I Don’t Know How to “Solve” Banking, and I Doubt Anyone Does

Unless I’m wrong, and you know how to solve it, in which case let me know in the comments. I’m curious. Or get it published in an Economics journal, and get the Nobel prize.

DollarSign

Consider this scenario: Vinny the Loan Shark, whom you owe $50,000, came up to you at 9:00 this morning and said, “Gimmee my fifty back by 5:00 tonight or I’ll break both your legs.” Vinny is a very direct guy. Isn’t it great to get away from stuffy circumlocutions?

Fortunately, you own a house worth $100,000. No problem! You’ll just sell it by 5:00 this evening, and you’ll have enough money to pay Vinny back and then some. You and your legs will be fine. What’s that? You can’t liquidate your house that quickly? Or dear, you do have a problem. I hope your health insurance is paid up.

Before you censure Vinny too harshly, grok this: When it comes to banking, you and I are Vinny.

See, we all want banks to offer checking accounts so we can use them to pay for stuff. Obviously this only works if you can spend the money in those accounts any time you want. So, from your point of view, the funds in that account are a zero-maturity asset. From the bank’s point of view, since they have to make payment whenever a check is cleared, those funds are a zero-maturity liability.

The problem, of course, is that most of the bank’s assets are in rather illiquid forms like 10-year loans they made to businesses, 30-year mortgage loans they made to families to buy houses, etc. They can’t liquidate all that instantly. So if a bunch of checking account owners – Vinnies – come up to them at once and say, “We all want our money back right now,” the bank can’t comply.

This is called a bank run and leads to that exciting scene in the movie It’s a Wonderful Life in which the bank where the hero works suffers a run and he has to deal with the emergency. It also leads to the same thing happening in real life, which is more exciting but less entertaining.

“OK,” you say, “just prohibit banks from holding very much of their assets in 10-year business loans, 30-year mortgage loans, etc.” Alas, that won’t work, because you and I demand that banks provide mortgage loans so we can buy houses. And businesses need loans for various purposes, etc.

So here’s the problem: You and I, the public, demand that banks borrow money from us with zero-maturity checking accounts and lend to us with 30-year mortgage loans. This is called “maturity mismatch,” for obvious reasons, and it’s not just an unfortunate accident that banks are set up this way. The public demands that they be set up this way. How are we supposed to square this circle?

I don’t know. So far, no one else knows, either.

Deposit insurance has greatly reduced the problem of bank runs, but as the crisis of 2007-2009 showed, we are far from Eden.

I once heard an economist say that he thinks the current system— riven though it is with occasional banking panics, waves of failures, etc.— may actually be the best that can be achieved! It was much worse in the bad old days. At the start of the Great Depression, there was a banking crisis that forced about 30% of the nation’s banks to shut their doors! Believe me, the regulators are very aware of the maturity mismatch problem. We’ve been tinkering away with banking policy in the last 80 years and seem to have improved things, but certainly haven’t achieved perfection.

So: If you know how to totally fix banking, send a quick email to Jerome Powell. He’ll appreciate it.

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International Trade: Oh God, Not This Again

Aright, bitches, the free trade thing.

This is not one of my “issues,” and I incline toward free trade, but the people who create these so-called free-trade deals obviously aren’t setting up free trade, and many of these “elites” (we need a better word for power-mad idiots) have an end-goal of eliminating western populations. They love treaties that destroy jobs held by European-descended people.

But they have much more dangerous ways of working toward that goal, which is why trade is low on my list of priorities. But for those for whom it is a high priority, some advice about debate:

Don’t contest free traders on theory. That’s their strength. Contest them on the thing that actually matters: the practical realities.

Why not take them on in the arena of theory? Because comparative advantage theory is not speculation. Its core proposition is a theorem, like the Pythagorean Theorem. That is, its core conclusion is proven to follow from the premises. We can judge from the amount of chatter that economists devote to it that the core proposition of comparative advantage theory is this:

If two nations have different tradeoffs in production, then there exists the possibility of mutual gains from trade.

(“Tradeoffs in production” means the slope of the production possibilities frontier, which describes a nation’s tradeoffs of one good for another. Like, how many apples they must sacrifice to grow another orange.)

This is the proposition free-traders have in mind when they repeat their mating call, “Ricardo!”

PPF
A production possibilities curve, showing tradeoffs in production.

And how are these gains from trade to be realized? Answer: if two nations have different tradeoffs in production, then it can be proven that they can minimize their joint costs of production… IF they trade in the right way.

The right way is the cost-minimizing way, where “cost” means the cost in terms of other goods you must sacrifice. (E.g., if you switch land from growing apples to growing oranges.) Minimizing costs of output means more output. So produce and export goods of which you’re the low-cost producer. That’s trade according to comparative advantage.

You cannot dispute the if-then statements in bold without looking like a doofus to anyone who is knowledgeable.

So don’t dispute them. If someone tells you, “Here is a triangle that is NOT a right triangle, and the Pythagorean Theorem tells us that…” you should point out that the Pythagorean Theorem doesn’t apply if it’s not a right triangle. Don’t dispute the Pythagorean Theorem; you’ll look like an idiot. Dispute its relevance to the matter at hand.

If you want to argue against so-called free trade agreements, here are some points you can make:

1. Verifying what a county’s comparative advantage is, is empirically impossible as a practical matter. Note what the central theorem says and doesn’t say. It says that if countries have different tradeoffs, then there exist some mutually beneficial trading opportunities. It doesn’t say that we know what those opportunities are… let alone that we can guarantee that actual trade is according to those mutually beneficial possibilities.

2. So-called free trade agreements are never actually that. Many people have made this point. They’re managed trade agreements, in which governments tweak the interventions they do in international trade.

Even George F. Will, before he became a contemptible cuck, pointed out when NAFTA was passed that if it were really a free trade agreement it would only be a couple of sentences, not hundreds of pages.

3. The proposition that there exist mutually beneficial gains is a statement about the aggregates of a nation. The theory does not say that all groups within the nation benefit. It leaves open the possibility that one group benefits to the tune of 10 units while another group loses 8, for a total aggregate gain of 2. OK, but if you’re in the group that loses 8 it’s not clear why you would support such a move. This is actually not heterodox, apparently. I once read on some Econo-blog about a (peer-reviewed!) paper that concluded that one group could benefit and another lose, from moving to free trade. I can’t cite the paper(s) off the top of my head, but apparently this has been out there in the literature for years now.

4. The theory says nothing about who captures the gains from trade even on a nation-to-nation level. It could be, in principle, that one nation captures all the benefits from trade and leaves the other nation exactly as well off as it was before. Except that not really, because all the adjustment costs are real costs, and then you never get any benefit. Adjustment costs include e.g. having to move to a new state to get a new job. Ricardian comparative advantage theory totally ignores adjustment costs.

The same point applies if your nation gets a small benefit from adjusting its industries, but the benefit is smaller than the adjustment costs.

* * *

Of course there is a real case against government interventionism in trade. The real case against interventionism is that governments are no more knowledgeable or angelic here than they are in any other area of life. They are ignorant and corrupt assholes, and there’s no reason to let them tell us what we can buy or sell.

Above I pointed out that many of the people who create “free trade deals” hate western populations. Well, giving those same psychopaths power to limit the trade we can do would be even worse than the current situation. In the current pro-free-trade political environment, they at least have to pay some sort of lip service to reducing trade barriers, which has occasionally forced them to actually do such. If we tell them, “Go ahead and control who we can trade with,” they will do exactly that, with great joy and gusto, and it won’t be with our best interests at heart.

If these people ever get the unlimited power they crave, they’ll try to starve us to death, following Stalin’s Ukraine genocide. Part of that attempt will be outlawing food imports. They’re likely to try that anyway, if they think they can get away with it, but for fuck’s sake let’s not make it any easier for them.

But all this is a relatively long-term issue. In the current political situation, worrying about international trade is rearranging the deck furniture on the Titanic just after it got hulled by the iceberg. Right now we need to worry about emergencies like immigration and the lawless judiciary. Once we solve those problems, we’ll have all the time in the world to worry about trivia like trade policy.

Socialism: Why you can’t do that

When socialism was a rampaging idea in the twentieth century, part of the intellectual war was the socialist calculation debate. This debate made the point that a socialist central planner could never have enough information to plan the economy. The basic reason is that you need to know people’s desires to do that, and the only way to know their desires is to set them free and see what choices they make.

Additionally, the engineering tradeoffs in the economy are immensely complicated. E.g., how much steel should we devote to building apartment buildings, how much to car production, how much to computer production, etc.? Only a decentralized mechanism – markets – has a prayer of dealing with those tradeoffs in a sane manner. A market economy is a practical solution to the information problem because each small unit – each firm or individual person – only has to wrestle with their own small piece of the economy. They don’t have to plan the whole thing.

Furthermore, markets have a crucial feature: Feedback. Businesses are punished for bad decisions by making losses. A central planner, in a world without profit and loss, wouldn’t even know about his mistakes, let alone have any incentive to correct them.

Socialists, being socialists, got their asses thoroughly kicked in this debate, then declared victory. (Plus ca change…)

A while ago Slate Star Codex had a post reviewing a book, Red Plenty, in which these issues arose. In the comments the socialist calculation debate flared to life.

One commenter says of the planners’ problem compared to the market problem, “This fails a simple sanity check. I refuse to believe that [individual] humans are able to calculate those equations…”

This fails to get a large number of relevant points. To mention just two:

(1) To solve that planning problem, the planner would need information about people’s preferences, which is in the people’s heads, so the planner would have to read people’s minds. The people, in contrast, are not faced with the problem of reading their own minds.

(2) The individuals don’t have to solve the same problem the planner does. They have prices to do a large amount of the computational work for them. Market prices convey information; specifically, prices sum up the scarcity of something relative to the demand for it. Here’s economist Friedrich Hayek, in a famous passage (http://www.econlib.org/library/Essays/hykKnw1.html, paragraphing added for ease of reading):

Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose-and it is very significant that it does not matter-which of these two causes has made tin more scarce [relative to the demand for it].

All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply.

Hayek notes that if information is decentralized, and everyone just deals with their own small piece, the problem is manageable. He continues:

If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes… and so on; and all this without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes.

Tin’s price could have gone up due to a decrease in the supply… and a very large number of things could cause such a decrease. It also could have gone up due to an increase in demand… and a very large number of things could cause such an increase. The people making choices affected by that price don’t need to know why it went up— it is a summary statistic that only conveys what they need to know— but the planner does have to know. To plan efficiently, the planner has to know whether tin’s price rose due to an increase in demand for it, and what and where that specific demand was… or due to a decrease in supply, and what the particular decrease was. Otherwise the planning problem can’t be solved. E.g., maybe someone has discovered a new industrial use for tin, a new technological development. The planner, in contrast to market participants, must know this to come up with a new optimal plan – the planner can’t optimize without even knowing the engineering tradeoffs in the economy!

Now the “sanity check” radar of the commenter mentioned above may be pinging. “Why,” he might ask, “does the planner need to know something the market participants don’t need to know? Why can’t the planner just replicate whatever info-processing mechanism makes this work in a market economy?”

Answer: Because the mechanism that makes it work is decentralization.

Memo to socialists: You can’t have a goal of central planning, then whine because your goal involves centralization.

(Socialists in the 20th century often said the planners could use prices. This assumes an answer to the question that is being debated. Where do the prices come from? Who sets them? What gives them any connection to real-world supply and demand?)

Alternatively, you could embrace decentralization – and I hope you do – but then you’re basically just replicating the market. (In the context of a basically market economy, conventional deviations from pure market, like taxes and welfare programs, are of second-order importance compared to the complete informational chaos that would attend an attempt at central planning.)

This is what the commenter meant, though he didn’t know it, when he wrote,

“What really happens is that those humans don’t really calculate all those equations, but use some simplified version. But then, why does the computer need to use the 1,001,000 equations instead of using similar simplifications, or approximations, or better algorithms…”

The simplifying trick those humans use is decentralization.

This is, indeed, the dilemma upon which all socialist notions must founder: Either you depart radically from the market, in which case you can’t solve the information problem and all is chaos, or you simply replicate the market outcome, in which case why bother?

One more point: If you’re trying to enlist me in your violent revolution that’s going to kill tens of millions of people to replace the market, you’ll have to provide an argument a lot more concrete than, “There must be some way to do it.”