Archive for June 2017


Gabe Newell contributes to Hypermind

I’d like to thank Gabe Newell (President of Valve Software) for very generously agreeing to directly contribute $10,000 to the Hypermind NGDP prediction market. You may recall that Mr. Newell made a similar contribution a few years ago, in our previous effort.  Note that some of the recently donated money is still working its way through the bureaucracy, but rest assured it will get there.  I hope to be able to announce a much larger prize total in the near future.  The goal is to boost trading volume.

In this previous post, I explained how you can also assist the prediction market project by contributing to the Mercatus Center.  I believe that this sort of contribution has tax advantages due to the non-profit status of Mercatus.  However I recently learned that Mercatus has a policy where researchers don’t publicly thank donors, as research and fundraising are kept separate.  Sorry about that misunderstanding.  That does not apply to direct donations to Hypermind, but AFAIK those are not tax deductible.

PS.  As I get older, things just seem to get more complicated.  But I’m working hard to simplify my life.  Last month I owned two rental properties. Now I have one.  Next month I’ll have zero.  Never become a landlord.

Josh Hendrickson reviews The Midas Paradox

Josh Hendrickson has a very good review of my Great Depression book, published in the Journal of Economic History.  Here is one part of the review:

The role of monetary policy expectations is central to the modern New Keynesian model. Forward guidance has been a tool of monetary policy in the aftermath of the Great Recession. The role of expectations following the increase in the price of gold would seem to provide some empirical support for both the model and the practice. However, hidden in Sumner’s book is a cautionary tale about this type of policy. While it is true that the price level increased immediately following the increase in the price of gold, the gold standard has a built-in mechanism, namely international price arbitrage, which ensures that the price level would eventually rise. In a modern fiat regime there is no automatic mechanism capable of generating this outcome. The public’s expectations in a fiat regime depend on the commitment of the central bank to do something in the future. This word of caution is important because a key and recurring empirical observation in Sumner’s book is that fears of devaluation often led to private gold hoarding, which was deflationary (precisely the opposite effect of an actual devaluation). Sumner leaves the question of why expectations of devaluation and actual devaluation had precisely the opposite effect as a subject for future research. However, one possible hypothesis is that an actual devaluation had a built-in commitment mechanism. At the very least, this should give current policymakers some pause about forward guidance.

I think Josh is correct about the commitment mechanism, which is what made the 1933 dollar depreciation so effective.  Josh is right that I struggled with explaining why expectations of devaluation were often contractionary (not just in the Depression, BTW, but also in the 1890s.) It may have something to do with the dual media of account, gold and currency.  In a modern fiat money system, there is only one medium of account—base money.  If there is a 2% chance that the dollar will be devalued by 50% next year, then the expectation is that gold will earn a return 1% higher than currency.  If government bonds are also earning near zero interest rates, then gold becomes an relatively attractive investment.  This drives up the real value of gold all over the world, including the country where devaluation is thought to be a possibility.  That’s deflationary.  On the other hand, this reduces the demand for currency, which should be inflationary. And until the devaluation actually occurs, currency is pegged to gold at a fixed price.  There may be a way to model all this, but it’s not clear to me what it is.

An added complication is that fear of devaluation also seemed to trigger bank runs during 1931-33, and that’s also a deflationary factor.

Nominal illusion

In order to better understand money illusion, it might help to consider some similar examples in other areas.  The Economist has an interesting story on the rare coin market:

The [rare coin] market’s wild-west days ended in 1986 when the first independent coin certifier, the Professional Coin Grading Service (PCGS), based in California, established itself as an authority on authenticity and quality. Grading each coin on a one to 70 scale, PCGS gave the market transparency, boosting investor confidence and sales volumes. Today, global sales of rare coins are estimated at $5bn-8bn a year, with 85% of the market in America. So important has third-party grading become that almost all rare coins sold at auction these days have been graded and sealed in stickered plastic by either PCGS or its main rival, Numismatic Guaranty Corporation (NGC), which is based in Florida.

Some blame the grading system itself for the eye-watering returns. Investors cling to the assigned grade: even a one-point boost can double or even triple a coin’s retail price. An 1884 silver dollar from the San Francisco mint, for instance, sells for $19,500 at the 62 grade but surges to $65,000 at 63.

The grading process is subjective: the evaluation criteria include “eye appeal”. Scott Travers, a coin dealer in New York, says investors sometimes resubmit the same coin ten or 20 times to the same company in hope of an upgrade. All this led to a steady “grade inflation”, that has been cheered along by investors. But in the long term, a sustained rise by simple fiat in the number of high-grade coins will surely depress prices. Already, a new type of “grader of graders” has emerged, hoping to instil some discipline by rating the consistency of the two primary graders. Next: graders of graders of graders?

This is, of course, another example of the sort of grade inflation that you see in American education.  What can we learn from this?

1. The incentive to inflate exists in both the private and public sectors.  I’ve heard that grade inflation is often worse in private schools, can anyone confirm?

2.  From a sociological perspective, the rare coin market is quite different from academia.  Whereas educators have a left wing bias, the rare coin world is more right wing.  So theories of academic grade inflation based on the left wing bias in education should be viewed with suspicion.

3.  In my view, monetary inflation, academic grade inflation, and rare coin grade inflation are partly motivated by what could be called “nominal illusion”, the tendency to see numbers as having the same meaning at two different points in time.  People wrongly assume that a dollar is a dollar, a 4.0 is a 4.0, and MS62 silver dollar is a MS62 silver dollar.

4.  In all three cases the illusion is only partial.  Workers feel better with a 10% raise during a period of 10% inflation, than a zero raise during zero inflation. That’s money illusion.  But they are not completely ignorant on this point.  They’d prefer an 8% raise with zero inflation to a 10% raise with 10% inflation.  Employers don’t know enough to completely look past the effects of grade inflation, which differ by college and by cohort, but they have some awareness that a 4.0 back a few decades is worth more than a 4.0 today.  And in the rare coin market, a coin that was graded MS62 a couple of decades ago has more value than one receiving that grade today.  If you look at rare coins on eBay, you’ll occasionally see references to the older form of packaging being used by the grading service, which makes the grade more desirable. It’s not just old coins that are more valuable; coins graded long ago are also more valuable.

5.  It’s possible that the incentive to inflate grades is greater than the incentive to inflate the money supply, because money is a government monopoly.  Think about the example of gasoline pricing in America.  Most consumers know that gas listed at 239.x a gallon is actually 239.9 a gallon, even though the 9 is so small that it’s hard to read.  Since almost all gas stations do this, any single station that did not would be at a competitive disadvantage.  My daughter told me that Berkeley does less grade inflation than other schools, perhaps because they are an elite government institution, with prices far below market.  They have a captive audience.  And government institutions have less entrepreneurial zeal. But I believe that most schools and most coin graders grade inflate because not doing so puts them at a competitive disadvantage.  I know that I inflated my grades over time because I wanted my student grades to be understood by employers, and I thought the best way of doing so was by grading under a similar set of criteria to other professors.  As they inflated, so did I.

6.  Contra Hayek, if we went to a system of competitive private monies, there is no reason to believe that issuers would keep the value of their currencies stable.

The Canadian Taliban

Here’s the New York Times:

The controversy began when Hal Niedzviecki, editor of Write, the magazine of the Canadian Writers’ Union, penned an editorial defending the right of white authors to create characters from minority or indigenous backgrounds. Within days, a social media backlash forced him to resign. The Writers’ Union issued an apology for an article that its Equity Task Force claimed “re-entrenches the deeply racist assumptions” held about art.

Another editor, Jonathan Kay, of The Walrus magazine, was also compelled to step down after tweeting his support for Mr. Niedzviecki. Meanwhile, the broadcaster CBC moved Steve Ladurantaye, managing editor of its flagship news program The National, to a different post, similarly for an “unacceptable tweet” about the controversy.

It’s not just editors who have to tread carefully. Last year, the novelist Lionel Shriver generated a worldwide storm after defending cultural appropriation in an address to the Brisbane Writers Festival. Earlier this year, controversy erupted when New York’s Whitney Museum picked for its Biennial Exhibition Dana Schutz’s painting of the mutilated corpse of Emmett Till, a 14-year-old African-American murdered by two white men in Mississippi in 1955. Many objected to a white painter like Ms. Schutz depicting such a traumatic moment in black history. The British artist Hannah Black organized a petition to have the work destroyed.

Other works of art have been destroyed. The sculptor Sam Durant’s piece “Scaffold,” honoring 38 Native Americans executed in 1862 in Minneapolis, was recently being assembled in the Minneapolis Sculpture Garden. But after protests from indigenous activists that Mr. Durant was appropriating their history, the artist dismantled his own work, and made its wood available to be burned in a Dakota Sioux ceremony.

I wonder if this is just a sign of old age.  If I were to graph the fraction of the articles I read each day that seem indistinguishable from an Onion parody, it would have risen from under 1% in 2000 to perhaps 5% today.  At this rate what will things look like in 20 years?  Is anyone else seeing an increase?

The Nazis burned books and paintings and the Red Guard destroyed monasteries. The Taliban destroyed a couple big statues in Afghanistan:

ISIS is destroying architectural sites all over the Muslim world.  But the Canadians? Perhaps Trump needs to redirect our drone strikes away from Yemen and towards Toronto.

I consider libertarianism a sort on inoculation against this madness. Throughout history, these bouts of insanity have infected both the left and right, at various times.  But if you start with the principle that everyone should be free to produce whatever sort of art they like, and if you don’t like it then don’t buy it, then you are less likely to buy into this sort of craziness.

PS.  I would not have even done this post if the story was not in a respectable outlet like the NYT.  I am well aware that the internet is full of reports of outrages, which on close inspection are actually less outrageous than they appear.  But I have to assume the editors of the Times checked the facts, and these events actually occurred.  Am I wrong?  Is this fake news?

PPS.  In all of human history, has anyone ever produced a work of art that does not involve cultural appropriation?  Just asking.

Is the Fed evil or misguided?

I say misguided, although many smart people think the Fed is intentionally undershooting its 2% inflation target, or treating it like a ceiling.  That would of course be evil, because it would mean the Fed is lying. Call me naive, but I still don’t quite accept that the Fed is a Trump-like institution. I believe they are misguided.

So what are the implications of my theory?  How can we test it?

If’ I’m right, then I believe that the Fed will eventually see that its reliance on the Phillips curve model has been a mistake. Low unemployment does not cause high inflation.  I expect this realization to occur at some point during 2018, at which time the Fed will switch to an easier money policy—to boost inflation.  I believe this because the market believes it, and (like Larry Summers) I’m a market monetarist.

This is one reason why I expect this expansion to be the longest in American history.  It won’t be the best (the 60s, the 80s, and the 90s were all better), but it will be the longest.  Switching to an easier money policy in the 9th year of an expansion is unusual.  It will prolong the expansion for at least a few more years.

I do not expect the Fed’s undershoot of inflation to cause a recession (although I wouldn’t entirely rule it out–it just seems unlikely.)  The economy has basically adjusted to 1.7% inflation.  The real problems with this are:

1.  A loss of Fed credibility, which will hurt them when the next crisis occurs.

2.  More zero bound episodes.

So the Fed needs to fix this problem.

BTW, there is nothing intrinsically wrong with 1.7% inflation during a period of low unemployment, if the Fed is a flexible inflation targeter.  Indeed in a sense that’s desirable.  But only if the Fed runs above 2% inflation during recessions.  And that’s why the Fed’s Phillips curve thinking is so pernicious.  The Fed fully expects inflation to fall during the next recession—the opposite of what they should be doing.  In that case the Fed needs to generate above 2% inflation during booms, in order to average 2% over the entire business cycle.  They are not doing so.

PS.  Stephen Kirchner directed me to an excellent Martin Sandbu column in the FT.  It does a great job analyzing the recent letter calling for a higher inflation target.  Indeed a far better job than I did in my recent analysis.  Here is the conclusion:

None of this means the target should not be reconsidered. But if there is going to be a change to what the Fed aims to achieve, one can do much better than a higher inflation rate target. One attractive possibility is to target a steadily growing price level rather than an inflation rate, which would require policymakers to pursue higher-than-target inflation for a while to make up for lower-than-target inflation in the past. Another is to consider targeting a path for the nominal size of the economy — nominal gross domestic product level targeting — which would allow for greater monetary stimulus when it is likely to do the most good.

PS.  The Larry Summers link above may be of interest to some people.