Why Tie to Gold? Why Not 1982 Bordeaux?

Photo via Flickr user hto2008, Creative Commons.

The University of Chicago IGM Economic Experts Panel, a group of economists spanning the ideological spectrum, was asked this week whether they agreed with a statement regarding the gold standard:

If the US replaced its discretionary monetary policy regime with a gold standard, defining a “dollar” as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

Hilarity ensues.

Austan Goolsbee: “eesh. Has it come to this?”

Richard Thaler: “Why tie to gold? why not 1982 Bordeaux?”

Of the 37 economists, 57% strongly disagreed with the statement and 43% disagreed.  William Nordhaus and Anil Kashyap chose to use their answers to drop some truth on all the Ron Paulistas out there.

Nordhaus: “This proposal makes no sense in the modern world. Just look at the Eurozone to see the consequences.”

Kashyap: “A gold standard regime would be a disaster for any large advanced economy. Love of the G.S. implies macroeconomic illiteracy.”

On a more serious note, Pete Klenow linked to a short, interesting 1982 paper by Robert Hall on the implications of a gold standard and, more broadly, a commodity standard.  Hall dismisses the possibility of a gold standard (“unacceptable as a basis for stabilizing the dollar because variations in the relation between the world price of gold and the United States cost of living are much too large”) but goes on to contemplate a commodity standard for the dollar based on certain quantities of aluminum, copper, plywood and ammonium nitrate.  It’s an interesting hypothetical, although problematic for any number of reasons, some of which Hall points out.  In the end, Hall concludes that the quality of monetary policy is the determining factor under both a fiat currency and a commodity standard system.  That’s one thing that people who love the gold standard don’t seem to grasp–under the gold standard, the government’s ability to influence monetary policy doesn’t go away.  The government just influences policy in a different way, by determining what quantity of gold is equal to a dollar, rather than directly regulating the quantity of money.   So even if you think government/Fed control is the problem, the gold standard still isn’t the answer.

h/t Ideas Market

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Why America Losing Out on iPhone Work Isn’t That Big a Deal

Photo via Flickr user Yutaka Tsutano, Creative Commons.

Today’s must-read article in the New York Times is Charles Duhigg and Keith Bradsher’s piece on why the iPhone isn’t manufactured in America.   The article starts off lamenting the relatively few jobs that Apple has created in America compared to, for example, the 400,000 employed by GM in the 50’s, especially when Apple’s employing hundreds of thousands in China.  I don’t want to downplay the weaknesses with America’s workforce, factories and manufacturing clusters that the article highlights, but there are a lot of reasons why Apple’s reliance on China rather than America isn’t as big a deal as it seems.

To state the obvious, a lot of China’s advantage lies in its relatively lax regulations related to workers’ rights, and the ineffective enforcement of these regulations–a weakness which in this article becomes a strength.  Factories in China have dormitories so that workers are “available 24 hours a day,” Duhigg and Bradsher write, so that when last-minute new iPhone screens arrived at one factory in the middle of the night, the factory woke up thousands of its workers to begin producing the new iPhones immediately.  It’s hard to imagine that happening in the US; indeed, it’s even illegal in China, though that didn’t seem to make much of a difference.

According to Apple’s 2012 Supplier Responsibility Progress Report (pdf), only 38% of the factories it audited were in compliance with working hours regulation.  Only 69% of its factories were in compliance with wages and benefits regulations.  And, most shockingly to me, only 78% were in compliance with “prevention of involuntary labor” regulations, which makes it sound like a fifth of Apple’s factories rely on something akin to slavery.  In short, this isn’t really an area in which America should be competing with China.  The difference in regulations and enforcement of regulations between China and the US is the reason why, contra Ygelsias, even if Apple’s Chinese workers came to America, they wouldn’t be as efficient and productive as they are in China.

Duhigg and Bradsher write that, if America had the same manufacturing capabilities as China, “paying American wages would add up to $65 to each iPhone’s expense. Since Apple’s profits are often hundreds of dollars per phone, building domestically, in theory, would still give the company a healthy reward.”  I’m not sure what constitutes a “healthy reward,” but regardless, Apple’s goal is to maximize profits for its shareholders, not the number of Americans it employs.  $65 per iPhone works out to about $4.7 billion in 2011, over 15% of Apple’s annual profits.  The article seems to imply that this wouldn’t be that bad an outcome, which sounds reasonable when you’re focusing on how America benefits from the jobs Apple creates rather than the shareholder value it creates.  But that’s not a great metric to judge a corporation by.  Here’s what the article has to say about Apple’s stock:

Since 2005, when the company’s stock split, share prices have risen from about $45 to more than $427.

Some of that wealth has gone to shareholders. Apple is among the most widely held stocks, and the rising share price has benefited millions of individual investors, 401(k)’s and pension plans. The bounty has also enriched Apple workers. Last fiscal year, in addition to their salaries, Apple’s employees and directors received stock worth $2 billion and exercised or vested stock and options worth an added $1.4 billion.

The biggest rewards, however, have often gone to Apple’s top employees.

Say what you will about Tim Cook’s compensation–and there’s a pretty strong case to be made that it’s excessive–but it’s certainly not larger than the tens of billions of dollars in wealth that Apple has created for its shareholders in the past decade.  Certainly, that money has disproportionately gone to the upper class in America, to the extent that wealthier people are more likely to own stocks than the less wealthy.  And it’s not a good thing when that wealth is a result of human rights abuses, although Apple seems to be making a strong effort to promote sound practices in its factories.  Overall, though, we shouldn’t downplay the extent to which Apple has created an incredible amount of wealth for this country even if it’s been in the form of capital gains rather than jobs for the middle class.

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Does Dylan Ratigan Want to End the Fed?

Photo via Flickr user Fibonacci Blue, Creative Commons.

Noam Scheiber wrote about what sounded like a pretty crazy idea in Dylan Ratigan’s new book on Tuesday: derivatives should be classified as online gaming and naked derivatives should be “deemed null and void.”  I wasn’t even really sure what that meant, but Felix Salmon helpfully quoted the full page of Ratigan’s book Scheiber is referring to:

We must require not only that banks retain more capital but also that when they place bad bets, they pay the price for their losing bets themselves. Otherwise we are stuck with the worst of two economic systems: like a capitalist country, we have private banks that keep their profits. But like a communist country, we have a system where banking losses are charged to the government. Only when we end this corporate communism will we realign the interests of the banks with the investors they serve. The way to do this is debt reduction or cancelation. If the system is so out of control that we can use a computer to fabricate trillions in new money by simply adding some zeros, then surely we can find a way to delete some zeros as well. By definition, if you can print it, you can cancel it.

As we have already seen, a swap can either be an insurance policy that helps to lower long-term costs for a business or a bet by an outsider on whether a given company or country will succeed or fail. Putting swaps on a public exchange would create the visibility for all to see the difference between commodity insurance that is critical to the economy and speculative bets that are not much different from gambling.

Salmon does a great job pointing out what’s so ridiculous and incoherent about this passage.  Although I haven’t read Ratigan’s book in its entirety, I had much the same reaction and wanted to both expand on one section in particular that Salmon quotes:

The way to do this is debt reduction or cancelation. If the system is so out of control that we can use a computer to fabricate trillions in new money by simply adding some zeros, then surely we can find a way to delete some zeros as well.

Ratigan seems to confusingly conflate debt cancellation with the creation of money.  But more significantly, Ratigan takes our ability to “use a computer to fabricate trillions in new money” as evidence that “our system is so out of control.”  Nevermind that “deleting some zeros” is what happens when the Fed reduces the monetary base.  In Ratigan’s eyes, the Federal Reserve’s ability to enlarge of the monetary base to stabilize the economy and, in the present case, stop a recession from becoming a depression is a bad thing.  It’s possible  Ratigan doesn’t realize the implication of what he’s saying here and doesn’t actually believe this.  Or maybe he does want to take away the Fed’s power to set monetary policy and put the US back on the gold standard.  I haven’t read his book and haven’t watched much of his show, so I don’t really know.  Either way though, these are ideas that I’d expect to find in a book by Ron Paul or Glenn Beck, not an MSNBC host purporting to write a serious book on policy.

I don’t want to be entirely negative though, and there are sentences in the passage that, on their own, are quite sensible and which the Dodd-Frank Act is trying (in some cases more successfully than others) to address.  It’s true that the banks shouldn’t be able to keep their profits in good times and pass off their losses on the government in bad times.  Dodd-Frank’s answer was Orderly Liquidation Authority, which in theory would make it so large financial institutions can be resolved in an orderly manner rather than having to be bailed out by the government.  There should be greater transparency for swaps and derivatives–that’s why Dodd-Frank created Swap Execution Facilities and Swap Data Repositories.  Clearinghouses don’t really function the way Grasso talks about them, but Dodd-Frank has provisions for those too, which the CFTC and SEC are in the process of implementing and should go a long way towards making the swap and security-based swap markets less dangerous.  In short, the zany parts of Ratigan and Grasso’s argument are, well, really, really zany, and the bits that are non-zany are already being worked on.  Maybe not in the most effective way, but give credit where credit’s due.

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There’s No Such Thing as a Free Hedge

Starbucks photo via Flickr user Abllo, Creative Commons.

Matt Yglesias had an interesting post last week on Starbucks’ impending price increase:

The fact that Starbucks is poised to raise coffee prices in most American markets is not all that interesting, but the underlying cause is. Basically last year Starbucks saw that coffee prices were on the rise, so they made an advance agreement to purchase coffee for the fiscal year that started in October to lock in the then-prevailing prices. Unfortunately for them, the coffee market fell soon after that leaving Starbucks locked in to paying higher prices than what you can get on the spot market.

I’m not sure that you can attribute Starbuck’s price increase to the fact that Starbucks locked in the price they pay for coffee beans only to see the price fall.  Sure, Starbucks is now paying a higher price for their beans than their competitors, but they’re still paying the same for their coffee beans as before, so, all else equal, they shouldn’t need to raise their prices.  If a cup of coffee cost you $1 to make last week and you sold it for $2 and it costs you a $1 to make this week, then you should still be able to sell it for $2, even though it only costs your competitors $0.80 to make that cup now. It seems there’s got to be some other cause for the price bump (other costs have gone up, sales are down, etc.) and either Starbucks is using this as an excuse  to raise prices or the WSJ is getting it wrong.

But on a broader level, I think Matt is a bit off when he says that “it doesn’t really make sense for the Starbucks management team to be speculating on coffee prices” and “people who are good at [managing coffeehouses] may turn out to be pretty bad bean speculators, as we see here.”  The thing is, Starbucks’ management was doing exactly what Matt says they should have been doing: eliminating the speculative aspect of the business by hedging the volatility of coffee bean prices so they could run their business as if the price were flat.  Unfortunately for them, coffee bean prices declined after they locked in their price, but that doesn’t mean they were bad speculators or that the hedge was a bad idea.  That’s the cost of a hedge.  The reason you lock in your prices in the first place is to eliminate the uncertainty that comes with dealing in a volatile market like coffee beans.  In theory, the certainty you gain from knowing how much you’ll be paying over the next year is worth the probability that prices will go down and you’ll pay more than you otherwise would have.

As for the need for speculators, I agree that it’s important for Starbucks to be able to find a counterparty to take the other side of the bet when they want to lock in their prices.  If that counterparty is a speculator, so be it–there’s nothing inherently wrong with speculating.  To the extent that there is no natural counterparty for Starbucks (a coffee farmer who wants to lock in the prices at which he’ll sell his coffee) then the existence of speculators is critical.

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The Limits of Intrade

Reporters, bloggers and political junkies love to cite prices on Intrade as indications of the true state of the Republican primaries.  It’s understandable why–Intrade often gives a much clearer picture of each candidate’s chances than polling or political commentary.  But Intrade has a number of flaws that aren’t apparent to passive observers.  I started trading on Intrade last fall and was pretty surprised at the problems in what’s generally thought of as the top political predictions market.  In short, the problems are illiquidity (leading to unreliable and volatile “last prediction” quotes, even in popular markets) and uncertainty regarding how Intrade is run and how it functions:

Spreads on Intrade are huge: For nearly all markets, there’s a significant spread between the standing buy price and the standing sell price.  For example, if you want to go long Newt winning South Carolina, a contract will currently cost you $1.87 (18.7%).  If you want to short the same contract, you’ll currently have to short it at $1.30 (13%)–a massive 50 cent spread for what should be one of the most popular contracts.  While reporters and bloggers only cite a single percentage reflecting the most recent transaction (“Romney at 70% on Intrade”), the bid-ask spread gives you a much clearer picture of the market.

Intrade’s management is unpredictable:  Last November, I bet against Herman Cain dropping out of the campaign before the end of 2011.  This obviously didn’t work out too well for me, but what’s interesting is how Intrade reacted to Cain’s announcement that he was “suspending” his campaign.  Cain’s announcement came on a Saturday and throughout the whole weekend, people bought and sold contracts (I think the going rate was around 90%) while they waited for Intrade to decide whether suspending a campaign is the same as dropping out.  All of the trading was purely based on uncertainty regarding Intrade’s judgement.  On Monday, Intrade not only decided that Cain’s suspension was equivalent to dropping out but they also reversed all trades which occurred since Cain’s announcement.  That Cain had dropped out was a no-brainer but that Intrade would reverse trades which had occurred between willing counterparties was pretty shocking to me.  Not the best way to run a market.

Intrade’s website can get overloaded:  During the night of the Iowa caucuses, the price of contracts for Santorum, Romney and Paul fluctuated wildly as breaking news favored one candidate or the other.  At one point, Nate Silver pointed out that Ron Paul had hit 50% on Intrade–for Ron Paul bears, a great opportunity for a short.  Unfortunately for those bears, Intrade’s website was massively overloaded that night and, at least for me, too slow to get any trades in.  So on a primary night, just when you might want to turn to Intrade to get an idea of what’s actually going might be when the site’s at its most unreliable.

All of this isn’t to say that Intrade’s predictions should be ignored.  They’re often one of the most accurate predictors available.  But when you see an Intrade probability on some political blog, just know it comes from a highly illiquid, at times dysfunctional market and treat it with appropriate caution.

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