Friday, July 31, 2009

Health Care

I have been quite reluctant to comment much about health care. But this article in today's WSJ is well worth reading (subscription required). The best part is the realization that the only way that you can cut costs is to get somebody to take less.
We may not like it, but the only way a government can control costs is by wielding great purchasing power to get concessions on the price of drugs, physician fees, and hospital services; the only way they can control administrative costs is by providing a simplified service, yes, the Medicare model (with a 3% overhead), and not allowing private insurance to cherry-pick patients (some of them operating with 30% overheads, the cost passed on to you).
There is no magic bullet for reducing health care costs. And we should always remember that the reason why health expenditures increase over time is because they provide us something very valuable -- good health.

And, on the whole issue of costs, you can learn a lot from Diane Rogers at EconomistMom.

Wednesday, July 22, 2009

Macroeconomics in Crisis

Paul De Grauwe argues in the Financial Times that macroeconomics is in crisis. There is much to agree with.

The science of macroeconomics is in deep trouble. The best and the brightest in the field fight over the most basic problems. Take government budget deficits, which now exceed 10 per cent of gross domestic product in countries such as the US and the UK. One camp of macroeconomists claims that, if not quickly reversed, such deficits will lead to rising interest rates and a crowding out of private investment. Instead of stimulating the economy, the deficits will lead to a new recession coupled with a surge in inflation. Wrong, says the other camp. There is no danger of inflation. These large deficits are necessary to avoid deflation. A clampdown on deficits would intensify the deflationary forces in the economy and would lead to a new and more intense recession.

De Grauwe argues that finance must be re-integrated into macroeconomics, a position I would agree with for sure. He also argues that there is a deeper problem:

This is the underlying paradigm of macroeconomic models. Mainstream models take the view that economic agents are superbly informed and understand the deep
complexities of the world. In the jargon, they have “rational expectations”. Not only that. Since they all understand the same “truth”, they all act in the same way. Thus modelling the behaviour of just one agent (the “representative” consumer and the “representative” producer) is all one has to do to fully describe the intricacies of the world. Rarely has such a ludicrous idea been taken so seriously by so many academics. (Other fields of economics have not been deluded by this implausible idea and therefore do not face the same criticism.)
This is a common criticism but I would distinguish between the rational expectations assumption, which is a modelling convention that is useful in revealing what models are about, and the representative agent assumption. It is the latter that has gotten macroeconomics in trouble. This is what makes it hard to get finance into the models. It is the interaction of different agents that makes macroeconomics interesting, and the representative agent paradigm deflects attention from many problems. But rational expectations is a discipline device. It is a way of showing that one has nothing up his sleeve.

No More California Dreamin

I grew up in California, and was a beneficiary of the great services the state provided. I went to UCLA and UC Berkeley, and got a great education. But today, the California dream is waning, as this article in the NY Times points out.

California's new budget deal is not going to help. The fundamental fiscal problems that plague the state are not addressed. California needs two things: eliminate referenda and eliminate proposition 13, that limits property taxation. The former creates spending, the latter limits the ability to pay for it. Without property taxation California relies on taxing high incomes, which are both mobile, and highly procyclical. The referenda support extra spending without considering where the funds are to come from. The system is obviously totally broken.

Monday, July 20, 2009

Financial Innovation

Felix Salmon has a silly post arguing that financial innovation is a net waste to society. One problem with his argument is that his view of financial innovation is too narrow.
if you look at how fast the US economy managed to grow in the 50s and 60s without the benefit of Black-Scholes or the Gaussian copula function — or, for that matter, how fast the Chinese economy has grown of late with very strict fetters on financial activities — it looks very much as though most of the financial innovation in recent decades constitutes a history of increasingly-desperate attempts to eke out returns in the context of a naturally-slowing economy. And that history, I think, is doomed to failure.

There are two problems here. First, he simply ignores many innovations that are of recent vintage. In the period he castigates as net loser, we had such innovations as:

*money market investment funds
*NOW accounts
*municipal bond mutual funds
*IRA accounts
*Universal Life insurance policies
*financial transactions by personal computer
*electronic funds transfer

and many others. For more see Van Horne's Presidential Address to the AFA in 1985. He discusses many financial innovations and possible excesses. At least the issue is taken seriously there.

The second problem, which is perhaps more significant, is that he only thinks about the impact of financial innovation on growth. But many financial innovations are ways to share risks. They may increase welfare without increasing growth. Think of any insurance. Without fire insurance I have to save more to cope with the state where my house burns down. My consumption is lower but my savings is higher. Growth might even be higher without the insurance because of higher savings. But welfare is lower because the goal of an economy is to allow people to consume.

Saturday, July 18, 2009

Congress, Paulson, and the Rescue

Joe Nocera reviews the Congressional hearings into the Bank of America merger with Merrill Lynch. These hearings are an object lesson why we are lucky that we do not have to rely on Congress during a crisis. Of course, those who have to deal with the crisis must deal with the Monday Morning Quarterbacks.

Last December we were tottering on a collapse of the credit system. That crisis was averted. It is not uncommon to forget how close we were to a crisis. Then the actions that proved vital may in retrospect seem unnecessary. This is how bad policy is made.

Thursday, July 16, 2009


How difficult is it to forecast oil prices? Compare the prediction of Philip Verleger, as reported in Bloomberg today, with the forecasts I talked about yesterday in my post on speculation:
Crude oil will collapse to $20 a barrel this year as the recession takes a deeper toll on fuel demand, according to academic and former U.S. government adviser Philip Verleger.

“The economic situation is not getting better,” Verleger, 64, a professor at the University of Calgary and head of consultant PKVerleger LLC, said in a telephone interview yesterday. “Global refinery runs are going to be much lower in the fall. If the recession continues and it’s a warm winter, it’s going to be devastating.”
But as I noted yesterday, these are not the only predictions for oil prices. Many forecast higher prices in the future. As the Bloomberg reporter notes:
At the other end of the spectrum from Verleger, Goldman Sachs Group Inc. predicted in a report yesterday oil will rally to $85 a barrel by the end of the year, and recommended that clients buy futures contracts for delivery in December 2011.

Why is it so hard to predict oil prices? These two quotes demonstrate that there are deep differences on fundamentals. That is, it is very hard to predict what will happen to fundamental factors like demand and supply in one year. Then it should not surprise that prices are hard to predict.

So oil prices are pretty surely to be either $20 a barrel or $85 per barrel. That is what I call uncertainty in forecasts.

Wednesday, July 15, 2009

Shoot the Speculators

Lenin could just order that speculators be shot. Today we have to have an investigation by the CFTC. So we learn in the Washington Post:

"Here we go again," Bart Chilton, a commissioner at the Commodity Futures Trading Commission, said late last month. "Crude oil prices are up 60 percent on the year. Supplies are at a 10-year high, and demand is at a 10-year low. You do the math. Why should prices be over $70?"

Last week, the CFTC said it would consider new measures to curb speculation and increase transparency in energy markets, where the agency's data suggest that a substantial amount of oil trading was concentrated in the hands of just a few investment banks and trading firms. Also last week, the leaders of Britain and France urged measures to counter "damaging speculation."

The argument seems to be that with oil demand lagging and inventories very high, that oil prices should be falling. Current prices of $60 per barrel must thus reflect the role of speculators. Worse, financial speculators!

It is always hard to understand how people can make money by moving a price away from its fundamental value. And what is most important about oil is how difficult it is to predict its future price. Oil prices are volatile, they tend to resemble a random walk, although for most of the period since 1859 (when oil was discovered in Pennsylvania) real oil prices have rarely exceeded $25 per barrel in current prices (see here, for example, for excellent charts).

Another reason why investors are looking to oil is because of fear of inflation. Oil can be a hedge against inflation:
Many of these investors are seeking to diversify their holdings or protect themselves against inflation that governments and central banks might foment while jolting the global economy. "It's like a barbecue that is not catching fire," said Jan Loeys, J.P. Morgan Chase's London-based head of market strategy. "You put all kinds of lighter fluid on it, and it's not taking. Then at some point, it takes, and then you don't have a lot of time before it blows up in your face."
So the actions of governments are leading to speculation that oil prices will increase. Either because they will head off recession and thus spur oil demand, or because they increase debt so much that there will be inflation. And, if the dollar declines in value oil prices will rise simply due to the fact that the price is denominated in dollars.

The fundamental point, of course, is that oil prices are just very hard to forecast. Each day, the price moves up or down, and there is some clever commentator who can explain why it moved. But it is very hard to forecast oil prices over longer periods. That does not mean it is not a good investment, however. It could help diversify risk for many investors.

Now suppose you are an investor and you read that oil prices are likely to rise to $85 by 2010, as in this report from Bloomberg:

Commodities will rise as investors’ appetite for risk revives along with the global economy, Morgan Stanley analysts, led by Hussein Allidina, said in a report yesterday. At the same time, oil production will drop as much as 6.3 percent a year among suppliers outside the Organization of Petroleum Exporting Countries and by 3.5 percent within the group, the bank said.

Oil demand is expected to rise 1.4 million barrels a day, or 1.7 percent, in 2010, led by emerging markets outside the Organization for Economic Cooperation and Development, the International Energy Agency said on July 10. Crude prices have climbed 35 percent this year on optimism that government stimulus will overcome the worst recession in six decades.

Under such circumstances I think investing in oil might not be a bad idea when the current price is $60. And if producers read these articles they have less incentive to produce now. So it is hard for me to believe that it is just evil speculators who push the price up.

Let us suppose that without the speculators the price would fall today to $50. But in 2010 it will be $85 as the stories say. Then absence of speculation means a much larger price jump in the future. Won't that be more disruptive? If prices are lower today, then there will be less exploration so that when demand recovers the price increase will be even more severe.

So, by all means, lets shoot some speculators. Good entertainment. But I will bet that shooting regulators and even government officials would get higher TV ratings.

Wednesday, July 8, 2009

President Obama comes to NES

As everybody knows by now, President Obama gave the commencement address at NES' 16th annual graduation. It was a great occasion for NES, a real coming out party.

It was a special honor for me to welcome the President and First Lady to our commencement.

You can see the whole speech here. Visit the NES website for more, here.

One thing I should mention. Some of the press commented that the response of the NES crowd to the speech was respectful but not enthralled. I think this is incorrect. There was no applause during the speech, but that was out of respect. The crowd was totally into the speech, and enjoyed it immensely. But nobody felt comfortable applauding in the middle.

But to say that the audience was not enthusiastic is totally off base.

Saturday, July 4, 2009

I agree with the Chinese Government

From the WSJ (subscription required) the Chinese Government attacks carbon-tariff policies:
China's central government reiterated its opposition to carbon tariff policies and said they could provoke a trade war, ratcheting up the rhetoric as lawmakers in the U.S. consider legislation to reduce greenhouse gases.
They argue that this is more trade protection than environmental protection, and I have to agree with them.


Stan Leibowitz analyzes data on foreclosures and shows that negative equity is much more important than mortgage resets (subscription required).