The Skeptical Optimist

Read This Book

I just finished this book (The Origin of Wealth by Eric Beinhocker), and it is one of the best I’ve ever laid my hands on.  Although economists set in their ways will find discomfort in its challenge to their worldviews (neoclassical, neo-Keynesian, take your pick), it will be a page-turner for anyone else—especially anyone who has a background in science or engineering, although that’s definitely not a prerequisite. 

The economy is a stubborn thing that does not behave the way the equations say it should—regardless of which economists’ equations we’re talking about, and regardless how many centuries they’ve spent developing the deterministic models.  Instead, the economy is a complex adaptive system, always evolving (or trying to evolve) to a higher state of order. 

If you only read two chapters, pick chapters 3 and 4.  Chapter 3 summarizes the critique of conventional economics’ assumptions and so-called axioms; as at the end of the Wizard of Oz, it is an unveiling of the man behind the curtain.  Chapter 4 introduces the new paradigm, using agents in computer simulations to demonstrate how complex economies evolve from scratch in an environment with just a few simple rules and survival motives.  After you read chapter 4, I predict you won’t want to stop reading. 

The future is nowhere near as predictable as deterministic equations and models would suggest.  That’s why there’s a better way to prepare for a better future than predicting, committing, and planning.  The better way is to experiment, learn, and adapt; to try a whole lot of new, different things, each one in a little way; i.e., to adopt the "Thomas Edison" approach.  All it takes to discover a paradigm-shift technology is just one success out of all those many little experiments—and there’s no way of knowing ahead of time which of those many experiments will succeed. 

A few years ago, my company was experimenting with a few large customers on a new idea for doing business together.  Early on, we had many disappointments; I described the process as follows:

“We’ve been trying a lot of things that don’t work.  That’s encouraging, because the faster we do that, the sooner we’ll run out of things that don’t work.”

Experiment, learn, and adapt.  That’s how (not just) economies evolve faster and better.  The more favorable the environment for that process, the faster the economy evolves to a higher order. 

I’ll be talking more about that process in the next few articles (coming soon) of my series on energy.

FQ.06.39: Favorite Quote for This Week

You can't cut your way to prosperity, you've got to grow the economy.
—Steve Forbes

Foreign buyers of US debt: Brits take the lead

I keep hearing “warnings” about all the US debt being bought up by foreigners.  Here’s one typical example from the Blue Dog Democrats; no doubt a lot more statements like this are being made on the campaign trail today:

“Mr. Speaker, you don't need a doctorate in economics to appreciate that our Nation's economy and its security is more vulnerable when we are deeply indebted to foreign creditors.”

Scaring people seems to be working.  Judging from the many forums I visit (usually to see who’s linking to this website), it appears that fear-peddling tactics by politicians like the Blue Dog Democrats have made some headway with the public.  Many people seem to be convinced that foreigners are about to spring a trap on us.  According to the fear-peddlers’ innuendo, we’re supposed to be preparing for foreign T-bond owners—especially the Chinese—to conspiratorially dump all their holdings at once, sending everyone (including themselves) into the poorhouse.  (Sounds a lot like the global-finance version of a suicide bomber, doesn't it?) 

So I keep checking the official statistics looking for something to be frightened about.  Unsurprisingly, I still can’t figure out what’s supposed to be so scary. 

Below is the latest official data on foreign ownership of US Treasury debt.  This one is sorted to show which foreigners have bought up (or sold) our debt instruments in the last twelve months.  (The pie chart of who owns the debt hasn’t changed much since last time I posted it.) 

The official numbers say that, if we are to trust the Blue Dog Democrats' rhetoric, we should now be deathly afraid of the British, who have bought three times as much new debt than the Chinese have in the last twelve months. 

This probably won’t surprise you: I don’t take the same stance as the Blue Dog Democrats.  I do think the British, the Chinese, the Canadians, and many other foreigners know a good, safe, secure investment when they see one.  So my response to the Blue Dog Democrats fear-mongering about “foreign creditors” investing in United States Treasury securities is this:

“Mr. Blue Dog, you don’t even need a high school diploma to appreciate that the British are buying up our debt because they think it’s a safe, secure investment—and not because they’re planning to become T-bond suicide bombers.” 

Sep 2006: USA GDP growth, Q2 final

The Department of Commerce reports that second quarter annualized real GDP growth was 2.6%, and current-dollar growth was 5.9%.  But if one uses the two-quarter method to estimate annualized growth, the numbers are 4.1% and 7.5% respectively.  (Although both methods are factual statements of what the growth rate has been, the two-quarter method has a better track record of predicting future growth for the upcoming year.)

The math to calculate growth either way can be found here.  The chart below shows real and nominal GDP, and all four growth numbers.

Al-Jazeerah op-ed echoes Blue Dog Democrats and Concord Coalition

An opinion editorial in Al-Jazeerah yesterday expressed deep concern about how the US government will ever be able to pay its national debt, and about who will get stuck with the bill.  The author’s concern parallels the opinions already being loudly expressed by our own Blue Dog Democrats, all other Democrats, many Republicans, our government’s comptroller general, the Concord Coalition, nine out of ten American journalists, and nine out of nine foreign journalists.  Financial doomsday is just around the corner, according to just about everybody. 

Should I start looking less favorably on those US Treasury bonds I plan to bequeath to my granddaughter?  I know exactly what happens when a borrower is on the way to financial collapse: lenders figure it out, and interest rates on that borrower’s new debt instruments go to the stratosphere.  The old bonds become worthless, and I’d then be left holding the bag. 

Al-Jazeerah is so concerned about our debt that they display a US National Debt Clock on their home page.  Tick, tick, tick.  Their clock is presumably modeled after the ones used by the Blue Dog Democrats and the Concord Coalition.  [I hate to break it to all of them, but those single-entry-accounting debt clocks are now obsolete because of the new, Twenty-first Century debt clock at the upper right of this website.]

Anyway, it’s almost unanimous: financial doomsday is just around the corner for good ol’ Uncle Sam.  But wait ... hold on there just one minute: there’s a big, big disconnect.  Something doesn’t add up, and nobody’s explaining it—not Al-Jazeerah, not the Blue Dog Democrats, not the Concord Coalition, not the Republicans who should know better.  Nobody. 

The discrepancy is this:  The free-market buyers of US Treasury securities—many US citizens and many foreign buyers—are currently demanding a mere 4.91% interest on the USA’s 20-year constant-maturity Treasury note.  Not only that, but that interest rate has been declining.  Click on this thumbnail and look at the blue lines:

Judging from the interest rate on long-term US Treasury securities, America’s bond-buying customers are apparently becoming more and more optimistic about America’s future, not more and more alarmed.  So the question nobody is asking (or answering) is this:

If America is headed for financial doomsday as everyone says, why are long term interest rates remaining low—even declining—instead of skyrocketing?  Hello?  Al-Jazeerah?  Blue Dogs?  Concord?  Anyone?  Are you doomsters all smarter than the collective millions who buy US Treasury securities?  If so, what do you know that they presumably don’t?  If not, then what do they know that you’re ignoring—and why are you ignoring it? 

To me, the silence on that question is deafening.

I guess our bond-buying customers are not buying Al-Jazeerah op-eds, Blue Dog Democrats’ speeches, or the Concord Coalition’s head-for-the-hills literature.  I guess they’ve rejected all that disaster-mongering, opting instead to continue having faith in America’s future.  Are they misinformed idiots?  Or do they know something Al-Jazeerah and the Blue Dog Democrats don’t know?

I guess the bond-buyers, Group B below, still have faith that when their bonds mature in the future, they will collectively become Group A.  In other words, the bond-buyers know there's a simple answer to Al-Jazeerah's urgent question Who will pay the US national debt?  The answer is, The US government will pay it using a well-known action called rollover.  It’s nothing new; it’s the same process that’s been happening ever since the beginning of the market for US Treasury securities. 

Again, the process above is called “debt rollover.”  Every bondholder is paid back her principal when her bond matures; there are no defaults.  It can continue indefinitely into the future, as long as the bond buyers have confidence in the borrower’s future.  They communicate their degree of confidence through the interest rate they demand—4.91% as of last Friday.  Sounds to me like they have a good deal of confidence.  Unfortunately, it also sounds to me like everybody else is trying their darndest to talk Group B into becoming pessimistic—but it’s not working, is it?  The US economy just keeps on growing, the US government's tax receipts keep growing, as does its ability to meet the growing interest payments with ease, and the bond buyers keep expressing their confidence in America's future by continuing to re-up their investments in T-bonds.  The doomsters are persistent, but their rhetoric just isn't having much effect on the bond buyers.

It’s not working on me, either—but thanks anyway for the advice, Al-Jazeerah, Blue Dogs, and Concord.  If you don’t mind (...and even if you do), I think I’ll keep buying those T-bonds for my granddaughter.

================
UPDATE, 10-02-2006:  Two emails have informed me that the "Al-Jazeerah" website at the link above is not the same as the TV station.  Here are some excerpts from those emails:

...the Al-Jazeerah you refer to in your latest post is not related to the TV station of the same name. This appears to be just your average anti-American hate site, not backed by a major organization.

The real Al Jazeerah is at www.aljazeera.net, with the English version at english.aljazeera.net

Because the website of the fake Al-Jazeerah is still up and running, I have to presume that the real Al-Jazeerah doesn't mind whatever copyright or trademark infringment is happening. 

 

An October Surprise for Republicans and Democrats

There’s a secret solution to deficits and debt.  Republicans rarely talk about it, and Democrats avoid it like the plague.  As a result, it remains a secret from the voting public—especially during political campaign season—and the two parties keep presenting us with the same, tired old false dilemma of “cutting spending” or “increasing tax rates.” 

Yes, it’s a false dilemma, because there really is a third solution to deficits and debt.  You may already know what it is.  Here’s a simple fill-in-the-blank quiz, which should be easy for anyone who’s read a few articles in this blog:

The three different ways to fix the so-called problem of deficits and debt are:

1.  Increase tax rates.
2.  Cut spending.
        or ...
3.  ______________.

Before revealing the answer, I’ll comment briefly on the two choices that comprise the false dilemma. 

Increase tax rates
Democrats love to focus on this half of the false dilemma.  Although I do think it’s possible for tax rates to be too low, that’s not the case today.  The federal government’s “take” is 18% of GDP; that’s not too little, that’s very close to the decades-long historical norm.  (The government’s 21% “take” during the late 1990s was a short-term blip, properly corrected by the 2001 tax rate cuts.)  So what if spending is higher than 18% of GDP?  If we are spending it productively, it’s money well spent.  (Reducing embassies’ vulnerability to terrorist bombs is just one example of productive spending—and, as I’ve said before, productive spending pays for itself in future benefits, so it doesn’t matter if it’s funded by selling more T-bonds to the public.)  Higher tax rates than we have today divert a higher portion of the private sector’s energy to tax avoidance activities, legal and illegal; the resultant effect on the tax base is not productive, and that’s why I am against the Democrats’ half of the false dilemma.

Cut spending
Republicans occasionally talk about growth, but mostly love to focus instead on spending cuts, the other half of the false dilemma.  Although I am personally in favor of cutting wasteful spending—every bit as much as I’m in favor of motherhood and apple pie—there’s a big difference between “cutting wasteful spending” versus just “cutting spending.”  It’s the difference between trimming your fingernail with a small clipper, versus chopping your finger off with a meat cleaver.  The latter is what we did in the mid 1990s, when we fed bipartisan surplus-mania by making big cuts in national security spending.  (The surpluses started in ’96; the bleeding started in ’98, when Al Qaeda blew up our unprotected embassies in Kenya and Tanzania—unprotected due to budget constraints that enhanced the surplus we thought we loved so much.)  That’s what tends to happen when we “cut spending,” and that’s why I remain very skeptical about the Republicans’ half of the false dilemma.  [What about cutting pure waste?  I'm in favor of it as long as every dollar of wasteful spending cut is matched by a dollar of tax cuts.]

Summary of the false dilemma
False fear of deficits creates an unnecessary desire to eliminate them.  Republicans usually propose “spending cuts”; Democrats usually propose “tax increases.”  It's no wonder voters are left with the false impression that spending cuts or tax hikes are the only two choices for achieving the elusive condition called "fiscal responsibility."

Choice 3, the big secret
“Grow the economy.”  That’s the choice we rarely if ever hear about, especially during political campaigns.  [It’s more accurate to say “grow the economy at least as fast as the debt grows”—but political campaigns rely on sound bites and bumpersticker-length slogans, and we’ll be lucky to see the three-word version in anyone's talking points any time soon, let alone the fully-qualified version.]   

“Growing the economy” means “creating more and better jobs that yield higher and higher pay.”  Growth is the third way to “fix” deficits and debt, and it’s a much better fix than spending cuts or tax rate hikes, for a number of reasons.  "Fiscal responsibility"—a term nobody takes the time to define today—could at long last take on a very precise definition that would force both sides to bring economic growth into the debate:

Fiscal responsibility - The fiscal budget which results in no increase and no decrease in the ratio of debt to Gross Domestic Product.

Nonetheless, growth remains the well-kept secret.   Republicans mention it only rarely, usually opting instead to talk about spending cuts. Democrats almost never mention growth; they'd rather focus on tax hikes for the undefined "rich" (...don't tax you, don't tax me, tax the guy behind that tree).  Just listen to the speeches; "growth" is barely in anyone's vocabulary. 

October Surprise 2006
How about we give our politicians a nice little October Surprise this year?  Why don’t we give them the quiz above, and see how many of them can fill in the blank correctly—then elaborate about (a) what they’ve done about it already, and (b) what they propose for the future? 

My guess, based on my experience, is that Republicans will tend to be much more willing and able to address the growth question than the Democrats.  There are exceptions on both sides, of course—but the point is, We need to start asking them about it if we want to start hearing something besides "cut spending" or "increase taxes." 

A quick reminder
Here’s a graphic, in case you need to remind anyone why growth is so important to the debate.  This is an 8% annual growth scenario for GDP and debt, illustrating that the debt could grow by ten trillion dollars in a decade without affecting our debt burden (ratio of debt to GDP).  Feel free to copy it and use it as you see fit. 

[Growth of 8% nominal is within a point of today's rate, by the way.]

The next graphic below shows how economic growth (or contraction) almost always dictates which direction tax receipts will go.

Finally, the graphic below shows when deficits are okay, as well as the gloomier scenarios when surpluses are necessary.  I hope I never see any of the last three scenarios come about, but the principle of holding debt-to-GDP constant is the same.

Once again: Why don’t we give our politicians an October Surprise of our own this year?  Let’s start asking them about growth; some will have good answers, others will stutter like Porky Pig, but in either case, it would make the campaign more fun for us voters, wouldn't it?  If nothing else, it would give us (and them) some good practice for the presidential campaign coming up in a sixteen months. 

FQ.06.38: Favorite Quote for This Week

One thing is clear: the exceptional stability of real oil prices during the 1990s undoubtedly lulled the world into complacency.  Oil remains a political commodity.
—Vijay Vaitheeswaran

Energy, post 4: Dissenting from Mr. Gore

Al Gore spoke at NYU Law School yesterday, laying out his latest ideas for applying Stick Economics to the project of saving the planet from atmospheric CO2 generated by USA residents. 

Mr. Gore thinks the top priority for our nation’s energy policy should be the reduction of carbon dioxide gases U.S. residents emit into the atmosphere.  (Even though North America is a carbon dioxide sink, not source, it might be important for us to become an even larger sink—to help offset some of the extra CO2 that China and India will soon be emitting as they grow their economies.  That tidbit wasn’t in the article, but does help remind me which part of the planet is doing what to the atmosphere, net-net.)   

Mr. Gore has his opinion about priorities; my dissenting opinion is this:

Our most pressing problem is not carbon dioxide emissions, it is the national security effect of energy sourcing.  CO2 emissions may or may not be a problem we need to fix.  Dependence on oil is a bigger problem for the USA right now.

The figure below shows today’s good-news-bad-news status for each of the five categories of energy sources mentioned in the first article of this series.  Nuclear power [see End Note] and renewables are the only two categories today that satisfy both the CO2 and national security goals (i.e., no emissions and secure sourcing within North America).  With some breakthroughs in carbon sequestration technology, coal and natural gas might get there as well.  But still, there’s one major drawback to all four of those non-oil categories: they are all used largely for generating electricity, which is primarily use-it-now energy.

Sure, we store some electric potential in batteries ...but not much.  Also, where the topology is favorable, we use some excess generating capacity to pump water uphill into reservoirs, to drive electric turbines later when the electricity is needed.  But the vast majority of electricity is of the use-it-now kind.  Look at this red dot. ->•<-  The electricity it took to light up those red pixels was generated by a power station less than 0.003 seconds before you looked at it (...unless, of course, it came from the battery in your uninterruptible power supply—in which case you’d better stop reading this article and fix your more pressing problem). 

The next figure, below, indicates the two most pressing energy problems we face right now—in my opinion, not Al Gore’s. 

First problem: Our dependence on oil for transportation energy, which drives world demand for oil.  When you think about it, our dependence on oil means that we are directly or indirectly funding both sides of the war on terror (taxes and petrodollars); just think for a second about how stupid that sounds.  Second problem: Our near-inability to generate electricity and store it in high-energy-density forms, for later use (e.g., in personal transportation vehicles). 

In fact, if science and technology could crack the second problem, we’d probably (and ironically) end up solving Al Gore’s top priority problem, CO2 emissions, decades sooner.  Reason: Al Gore’s government mandates (Stick Economics) would stop at our borders; that is, our government would not be able to mandate behavior in China and India.  On the other hand, if our science and technology, motivated by Carrot Economics, could come up with an affordable way to store 300 vehicle-miles of electric potential safely in a gasoline-tank-sized container for personal vehicles—thereby "making better quality of life more affordable to the masses"—oil independence would be right around the corner not just for US residents, but for every automobile owner on the planet.  Combined with more nuclear plants and carbon sequestration at the coal-burning plants, not only would worldwide CO2 emissions plummet, but it just might turn the USA into a net exporter of the new energy solution for personal vehicles. 

Technology breakthroughs displace old paradigms; I strongly prefer that to government-mandated tweaks of the old, entrenched paradigms.  Remember, just as the Stone Age didn’t end because we ran out of stones, the oil age won’t end because we ran out of oil.  Let's just be sure not to let Al Gore's Stick Economics get in the way of a paradigm shift that Carrot Economics is likely to bring about.  (Definitions.)

This is the fourth article in the series.  [See also articles 1, 2, and 3.]  Future articles in this series will cover more about the technology advances in progress, as well as some policy options that could speed things up (definitely under the heading of Carrot Economics).

==========
Here are links to all seven articles in the energy series:

• Article 1: Energy facts, certainties, and possibilities
• Article 2: Government spending and its consequences
• Article 3: Yes, growth DOES require more energy
• Article 4: Dissenting from Mr. Gore
• Article 5: The obstacle to oil independence
• Article 6: A tankful of electrons
• Article 7: A 21st Century “GI Bill”

--------
End Note...

Republicans vs Democrats: Carrot Economics vs Stick Economics

Which do you prefer: Carrot Economics, or Stick Economics?  The definitions (mine) are below, and comments are open.  As I’ve said before, more often than not, I prefer the party of Carrot Economics (but not always).

[Note: A friend saw these two definitions at the bottom of a previous post of mine, and suggested I publish them front and center in their own post, open for comments.  He said it should attract some fun replies.  I responded that it would probably also attract some cranks, judging from what I see at other blogs that focus on political issues ... but what the heck, here goes.  Although I usually don’t have time to babysit commenters, I will definitely make time on this one to delete garbage and ban anyone who acts like a jerk.] 

1. Carrot Economics:
"Growth is good."  Encourage innovation, and allow rewards to be reaped by anyone who can make better quality of life more affordable to the masses.  Expect median income to grow as a result, and expect some to get rich in the process.  Have faith in the future.  Trust in the competitive marketplace of ideas and incentives, and in the process of creative destruction.  Favor the experiment, learn, and adapt approach over the predict, commit, and plan approach. 

The Carrot Economics crowd thinks "success" is when aggregate growth not only accelerates, but also produces pleasant surprises benefiting not just aggregate income, but also national security and the environment.

2. Stick Economics:
"Rich is unfair."  Tax more and more heavily anyone who somehow got "rich"—even if that status was achieved by making better quality of life more affordable to the masses.  Try not to get cornered into defining the word "rich" or discussing causes of "growth."  Trust the government to make fewer mistakes than the market makes.  Favor the predict, commit, and plan approach over the experiment, learn, and adapt approach.  Spread fear of the future, and suspicion of people and organizations who practice Carrot Economics. 

The Stick Economics crowd thinks "success" is when the top two quintiles of households get their comeuppance for destroying the environment and for mercilessly suppressing the bottom three quintiles. 

------------
FYI, here’s a link to the previous article, which also explains some of the reasons I am not always enamored with the Republican party line. 

FQ.06.37: Favorite Quote for This Week

Recent work in cognitive science shows that people tend to learn within the context of a mental model.  And while humans are good at adding new information to their existing mental models, they have a more difficult time changing those models at a more fundamental level.  In short, we tend to get stuck in our ways.
—Eric Beinhocker