone else was doing the same sort of thing. It’s a throwback to the approach taken by Friedman and Schwartz.  The differences from F&S include:

1.  Defining monetary policy in terms of the global gold/currency ratio, not the domestic money supply.

2.  Focusing on both supply and demand shocks, instead of mostly demand shocks as F&S did.

3.  Looking at market reactions to policy shocks, which led me to abandon the F&S “long and variable lags” approach.  I noticed that policy shocks, the market reaction, changes in the WPI, and changes in industrial production all tended to occur at roughly the same time, or perhaps a month lag, which is impossible if there are long and variable lags.  If there actually are long and variable monetary policy lags then my entire book is utterly worthless, and should be thrown in the trash.

Ideally, my book should have been done using NGDP instead of the price level.  But I had better price level data at the monthly frequency, and it turns out that during the 1930s you get roughly the same results either way, both the WPI and NGDP fell roughly in half during 1929-33.  (Both the WPI and NGDP were also highly correlated, as output was highly correlated with prices during this period.)  But if I were doing a similar study with postwar data I’d definitely use NGDP.

I sort of regret having to be so critical of the Fed’s performance during the Great Recession.  This material was added after the book was finished, and I would still defend everything I say.  But when I wrote the book I always envisioned Bernanke as the “ideal reader.”  I think he might have liked the book when it was finished in 2005, but would now hate it, due to just a half dozen pages out of 500.

I looked briefly at the 1920-21 recession, and it seems to have had the same cause—central bank gold hoarding.  I seem to recall that the Fed alone hoarded enough gold in 1920-21 to reduce the entire world price level by about 17%.  I did not study the 1893 depression, but I suspect that gold hoarding (perhaps private) associated with devaluation fears explain some of that depression too.  I also suspect there were a few other factors as well.  Someone could do the same sort of study of 1893-96 as I did for 1929-33, and it would be interesting to compare results.

For better or worse this is my life’s work.

PS.  Scott Alexander (who I had the good fortune of meeting last week in Boston) said the new title sounds like an airport thriller.  (I’ll bet Robert Ludlum could have made it into a real page-turner.)  Speaking of Alexander, I hope everyone saw his list of suggested hardball questions for the next debate. Funniest post of the year.

PPS.  I also have some comments over at Econlog.

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Why so negative?

Here’s an interesting graph in The Economist, showing the extent of negative interest rates, by country and by maturity:

Screen Shot 2015-11-30 at 5.30.45 PMNot only are interest rates negative on 10-year Swiss government bonds, they are significantly negative, minus 41 basis points according to the FT.  Here are some observations:

1.  The differences within the eurozone mostly reflect default risk.  But notice that despite the default risk, even Spain and Italy have lower government bond yields than the US.

2.  The differences between the eurozone (especially Germany) and Switzerland relate to expected exchange rate changes.  The Swiss franc is expected to gradually appreciate against the euro.  Why is that?  Perhaps because the Swiss National Bank (SNB) has pursued contractionary policies in the past, especially when it (foolishly) allowed the SF to sharply appreciate at the beginning of the year.  Traders naturally expect more of the same.  The Danes sensibly kept their currency pegged to the euro.

3.  OK, but then why are eurozone rates lower than in the US?  The euro has recently depreciated.  Here you need to distinguish between levels and rates of change.  (And this is something that lots of people miss.)  An expansionary monetary policy can be thought of as reducing the value of the currency, or reducing the expected growth rate in the value over time (or both).  But those are actually two radically different kinds of expansionary policy.  The recent ECB policy has resulted in a one-time reduction in the value of the euro, but from this point forward it is expected to appreciate against the US dollar.  Why?  Probably because the ECB’s inflation target is a little lower than the Fed’s inflation target, although low eurozone rates may also be related to ECB credibility problems.

4.  As far as the low level of interest rates in all developed economies, I attribute that partly to slow NGDP growth, but there also have to be other factors involved.  And always remember that a low interest rate is not a monetary policy, it might reflect either easy money (liquidity effect) or tight money (NeoFisherian view.)  Keynesians and NeoFisherians both make a mistake in assuming that a low interest rate policy can deliver some sort of desired result.  (Oddly they make exactly opposite errors on what sort of results.)  Low rates are not a policy.

5.  Tyler Cowen linked to Matt Rognlie’s research papers.  (Any top university not making him a job offer should have their head examined.)  He has a paper on the zero bound that is full of interesting stuff.  I particularly liked the analysis of the welfare costs of negative interest. Friedman showed that positive interest rates were a tax on money, and hence inefficient, but I had never given much thought to the costs of a subsidy on currency use.  Rognlie also notes (correctly in my view) that before currency is withdrawn from circulation the government should first withdraw high denomination notes.

6.  Although most have us have been surprised that currency demand near the zero bound is less elastic than we expected, I still think it might be more elastic in the long run than in the short run, due to the cost of adjusting currency stocks.  I’d note that US currency demand seems to be moving upward with a lag, after short term rates fell close to zero in late 2008.  On the other hand the negative 41 basis point yield on long-term Swiss bonds suggests that investors expect the SNB to maintain significantly negative rates for an extended period of time.  So even in the long run, demand can’t be perfectly elastic at the zero bound.  I recall reading that the SNB was informally discouraging currency use, by telling banks not to pay out large sums of currency to depositors. (Unfortunately I forgot where I read that.)  Of course the US government has been trying to criminalize the use of significant sums of currency.

7.  The Economist article has some interesting speculation on the future of currency at the zero bound:

As interest rates creep further into the red, economists’ prescriptions have become bolder. In a speech in September Andy Haldane, the chief economist of the Bank of England, outlined a range of options to allow rates to go lower still. The most radical would be to get rid of the mattress option by abolishing cash altogether. Ken Rogoff of Harvard University calculates that there is $4,000 of currency in circulation for every person in America. Much of it is used to hide transactions from tax authorities or the police. Abolishing it would curb such activities, as well as helping central bankers.

Yet depositors might still find ways to safeguard their savings. Switching to foreign currency or precious metals would be an obvious option. As Kenneth Garbade and Jamie McAndrews of the Federal Reserve Bank of New York point out, taxpayers could make advance payments to the taxman and subsequently claim them back. Depositors could withdraw funds in the form of bankers’ drafts (certified cheques) to use as a store of value. Such drafts might even become a form of parallel currency, since they are transferable. Any form of pre-paid card, such as urban-transport passes, gift vouchers or mobile-phone SIMs could double up as zero-yielding assets. If interest rates became deeply negative, it would turn business conventions upside down. Companies would seek to make payments quickly and receive them slowly. Their inventories would grow fatter.

Note that even if depositors found a way to avoid sharply negative interest rates after the abolition of currency (say by holding foreign currency, or pre-paying taxes), the central bank could still use negative rates to reduce the demand for bank reserves (make it a hot potato), and hence boost NGDP.  But as always they need to be aware of where the Wicksellian rate is, and not just chase the Wicksellian rate lower in a futile attempt to jump-start NGDP growth.  They need to get ahead of the curve.

BTW, I strongly oppose the abolition of cash.  Like high taxes on cigarettes, it’s a highly regressive policy that seems to have support among progressives.

PS.  Marcus Nunes sent me an excellent Jim Pethokoukis interview of Tino Sanandaji, discussing the Swedish economy.  Lots of interesting info on Swedish history, the current immigration crisis, etc.

1997 and 2015

The East Asia crisis of 1997 had many causes, including a strong dollar, fixed exchange rates and poorly regulated financial systems.  One additional factor was the rise of China, which had begun competing with other East Asian exporters.  At the time, China was still fairly low tech, and hence the 1997 crisis hit the lower income countries of Southeast Asia much harder than places like Singapore, Taiwan and Japan.  Those higher income places had a more complementary relationship to China, supplying needed capital goods.

But the China of 2015 is very different from the China of 1997.  It is now a much more advanced economy, and it is beginning to offer fierce competition to the more sophisticated economies of East Asia, such as Singapore:

The Ministry of Trade and Industry on Wednesday forecast economic growth in 2015 at “close to 2 percent” and between 1 and 3 percent in 2016. It previously forecast 2015 growth at between 2 and 2.5 percent.

Singapore, a city-state at the tip of peninsula Malaysia, is the wealthiest economy in Southeast Asia but has shifted to lower growth rates in the past decade as other countries including China eroded its traditional strengths in electronics and other manufacturing. It has encouraged investment in higher value industries such as pharmaceuticals and also tried to boost services by opening two casinos, encouraging tourism and becoming a center for private banking.

And Taiwan:

Last year Taiwan grew by 3.8%. Many analysts had expected about the same this year. Instead, it will do well to hit 1%, says Gordon Sun of the Taiwan Institute of Economic Research. . . .

Until a few years ago, the economic relationship between China and Taiwan was symbiotic. Taiwanese firms, among the world’s biggest makers of electronic components, needed China’s cheap labour; China craved Taiwan’s technical know-how. But this complementarity has given way to competition. Chinese producers of petrochemicals, steel, computers and digital displays have moved into terrain once occupied by Taiwan. Taiwanese firms with operations in China are themselves buying more materials and machinery from Chinese suppliers. Chinese firms are now trying to break into semiconductors, Taiwan’s last big industrial redoubt.

Sometimes size gives producers additional monopoly power.  Ironically the size and homogeneity of the Han Chinese population (both inside of China and overseas) depresses the prices of the things the Chinese have a comparative advantage in producing.  Perhaps this partly explains the disappointing performance of China’s stock market in recent years.  With each China advance, a new set of ever more sophisticated industries are flooded with output.  Meanwhile non-Chinese industries that sell to the Chinese (BMW, Louis Vuitton, etc.) benefit from the China boom.

BTW, lots of people like to cite the “Li Keqiang index” as an alternative to the official Chinese statistics.  I’ve argued that this index does not apply to an economy rapidly shifting from heavy industry to services.  It seems as though Li himself now agrees with me:

In short, despite moderation in growth, the Chinese economy is moving in the desired direction of stronger domestic demand and innovation. One by-product is a fall in the relevance of indicators such as power consumption, rail-cargo volume and new bank credit in gauging economic performance. Yet this transition from “bigger is better” to “less is more” is a good thing. I would otherwise be worried whether the reforms were working as intended.

And now I anticipate commenters who believed Li’s early statements telling me that you can’t believe anything a Chinese leader says.

Wenzhou people

If you talk to enough Chinese people, you will eventually come across the phrase “Wenzhou people”, referring to people from a particularly entrepreneurial city on the coast of China.  They have a reputation for being good at business.

Wenzhou is a city in Zhejiang province.  Yasheng Huang says that Zhejiang province is rather special, as it embraced capitalism before the rest of China.  It’s leaders were more tolerant of private business during the 1980s, and as a result private enterprises did better than in other parts of China.  The province directly to the north (and most similar in some ways) is Jiangsu.  Because property right were less secure in Jiangsu, they relied more on foreign investment from multinationals.  Ironically, during the 1980s property rights in China were far more secure for multinationals than for local firms.

Even today Jiangsu has a higher GDP per capita than Zhejiang, due to all the multinational investment.  But Zhejiang has a higher level of domestic income, as much of the Jiangsu income earned by multinationals flows out of the country. Zhejiang is China’s richest province, excluding the independent cities such as Shanghai and Beijing.  Its 55 million people are a mix of urban and rural. (Similar population to England, in a 20% smaller area, with many more mountains and more rural people.) And it also seems to exhibit some other very interesting characteristics.

For instance, Zhejiang residents have a very long life expectancy.  Unfortunately I had a really hard time finding this data.  The data that is easy to find on the internet is out of date. Lancet has an article that suggests that in 2013, the life expectancy in Zhejiang had surged to over 81 years, nearly two years higher than the number two province (Jiangsu–again ignoring independent cities.)  That’s up from 74.7 in 2005, meaning their life expectancy grew by roughly 6 1/2 years in 8 years.  And more importantly, the gap with other top provinces widened significantly.  (Overall, life expectancy in China usually grows fastest in those areas where it is lowest.)

Reading Garett Jones’s fascinating new book “Hive Mind” got me wondering about Chinese IQ.  Shanghai’s PISA scores are highest in the world, but no one thinks Shanghai is representative of China as a whole.  Unfortunately, the figures for other provinces are not reported—in English.  I dug a round a bit on the internet and found a post that reports IQ equivalents for some other Chinese provinces.  Here’s what it says:

Happily (via commentator Jing) we learned that the PISA data for Zhejiang province and the China average had been released on the Chinese Internet. I collated this as well as data for Chinese-majority cities outside China in the table below, while also adding in their PISA-converted IQ scores, the scores of just natives (i.e. minus immigrants), percentage of the Han population, and nominal and PPP GDP per capita.

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* Twelve provinces including Shanghai, Zhejiang, Beijing, Tianjin, Jiangsu totaling 621 schools, 21,003 students. Results have been released for Shanghai, and later on for Zhejiang (59 schools, 1,800 students – of which 80% were township-village schools) and for the 12-province average.

(1) Academic performance, and the IQ for which it is a good proxy, is very high for a developing nation. Presumably, this gap can largely be ascribed to the legacy of initial historical backwardness coupled with Maoist economics.

(2) The average PISA-converted IQ of the 12 provinces surveyed in PISA is 103.0. (I do not know if provincial results were appropriately weighed for population when calculating the 12-province average but probably not). We know the identities of five of the 12 tested provinces (Shanghai, Zhejiang, Beijing, Tianjin, Jiangsu). They are all very high-income and developed by Chinese standards. Furthermore, these five provinces – with the exception of Tianjin – all perform well above average according to stats from a Chinese online IQ testing website.

The author of the post, Anatoly Karlin, then makes this claim:

Addendum 8/15: The commentator Jing graciously provided the list of all the 12 Chinese provinces that participated in the PISA 2009 study. They were: Tianjin, Shanghai, Beijing, Jiangsu, Zhejiang, Jilin, Hubei, Hebei,

Hainan, Sichuan, Yunnan, Ningxia.

This allowed me to make an interesting conclusion. No matter whether you weigh the provincial IQ scores above by population or not, the difference between the 12 provinces and China on average is only about 0.5 points in favor of the 12 provinces. This means that the PISA sample is actually pretty good – and that China’s PISA-derived IQ is in fact about 102.5 or so.

Even if that’s not exactly right, it’s probably in the ballpark.  Some of those 12 provinces are in the west, and Sichuan has a huge population.  So while the group of 12 would be somewhat upwardly biased by the three big cities, the sample includes a large number of very populous inland provinces.  Even if the actual number were 100, it would be an astoundingly high IQ for a country at China’s level of development (recall the so-called “Flynn effect.”)  For instance, Switzerland’s 101 is the highest average IQ in Europe.  I recall that Garett Jones mentioned that Hong Kong and Taiwan had scored surprisingly high when they were still poor, and of course they are ethnic Chinese.

I assume you know where I’m going with this.  Zhejiang seems to have an especially high average IQ, especially for a province with a mix of urban and rural residents.  In eastern China, one cannot point to ethnic differences to explain IQ variation, Zhejiang is more than 99% Han, and other eastern provinces are also overwhelmingly Han. Instead, the anomalous IQ must represent some sort of (local) cultural or educational difference. Did this arise recently, like their long life expectancy?  Is it caused by the fact that Zhejiang got a head start on capitalism?  Or does the cause go deep into Chinese history?  After all, Zhejiang contains the city of Hangzhou, which Marco Polo marveled over. Hangzhou is host to a top university, and the internet giant Alibaba. It’s also home to Pritzker prize winning architect Wang Shu who designed a college campus in Hangzhou.  And it’s one of China’s most (only?) beautiful cities.

And here’s what Wikipedia says about Wenzhou:

Wenzhou has given birth to more mathematicians more than any other city in the world.

No answers here, just some interesting regional differences to think about.

PS.  Possibly related (or not) I saw this astounding story:

Beijing will replace an aging overpass with a new one weighing 1,300 metric tons within 24 hours starting on Friday.

If the job is completed as planned, it will set a record in China for the shortest replacement time involving such a large structure in heavy-traffic downtown areas, the Beijing Municipal Commission of Transport said on Tuesday.

The replacement will take place at the Sanyuanqiao overpass on the northeast section of the Third Ring Road, which links the city with Beijing Capital International Airport. It is one of the busiest traffic hubs in the city.

This will be the first time in China that special dollies – low, wheeled platforms – that are able to carry 1,000 tons each will be used to move giant prefabricated bridge pieces and install them fully intact, said Hou Xiaoming, deputy director of the road management department of the commission.

The original overpass was completed in 1984.

.  .  .

In the past, building an overpass in downtown areas has taken months to complete. This project will be fast because of sophisticated engineering and careful preparations, Hou said.

Beijing has more than 200 overpasses inside its Fifth Ring Road, the most in the country. Sanyuanqiao is four times the size of the Xizhimen overpass in downtown Beijing, which was replaced six years ago using older engineering technology.

“If successful, it will serve as a good example for other cities to follow in downtown areas troubled by traffic jams,” Hou said.

And they say the Chinese don’t innovate.  The giant highway engineering project will cost $7.77 million.  In Boston it would cost many times more, and would take more like one year, not one day.

Will China get stuck in the middle-income trap?  Can you point to any countries that did get stuck in the middle-income trap, and have average IQs anywhere near 109.5? Or even 100?  Russia might be the best case, with an average IQ of 97, and (perhaps) stuck near the top of the middle-income range.  (Actually it’s too soon to tell.)  But China seems very different to me. Time will tell.

Sad news from down under

[Update:  Check out the comment section, it looks like the US is ultimately to blame for this too.  Everywhere I travel I hear people complaining about our government’s arrogance.  People tell me “I used to look up to the US.”  I no longer hear anything positive about the US.  Meanwhile we have a welcome sign out for corrupt officials from all over the world who want to launder money here in real estate, and we couldn’t care less what the rest of the world thinks about it.  Do as we say, not as we do.  What a disgraceful government. Just one more issue the media will ignore, as they cover the clown show called “debates”.]

When I visited Australia and New Zealand back in 1991 they seemed like much freer countries than America.  Probably they still are.  But I was disappointed to see this:

Over the past seven years, the team at Victoria Link have been running New Zealand’s only prediction market, iPredict. It is one of only three “commercial” prediction markets operating globally. We’ve really enjoyed turning it from research into a practical tool which has become part of the New Zealand political narrative.

Prediction markets function based on the assumption that people will be more accurate when they back their opinion with money. There is a wide academic field studying this, and it could one day result in more accurate forecasting of a huge variety of events and even change how governments make decisions.

As prediction markets do not comfortably fit within any existing regulatory boxes, we have been working closely and positively with the Financial Markets Authority (FMA) to enable us to operate economically within the financial market regulations.

Regrettably the Ministry of Justice has not been so positive. We applied for an exemption from the Anti-Money Laundering and Countering Financing of Terrorism Act. We believed we would secure an exemption due to the limited possible investment into iPredict trades and the small nature of the Prediction market transactions.

Our application has been declined by the Minister, Simon Bridges, on the grounds that we are “a legitimate money laundering risk”. This is essentially because we have no customer due diligence checks. He considered the level of regulatory burden is proportionate to the risk. He formed these views without any discussions with us.

We are an academic not-for-profit organisation and our agreement with the FMA dictates we place caps on transactions. For example, over the past seven years, we have handled a total of 3,782 withdrawals, with an average trader net worth of $41. Our withdrawal process is lengthy and we are a low risk of money laundering.

Because the cost of compliance is too high, we are forced to wind up operations in NZ.

It seems that it’s not just the US government that is anti-science, other governments are too.

Over at the blog Offsetting Behavior they printed an email from Glenn Boyle, who helped set up iPredict:

When we were setting iPredict up between 2005 and 2008, all the holdups were technological and financial, not regulatory.  Liam Mason and others at the Securities Commission were generally helpful and tried to eliminate roadblocks rather than put them in our way, and there certainly didn’t seem to be any impediments thrown at us by ministers.

I recall the money laundering bogeyman coming up only once, and then only in jest.  I don’t remember the exact wording, but it was something along the lines of “you’ll probably get hit with money laundering charges if the Americans invade or we ever elect a communist government.”  Ouch…

This wasn’t taken seriously at the time though.  Looking back through all the various memos etc I prepared during the 3+ years iPredict was being set up, I can’t find any reference to money laundering regulation at all.  I guess we were naive!

Ironically, it was a conservative government that put iPredict out of business.  Can’t have people laundering $41, which is what, $28 in US money?

HT:  Stephen Kirchner