Who Gets the Pie?

October 27, 2010

Suppose a family of four was setting down to desert after dinner; a pie is cut into eight equal pieces. Each member of the family received two slices. Now, suppose one member of the family said, “Let’s create eight additional slices and split the pie into sixteen equal pieces.” Clearly, if each member of the family received four slices there would be no practical reason (other than a smaller serving size) to create the additional slices. The amount of pie each family member received would be exactly the same.

Suppose that the pie cutting member of the family has an ulterior motive. He wants more pie at the expense of everyone else. So after slicing the pie sixteen ways, he gives everyone the same two slices they previously had and keeps the eight additional slices for himself. Someone in the family might remark, “My slice of pie is smaller and less filling.”  “No, you are mistaken,” he lies. “You are receiving the same amount of pie you always have.”

This little story gives us insights as to why the Federal Reserve inflates the supply of money. Have you been trying to make sense of the incessant claims by policymakers and some economists that in order to save the economy the Federal Reserve has to engage in a new round of quantitative easing? The Fed tells us that our inflation targets may be too low and may need to be increased. You might be asking yourself the obvious question—how would more inflation help the economy?

The answer is, it won’t. In the pie example, after cutting the pie in eight pieces, each of the four people expected two slices. If you cut the pie into sixteen slices and gave everybody four slices, increasing the number of pie slices will have no effect. But when people expect two slices, if the pie cutter increases the number of pie slices to sixteen, the pie cutter will have slices to keep for himself or to give to other favored pie eaters—increasing the number of pie slices has an effect. And that is exactly what the Federal Reserve does. When the Fed increases the supply of money and credit, the new money is not injected equally throughout the economy. For some, due to inflation, their slice of the pie shrinks; others get more.

Admittedly my pie analogy is simplistic. I use it to help cut through the idea that we should leave policy to the experts. But how can an expert like Ben Bernanke be so wrong? Some say he is an innocent Chauncey Gardner character; others believe he is simply a puppet whose strings are pulled by his banking masters. The more likely explanation is that Ben Bernanke is who he seems—a bright but limited man being guided by incorrect theories that have taught him that bright men can and should control the economy.  The end result of our hubris will be suffering on a larger scale than we can imagine. No, our is not a typo—it is our collective hubris that empowers Bernanke’s personal hubris.

Regardless of Bernanke’s motives the question remains: who is getting the new slices of pie? Here are some recent examples:

This week the New York Times reported that “the real wage and salary income of finance industry employees based in Manhattan rose nearly 20 percent in the first quarter of this year. That surge helped make Manhattan the fastest-growing county in the United States in terms of terms of year-over-year gains in income.”

This week when asked about receiving bags of cash from Iran, Afghanistan  President Hamid Karzai said “This is normal…The U.S. gives us large bundles of cash as well.”

Of course, asset bubbles form as new money is injected in explosive amounts. Grain prices and other commodities have increased sharply with wheat and corn both up over 50% this year. If firms try to pass on their higher costs through higher prices, family budgets feel the pressure of the increase. When firms are unable to raise prices due to market pressure, they feel increased pressure to reduce labor costs and unemployment increases.

Bloomberg reported yesterday on the Fed-induced  bubble in junk bonds: “The lowest-rated junk bonds are the most expensive corporate debt following a Federal Reserve- induced rally in high-risk assets, adding to concern fixed- income securities are overvalued.” No doubt after this bubble bursts, “for our own good,” we will be giving our pie to those who recklessly invested again.

Yet, we are told, if not for the heroic efforts of Ben Bernanke, we would have a terrible depression and no pie at all. Of course, a clear thinking child could see through the lies. A child might ask: “Has Ben Bernanke created even one new pie?” The answer, of course, is “no”—his policies have helped to redistribute the pie: Ordinary Americans who are not subsidized have given their share of the pie to the financial services industry, to contractors waging war in Afghanistan, to General Motors, to junk bond investors, and you name it.

This is an uncomfortable post to write. I have always taught that free market economies expand the supply of the proverbial pie. On a free market, there is no reason to see the world through win-lose eyes. Yet, we no longer have anything resembling a free market. For many Americans, their share of the pie is now contracting; a new round of quantitative easing will only reduce their share of the pie further.


Against the Fall of Night

October 21, 2010

There have been many memorable moments in my teaching career. A memorable moment never occurs just because of something I say but because of the impact it has on the audience. Without an impact, my words quickly fall back into the nothingness from which they come.

I distinctly remember a Saturday morning MBA class back in the fall of 2002. I was explaining Friedrich Hayek’s ideas on the rule of law. After interpreting Hayek’s ideas, I began to explain that the seed corn for respect for the rule of law must be stored during prosperous times. In other words, the metaphorical phrase “eating our seed corn” is applicable not only to physical assets and money, but also to ideas. During economic downturns, as the fear level goes up, the pressure on the rule of law often becomes great; it become difficult to keep intact respect for this important principle of a free and prosperous society. Of course, it doesn’t take too long until the Faustian bargain—trading the cultivation of long-term principles for short-term expediency—backfires.

I gave as an example the housing market. I explained why I thought housing was overpriced, and why we could expect to enter a manic phase of the market. This was in 2002; I was naïve and had no idea how overpriced the housing market was to become. I explained that because we were not storing the seed corn of respect for the rule of law, when the housing market did crumble, many would demand to be bailed out for their mistakes. To be sure, I didn’t anticipate that the banks would demand to be made whole for their costly errors. I was thinking more of homeowners who would claim that they which tricked into buying overpriced homes and would ask for government bailouts.

There was a bright and energetic woman sitting in the class. That day she played the part of Rick Santelli (the CNBC reporter who went off about homeowner bailouts on live television)—even before any of us heard of Rick Santelli. My version of what was to come resonated with her; she was outraged. “I’m going to be bailing out those who bought more housing than they can afford,” she emphatically exclaimed.

Both the student and I were innocent that day. Neither she nor I had any idea or how bad things would get. Meet Jim and Danielle Earl:

In 2001, Jim and Danielle Earl bought a home in California with a $500,000 mortgage. As housing prices began to rise, like many others, the Earls began to use their home as a cash cow. In 2005, they refinanced their home for $880,000.  By the time their house was foreclosed on, they owed over $1,000,000.

According to the Wall Street Journal: “ Investors…bought the house for $697,000 at a lender’s trustee sale and put $40,000 of work into a remodel, replacing carpeting and appliances, as well as upgrading the kitchen.” Investors then sold it to new buyers for $800,000.

Last week, just as the new owners were about to move in, the Earls, accompanied by their lawyer and a locksmith, broke into the home and moved back in. The police were there but stood down for the break-in.

In the Wall Street Journal, Michael T. Pines, the attorney for the Earls, is quoted as saying:

I’m trying to teach homeowners what their rights are. In my opinion, they are the legal owners of the property. All of these foreclosures, all of these evictions are grossly unlawful. All of the loans that are currently outstanding are grossly unlawful. Homeowners have a right to get their houses back because they were illegally stolen from them. I feel very confident in saying they have the legal right to do it.

In other words, Pines believes that not only are the foreclosures are illegal; but the mortgages are illegal too. Apparently, foreclosed homeowners should be given the homes free and clear of any financial obligations. Danielle Earl said, despite being over $880,000 in debt, “I don’t believe I owe anything at this point.”

Of course, not owing anything is the logical conclusion of placing a moratorium on foreclosures. A house is foreclosed on when the mortgage loan payments is not being made, usually the home owner has been delinquent for many months. The only possible way to still keep the delinquent homeowner in the house is to forgive or substantially write down the debt.

But why not write down or forgive the debt? Wouldn’t that be a good social policy? Wouldn’t that hasten an economic recovery?

There are many reasons that forgiving the debt is a bad policy. First, it will delay a housing recovery as housing prices are prevented from reaching a sustainable price level. Next, it will make it very difficult to sell foreclosed homes; new home buyers will find it impossible to obtain title insurance for such homes. Importantly, it creates a moral hazard for other homeowners to default on their loans.

But most importantly, it would further destroy respect for the rule of law. A vibrant economy depends on a vibrant middle class playing by the rules and believing that the rules are fair. Despite politicians continuing to claim that the banking sector bailouts were a necessary evil, there is still widespread disgust and anger; the general public feels they were forced to bail out the banking sector’s gross errors. The next wave of disgust and anger will occur as those who play by the rules watch those who don’t play by the rules reap large windfalls. Why should homeowners be rewarded when they bought houses they couldn’t afford and then took out home equity loans? Dangerous populist political movements will be born out of such disgust and anger.

In the former Soviet Union, where the rule of law was not respected, there used to be a maxim: “He who does not steal, steals from his family.” In other words, take every unfair advantage that you can get; since everyone else doing so, if you don’t, you are at a disadvantage.

In 2002, when I predicted that underwater homeowners would demand to be bailed out, I never foresaw that they would be breaking into homes with the police standing down. I never foresaw that they would demand that their mortgages be completely forgiven. Eight years of politicians and ordinary Americans working against the rule of law have made such nightmares possible.

The English poet A.E. Housman asked in his poem Smooth between Sea and Land:  “What shall I build or write against the fall of night?” When there is a sea change in collective attitudes about how society should be organized, the answer to the poet’s question is nothing. Nothing will change until individuals change their minds.

In his classic essay “Individualism: True and False,” Friedrich Hayek cautioned: “While it may not be difficult to destroy the spontaneous formations which are indispensable bases of a free civilization, it may be beyond our power deliberately to reconstruct such a civilization once these foundations are destroyed.” We can hope we change our minds before night falls.

Field Guidance

September 23, 2010

I recently read a news story about North Korea’s despotic leader, Kim Jong-il. He was on the scene at a coal mine, according to the North Koreans, to provide “field guidance” to the mine’s workers. Most North Koreans tolerate or support a system that has starved millions to death and has reduced most of the rest to a state of unimaginable deprivation. Support for the regime can be traced, in part, to relentless propaganda that first Kim Jong-il’s father, Kim Il Sung (the so-called Great Leader), and now Kim Jong-il (the Dear Leader) are semi-divine and possess powers far beyond those of mortal men. Apparently, one of those powers is an ability to dispense accurate field guidance.

Waiting in the wings to succeed his father is Kim Jung-Un. The North Korean propaganda machine is going full steam ahead as it reports on Kim Jung-Un, calling him “the brilliant comrade.” No doubt his brilliance will allow him to dispense field guidance at least equal to that of his father and grandfather.

If it wasn’t for the terrible human suffering in North Korea and the possibility of war on the Korean Peninsula, it would be easy to view all of this nonsense with amusement. It is easy to dismiss what we hear in North Korea believing it is something totally different from the American experience. Unfortunately, we are not so different. In the United States there are plenty of “brilliant comrades” dispensing “field guidance.” The only difference between North Korea and the United States is the degree to which their “field guidance” has ruined the economy.

Consider Larry Summers, the president’s current (but set to depart early next year) chief economic advisor. Last week we covered his arrogance, now let’s take a look at some of his pearls of wisdom. One of Larry Summers’ pronouncements on the automobile bailout is shared by Steven Rattner in his book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry:

“We’re already in Vietnam,” Larry Summers said in a separate meeting, referring to the all-but-certain decision to provide more aid to the auto makers. “I can imagine doing something in Cambodia.” By that he meant indirectly helping a few key suppliers, the equivalent of fighting from Vietnam and not sending ground troops across the border. But there he drew the line: “There’s no way we’re going into Laos.” He wasn’t about to commit the government to a full-scale invasion that involved bailing out the entire supply chain.

Apparently, Summers speaks in metaphors that only those attending a Georgetown cocktail party could appreciate. Is this brilliant “field guidance” or nonsense from a meddling and, despite his reputation, apparently mediocre mind? Consider this: While Summers was president of Harvard he approved the purchase of over 3.5 billion dollars of financial derivatives involving interest rate swaps. Like most of these derivatives, this ended badly for Harvard as Harvard lost approximately two-thirds of its investment.

Despite this, Summers had the temerity to appear on CNBC last week and pronounce that: “This administration is committed to fixing the disaster brought about by the last one which was solely a function of financial deregulation.” Of course this is absolute nonsense and flies in the face of Summers’ own record at Harvard. A major cause of the disaster has been decisions made by individuals, such as Summers, who believed they were smarter than the rest of us. They took risky bets and then demanded to be bailed out.

If the United States was completely unlike North Korea, Summers would have been repudiated by now. Rather than issuing economic advice to the president, he would be out of a job like the millions of workers his policies have helped to displace.

Of course, Summers is not the only one dispensing “field guidance” in the United States. To be fair to Summers and our other field guides, they are not as vicious as their North Korean counterparts. But they are just as wrong about their abilities as are those in North Korea’s Kim dynasty.

Consider Congressman Barney Frank. As chairman of the House Financial Services Committee, Frank is generous in giving out his “field guidance.” For example, regarding the automobile industry, in June 2009, Frank called Fritz Henderson, then GM CEO, and demanded that Henderson keep open a GM distribution center in Frank’s Congressional District. Frank discussed with Henderson “the facility’s value to GM.” Henderson agreed to keep the facility open after having his arm twisted. In his own mind, Frank was dispensing needed “field guidance” on corporate assets.

Or consider President Obama. Rattner relates this conversation:

Mr. Obama had asked, “Is there any way these guys are going to avoid bankruptcy?”

“Unlikely,” he was told.

“Why can’t they make a Corolla?”

“We wish we knew,” replied his advisers.

Again, this is a conversation best fit for a Georgetown cocktail party. Most people outside of government and academia understand that one could no more “make a Corolla” then “make a Mozart.” The ability to make a reliable, inexpensive car like a Corolla is grown over many laborious interactions through a discovery process that takes many years. A Corolla cannot be ordered up by central planners. GM and Chrysler could not make a Corolla because their top-down, hierarchical organizational structure with all their plans did not allow for enough innovation and discovery. If a Corolla could simply be ordered up, Chrysler would be the number one carmaker in the world; and North Korea, the world’s wealthiest economy.

The Diminishers

September 16, 2010

Before he resigned in the summer of 2009, Steven Rattner was Obama’s Car Czar (officially the leader of the Presidential Task Force on the Auto Industry) nominally in charge of the bailout of the automobile industry. Recently the Wall Street Journal published excerpts from Rattner’s new book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry.

In the excerpt, Rattner conveys a sense of gravitas as he relates stories of the endless meetings and the hard work that he and other administration officials put in on the automobile bailout.  Treasury Secretary Geithner and Larry Summers, Director of the White House National Economic Council, are large figures in his narrative. Rattner is writing to an audience that shares his view of the world: Washington insiders are powerful people who are smarter than everyone else, who work harder than everybody else, and by dint of their superiority, should plan the economy for us. For anybody else who doesn’t share that worldview, the Wall Street Journal excerpt serves as a reminder of how far America has gotten off-track.

Consider Rattner’s description of Summers. Rattner writes:

I was well aware of his reputation for bumptiousness . But working for him turned out to be stimulating, enjoyable and harmonious. Like me—with more justification in his case—Larry didn’t suffer fools. Titles and résumés meant little to him; he listened to what was said and decided whether the speaker seemed worthy of attention…

When he returned from a meeting in the West Wing, fuming about stupid ideas that had been put forward, Marne could calm him. Larry visibly worked hard to control himself. At one meeting I attended, a junior colleague in the bleachers (the couch on the other side of his office) offered an unsolicited comment. “That’s one of the silliest…” Larry began, but then caught himself and said, half under his breath, “That’s the old Larry. The new Larry says, ‘Have you thought about it this way?’ ”

Once Diana Farrell, one of Larry’s deputies, began to offer an opinion, but before she passed the midpoint of expressing her thought, Larry interrupted to say (not harshly), “I’ve already considered that idea and rejected it…”

Larry was an economist, however, not a businessman. Occasionally I thought he didn’t have the best perspective on financial markets or business. I wasn’t sure that he wanted to be told bluntly that he was wrong, especially by a subordinate…

And Rattner’s conclusion about Summers? He writes: “Our discussions were the high point of my Washington experience; I would leave convinced that there could be no happier future circumstance than the chance to work for him again.”

Rattner seems to idolize Summers. We can imagine that Rattner was led to believe by Summers that he, Rattner, was one of the special bright ones. Bumptiousness means crudely assertive; and by many accounts, Rattner’s description of Summers is dead on. Summers thinks he is smarter than everyone else.

In their excellent new book Multipliers: How the Best Leaders Make Everyone Smarter Liz Wiseman and Greg McKeown observe how those leaders who think they are smarter than everyone else can actually diminish the intelligence of others. They call such people diminishers. They write:

Some leaders seem to drain intelligence and capability out of the people around them. Their focus on their own intelligence and their resolve to be the smartest person in the room had a diminishing effect on everyone else. For them to look smart, other people had end up looking down. We’ve all worked with these black holes. They create a vortex that sucks energy out of everyone and everything around them. When they walk into a room, the shared IQ drops and the length of the meeting doubles. In countless settings, these leaders were idea killers and energy destroyers…

The Diminisher’s view of intelligence is based on your elitism and scarcity. Diminishes appear to believe that really intelligent people are a rare breed and I am one of the few really smart people. They then conclude, other people will never figure out things without me.

Most of us understand well the dynamics of the diminisher. We have been both victim and victimizer as we have worked for diminishers and have played the part of a diminisher. Perhaps we are more of a diminisher in private with our spouse and children. Perhaps in public we have trained ourselves to appear more receptive to others, while not really listening to what someone else is saying. If so, no matter how polished our behavior is, we are fooling no one.

For many of us, age and the demands of our career begin to bring wisdom. The follies of our youthful arrogance fade as life and reflection teaches us that it is impossible for any of us to have but a fraction of the available knowledge that could be brought to bear on a problem. We learn that if not for the efforts of others, we would live in abject poverty.

But reflection often doesn’t come easy to those in academia or government. Privileges and protections in both fields of endeavor encourage an individual to believe that he or she is special. The diminisher can become a permanent role for such an individual.

To be sure, diminishers are prevalent in corporations too. But, they tend to be selected against in corporations. Why? A diminisher leaves important organizational intelligence on the table and, in so doing, diminishes the viability and profitability of his or her organization. There is no such profitability constraint in government or academia where intellectual arrogance is all too prevalent.

When we play the part of a diminisher, we assume that for anything to get done, everything has to be funneled through us. We assume control and micromanage everything.

Diminishers believe in a zero-sum game. Their status is enhanced as others look bad. In the world of the diminisher, there is no room for the genius inherent in each individual to shine.

Diminishers may think they are special, they may think they are the life of the party, but most would disagree. Working for Summers may have been a happy circumstance for Rattner, but most would feel otherwise. For most of us, having our ideas shot down through instant analysis by an arrogant person is not fun. Most Americans don’t believe that Summers’ self-proclaimed wisdom means he has any special insight into the car industry. The average citizen does not believe that Summers should be able to confiscate their earnings from their productive endeavors and redirect their earnings in a way that Summers sees fit.

Diminishers and the diminisher that lurks in each of us are inimical to a free society. Diminishers don’t trust others to make decisions, believing they should plan for the rest of us.  As we each decide to stop being a diminisher, we automatically withdraw our permission for all the Larry Summers of the world to intellectually bully and exercise power over us.

Producers and Thieves

October 22, 2009

Today it was announced that Kenneth Feinberg, the Treasury Department’s special master for compensation, “will slash compensation for the 25 highest-paid employees at seven firms receiving large sums of government aid.” In a free-society, there is no room for a “compensation czar;” the problem will be gone instantly when the aid is eliminated.

In his classic book The State, the German sociologist Franz Oppenheimer taught there are two means to wealth: economics and political. In his inimitable blunt style Murray Rothbard sums up the difference between the two:

There are only two ways for men to acquire wealth. The first method is by producing a good or a service and voluntarily exchanging that good for the product of somebody else. This is the method of exchange, the method of the free market; it’s creative and expands production; it is not a zero-sum game because production expands and both parties to the exchange benefit. Oppenheimer called this method the “economic means” for the acquisition of wealth.

The second method is seizing another person’s property without his consent, i.e., by robbery, exploitation, looting. When you seize someone’s prop­erty without his consent, then you are benefiting at his expense, at the expense of the producer; here is truly a zero-sum “game”–not much of a “game,” by the way, from the point of view of the victim. Instead of expanding production, this method of robbery clearly hobbles and restricts production. So in addition to being immoral while peaceful exchange is moral, the method of robbery hobbles production because it is parasitic upon the effort of the producers.

With brilliant astuteness, Oppenheimer called this method of obtaining wealth “the political means.” And then he went on to define the state, or government, as “the organization of the political means,” i.e., the regularization, legiti­mation, and permanent establishment of the political means for the acquisition of wealth.

In other words, the state is organized theft, organized robbery, organized exploitation. And this essential nature of the state is high­lighted by the fact that the state ever rests upon the crucial instrument of taxation.

What good is a theory if it is not applied? I don’t know if Max Keiser has ever read Oppenheimer or Rothbard, but listen to Keiser as he colorfully explains the differences between firms like Google who earn their wealth through production and the banking industry who he explains has obtained its wealth through theft.

Is this mere hyperbole on Keiser’s part? While I can’t say, as Keiser does, that accounting fraud is currently being committed by the banks, I can say that the bonuses being paid would not be paid on a free market. These bonuses are being financed, in part, by direct transfer of taxpayer’s money and by record low interest rates that indirectly transfer resources from productive savers into the hands of banks and debtors. The latter is a direct consequence of Federal Reserve policy.

For many, Keiser’s words create cognitive dissonance; and cognitive dissonance may cause an instant rejection of his message. Cognitive dissonance “is an uncomfortable feeling caused by holding two contradictory ideas simultaneously.” Dissonance, according to psychologist Carol Tavris, “produces mental discomfort, ranging from minor pains to deep anguish; people don’t rest easy until they find a way to reduce it.” After all, aren’t our government officials looking out for our well-being? Surely they are more concerned about the well-being of all Americans than they are concerned about the bankers? If you believe the answer is “yes” to both questions, then Keiser’s message will produce dissonance in you. Yet, the facts suggest Keiser is more right than wrong:

  • “An analysis of Mr. Geithner’s calendars…shows that Mr. Geithner had contact with top executives at Citigroup, Goldman Sachs and JPMorgan Chase more than 80 times during his first seven months at Treasury.” Source here.
  • “Goldman Sachs posted near record trading profits in the third quarter of 2009.  The projected 2009 Goldman Sachs bonus pool will be around $20 billion, a near record amount. Therefore the average pay out per employee could be more than the $661,490.” Source here.
  • “As a whole financial firms “accounting for more $350 billion in federal bailout funds, increased these perks and benefits 4 percent on average last year, according to an analysis of corporate disclosures filed in recent months.” Source here.

Without government bailouts, these result would not have been possible—failing firms do not pay bonuses.

None of this is to say that officials like Treasury Secretary Geithner are evil individuals who are consciously trying to undermine the American economy. Instead, perhaps Geithner has his own form of cognitive dissonance as he tries to internally justify his behavior. He may begin with a truth that a healthy banking system is essential to the American economy; and then, he may resolve his dissonance by adding the false premise that JPMorgan, Chase, Citibank, etc. are essential to a healthy banking system.

Nothing could be further from the truth. The financial institutions that are being subsidized took reckless risks. The economy cannot have a sustained recovery until those firms which made bad loans and who can not survive without government assistance are liquidated. Nothing in the conduct of these financial institutions suggests that they have reformed. They will continue to seek the political means to wealth; and like a drug addict who would destroy his family before giving up his habit, they and their government enablers will do the same to America. And when they are through, they will relieve their cognitive dissonance by chanting the big lie—there was nothing else we could have done.

The Delusion of Control

May 27, 2009

The National Association for Business Economics released a survey this week reporting that “more than 90 percent of economists predict the recession will end this year.” On that forecast, I would not bet any money that I could not afford to lose.

Their cautious but optimistic forecast is in line with those of government officials, such as Ben Bernanke, and it reflects two biases. First is the well-known herding mechanism that drives forecasters. If you issue a forecast that is in line with the forecasts of others but the consensus is wrong, who can blame you? There is safety in numbers. All who are wrong exclaim, “We didn’t anticipate….” The second bias comes from the belief that surely what Obama, Bernanke, and Geithner are doing will have some effect.

In her book A Mind of Its Own, Cordelia Fine describes a classic social psychology experiment about the delusion of control:

Take, for example, a task in which volunteers are asked to try and get a light to come on by pressing a button. Volunteers are told that the button might control the light; in fact, the light comes on and off randomly and its illumination is entirely unrelated to what the volunteer does with the button. Yet although the volunteers have actually no control over the light, their perception is very different. They experience the illusion of control, as it is known, and claim to have an influence over the light. As subjects for further vanity, people rate their personal control more highly if the light happens to come on more often. In other words, we are even more susceptible to the self flattering impression that we are responsible for how things have turned out when they turn out well.

Let’s apply this to our seemingly bottomless—for now—faith in the capacity of Obama, Geithner, and Bernanke to control the economy. Obama, Geithner, and Bernanke tell the public that there are light switches in their offices and that they know how to turn them on. The three of them sit by their switches, frantically trying to get the lights to come on. And when the lights happen to come on—in other words, when there is occasional good news about the economy—the public dutifully applauds and says on cue, “Aren’t we fortunate that in our time of troubles we have found such talented individuals who know how to turn on the lights.”

The only problem is that—to the extent they have any control at all—their light switches are not connected to a healthy economy but rather to mechanisms that causes further harm to the economy.

Notice the title of my essay is “The Delusion of Control” and not the more genteel “The Illusion of Control.” David Gershaw explains the difference between illusion and delusion.

An illusion is a perceptual disturbance, while a delusion is a belief disturbance….a delusion is a deeply held false belief that is maintained—even when other information contradicts the belief. The contradictory information is either ignored completely or discounted in some way.

In other words, some are under delusions about how the economy works. They believe—against all evidence—that the cure for too much debt is even more debt and that the cure for a failed business decision is a bailout. They are not suffering from illusions; they are deluded.

Back to the forecast by the business economists. An astute observer, Bill Bonner, recently wrote:

The private sector is not going to begin a new growth period until they’ve paid off, worked out, defaulted on, or shirked a lot of their present debt load. We’ve estimated that they need to get rid of about $20 trillion worth. And that’s going to take time. And a lot of painful decisions by a lot of people. Bad business, investment and spending decisions need to be recognized…and fixed. Debt needs to be reduced.

Do business economists really think that this process—in the face of all the interferences by government—will be completed this year?

Does Bloodletting Boost Stocks?

May 21, 2009

Daily we are told by the pundits that consumer confidence is back and that the worst of the economic crisis is over. It is not hard to find stories such as yesterday’s at CNNMoney.com where Paul La Monica told us:

The market rally keeps chugging along. And even though some are concerned that stocks have moved up too quickly from their March lows, there is one undeniably healthy thing about this surge: Investors are not nearly as afraid about the economy as they were a few months ago.

What is the cause of this optimism? The Washington Post tells us today:

The improvement [in the financial system] reflects the combined impact of a wide range of actions, many of them taken with little public attention, according to government officials and private economists. But more important than any single program, the sources say, is a deepening confidence from financial markets that the government is prepared to take aggressive action — a confidence that Obama officials have repeatedly worked to cultivate in speeches and public appearances.

In other words, the good guys are in office, they are very smart, and they are willing to act. So now, we can all be confident.

Treasury Secretary Geithner told the Washington Post: “A huge part of getting out of this crisis is about confidence. And it’s the impressions, the impacts, not just by the quality of policies themselves, but by the sense of action by the government . . . that’s critically important to confidence.”

According to Geithner, it doesn’t even matter what he, Bernanke, and Obama do, as long as they do something. Can this really be true?

A classic logical fallacy is post hoc, ergo propter hoc which means “after this, therefore on account of this.” In other words, Geithner, Bernanke, and Obama took action; therefore, since the stock market is going up, it is because of their boldness. Of course, this negates obvious questions, such as “Why did the markets go down until March?” And other explanations, such as “the market is in a classic, countertrend, bear market rally that many expected and predicted,” are ignored.

And what happens in the not-so-distant future when the stock market begins to fall and goes under its March low? First, we can be sure that the media will not apply post hoc, ergo propter hoc to Obama, Bernanke, and Geithner. We will be told that the market is going down despite all of their heroic efforts. And those “heroic” efforts will continue—despite evidence that they don’t work.

Consider bloodletting. The “art” of bloodletting as a medical treatment persisted for over 2500 years until the 19th Century. Here is one account of an unfavorable outcome—the death of George Washington:

According to his physician’s notes, Washington was afflicted with an inflammation of the upper windpipe on a Friday night. As it progressed, he developed a fever and difficulty breathing. Following medical standards of the time, he had someone come to bleed him that night. Twelve to 14 ounces of blood were removed, but he did not improve. The next afternoon, he was bled “copiously” twice more. When that proved ineffective, another 32 ounces of blood were removed. In addition to bleeding, his physicians also tried purging. By Saturday night, he was dead.

While here is an account of a “successful” treatment in 1824:

One typical course of medical treatment began the morning of 13 July 1824. A French sergeant was stabbed through the chest while engaged in single combat; within minutes, he fainted from loss of blood. Arriving at the local hospital he was immediately bled twenty ounces (570 ml) “to prevent inflammation”. During the night he was bled another 24 ounces (680 ml). Early the next morning, the chief surgeon bled the patient another 10 ounces (285 ml); during the next 14 hours, he was bled five more times. Medical attendants thus intentionally removed more than half of the patient’s normal blood supply—in addition to the initial blood loss which caused the sergeant to faint. Bleedings continued over the next several days. By 29 July, the wound had become inflamed. The physician applied 32 leeches to the most sensitive part of the wound. Over the next three days, there were more bleedings and a total of 40 more leeches. The sergeant recovered and was discharged on 3 October. His physician wrote that “by the large quantity of blood lost, amounting to 170 ounces [nearly eleven pints] (4.8 liters), besides that drawn by the application of leeches [perhaps another two pints] (1.1 liters), the life of the patient was preserved”. By nineteenth-century standards, thirteen pints of blood taken over the space of a month was a large but not an exceptional quantity. The medical literature of the period contains many similar accounts-some successful, some not.

Bloodletting persisted so long because favorable outcomes were attributed to the treatment, while unfavorable outcomes were deemed to have occurred despite the excellent treatment.

Bloodletting is an apt comparison to the bailout orgy that Washington is giving us. Unfortunately, the “blood” of healthy and productive economic contributors is being “let” and it is being transferred to those who are already dead, such as Chrysler.

Can that work? Of course not! But not to worry! The treatment, according to Geithner, doesn’t matter. The public will become more confident with every quart of blood he takes.

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