Dodonomics: The prostitute and the baby-sitters’ club

The Mises blog links to this “brain teaser”-

It is the month of August; a resort town sits next to the shores of a lake. It is raining, and the little town looks totally deserted. It is tough times, everybody is in debt, and everybody lives on credit. Suddenly, a rich tourist comes to town. He enters the only hotel, lays a 100 dollar bill on the reception counter, and goes to inspect the rooms upstairs in order to pick one.

The hotel proprietor takes the 100 dollar bill and runs to pay his debt to the butcher. The Butcher takes the 100 dollar bill and runs to pay his debt to the pig raiser. The pig raiser takes the 100 dollar bill and runs to pay his debt to the supplier of his feed and fuel. The supplier of feed and fuel takes the 100 dollar bill and runs to pay his debt to the town’s prostitute that, in these hard times, gave her “services” on credit. The hooker runs to the hotel, and pays off her debt with the 100 dollar bill to the hotel proprietor to pay for the rooms that she rented when she brought her clients there.

The hotel proprietor then lays the 100 dollar bill back on the counter so that the rich tourist will not suspect anything. At that moment, the rich tourist comes down after inspecting the rooms, and takes his 100 dollar bill, after saying he did not like any of the rooms, and leaves town.

No one earned anything. However, the whole town is now without debt, and looks to the future with a lot of optimism.

The first comment on the post gets the answer right-

This town seems to have reverted to the barter system of economics. It’s not much of a brain twister and becomes more obvious if only two people (barterers) are involved: the baker gives the cobbler $100 worth of bread for $100 worth of shoes. They could continue the fiction that each owes the other $100, but on their respective balance sheets, payables and receivables perfectly cancel out.

and another one a few comments later, but its disheartening to see people tie themselves up in knots by bringing in “macro economics,” economic models and even suggesting fiat currency! The hotelier could have written a promissory note on a piece of toilet paper, signed it as Karl Marx and sent the note on its way and things would have evened out because of the circular nature of the debt.

The trouble is that such crackpot analogies are used by statist economists to support the “stimulus,” either “quantitative easing” (let the printing begin) or credit expansion by fiddling with the central bank-determined reserve ratios. Since Friedman’s helicopter is defective by design, those who get their hands on such money last are the ones who get screwed, every time. What’s missing in the teaser is an acknowledgment of the fact that though consumption drives production, something has to be produced first before it can be consumed. If Scrooge McDuck left the hotelier a trillion dollars in cash, there’s nothing he can do within the ghost town with that kind of money because there are no goods to buy because there’s no one producing them. He could at most buy out the butcher’s entire production and hire the prostitute for the whole year, but what are the recipients of his largess going to do with those dollars? That’s the dirty secret of the stimulus. It doesn’t produce anything, stimulate anything, create or save anything. It only lets those who see the money first take advantage of that fact. Everyone else gets the shaft.

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Krugman and his economics. Some of his ideas are, to use a phrase his colleague(?) DeLong used to describe Mises’ monetary theory, “batshit insane.” His ideas being part of the mainstream, therefore, tells us a lot about the quality of the mainstream. His brilliant idea, which he keeps repeating every few years or so, the babysitters’ co-op/ club/ whatever-

The Sweeneys tell the story of–you guessed it–a baby-sitting co-op, one to which they belonged in the early 1970s. Such co-ops are quite common: A group of people (in this case about 150 young couples with congressional connections) agrees to baby-sit for one another, obviating the need for cash payments to adolescents. It’s a mutually beneficial arrangement: A couple that already has children around may find that watching another couple’s kids for an evening is not that much of an additional burden, certainly compared with the benefit of receiving the same service some other evening. But there must be a system for making sure each couple does its fair share.

The Capitol Hill co-op adopted one fairly natural solution. It issued scrip–pieces of paper equivalent to one hour of baby-sitting time. Baby sitters would receive the appropriate number of coupons directly from the baby sittees. This made the system self-enforcing: Over time, each couple would automatically do as much baby-sitting as it received in return. As long as the people were reliable–and these young professionals certainly were–what could go wrong?

[...]

Now what happened in the Sweeneys’ co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low. As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple’s decision to go out was another’s chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.

In short, the co-op had fallen into a recession.

His solution, print more “coupons” because as far as he’s concerned, people are after coupons. But why not print a gazillion coupons and borrow the Friedman-Bernanke Helicopter Co.’s one and only helicopter and shower them all over Washington D.C.? Oh no. That would cause a problem of plenty. The system that must be followed is one central coupon printing authority which controls the coupons in the “market” based on how the market is stocked up on the same. If there are few coupons because everyone has stockpiled them, flood the market with coupons by allowing couples to “borrow” coupons and then “repay” them when they do earn their own coupons. Thus the recession is averted. So, instead of spending money on babysitters, thus getting rid of all these calculations and fear psychosis, one should give up control over one’s life, at least partially, to a coupon printing authority. There, such a simple story has taught an excellent lesson in economics-

If you think this is a silly story, a waste of your time, shame on you. What the Capitol Hill Baby-Sitting Co-op experienced was a real recession. Its story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year’s worth of Wall Street Journal editorials. And if you are willing to really wrap your mind around the co-op’s story, to play with it and draw out its implications, it will change the way you think about the world.

Of course one could also use Mankiw’s trick of declaring “coupons” with a particular end digit invalid as long as the recession continues. That way everyone will be rushing out to visit places they don’t want to visit thus spending money they wouldn’t have spent, or imposing on people who don’t want to have them there at that particular time. In the long run, it would have been much better if they had hired the damn babysitter. But if people start doing that, what will the poor bureaucrat who’s manning the coupon printing authority do?

The tale is so flawed that its astonishing that people are taken in by it. But then people are taken in by fiat money too. The first mistake, if one is not careful, is assuming that the demand is for coupons which it is not. The demand is for baby-sitting hours. The demand for coupons exists only because it is supposed to guarantee such hours. If we kill the “co-op” idea and adopt laissez faire, as long as there are more baby-sitters than “baby-sittees,” there is no problem in the market. The couples could have different kinds of agreements amongst themselves, “borrow” and “repay,” take turns, hire someone from outside—the free market is extremely versatile in this sense. But we have an economist who’s a rabid anti-freemarket type, or miserly couples, or a combination of the two. So everyone has decided to adopt the authoritarian model of baby-sitting instead of the free market one. That is the first “wrong.”

Okay, babysitting for profit is banned in the city and the only way to get babysitters is if you are registered with the co-op. Even then, the system would work well if the bureaucrat stopped meddling in the affairs and the couples stopped paying attention to the “face value” of the coupons. If there are a limited number of coupons in circulation, those who don’t have it would be willing to offer more hours than what the face value promises. A desperate couple could offer three hours of service for two coupons or any ratio which the market could settle upon. Its only the bureaucratic mindset of the couples which prevents them from thinking about the issue in these terms. After all, they are all employed by the government, or those who make money by being in power (“congressional connections”). Thus the market could take care of itself, decide its own rate without the authority being involved at later stages. “This,” the increase in the purchasing power of the coupons, is deflation. It helps those who save, and penalizes those who don’t. And that’s why Keynesians hate it so much. He, Keynes, did advocate the “euthanasia of the rentier”. And then there’s the so-called “paradox of thrift” blah blah blah—excess savings cause recessions.

But the authority won’t let this happen. Any attempt at trading coupons at more than face value will be treated as usury, exploitation etc etc, and the authority will lend to profligate couples who have a track record of zero savings plus living beyond their means. The assumption here is that these couples will somehow pay them back, which might not happen. Further, the new coupons have been produced out of thin air with no baby-sitting hours to back them. (Actually so were the original coupons. One still doesn’t know how the original distribution took place.) And these couples will enter the market with their new found wealth. In this limited scenario, one doesn’t know how the couples who saved fared, but Krugman has a little gem tucked in the long piece “Eventually, of course, the co-op issued too much scrip, leading to different problems …” Which is what happens in the real world because the central bank is as clueless as the co-operative looking over 150 families. What didn’t work, can’t work, at such a small scale is supposed to be a lesson for countries with gazillion dollar economies.

If this is economics, I prefer witchcraft.

[Read the Mises Institute's David Gordon writing about the same tale. He completes the story using Krugman's book. Krugman is not a fool; I take back my "batshit insane" comment w.r.t. him, and only him. He's merely anti-free market. That's his religion.]

The improbable and the impossible

Sherlock Holmes, the brilliant detective who was invented by Arthur Conan Doyle while swatting flies in his clinic, made a very profound statement in one of his stories. He said – “when you have excluded the impossible, whatever remains, however improbable, must be the truth.” He drew a line between possibility and probability, thus stating the obvious. But, apparently, US Treasury Secretary Geithner hasn’t read Holmes. From Reuters-

Treasury secretary Timothy Geithner on Tuesday said difficulty in setting a value on banks’ toxic assets was a continuing hindrance to their ability to lend and borrow.

On this, Lucas Engelhardt of the Mises blog writes-

Apparently, Secretary Geithner has discovered that it is “hard” for the government to “set” the “value” of toxic assets. (Pardon my quotation marks.)

I’m sure he’s right, given that he’s simultaneously trying to:
1. Set the value so that the banks look solvent.
2. Set the value so that the assets can be sold without bank balance sheets deteriorating.

The problem, of course, is that establishing (2) requires that we value the toxic legacy assets according to what they can actually be sold for. Something economists like to call the market price. But, (1) requires that we value the toxic legacy assets above the fair market prices. No force of will or “clever” policy can change that fact.

So, it seems that Geithner has realized that a task that is logically impossible is “difficult”. At least his understanding is moving in the right direction.

I am not sure I get Engelhardt’s point. Geithner requires that most banks are “solvent” after the toxic assets are removed from their balance sheets. He also requires that taxpayers are not being “swindled.” That’s what the whole “public-private” “partnership” is about. But the banks “are” insolvent if the assets are valued at “market price” – they will go kaput. So the assets will need to be valued at way above “market price” to keep them solvent. I guess that takes care of (1). But isn’t (2) (1) rephrased, or is it a “I am insolvent to the tune of 10 billion dollars, and I don’t want to go beyond that” statement?

Whatever it is, Geithner’s “plan” is impossible purely on the insolvency-swindle dichotomy. If he pays way over the “market price,” (it can’t be determined unless there “is” a market) the taxpayer is being swindled. If he pays less, the banks are insolvent. Not difficult, but impossible. He should either worry about the taxpayer, or about the banks, or simply leave the matter to the market which will then fix the problem in its own ruthless way – by bringing down a few thousand banks.

If we call Holmes’ statement Holmes’ Razor, then “For me, the impossible is merely ‘difficult’” would be Geithner’s Razor. He should be careful with it. Otherwise he might nick someone, or something.

—

I read the comments on the above blog post and found a link to this crazy idea by a top economist, who’s a … Keynesian. The only things that need “targeting” are such economists and the central banks. That’s why you shouldn’t trust the government, or its currency. But you can’t trust gold either – not because of any problems with value, but because of thieves like FDR who could throw you in jail if you didn’t surrender the gold. As long as you have a State, particularly the crooked one of present day, you are bound to be fucked either way. A funny but spot-on comment – “Hey Mankiw — how’d you like a negative salary this year?”

“A sacred lie”

Doug French of the Mises Institute reviews a book-

New president Barack Obama’s $3.55 trillion budget serves notice that if you thought government couldn’t get any bigger or more intrusive, think again. The budget “represents real and dramatic change,” according to the President. But really the Obama plan is just more of the same, with the federal government expanding its role in education, foreign policy, energy policy, health care, and environmental policy.

“The eyes of all people in all nations are once again upon us — watching to see what we do with this moment; waiting for us to lead,” Obama told the assembled and adoring senators and congressmen. “Those of us gathered here tonight have been called to govern in extraordinary times.” The new president believes government can fix the economy and anything else it sets its collective mind to, after all, “we aren’t quitters,” repeated the president.

But as Paul Cleveland explains, what Obama believes is a lie — a sacred lie. “The first, and biggest lie, is the notion that the institution of government is capable of successfully and adequately addressing all human problems,” Cleveland writes in his book Unmasking the Sacred Lies. “The truth is that such collectivism hampers human progress because it opens the door for many flagrant abuses of people and their property rights.”

[...]

The environment is big on the Obama agenda and Cleveland’s chapter on environmental policy shows why green is the perfect issue to expand governmental power. A generally prosperous people cares about the environment, so it votes for green candidates. Since the issue attracts votes, it attracts money, and ultimately “if carbon dioxide is classified as a pollutant, then every breath we take can be regulated by government.” That sums it up perfectly.

All of these laws put on the books to further policies for political ends, Cleveland explains, really amount to lawlessness. And lawlessness ultimately leads to a decline in civilization. The author would like to turn this trend around and have America return to a “nation founded upon the belief in natural law,” with people having rights — to life, to the freedom to act, and to property.

The real trouble, as professor Cleveland points out, is that the vast majority of people have accepted big government as the solver of all problems, thus Obama’s overwhelming election victory. Education is what is needed to fix this problem. It won’t happen overnight, but if more young people read sound, well-written books like professor Cleveland’s, the nation will ultimately return to its roots.

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There are very few “respectable” politicians in India. Till sometime back, I had included Arun Shourie of the BJP, and Jairam Ramesh of the Congress in the list. I dropped Shourie because of his opposition to the nuke deal. And, while I have not been paying attention to what Ramesh has been doing, this interview means the list is now (nearly) barren.

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Swagato Ganguly, writing in the Times of India says that if India is to progress, the Left has to be kept out of power-

Market bashers are having a field day in the current atmosphere of economic downturn, barely concealing we-told-you-so smirks on their faces. For those on the Indian left, the joys of power without responsibility are many. After handcuffing the UPA government to its economic policies through most of the UPA’s tenure the CPM, in its recently released election manifesto, is lambasting the UPA for increasing the “rich-poor divide”.

In doing so, the CPM has unwittingly revealed an important truth. The Indian left isn’t an egalitarian force working to reduce social and economic disparities across Indian society, even if it projects itself as such. In practice policies pushed by it widen the gulf between privileged and less privileged. The converse is also true. Market-friendly reforms can cut down on disparities by growing the middle class and encouraging a shift from agriculture to industry. The next government will need to push forward on sectors such as infrastructure, retail, education, agriculture, labour laws and FDI policies if it hopes to renew the economy. What’s needed in the Indian context are more market-oriented reforms, not less.

It speaks volumes about the triumph of left-wing discourse that reforms and market-oriented policies are automatically taken to have pro-rich and anti-poor implications by Indian political parties, no matter which part of the political spectrum they inhabit. For any party to stand up and say that market-oriented capitalism can deliver the goods better than statist socialism would be tantamount to political heresy. That’s why most reforms in India have to be undertaken by stealth, as their opponents charge. That’s also why they grind to a halt during good times when, arguably, they would deliver the least short-term pain while boosting significantly the long-term prospects of the economy.

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The ET (either today, or the day before) carried a reprint of this Newsweek article by Robert Samuelson-

Joseph Schumpeter, one of the 20th century’s eminent economists, believed that capitalism sowed the seeds of its own destruction. Its chief virtue was long term—the ability to raise wealth and living standards. But short-term politics would fixate on its flaws—instability, unemployment, inequality. Capitalist prosperity also created an oppositional class of “intellectuals” who would nurture popular discontents and disparage values (self-enrichment, risk-taking) necessary for economic success.

Almost everything about Schumpeter’s diagnosis rings true with the glaring exception of his conclusion. American capitalism has flourished despite being subjected to repeated restrictions by disgruntled legislators. Consider the transformation. In 1889, there was no antitrust law (1890), no corporate income tax (1909), no Securities and Exchange Commission (1934) and no Environmental Protection Agency (1970).

[...]

If companies need to be rescued from “the market,” then why shouldn’t Washington permanently run the market? That is a dangerous mindset. It justifies punitive taxes, widespread corporate mandates, selective subsidies and more meddling in companies’ everyday operations. Older and politically powerful industries may benefit at the expense of the new. Innovation and investment may be funneled into fashionable, though economically dubious, projects (think ethanol).

His facts are right, but his arguments are wrong. Read the article to know what I mean. It also pays to revisit his 1992 article on Joseph “creative destruction” Schumpeter-

“[C]apitalism … creates, educates and subsidizes a vested interest in social unrest,” Schumpeter wrote. Popular discontent and intellectual hostility would, he thought, doom capitalism and lead to socialism.

Of course, this prophecy remains unfulfilled. Quite the opposite has happened. By socialism, Schumpeter meant governmental control of production, and societies that adopted that system-from the former Soviet Union to China-are now repudiating it. Though personally opposed to socialism, Schumpeter assumed that socialist societies could prosper because giant economic organizations (whether public or private) would gradually master the process of innovation. The entrepreneur would vanish. On this, he was wrong.

Still, his basic insight survives: capitalist economic success, because it is incomplete and interrupted, breeds its own backlash. The sour public reaction to the present slow economic recovery only highlights a longstanding trend. The growth of Big Government-here, in Europe and in most advanced market societies-has aimed to placate popular discontent without undermining capitalism’s ability to raise living standards.

Were he alive, Schumpeter would surely be wondering whether these two desirable goals are incompatible. What we know is that the rise of Big Government-the expansion of welfare spending and regulation-has roughly coincided with a slowdown in economic growth. The trends are clear. Between 1960 and 1989, government spending in the United States rose from 27 to 36 percent of output; in Germany, the increase was from 32 to 46 percent. Meanwhile, economic growth in industrial countries slowed in the 1980s to about half the rate of the 1960s.

Samuelson ends the article with “[Schumpeter] is typically rated as the century’s second most important economist, behind Keynes.” Then you are reminded of the forgotten Ludwig von Mises, who Peter Boettke refers to as “greatest economic mind of the 20th century.” But remember that Keynes told politicians what they wanted to hear – that they could increase the size of government, and government spending without worrying about “old-fashioned” economic ideas. “That” is why he is the “century’s most important economist”. And “that” is why Mises won’t be recognized – he said that the government had no role to play in the economy. Which politician, and which bureaucrat, and which “intellectual” would be happy to hear that “they” are irrelevant?

As for the ordinary man on the street, you can make him believe anything. His position is not dissimilar to that of a monkey that is part of a road-side show. The primate will jump, roll over, and do any trick that its trainer makes it perform. The same is the case with the man on the street, with the politicians, bureaucrats, and “thought leaders” in control, telling him what to think, and what to do. The sad part is, he thinks that he’s in charge.

The Oracle and the Sphinx

simply Capitalism writes about the “Oracle of Omaha” – Warren Buffett – and his preference for the “mixed economy” plus his attributing his success to an “ovarian lottery.”

O&M writes about why politicians and economists “heart Keynes”. This part is very interesting-

Third, the Keynesian delusion afflicts not only policymakers, but professional economists as well. I’ve long suspected that the appeal of Keynes to people like Krugman and DeLong is ultimately based on aesthetic, not scientific, grounds. Deep in their hearts, they just don’t like private property, markets, and individual choice. They don’t think ordinary people are capable of making wise decisions and think they, the elites, should be in charge. They resent the fact that most people don’t want their lives controlled by liberal intellectuals. Technical arguments about the effectiveness of monetary and fiscal policy, the relationship between aggregate demand and output, the experience of the 1930s, and the like are really beside the point. For Keynesian economists, the belief that markets are naturally unstable in the absence of government planning is a matter of faith.

I think Nozick’s hypothesis on intellectuals vs. capitalism is relevant here; he takes them back to school. From “Why Do Intellectuals Oppose Capitalism?”-

Central Planning in the Classroom
There is a further point to be added. The (future) wordsmith intellectuals are successful within the formal, official social system of the schools, wherein the relevant rewards are distributed by the central authority of the teacher. The schools contain another informal social system within classrooms, hallways, and schoolyards, wherein rewards are distributed not by central direction but spontaneously at the pleasure and whim of schoolmates. Here the intellectuals do less well.

It is not surprising, therefore, that distribution of goods and rewards via a centrally organized distributional mechanism later strikes intellectuals as more appropriate than the “anarchy and chaos” of the marketplace. For distribution in a centrally planned socialist society stands to distribution in a capitalist society as distribution by the teacher stands to distribution by the schoolyard and hallway.

DeLong and the short of it

Steve Horwitz of “The Austrian Economists” writes about how economist Bradford DeLong, fervent supporter of the “stimulus”, has been tampering with his opponents’ arguments on his blog. As Horwitz says-

An honest scholar would let his readers decide rather than refusing to post any evidence that might possibly contradict him. And DeLong has the chutzpah to call critics of Obama’s stimulus package “ethics-free”?

But as people should know by now, Keynes and ethics should never be mentioned in the same sentence; it is an insult to the great man. He was, after all, to paraphrase Nietzsche, “beyond good and evil”. While the “conservatives” of the world believe in “Our Lord”, the Krugmans (“Blame it on the lender”), and Stiglitzes (“Free Market”), and Rodriks (“Racket-onomics”), and DeLongs (“The End of the Age of the ‘Free’ man”) of this world believe in “Our Lord, The State”. So it would be stupid of libertarians and the-real-liberals to expect that “any” kind of intelligent – intellectually honest – debate can be carried out with them – the fundamental beliefs of the three groups are poles apart and the differences are unbridgeable.

One more thing; DeLong has joined the crowd of Yahoos unloading on Rand, though he’s doing it a bit nicely – by warning Christians that Ayn Rand is anti-religion. Maybe he should also warn them that Lord Keynes was a homosexual, or at least a bi, and what Rand thought about “them”, as did the APA. That would set up a wonderful debate on ECONOMICS.

Arguing against someone whose political position essentially was that man must not be used as a means to an end, someone who said this about her magnum opus-

[Atlas Shrugged was written] to glorify the real kind of productive, free-enterprise businessman in a way he has never been glorified before. [But] I make mincemeat out of the kind of businessman…that runs to government for assistance, subsidies, legislation and regulation.

no – arguing against such a position, shows you on which side of the freedom divide you really stand.