Archive for the ‘Economics’ Category
Buffett and Goldman Team Up to Help Small Business
Posted by: Todd Metheny in Business Profiles, Economics on November 19th, 2009
Seriously, though, I just want to help you out.
I hear and see a lot of conspiracy theories out there about Goldman Sachs. More than any other investment banks or companies, I think GS might be the most scrutinized, talked about, and hated organization this side of the New York Yankees. In a distractionary move disguised as benevolence (j/k), Goldman is teaming up with Warren Buffett to fund loans for small business owners. The two are teaming up to provide $500 million for small business owners – both as access to capital and to further education.
I firmly believe that these are the kind of actions that will actually be effective in stimulating the economy. Businesses and business people require support, which means they’ll spend more money on supplies, raw materials, attorneys and accountants. Aside from the possible jobs that the businesses directly create, they indirectly create jobs by creating demand for all of these ancillary services.
I think Buffett is on the right track here. This is a market solution of sorts. They’re calling this a “philanthropic” effort. I’m not sure what the terms attached to the capital or the educational funding are – but they sound like they’re pretty nice based on that word, philanthropic.
This appears to be part of an effort for Goldman to clean up their image post-bailout. Wall Street’s extravagant salaries in tough times are exactly endearing to the general public. They’re already being criticized for offering too little. Having their name in the headlines with Buffett (who’s officially their largest shareholder) can only help them. His squeaky clean brand is just the sort of thing Goldman needs. Initiatives that help this country out of a tight spot, like this one, is icing on the cake. Thanks for reading.
The Zen of Scott Boras
Posted by: Todd Metheny in Business Profiles, Economics, Entrepreneurship on November 12th, 2009
Make it $300 million and you've got yourself a deal.
For as long as I can remember, in any setting, big businesses have been viewed as the bad guys and the workers have been viewed as the good guys. I think this started with Karl Marx’s theory that a profit can only be made by a business owner by exploiting the worker. Marx’s theory, now dismissed by economists, was that the value of a product was set by each person’s work in making it, and that the owner of the business added no value to anything. Thus, the only way a profit could be made was if you exploited your workers (paid them less than the value of their efforts). Obviously, this ignores the value added by the risk undertaken by the business owner. The business person had to invest his time, money and resources into making the product, and should be rewarded if it ends up making money.
Interestingly, you never hear anyone say that they feel like professional athletes are being exploited. Even Karl Marx would have found this ludicrous (I think). These are people that make (on the low end) hundreds of thousands of dollars every year. Top players in their respective sports now make tens of millions of dollars every year. So it’s hard to say they’re being exploited, when the President of the United States makes a paltry $400,000, the Chief Justice of the U.S. Supreme Court makes $217,400 (John Roberts reportedly made over a million dollars practicing law the year before he become a US Supreme Court Justice), and your very capable family physician only makes $150,000 (and he’s handing over part of that to malpractice insurers, because you’ll sue him if he makes a mistake).
That being the case, you have to assume that if the Yankees can afford to pay Alex Rodriguez $30 million per year, that the people that own the team are making a little money of their own, right? I don’t know. I honestly don’t know this for sure. I do know that I hear owners complain about how high the salaries are, but they couldn’t keep escalating if the money wasn’t coming from somewhere right.
If you follow baseball, you may have heard of an agent named Scott Boras. Boras is associated with everything that’s wrong with baseball and the world. He consistently gets players top dollar. He got this year’s number one overall draft choice over $15 million. He got the Yankees first basemen $180 million over 8 years. He’s innovative and sneaky. He sometimes uses the rules to his advantage, once famously using a technicality to have two of his clients declared free agents outside the draft, and allowing them to sign for a lot more money than they otherwise would have. He might be the best at what he does.
What makes Scott Boras especially interesting is that almost every baseball fan you meet hates his guts. His responsibility to his clients is to get them the best deal he can. He’s good at getting them very good deals. And people hate him for it, because it usually means that the top talent goes to the teams with the most money to spend. But people don’t hate the players for taking the largest deal (which is simply logical to do, all other factors being equal – you can’t play baseball forever).
People don’t hate the owners. After all, they’re in the same boat we are. They’re poor and lonely and just want to win games, but greedy super agents like Scott Boras are ruining the game, right? Right?
It’s unique, that the employees and their agents are viewed as greedy for taking top dollar. The owners escape being viewed as Wal-Mart. The owners would not pay so much that they no longer made money. They are running businesses, and you can’t stay in business losing money every year. I don’t have a point, other than this: lay off poor (he’s rich), defenseless (actually, he’s very capable of defending himself) Scott Boras. I actually just think this is pretty interesting. Thanks for reading.
People Respond to Incentives
Posted by: Todd Metheny in Economics on October 19th, 2009
Are deductions for these guys a good idea?
The title of my post is one of my favorite economic maxims. People aren’t always rationale. People don’t always do a cost benefit analysis before making a particular decision. We don’t always make a decision that will optimize our benefit. As a general rule of thumb, though, I think it’s safe to say that people usually respond to incentives.
We’ve seen people respond to incentives created by the government lately, with the $8000 first time homebuyers credit and the Cash for Clunkers program. People are more likely to borrow money when interest rates are low. The Federal Reserve attempts to lower interest rates to give people (and businesses) this incentive. The tax code is littered with incentives, all created to encourage people to respond with some sort of behavior that legislators feel will be favorable for the economy or for the country in some non-economic way.
Companies create incentives for their employees to try to optimize productivity. All kinds of incentive based programs exist. Salespeople earn commissions. Executives have special compensation programs that are tied to their stock prices (people differ as to whether this is an effective incentive – it encourages risk taking for short term gain).
The question becomes who should decide what behavior we’re trying to encourage. Policy makers can be wrong, can’t they? I saw an interesting tax deduction on the table to be added in the near future the other day. It appears that U.S. Representative Thaddeus McCotter (R-MI) has introduced a bill that would create a tax break for pet owners.
Before I go any further, I’d like to openly proclaim that I love animals. And I’d like to go ahead and concede that owning a pet is extremely expensive. The question I have, that I’d like to raise with this particular piece of legislation is, what incentive are you trying to create? It appears to me that this piece of legislation would create and incentive to own a pet. What government purpose would this serve? Will this create more tax revenue in some way? What is the opportunity cost?
Josh, a new contributor to the site (his first post likely coming in early November), astutely pointed out to me that pet services create jobs. If more people owned pets, then they would buy more pet food, buy more chew toys and spend more money on veterinary services and services such as kenneling. He was saying this somewhat tongue in cheek – but he’s right. All of those things would be stimulated.
In a situation like this, I would think that it would be necessary to look at the opportunity costs. Will this create more tax revenue than you lose? Is there another place we could use this deduction that’s more productive? What about another $3500 for people that start manufacturing businesses? Or another $3500 dollars worth of deductions for people who put solar panels on their homes (something that would pay for itself in saved energy costs very quickly), or another $3500 for people who get engineering or hard science degrees? Those are just examples, but legislators need to be thinking about what kind of behavior we’re trying to encourage on a daily basis. If you’re in a position where you have the responsibility of shaping policy, you owe it to us to try to maximize your ability to do so. As nice as it would be to save money for having pets, I’m not sure I agree with this – though I love the novelty of it (that’s why I’m writing about it). What do you think about tax deductions for pets? What am I missing? Thanks for reading.
Follow up to Ken Fisher discussion
Posted by: Todd Metheny in Economics on September 24th, 2009
In response to the recent post about Ken Fisher’s view on US borrowing, a couple of readers offered interesting takes. Chessiq, a friend of the blog who works in accounting, and a CPA candidate (I think he’s on his 4th test?) offered the following:
“My understanding of Fisher’s argument is that as long ROA>i [return on assets is greater than cost of debt] you should keep borrowing, because you will be able to pay off the debt, the interest, and have some left over for yourself. First off, what are these assets (for the USA or USA govt). My hope is that these assets are not 1) used up plugging the deficit, and 2) are not the borrowed money i.e. you borrow cash, so you have cash as your asset. The follow in the combination of 1) and 2) is that at the end of the day, you need a long time to pay off the debt. a simple example. deficit 100, interest 1, ROA 2, you would need 100 years to make enough profit to pay off the debt without using dipping into the principal/asset 100. If the debt needs to be paid in 20 years, then at that time, you will only have to get about 80 from the original borrowed money. My other issue is that it appears the debt we are getting is “consumer debt”. The government is needing this debt for operational purposes, not for investment, and the last time I checked, ROA or ROI on consumer debt was 0 or -ve. Am I missing something?”
I don’t think he’s missing something. That’s a better explanation than I could have given, which is why I’m moving it to the front page. I had the same thought about Fisher’s “return on assets” hypothesis. What assets? If they really are investing in “assets” then that’s one thing. If they’re borrowing the money to pay their debt or to spend more money on things that have little chance of benefitting the country, then the return is minimal. To the extent that the money creates jobs or raises salaries, then the US will experience some return by an increase in taxes paid in, as well as an increase on sales taxes (when people have more money, they buy more stuff). I’d like to see exactly how and what Fisher is classifying as “assets.” What are the assets, and how will they benefit the country? Thanks for reading.
The One About Prognosticators
Posted by: Todd Metheny in Business Profiles, Economics, Value Investing on September 15th, 2009
I'd the chance of rain tomorrow is 1000%. You can quote me on that.
There’s a great story in the intro of Common Stocks and Uncommon Profits by Philip Fisher. The intro is written by the author’s son, Kenneth Fisher, another famous investment manager and author. Ken was at conference with his father, and a contest was announced at dinner the first night they were there. Each person was asked to write down what the market would do the next day. The winner would receive a color television, and would be announced the next day at lunch, just after the market closed (CA time). Both men acknowledged that this was a silly exercise. In Ken’s own words:
“Most folks, it turned out, did what I did – wrote down some small number, like down or up 5.57 points. I did that assuming that the market was unlikely to do anything particularly spectacular because most days it doesn’t. Now in those days, the Dow was at about 900, so 5 points was neither huge nor tiny. That night, back at the hotel room, I asked Father what he put down; and he said, “Up 30 points,” which would be more than 3%. I asked why. He said he had no idea what the market would do; and if you knew him, you knew that he never had a view of what the market would do on a given day. But he said that if he put down a number like I did and won, people would think he was just lucky – that winning at 5.57 meant beating out the guy that put down 5.5 or the other guy at 6.0. It would all be transparently seen as sheer luck. But if he won saying “Up 30 points,” people would think he knew something and was not just lucky. If he lost, which was probable and he expected to, no one would know what number he had written down and it would cost him nothing. Sure enough, the next day, the Dow was up 26 points, and father won by 10 points.
When it was announced at lunch that Phil Fisher had won and how high his number was, there were discernable “Ooh” and “Ahhh” sounds all over the few hundred person crowd. There was, of course, the news of the day, which attempted to explain the move; and for the rest of the conference, Father readily explained to people a rationale for why he had figured out all that news in advance, which was pure fiction, and why the market had done what it did, again pure fiction and nothing but false showmanship. But I listened pretty carefully, and everyone he told all that to swallowed it hook, line and sinker.”
I think of that story when I see all the headlines touting that doomsday is near, or predictions that the Dow is going to hit 50,000 by such and such date. There’s clearly an incentive to make such predictions. No one puts your name in the news or publishes a quote that says something to the effect of, things are so-so now and will continue to be so-so in the future, though they might improve or deteriorate just a little bit. If you predict that the world will end in 8 days – that’s an exciting news story.
Plus, if your predictions turn out to be wrong, there’s no penalty. You already had your 15 minutes of fame. They aren’t going to write many articles proclaiming, “Todd Metheny was wrong 5 months ago,” for a couple reasons – I could turn out to be right sometime in the future, and because that’s not news. It’s the next prediction that makes the news. People don’t care who was wrong. People like Peter Schiff and Nouriel Roubini have gained notoriety for their doomsday predictions. Both of those fellows know a lot more about economics than I do, but give me the tempered view. In my experience, the worst case scenarios have often been wrong – from Thomas Malthus‘ prediction that we’d run out of food before 1900 to Chicken Little’s insistence that the sky was falling. There are too many variables involved to be right for any reason other than luck. Malthus was wrong because he ignored the possibility of technological advances and overlooked man’s ability to innovate and survive. Do yourself and a favor and be an optimist. If the worst is coming, it’s not going to matter. People that listened to people predicting the worst for the longest term took their money out of the stock markets, only to see a historic rise. Lately, many of those same people have plowed their money back in at much higher prices, because markets have “stabilized.” If you want to watch someone, watch Warren Buffett. Watch Seth Klarman. Compare Peter Schiff’s returns in his fund to Seth Klarman’s over the last 5 or 10 years (hint: Klarman is killing him). You can have all the PhDs in the world, and it doesn’t mean you’re going to be better at assessing market risk than Buffett or Klarman. Remember that when you hear the prognosticators prognosticating;) Thanks for reading.
The Economics of Crime
Posted by: Todd Metheny in Economics on August 25th, 2009
If they make another The Longest Yard, they should hire Plax as a consultant.
That title implies a much wider, sweeping scope than this post is actually about. It’s actually just a thought about the economics of one particular incident. Plaxico Burress, an NFL wide receiver formerly of the New York Giants, was sentenced to 2 years for violating the gun laws in New York when he accidentally shot himself in a night club.
I can’t help but think that this sentence was somewhat politically driven. When a person of some celebrity goes to jail, it’s not a surprise that politics are involved. On the surface, I can’t say that I disagree with it. Burress broke the law, and the sentence is within the range of punishment under the laws of that state. Gun laws in NY do seem to be particularly harsh, but that’s the way they’ve chosen to govern their state, and perhaps studies have shown that harsher gun laws have led to less crime (I honestly don’t know but that makes sense to me).
Obviously, there’s a philosophical side. I’ve heard people call this a victimless crime, like prostitution or gambling. Of course, laws aren’t only in place to vindicate acts in which someone was harmed – they also exist to prevent crime from happening. There are basically two ways to deter crime (according to Steven Levitt), you can (1) Raise the probability of apprehension, or (2) increase the severity of the punishment. Those two are related. If the probability of apprehension is low, then the severity of punishment needs to be high in order to deter crime.
I want to look at a different side of the issue. An economic side. If we assume, as I do, that Plaxico Burress is neither dangerous nor a menace to society, then why is he being incarcerated? To pay his debt to society? I think an economist would say that the most efficient way for him to pay his debt to society would be with his money (Judge Richard Posner says that very thing). Instead of putting Burress in jail, where he’ll actually cost the taxpayers money (unless he can produce lots of furniture and license plates) – why not give him an extremely high monetary fine. Burress made $11 million last season.
How much value will he create in prison? A negative number? A very small positive number? Wouldn’t it make more sense to make him pay a hefty fine. Again, this is only assuming that he’s not dangerous. What if you made him pay a fine of $10 million over 2 years instead of going to jail. What would benefit the people of New York more? There could even be a mandate that the $10 million be put toward enforcing the gun control laws in the state of New York.
Of course, on some level, this is offensive. Should a professional athlete be able to effectively “buy” his freedom, just because it’s what’s best for the people? Is it even what’s best for the people? Shouldn’t he get whatever punishment that any other citizen would have gotten? I’m not so sure that this is a sentence that any other citizen would have gotten. Donte Stallworth (another NFL wide receiver – tough league) recently killed someone in a drunk driving accident and got 29 days in jail. Burress gets 2 years for shooting himself in the leg. I’m not so sure your average Joe goes to prison over having a gun, especially if they didn’t have a record to begin with. I don’t know. I could be wrong about that. I don’t think I am.
Fines are a solution that the market likes. It’s basically a tax on wrong doing. If someone is dangerous, and they need to be separated from society for the greater good, then of course, imprisonment is the right solution. Many studies have shown and it is widely accepted in sociological terms that prison does not rehabilitate. So the only purpose is to protect people by taking the crimes they would be committing out of society. Anyway, just thought I would throw this out in light of a pretty interesting news story. What do you think about the idea of using fines whenever possible and avoiding jail time? Thanks for reading.
Conscious Capitalism
Posted by: Todd Metheny in Business Profiles, Economics on August 3rd, 2009
When I was in law school, my Business Organizations professor, a really nice and smart fellow named Tony Luppino, handed out an interview with Milton Friedman in which he stated that the only social responsibility that a company has is to increase profits. The argument goes something like this, if you are elected to the Board of Directors of a company, your stated purpose is to make money for the people that voted for you. The people who elected you didn’t vote for you so you could use the company to pursue your vision of a better world, the shareholders elected you so you could make decisions in line with the fiduciary duty you have to them. Your duty is to the company, not to the rest of the world.
If you’re elected to the board of directors of a cigarette company, for example, you should be focused on selling more cigarettes rather than reducing their prevalence and their propensity to make people addicted to something that eventually makes them sick and shortens their life span.
There’s a movement away from Friedman’s viewpoint. Many companies are showing that sometimes what’s best for the world, in the long run, may also be best for business. Companies like Google (GOOG) (the one that stands out the most to me), Microsoft (MSFT), Whole Foods (WFMI), Berkshire Hathaway (BRK-B). Henry Ford was once famously sued by his shareholders for pursuing what was his vision: that every American be able to own their own automobile. He was focused on making cars more affordable rather than doing what some shareholders believed he should have been doing, which was maximizing shareholder value.
Google stands out because of their motto, “don’t be evil,” and for their drive to make things better. To make knowledge more available. They recently held a contest for someone to make the world a better place. And they were willing to invest up to $10 million in the idea. It was venture capital. They weren’t running it as a charity – they were running a business. They were going to make money off of the idea, if possible. I think that’s reasonable. You can make the world better and make money at the same time. It’s possible, and it’s what a lot of companies are shooting for.
On the other side of the coin, there’s the Bill and Melinda Gates Foundation, which is an effort to make the world a better place with no possibility of making money. The Foundation has a directive to spend all of its money in the next 50 years, so they’re shooting to make an immediate impact. They could have set up the Foundation so it only paid out the required 5% distribution to remain a charitable foundation, and it would have lived on well beyond them. They would have been historically very famous if they had chosen to dole out their money this way. They didn’t. They don’t take money from other people, either (with the exception of Warren Buffett – whom they accepted about $30 billion from). If you want to help the Foundation, they’ll tell you that you should donate to their causes, not to them. The money in the Foundation came from Bill Gates‘ company, and he turned it around and used it in his attempt to reduce poverty and improve education.
The movement toward business that gives back is an important one, but the lines aren’t clearly drawn. My brother-in-law is starting a company that he believes will make the world a better place. The tough part comes in when his shareholders, like Henry Ford’s, accuse his board of not putting shareholders first. Not everyone has the same plan of making the world a better place that business visionaries do. What happens when shareholders challenge the companies plan. Worse yet, what does a company do when faced with the possibility that it won’t be profitable? Does it stick to its goal of making the world a better place? What comes first? How do you balance the two things? Friedman’s view keeps this clear cut and simple. People know their roles and can make logical decisions according to those roles. In some ways it’s hard to disagree with that. The new way is harder, but it also has the potential to be better. Companies that care about the world (like my brother-in-law’s!) have power. It’s a form of technology, really. The same way products keep innovating to make them more efficient and useful, companies seem to be at the next stage of their innovation. They can be about making money and doing good at the same time. What do you think? Do you agree or disagree with Friedman’s take in the clip above? Don’t be evil and thanks for reading.
The Issue of Underemployment
Posted by: Todd Metheny in Economics on May 27th, 2009
Unemployment stats have made headlines in recent months. Many think that the unemployment rate is one of the best measures of the current state of the economy. When there’s money floating around, and people are using that money to buy more things, companies make and market more things, creating jobs. That is not the case right now. In April, according to the Bureau of Labor statistics employers took 2,712 mass layoff actions, laying off 271,226 workers. It’s a problem that gets a lot of press.
What doesn’t get a lot of press are the many workers who still have jobs, but aren’t working nearly as much. How many people out there have had their hours cut back? How many people don’t get the shifts they need to make ends meet? How many have been asked to take a pay cut? Or have duties added in order to keep their job? How many people out there are working more for the same or less pay? This is an issue that doesn’t show up in the statistics, but damages the economy just the same. Like unemployed workers, these workers are bringing in less money, giving them less money to spend at other businesses that employ people, which in turn creates jobs and stimulates the economy.
There’s another, less obvious type of unemployment going on as well. Lots of people out there have skills that aren’t being utilized. That is, you have lawyers, computer science degrees and MBAs waiting tables, walking dogs and delivering pizzas. This isn’t necessarily wrong. If there was sufficient demand for more people to do the jobs that these people would do in their specialty areas – they would be able to get jobs in their field. This creates other problems though. A lawyer, straight out of law school has knowledge and skills that aren’t being acquired. They also tend to have debt. MBAs are the same way. Their mistake was going into fields that had a surplus and inadequate demand. Both degrees provide knowledge that is very practical and useful. Using lawyers as an example, there are 553,690 lawyers employed in the US. That number doesn’t include lawyers doing something else (and there are lots).
The point is, based purely on perception, people have pursued careers that the market lacked sufficient demand to support. By the time applicants realize this, it’s too late, and there are too many of a particular thing. Of course, the correction will work the same way. A shortage of lawyers (or whatever) will creep up on us, and before we know it, the 300,000 people practicing law will be raking it in, it will gain a reputation for being the place to be again, and people will rush out and take the LSAT, eager to fulfill their dream of becoming a lawyer. Of course, it may never swing this much. This is just an example for the sake of the example. Because so many have pursued degrees and training that isn’t in adequate demand, underemployment occurs, and the economy suffers. Thanks for reading.
The Personal Finance Playbook was honored to be awarded the Silver trophy in the most recent Carnival of Real Estate hosted by Web Real Estate Marketing. Head over and check out all the posts.
New Ideas from Dead Economists, Part 12 (Special Interest Groups)
Posted by: Todd Metheny in Economics, Reviews on April 24th, 2009
This is part 12 (I know it’s getting ridiculous) of my review of New Ideas from Dead Economists by Todd Buchholz. Here are parts 1 (Adam Smith), 2 (Thomas Malthus), 3 (David Ricardo), 4 (John Stuart Mill), 5 (Karl Marx), 6 (Alfred Marshall), 7 (Thorstein Veblen), 8 (John Kenneth Galbraith), 9 (law and economics), 10 (John Maynard Keynes) and 11 (Milton Friedman) if you’d like to look back. Any of the entries can stand alone, of course.
If you’re the type of person that complains about bureaucracy, this is the chapter for you (I am one of you). Among other things, this chapter looks at the incentives on politicians. What do politicians maximize, Buchholz asks? Politicians maximize their power and their ability to gain votes. All of my posts look at the theories and ideas that economists have developed over years of study and experience. But how do we apply the best ideas without the politicians mucking it up?
Special interest groups and lobbyist have a tremendous amount of power in this country. Special interest groups aren’t, contrary to public opinion, lobbying Congress to try to get them to increase efficiency and the national wealth. They’re lobbying a very specific interest, without regard for what’s right, or what’s best for America, or what’s best for you or I. Why? Because whatever their special interest is, they’re getting paid to support that interest.
Buchholz offers the example of the Associated Milk Producers, which ranks high on the list of donators to congressional campaigns. Milk producers enjoy the government legislated price supports, because it guarantees that they will get a good price for their milk. Economists, on the other hand, would prefer to allow the market to set prices (economists hate price supports). Suppose the milk producers comprise 1% of the population – if they lobby Congress to raise productivity, they only receive 1% of the benefit. if they lobby Congress to support their interest exclusively, they reap 100% of the benefits. There is no incentive for patriotic lobbying. This political activity hurts society, but they only absorb 1% of that hurt, while they’re reaping a great deal of benefit from the activity.
Why don’t consumers organize to defeat this process? Because it’s difficult to organize and because it doesn’t pay. If the total cost to consumers is $10 million, and the population equals 250 million, it costs each consumer about $.04, but it benefits each producer by $4. Plus, it’s easier to organize the producers.
Lobbyist for sugar growers represent only .0002% of the American population, keep the price at about triple the world price. They benefit from this, but so do the producers of corn sweeteners (the predominant US crop), who make a lot of money from artificially high sugar prices. Log Cabin maple syrup actually doesn’t have any maple syrup in it – can you believe that? It’s corn syrup – because it’s cheaper. That’s what artificial price supports do.
This is how motivated organizations take advantage of consumers, who have a smaller stake in the outcome. I know I sound like I’m trumpeting an anti-establishment, but I’m really not. I’m just pointing out some of the flaws in the current system. I’m sure you’re already familiar with them. It’s what gets discussed around dinner tables all across the country. It’s why people are cynical when it comes to politics and politicians. It’s not a perfect system. Nothing is when real people are involved. People will usually act in their own interest. Usually, in a free market system, acting in your own interest helps the group as a whole. In this case, however, we’re dealing with virtual monopolies and oligopolies, and that tends to be a negative thing. In any case, it’s historically been the best system for creating wealth in the history of the world. For all of our flaws, we’re doing it better than most governments are. Hopefully America is not dead yet. Thanks for reading.
New Ideas from Dead Economists, Part 11 (Milton Friedman)
Posted by: Todd Metheny in Economics, Reviews on April 16th, 2009
This is part 11 (I know it’s getting ridiculous) of my review of New Ideas from Dead Economists by Todd Buchholz. Here are parts 1 (Adam Smith), 2 (Thomas Malthus), 3 (David Ricardo), 4 (John Stuart Mill), 5 (Karl Marx), 6 (Alfred Marshall), 7 (Thorstein Veblen), 8 (John Kenneth Galbraith), 9 (law and economics) and 10 (John Maynard Keynes) if you’d like to look back. Any of the entries can stand alone, of course.
John Maynard Keynes is a tough act to follow. If you’re going to be that guy that disagrees with Keynes, you’d better be a pretty big dog. Milton Friedman is exactly that. Interestingly, Keynes began his career as what would be called a monetarist and ended up a Keynesian. Friedman, influenced (as most people were) by Keynes, began his career as a Keynesian and ended up a monetarist. He went from an adherent of Keynes ideas to his most famous critic.
Keynes used basic methods to stimulate the economy (1) lower taxes, or (2) increase government spending. This could be analogized to a gas pedal, or accelerator. If you want to accelerate, lower taxes or increase government spending. If you want to tap the brake, raise taxes or decrease government spending.
Friedman felt that the government were lousy drivers of the economy, and critcized Keynesians for ignoring monetary policy. The proper way to hit the accelerator, according to Friedman, was to increase the money supply. He thought the Federal Reserve Board was the proper driver of the economy.
A note on money. Obviously, too much money is not necessarily better, because if the money supply becomes too large, then a threat of inflation exists. The question then becomes, what is the proper amount of money to be available? Buchholz answers this simply by saying the proper money supply is enough money to buy all the goods produced, so that full employment is reached without a change in prices. Also relevant is how fast people spend it, also known as the velocity of money. Assume that the total money supply is 60. If the GDP (gross domestic product) is 360, then the velocity of money is 6. One of the basic tenets of monetarism is that velocity remains stable.
Increasing the money supply will, theoretically at least, increase prices (through inflation). While this happens, it has the power (theoretically again) to stimulate the economy in the short term, because the availability of money speeds up the velocity of money.
How does the Federal Reserve control the money supply? With government issued securities (such as Treasury Bills or Government bonds), of course. The Federal Reserve can increase the money supply by buying bonds from the public. When they’re held by the Fed, they aren’t part of the money supply. If they want to tap the breaks, they can sell back the securities, and take that money out of the money supply.
Friedman recognized that manipulating the money supply was a slippery slope. If you reign it in too much, you risk ending up in a recession. If you let too much money run freely, you risk high inflation. He was known to admit that economists don’t know enough about monetary policy to manipulate it wisely. Currently, we use a blend of monetary policy, as Friedman advocated, and fiscal policy, as Keynes advocated. Both contributions are important to the current state of economics and their strategies are both being used in an attempt to get us out of the current recession. We’ll know more about how well those theories were executed as time goes by.
On a final note and wholly separate note, Friedman also had a lot to do with getting rid of the draft system in favor of a volunteer army. Buccholz recounts a conversation between Friedman and General Westmoreland in his book. Westmoreland testified in front of a commission to decide the issue that he did not want to lead an army of mercenaries. Friedman stopped him and asked whether he would prefer to lead an army of slaves. The general replied that he did not like to hear our patriotic draftees referred to as slaves. Friedman replied by saying that he didn’t like to hear our patriotic volunteers referred to as mercenaries. “If they are mercenaries, then I, sir, am a mercenary professor, and you, sir, are a mercenary general; we are served by mercenary physicians, we use a mercenary lawyer, and we get our meat from a mercenary butcher.” The commission unanimously voted for an all volunteer army. He was a very impressive man, by all accounts. Thanks for reading.
