Friday, March 13, 2015

Smith, Marx, Schumpeter, Keynes, Mandelbrodt

There are two classes of economists:  the apologists and the ones concerned with market place paradoxes. Adam Smith is the most readable economist. His use of the word corn is confusing, corn meant grain, or animal feed which now would correspond to gasoline.  Otherwise, he wants to give you the grand tour and show you why the market place is such a great thing.  The reason is that his paradox is unanswerable: the one who wins the game gets to change the rules.  He desperately wants to convince us to stop being such chumps, in particular stopping colonialism, tariffs and government borrowing, good luck with that. All economics after Smith is embroidery.
Marx’s Capital is the Koran of economic writing, much harder to wade through than Smith’s Wealth of Nations.  Unfortunately, although Marx referenced Smith in other writing he did not preface Capital by saying you should read Smith first.  He assumed that you would have read the earlier work that he was answering.  Marx makes a lot more sense once you have read Smith.   You are undoubtedly familiar with Marx’s ideas without having dragged yourself through Capital.
1.       Labor theory of value, a reworking of Smith’s explanation of money
2.       Dictatorship of the proletariat
3.       Class Struggle
4.       Business cycle caused by short term greed
5.       Failure of colonialism (see Smith)
6.       Centralization of production leads to unions
The United States attempted to answer the business cycle by regulating monopoly, banking and trade unions.  As Smith and Marx would have predicted, the only regulations still enforced are the ones pertaining to unions.
Schumpeter’s answer is “so what”.  It’s all part of the great circle of life.  He talks indefatigably of “the creative destruction of capitalism”, not all that comforting if you are the one being creatively destroyed.
The other great apologist is Keynes.  Keynes, beloved of politicians, points out that government borrowing is stimulative.  The reason that Keynes deserves a very special place in hell is that he argued that it didn’t matter how they spend the money, the important thing is to borrow.  Recent events give a counter example.
The banks, freed of regulation, packaged and sold their loans rather than managing them themselves.  This allowed them to loan a lot more money.  In order to make these securities palatable they included insurance on the loans provided for a fee as part of the package.  Then the idiots bought their own packaged securities as investments.
Unfortunately, in order to prevent fraud the terms of the insurance required that the borrower default in order to pay off.
Call this the Mandelbrot depression. His book, The Misbehavior of Markets, published in 2004, explains that prices are fractal rather than discrete statistical events.   The previous price has a lot to do with the current price, and in that way is recursive. This means that the current financial models and risk measures are invalid.  To put it simply when people say that the markets are “risky”, they are correct.
Fundamentally, it doesn't matter what the risk is when the dollar is falling. We, the American people, voted for that.  Even before his election, it was obvious that George W. Bush didn’t care about deficits and that the electorate didn’t much either.   When we Americans say we are opposed to deficits, it means social welfare, not borrowing.
Therefore, as the dollar falls and everybody heads for the exits, it is in the bank’s interest to push borrowers into default rather than discounting the value of the loans and the quicker the better while the insurance still has funds.
Since companies with cash reserves are takeover targets, the businesses were at the mercy of the banks.
If the government had not propped up the insurance, it would have been disaster for the financial industry but investors, those that remain, would have had their choice of discounted industries shorn of their debt; this would have been Schumpeter perfection.  Instead, the banks couldn’t take the deal because they aren’t allowed to take a loss on the insured asset.  
Even today in America, manufacturing employs more people than finance.
Therefore, of course, it is crucial how the government invests the money it has borrowed.
However, as Smith and Marx would point out, it will not be for the greater benefit.
To sum up, it is true that government has the means, through regulation and intervention, to flatten the business cycle but it is unlikely that it will operate in the general interest.

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