Saturday, December 16, 2006

The Ethanol Scam

Can we grow our way out of an energy crisis by using ethanol?

Not likely, according to Cornell University professor David Pimental who said in a
recent article: "It is absolute stupidity, and it is a major scam."

Why would business leaders, state and U.S. lawmakers perpetuate a "major scam" on the public?

"Big money and politics" Pimentel said. "Those two words tell it all. Ethanol has 45 times the subsidies that gasoline has. Our government is spending $6 billion annually on subsidies for ethanol."

And the government has, since 1978, subsidized the ethanol industry, according to the non-partisan budget watchdog, Taxpayers for Common Sense. Tax exemptions that total more than $11 billion with a production mandate through 2012 plant dollar signs in the eyes of investors, even if the dynamics of corn-produced biofuel present economic and environmental challenges.

Fed Funds Forecast

From the CBOT trading for Federal Funds futures contracts, speculators are betting on future Fed-funds target rate decreases, and we can therefore determine the following forecasts for the fed-funds target rate in 2007:

Percent chance that the Fed funds rate will be 5.0% by:
March 2007: 4%
April 2007: 12%
May 2007: 30%
June 2007: 42%
July 2007: 74%
August 2007: 100%

Percent chance that the Fed funds rate will be 4.75% by:
August 2007: 8%
September 2007: 28%
October 2007: 50%
November 2007: 86%
December 2007: 100%

Percent chance that the Fed funds rate will be 4.5% by:
December 2007: 12%

Bottom line: Futures trading predicts a 100% chance of two rate-cuts by the Fed in 2007 to 5.0% by August and then 4.75% by December, and a 12% chance of three rate cuts, to 4.5% by next December.

More Forecasts for 2007

From the WSJ economic forecasting survey in November, these are the average forecasts of 56 economists surveyed:

1. First half of 2007 real GDP growth: 2.5%
2. Second half of 2007 real GDP growth: 2.8%
3. CPI Inflation for May 2007: 2.1%
4. Unemployment rate for May 2007: 4.8%
5. Fed Funds rate in June 2007: 5.02%

Renting vs. Buying a Home

From an article in the WSJ, "First-Timers Begin Looking At Houses Again: Lower Prices, Mortgage Rates Lure Buyers Off the Sidelines:"

"The share of first-time home buyers dropped earlier this year to its lowest level since 1987. First-time home buyers now account for 36% of home purchases, down from 40% in the three previous years.

High home prices have helped drive many first-time buyers out of the housing market. Now, with prices falling in many areas, there are some signs that buyers are beginning to drift back."
By definition, first-time home buyers are renters, and make a rent-buy decision based on the relative cost of renting a house or apartment vs. buying a house or condo. Therefore, there is significant competition between the two real estate markets: rental market vs. home buying market.

As the table above shows, the cost of renting an apartment, relative to buying a home, has decreased in all cities (except Indiapolis) over the last 5 years, due mostly to the 42% rise in home prices over this period. The table also show that in 2001, it was about 2% more expensive to rent than buy on average, but now it is about 21% less expensive to rent than buy. However, as home prices and interest rates fall, the advantage is shifting back towards buying, and the first-time home buyers are shifting from renting to buying, as the article points out.

For example, a year ago, the monthly payment for a home at the median price of $229,000, at the average 30-year mortgage rate of 6.33%, with a 20% down payment, was $1138. Today, the monthly payment for a median price home of $221,000, at the current rate of 6.16%, would be $1,078, or 5.3% lower than a year ago.

Bottom Line: There probably won't ever be a significant crash in home prices, because of a powerful self-correcting mechanism in place: Once home prices start to fall enough, the advantage shifts towards owning a home vs. renting, first-time homebuyers are attracted by the falling prices, and the demand for buying houses increases. Right now, it's as if houses are "on sale" at a 5% discount compared to a year ago because of falling home prices and falling interest rates. If Macy's can have a sale, why not the real estate market? It's a great time to buy a house.

Economic Week in Review

Summary: In an upbeat week for economic news, the Federal Reserve Board announced Tuesday that it left the target for short-term interest rates unchanged at 5.25%. This marked the fourth meeting that the central bank made no rate adjustments. Investors were also cheered by reports of strong retail sales, a shrinking trade deficit, increased industrial production, and more signs that inflation is being held in check. For the week, the S&P 500 Index rose 1.2% to 1,427, the highest close in more than six years (since Nov 8, 2000). The yield of the 10-year U.S. Treasury note rose 4 basis points to 4.60%.

Read more
here.

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Top Ten Economic Predictions for 2007

Just released from Global Insight:

1. SLUGGISH GROWTH FOR THE U.S. (2.2%).
2. OTHER REGIONS (like Europe) WILL ALSO SLOW A LITTLE.
3. ONCE AGAIN, CHINA AND INDIA WILL BE STAR PERFORMERS.
4. OIL PRICES SHOULD REMAIN HIGH - $60-65 per barrel.
5. CORE INFLATION WILL EASE to 2% core inflation by late 2007.
6. THE FED WILL CUT RATES (to 4.5%) AS OTHER CENTRAL BANKS TIGHTEN.
7. HOUSING WILL KEEP DAMPENING U.S. GROWTH, AND COULD BECOME
A THREAT ELSEWHERE.
8. CURRENT-ACCOUNT IMBALANCES WILL EASE A LITTLE.
9. DOWNWARD PRESSURE ON THE DOLLAR WON'T EASE - $1.40/euro.
10. NO RECESSION IN 2007 UNLESS MUCH HIGHER OIL PRICES, INFLATION, AND INTEREST RATES.

See Global Insight's Top Ten Predictions for 2006 from one year ago
here, and see how accurate they were.

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Friday, December 15, 2006

Real Income is Rising, Not Stagnating

According to another BLS report today, average weekly earnings increased by 4.4% over the last year, from $550.26 last November to $574.27 in November 2006, a 4.4% annual increase. After adjusting for inflation, real average weekly earnings increased by 2.6% over the last year. Data therefore show an INCREASE in real wages, not flat or declining real wages as prevailing popular myths would suggest. And this report is for monetary wages only (excludes fringe benefits), not for Total Compensation, which is released in a separate quarterly BLS report.

CPI Report

From today's Consumer Price Index (CPI) report:

1. Overall annual inflation from Nov 2005 to Nov 2006: 2.0%

2. Inflation over the last year without energy and food: 2.6%

3. Monthly inflation from Oct 2006 to Nov 2006: -.1%

4. Largest price decline over the last year: Energy, -3.8%

5. Largest price increase over the last year: Medical care, +3.7%

6. Weight of food prices in the CPI: 15%

7. Weight of housing prices in the CPI: 42%

Diamonds Are For Never?

From an article in the NY Times about diamonds:

American purchasers account for half the world’s $60 billion in annual retail sales.

“Many women are saying, ‘This is supposed to be a symbol of all things good and I don’t want to look down on my finger and think of women and children being killed.’ It undermines the entire meaning of that ring.”

Why Do Investment Bankers Get Paid So Much?

Read Tyler Cowen's explanation here at Marginal Revolution.

Quote of the Day

"Lou Dobbs is worried because the U.S. imports more than it exports and China sends a lot of its capital here, making us "a debtor nation." But his alarmist case really relies on the tired stupidities of old-fashioned protectionism."

See my post
yesterday.

Supply and Demand, Beer Style

At the Broker's Bier Börse in Berlin, East meets West, supply meets demand, and the customer meets market forces. Beer prices are displayed on electronic scoreboards and prices fluctuate depending on the demand. The more beer people order, the higher the cost ... the less they buy, the lower the price. See a Yahoo Travel report here, and a Freakonomics post here.

China Facts

1. 150 million people in China -- more than 10% of the population -- live on less than a dollar a day.

2. 300 million people in China are expected to migrate from the fields to the cities over the next 20 years.

Thursday, December 14, 2006

Craigslist Meets the Capitalists

It's not always about Profit Maximization, see the article in the NY Times about Craigslist:

"Jim Buckmaster, the chief executive of Craigslist, caused lots of head-scratching Thursday as he tried to explain to a bunch of Wall Street types why his company is not interested in “monetizing” his ridiculously popular Web operation. Appearing at the UBS global media conference in New York, Mr. Buckmaster took questions from the bemused audience, which apparently could not get its collective mind around the notion that Craigslist exists to help Web users find jobs, cars, apartments and dates — and not so much to make money."

DJIA Hits Record High

Read the WSJ report here.

Don't Melt Down Those Pennies or Nickels


The value of the metal in a nickel is now 6.99 cents, while the penny's metal is worth 1.12 cents, according to the U.S. Mint.

Prices for zinc, which accounts for nearly all of the metal in the penny, have risen 134 percent this year, according to the London Metal Exchange.

Even accounting for a recent decline, the price of copper is up 50 percent since the start of 2006.

But people who melt pennies or nickels to profit from the jump in metals prices could face jail time and pay thousands of dollars in fines, according to new rules set up by the U.S. Mint.

See article in USA Today.

See article in WSJ.

Quote from NPR

I didn't catch his name, but an economist on NPR today said something like "Economists have known for hundreds of years about the documented and proven benefits of free trade, but every generation we have to educate a new group of politicians about the benefits of free trade."

Spontaneous Order

George Mason economist Don Boudreaux has a commentary in today's Pittsburgh Tribune-Review about spontaneous order.

Also see
this article, "Controlled Chaos: European Cities Do Away with Traffic Signs," for another example of spontaneous order.

See my previous post on spontaneous order, about Skating Rink Economics
here.

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Your Global Cell Phone


In your cell phone's LCD screen and backlight, circuit boards, microchips, battery and case there are about 20 different raw materials like lithium, copper, nickel, aluminum, tin, silver, gold, indium, gallium, etc. from 18 different countries, see the article in Wired Magazine here, and thanks to Cafe Hayek for the tip.

Politically Correct, yet Factually Incorrect

"In a forthcoming Cato Institute paper I survey a wide range of official and academic statistics, finding no clear trend toward increased inequality after 1988 in the distribution of disposable income, consumption, wages or wealth. The incessantly repeated claim that income inequality has widened dramatically over the past 20 years is founded entirely on these seriously flawed and greatly misunderstood estimates of the top 1%'s alleged share of something-or-other.

The politically correct yet factually incorrect claim that the top 1% earns 16% of personal income appears to fill a psychological rather than logical need. Some economists seem ready and willing to supply whatever is demanded. And there is an endless political demand for those able to fabricate problems for which higher taxes are, of course, the preferred solution. In Washington higher taxes are always the solution; only the problems change."

By ALAN REYNOLDS of the Cato Institute writing in
today's WSJ.

No More Steel Protection

"The tariffs on corrosion-resistant steel -- the type of steel used most in cars and trucks -- must end. This special protection, in place since 1993, is no longer needed. It increases costs and puts us at a competitive disadvantage against other manufacturers outside the U.S.

These duties on corrosion-resistant steel penalize auto makers and other steel users by distorting competition in the U.S. market. Steel is not only more expensive than it would be without these duties; there is also less product available. Adding it all up, higher steel prices fueled by these duties have cost our companies over $3 billion in the last three years. That's a sum of money that we would prefer to invest in new products, facilities and jobs in America. Also, in today's cost-competitive market these price increases hike the price consumers pay for a vehicle.

However, for the health of all U.S. manufacturers, we oppose unnecessary protection for steel or any other industry that is thriving, powerful, profitable and globally competitive."

Excerpt from a
joint letter by the presidents and VPs of GM, Ford, Honda, Toyota and Chrysler in today's WSJ.

Just wondering, isn't pretty much all protection unnecesssary?

Update: The U.S. International Trade Commission allowed tariffs to lapse on certain high-end steel imported from Australia, Canada, France and Japan today, but voted to keep them in place for the same type of steel imported from Germany and Korea, representing a partial victory for the the U.S. auto industry, read the
WSJ article here.

Let me add that it is also a partial victory for U.S. consumers, who have been paying higher prices because of the steel tariffs.

Publik Skools: Flabby, Inefficient, Outdated

"For much of the 20th century, the education level of America's work force was second-to-none. But others have caught up, and even moved past us. Now, unless we take bold action, we risk losing our competitive edge. The problem is not that America doesn't spend enough money on education -- we spend enormous amounts, far more than any other nation. But we're not getting a sufficient return on our investment. The fact is, our education system looks a lot like the U.S. auto industry in the 1970s -- stuck in a flabby, inefficient, outdated production model driven by the needs of employees rather than consumers."

Michael Bloomberg, mayor of New York City,
writing in today's WSJ.

U.S. Consumers are Alive and Well


Monthly retail sales in November ($368.9 billion) hit an all-time record high in November (see graph above), and were 5.6% higher compared to November last year, and 1% higher than October of this year.

CNBC host of "Kudlow and Company" Larry Kudlow says: "Today’s remarkably strong retail report dealt a big body blow to the recession scenario. This unexpected 1% gain is a big number. It took most people by surprise. It’s another sign pointing to the resiliency of the U.S. consumer.

I’ve been saying for quite some time now that U.S. consumers are alive and well. Back in the middle of August, I wrote “The great American consumer has been written off so many times in the last couple of years, just like the rest of the economy. But he/she is alive and kicking. Another great story never told.”

The key themes are strong job creation, low unemployment, and rising wages."

E-Shop From Home, In Your Robe

U.S. retail e-commerce sales for the third quarter of 2006 was $27.5 billion, the highest level in history, and an increase of 4.5% from the second quarter of 2006, and 21% from the same quarter last year. E-commerce sales in the third quarter of 2006 accounted for 2.8 percent of total sales, the highest percentage in history on a seasonally adjusted basis (blue line above).

Wednesday, December 13, 2006

Free Trade

For a clear demonstration of why CNN news anchor Lou Dobbs cannot be taken seriously on issues of trade and globalization, this is an exercpt from his interview in Mother Jones:

"This administration -- and frankly, it's both parties, Democrats and Republicans as well as the administration -- seems indifferent to the impact of a trade deficit that now amounts to $4 trillion in external debt. We have to borrow nearly $3 billion a day to support it. The dollar has plummeted. And yet everyone keeps saying, "Free trade is good for you." I cannot find anyone for whom free trade is good."

Well, what about Dobbs' employer CNN, which broadcasts globally?

Thanks to
Cafe Hayek for the tip.

I think a more accurate statement would be: "I cannot find anyone who has not benefited in some way from free trade." Think about that as you read this on a computer monitor that might have come from Taiwan, sitting at a keyboard that might have been produced in Malaysia, on a computer using an Intel processor that might have been produced in China, that operates on various software programs that might have been written in Ireland, India and Indonesia, while you drink coffee from Colombia or Brazil, or tea grown in India or Africa, and eat bananas from Costa Rica or grapes from Chile, while you book your airline tickets for trip to vacation in Europe on the Dutch airline KLM, sitting in your house that might have been built with lumber from Canada, that might be financed with mortage funds from a Dutch investor, wearing clothing that might have been made in Thailand or the North Mariana Islands, before driving to work in your Mexican-built VW, fueled by gasoline from Venezuela, etc., etc., etc.

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Fixed Costs vs. Marginal Cost

Richard Epstein, law professor at the University of Chicago has a new book "Overdose: How Excessive Government Regulation Stifles Pharmaceutical Innovation." He has a commentary ("What's Good for Pharma is Good for America") in the Boston Globe, based on his book:

"Pharmaceutical firms still must recover their huge front-end costs, which can run over $1 billion for a new drug, over an ever shorter useful patent life. In addition, their successful drugs must generate additional revenues to cover the predictable flops. Yet companies need to charge someone for the initial costs of production, not just for the small cost of producing additional pills. Any system of direct price controls will dry up the capital needed for innovation."

See a
previous post on this topic, where I mentioned a scence from the TV show "West Wing" about protecting pharmaceutical patents. First guy: "Those pills cost them 4 cents to make." Second guy: "That's not true. The second pill costs them four cents, the first pill costs them $1 billion dollars." He must have read Epstein's book.

Tuesday, December 12, 2006

The Ultimate Rejection Letter

Professor Mark Perry
Chair - Finance Search Committee
University of Michigan-Flint
Flint, MI

Dear Professor Perry,

Thank you for your letter of November 20. After careful consideration, I regret to inform you that I am unable to accept your refusal to offer me an assistant professor position at your university.

This year I have been particularly fortunate in receiving an unusually large number of rejection letters. With such a varied and promising field of candidates, it is impossible for me to accept all refusals.

Despite the University of Michigan-Flint's outstanding qualifications and previous experience in rejecting applicants, I find that your rejection does not meet my needs at this time. Therefore, I will assume the position of assistant professor at your university this August. I look forward to seeing you then.

Best of luck in rejecting future applicants.

Sincerely,
Chris L. Jensen

Real Income is Rising, Not Stagnating

According to Diana Furchtgott-Roth in the New York Sun, "the myth of stagnating real median incomes over the past 30 years is one of the most enduring in the popular press. But, with apologies to Lou Dobbs, it just doesn't hold up."

The truth is that median wages haven't been stagnating for decades. They've been rising. Not only is the median American family doing better than ever, but poor families are doing better also.

Adjusting for decreasing family size, real median family income is 13% higher than in 1994, 22% higher than in 1984, 37% higher than in 1974, and 88% higher than in 1964. That's a significant increase, and these numbers represent income before tax and don't include subtractions for federal, state, and payroll taxes, which reduce income. Nor do they include additions to income such as employer-provided health insurance and pensions, and government benefits such as Medicaid, food stamps, school lunch programs, and tax credits.

When all these are taken into account, real median household income adjusted for household size has risen by 34% over the past 20 years. A substantial increase, yes. Stagnant real incomes, no.

Why Is Health Care So Expensive? You Don't Pay

Imagine that you went shopping for a new car and you only had to pay 13% of the sticker price, and somebody else picks up the other 87% of the cost - how would that affect your car shopping? That $70,000 Jaguar XJ8 that was previously way out of your price range would now cost you only $9,100, so you might now be able to afford it. That $22,000 Toyota Camry would now only cost you $2,860, so you might buy two instead of one.

And what about grocery shopping if you only paid $13 out-of-pocket for every $100 worth of groceries? It wouldn't take Nostradamus to predict that you'd be eating a lot better than you are now, and probably your dog would be too.

When it comes to spending on health care, it isn't any different when we only pay 13% of the cost and somebody else (insurance, employers, HMOs, government) pays the other 87% (see graph). And it wasn't always like that - as recently as the 1960s, almost half of health care costs were paid out-of-pocket by consumers, and consumers were probably a lot more cost-conscious.

From today's
Investor's Business Daily: Workers with employer-provided health plans were surveyed recently about their sensitivity to the cost of care. As expected, because 87% of the costs are paid by somebody else, consumers of health care are insulated and unconcerned about costs:

• Fewer than half said they consider costs when deciding to see a doctor or fill a prescription.
• Only 38% ask their doctors about lower-cost alternatives for recommended treatments.
• Less than one-quarter bother to ask about the cost of an office visit before making an appointment.
• And only one in 10 said they chose a lower-cost option for a test or treatment in the past year.

This bizarre market is no accident. It is the result of federal tax policy that has encouraged the growth of "third party" payment of health care since WWII. Tax laws provide a full tax benefit only for health care paid by employer-sponsored plans.

This has given rise to low-deductible plans that funnel as much health spending as possible though insurance companies. At the same time, Medicaid, Medicare and other government programs increasingly take on the burden of paying for health care.

Where Do Americans Shop?

When American shop in the Global Economy, where exactly do they do their shopping? The table above shows imports per person in the U.S., year to date through October 2006. Depsite all of the attention about China, the average American actually spends more on products from Canada than from China. And taken as a group, Americans spend more on goods from Mexico and the rest of Latin America countries than from China, and more on goods from EU countries than China.

Shop globally.

Hong Kong Dollar vs. Chinese Yuan

The Hong Kong dollar has been pegged to the United States dollar since 1983 at HK$7.80 per U.S. dollar through a currency board system (see graph above, left scale). China has also successfuly stabilized the value of the Chinese yuan over the last ten years, not through a currency board, but with the same results as a currency board (see graph above). China has now let its currency depreciate by about 6% over the last year, partly under pressure from the U.S.

Q: Why do people complain about "currency manipulation" of the Chinese yuan, and not about "currency manipulation" of the Hong Kong dollar, when both countries have attempted to maintain stable currencies vs. the USD, just through slightly different approaches? Perhaps Treasury Secretary Paulson should stop in Hong Kong after his trip to China, to pressure Hong Kong to end its currency board, and 25-year history of a stable ex-rate vs. the USD?

See the
results here of a Google News search for "China currency manipulation" that returns 256 examples of that phrase in recent news reports. See the results here for a Google news search of the phrase "Hong Kong's currency manipulation" that returns O examples of those words. There are about a dozen countries around the world using currency boards, with the express intention of a stable currency and stable ex-rate vs. some stable currency like the pound (Falkland Islands), euro (Bosnia, Lithuania) or dollar (Cayman Islands, Bermuda, Hong Kong).

Perhaps China should move to a currency board? Results would be the same, but the charges of "currency manipulation" would stop.

Inflation, Deflation

A 78% drop in price in 7 years for DVD players. We are so accustomed to price declines like this for common household appliances, computers and electronics, that we take it for granted.

In 1996, I bought a Dell computer when the standard hard disk was 2 GB, and the cost was about $2,000 (about $2500 in today's dollars). I bought a computer last week and the MINIMUM hard disk on a Dell XPS 410 computer is 250 GB, and the computer cost less than $1500. 125 times more disk space for a 40% lower price. This example illustrates why the Bureau of Labor Statistics has difficulty measuring inflation, or deflation in this case. Computer prices have fallen in real dollars, and the quality has increased significantly.

Monday, December 11, 2006

Lou Dobbs: Anti-Globalization Xenophobe

Nobody has been more of a vocal critic of outsourcing, globalization and international trade than CNN news anchor Lou Dobbs.

From a new article about Lou Dobbs titled "Mad As Hell" by Ken Auletta in the most recent issue of the
New Yorker:

New York Times columnist Thomas Friedman told a law-school audience, “And then you have a blithering idiot like Lou Dobbs, in my view, who’s using the platform of CNN in a news frame. . . This is not news. And so we have a political class not making sense of the world for people and that’s why the public . . . is so agitated.”

The Economist said that one might expect “CNN’s flagship business-news program . . . to strive for economic literacy,” but, instead, Dobbs greets “every announcement of lost jobs as akin to a terrorist assault."

The Nation accused him of “hysteria and jingoism.”

Ted Turner recently criticized journalists who fail to convey a sense of “covering the news from an unbiased” perspective. Turner didn’t single anyone out, but Dobbs is sure that he was referring to him.

MP: Lou Dobbs has an economics degree from Harvard but I think he missed that part of ECN 101 about trade being WIN-WIN. And as
Cafe Hayek pointed out, CNN and Lou Dobbs appear every evening in millions of American homes on foreign-produced televisions, and CNN's news programs are carried worldwide, so I guess Lou Dobbs isn't totally opposed to globalization, at least not when he and his employer CNN benefit. And I doubt he has any problems with globalization when he personally travels to Europe or the Carribean with his family and outsources his vacation overseas? And I doubt he has any problem with globalization when his books are sold overseas?

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Quote of the Day

Sir James Russell Lowell: "The ultimate result of protecting fools from their folly is to fill the planet full of fools."

Or "If you make the world safe for idiots, you'll get a world filled with idiots."

Another First for Infosys (INFY)

In 1999, software giant Infosys Technologies (INFY: NASDAQ), headquartered in Bangalore, India, became the first Indian firm listed on NASDAQ. Starting today, Infosys joins Ebay, Google, Yahoo, Microsoft, Dell, Intel and Amazon, and becomes the first Indian firm on the NASDAQ-100 Index, as part of an annual revision to the index, based mostly on market capitalization.

Read a
Forbes article here. See how it is being reported in India. Notice in the graph above that Infosys' share price has about doubled over the last two years ($30 to $60), generating approximately a 36% annual return using the Rule of 72.

Economics of Skating Rinks: Spontaneous Order

Undercover Economist Tim Harford writes in the Financial Times about skating rink economics:

"A skating rink has to be seen to be believed. Dozens of skaters hurtle around the ring while others, inexperienced, teeter precariously on sharp-bladed skates. Nobody has been checked for competence, there are no lanes, speed limits, rights-of-way or traffic signals. And yet the rink works perfectly, everybody skates around in the same direction and at their own pace, and little fingers and toes rarely get sliced off."

The skating rink is an example of what economist Friedrich Hayek called “spontaneous order,” the natural process of self-organization and order that often emerges spontaneously, without any central planning or control.

For example, think of the English language - who's in charge? Nobody. And yet it's organized very systematically without any central planning, because of spontaneous order. Think of the Internet - who's in charge? Nobody really, but think of how well-organized it is, because of spontaneous order.

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WSJ: 5 Macroeconomic Myths

Nobel economist Edward Prescott addresses 5 macroeconomic myths in today's WSJ:

Myth #1: Monetary policy causes booms and busts. It doesn't.
Myth #2: GDP growth was extraordinary in the 1990s. It was average.
Myth #3: Americans don't save. Measured by economic wealth, we save as much as we always have, and it's the right amount.
Myth #4: The U.S. government debt is big. As a percent of GDP, the deficit this year will be about 2%, below historical average.
Myth #5: Government debt is a burden on our grandchildren. It's not.

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Booyakasha! Ali G on Economics and Stocks

Ali G on economics, the U.S. monetary system, the stock market and "selling high." Booyashaka!

Harvesting Cash

Q: How do you starve a farmer?
A: Weld his mailbox shut.

As Congress prepares to debate a farm bill next year, the Washington Post is examining federal agriculture subsidies that grew to more than $25 billion last year, despite near-record farm revenue. The Wash Post series is called "Harvesting Cash: Working a Farm Subsidy." Since last summer the Post has run about a dozen articles on how US farmers "harvest cash" through farm subsidies, getting paid not to farm, etc. See the entire series
here.

In today's Washington Post, there is another article in the Harvesting Cash series titled "
Dairy Industry Crushed Innovator Who Bested Price-Control System," (featured today in Cafe Hayek - "Milking Us"), about a maverick Dutch-born dairyfarmer Hein Hettinga "who started bottling his own milk and selling it for 20 cents a gallon less than the competition, exercising his right to work outside the rigid system that has controlled U.S. milk production for almost 70 years. Soon the effects were rippling through the state, helping to hold down retail prices at supermarkets and warehouse stores."

Hein's entrepreneurial approach of selling milk below the government-mandated guaranteed prices, set by the Department of Agriculture through "milk marketing orders," didn't go over real well with the Dairy Cartel, a.k.a. Dairy Lobby.

"That was when a coalition of giant milk companies and dairies, along with their congressional allies, decided to crush Hettinga's initiative. For three years, the milk lobby spent millions of dollars on lobbying and campaign contributions and made deals with lawmakers," and eventually succeeded in ending Hettinga's business model.

Bottom Line: This is a victory for a well-organized, special interest group (the Dairy Cartel), and a defeat for U.S. consumers, who pay about $1.5 billion per year in higher milk prices due to agricultural subsidies and protection.

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What if China or Canada Became 51st State?

We have about a $200 billion annual trade deficit with China for goods and services. American consumers and businesses buy about $275 billion of Chinese goods per year and the Chinese buy about $75 billion of goods from the U.S. There is a lot of angst, hand-wringing and concern about our overall trade deficit ($750 billion for 2006) with the rest of the world, and a lot of specific concern about our $200 billion trade deficit with China. Treasury Secretary Henry Paulson will visit China this week to discuss trade issues.

Think about this simple thought experiment, and for the moment ignore any of the cultural and political implications. Suppose that in 2007, China became the 51st state of the United States. In that case, the $200 billion trade deficit would suddenly disappear. If that is too hard to imagine, assume that Canada became the 51st state in the United States - our $75 billion annual trade deficit with Canada would immediately disappear.

How could the trade deficits with Canada or China be considered a concern or problem now, when those trade deficits would disappear if Canada or China were one of our states? If you're not convinced, when is the last time you heard any concern or hand-wringing about any trade imbalances or trade deficits between two states like Michigan and Arizona?

No doubt, Michigan exports a lot more merchandise (motor vehicles) to Arizona, than Michigan imports from Arizona, leading to a "trade imbalance" between those two states. Michigan probably has a trade surplus with Arizona, and Arizona has a trade deficit with Michigan. Who cares? Nobody. What difference does it make? None.

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Sunday, December 10, 2006

Incentives Matter

Who do you think gets stuck in the mud or snow more often - people with 4-wheel drive vehicles or those with 2-wheel drive vehicles? Probably those with 4-wheel drive vehicles, right?

Feeling more powerful and invincible with a 4-wheel drive vehicle, drivers are more likely to go off-road or take additional risks and chances in the snow or mud that they would never take with a regular vehicle. Although 4-wheel drive vehicles are less likely to get stuck because of the additional power, the drivers of 4-wheel drive vehicles often take more risks and chances and are more likely to get stuck. Depending on which effect is stronger, drivers of 4-wheel drive vehicles might be more likely, less likely or equally likely to get stuck as drivers of regular vehicles.

Likewise, who do you think gets in more fatal car accidents - drivers wearing seatbelts, or those not wearing seatbelts? Well, it depends, because there are two opposite and offseting effects of wearing seatbelts, just like there are offsetting effects of 4-wheel vehicles:

1) people wearing seatbelts are more likely to survive a serious car accidents; but
2) people wearing seatbelts are also more likely to drive more aggressively and recklessly (like those drivers with 4-wheel drive) and will take more risks and chances when driving.

If Effect #1 is stronger, mandatory seatbelt laws will reduce fatal car accidents. If Effect #2 is stronger, mandatory seatbelt laws will increase fatal car accidents. If Effect #1 and Effect #2 are equal, seatbelt laws will have no effect on fatal car accidents.

From a
Time Magazine article (mentioned in the Freakonomics blog) titled "The Hidden Danger of Seat Belts:"

"John Adams, risk expert and professor at University College London, was an early skeptic of the seat belt safety mantra. Adams first began to look at the numbers more than 25 years ago. What he found was that contrary to conventional wisdom, mandating the use of seat belts in 18 countries resulted in either no change or actually a net increase in road accident deaths.

How can that be? Adams' interpretation of the data rests on the notion of risk compensation, the idea that individuals tend to adjust their behavior in response to what they perceive as changes in the level of risk.

Drivers who feel safe because of seat belts may actually increase the risk that they pose to other drivers, bicyclists, pedestrians and their own passengers. And risk compensation is hardly confined to the act of driving a car. Think of a trapeze artist, or a rock climber, motorcyclist or college kid on a hot date. Add some safety equipment to the equation — a net, rope, helmet or a condom respectively — and the person may try maneuvers that he or she would otherwise consider foolish."

Bottom line: You might actually be MORE safe when driving if you: a) don't buckle up (you'll drive more safely without the protection of a seat belt), or b) install a sharp spike that would come out of the steering wheel on impact (you'll drive a LOT more safely).

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Market Value vs. Face Value

Face value of tickets to the BCS championship game between OSU and UF: $175 per ticket

True, market value of tickets to the BCS game based on recent
Ebay sales: $1500 per ticket for the 5-15 yard line

The Economics of Diamonds

The new movie "Blood Diamond" has brought attention to the economics of diamonds.

Q: How did diamonds, which are a relatively common mineral, become so expensive?
A: The supply of diamonds to the market is tightly controlled and restricted by a powerful diamond cartel: DeBeers Consolidated Mines Ltd. DeBeers is a South African firm with an office in London as its main distribution operation for selling rough stones, at non-negotiable prices to diamond wholesalers, only ten times a year.

Q: Which country has the world's largest supply of unpolished diamonds?

A: It's not Botswana, Russia, Canada or S. Africa which are the four largest diamond producers. The answer is: the UK. The world's largest stockpile of uncut diamonds is in the vault of the DeBeers office in central London, at 17 Charterhouse Street. DeBeers maintains high prices, while it successfully peddles the myth that supply is scarce with effective advertising and marketing. DeBeers alone spends $180 million yearly on advertising, and its clients (wholesalers) spend another $270 million.

There is a recent book about diamonds: "
The Heartless Stone: A Journey Through the World of Diamonds, Deceit and Desire," by Tom Zoellner, here is the website for the book. Here is an excerpt that appeared in Time magazine:

"De Beers has managed the remarkable feat of operating a 17th century economic model in a 21st century world. Fluctuations of supply and demand are not tolerated. Three floors beneath the DeBeers office in London are a series of vaults that contain the world's largest stockpile of unpolished diamonds—the best estimates put it at half a billion dollars. To De Beers, they remain much more valuable right where they are. The continuing stability of the diamond industry depends on an artificial scarcity that De Beers has worked hard to create."

From an
article in The Economist about diamonds:

"The diamond industry sells $60 billion of jewelery alone each year. For generations it has been run by De Beers as a cartel. The South African firm dominated the digging and trading of diamonds for most of the 20th century. The system for distributing diamonds established decades ago by De Beers is curious and anomalous—no other such market exists, nor would anything similar be tolerated in a serious industry. With its near monopoly as a trader of rough stones, De Beers has been able to maintain and increase the prices of diamonds by regulating their supply."

The diamond industry has to be one of the biggest marketing scams in the history of the world:

Step #1: Take a relatively common mineral of compressed carbon, artificially restrict the supply and distribution of that mineral by means of a powerful and ruthless cartel, and charge consumers an artificially high price, way above the true market price.

Step #2: Pursue an aggressive worldwide marketing campaign to deceive people into believing the myth that diamonds are somehow "special and scarce," when that specialness and scarceness are completely man-made and artificial, carefully created and orchestrated by the DeBeers diamond cartel.
 


Think about the advertising slogan "Diamonds are forever." Well, wouldn't a rock or a penny or a piece of steel be forever too? I have sharks' teeth that are 50 million years old, so I think sharks' teeth are probably forever too. And wouldn't a ruby or an emerald or a bar of gold be forever too? And why pay a lot of money for something that will last for a million years when you'll only be able to use it for maybe 50 years? Seems irrational.

What is the current biggest threat to the diamond cartel, and why is it possible that "cartels aren't forever?" Cultured, laboratory-grown diamonds, produced in diamond growth chambers by companies like Gemesis that have the same physical, chemical and optical characteristics as a mined diamond.

Bottom Line: Don't support the diamond cartel, don't buy into the myth and scam of "false scarcity," and if you must buy diamonds, buy laboratory diamonds!

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Quote of the Day

From Cafe Hayek (George Mason economist Don Boudreaux) today: "Many people who rightly applaud commerce between two or more citizens of the same country get all confused and befuddled if the very same commercial transaction takes place between people living in different sovereign jurisdictions."

That is, voluntary trade is always mutually beneficial (win-win), and it doesn't matter a scintilla whether the buyer and seller (or lender and borrower) are both on the same side, or different sides, of an imaginary line we call a national border. For example, what difference does it make to you if the funds for your student loan, mortgage or auto loan came from an investor in Singapore, Brazil, the Netherlands, Canada or Arizona? None.

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