Dental Malpractice and the Wisdom of Markets

The Economist's lead story this week is "Lessons from the Credit Crunch". The leader raises more questions than it answers, and I was surprised to see the venerable British newspaper equate Ben Bernanke to a dentist. A dentist who commits malpractice would be more to the point.

In 1979 I rented an apartment on the east side of Manhattan, diagonally across from the United Nations. The rent was $240 per month. The cockroaches were thrown in for free. Today, New York's cockroaches have multiplied several times, but apartment values have gone up even more. My father-in-law's apartment on the west side of Manhattan runs in the range of $2.5 million.

Of course, Manhattan apartment prices have gone up more quickly than prices in general. The Bureau of Labor Statistics, a branch of the US Department of Labor, has an inflation calculator that says that the a 1979 dollar has the purchasing power of $2.87 today. Thus, the value of that dollar has eroded to 1/2.87th or 34.8 percent of its value over the past 28 years. This equates to a compound inflation rate of about 3.7% per year over the past 28 years. Currently, savings account rates range in the New York Metro area from 0.10% at Astoria Federal to 5.23% at Amtrust Direct. Thus, a large part or all of the return on savings accounts is eaten up by inflation. No wonder more Americans do not save and that they have been on a borrowing binge. Because of Fed policy, the chief way to get ahead with saving is through the stock market.

But is every American supposed to be a stock market guru? What effect does this distortion of returns have on other economic choices, such as where to locate factories or what careers people might pursue? Can the Fed's economists answer such questions? Do they care that they have played a role in distorting and perhaps grievously harming the United States's economy?

It would seem that people who put money into savings accounts see small or negative returns. Who puts money into savings accounts? Not the affluent readers of the Economist, who have Ph.D.s, law degrees or MBAs and work in high paying jobs. Rather, the low-wage worker, older retiree and schoolteacher. They are the Economists' suckers.

1979 was the last full year of the Carter administration. Thus, the moderately aggressive inflation that has proceeded since 1979 has been the product of the Greenspan Fed, which spanned three Republican and one Democratic administrations. Given the relatively high rate of inflation, which has served to harm the thrifty, one would suppose that few media outlets would have much to say that is positive about the Fed's competence at fighting inflation. But this is not the case. The Economist and the other media outlets have little negative to say about 3.7% inflation over 28 years, which is more than enough to cause massive distortions in expectations, investment and economic decisions.

Moreover, these statistics understate the problem because the federal government has gotten into the confidence game. In general, government has not proven itself competent in areas like education; health care financing (to wit, the massive fraud in Medicaid in New York); regulation of taxi cabs; rent control; social security; crime; operations ; the Iraqi War; Vietnam; the New York City subways; higher education; welfare; or virtually anything else government goes near. It bungles everything. Yet, economists, Democrats, Republicans, the major news media and the Economist encourage trust in government inflation statistics.

There are specific reasons to question the veracity of inflation statistics. The Department of Labor discontinued inclusion of house prices in the Consumer Price Index about 25 years ago and replaced them with rents. Probably not coincidentally, house prices have gone up at a much faster rate than rents. My apartment in 1979, a one-room hell-hole, probably sells for $500,000 today. By replacing house price increases with rental increases, the Department of Labor may have reduced the visible inflation rate by one third. The true inflation rate since 1979 may be closer to 5% per year. Lying about it makes the effects worse, not better, because the least sophisticated, the poorest Americans are the ones who make the worst choices.

The St. Louis Fed publishes M-1 money stock statistics here In September 1979 the stock was $379.3 billion. In September 2007 it was $1,368.8 billion. In other words, the money supply has grown 360% while official prices have gone up 287%. People who keep their money in savings accounts, the middle class schoolteacher for instance, are poorer. Hedge fund managers and Wall Street financiers are wealthier because low interest rates invigorate the stock market. Low rates do this by increasing the present value of expected earnings (for an explanation of this point see my blog "The Fed's Inflation Has Driven American Jobs to the Third World"). Moreover, official CPI increases may be understated by one third or more, so the true inflation rate may be very close to the 28-year m-1 money stock increase.

The Economist's leader involves much double talk. Double talk is common among economists and media that cover money supply and income inequality because the Federal Reserve, banking and financial system is the one thing that the establishment really cares about protecting. Moreover, both political parties and the labor unions, which are mainly in construction and the public sector, have a major stake in the Fed and in inflation, and the Economist and economists are part of the establishment gravy train, as is the academic left and Moveon.org, which owes its funding to hedge fund operator George Soros. Thus, the entire ball of wax aims to blow smoke about the Fed. The school teacher and truck driver have no friend.

The Economist fails to disappoint in its leader. First, the Economist claims that:

"since the 1970s, the central banks' record has been remarkable."

The writers don't specify why they believe a compound inflation rate of 3.7% and negative returns to savers, increasing income inequality and a dollar crisis are "remarkable". Perhaps the Economist believes that the Fed's performance has been "remarkable" in the sense that PT Barnum was remarkable.

Second, the Economist makes the argument that

"Central banks have done more than enough to justify the argument that monetary policy should be run by technicians rather than by elected politicians--an astonishing achievement in a democratic age."

Anyone familiar with the history of the Fed knows that is nonsense. There were no monetary policy experts before 1913, and there is no need for monetary policy experts now. Government destroys everything it touches. By claiming expertise, the state bamboozles the public. The banking lobby has convinced the public that there should be government involvement in the money supply, then establishes a Fed that panders to bankers, Wall Street and large corporations while claiming that some "technical calculation" is involved in counterfeiting. No special expertise is needed beyond a lack of conscience and a comfort level with fraud. Since 1913 there have been steady increases in the money supply and inflation. American democracy thrived from 1776 to 1913 without a Fed. It has no need for technicians of the Alan Greenspan and Ben Bernanke variety. The Economistt advocates quackery.

Moreover, the Economistt makes the claim that "central banking has become an increasingly technical business performed by leading monetary economists". This is gibberish. There is nothing technical about increasing the money supply 4 percent a year. The Fed represented the interests of banks and the wealthy in 1913; they represented them when Roosevelt took the US off the gold standard in the 1930s; they represented them when Nixon took the dollar off gold internationally in 1971; and they represent them now.

The Fed is a political body. As Mancur Olson has pointed out, special interest groups benefit tremendously when they can pretend policy issues are complex, or when they can make simple issues like monetary policy seem complex. Indeed, monetary policy need not be a governmental function at all. Claiming it is complex is like claiming that the determination of oil prices is complex. It isn't complex if you have a free market. It is complex if you try to mimic a market, or replace fallible human judgment for the market. Then you make work that seems complex, but it is nonsense work.

The Economist claims that "if any economists have become the 'dentists' that John Maynard Keynes thought they should aspire to be, it is those in central banks." But if the central banks have become like dentists, the dentists commit malpractice. They drill where there are no cavities. They print money and cause inflation. They extract wealth from the poor and reallocate it to the wealthy.

Indeed, the Economist contradicts itself in the following paragraph. On the one hand it claims that the Fed has performed like dentists. On the other, they say that "loose monetary policy is partly responsible for the mess that the central bankers are now trying to clean up." Which is it? Technical experts? Or dentists who commit malpractice?

Review of Jane Jacobs' Dark Age Ahead

New York: Random House, 2004, 241 pp., $23.95 hardbound

Jane Jacobs’s book Dark Age Ahead, published last year, is a major disappointment. In her most famous book, Life and Death of Great American Cities, Jacobs’s arguments are close to those of the Austrians and other free marketeers. She argues that communities need to evolve spontaneously, and that large scale planning schemes such as the urban renewal of the 1950s had been a failure.

Dark Age Ahead shows that without an underlying theoretical grasp, even the most brilliant authors with the most brilliant insights, such as those evinced in Life and Death of Great American Cities, are likely to falter. In Dark Age Ahead Jacobs claims that Western civilization is teetering on a Dark Age because our culture cannot cope with technological change and interest group pressure on public policy. Ms. Jacobs defines a Dark Age to be a state of cultural amnesia, a “horrible ordeal” where a previous way of life slides into “an abyss of forgetfulness” (pp.6-7). She claims that five trends interactively evidence an incipient Dark Age. These include: (i) The decline of the suburban family and community, (ii) credentialing in higher education, (iii) second-rate science in fields like traffic engineering, (iv) incompetently managed public finance systems and (v) the decline of ethics in the accounting profession.

With respect to the decline of the family and community, Ms. Jacobs points out that the spirit of community characteristic of the urban neighborhoods of the 1950s is missing in twenty-first century suburban communities. Her point that modern urban planning has resulted in the deterioration of community spirit and family relationships is similar to arguments in Death and Life of Great American Cities.

In the second chapter, Ms. Jacobs argues that credentialing, or an emphasis on obtaining a degree regardless of the quality of the underlying education, has become the primary business of North American universities. Complaints about the rituals of higher education date back at least to Thorstein Veblen’s (1993) Higher Learning in America, and in light of this tradition Ms. Jacobs does a credible job of depicting higher education’s transformation into an employment signal. In her view credentialing has served the narrow economic interests of universities as well as employers.

With respect to second-rate science, Ms. Jacobs criticizes the lack of scientific imagination of traffic engineers, public health experts at the Centers for Disease Control, and Canadian economists.

In a chapter entitled “Dumbed-Down Taxes” Ms. Jacobs discusses the fourth trend, incompetently managed public finance systems. Ms. Jacobs argues that government works best when it is responsible to the people it serves, and that this objective is best satisfied when government finances are transparent. Government accounting and budgeting processes often serve to cloak what “provincial kleptocracies” (p.110) do with federal grants. Not enough resources are available for social programs, and there is an absence of fiscal accountability because government accounting information is obscure. Her concerns about fiscal responsibility and budgetary equity in Canadian provinces are similar to issues that face state governments in the U.S.

Ms. Jacobs’s observations with respect to the fifth trend, the decline in professional ethics, notably with respect to the accounting profession, reflects the recent series of corporate scandals involving Adelphia, Enron, Lucent, Tyco, Worldcom and other large firms. This chapter is weak because it confuses issues involving government accounting with the corporate scandals, and fails to address either government accounting or the scandals coherently. Harvard professor Robert N. Anthony (Anthony and Young, 1993) has spent a substantial part of his notable career arguing that government and private sector accounting should not be treated all that differently, and conservative economists such as Mancur Olson (1983) have developed theories that explain the lack of transparency of public sector accounting in terms of special interest group pressure. But problems with government accounting are at most obliquely related to the private sector accounting issues that have been relevant to Enron et al.

An underlying problem with Dark Age Ahead is that Ms. Jacobs’s definition of Dark Age is vacuous. Ms. Jacobs’s definition of a Dark Age as cultural forgetting implies that 18th century American culture is in a Dark Age of cultural forgetting because the techniques of slave driving, horse-drawn carriage driving, and blood letting as a medical cure have been forgotten. Rather, some form of compulsion, elimination of free choice, or erosion of transportation or communication systems would seem to be necessary for a Dark Age.

Social scientists sometimes accuse economists of methodological imperialism when the economists extend their neoclassical paradigm to adjacent fields. In this book Jacobs seems almost imperialistic in discussing education, labor economics, general science and political science.

I had philosophical quibbles with much of the book. For instance, Ms. Jacobs’ claims about the Centers for Disease Control study are overdrawn. Rather than suggesting a Dark Age, the incentive structure provided to government researchers likely offers clues as to why their work was of poor quality. The solution might be to redesign the incentive structure, although the special interest group pressures that government employee unions pose may play a role. Perhaps Ms. Jacobs should have included a chapter on the role that public sector unions play with respect to economic decline.

Likewise, in the chapter on government finance, Ms. Jacobs intelligently argues for fiscal accountability in government. But she also condemns “neo-conservative” approaches to “reinventing government” such as requirements that government programs pay for themselves. Of course, the reason voters often have favored such “neo-conservative” reforms is the very lack of accountability and misuse of government monies that she observes in other contexts. Ms. Jacobs seems to argue both that (a) government programs should be encouraged even though (b) government behaves unaccountably.

Ms. Jacobs is a fine writer and imaginative observer, but this book is far from her most important work. Rather than indicating a Dark Age ahead, many of the issues that she adduces could best be resolved by limiting government, a solution that she paradoxically opposes. It is a significant loss to libertarians that Ms. Jacobs lacks the theoretical rigor that would have directed her toward a more consistently free market solution set. Her ideas are garbled and self-contradictory. This book represents a loss to anyone seriously interested in seeing reform of liberalism’s failed institutions.

References

Anthony, R.N. and Young, D Management Control in Non-profit Organizations Seventh Edition. Boston: McGraw-Hill/Irwin 2003.

Jacobs, J. Death and Life of Great American Cities, New York: Vintage Books, 1992.

Olson, M. The Rise and Decline of Nations, New Haven, Conn.: Yale University Press, 1983

Veblen, T. The Higher Learning in America, New Brunswick, NJ: Transaction Publishers, 1993.