Thursday, December 23, 2010

Animal Spirits Pt. 4: Conclusion

Having finished this book, I can say I do like what I've read. Certainly I don't agree with every conclusion they've reached, nor do I agree with every analysis. But their approach is certainly more valid than the approach made by even the standard economics stories I'm familiar with. In a way, by acknowledging the fact that individual and cultural variations make most dry quantitative approaches to economic study less than helpful, their approach has more in common with the approach promoted by Ludwig Von Mises than that of those labeled Kensian and Monetarist.

That's not to say they are the same. Where Mises described a discipline that stuck to exploring the structure of logic that can be built upon certain basic, knowable facts (including the fact that human motivations are infinite and complex), Akerlof and Shiller explore the impact of specific psychological and cultural information on economic analysis. Indeed, were one to engage in a multidisciplinary approach that deliberately combined Misesian praxeology with psychology and cultural studies, it would likely look something like this (assuming the reader can accept that "Misesian" and "Rothbardian" are not necessarily the same, and that two people can attempt the same approach and, thanks to the role "understanding" plays in the comprehension of complex phenomena, can come to different conclusions). I can only hope their ideas have some effect on the overall profession.

So this book is a starting point, though I suspect there is a hurdle the authors are not anticipating. They speak of the role of "animal spirits" (and yes, they are using the term in the fashion I had hoped when I wrote Part 1) in shaping the overall economic and driving economic events. They say government regulation is an appropriate remedy to the excesses that can be caused by these "animal spirits". The question then becomes: how do we get appropriate policy out of the government? For it is not only the overall economy in which "animal spirits" plays a role; it is also in politics, and administration, that human motivation plays an important role.

In other words, would would be the result of applying "animal spirits" theory to public choice theory? For the government isn't a machine that inputs information and outputs policy: it, too, is made up of human beings with diverse motives. It, too, suffers from the effects of a confidence cycle, corruption, notions of fairness that may or may not be good for the overall output, changing stories, and other things identified as "animal spirits." Any policy recommendation resulting from an analysis must take this into account as surely as the original analysis must.

Sunday, December 19, 2010

Animal Spirits Pt. 3: Natural Wage Theory, Money Illusion, and Wages

I just finished reading Chapter 9 of Animal Spirits. Now I see the point of criticizing Natural Rate Theory. I mentioned in an earlier installment that I suspect that, over the long time, wages will tend to track inflation, but lag behind. Akerlof and Shiller appear to be saying that this is precisely the point. Steady inflation holds wages at a lower level, one which allows a lower level of unemployment. Employers can grant employees raises for the financial purpose of keeping it in line with the purchasing power of money, while still giving the employee the feeling that they are being rewarded for their efforts. In the absence of inflation, the employer can't afford to give so many raises, the employee feels he's not being treated fairly, and worker productivity falters. So, in their analysis, because of money illusion and fairness, a certain level of inflation is required to keep productivity up.

Outside factors they failed to take into account (which I will get into below), I can find no fault with their analysis. Particularly in a world in which people have, over multiple generations, come to regard raises as a regular obligation, perceived unfairness (that very phrase is redundant, given all fairness is subjective) could well result in productivity losses in the absence of inflation-motivated raises.

Of course, this likely leads to the recommendation that a level of inflation should be maintained at all times. Further, it makes something like a commodity money seem untenable. However, there is something else to put into the analysis: the credit cycle. Wages are downwardly rigid, therefore deflation can damage employment levels, as falls in wages fail to keep pace with falls in other prices. But what if "fractional reserve" banking were abolished, and therefore the bank created inflation that ultimately leads to deflation never occurred in the first place? The downward rigidity of wages could become irrelevant, in this scenario. But then, it could also lead to an extended (possibly multigenerational, meaning it would be politically unsustainable in reality) period of adjustment, until people finally realized psychological satisfaction is not going to come from making the numbers bigger.

It's a big hurdle to get over. From a strictly logical standpoint, wages generally rising over time, but lagging behind prices is not as good for workers as wages falling slowly but lagging behind prices. But falling prices, though it is good for a person whose wages have not yet fallen, is an impersonal phenomenon. Rising wages, though, feel like a personal reward, even if the employer is only keeping the wage in line with rising prices, and even lagging behind. The gradual price drops of a stable money supply may be better for workers materially, but rising wages, even insufficient to cover rising prices, are more emotionally satisfying.

Were it not for the dangers inherent in a fiat token-based (whether paper or digital) currency (which we are seeing today, as the results of bad monetary policy hit the economy like a hurricane), a fiat currency would definitely be better... IF the money supply expanded evenly. Unfortunately for fiat money supporters, it does not. Industries grow beyond what they should because of investment bubbles, and then people lose their savings, workers lose time building knowledge and experience in bad industries (not to mention their jobs for no good reason), people lose confidence (which the authors just spent a chapter talking about). I'm presently convinced the negatives of fiat money and an inflationary policy outweigh the negatives.

That, and I have moral difficulties with the idea of a monetary elite making things better by deliberately deceiving laborers.

Saturday, December 18, 2010

Worst Case Scenario

It occurs to me the world could actually end (or rather, begin to unravel) in 2012. This has little to do with Mayan calendars and what not, and more to do with the potential consequences of the unraveling of the final bubble, the bond market. In the late nineties bubble money fled from the stock market on the wake of the tech boom, into the real estate market. Real estate collapsed, and bubble money has fled into gold and bonds. What will happen when the bond market collapses? Will the gold market collapse?

2012, the bond market collapses. Many, many businesses find themselves unable to roll over their debts, and aside from those businesses politically connected enough to receive the next round of bail-outs, many businesses fail, and unemployment doubles, at least. The government rolls its own debt into a much higher interest rate, and debt-servicing beings to swallow a majority of government revenues. Those who continue to work pay out ever more taxes to finance the debt as services are reduced.

The tug-of-war over public funds intensifies to something more like a real war, as those with wealth held in treasuries pour enormous amounts of money into the political system to ensure that the idea of repudiating even a portion of the debt never sees the light of day. This further corrupts the two-party system, as increasing numbers of Americans come to realize they simply are not represented, and find any efforts to change this thwarted by the rigidity of the two parties, in the thrall of all this political money.

Riots break out at various places and time over the government's increasing inability to pay out social security, medicare, and other welfare "entitlements", the political system mostly denied to them. The democratic system begins to break down. Radical cutting of military spending results in a combination of large numbers of unemployed, militarily trained young men and resentful elements of the former military-industrial complex. Brigandry and the necessary government response (which brings many military suppliers back into the money stream) result.

This occurring all over the world, the largest country without debt problems, China, begins the process of establishing hegemony over most of Asia, and carving out sizeable spheres of influence in Africa. Most of the mainland countries fall into China's orbit without complaint. Russia and China maintain a low level of conflict over spheres of influence in the central asian countries between them. Violence erputs in Taiwan between pro-Washington and pro-Beijing forces, and China moves in to forcibly re-establish order. Either this, or a war between China and Japan, trigger war between the United States and China. The war is brief, and the US leaves just as quickly as it entered, as the American economy finally collapses completely under the strain, governments collapse with it, law and order collapses, all vestiges of civil society collapse, plunging most of the Western world into a new dark age. This assumes nuclear weapons are not a factor.

Even without them, the total break-down of the division of labor in the Western world results in a severe drop in the efficiency of the use of natural resources... resulting in unmitigated environmental disaster as people desperately try to survive in the absence of a functioning market, concerning themselves more with day-to-day survival than long-term viability.

All of this begins with the collapse of the bond market bubble. Stocks can collapse, and we're okay. Real estate can collapse, and still we're fine. But when the bond market collapses, it will affect the ability of the government, itself, to meet its own obligations.