Grasping Reality with Both Hands: The Semi-Daily Journal Economist Brad DeLong

Gideon Rachman of the Financial Times Endorses Barack Obama

Gideon Rachman:

FT.com / Columnists / Gideon Rachman - Back Obama for commander-in-chief: [W]hile the armchair generals in Washington will denounce Mr Obama for weakness on Iran, the real generals support his position. The great constraint on the radicals in the Bush administration is that the US’s top brass has made it clear that it has no appetite for launching yet another war... the last thing the American military needs is a third front.

The generals know that the idea of a surgical strike to “take out” Iran’s nuclear facilities is a fantasy.... Mr McCain would risk all this because he believes that the Iranian leadership just might be crazy enough to risk Armageddon by using nuclear weapons or passing them to terrorists. Talk long enough about President Mahmoud Ahmadi-Nejad’s religious beliefs and you just might scare yourself into thinking that it is worth launching the third and biggest war in America’s stumbling bid to remake the Middle East.

But the calmer heads around Mr Obama are, fortunately, not convinced.... The US has already had to learn to live with nuclear weapons in the hands of countries that are far more oppressive and irrational than Iran: North Korea, Mao’s China, the Soviet Union.

One of the great lessons of international relations since 1945 is that nuclear deterrence has worked. Mr Obama respects that lesson. Mr McCain does not. For that reason alone, Mr Obama would make the better commander-in-chief.

Let Us Welcome Our Web 2.0 Publisher Overlords

Charlie Stross on Tor Books's arrival on the internet at http://www.tor/com/:

Charlie's Diary: Dragged kicking and screaming into the Century of the Fruitbat: It's something of a truism that the larger a publisher gets, the more trouble they seem to have in understanding this interwebnet thingy. While smaller outfits like Baen Books and Subterranean Press seem to have more than half a clue, it's been almost embarrassing to watch the larger book publishers flailing around... so it's nice and refreshing to see one of them get their act together.

Case in point: Tor.com — Tor's revamped and relaunched web presence. It's very Web 2.0, with original fiction, blogs, and social networking bells and whistles; hopefully it'll be linked up to their long-awaited ebook store fairly soon so you can all buy my books. (Ahem ...)

Tor editor Patrick Nielsen Hayden says:

Welcome to the Frontpage: The conversation: Effective blogging is a combination of good personal writing and smart party hosting. A good blog post can be a sentence long, or three pages long; what matters is that it encourages further conversation.

Back in the heyday of the Whole Earth Catalog, visionary Catalog editor Stewart Brand told would-be reviewers to (I quote from memory, and probably imperfectly) “write as if you are writing a letter to an engaged and interested friend who knows almost nothing about the subject.” That’s a good starting point for blogging. Tor.com is for fans of science fiction, fantasy, the universe, and the many “related subjects” that such persons are also liable to be interested in.... We’re not trying to convert everyone to our particular geeky obsession, but we do assume that our natural audience is composed of people who understand the pleasures of geeky obsession, and we hope to share the cool.

Much of what has driven Tor.com is our desire to more fully contribute to the great conversation that is the subculture of SF.... That conversation has done nothing but expand. It is a major tributary to the modern Internet. Tor.com aspires to be part of that conversation. We recognize it as something older and bigger than we are.

We’ve recruited a number of front-page bloggers based on their knowledge of certain specialized subjects and their demonstrated ability to blog interestingly....

As this site’s editorial straw-boss, I guess what I’d say to everyone playing here, front-page bloggers and commenters alike, is: Converse. Be yourself; be a person, not a megaphone--a personal point of view, not an encyclopedia or an “objective journalistic voice.” Even the original fiction is part of the conversation; the authors writing for us are aware that there'll be a public comment thread following every story, just as if it were a blog post. Talk to the rest of us like we’re human beings at an interesting social event. If you feel like you’re up at a lectern on a big stage, reconsider. Tor.com aspires to be a room party, not Carnegie Hall. Circulate and talk.

Alan Beattie's All-Purpose International Conference Report

Clive Crook sends us to Gideon Rachman who sends us to Alan Beattie who writes the all-purpose international conference report:

FT.com | Gideon Rachman’s Blog | The G8: How to write about pointless international organisations:

Generic Column on International Institutions

By reporters everywhere

An ineffectual international organisation yesterday issued a stark warning about a situation it has absolutely no power to change, the latest in a series of self-serving interventions by toothless intergovernmental bodies.

“We are seriously concerned about this most serious outbreak of seriousness,” said the head of the institution, either a former minister from a developing country or a mid-level European or American bureaucrat. “This is a wake-up call to the world. They must take on board the vital message that my organisation exists.”

The director of the body, based in one of New York, Washington or an agreeable Western European city, was speaking at its annual conference, at which ministers from around the world gather to wring their hands impotently about the most fashionable issue of the day. The organisation has sought to justify its almost completely fruitless existence by joining its many fellow talking-shops in highlighting whatever crisis has recently gained most coverage in the global media.

“Governments around the world must come together to combat whatever this year’s worrying situation has turned out to be,” the director said. “It is not yet time to panic, but if it goes on much further without my institution gaining some credit for sounding off on the issue, we will be justified in labelling it a crisis.”

The organisation, whose existence the White House barely acknowledges and to which hardly any member government intends to give more money or extra powers, has long been fighting a war of attrition against its own irrelevance. By making a big deal out of the fact that the world’s most salient topical issue will be placed on its agenda and then issuing a largely derivative annual report on the subject, it hopes to convey the entirely erroneous impression that it has any influence whatsoever on the situation.

The intervention follows a resounding call to action in the communiqué of the Group of [number goes here] countries at their recent summit in a remote place no-one had previously heard of. The G[number goes here] meeting was preceded by the familiar interminable and inconclusive discussions about whether the G[number goes here] was sufficiently representative of the international community, or whether it should be expanded into a G[number plus 1, 2 or higher goes here] including China, India or any other scary emerging market country that attendees cared to name.

The story was given further padding by a study from an ambulance-chasing Washington think-tank, which warned that it would continue to convene media conference calls until its quixotic and politically suicidal plan to ameliorate whatever crisis was gathering had been given respectful though substantially undeserved attention.

Ends

The sad thing, of course, is that a decade ago things were different: back when the White House believed in international institutions, they actually did things--important things. And even those that did not do things knew that they could have done things--and worried about it.

Duncan Black Lays Down the Party Line

From Atrios, apropos of the press's treatment last week of General Clark:

Eschaton: So Predictable: This past week gave us a look at how things will be going forward. The McCain campaign will inject a narrative, and the donut & BBQ loving press will dutifully type it up, completely making up facts to do so if necessary.

And we're going to have to start creating 360 degree s---storms around them when they do.

DeLong: Capital and Its Complements

J. Bradford DeLong (2008), "Capital and Its Complements: International Capital Mobility and Economic Growth in the Twenty-First Century" http://www.j-bradford-delong.net/2008_pdf/20080521_capital.pdf

The old "write a paper to figure out what you think about an issue" trick has gone wrong: I still don't know what I think about the issues at hand...

Unexpected Benefits of Manhattan...

Unexpectedly early to a lunch in Greenwich Village:

View Larger Map

I halt the cab at the Flatiron Building

to see if can possibly finally meet a Nielsen Hayden or two in the flesh. And whom do I also find there sitting in a semi-lotus position but New York Times bestselling author Cory Doctorow of BoingBoing on tour for his brand-new (and excellent) book Little Brother, who proceeds to:

• give me his five-minute lecture on why he finds David Brin's The Transparent Society too optimistic,

• and then hands me a pre-sale copy of Jo Walton's Half a Crown for me to read on the plane back to San Francisco.

(I had expected to meet Doctorow at CFP on Thursday, but he was then in San Francisco signing books).

Now off to lunch with Nouriel Roubini at the Mercer Kitchen...

Sunday Morning Upper San Leandro Reservoir Kings Canyon Cattle Drive Blogging

Sunday Morning Upper San Leandro Reservoir Kings Canyon Cattle Drive Blogging: We--that is, two monkeys and a Labrador Retriever--just drove 20 head of cattle 6 miles down one side of Kings Canyon and back along the Rocky Ridge trail. I am telling you: these aren't the ancient fearsome aurochs of the Eurasian forests. The only sticky point was when the cattle we were driving met head-on at a narrow place on the trail two quants from Barclay Global Investments and their ancient Golden Retriever coming the other way...

listen

---

Now is this a good job or a bad job of voice recognition we have here?:

Sunday morning, Upper Family(?) Reserver King Canyon cattle drive(?) logging. We, that is two monkeys and a Labrador Retriever just drove 20 head of cattle 6 miles down the one side of the King Canyon and back along the Rocky Ridge Trail. I am telling you these are no longer the ancient fearsome ora rasion(?) forest. The only sticky pipe was where the cattle we were driving met a head on a narrow pass in the trail to quants(?) from Barkley(?) global investors and agent golden retrieval coming the other way. listen

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David Leonhardt Sums Up a Gloomy Macroeconomic Situation

David Leonhardt writes:

Seeing an End to the Good Times (Such as They Were): The dismal jobs report released Friday showed overall employment to be lower than it was three months ago.... And if the good times have really ended, they were never that good to begin with. Most American households are still not earning as much annually as they did in 1999, once inflation is taken into account.... [A] prolonged expansion has never [before] ended without household income having set a new record.

For months, policy makers and Wall Street economists have been predicting, and hoping, that the aggressive series of interest rate cuts by the Federal Reserve would keep the economy growing, despite the housing bust. But the possibility seemed to diminish almost by the hour on Friday.

Shortly after 8 a.m., the Fed announced yet another measure meant to unlock the struggling credit markets. At 8:30, the Labor Department released the unexpectedly poor jobs report. Almost immediately, the economists at JPMorgan Chase -- who only last week had told clients they thought the economy was still growing -- reversed course and said a recession appeared to have started earlier this year....

Over the last year, the number of officially unemployed has risen by 500,000, while the number of people outside the labor force %u2014 neither working nor looking for a job -- has risen by 1.3 million.... Much of the economic stimulus put in place by the government will begin to take effect in the next few months, which does leave open the possibility that the country can still escape a recession. Policy makers have reacted quite quickly to this slowdown, relative to previous ones.

The Treasury Department will begin sending out rebate checks -- of up to $1,200 for couples, plus $300 per child -- in May, as part of the stimulus package negotiated by President Bush and Democratic leaders in Congress. The Fed has already cut its benchmark short-term interest rate five times since September, and such reductions typically take six months or more to wash through the economy....

The median household earned $48,201 in 2006, down from $49,244 in 1999, according to the Census Bureau. It now looks as if a full decade may pass before most Americans receive a raise.

People Should Not Provoke the Krugman!

But people do. And he is annoyed.

He is annoyed at Reaganite commenters who have been misled by Republican "economists":

Reagan and revenu: Ah - commenter Tom says, in response to my post on taxes and revenues:

Taxes were cut at the beginning of the Reagan administration. Federal tax receipts increased by 50% by the end of the Reagan Administration. Although correlation does not prove causation the tax cut must have accounted for some portion of this increase in federal tax receipts.

I couldn’t have asked for a better example of why it’s important to correct for inflation and population growth, both of which tend to make revenues grow regardless of tax policy.

Actually, federal revenues rose 80 percent in dollar terms from 1980 to 1988. And numbers like that (sometimes they play with the dates) are thrown around by Reagan hagiographers all the time. But real revenues per capita grew only 19 percent over the same period — better than the likely Bush performance, but still nothing exciting. In fact, it’s less than revenue growth in the period 1972-1980 (24 percent) and much less than the amazing 41 percent gain from 1992 to 2000.

Is it really possible that all the triumphant declarations that the Reagan tax cuts led to a revenue boom — declarations that you see in highly respectable places — are based on nothing but a failure to make the most elementary corrections for inflation and population growth? Yes, it is. I know we’re supposed to pretend that we’re having a serious discussion in this country; but the truth is that we aren’t.

He is annoyed by Ben Bernanke's insistance that any recession will be effectively over before we are sure that it has begun:

Not so fast - Paul Krugman - Op-Ed Columnist - New York Times Blog: One assumption in Ben Bernanke’s testimony today was that if a recession happens, it will be over soon, so stimulus has to come fast or not at all. It’s by no means clear that this is right. To be fair, I think it’s right to caution Congress not to do anything now that won’t come in quickly. But both recent history and the nature of our current problem suggest that we may be in for more than a few bad months. It’s true that the 2001 recession was officially very short. But the economy felt weak for much longer than that. Here’s my favorite picture, the employment-population ratio, once again:

[The employment-population ratio] kept falling through the summer of 2003. And the Fed certainly thought the economy was weak, and needed more help; it kept cutting rates long after the recession was officially over, and didn’t start raising them until 2004.

So the last slump de facto lasted about 2 1/2 years. And I don’t see why the same couldn’t happen this time. After all, what’s supposed to take the place of weak housing and consumer spending. Exports, yes — but how much will come, how fast?

Anyway, the point is that the last recession was not, in reality, short — and this one might not be, either.

And he is annoyed by Anna J. Schwartz:

Great Depression blogging: Can’t resist. I see that Anna Schwartz is blaming the Fed for the subprime crisis; I have some sympathy for this view, but not for the reasons she gives. But anyway, the article mentions the whole “did the Fed cause the Great Depression” issue, and explains succinctly why the Friedman-Schwartz claim that it did matters:

“The book was a bombshell,” says British monetarist Tim Congdon. “Until then almost everybody thought the free-market system itself had failed in the 1930s. What Friedman-Schwartz say was that incompetent government bureaucrats at the Fed had caused the Depression.”

The trick here is the word “caused”. Everyone agrees that the Fed failed to do what it should have in an effort to prevent the Depression. But saying that it “caused” the Depression is like saying that FEMA, through its inadequate response, caused the devastation of Katrina. The market system did fail; government’s failure was in not doing enough to rescue the system.

On what basis do I say this?... The monetary base is bank reserves plus currency in circulation. It’s what the Fed controls directly: monetary base only gets created or destroyed through Fed actions. M2 is a broad definition of the money supply, including a wide variety of bank deposits, preferred by Friedman and Schwartz.... M2 plunged in the Depression--and the Fed should have tried to prevent that. But the reason M2 plunged was because of the banking crisis, which led people to prefer cash to bank deposits and led the surviving banks to hold lots of reserves. This reduced the “money multiplier”: the amount of money supported by a dollar of reserves. M2 did not plunge because the Fed sharply reduced monetary base, although there were occasions in later life when Friedman asserted that it did.

The point is that the Fed’s sin was passivity. What the economy really needed was more activism.

All three of these acts of annoyance seem to me to be highly justified.

The Dollar and Its Implications: Project Syndicate

Taipei Times - archives: Is the dollar leading us into a depression?

The falling US dollar has emerged as a source of profound global macro-economic distress. The question now is how bad that distress will become. Is the world economy at risk? There are two possibilities. If global savers and investors expect the US dollar's depreciation to continue, they will flee the currency unless they are compensated appropriately for keeping their money in the US and its assets, implying that the gap between US and foreign interest rates will widen. As a result, the cost of capital in the US will soar, discouraging investment and reducing consumption spending as high interest rates depress the value of households' principal assets: their houses.

The resulting recession might fuel further pessimism and cutbacks in spending, deepening the downturn. A US in recession would no longer serve as the importer of last resort, which might send the rest of the world into recession as well. A world in which everybody expects a falling US dollar is a world in economic crisis.

By contrast, a world in which the US dollar has already fallen is one that may see economic turmoil, but not an economic crisis. If the US dollar has already fallen -- if nobody expects it to fall much more -- then there is no reason to compensate global savers and investors for holding US assets.

On the contrary, in this scenario there are opportunities: the US dollar, after all, might rise; US interest rates will be at normal levels; asset values will not be unduly depressed; and investment spending will not be affected by financial turmoil.

Of course, there may well be turbulence: When US wage levels appear low because of a weak US dollar, it is hard to export to the US, and other countries must rely on other sources of demand to maintain full employment. The government may have to shore up the financial system if the changes in asset prices that undermined the US dollar sink risk-loving or imprudent lenders.

But these are, or ought to be, problems that we can solve. By contrast, sky-high US interest rates produced by a general expectation of a massive ongoing US dollar decline is a macroeconomic problem without a solution.

Yet so far there are no signs that global savers and investors expect a US dollar decline. The large gap between US and foreign long-term interest rates that should emerge from and signal expectations of a falling US dollar does not exist. And the US$65 billion needed every month to fund the US current-account deficit continues to flow in. Thus, the world economy may dodge yet another potential catastrophe.

That may still prove to be wishful thinking. After all, the US' still-large current-account deficit guarantees that the US dollar will continue to fall. Even so, the macroeconomic logic that large current-account deficits signal that currencies are overvalued continues to escape the world's international financial investors and speculators.

On one level, this is very frustrating: We economists believe that people are smart enough to understand their situation and capable enough to pursue their own interests. Yet the typical investor in US dollar-denominated assets -- whether a rich private individual, a pension fund, or a central bank -- has not taken the steps to protect themselves against the very likely US dollar decline in our future.

In this case, what is bad for economists is good for the world economy: We may be facing a mere episode of financial distress in the US rather than sky-high long-term interest rates and a depression. The fact that economists can't explain it is no reason not to be thankful.

Economics 113: Paper Topic 1: Bellamy's Looking Backward

Edward Bellamy is a Boston social reformer writing at the very end of the ninteenth century. Even though the America of his day is much richer than the America in which he was born, he sees major flaws in American society. He also, however, sees a great deal of hope.

React to Edward Bellamy's Looking Backward in 500 words (i.e., papers of less than 450 words or more than 800 words will received grouchy readings). Consider some of the following:

• What are the major flaws that Bellamy sees in America of his day?
• What does Bellamy think of markets?
• What does Bellamy think of immigration?
• What does Bellamy think of technology?
• What does Bellamy hope the future will hold in the way of technology?
• What does Bellamy hope the future will hold in the way of social organization?
• What does Bellamy hope the future will hold in the way of economic institutions?
• What are Bellamy's major fears?
• Which of his hopes and fears have been realized over the course of the past century?

Due at the midterm on October 1.

Kevin Drum on Joe Klein and the Little Deceptions of the Mainstream Media

Kevin Drum writes:

The Washington Monthly: THE POLITICAL PAST TENSE....In his column this week griping about blogger bile, Joe Klein lets us in on a trick of the trade. He's describing a blog post he wrote shortly after the vote on the war supplemental:

Congresswoman Jane Harman of California called as the debate was taking place. "Look, I would love to have cast a vote against Bush on this," she told me....

And then Harman changed her position. After we spoke, she voted against the funding. The next day, I was blasted by a number of left-wing bloggers: Klein screwed up! I had quoted Harman in the past tense — common usage for politicians who know their words will appear after a vote takes place. That was sloppy and... suspicious! Proof that you just can't trust the mainstream media.

Huh. Is it true that politicians routinely speak in the past tense in situations like this? This makes sense (and I've done it myself) if you're taping a radio show that won't air for a while, which makes the time context unclear to the audience. But in news articles that's not really true. The time context is usually obvious.

Anyway, I've never heard this before, so it's an interesting tidbit to know. Do all politicians do this? For print and broadcast, or just print? Or what? Inquiring minds want to know.

I think that there is a little more here that Kevin Drum misses. Let's roll back the tape and watch Joe Klein:

The Iraq Vote - Swampland - TIME: I was wrong, sadly, last week to say that Hillary Clinton and Barack Obama would vote for the Iraq supplemental bill. They voted against.... Voting against it means you're in favor of a precipitous departure from Iraq.... It's difficult... to have much respect for Clinton and Obama, who... are opposed to an immediate withdrawal, but voted for a measure which, if passed, would force one.... Yesterday I spoke with Congresswoman Jane Harman (D-Ca.) just back from Iraq, who voted for the bill--as did a majority of Democrats who are not running for President. "Look, I would love to have cast a vote against Bush on this. We need a new strategy and I hope we can force one in September," she told me. "But I flew into Baghdad on a troop transport with 150 kids, heading into the field. To vote against this bill was to vote against giving them the equipment, the armor they need. I couldn't do that"...

Now there are two things wrong with Klein here. The first--the big one--is the claim that voting against the supplemental "would force" "a precipitous departure from Iraq." That's simply wrong--(i) "precipitous" needs to be redefined to mean "slowly and gradually over the next year or more," (ii) voting against this version of the supplemental has to trigger not a new round of Pennsylvania Avenue negotiations but an immediate reversion to the earlier supplemental, (iii) Bush has to--this time--sign the earlier supplemental, and (iv) all language in the supplemental has to be automatically rolled into the fiscal-2008 Defense appropriation for Klein's claim to have even a colorable chance of not being totally false. But let that pass.

But there is a second thing wrong with Klein here. It's the authorial viewpoint Klein adopts. The viewpoint he adopts is the viewpoint of someone writing and reporting about the supplemental vote after it takes place. After the roll call vote, he looks and sees which prominent Democrats he respects voted for the supplemental, and finds that Jane Harman voted against it. He talks to Jane Harman on a person-to-person level. She discusses her inmost thoughts with him. He is a Washington insider, with special sekrit access to the thoughts and ideas of powerful decisionmakers.

Suppose that a basement-dwelling bathrobe-clad weblogger had written Klein's passage. It would have read somewhat differently. Perhaps:

I thought that Hillary Clinton and Barack Obama would vote for the Iraq supplemental bill. But the clowns voted against it! By voting against it they voted for an immediate, cowardly withdrawal from Iraq, sacrificing the lives of thousands of our dedicated Iraqi allies! You can't respect them.

But there are Democrats you can respect. I have here a statement Democratic representative Jane Harman's office issued yesterday, before the vote, explaining that she planned to vote against it:

I would love to have cast a vote against the administration on this. We need a new strategy and I hope we can force one in September. But we have to think of the troops first. I flew into Baghdad on a troop transport with 150 kids, heading into the field. To vote against this bill was to vote against giving them the equipment, the armor they need. I could not do that.

UPDATE: Ooops! Jane Harman voted against the supplemental on this. I guess she found that she could vote against the troops and against giving them their equipment after all.

This second version makes no pretenses at being a Washington insider with special knowledge and insight into the hearts and thoughts of powerful decisionmakers. It makes no pretense at being able to get Jane Harman on the phone in the immediate aftermath of an important vote. It makes no pretense that one's interactions with Harman are one-on-one person-to-person talks that reveal inner thoughts rather than guarded and scripted interactions that are part of a superb politician's presentation of her public image.

One of the important things going on here is that Klein's error let slip the secret that the insider status which is supposed to create the knowledge that Time pays Joe Klein to convey to the readers is worth much, much less than Klein (and Time) with it were. After all, Harman didn't tell Klein what she was thinking, did she? She didn't say "I'm under enormous pressure here, with powerful political and policy arguments cutting both ways," did she?

An Unrealistic, Impractical, Utopian Plan for Dealing with the Health Care Opportunity

Felix Salmon deploys me as a weapon in an internecine struggle with his fellow Portfolio magazine writer Russ Mitchell Kevin Maney by blogging a piece of our coffee yesterday at Strada, at the corner of Bancroft and College, in Berkeley:

Finance Blog - Market Movers by Felix Salmon: How to Deal With Rising Healthcare Costs - Portfolio.com: Russ Mitchell weighs in on the subject of healthcare today, and specifically the problem that healthcare technology is driving prices up so far and so fast that at present rates it won't be all that long until there's no money left over for anything else. Mitchell's solution... is, in a nutshell, better healthcare for the rich.... "A real menu of health care packages, so people can choose from a variety of programs matching their needs with their ability to pay, from basic Mazda to luxury Mercedes. Employees (and the government, for the uninsured) can decide what packages they'll provide for how much."...

By coincidence, I'm in Berkeley myself right now, and took the opportunity to have coffee yesterday with Lance Knobel and Brad DeLong.... Brad painted a picture of people having spare eyeballs and kidneys stored... in a hospital basement... to... replace the existing ones if they failed for whatever reason.... I'm sure I'll get the details wrong, but in a nutshell, Brad would like to see a health insurance plan or plans in which the deductible is very large: 20% of any individual's pre-tax income in the previous year. Insurance would... [be] against catastrophically large medical expenses, as opposed to the present situation, where consumers have no real skin in the game and therefore no incentive to try to drive down prices. Where consumers do pay their own money, Brad notes, as with laser eye surgery, prices have a tendency to come down quite impressively.

Brad's system isn't perfect, of course. The cost of very expensive procedures would probably not come down much, since people would be losing their entire deductible anyway.... [M]any people might end up not getting necessary healthcare because they didn't want to pay for it. But it's still a very interesting idea which tries to seriously tackle the problem of health-cost inflation – an area where the present health plans from Democratic presidential candidates are quite weak...

Well, now that I am outed, let me explain. First, it's definitely not a plan, and it's certainly not a proposal for the current or any forseeable future policy and political environment. Think of it as a utopia--and think of it as a utopia coming from a guy who is not a real health economist but has an undeserved reputation because he was good at translating the economese spoken by real health economists like David Cutler, Sherry Glied, Ken Thorpe, Len Nichols, et cetera in a way that made it intelligible to senior Bentsen aides like Marina Weiss and Michael Levy.

So here it is:

20% Deductible/Out of Pocket Cap: The IRS snarfs 20% of your family economic income. 5% of it is an increase in taxes (but that replaces your and your employer's current health insurance premiums). 15% of it goes straight into your Health Savings Account. That HSA is then used to pay all your family health bills. If your expenses in a year are less than what's in your HSA, the balance is rolled into your IRA (or, if you prefer, returned to you with your tax refund check).

Single-Payer for the Rest: If your HSA is emptied and you still have more health bills that year, the federal government pays them. The main point, after all, is insurance: if you fall seriously sick, you want right then and there to be treated whether or not your wallet biopsy is positive.

Sin Taxes: on Tobacco, Gorgonzola, Three-Liter Bottles of Liquid High-Fructose Corn Syrup, Tanning Clinics (Melanoma), et cetera: Sin taxes (and, perhaps, someday general revenues) pay for an army of barefoot doctors and nurses and mobile treatment vans roaming the country, knocking on doors, and providing preventive and other long-run lifestyle services for free: Let me examine your prostate. Mind if I check your refrigerator and tell you how to eat healthier? Have you exercised today? I'm a Pilates instructor, and we could do a session now? Are you up on your immunizations? Anybody here have a fever and need antibiotics? Come on out to the van and I'll clean your teeth." The idea is to make the preventive care cheaper-than-free, to insure that nothing with a high long-run benefit/cost ratio gets left undone because people would rather get a bigger check the next April to use to buy an HDTV.

A Lot of Serious Research on Best Public-Health, Chronic-Disease, and Hospital Practices: Made easier, of course, by linking the payment records from the health branch of the IRS to hospital records to the wirelessly-transfered logs from the barefoot doctor vans.

That's it. No deduction for employer-paid health expenses. No insurance companies.

The key is that we face not a health-care financing crisis but a health-care treatment opportunity. Technologies are going to do marvelous things: we are going to have livers grown from our own tissue on reserve in hospital basements in case we go picnicking and eat the wrong mushrooms. We need to figure out (1) how to spread the benefits of current and future medical treatment options as widely as possible while (2) also making sure that a lot of thought and energy goes into figuring out what effective treatments have the highest benefit/cost ratios--i.e., cost least--because those are the ones we can collectively afford to do the most of, and while (3) making sure that we collectively earmark as much of our total resources to health as we really want. Government programs are good at (1). Markets are good at (2). And insurance is good at (3) if we can deliver the right incentives to insurers. These three goals are in considerable tension.

The package above strikes this relatively ignorant economist as likely to give us the best chance of getting as close as possible to utopia.

Why the 20%? Because I am very impressed by the use of technology to drive the cost reductions--which means the reductions in doctor and nurse time: the increases in the number of procedures that a given treatment unit can perform, and thus in the number of people whom we can, collectively, treat--in beneficial-but-optional areas like eye surgery and lenses. It does seem to matter that consumers are cost conscious and economize when they have financial skin in the game. This is the mother of all Health Savings Account proposals.

Why the barefoot nurses? Because there are an awful lot of games where we don't want economization. This is the mother of all public-health and subsidize-preventive-medicine proposals.

Why single-payer above 20%? Because I think there's no space left for insurance companies. Insurance executives' and actuaries' incentives are horribly wrong--they are either to figure out how to exclude the sick from their coverage or to skimp on preventive stuff because twenty years hence the patient will be covered by some other company. You want doctors to have incentives to deliver necessary and appropriate care better. You don't want insurers to have incentives to deliver shoddier and cheaper care in hard-to-monitor ways.

---

But for the current political climate, I like Obama and I like Edwards (and I am likely to like Rodham Clinton too, when it emerges): either they would succeed enough to get us to a much better place than we are at now, or if they fail they will fail in interesting ways that will make it obvious both policy-wise and politically what the next step is.

If, for example, we were to adopt Obama's plan and it were to start leaking money because young healthy yuppies were going uhcovered in large numbers, it would be clear that the needed fix was a mandate. If Obama's plan were to start leaking money because insurance companies were using the Health Exchanges and figuring out how to insure only the healthy while dumping the expensive sick into the the public part, that would create the--currently nonexistent--political will to shut the health insurance companies down.

And I am not a real health care economist. I just play one in the weblogosphere.

What Can China Do with Its Foreign Exchange Reserves?

My contribution to Project Syndicate: http://www.taipeitimes.com/News/editorials/archives/2007/06/04/2003363810

Taipei Times: When China National Offshore Oil Company tried to buy the US firm UNOCAL two years ago, it set off a political firestorm in the US. When Dubai Ports World bought Britain's P&O Steam Navigation Company, the fact that P&O operated ports inside the US led to more controversy. One would think that a country like the US, with a current account deficit of roughly US$800 billion a year, would realize that such a yawning external gap is inevitably financed only by selling off assets, which means that foreigners with money acquire ownership and control of US-based businesses. But the US -- or at least Congress and the media -- doesn't get it. Americans evidently hope for a world in which they have feckless deficit-generating fiscal policies, a very low private savings rate and a moderate rate of investment, all financed by foreign capital whose owners are happy to bear the risks yet have no control over their assets.

One might think that foreign investors would quake in terror at these terms and shy away from dollar-denominated assets. But this has not been the case. High oil prices have created huge export revenues for Middle Eastern governments, which still want to park their earnings in US assets. The same is true of Russia, whose oligarchs, as well as the huge state investment fund that Finance Minister Alexi Kudrin has created, also want to invest their oil revenues in the US. As for Asia's governments, with China in the lead, the US remains the importer of last resort. The key to their development strategy is to put migrants from the countryside to work making exports destined for the US market. They doubt that an alternative development strategy based on boosting domestic demand would succeed. Thus, the real values of their currencies must be kept low relative to the dollar, which means that their reserves now invested in the US must continue to grow.

Someday, of course, this will come to an end. Perhaps Asian real currency values will rise sharply as a result of a burst of inflation in Asia. Perhaps the dollar will collapse and there will be a burst of inflation in the US as the Federal Reserve Board decides that temporarily abandoning its price-level peg is a lesser evil than the unemployment fallout that will result from a dollar collapse and interest rate spike.

A government that buys political risk insurance by placing an ever-growing stock of reserve assets in dollar securities guards against some dangers. But it is exposed to other risks, especially if it confines its investments to that slice of the asset pool, US Treasury and high-grade corporate bonds, that US politicians are comfortable having foreigners own. Nominal bonds are not well hedged against inflation and, over the long run, assets that are claims to cash without effective control are highly vulnerable to financial vultures. Prudent foreign government and private investors would find some way to diversify.

But how? Buying other countries' bonds would mean abandoning the goal of keeping real currency values low against the dollar. Buying up whole enterprises triggers angry speeches in the US Congress. What are needed are intermediary organizations that will grant a measure of control to foreigners, allow diversification across a wider range of US-located assets, and yet still appear 100 percent American to US politicians.

Enter the Blackstone Group.

China's US$3 billion investment in Blackstone, while insignificant relative to China's US$1.3 trillion in reserve assets -- a sum headed for US$1.5 trillion by the end of this year and likely to hit US$2 trillion sometime in 2009 -- is but a toe dipped in the water, a test run. At the start of the process, China will have small and indirect ownership stakes in a great many US enterprises, and the odds are that the usual objections will be absent. China will gain a measure of risk diversification, reduce the price pressure that has kept earnings on its foreign exchange reserves low and avoid running into political trouble. Blackstone will gain extra cash to deploy and extra fees.

Some observers think that the US political backlash against foreigners "buying up America" is what will bring the current configuration of global imbalances to an end. Deals like China's investment in Blackstone postpone that backlash, but not for long: US$3 billion is equivalent to what China accumulates in reserve in less than three working days.

The question following China's Blackstone investment is this: How far can this process go? And how much control will US investors ultimately realize they have given up?

I Like Barack Obama's Health Care Plan

Mark Thoma reports http://economistsview.typepad.com/economistsview/2007/06/brad_delong_oba.html that I am live in the Financial Times:

FT.com / Comment & analysis / Comment - Obama can remedy ailing healthcare system: June 3 2007 18:44: It is an iron law of American politics that Democratic party politicians who propose relatively detailed healthcare reform plans – as Barack Obama did last Tuesday – get trashed. If they propose a plan that might actually pass, securing the 60 needed votes to close off debate and proceed to a final vote in the Senate, they will be trashed for having abandoned their base and their own principles. If they propose a plan that corresponds to the world that they wish they could attain, they will be trashed as having no practical sense. In either case, they lose. It is like hitting yourself on the head with a hammer: a pointless and painful exercise.

This is too bad, as the US needs to have a debate on its healthcare system. It spends twice as much as western Europe for little clear benefit: Americans are no more healthy or long-lived than western Europeans. If the US could get the same value for its healthcare dollars as western Europe, it would have an extra $800bn a year to spend: enough to pay room, board and private college tuition for every American 18-21 year old, and still have enough left over for Marshall Plan-scale economic development programmes for Bangladesh, Pakistan, Egypt and the Maghreb.

There is an extraordinary opportunity for the US to spend the $1,700bn a year it spends on healthcare better. The most visible and damaging part of the failure of its spending is that 45m Americans lack health insurance. Mr Obama is trying to avoid performing the political equivalent of hitting himself on the head with a hammer by proposing something more like a gardening effort. Instead of doing the equivalent of declaring that there must be an aspidistra five yards from the main gate, he is talking about providing seeds, fertiliser, water and hoes. In this way, Mr Obama’s advisers hope, he will please those party activists who want a vision of utopia and those who want a successful legislative road map.

The gardening plan begins with a tax on employers who do not offer their workers employer-sponsored health insurance – “pay or play”, it is called. If this tax induces them to do so, then the number of uninsured falls to a small and manageable number that can be covered by public hospitals: this particular flowerbed flourishes. If employers do not respond, then the government collects the tax and has money for expanded public health programmes or to subsidise affordable healthcare coverage for the uninsured working poor.In the US, however, there is an additional problem. If you are a single individual without employer sponsorship it is very hard to buy affordable health coverage. “Why do you want to be insured?” the insurance companies ask. “Are you sick? The fact that you want insurance means you are a bad risk.”

Thus the second part of the gardening plan: offer the Federal Employee Health Benefit Program to everybody. It works for federal employees. It should work for everyone – especially with subsidies to cover the cost for the working poor. If the take-up is high, then well and good: uninsurance is reduced to a minor nuisance. If people do not find FEHBP attractive, then move on to the third stage of the gardening plan: health exchanges to serve small companies and individuals the way that benefits departments currently serve the workers of large corporations, collecting bids and assuring quality from insurance companies, and so offering families choices.Mr Obama’s people are betting that at least one of these three flowerbeds will flourish: that people will opt for at least one of these options and that the problem of covering the 45m uninsured will disappear. If not – if, say, young, healthy and rich people become free riders in large numbers – then they move on to mandating coverage and levying taxes. But all four roads lead to the same place: a US that no longer has a massive uninsurance problem.

In a country with rational politics, such a plan ought to be attractive. All should recognise that failure to reform healthcare is a wasted opportunity. The right should embrace it for its market elements – allowing people to vote with their feet for the mechanisms that they want and the promise to support successful institutions. The centre should embrace it because the right has no strong ideological reason to oppose it – hence it is politically viable. And the left should embrace it because it promises the utopia of ending the problems of the uninsured. Unfortunately, however, judging by the brickbats the plan has already received, Mr Obama is set to be another victim of the iron law of American politics.

Historical Scholarship and the New Media

Courtesy of Eric Rauchway and the U.C. Davis History Department:

Historical Scholarship and the New Media: A History Colloquium event sponsored by the UC Davis Department of History, the Institute of Governmental Affairs, and the Center for History, Society and Culture, with Brad DeLong, Scott Eric Kaufman, Tedra Osell, and Ari Kelman, held May 23, 2007, at 12:10 in the Andrews Room of the Social Sciences and Humanities Building.

Downloadable .mp4 podcast (82.2M, slightly over 50 minutes of video): http://history.ucdavis.edu/podd.php

Weblogging and Scholarship

An item on my calendar for which I am not prepared looms out of the mists of time:

U.C. Davis History Department - Schedule of Events: Colloquium on Blogging and Scholarship: Date: Wednesday, May 23, 2007, 12:10, Andrews Room, with Tedra Osell, Scott Eric Kaufman, and Brad DeLong.

On May 15, 2007, at 3:57 PM, Eric Rauchway wrote:

Brad,

Below please find a Google Map customized to show you how to get to the UC Davis History Department.  Please call me on my mobile at (530) XXX-XXXX if you have any questions or on arrival.  Please document your mileage and we will reimburse you.  I'm looking forward to meeting you.  Again, the event is at noon on the 23d.

All best,

Eric

http://maps.google.com/maps/ms?ie=UTF8&hl=en&msa=0&ll=38.543873,-121.748361&spn=0.00193,0.002465&t=k&z=19&om=1&msid=111835889275877514250.0000011291e64595859e1

And I write back:

Dear Eric--

OK. So now the questions:

The question of audience: Who will be there? What will they know? What will they expect?

The question of organizer: What, in your view, would people get out of a successful event? What do you fear would happen at an unsuccessful event?

The question of style: Would it be effective to read paragraphs from Frederick II Hohenstaufen "The Remarkable"'s Executive Order setting up the University of Naples http://delong.typepad.com/sdj/2006/06/an_early_studen.html, and from Niccolo Machiavelli's "Letter to Vettori" http://www.j-bradford-delong.net/movable_type/2003_archives/000006.html? Would people be amused to hear of Greg Clark's reaction on being awakened early in the morning by a phone call from upstate New York from somebody he had never met--a phone call that began, "I want to dispute your estimate of the weight of the medieval Scottish ox"? Would the audience feel a resonance with the idea of the Invisible College[1] or would they think that twee?

The question of interaction: We economists like to interrupt--to take it for granted that everyone in the audience is already familiar with the broad outlines of the speaker's argument, and to give them ten minutes (at most) to summarize before breaking in. Others do not--they prefer to hear set-pieces followed by reaction speeches.

The question of pre-meeting circulation: What pieces of paper can I send around beforehand that people will actually read? How much? How long?

The question of participants: I think I know who I am, but who are the other two people on the panel? Am I appearing with Tedra Osell and Scott Eric Kaufman, or with [signifier] and [signifier]? This is, I think, something like the difference between Humphrey Bogart and Rick Blaine...

Yours,

Brad DeLong

---

[1] J. Bradford DeLong (2006), "The Invisible College," Chronicle of Higher Education Review 52:47 (July 28, 2006) http://delong.typepad.com/sdj/2006/07/the_invisible_c.html

For Some Reason, Mark Thoma Feels He Has to Acknowledge Stanley Fish...

And because Mark has acknowledged his existence, I feel impelled to do so too:

Economist's View: Interpreting Economic Statistics through Normative Lenses: Do economic statistics represent a value-free picture of the economy'sperformance, or are such judgments necessarily value laden? This is Stanley:

The All-Spin Zone, by Stanley Fish: It all sounds so – well – rational: There’s a world of fact out there waiting to be accurately perceived, but the distorting power of words, abetted by the psychological disorders of passion and bias, tends to obscure it and lead us astray. And the remedy? Watch your words and watch your mental processes, paying particular attention to your “existing beliefs” lest they “reject evidence that challenges them.” In short, Jackson and Jamieson recommend, “practice active open-mindedness.”

But... a 2006 statement by Karl Rove to the effect that “Real disposable income has risen almost 14 percent since President Bush took office.” Jackson and Jamieson regard this claim as “so divorced from reality as to seem unhinged.” Why? Because the real disposable income Rove cited “was a statistic that measures the total increase in income, not how that income is distributed.” That is to say, the 14-percent increase did not benefit everyone, but went largely “to those in the upper half of society”; the disposable income of the lower half had “fallen by 3.6 percent.”

Does this prove spin? I don’t think so. What it proves is that in Rove’s view, the health of the economy is to be gauged by looking at how big investors and property owners are doing, while in Jackson’s and Jamieson’s view, an economy is not healthy unless the fruits of its growth are widely shared. This is a real difference, but it is a difference in beliefs about what conditions must obtain if an economy is to be pronounced healthy. It is not a difference between a clear-eyed view of the matter and a view colored by a partisan agenda...

Dierdre McCloskey assures me that Stanley Fish is smart, so I cannot acknowledge Fish's existence by nominating him for the Stupidest Man Alive. I can, however, nominate him for Most Mendacious Man Alive. Here's why: If Karl Rove believed that an economy is doing well when its super-rich are getting richer and that the economy is doing well, Rove would say so. Rove would say something like:

We see that President Bush's economic policies are successful because the Forbes 400 today are far richer than they used to be.

Labor Secretary Elaine Chao actually did say something similar: that the economy was doing well because the stock market was up, and the stock market is what matters.

But that's not what Rove says. He says "Real disposable income has risen almost 14 percent since President Bush took office." And then he is silent. And his subsqeuent silence speaks. His subsequent silence says that that 14% number is what you need to know--that there is no major qualification that needs to be made. And so Rove's subsequent silence is a loudly spoken lie: Rove agrees with Jackson and Jamieson that a healthy economy is one with large and broadly-distributed income gains. And he agrees with Jackson and Jamieson that that is not the case. But Rove wants his auditors to think that that is in fact the case--hence his one sentence, followed by silence.

Now Stanley Fish--whom Dierdre McCloskey assures me is very smart indeed--knows all this. But he doesn't say it.

So how are we to interpret Stanley Fish's false statement that Rove on the one hand and Jackson and Jamieson on the other have "a difference in beliefs about what conditions must obtain if an economy is to be pronounced healthy"?

"Rich" and "Poor" Across the World

Dani Rodrik writes:

Dani Rodrik's weblog: And the winner is ...: The  correct answer is that a poor person in a rich country is three times better off than a rich person in a poor country (given my definition of what "rich" and "poor" mean in this context). It is not even close.

The relevant numbers are [rich individual in poor country = $3,039; poor individual in rich country = $9,387]

He goes on:

The reason we are tempted to answer "rich in a poor country" is the obvious wealth at the very top of the income distribution. But by the time you average the entire top 10%, the income level goes down quite a bit...

The thought experiment Dani does is to compare the income of the 10th percentile person in the 90th percentile country with the income of the 90th percentile person in the 10th percentile country.

I suspect that people get this wrong because when they think of "rich" they think not of Dani's 10th percentile but of the 0.1st percentile. The 10th percentile person in the world's richest country has a GDP-per-capita-concept income of roughly $12,000 a year. The 0.1st percentile person in the 10th percentile country has a GDP-per-capita-concept income of something like $60,000 a year.

The 90th percentile person we call "upper middle class"; not "rich."

While America's Watch Dogs Slept...

Mark Thoma tells me that I am live at Project Syndicate :

---

I want to deviate from my usual economic themes this month and focus instead on the system by which the press – mostly the American press – covers government nowadays. But perhaps this is not too great a deviation, for the behavior of the press affects not only politics, but economics as well.

Consider an editorial written in March by the Washington Post’s editorial director, Fred Hiatt, in which he makes a very small and limited apology for the newspaper’s coverage and evaluation of the Bush administration. According to Hiatt, “We raised such issues” as whether the Bush administration had properly thought its proposed adventure in Iraq through, “but with insufficient force.” In other words, Hiatt finds fault with himself and his organization for saying the right thing, but not loudly enough.

Next, consider a comment by the former editor of the New York Times, Max Frankel, about how the Washington ecology of media leaks is healthy, because “most reporters do not just lazily regurgitate...leaks.” Instead, “they use them as wedges to pry out other secrets” and so oversee the government. The system may be “sloppy and breed confusion,” but “tolerating abusive leaks by government [that misinform] is the price that society has to pay for the benefit of receiving essential leaks about government.”

So, where Hiatt sees a press corps that was a little too cowardly about overseeing the Bush administration, Frankel sees a press corps where a sloppy and confusing process is nevertheless doing a reasonable job.

I see a very different picture.

It was the summer of 2000 when I began asking Republicans I know – generally people who might be natural candidates for various sub-cabinet policy positions in a Republican administration – how worried they were that the Republican presidential candidate, George W. Bush, was clearly not up to the job. They were not worried, they told me, that Bush was inadequately briefed and strangely incurious for a man who sought the most powerful office in the world. One of President Clinton’s problems, they said, was that the ceremonial portions of the job bored him – and thus he got himself into big trouble.

Look at how Bush had operated as president of the Texas Rangers baseball club, they said. Bush let the managers manage the team and the financial guys run the business. He spent his time making sure the political coalition to support the Texas Rangers in the style to which it wanted to be accustomed remained stable. Bush knows his strengths and weaknesses, they told me. He will focus on being America’s Queen Elizabeth II, and will let people like Colin Powell and Paul O’Neill be America’s Tony Blair and Gordon Brown.

By the summer of 2001, it had become clear that something had gone very wrong. By that point, Bush had rejected O’Neill’s and Christine Todd Whitman’s advice on environmental policy, just as he had rejected Alan Greenspan’s and O’Neill’s advice on fiscal policy, Powell’s and Condoleezza Rice’s advice on the importance of pushing forward on negotiations between Israel and Palestine, and – as we learned later – George Tenet’s and Richard Clarke’s advice about the importance of counterterrorism.

A strange picture of Bush emerged from conversations with sub-cabinet administration appointees, their friends, and their friends of friends. He was not just under-briefed, but also lazy: he insisted on remaining under-briefed. He was not just incurious, but also arrogant: he insisted on making uninformed decisions, and hence made decisions that were essentially random. And he was stubborn: once he had made a decision – even, or rather especially, if it was glaringly wrong and stupid – he would never revisit it.

So, by the summer of 2001, a pattern was set that would lead British observer Daniel Davies to ask if there was a Bush administration policy on anything of even moderate importance that had not been completely bollixed up. But if you relied on either the Washington Post or the New York Times, you would have had a very hard time seeing it. Today, it is an accepted fact that the kindest thing you can say about the Bush administration is that it is completely incompetent, which is the line now taken by hard-line Bush supporters like the National Review and the commentator Robert Novak.

Why didn’t the American press corps cover the Bush administration properly for its first five years? I really do not know. I do know that the world cannot afford to rely again on America’s press for its information: fool me once, shame on you; fool me twice, shame on me. So I appeal to all of you working for newspapers, radio, and television stations outside the United States: it is to you that we – including those of us in America – must look to discover what our own government is doing.

---

There are honorable exceptions. Ron Suskind. Paul Krugman. McClatchy--the news service and organization formerly known as Knight-Ridder. David Wessel and the crew at the Wall Street Journal's Washington Bureau got medieval on economic policy missteps early. The Financial Times was measured but accurate, and didn't follow the strategy of keeping its good reporters off the front page.

Suggestions for other notable candidates for the honor role would be welcome...

A Teaching Note: The Gordon Equation, Earnings Yields, and Stock Returns

Why can't I find this anywhere? And I could have sworn that I--personally--had written this down before:

---

A Teaching Note: The Gordon Equation, Earnings Yields, and Stock Returns

J. Bradford DeLong, U.C. Berkeley and NBER
May 2007

At the level of the stock market as a whole, the ratio of cyclically-adjusted and normal earnings to stock prices--the permanent earnings yield--should be a good guide to the market's expectation of the real rate of return.

Think of it as a Modigliani-Miller result. Firms could pay out all their earnings in dividends and still keep their companies' productive potential unimpaired--that's what "earnings" means, after all. In that case, as long as the companies' productive potential is truly unimpaired the expected return is the earnings yield. When firms retain and reinvest earnings it is because managers see it as advantageous (to them or to shareholders) to do so. Thus with the appropriate caveats--as long as there are no big gaps between the required market and firms' internal rates of return, and as long as current accounting earnings do not grossly understate or overstate true Haig-Simons permanent earnings--the earnings yield on an index should be a good guide to the market's expectation of the long-run real rate of return on equities.

To fix this intuition, consider the Gordon equation in a steady-state context. The Gordon equation relates the long-run rate of return r on a company's stock--or a stock index--to the long-run dividend yield D/P and to the long-run rate of capital gain g:

r = D/P + g

In steady-state there is a constant dividend yield D/P and a constant share of earnings paid out as dividends:

D/E = θ

Assume also a simple generating process determining earnings. Assume a constant internal rate of return r+ρ on reinvested earnings. Earnings are then:

E = (r+ρ)K

where K is the comprehensively-defined productive capital stock assets of the firm (or index), and where the capital stock increases over time as retained earnings are used to purchase new plant and equipment or acquire already-existing productive assets:

dK/dt = E-D

In steady-state, the rate of capital gain g will be the same as the rate of growth of the capital stock:

g = (1/K)(dK/dt)

And then it is a simple matter of algebra:

(1/K)(dK/dt) = (1-θ)E/K = (1-θ)(r+ρ)

r = D/P + r - θr + ρ - θρ

θr = θE/P + ρ - θρ

r = E/P + (1/θ - 1)ρ

For ρ=0--when there is no difference between the market and the internal rate of return--then simply:

r = E/P

For θ=1--when there are no retained earnings--then simply:

r = E/P

When θ is less than one--when there are retained earnings--then earnings yields will understate returns to the extent that superior managerial knowledge of projects creates a positive gap ρ between internal and market rates of return; earnings yields will overstate returns to the extent that managerial entrenchment allows the dissipation of retained earnings on low-return projects--a negative gap ρ.

When firm managers classify investments as operating expenses to reduce tax liability, there will be a further positive wedge between r and the accounting earnings yield. Should firm managers overstate earnings to try to boost stock prices to increase the value of their options, this will drive a negative wedge between r and the accounting earnings yield.

And, of course, these are permanent earnings yields we are talking about: they must be properly adjusted for the state of the business cycle and for windfalls and non-recurring expenses.

But with these caveats--accounting earnings a good approximation to true Haig-Simons permanent earnings, managerial entrenchment offsetting superior managerial information to keep internal close to market rates of return, and so forth--the same logic that leads us to the Gordon equation conclusion that the dividend yield should be equal to the difference between the required rate of return and the dividend growth rate leads, if taken one step further, to the conclusion that the earnings yield should be the required rate of return.

The Wild, Paranoid Distortions of Matthew Yglesias (Why Oh Why Can't We Have a Better Press Corps? New Republic Edition)

Jonathan Chait--in an article titled "Paranoid Delusions"--denounces what he calls the wild, paranoid distortions of Matthew Yglesias. What are these wild, paranoid distortions? They are Yglesias's noting the existence of the elephant in the living room of the New Republic:

Yglesias: >Until its recent sale to CanWest, [the New Republic] was owned by men who seem to hate most liberals and liberalism as an ideology, which were strange attributes for a liberal publication...

and:

An institution like The New Republic, whose main institutional and emotional commitment is to right-wing Israeli nationalism (a commitment, I might add, frequently expressed through the sort of demagoguery, name-calling, and dishonesty Chait professes to find distasteful), infuriates the netroots even though individual TNR writers and articles garner praise...

The elephant's name, of course, is Marty Peretz, shaper of the New Republic's institutional dislike for prominent African-Americans, Arabs, non-Likudnik Israeli politicians, American Democratic politicians not named Gore or Lieberman, et cetera.

I think that Jonathan Chait's claim that Matt's statements are wild, paranoid distortions is a Class I breach of communicative discourse ethics. Chait's elders, peers, and betters who write for the New Republic paint, in private, a picture of the internal workings of the magazine that agrees with what Chait, in public, calls wild, paranoid distortions.

Briefly, Chait's elders, peers, and betters say that Marty Peretz:

• frequently chooses managing editors for the New Republic who have no business editing a magazine whose core subscribers are American liberals and Democrats: think Michael Kelly, Andrew Sullivan.
• places his own writings in the New Republic without their being checked or edited for sanity or accuracy or coherence.
• personally commissions articles that are then not checked or edited for sanity or accuracy or coherence.
• Hence even under the best possible managing editors there are and will always be a number of destructive, mendacious, and deceptive "specials" in the New Republic.
• Please don't judge the rest of us who write for the real New Republic by these "specials": they have nothing to do with us.
• Please don't ask us to point out in public that these are "specials" that have nothing to do with us: we can't--Peretz own[ed] the magazine.
• Please don't say that we told you that [particular articles] are "specials": we're on background here.
• There is no destructive blowback from the "specials" to the work of the rest of us--everybody knows what the "specials" are and that we and they have nothing to do with each other (even though we cannot say so).
• There is no leakage by which the reputation we gain through our work spills over and enhances the influence of Peretz and his "specials"--everybody knows what the "specials" are and that we and they have nothing to do with each other (even though we cannot say so).
• It's fair and proper that he shapes the content of the magazine this way--it's his [wife's] money that pays for the magazine.
• There's no moral fault attached to those of us who write for the real New Republic, because it's not our responsibility that some people don't understand that the "specials" are not part of the real New Republic
• If it is indeed the case that the New Republic as an institution has raised the chances that Tel Aviv (and Damascus, and Cairo, and Baghdad, and Tehran) will become seas of radioactive glass--and we are not admitting that that is the case--that has nothing to do with those of us who write for the real New Republic.

This--well, I cannot call it a defense or a justification--call it an explanation--seems to me to be inadequate. As a (former) subscriber, I think that I am paying for the best efforts of the editorial team--and I am not getting them: I have to ask with every story whether this is in fact the best the right managing editor for trhis journal would do in getting the right person to write the right story about the right question. And when it is the right person writing the right story about the right question, I have to think hard about whether and in what ways the author is redirecting or pulling his or her punches in the interest of not offending the powers-that-be. This pushes the New Republic toward the bottom of the pile--well below the FT, the news pages of the WSJ, the Economist, the Nation, the NYRB, the Atlantic, the Washington Monthly, et cetera.

An Attack on Jeremy Siegel...

Hussman is unhappy with Jeremy Siegel:

Hussman Funds - Weekly Market Comment: April 30, 2007 - Double Counting: In a little piece of hubris published in the Financial Times by Jeremy Siegel (who is increasingly becoming a modern-day Irving Fisher), investors were told:

Since the long-term real growth of per share earnings is also only about 2 per cent, pessimists project real returns of only 4 per cent in the stock market, well below the 6.5 to 7 per cent average real returns that the historical data have indicated.

Real returns can be estimated from the earnings yield, the reciprocal of the more popular price-earnings ratio. Since stock earnings are based on real assets, the earnings yield provides a good estimate of the real return on the stock market.

In the US , the long-term average p/e ratio has been 14.4 times, which corresponds to a 6.9 per cent earnings yield. This is extremely close to the historical average real return on equities. 2007 estimates for earnings on the S&P 500 Index range from $87 to $91 per share. With the index at 1,450, this leads to a current p/e ratio of between 15.5 and 16.5 times and a corresponding earnings yield – and hence real return – of 6.0 to 6.5 per cent on S&P 500 stocks. Even though current returns on stocks look good, future stock returns may even be higher....

[W]hy does Siegel say that the earnings yield is an estimate of the real return on stocks? Think of it this way. Reported earnings subtract out depreciation, which is another way of saying that earnings are reported as if the company reinvests only enough to replace depreciation and keep its stock of productive assets constant over time. If the company were not to invest anything for growth, it would theoretically be able to pay out all of its net earnings as dividends. If earnings on the fixed stock of capital could grow at the inflation rate by virtue of monetary factors alone, you would get zero real earnings growth. Then holding valuations constant over time, the earnings yield would be a measure of the real return on stocks. Fine if you believe the assumptions. Now let's look at the data.

The first problem is that in order to produce 2% real annual growth in earnings per share, companies have historically devoted about 50% or more of their earnings to reinvestment and repurchases - over 300 basis points of that earnings yield to get 200 basis points of real growth. That's a tip-off that historically, competitive pressures have prevented earnings from simply growing at the rate of inflation without new investment. You had to invest new money to get your earnings growth up to the inflation rate. In general, once your return on invested capital falls to the point where you're willing to buy your own stock instead of making new investments, the simple earnings yield overstates probable long-term real returns (especially if the yield is based on record earnings). In fact, about 1% of the long-term real return on stocks has come from an increase in the overall level of valuation in recent decades. Absent that increase in valuations, the real return on stocks would actually have been at least 1% less than the average long-term earnings yield.

Next, the historical average p/e Siegel cites is based on trailing net earnings, not forward operating earnings. Also, current earnings figures reflect unusually wide profit margins. On the basis of trailing net earnings even modestly normalized for profit margins, the relevant p/e for the S&P 500 is currently above 20, and actually closer to 25. That puts the applicable, normalized earnings yield at about 4-5% here. Give that a 1% haircut as explained in the foregoing paragraph, and assuming that p/e valuations don't contract in the future, you could expect a long-term real return of 3-4% from stocks going forward. Add in inflation of 2-3% and the long-term nominal total return priced into stocks here (say, on a 20-30 year horizon) is probably somewhere between 5-7% annually.

Over a shorter horizon, say 5-7 years, the likely real and nominal returns on stocks will probably be lower. At GMO, Jeremy Grantham estimates (and my work largely agrees) that the real return on stocks over the coming 7 years should be about -2% annually (about zero in nominal terms). GMO calculates its estimates for a wide variety of asset classes, including bonds, foreign stocks, and so forth. Grantham noted last week that “We now show – drum roll – the first negative sloping return/risk line we have ever seen. The process of moving all asset prices to fair value over 7 years (which is how we do our 7-year forecasts) will have resulted in a world where investors are paying to take risk!”

If investors believe that stocks should be priced to deliver long-term returns of 5-7% annually, then yes, stocks might be fairly priced here.

Even optimistic assumptions and alternative models produce only modest changes to long-term expected returns. For example, optimists might take the current earnings yield of 5.5% (a trailing price/peak earnings multiple of over 18) as sustainable, assume that profit margins will never come down, assume all earnings can be paid out as dividends, and assume earnings will achieve nominal 2% growth anyway due to inflation alone. In that case, stocks would be priced to deliver a 7.5% long-term annual return. Alternatively, optimists can assume that earnings will continue to grow along the peak of their historical 6% peak-to-peak earnings channel (a point from which earnings have always been vulnerable to long periods of tepid growth), and that valuations and profit margins will remain permanently elevated. Adding in a further 1.8% dividend yield, they might even estimate stocks to be priced for a 7.8% annual return.

It's very difficult, however, for a reasonable analysis to project long-term returns on stocks much higher than about 7.8% over a 20-30 year horizon. Again, 5-7% is more likely in my estimation, with nominal total returns on stocks close to zero over the coming 5-7 years.

The criticisms appear to be three:

• Accounting earnings overstate true Haig-Simons earnings needed to maintain real profitability by about 1% of market value.
• We want not earnings but earnings adjusted for the business cycle, which would give another 1% of market value haircut to earnings.
• We want price-to-trailing-earnings, not price-to-current earnings, which would give an additional haircut of 0.1% of market value to earnings.

Add up these three criticisms, and you get an adjusted earnings yield of not 6.3% but 4.2% as the long-run real return to equities.

I tend to split the difference, sitting at 5.3%, and sharing Hussman's great anxiety about the medium-term. Of course, if the medium-term turns south one way it might turn south is with substantial inflation, so bonds are not an attractive hedge. Real estate is also not an attractive hedge. A combination of European and emerging market equities looks to be the best thing you are going to get.