Browsing the blog archives for May, 2013.

The Fed and the Stock Market

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This brief post is a follow-up to an earlier one and begins with the following excerpt from a Reuter’s story posted on May 23:

Stocks dropped on Thursday, with the S&P 500 on pace for its first back-to-back daily drop in a month amid investor concerns the U.S. Federal Reserve’s stimulus may be scaled back sooner than hoped and after weak data in China.The S&P 500 had posted its biggest decline in three weeks on Wednesday after minutes from the latest U.S. Federal Reserve meeting showed some officials were open to tapering large-scale asset purchases as early as at the June meeting. The minutes came in the wake of comments earlier in the session by Fed Chairman Ben Bernanke, who said the Fed could scale back the pace of its bond purchases at one of the “next few meetings” if the economic recovery looked set to maintain forward momentum…In a bright spot, the number of Americans filing new claims for unemployment benefits dropped 23,000 to a seasonally adjusted 340,000, slightly better than expectations for a decline to 345,000, a report showed.

Most Americans either won’t read the Reuter’s story or will be unable to decipher it, so I’ll provide a clearer interpretation:

Even with a slight improvement in unemployment data, stocks dropped late Wednesday and early Thursday after Federal Reserve Chairman Ben Bernanke hinted that the Fed might stop printing $85 billion each month to prop up the economy.

If you think the market rally is primarily due to some sort of economic recovery, think again. Of course, stock prices are affected by a number of factors and it’s fair to say that the economy has seen some marginal improvement in the last few months. However, this market response was triggered by a mere suggestion that the Fed might cut back it’s $85 billion month bond-buying program and is evidence that the recent rally is Fed-driven. Big investors are counting on an ongoing Fed subsidy. Just imagine where stock prices would be if the Fed had stayed on the sidelines from the beginning. Imagine the economic hit the economy will take when these billions begin to circulate throughout the economy.

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Speech Control on Campus

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Greg Lukianoff wrote an interesting op ed in today’s Wall Street Journal. It deserves serious attention because it illustrates the complex web of government control within higher education.

The U.S. Departments of Education and Justice recently investigated the mishandling of sexual assault cases at the University of Montana, determining that the school failed to comply with the Civil Rights Act of 1964 and Title IX of the Education Amendments of 1972. A joint letter from the departments announced a “resolution agreement” with the university, but it extends well beyond Montana. The document, touted as a “blueprint for colleges and universities across the country,” expands the notion of sexual harassment from “objectively offensive” behavior to include all “unwelcome conduct of a sexual nature,” including speech. Put another way, students have a right not to be offended by what they hear on campus.

There is an obvious problem with this ruling. Not only should professors and students refrain from harassing speech, but they must also refrain from any speech that might be perceived as harassing. This clearly violates the first amendment, creating a chilling effect on speech with no clear standard concerning what is acceptable.

But what empowers the federal government to issue such a directive concerning speech on college campuses in the first place? You need only follow the money trail to get the answer. Federal financial aid—including both grants and loans—is an essential part of almost every college’s revenue stream. Choose not to accept it and you most students will be at a financial disadvantage if they attend your school. Choose to accept it and you get the unwanted oversight as well. For this reason, only a handful of colleges (Hillsdale and Grove City College are two of them) reject federal aid for their students.

This is truly the devil’s dilemma. Tax revenues—present and future—are confiscated every year to provide financial aid. The federal government issues $112 billion in student loans in 2012 alone. Like the system or not, all of us must pay for it, and opting out is costly to say the least. It’s like paying to send your kids to private schools after you’ve already been taxed to pay for public schools. Technically, we can choose to avoid government intrusion in education, but the system requires us to overpay to exercise the choice.

The fundamental problem here is the federal control of activities over which it should have none, in this instance student financial aid. The Feds took over the program from banks in 2010, ostensibly to run it more efficiently. But the greater the role the federal government plays in financial aid, the more control it has over what happens on college campuses. The University of Montana case illustrates the type of overreach that occurs when the Feds have too much power.

It should go without saying that I favor and attempt to model civil discourse on my college campus, and insulting or harassing behavior is inappropriate. Nonetheless, we need more speech on college campuses, not less. Any steps the federal government takes to restrict speech on campus will inevitably limit the robust exchange of ideas, shortchanging students as a result.

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More Inflation?

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Andrew Wilkow and I recently discussed Paul Krugman’s piece in the New York Times. The left-leaning economist called for more inflation as a cure for the nation’s economic ills. My comments on the show generated a lot of email so I am following up with a blog post.

Before we get to Krugman, let’s start with a few definitions. In a classic sense, INFLATION occurs when the money supply expands and DEFLATION occurs when it contracts. More money in circulation means that each dollar is worth less, so inflation typically translates into higher prices, sooner or later. Today, the word INFLATION is often used when we are really referring to PRICE INFLATION—an increase in a market basket of goods and services—but there is always a lag between expansion of the money supply and price hikes. The Fed has expanded the money supply recently, which means that prices down the road will be higher than they otherwise would have been. This to be an economic certainty, although we don’t know when prices will rise, by how much, and to what extent some of the change could be mitigated by deflationary pressure. As Milton Friedman put it, “[price] inflation is always and everywhere a monetary phenomenon.”

We can illustrate this with a simple example. Consider a small island economy where everyone agreed to use a certain type of shell as money, and 1,000 shells were in circulation. A coconut costs 2 shells and a pineapple costs 1 shell based on scarcity, preferences for each, difficulty in harvesting, and other market factors. Suppose that I uncovered a box of 1,000 additional shells buried by previous inhabitants. The money supply would double at that time and I’d be relatively rich, but prices would not change immediately, especially if nobody else knew of my discovery. As I began to spend these shells, however, the total number in circulation would rise, providing others with extra shells to make more purchases of their own. This increase in demand would enable sellers to raise prices. Eventually—when all of the additional 1,000 shells are in circulation—prices would rise proportionately to the increase in the money supply. A coconut would cost 4 shells and a pineapple would cost 2 shells. If this were not true, then economies could prosper by simply printing more money. It’s been tried before, but has never succeeded.

Interestingly, and contrary to common belief, inflation doesn’t occur naturally. In fact, without expansion of the money supply, many prices would decline as innovation and technology enable us to produce more for less.  Keynesian economists like Krugman like to see modest inflation. Their greatest fear is deflation. When prices are falling, they argue that consumers are more likely to hold on to their money in hopes of cheaper and better prices in the future. This would reduce demand even further and lead to greater unemployment, more deflation, and a downward spiral. Hence, government must intervene to keep demand rising.

But this argument is shortsighted. It fails to consider adjustment mechanisms already built into the market. Computers get better and cheaper every year, but this fact doesn’t keep us from buying one. If deflation automatically creates a downward spiral, then why doesn’t inflation automatically create an upward spiral?

The key point here is that promoting inflation is, by definition, consistent with central economic planning. Deflation empowers the holder of money because his spending power increases automatically. Inflation—particularly accompanied by a Fed that keeps interest rates artificially low—empowers the government because those who have money must either spend it or put it at risk (typically in the stock market) to avoid losing value. This is financial manipulation; it punishes savings and places individual wealth at the mercy of the central planners.

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