Did FDR Make the Great Depression Worse?

Fortune has an article on the growingly common criticism that FDR's New Deal actually prolonged the Great Depression. The conclusion is that it probably wasn't as good as the fans claim or as bad as the critics complain. But I found an interesting juxtaposition of information. Here are statements from the article:

• "Roosevelt's programs were first passed in 1933 but economists generally agree that the Great Depression did not end until 1939, when the country began preparing for World War II."


• "On the more dire end of the scale, Harold L. Cole and Lee E. Ohanian, economics professors at the University of Pennsylvania and UCLA respectively, estimate the New Deal's labor and industrial policies caused the Depression to last seven years longer than otherwise."

Does that mean that the Depression should have been over two years before the New Deal was even passed?

Wall Street and the Wages of Estimation

Last week, the New York Times blog Bits had a piece about Wall Street analysts "lying" to their computers. Written by a journalist who has covered both the Internet and trading and finance, it indicates how little many reporters know about the mathematical processes they write about -- otherwise there might have been much earlier warnings of the problems now facing the world's economy.

Yes, the current meltdown is supposed to be a "once in a hundred years" event, as the president of a consulting firm told the reporter. However, these black swan events, when considered together, happen far more frequently than every hundred years. That's because when you have potential events that are independent of each other, but still capable of creating financial cataclysm, the cchance of at least one of them happening is the sum of the separate chances of a given one happening.

So already experience and math suggest that the surprise at an unusual event should have the same tone as Captain Renault being "shocked, shocked" at the gambling at Rick's in Casablanca. The concept of adding probabilities for independent events has literally become math in grade school, or at least high school.

Now for the other revelation:

The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.

Top bankers couldn’t simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the models say a firm’s risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong.

In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn’t see much risk.

I'm sure there's something to this, but let us get at a more fundamental issue: many complex problems in math and engineering and science are too tough to easily solve. What people do, then, is simplify. You put the world into models and approximations that you have a prayer of solving. You drop factors that seem tiny in comparison with the rest of the problem in an attempt to simplify the equations even more. You employ numeric methods to get closer and closer to the "real" answer ... as close as you need.

Unfortunately, your answer is simply an approximation, nothing more. It may be acceptible for your uses if the real world conditions are forgiving enough. But when things get hairy -- you're trying to predict the behavior of materials in the face of quantum mechanics effects or trying to understand how an incredibly complex system, such as the weather or global finance, will behave -- then approximate may not be good enough. If a chip fails, well, you head back to the drafting board. When an economy fails, then you end up with huge banks and investment companies going out of business, oil prices swinging by $25 in a single day as short-sellers have to cover their positions, and governments begging for the right to spend $700 billion of taxpayer money to get their croneys out of the frying pan.

The Fed in an Insulated Nutshell

The Washington Post has a good editorial on the Fed that explains a lot. Yes, it's been worried about the credit crisis, but it's always worried about something, and that has kept the U.S. central bank from significantly raising interest rates for years. "No worry of inflation," it has claimed. Guess what? The Fed's definition of inflation comes with a pair of blinders:

Every American who drives or shops for groceries understands this [that prices of food and energy are soaring], except at the Fed, where they bow before something called "core inflation." This is a way of measuring prices without including food and energy, and so we are supposed to take comfort that "core inflation" is rising at only a 2.3% annual rate. Yet it is the Fed-induced price spike in food and energy since last August that has Americans in an uproar and Congress in a panic that may yet produce major policy blunders.

In other words, the Fed ignores some of the most potentially volatile basic commodities that there are.

In some sense, I can understand the impulse. When you want to see a trend, it's a common enough practice to eliminate wild variations to get an overall pattern and not go off on a quest after what is only a transitory effect. By the time you change policy, and maybe pass legislation, the variation is over, or moving in another direction, and you've committed yourself to a course of action that will now have an effect other than what you wanted.

But we're talking about oil more than doubling price - possibly tripling - and food prices that, experts say, are going to be up for a long time, possibly a decade. Changes this high, or that will go on for that long, are more than transitory, because they have a transforming effect. It could be enough to shift the economy from one steady state into another - an older term for the more fashionable "tipping point" phrase that represents the same well-established engineering concept.

One big factor in the price rises, and the overall shakiness of the economy, is the weakness of the dollar, and, as my feeble brain understands it, that results from pumping money into the system and keeping interest rates too low for too long so those who have money aren't screaming at you that they cannot borrow even more money cheaply enough.

Maybe borrowing is over rated. Yes, it's convenient, and, yes, it can make certain types of transactions possible. But there are a lot of companies with enough profits to invest sizable amounts into their new ventures. It's called capitalism, folks - you make capital and then you invest/risk big chunks of that to get to the next place. Those who want assured profits perhaps should be apprised of the nature of the endeavor. Real wealth comes from long-term investment and building, not from squeezing every possible dollar out of the business.

Instead of appeasing the loud cries, the Fed governors should grit their teeth and do the hard work that is necessary. Yes, people will scream and call for their heads, but they took the job, and it's their duty to take the actions necessary for the long-term health of the country. When you hear from person after person wondering whether they will be able to afford to heat their homes this winter, it's not healthy.

Pushing a Rope

Well, looks like everyone from the president to the Fed's chairman is ready for economic stimulus. There's only one problem, as I heard Robert Reich state well on Marketplace Morning Report. I have my own way of thinking about it. A rope can be a great tool to get something moving, but only if you are pulling on it hard enough. Push, and the mass of fiber collapses.

The problem with current proposals to stimulate the economy is that the people in charge are forgetting this simple yet telling physical experience. To put a few hundred into the hands of many, given the rise in energy and food prices, means that they might almost, but probably not quite, stay where they were. That's just holding the rope, not pulling. The richest part of the populace would have more free capital, but there's only so much they can consume; there are just not enough of them to make a difference.

Trying to get businesses to invest is like pushing the rope. Companies spent 15 to 20 years relearning the lesson that it makes no sense to invest in infrastructure, capacity, and inventory that you don't need. Make the money available, and corporations won't invest money in stimulating ways because for them it is a waste. Instead, they'll look for other places to park the cash that might offer some return.

And to stimulate the economy, the government and the Fed effectively have to loosen the money supply, reducing the value of the dollar and burying the country under the weight of even more debt and unsupported currency. Better we should realize that sometimes you have to wait out unpleasant news rather than get a nasty rope burn trying to finagle your way out of it.

I actually just posted this on my blog about the writing business, but I realized that it was an interesting question of economic dynamics of e-books and the Kindle, so thought I'd post it here as well without using a link back.

Tim O'Reilly is a smart book publisher, and he took a look at some of the numbers that e-book enthusiasts tossed around with the advent of Amazon's Kindle. His argument is that even if prices do tumble for e-books, it will likely be only temporary. It's worth the read.I'll add an additional angle. Let's assume that he's wrong and prices do drop and stay at $5 a title. What publisher and author combination can make money that way? Reading hasn't reduced in volume because the prices are too high - books just aren't that expensive.

If you have a current business model under which most titles don't even make back the pitiful advances that authors get, and where the cost of the actual paper is only about $1.50 a copy, then dropping the price by 60 to 80 percent is going to mean that publishers won't be able to afford to print anything that isn't going to be wildly successful.Current backlists may stay around (if the publishers have acquired the necessary rights), but forget the variety of titles coming out now. You'll be down to a handful of authors who can generate the necessary sales.

Some individual authors might be able to self publish, but if they're getting 35 percent of $5, that's $1.75. Take out costs of design and production, and maybe they're at $1 a book if they're lucky, which is the inadequate stream of money they made from publishers - too low to support self-publishing. So $5a copy, if really gutting the paper model, would actually leave book publishing virtually dead. Then supply and demand will kick back in, because there are those massive infrastructures to feed, and prices will head back up anyway.

Greenspan on the Daily Show

Alan Greenspan has been making the rounds for his new book, and one stop was to see Jon Stewart last week. At one point during the conversation, he made what I thought was a fascinating statement - that in the last 50 years, he hasn't seen a real improvement in the ability to forecast what the market was going to do. The problem is that people either feel euphoric or fearful, and then make decisions based on emotional states, not on reason.

Anyone who has a solid grasp on marketing could have made the same point, but it sounds different when someone who has spent so many years trying to use mathematics to grasp mass behavior comes out and says so.

Output and Jobs Statistics Don't Match

Although there isns't a free link to this, I'd urge people to subscribe to the Financial Times and look at the April 26 story by Krishna Guha titled Output and jobs pose statistical mismatch. It's an interesting examination of why output growth is apparently less than its potential and yet unemployment doesn't seem to go up, in violation of an economic rule called Okun's Law. Seems that there are three explanations. One is that official counts of unemployment are below the actual (the article seems to find this unlikely because the count is done by a household survey, but that would still depend on how the answers are classified). Another is that the official counts of economic growth are low-balling the number. The third is that the ptoential for the economy is lower than people have been thinking. In any case, an interesting read.