Insightful:

I would compare those who advocate such outright borrowing without committing to credibly repay at maturity to people who fall for teaser mortgage rates and are rather negatively surprised to see the rate adjust later. It is interesting though that there seems to be a large positive correlation between people who advocate government borrowing because rates are low NOW, and those who call for protecting consumers against reckless lenders who tease them with a low temporary rate. To quote a famous Canadian singer, Isn’t it ironic?

John Taylor:

The low interest rates added fuel to the housing boom, which in turn led to risk taking in housing finance and eventually a sharp increase in delinquencies, foreclosures, and the deterioration of the balance sheets of many financial institutions as toxic assets grew rapidly. To test the connection between the low interest rates and the housing boom I built a simple model relating the federal funds rate to housing construction. My research showed that a higher federal funds rate would have avoided much of the boom and bust.

And:

Others might say that my research ignores mistakes in the private sector. Of course there were market problems of various sorts. Mortgages were originated without sufficient documentation or with overly optimistic underwriting assumptions, and then sold off in complex derivative securities which credit rating agencies rated too highly. Individuals and institutions took highly risky positions either through a lack of diversification or excessive leverage ratios. But such mistakes do not normally become systemic, and in my view, the government actions tended to convert non-systemic mistakes into systemic risks.

The link is to a PDF, but if you have any interest in politics or the economy at all, you should read it. And then read it again.

Placing the Federal Reserve’s awesome power in the hands of men is dangerous no matter how it is managed, but we would be in a much better position if the Fed followed Taylor’s recommendations.

Keith Hennessey nicely breaks down the different positions on fiscal stimulus.

It’s well done and a good way of framing the debate. For what it’s worth, I’m in the first group.

Russ Roberts has a nice, succinct overview of what F.A. Hayek argued. Hayek was a brilliant man.

(The article is gated, so you’ll have to click through from Google. The above link is to Google News–just click on the first link.)

Gregory Mankiw considers the administration’s response to the failure of their stimulus models:

The trouble is, we have no way of knowing for sure if the model was in fact correct. To react to a model’s failure to predict events accurately by insisting that the model was nonetheless right — as Obama’s economic advisors have done — is hardly the most obvious course. Careful economists should instead respond with humility. When their predictions fail — as they often do — they should not dig in their heels, but should instead be willing to go back to their starting assumptions and question their validity.

The administration predicted that without stimulus the economy would suffer 9 percent unemployment, and with stimulus it would not rise above 8 percent. The unemployment rate for May was 9.7 percent. Their conclusion is that the stimulus wasn’t large enough, rather than questioning their initial assumptions.

Mankiw’s piece is excellent, and looks at one of the assumptions they should have re-considered—that government spending’s multiplier is 1.5, while for tax cuts it is 0.99¹, and that this is the sole criterion for deciding what kind of stimulus should be used.

1. The multiplier is how much effect one dollar will have on GDP. So, for a dollar of government spending (with the 1.5x multiplier), GDP would increase by $1.50. ↩

Columbia professor Ang Yuen Yuen thinks China’s cheap labor advantage is slipping away:

Apparel production is a prime example of China’s declining competiveness in markets dependent on low-cost labor. According to a study by the US consulting firm Jassin O’Rourke, labor costs in China are higher than in seven other Asian countries. The average cost for a worker is $1.08 per hour in China’s coastal provinces and $0.55-0.80 in the inland provinces. India was in seventh place, at $0.51 per hour. Bangladesh offers the lowest cost, only one-fifth the price of locations like Shanghai and Suzhou.

That’s how developing markets work: an economy based on cheap labor leads to rising standards of living and wages, and that advantage erodes over time. The economy must then shift to different economic advantages, or higher up the supply chain, as Ang says.

James Surowiecki comments on market volatility created by increasing (and erratic) government intervention in the economy:

As a result, investors have a vast range of new things to worry about, like voter sentiment in Westphalia. They have to try to figure out whether policymakers will do things they shouldn’t, like slash spending during a downturn, and not do what they should, which is to intervene promptly when systemic crises appear.

He’s right that government intervention is creating uncertainty in the market, but his solution–that governments intervene “promptly” during crises–is exactly wrong.

Bubbles certainly are inherent to markets, but systemic crashes are not. The financial crisis we experienced in 2008 was a result of a housing bubble that the federal government (1) funded through low interest rates and the GSEs (Fannie Mae and Freddie Mac) and (2) encouraged through prior bailouts of ailing banks. This created an environment where risks were not properly considered precisely because of what Surowiecki recommends: Government would intervene if the bubble burst. And that’s precisely what they did.

We shouldn’t be creating standardized and routine government intervention in the economy to protect failing institutions. We should do the opposite: make clear government will not save failing firms nor their creditors. Government protecting firms and creditors makes Washington, D.C.’s whim, and not a company’s own fundamentals, ultimately responsible for a company’s success.

That isn’t capitalism. It’s authoritarianism, with markets merely serving the government’s desires.

Arnold Kling comments on the European Union’s bailout of debt-ridden members:

My take is that this is like TARP in that it treats the European debt crisis as a liquidity problem, when at least in part it is a solvency problem. Lately, I have seen several writers argue that a Greek default is inevitable, and no one seems to argue otherwise.

Suppose that banks had to write down the value of their Greek debt by 30 percent or more. At the very least, this would eat significantly into their capital, and they would have to curtail lending. This in turn would make funds scarce for other sovereign debtors. In some sense, this is what should happen–interest rates should rise, and financial intermediation should contract.

As he points out, the problem is this isn’t simply a liquidity issue (e.g. banks have stopped lending, but the country’s finances are actually strong). This is a solvency issue. These countries are in terrible shape financially.

Like TARP and the nationalizing of Fannie Mae and Freddie Mac here, this only extends the inevitable. These countries still need to fix their fundamental problem, and this is just prolonging the pain.

Russell Roberts, professor of economics at George Mason University, wrote a fantastic paper on the causes of the financial crisis.

The most culpable policy has been the systematic encouragement of imprudent borrowing and lending. That encouragement came not from capitalism or markets, but from crony capitalism, the mutual aid society where Washington takes care of Wall Street and Wall Street returns the favor.9 Over the last three decades, public policy has systematically reduced the risk of making bad loans to risky investors. Over the last three decades, when large financial institutions have gotten into trouble, the government has almost always rescued their bondholders and creditors. These policies have created incentives both to borrow and to lend recklessly.

Former acting CBO director Donald B. Marron has a fabulous look at why why our public debt is so dangerous, and what should be done about it:

First, once our economy is back on its feet, prolonged deficits and mounting debt will inevitably undermine economic growth. Americans simply do not save enough both to lend the government everything it needs to finance persistent deficits and to continue investing in the growth of the private sector. Future government borrowing will therefore require either more borrowing from abroad or significantly less domestic investment. If we reduce our domestic investment — building fewer factories, cutting back on research and development, and generating fewer innovations — our nation’s future earnings prospects will dim, and our future living standards will suffer. And while borrowing more from foreign lenders enables us to afford more investment today, that money (plus substantial interest) will eventually have to be repaid. As a result, more of our future income will have to be sent overseas — and again, our living standards will decline. Sometimes economics can be painfully simple: The more money we borrow now, the less we will have in the future.

Read the entire thing. We must reduce our debt to sustainable levels, and that means a significant reduction in spending and, unfortunately, tax increases.

This is precisely why the healthcare reform passed is so monumentally dangerous: our current spending and debt is unsustainable, yet we’ve decided to (1) tack on $100-200 billion in new spending a year, and (2) use up valuable means of cutting the budget.

A conversation with Gay Becker:

Mr. Becker places his hands behind his head. Once again, he reflects, then smiles wryly. “Of course that doesn’t mean there isn’t any systematic bias toward bad policy,” he says. “There’s one bias that we’re up against all the time: Markets are hard to appreciate.”

Paul Krugman on how the government will respond to rising debt:

How will the train wreck play itself out?… But my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

And as that temptation becomes obvious, interest rates will soar. It won’t happen right away.… But unless we slide into Japanese-style deflation, there are much higher interest rates in our future.

I think that the main thing keeping long-term interest rates low right now is cognitive dissonance. Even though the business community is starting to get scared — the ultra-establishment Committee for Economic Development now warns that “a fiscal crisis threatens our future standard of living” — investors still can’t believe that the leaders of the United States are acting like the rulers of a banana republic. But I’ve done the math, and reached my own conclusions — and I’ve locked in my rate.   

Krugman’s figured it out, right?

Well, no. That was Krugman in March 2003. Today, he’s taking every opportunity to justify sky-high debt and new government spending.

Funny how a change of heart for Krugman on government debt and spending corresponds with a change of party in control in Washington.

I wonder what that might mean.

(Via Greg Mankiw.)

Bond investors now require less return on Berkshire Hathaway’s debt than on debt for the U.S. federal government:

Two-year notes sold by the billionaire’s Berkshire Hathaway Inc. in February yield 3.5 basis points less than Treasuries of similar maturity, according to data compiled by Bloomberg. Procter & Gamble Co., Johnson & Johnson and Lowe’s Cos. debt also traded at lower yields in recent weeks, a situation former Lehman Brothers Holdings Inc. chief fixed-income strategist Jack Malvey calls an “exceedingly rare” event in the history of the bond market.

This means, basically, that investors believe a company to be more secure and stable than the U.S. government, once considered the safest investment of all because of its stability.

This will likely reverse, but it’s indicative of the doubt investors have for the U.S.’s financial stability. Moody’s warned last week the U.S. could lose its “AAA” credit rating if it doesn’t move to solve its debt problem.

This is the single-biggest issue facing us today. Not health care, not terrorism–it’s our financial situation. Our federal government depends upon debt to finance itself.

That’s why the Democrats’ healthcare reform bill is so dangerous: at a time when we must be figuring out how to pay down our debt and make current entitlements sustainable, Democrats are adding hundreds of billions of dollars of new spending to the budget each year, and using valuable means of paying for Medicare reform to pay for it. This is the height of irresponsibility.

Barry Ritholtz has a good explanation of how low interest rates helped precipitate the housing bubble.

Merely regulating lending institutions isn’t the largest issue. The issue is central banks, no matter how intelligent the people running them are, don’t fully understand what’s going on in the economy nor the effects of their monetary policy. Greenspan seemed justified in keeping interest rates low at the time–we just entered a recession due to the technology bubble’s collapse, and September 11th threatened to make it magnitudes worse. Under those conditions, low interest rates seem justified.

But they also helped inflate another bubble, one that led to a financial crisis. This perfectly illustrates why government having such an integral role in the economy is so dangerous.

Obama has released his own version of health care reform, and his new idea is price controls:

The president’s bill would grant the federal health and human services secretary new authority to review, and to block, premium increases by private insurers, potentially superseding state insurance regulators. The bill would create a new Health Insurance Rate Authority, made up of health industry experts that would issue an annual report setting the parameters for reasonable rate increases based on conditions in the market.

Support for price controls is based on the assumption that health insurance companies are charging their customers exorbitant prices to profit. That’s what the administration has been implying over the past few days when talking about rates rising by 39 percent. He means to say they’re taking advantage of people to profit.

The problem is, that’s false. The average profit margin for the industry is an anemic 3.4 percent. For comparison, Apple’s expected profit margin for the second quarter is 39 percent, yet there isn’t much complaint that Apple is price gouging consumers.

If rates are forced to hold steady by the federal government, this doesn’t magically eliminate what’s actually causing rising rates: increased costs for the insurers. The insurers will still have to pay those costs. Which means insurers will be forced to pare down what they cover, so they can remain break-even or profitable. In other words, the government may force insurers to ration care through these price controls. Is there any doubt that the president will use this to lambast the insurers as heartless crooks, and claim it as evidence why the government needs to be further involved in the health care market?

This doesn’t address the economic causes of rising health care costs. Instead, it uses the currently popular sentiment that business only exists to bleed people of their money to create an enemy for the people to rally against, and a progression where government control of health care is the only eventuality.

Forcing people by law to purchase health insurance, and setting health insurance rates by fiat, are just inching the foot farther into the door. Government-controlled health care lies just beyond the door.