One of the ideas we drill into students very early on is that economists use the term “investment” in a very different way from how it is used in everyday speech.  Thus average people may talk about “investing” in stocks or bonds, but economists consider that sort of activity to be saving (if the alternative is consumption–not if money is just moved from a bank account into stocks.)  Economists consider “investment” to be the construction of new capital goods.  That activity is financed through saving, and indeed it’s a tautology that aggregate saving equals aggregate investment, because saving is defined as the resources that go into investment.

Thus it makes absolutely no sense to talk about financial and physical investment as alternatives, as two types of “investment”.  Unless you are Kevin Warsh:

We believe that QE has redirected capital from the real domestic economy to financial assets at home and abroad. In this environment, it is hard to criticize companies that choose “shareholder friendly” share buybacks over investment in a new factory. But public policy shouldn’t bias investments to paper assets over investments in the real economy.

How has monetary policy created such a divergence between real and financial assets?

This is from a 2015 WSJ article where Warsh claims that expansionary monetary policy has reduced real business investment by encouraging business to buy financial assets rather than build physical assets.  If a business buys a financial asset, then someone else sells that asset.  There’s no first order net effect on saving or investment.  In contrast, if a business creates a new financial asset like a stock or bond and uses it to fund new investment, then aggregate saving and investment may rise (assuming no crowding out.)  At the individual level, the decision to “invest” in financial assets is simply unrelated to the question of aggregate physical investment.  It’s a non-sequitor.  And at the aggregate level, to the extent that financial investment is a form of saving then more financial investment implies more physical investment.  (And no, the paradox of thrift has no bearing on the points I’m making here, even if it were true.)

Warsh realizes that his ideas are at variance with basic textbook economics, but doesn’t seem to care:

On his recent book tour, former Federal Reserve Chairman Ben Bernanke stated that low long-term interest rates are not the Fed’s doing. Low rates result from a shortage of good capital projects. If there were good investment projects, he explained, capital would flow and interest rates would rise. Mr. Bernanke insists that the absence of compelling investment opportunities in the real economy justifies continued, highly accommodative monetary policy.

That may well be true according to economic textbooks. But textbooks presume the normal conduct of policy and that the prices of financial assets like stocks and bonds are broadly consistent with expectations for the real economy. Nothing could be further from the truth in the current recovery.

His disdain for EC101 economics makes him a perfect choice for Trump.

PS.  Actually, textbooks do not “presume the normal conduct of policy.”  That’s simply false.

PPS.  Warsh offers zero evidence that easy money reduced business investment, and zero evidence that asset prices are out of line with fundamentals.  Even if he is correct on both points, it’s “broken clock twice a day” correct; he doesn’t seem to understand basic macroeconomic concepts.

HT:  Karl Smith

I won’t have much time to post here until the end of the year, as I am on the stretch drive of two book projects.  But I thought I should go on record on a couple of policy issues in the news:

1.  There are rumors that Trump might pick Kevin Warsh to head the Fed.  I’d prefer he keep Yellen. She’s presided over more stable NGDP growth than any other Fed chair (although admittedly the sample size is small).  And there are two arguments against Warsh.  He’s far less knowledgeable about monetary economics than Yellen, and he was completely wrong about policy during the Great Recession.  Having said that, picking Warsh wouldn’t result in much change in policy, because Fed chairs don’t actually have all that much influence.  I doubt whether fed funds futures would show much change.

2.  Presidents also don’t have much impact on the economy, especially when they are as incompetent and ineffectual as Trump.  (This is basically year nine of the Obama administration.)  The one issue to watch is taxes.  If the GOP simply cuts rates and increases the budget deficit then it will have failed in at least as big a way as in health care.  The sine qua non of a successful tax reform is some combination of closing loopholes and simplifying the tax system.  (For health care it’s cutting costs.)  There is recent chatter that the GOP may back off from plans to close loopholes like the deductibility of interest (in corporate taxes) or the deductibility of state and local taxes (in the personal income tax code.)  That would be a huge mistake.  If all they do is cut rates then the Dems will simply reverse the cuts.  The Dems seem to have zero interest in reforming the tax code, so if the GOP fails in its once in 30 year attempt, and gives us something like Bush did in 2001, then they will have failed.

I’d add that a big tax cut that balloons the budget deficit would also increase the trade deficit. This FT article points out that Trump’s policies have already boosted the trade deficit (up by 9% so far this year) but his fiscal plans would make it far “worse”.  Fortunately, trade deficits are not bad for the economy.  Unfortunately, a budget deficit is.  (Economic nationalists like Bannon should be horrified by Trump’s tax plans, but they are generally too ignorant of macro to understand the implications of what he’s proposing.)

If politics makes it too hard to close tax loopholes then an interesting backdoor approach is to sharply raise the standard deduction.  Trump proposes doubling it to $24,000 for a married couple, which would reduce the number of itemizers from 45 million to 7 million.  In other words, this would mean that tax loopholes would no longer benefit the broad middle class.  Once they are linked only to the rich it would make them easier to go after in future reforms.  A clever idea, let’s see if he carries through. (I suspect he won’t.)

PS.  Limiting a loophole AMT-style doesn’t count as a partial victory, as it makes the tax code even more complex.

I’ve done a couple of posts on modern art over at Econlog, so I thought I’d try to avoid wearing out my welcome by doing the third over here.  It seems to me that people in the comment section object to modern art for two reasons; it’s ugly and it’s difficult.  Actually, lots of modern art is not ugly, but they especially don’t like the ugly stuff.

I tried to defend modern art, although even I don’t like most of it.  Recall that all art was once modern art, and most of the art from any period has not stood the test of time.  Museums are full of mediocre baroque history paintings and bland 18th century portraits.  Heck, former President Bush’s recent portraits of soldiers are better than half the portraits of colonial aristocrats you see in American museums.  And Bush’s work is somewhat “modern“. (Is Bush also a pretentious cosmopolitan phony?)

I’m going to try to get you to avoid being turned off by ugly and difficult.  Let’s start with two paintings that I regard as somewhat ugly.  Here’s Titian’s “The Flaying of Marsyas”:

Almost everyone, regardless of their views on modern art, would regard Titian as one of the all-time greatest painters.  And this painting, showing someone being skinned alive, is one of his very best works.  But I don’t think anyone would say it’s a pretty picture.

Nor is Picasso’s Les Demoiselles d’Avignon:

Also note that Picasso’s painting is an example of the “ugly” modern art that people dislike, whereas Titian’s is an “old master”.  The average philistine may not want the Titian hanging in their bedroom (and even I’d prefer one of his nudes), but they’d show a grudging respect.  But if you are going to reject works that are ugly, why is the Titian not equally objectionable as the Picasso?

OK, so let’s say that great works of art can be ugly, and move on to “difficult”.  The Picasso is in some ways more difficult than the Titian, and that difficulty is in part do to stylistic innovations that can be traced back to Cezanne.  Here’s a picture I took of a Cezanne that hangs over the fireplace in my bedroom), which is anything but “ugly”:

On the other hand, this picture by Thomas Kinkade is even prettier:

So why do I have a Cezanne in my bedroom, and not a Kinkade?  Let’s use an analogy from music, which most people understand better than painting (I’m the reverse.)  The Kinkade is like that catchy by annoyingly manipulative and sentimental pop song that you can’t get out of your head, perhaps sung by Celine Dion.  The Cezanne is like a tune by Radiohead, which seems difficult to follow, but grows with repeated listening.

Here’s the problem. Most people walk into a modern art museum, spend 10 seconds looking at each work (or even less) and then never again revisit these paintings. They think that a painting can be grasped in a quick glance, whereas music requires sustain concentration, but this is an illusion.

You may say that you “like” the Cezanne but don’t “like” abstract art like this Kandinsky:

Actually, if you don’t like abstract art then it’s very unlikely that you truly appreciate what makes the Cezanne so much greater than the Kinkade.  Indeed you probably don’t fully appreciate even old masters like Titian.  Don’t feel bad, I find even the greatest works of classical music, say the Goldberg Variations or Beethoven’s late piano sonatas, to be exceedingly difficult.  You can almost certainly appreciate them better than I can.  But my failure to fully appreciate these masterpieces doesn’t in any way make me think that those who do are simply being pretentious.

I’m not saying you should try to appreciate modern art.  Rather I’m saying you should try to appreciate people who appreciate modern art.

PS.  Technological progress in art reproduction has been impressive.  The Cezanne might sell for $200 million at auction, and I bought a very good reproduction and had it shipped from the UK for a little over $200 (half of which was shipping). I feel like a billionaire!  It uses giclee printing to achieve pretty good color fidelity, and is printed on canvas and then put in a tasteful and simple black wood frame.  (My photo doesn’t do justice to the reproduction’s quality.) When I was younger the available paper reproductions of paintings were so bad that it was pointless to put that sort of print on your wall.