On Krugman and Keynes and why fiscal stimilus will not make our economy better.

I don't want to say Krugman's post named The greatness of Keynes is outright wrong, but it is at least controversial, and I think Krugman should know better.

Krugman argues for massive fiscal intervention in the form of 'make work' programs. Here is the relevant part where Krugman responds to critics saying that market knows better:

That is, if the private sector wouldn’t have created a job on its own, that job shouldn’t have been created — whereas the real choice is between having workers doing something and being uselessly, destructively unemployed.

There are two problems with Krugman's logic. First, it isn't really Keynesian. Second, Keynes may have actually been wrong, too.

Let me address the second point first, because it is much more important. The key question is, why do we think it is more productive to put people to work doing something, rather than be unemployed? This may seem counter intuitive, but think about it this way. By asking government to step in and create projects just to get people employed, we are effectively moving to central planning as opposed to profit-motivated resource deployment. As so many governments throughout the history have demonstrated, central planning has a disturbing tendency to get things spectacularly wrong. So if you let government decide what to do, you run a big risk of wasting not only human resources, but also a lot of natural, financial and social resources. Whereas unemployed people represent only a temporary loss of human resource.

Remember that the main argument against central planning is not that it's bad itself (when the right decision are made by decision makers, central planning is actually very very effective) but because when it does direct things in wrong direction, the failures are monumental and absolutely disastrous for the society involved. So the argument for market-based decision making is that while it may not be perfectly efficient, at least it avoids the biggest screw-ups.

What Keynes was arguing is that sometimes companies are unable to deploy X amount of resources to produce Y amount of value because Y is underpriced in the market due to liquidity concerns. In other words, that is unprofitable because Y < X due to liquidity concerns only. If liquidity adjustment is Z, and we assume that X < Y + Z, then theoretically government should step in and stimulate the economy, since government can be less worried about liquidity. While there is certainly truth in this, I still wouldn't immediately say it's a good idea to actually try this in practice. This essentially means that your government should be smart enough to figure out what the actual value of X and Z are, and then deploy resources correctly. That is very tricky thing in practice. Market may be saying that Z is large (large liquidity preference) or it may simply be saying that X is unreasonable (workers want salaries they cannot get) and government probably would never tell one from another. Free market eventually would. So while Keynes had the right ideas, falling back on central planning is not the answer.

I would also argue that our current financial crisis is, in fact, the result of central planners deciding that it's a good idea to force debt on people and companies by endlessly 'stimulating' them with cheap credit. Which brings me to my first point, that Krugman's solution is not exactly Keynesian either. Keynes (I think) argued that when times are good you should run a surplus so that when times are bad you could use it (and maybe some more) on stimulus. United States has only had surplus for 4 years out of the last 40. In fact, the last half century represented non-stop stimulation of USA economy, and the mandate has been used up. The fact that economy is contracting nonetheless shows that stimulation no longer works, and should not be tried. Instead, focus should be on brining transparency into the markets and preserving the trust into the rule of law and value of currency.

Understanding the recent dollar strength.

As American economy is breaking down like a 1986 Oldsmobile, some people are wondering why the dollar has been strengthening so much, and whether it is just a weakness in Euro, Yen, etc, that we see.

My opinion - it's real dollar strength, not just euro weakness. But it is very temporary.
Let me explain.

In the last 2 decades, money has been flowing into BRIC, lots of dollars, that were converted to local currencies. In order to keep their currencies down, BRIC started to buy dollars at an ever accelerated rate, now approaching 90$ billion per month.

Now enter financial crisis. As investors realize that their BRIC companies are going to turn into smoking craters and the notoriously corrupt 3rd world government may just confiscate all their money, investors pull out of emerging world.

So what we have is that suddenly many private investors flock back to the political stability of the dollar. At the same time, BRIC continues to buy dollars due to the force of sheer inertia (and they still have trade surplus).

What's important to realize is this whole process is temporary. Private flight cannot continue for too long, and will stop in a few months. Also, Foreign Central Banks can only buy dollars with money made from selling stuff to us. As soon as real consumer depression hits in US, that money flow will wither out and die and central banks will have no choice but to withdraw their dollar.

Now combine this with ever more reckless fiscal policy of US government, and we are setting ourselves up for the dollar crash of epic proportions, some number of months ahead. And by epic I mean, 50% drop within a span of 1 month would not be unrealistic.

You cannot take pictures here.

You cannot take pictures here.
Have you ever been told this while trying to make a photo of a friend in a museum, a shop, or an office? More likely than not, you were bullied.
Andrew Kantor's Legal Rights of Photographers is a very nice summary of everything you need to know about law and photos. And it turns out, you can take pictures pretty much anywhere you damn want, and also, you can publish pretty much all of these photos.

Must read for anyone who owns a camera - and who doesn't?

When policy-makers speak in an empty forest, do they make a sound?

This weekend we had a very fine illustration of an important truth: every word said by politicians and journalists is a lie more likely than not.

By all looks, it should have been very important: after all, G-7 summit itself spoke of potential currency intervention, asserted that it would not tolerate a weak dollar, and French Finance Minister Christine Lagarde even went as far as to call this a "turning point" and a major policy change.

Look, if this really was a policy change, and a turning point of some significance, then this is the kind of stuff which makes currency rates jump by 10% or more in day.

But in fact, after the announcement, dollar has done nothing but continue its usual fluctuations around the all-time low. This, of course, means that when politicians - even of the highest level - speak, no one thinks it is worth listening anymore.

Of course, the press either cannot comprehend or doesn't want to admit that market fluctuations are just that - random fluctuations. So, as usual, the press makes itself look clinically insane by simultaneously asserting that Dollar rebounds after G7 meeting and Dollar remains on backfoot after G7 meeting. Both articles are from the same newspaper (Forbes) and are published within 25 minutes of each other.

This whole farce underscores that the real reason for the credit crunch and liquidity problems is that lies and deceit are now in every part of the financial system. The reason Fed has been and remains so impotent in fighting the credit crunch, despite its unprecedented, almost trillion-dollar sized intervention, is that Fed's actions do nothing to restore the trust and honesty in the system. In fact, Fed's intervention has done nothing but help the banks further hide the truth. And as a result, it is doing nothing but prolong the crisis.

Everyone wants their own Bear Stearns.

Now that JPMorgan Chase received an Easter present of Bear Stearns (gift-wrapped by Fed in a $30 billion MBS swap), everyone else is (naturally) envious.

I work not far from Bear Stearns main building, and today there is some kind of protest going on there, with people in yellow jackets picketing on the sidewalks. Turns out, it is a bunch of angry homeowners:

My interest rate is 12 percent and I can't refinance," Gail explained.

Gail is joining a dozen other homeowners from Connecticut who are protesting the federal bail out of Bear Strearns. The company went belly up and has added to the ongoing mortgage crisis.

"They need to help people out too, not just companies," said Gail.

This makes perfect sense to me. Everyone has equal rights, correct?
Wells Fargo CEO obviously agrees with me, too:

Wells Fargo CEO John Stumpf said the financial crisis is presenting the bank with more acquisition opportunities.

"I would not be averse to a Fed-assisted transaction," Stumpf said in a recent interview with the San Francisco Business Times. "Fixer-uppers don't bother us."

Note to Fed: if you are gonna give out any more free lunches, please tell us where to sign up in advance, so that we don't feel left out next time.

Black Guy Asks Nation For Change.

Don't miss this funny Onion: Black Guy Asks Nation For Change.
But they don't even know what they have hit on!

A year from now, when a massive financial bailout has begun, come back and read this again.

Fed: from exhausted to cornered.

Quite a bit ago I suggested that Fed was exhausted. I was almost wrong - Fed took some steroids, donned a bandit mask, and sacrificed half of its own balance sheet to open another facility to brokerages and to bail out Bear. This, as I already hinted yesterday, backfired and turned Fed from hunter to hunted. And today, the hunted was cornered.

The interest rates on 13-week Treasuries plunged today to 0.4%, going as low as 0.2% at some point during the day. There is no more room for rates to drop. Even worse, Fed is now being under investigation by Congress - which questions the legality of recent moves. This should make Bernanke think twice before trying more questionable experiments. And if you thought it couldn't get any worse than that, guess again: Krugman believes Fed is now incapable of controlling even its own Fed Funds rate!

At the same time TED spread widened yet again, back to its all time high. This, and the borderline insane flight to the safety of T-Bills, means only one thing: the credit market is screaming out loud "We don't trust anyone, and we think even the largest banks are about to go bankrupt!" Everyone is on his own now.

Market to Fed: check, check, and mate.