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.

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.

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.

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.

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?

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.

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.

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.

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.

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).

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!

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.

In Praise of Chain Stores, and Sweatshops

From the December issue of "The Atlantic" - an article by former NY Times business columnist, Virginia Postrel titled "In Praise of Chain Stores," here is an excerpt:

"Chains do more than bargain down prices from suppliers or divide fixed costs across a lot of units. They rapidly spread economic discovery—the scarce and costly knowledge of what retail concepts and operational innovations actually work. That knowledge can be gained only through the expensive and time-consuming process of trial and error. Expecting each town to independently invent every new business is a prescription for real monotony, at least for the locals.

Chains make a large range of choices available in more places. They increase local variety, even as they reduce the differences from place to place. People who mostly stay put get to have experiences once available only to frequent travelers, and this loss of exclusivity is one reason why frequent travelers are the ones who complain.

When Borders was a unique Ann Arbor institution, people in places like Chandler, Arizona—or, for that matter, Philadelphia and Los Angeles—didn’t have much in the way of bookstores. Back in 1986, when California Pizza Kitchen was an innovative local restaurant about to open its second location, food writers at the L.A. Daily News declared it “the kind of place every neighborhood should have.” So what’s wrong if the country has 158 neighborhood CPKs instead of one or two?"

MP: And remember, chain stores like Borders don't put small downtown merchants and bookstores out of business, "greedy" consumers shopping at chain stores for low prices put downtown merchants out of business. See my article on "consumer greed" here.

Last summer NY Times columnist Nicholas Kristof wrote an op-ed titled "In Praise of the Maligned Sweatshop."

Welcome NetPlus MBA Students

Carpe Diem welcomes University of Michigan-Flint MBA students in the NetPlus! MBA program who are taking MGT 551 Business Economics this semester (starting today December 9 until March 2), the P8 and P9 classes!

Any posting with special interest for the MGT 551 class will have a "551" label at the bottom of the post. Click on any "551" label to read all 551 postings.

In the "Links" section of the Carpe Diem website on the right side, there is a link to go directly to Blackboard from this website.

Welcome to Carpe Diem! Read early and read often!

Ghetto Capitalism

From Slate.com, a review of Sociologist Sudhir Venkatesh's new book on the mystery of the underground economy - Off the Books: The Underground Economy of the Urban Poor.

If you read "Freakonomics," you might remember Sudhir Venkatesh - he was a graduate student at the University of Chicago who entered poor black Chicago neighborhoods while studying urban poverty, and it was his research that provided the data for the chapter "Why Do Drug Dealers Still Live With Their Moms?"

He spent years in a 10-square-block neighborhood on Chicago's South Side observing the clandestine work of gangbangers and mechanics, prostitutes and pastors, based on that research he wrote "Off the Books:"

"Beneath the closed storefronts, burned-out buildings, potholed boulevards, and empty lots, there is an intricate, fertile web of exchange, tied together by people with tremendous human capital and craftsmanship," he writes. In this view, even gang leader Big Cat is a "stakeholder" in the neighborhood, with an interest in seeing norms adhered to and order preserved. "It's not a crack house," as an old Onion headline had it. "It's a crack home."