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Saturday, August 23, 2003

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It was just a little more than three weeks ago I pointed out that Brad DeLong was leaping to Paul Krugman's defense, pounding my "straight-out lies" that "only in 'the mind of Paul Krugman, where hopelessness springs eternal' is there a 'shortage of good economic news nowadays,'" and heaping up the litany of selectively chosen data to "prove" that there is no economic recovery at hand. But time flies when you're just making stuff up to fit the bias of the moment. Now DeLong is standing atop that heap of stolen intellectual property he calls his blog and crowing that there's "More good news about the third quarter." More good news, mind you. He writes,
"Real investment in high-tech equipment has been running at a world-record pace for several quarters now. But what's different about this piece of good news is that demand is finally strong enough for capital-equipment producers like Intel to actually make some money."
Let's see what DeLong says next time Krugman claims there's no economic recovery. Oh what a tangled web we weave, when first we set out to defend Krugman's deceptions. For DeLong, merely straight-out lies would be an improvement.

Posted by Donald L. Luskin at 2:51 PM | link  

Friday, August 22, 2003

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If pomposity were an argument, Brad DeLong would win hands down. But it's not, so I have to say I'm a little confused by his rebuttal to my post "Morgenson: Markets Out of Control" [8/18/2003]. Okay, I can understand why he's a little touchy when something I write brings up questions of plagiarism. But other than that, I'm lost. On the one hand, the professor seems to be confessing that I've taught him something new. He confesses,

"I had never before imagined that anybody would ever try to draw a distinction between a yield on a bond and an 'interest rate.' I have no idea what such a distinction might be..."

But should this idea really be new to an economics professor? I would have expected he'd understand that "...real interest rates should be determined by Federal Reserve policy and by opportunities for profitable investment produced by expectations of economic growth." The yield of a particular bond, on the other hand, is determined "by 'technical' factors in the bond market--specifically, the endogenous and poorly-understood duration of mortgage-backed securities...distorted by technical factors, noise, and bubbles."

The quotes in the preceding paragraph, by the way, come from DeLong's own rebuttal. (How embarrassing.)

Update... For some reason, I don't quite believe that DeLong is being entirely honest with us when he says that this his "first expedition" to my website.

Posted by Donald L. Luskin at 12:19 AM | link  

Thursday, August 21, 2003

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I'll do a complete fact-check on Paul Krugman's column today on Arnold Schwarzenegger and the California economy (you know, the economy where the state budget grew by 13.4%, but Krugman's faulty arithmetic comes up with 10% -- an error which he has never corrected, because a Princeton professor of economics can never be wrong). But I'm almost tempted not to bother. Alan Reynolds already did such a sensation job of setting the record straight on everything that's wrong with the People's Republic of California. So get a head start and check out Reynolds. It's good stuff.

Posted by Donald L. Luskin at 11:23 PM | link  

Wednesday, August 20, 2003

FAITH-BASED REREGULATION -- READERS RESPOND    We got some great emails from readers on "Krugman's Faith Based Reregulation" [8/20/2003]. Click here to go to our letters page, and scroll down to read them all.

Posted by Donald L. Luskin at 11:48 PM | link  

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Paul Krugman began his Tuesday New York Times column -- inevitably, about The Blackout -- with one of the very few truthful statements I can recall him ever uttering:

"We still don't know what started the chain reaction on Thursday."

But after that admission that he doesn't know what caused The Blackout, he proceeds to spend the next 649 words of his column telling us exactly what caused The Blackout. Can you guess? The culprit is "faith-based deregulation."

Of course it doesn't have anything whatsoever to do with President Bush's idea for using faith-based institutions to privatize the delivery of government social services. Krugman just uses that expression to sideswipe Bush in the process of criticizing the advocates of deregulation. His point is that as the partial deregulation of the electricity industry progressed over the last decade, the transmission grid did not properly adapt, and "politicians and deregulation enthusiasts simply had faith that somehow 'the market' would take care of the problem." 

And what exactly is the problem? Though he is an economics professor, this confused explanation is apparently the best that Krugman can do to illuminate it. Bear with me here...

" experts have long warned that deregulation would lead to neglect of the grid. Under the old regulatory system, power companies had strong incentives to ensure the integrity of power transmission — they would catch the flak if something went wrong. But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system. And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable. The result was a failure not just to add capacity, but to maintain and upgrade capacity that already existed."

To unravel all this, I had a long conversation yesterday with Lynne Kiesling, director of economic policy at the Reason Foundation, and a senior lecturer in the department of economics at Northwestern University (Lynne runs the Knowledge Problem blog that focuses on power policy issues -- and incidentally, she has a wonderful op-ed on this subject in today's Wall Street Journal, co-authored with Nobel Prize-winning free markets economist Vernon Smith).

While Kiesling comes solidly from the deregulation tradition, she agrees with several things that Krugman says here. For one, the problem is not that electricity transmission has been deregulated. Kiesling notes that, indeed, it's more heavily regulated than ever -- and as Krugman himself concedes, that's part of the industry's financial problem. As the Rebecca Smith reported Monday in the Wall Street Journal, "Many power companies have simply stayed away from building new towers and high-power lines because they don't want the hassle of a public fight. Another concern is split jurisdiction: States control where lines can be built, but the federal government usually sets rates." Or as Kiesling puts it, "Our regulatory institutions were not built for a cross-border industry, but the industry has become cross-border."

And Kiesling agrees with Krugman that the deregulation of power generation has put new demands and stresses on power transmission. But where Kiesling and Krugman part company is in what to do about it. While Krugman concedes that the regulation of transmission imposes financial hardships on it, his solution is to impose even more regulation (and he strongly implies that he would favor re-regulation of the generation side of the business, too).

And according to Krugman, what stands in the way of that needed regulation? The Bush administration and the Republican Party -- of course. Krugman gripes that

"...despite the blackout, the administration will bow to pressure from Senate Republicans and drop the only part of its energy plan that had any relevance to the blackout, a FERC proposal for expanded oversight of the transmission system."

He is referring to the Federal Energy Regulatory Commission's proposed  Standard Market Design (SMD), a federalized regulatory framework for the transmission industry. It's an out-and-out lie to suggest that SMD is being delayed because of "pressure from Senate Republicans." The truth is that SMD is a sweeping regulatory regime-change that has both friends and enemies on both sides of the aisle. For example, Kiesling told me that the state of Washington would be disadvantaged under SMD relative to the status quo ante thanks to its current reliance on the heavily federally subsidized New Deal-era Bonneville Power Administration. So Washington's Democratic Senator Maria Cantwell has worked aggressively to delay SMD implementation -- "despite the blackout," as Krugman might say.

So this is where Krugman and Kiesling sharply part company. Kiesling would hold that politicians of both parties are correct not to want to rush into a regulatory regime change -- because if The Blackout has taught us anything, it is that the stakes are high in making the right decision. And according to Kiesling, we can't make the right decision, because as long as regulation fixes the retail price of electricity, "we don't know bupkis."

What she means is that, without price signals to tell producers what to supply and at what level of reliability, and to tell consumers what to demand and with what usage patterns, we really have no idea how to design an electricity industry. In Kiesling's framework, the challenge is to develop an environment in which an electricity industry can safely design itself.

With regulation, we have -- as Krugman himself admits! -- a necessarily subsidized world in which there is "little financial incentive to invest in maintaining and upgrading the system." We have a government-induced reality-distortion field in which electricity consumers can write atta-boy letters to the New York Times praising Krugman's column, whining that "We shouldn't have to make choices about electricity. It should be there for all of us, like air and water."

That's what Krugman wants more of? Talk about faith-based!

Correction [8/20/2003]... Through an editing error, the Federal Energy Regulatory Commission was incorrectly referred to as the Federal Electricity Regulatory Commission. It has been corrected in the text above.

Posted by Donald L. Luskin at 2:41 AM | link  

Tuesday, August 19, 2003

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Milton Friedman gets a lick in. After giving an interview to the Financial Times in which he seemed to recant his monetarist approach to central bank policy, he's back with a Wall Street Journal op-ed praising the inflation-fighting success of central banks around the world because, over the last decade, they have abandoned the Keynesian paradigm of targeting employment. While he may be wrong to paper over the practical and theoretical inadequacies of his own exact policy prescriptions, he's right to note that the further the world's central banks move away from Keynesian fine-tuning, the better a job they do (even if he admittedly isn't sure exactly why). This is clearly a bit of tit-for-tat reputation management in the wake of the FT interview, and catty responses to it like this one from Paul Krugman (who, correctly, finds fault with Friedman -- but would replace flawed monetarism with an even worse Keynesianism).

Posted by Donald L. Luskin at 8:26 AM | link  

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I was right -- Paul Krugman's New York Times column today is all about blaming Bush, Republicans and the great demon deregulation for last week's blackout. Well, okay -- he didn't say anything explicitly about pot-holes, like I said he would. But he implied it -- the column is called "The Road to Ruin." So there.

Anyway, what's the diff? Who needs to even read it? Here, instead, are the winners of our first Faux Krugman contest!

David Hogberg:

The evidence that we are becoming a banana republic appeared sooner than expected last Thursday. However, the deterioration of our electrical grid was not inevitable. The funds to fix it have been held hostage by this administration and its friends in the oil industry for over two years.

The Bush energy policy is just another example of this Administration’s pattern of sacrificing the public interest to reward its corporate supporters. America may be in the dark about this right now. But sooner or later the lights will come on.


From budget deficits to power deficits, the Bush administration covers them all. Serious economists agree that excessive growth in a depression- or recession-bound economy complicated by tax cuts for the rich caused a huge blip in the national psyche. The blackout of 2003 represents the darkness of the Bushies, capitalist utilities and the Republican Party. The gods of profit sacrifice infrastructure improvements and preventive maintenance for the next quarter’s earnings report, supply and demand be damned.

John Primmer:

The most diligent search through the administration’s fiscal 2001-2 budget by the non-partisan Democratic National Committee fails to show even a penny allocated to maintaining (never mind upgrading) the Lake Erie Loop of our power grid. As former Energy Secretary Richardson points out, this loop had been the pride of the previous administration, which spared no effort or expense to keep it in showcase condition. According to the non-affiliated and universally respected Michigan economist, Michael Moore, failure of this loop could not occur unless it was deliberately targeted by a terrorist organization, such as Al Qaeda or, yes, the Bush Justice Department.

Is this the whole story? Not unless the tax cuts are rolled back. As Bush Administration principal spokesperson Tom DeLay reminds us, the opposite is more likely. And don’t expect the power grid, and the millions of low income people at the most frayed ends, to be the only victims. I hope I'm wrong, but the national consensus over environmental policy is also at grave risk, as the administration cynically tries to cloak its neglectful policies with a few gaudy pipelines, transmission lines and, yes, production facilities. Thoughtful observers realize that they’ll do this because it benefits their chums at Exxon-Mobil, Bechtel, and Kellogg, Brown & Root.

Dick Sheppard:

So while the light bulbs went out in New York, the light bulbs over the heads of the Bush Energy Cabal in the White House went on. Here was an opportunity for Bush to run two currents from a single outlet of failed Northeastern electricity: Gain political hay, one suspects, by calling for a renewed infrastructure while, yes, awarding lucrative contracts to his energy company pals to build it. Sources say they haven't seen this much glee at 1600 Pennsylvania Avenue since the disgraced former president Richard Nixon heard his first wiretaps.

Robert B. Sparks:

Rather than ask "Where were you during the Blackout of 2003?" the more than 50 million victims of last week's needless tragedy should be asking "Where was Bush?"

Oh yes, that's right, our "President" was off on another military photo-op leaving the country in the well manicured hands of his Chief of Staff, Andrew Card. Nowhere to be found, too, was the entire Department of Homeland Security. According to a recent article in, L. F. Leaning indicts Director Ridge for "misquote, misquote, misquote, and while it may be omission, omission, unfortunate white lie, bald-face lie, Americans misquote."

Matt Murphy:

We still don't know what started the chain reaction on Thursday. Whatever the initial cause, however, the current guess is that a local event turned into an epic blackout because the transmission network has been neglected. That is, the power industry hasn't spent enough on the control systems and safeguards that are supposed to prevent such things.

And the cause of that neglect is faith-based deregulation.

Posted by Donald L. Luskin at 2:06 AM | link  

Monday, August 18, 2003

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So far no one has dared to take the other side of my bet that Paul Krugman's column tomorrow will be about the Bush administration's "denial and deceit" and their "tax cuts for the very rich" leading to last week's blackout. So let's try something else -- a Faux Krugman Contest! Why should Hemingway and Faulkner have all the fun? It's my friend Bruce Bartlett's idea. He wrote,

"It is so obvious that Krugman's next column will be about Bush administration duplicity in the blackout. You should run a contest for people to write his opening or closing paragraph in advance. Might be fun!

Indeed it might -- so let's do it! You can send opening and closing paragraphs as Bruce suggests, or the whole thing if you want. Remember, a Krugman column is always 765 words. Send it as soon as possible to Winners will be posted here and on National Review Online. The contest ends when Krugman's column goes up tonight on the Times web site.

Get busy!

Posted by Donald L. Luskin at 3:04 PM | link  

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From Der Spiegel, as dutifully reported on the New York Times website:

"The discrepancy between demand and reality has becoming increasingly clear to Americans under George W. Bush. The President who, like several of his cabinet secretaries, is a man with roots in the oil industry, has placed little emphasis until now on improving the infrastructure, as long as it doesn't recognizably serve the interests of Big Business. According to American economics professor Paul Krugman, public services have been cut back in many areas to the benefit of "tax breaks for the rich."

And how does shutting down commercial life for 20% of the American population "serve the interests of Big Business" or "the oil industry"? The reality is that Big Business has been chomping at the bit to earn a fair profit upgrading America's electrical transmission infrastructure. But environmental and economic regulations -- put in place by a half century of Democratic congresses -- have effectively legislated away any hope of gain (and any hope of upgrading).

Anyone want to take a bet? Krugman's New York Times column tomorrow will be a litany of infrastructure horror stories of all sorts -- from potholes on up -- and it will all be blamed on the "denial and deceit" of the Bush administration. Who'll fade me? Give me 2-to-1 on the topic, with a special double 4-to-1 payoff if he uses the expression "denial and deceit." Email me at I'm serious. We'll settle via PayPal.

Posted by Donald L. Luskin at 10:57 AM | link  

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In writing so much about Paul Krugman I have, to some extent, become distracted from writing about the most common and most dangerous media manifestation of the conspiracy to keep you poor and stupid. Krugman's only a very special case of it: his writings about the economy and the markets are the work of a knowledgeable expert who is willing to tell bald-face lies for the sake of political partisanship. But a column in Sunday's New York Times by Gretchen Morgenson is actually a much better example of the way the conspiracy really works. Morgenson's column  is based outright ignorance about the economic subject matter being discussed; it is imbued with contempt for markets and market participants; it identifies a crisis where there is no crisis; and it blames a scapegoat for the crisis that doesn't exist in the first place.

The headline says it all: "Mortgage Markets Are Out of Control." So Morgenson must believe that other markets are in control. Who controls them? Who controls the stock market, or the pork belly futures market -- are any other market? What is so wonderful about markets is precisely that everyone controls them -- and yet no one does. That seeming self-organizing quality of markets is what makes them so effective in price discovery and resource allocation -- and what makes them so threatening to elitists like Morgenson, who believe that everything of importance should be under state control (with the state to be controlled by people like... them).

The essence of Morgenson's column is that interest rates are now being determined by the mortgage-back security market, which is now the single largest sector of the US bond market. She explicitly dismisses the idea that interest rates are determined by economic growth expectations. That, she says, is only believed by "folks wearing the rose-colored shades" -- as though the whole idea that economic growth could possibly be accelerating is simply a delusion.

No, what determines interest rates "is a force so large and brutish that it could propel rates higher and faster than many investors expect: the huge mortgage-backed securities market and the leveraged traders who call it home."

How is that supposed to happen? Morgenson explains that mortgage-backed securities traders hedge their holdings "by selling short Treasury securities with maturities roughly equal to the average life of the mortgages in their portfolio." She explains -- quite approximately -- how when mortgage rates rise and fall, the average life to be hedged changes (bond experts call that effect "convexity"), driving the need to adjust the Treasury hedge. When mortgage rates fall, hedgers must buy Treasuries (because, presumably, these brutish people find themselves short -- how very Hobbesian); when they rise, hedgers must sell them. That, she claims, produces "a snowball effect that can push rates far lower or higher, and faster, than in previous years."

Okay, there's nothing basically wrong with that explanation of increased Treasury volatility. Although my friend Jameson Campaigne noted in an email to me that much the same point was made last week in much the same language in the August 2003 Whitebox Market Observer -- oh, surely a coincidence! A Pulitzer Prize winner like Morgenson would never plagiarize from a publication affiliated with her old boss Steve Forbes...

Be that as it may, to the extent that the fixed income market has become increasing populated by high-convexity securities, there will be some spill-over to lower-convexity securities, insofar as all markets are linked. This is entirely natural and basically harmless (and probably averages out over time). If there are some market participants who would rather that Treasury yields not be so volatile as a result of this effect (or any other), well... there are many nice things that one can wish for, but the fact that one must wish does not mean that there is anything wrong in the world. It just means one must do something to earn one's wish -- other than kvetching.

And none of this says anything about what determines interest rates. However mortgage rates and Treasury rates are determined, neither of them are interest rates per se -- they are both nothing more than the yields of particular securities that reflect interest rates (just as stocks, and -- to differing extents -- everything else in the economy reflects interest rates). Interest rates are an abstraction. They are, by definition, the opportunity cost of money across time -- and opportunity cost is a function, mostly, of expected growth rates and expected inflation.

Thus Morgenson's explanation of rates being determined by mortgage trading is left looking very much like that so-called "proof" of the existence of God holds him to be the "prime cause." One can ask, "what caused God?" If moves in mortgage rates are the prime cause of interest rates, one can ask what moved mortgage rates? The answer is -- expected growth rates and expected inflation. Opportunity costs.

Morgenson inadvertently confesses as much, in a paragraph that she must not realize contradicts her entire thesis. Immediately after explaining how mortgage traders "helped push interest rates down to ridiculous levels earlier this year" and then later made "interest rates spike," Morgenson states,

"Last week, the Federal Reserve rattled the bond market by promising to keep rates low for as long as possible. Traders feared that the accommodative stance could be inflationary. They sold Treasuries, and rates rose."

Huh? First she says that the violent move in rates are caused "mortgage-backed securities market and the leveraged traders who call it home." Then, without taking a breath, she cites an explanation that has nothing to do with the mortgage market whatsoever. I have no idea (and either does Morgenson) what, if anything, "traders feared" last week. But at least this explanation gets to one of the true definitional drivers of interest rate changes -- inflationary expectations. Such expectations move mortgage markets and  Treasury markets (and those two markets move each other, too, as all markets move each other to some extent).

Having described -- and contradicted -- a problem that is not a problem, Morgenson looks for a scapegoat. And so the inevitable conclusion to a Gretchen Morgenson column -- the pointing finger, and the dire warning:

"It is unfortunate that the problems of mortgage traders can create such havoc. But these traders drove down rates, benefiting consumers, companies and bondholders. Now, it is higher borrowing costs — and their grimmer implications — for which everyone must prepare."

Why not say just the reverse? It works too: "these traders drove down rates, impoverishing investors, savers, retirees and companies invested in money market funds. Now, it is higher income -- and all its delightful implications -- for which everyone must prepare." Why didn't she include that perspective? Because the conspiracy to keep you poor and stupid requires that think of the market as a terrifying place where you are a likely victim of people who deliberately "create such havoc." When you think that, you'll want to be protected. And there is no shortage of politicians and regulators -- and the journalists who pimp for them -- who are only too happy to protect you... right into poverty.

Correction [8/18/2003]... Due to a simple typographical error of the kind that cannot be caught by spellchecking, as originally posted, I wrote that the mortgage backed securities market "is not the single largest sector of the US bond market." The word not should have been now. Thanks to Robert Musil of the Man Without Qualities blog for pointing this out.

Posted by Donald L. Luskin at 1:40 AM | link