• 15765_7.16_000010007327XSmall

    Blowing Bubbles

    Jul 17 • Economic History, Financial Markets • 198 Views

    In The Big Short, Michael Lewis explains the subprime bubble mentality through a quote about CNBC media coverage. “…they weren’t in touch with reality anymore. If something negative happened, they’d spin it positive. If something positive happened, they’d blow it out of proportion..” A page turner that clearly and capitvatingly describes the subprime believers and doubters on Wall Street, The Big Short is a perfect story of a bubble.

    In addition to the subprime bubble and the tech bubble, there once was a bowling bubble. In 1936, Gottfried Schmidt invented the first automatic pinsetter. With machines replacing pin boys, after World War II, bowling boomed and Wall Street responded. As a young Charles Schwab said, “Compute it out–180 million people times two hours per week, for 52 weeks. That’s a lot of bowling.” The result was soaring stock prices in firms such as AMF and Brunswick and the bowling bubble. By 1963, though, following the path of all bubbles, the market reversed and prices plunged to 20% of their all time highs.

    In The Wisdom of Crowds, New Yorker columnist James Surowiecki says that crowds can usually make decisions that are more accurate than individuals. In markets, crowds accurately price sodas and broccoli and tennis lessons. Studies demonstrate that crowds’ guesses cluster around the true number of jelly beans in those huge glass jugs. Similarly, bubbles are an example of crowd behavior. Here though, we have “collective decision-making gone wrong”.

    The Economic Lesson

    Usually investors have “long” positions. They buy a stock (ownership in a company), wait for its price to rise (hopefully), and then sell it.

    Selling before they buy, short sellers want prices to decline. How can you sell something you do not own?  Short sellers borrow a stock or some other type of security and then they sell it. Weeks, months, or years later, they buy the security and return it to the owner from whom they borrowed it. For example, assume you borrow something and sell it for $10; then, weeks later you buy something identical for $5 and return it to the lender. You have made $5.

    In The Big Short, a very small number of people, rather like the boy in “The Emperor’s New Clothes”, realized the folly of buying subprime related securities and instead shorted them.

     

    No Comments

    Read More
  • 15767_7.16_000000644072XSmall

    Post Hoc Ergo Propter Hoc?

    Jul 16 • Economic Debates, Government, Macroeconomic Measurement • 153 Views

    Ed Koch, former mayor of NYC used to ask, “How am I doing?” We can ask the same question about economic stimulus spending. By going to recovery.gov, you will see that there were 682,370 new recipient reported jobs between January 1 and March 31, 2010. Correspondingly, the July 14 Council of Economic Advisors’ Report (CEA) estimates that stimulus spending created, to date, somewhere between 2.5 and 3.6 million additional jobs. 

    Yes? Maybe. I wonder whether we can be sure that stimulus money created jobs. Perhaps they would have been there anyhow.

    In a recent blog post, economist N. Gregory Mankiw questions the CEA’s conclusions. Sympathizing with their assigned task, he says it is very difficult to ascertain the impact of the stimulus program through their model:

    1) He describes their Keynesian model as assuming that “no matter how bad the economy got, the inference is that it would have been even worse without the stimulus.” Consequently, whether the numbers go up or down, stimulus spending has to have had a positive impact.

    2) He points out that the CEA presents data confirming that the economy improved after the stimulus passed. How he asks, though, can we know if the stimulus was the reason the economy improved with so many other variables also having an impact. His basic point? “Post hoc ergo propter hoc.”

    All of this started me thinking about Paul the psychic octopus. As you probably recall, Paul accurately predicted 2010 World Cup Soccer results by the food receptacles he selected. Not quite “post hoc ergo propter hoc, ” but close.

    The Economic Lesson

    Most of us know whether we support more government or less as the thrust of macroeconomic policy. None of us though can statistically prove that we are right.

    No Comments

    Read More
  • 15763_5.7_000010364681XSmall

    Animal Emissions

    Jul 15 • Thinking Economically • 590 Views

    As most of us know, cow burps add to global warming. According to the NY Times, animal methane emissions account for 10% of Australia’s contribution to greenhouse gasses. The solution? The kangaroo. Like cows, kangaroos are “foregut fermenters”. However, because their digestive system uses a different microbe, they produce harmless acetic acids instead of methane. If researchers could discover how to give cows the kangaroo microbe, then bovine emissions would be less harmful.

    IPCC researchers predict that global warming will result in temperature increases that might average 4 degrees Celsius during the next century. As a result, warmer temperatures would diminish economic growth by 1% to 5%. In other words, the world economy will continue growing but just not as much. (You might want to look at a good debate on the topic at The New Republic.)

    Enter Congress. Pending legislation includes proposals for electricity producers using qualifying fuels, creating cap and trade programs and carbon taxes, studying carbon capture, subsidizing auto makers’ efforts to create more fuel efficient cars, providing loans for clean energy projects, and nuclear power incentives. They have also suggested a big battery contest.

    The Economic Lesson

    Using CBA (cost/benefit analysis), economists would compare marginal (extra) cost and marginal (extra) benefit. Next, they would conclude that as long as the extra cost does not exceed the extra benefit that results, the policy should be implemented. Here though, I wonder whether it is possible to assess the marginal cost and marginal benefit of congressional initiatives. Even for animal emissions, because the entire Australian beef industry would be affected by diminishing cattle methane, can we accurately assess the impact?

    And therein lies our dilemma. Will the current cost of diminishing greenhouse emissions which may be incalculable be worth a potentially indefinite future benefit?

     

    No Comments

    Read More
  • 15761_7.14_000007360101XSmall

    “LeBronomics”

    Jul 14 • Thinking Economically • 215 Views

    Called “LeBronomics” by NPR’s Planet Money, LeBron James’ decision to go to Miami was about much more than $99 million. Instead, the key issue was “utils”.

    Whenever economists want to quantify satisfaction, they use the “util”. If LeBron had selected Chicago, local residents might have felt 10 extra utils every time they watched their team play. (I just chose 10. The number does not matter.) Choosing New York, though, would have resulted in many more utils. 2009-2010 was a 50-loss, disappointing season for Knicks fans. Consequently, just seeing LeBron at every game would have generated lots of extra happiness for many New Yorkers.

    By contrast, according to the Planet Money people, selecting Miami created the least extra happiness in the United States. Because Miami already has other superstars, adding a third would not create very many more utils. We could compare this to the utils we get from the first bite of a chocolate chip cookie and the 15th bite. We get much more pleasure at the beginning before adding lots more.

    The Economic Lesson

    Getting less extra satisfaction from each additional unit is called diminishing marginal utility.

    We might add that LeBron James did not experience diminishing marginal utility when he added to his income because Florida tax rates are among the lowest in the country.

    No Comments

    Read More
  • Henry Ford's Model-T

    A Free Ride For Electric Cars?

    Jul 13 • Environment, Macroeconomic Measurement, Regulation • 176 Views

    Imagine a world filled with electric cars. In private homes, people could install their own charging devices. Others could be built in apartment building garages and on city streets. Some envision restaurants, department stores, and movie theaters offering a charge as you eat or shop. One firm hopes to build battery switching stations “manned’ by robots that would replace depleted car batteries during long trips. Demand for oil would drop. Energy independence could become a reality. Yes? Not so fast.

    Let’s first look at home. For a 20 hour charge, it would be easy. Just use your wall outlet. More speed, though, means lots more voltage and upgrading home capacity.

    We should also ask about the role of government. Raleigh, N.C. officials told Nissan that it would require permits, inspections, and electricians for homeowners to install faster charging docks. Electric utilities point out that 15 minute fast charges requiring 440 volts could overload grid capacity. In response, California regulatory authorities expressed concern while Houston says it can turn to wind farms and natural gas fired facilities to satisfy higher demand. In addition, California says it will end its HOV perk for hybrid owners but not for electric and natural gas powered vehicles.

    The U.S. auto-related infrastructure began to develop 100 years ago. In 1909, there were 3 “filling stations” in the United States. By 1925, millions owned Model-T Fords and General Motors advertised a car for every pocketbook by producing Chevrolets, Pontiacs, Oldsmobiles, Buicks, and Cadillacs. Government built an interstate highway network and private industry took care of gasoline stations, motels, and roadside restaurants. Is the next step electric?

    The Economic Lesson

    Two economic questions come to mind that always apply to innovation: 1) What are the tradeoffs? Yes, there are benefits but what are the costs? 2) What role should government play? 

    Furthermore, we should remember Joseph Schumpeter’s explanation of how creative destruction accompanies innovation.

    No Comments

    Read More