The Textbooks: Introduction

Consider the university professor. What is his function? Simply to pass onto fresh generations of numbskulls a body of so-called knowledge that is fragmentary, unimportant, and, in large part, untrue. His whole professional activity is circumscribed by the prejudices, vanities, and avarices of his university trustees; i.e., a committee of soap boilers, nail manufacturers, bank directors, and politicians. The moment he offends these vermin he is undone. He cannot so much as think aloud without running a risk of having them fan his pantaloons.

~H.L. Mencken

"The universities," wrote Hobbes, "teach." Adam Smith preferred to say the same the other way around: "the discipline of colleges and universities is in general contrived, not for the benefit of the students, but for the interest, or more properly speaking, for the ease of the masters." Those amidst the general confusion on Wall Street, many with Ivy League educations, must agree more and more every day; those among them who know better surely learned more in their first month of professional life than they did in all of college. Yet, is not precisely that which they were taught about economics part of the problem? The incredible agnosticism (read: mendacity) of the discipline today needs to answer to the market.

Towards that end, it is time to reread the textbooks which define the undergraduate curriculum. We apologize in advance—reading textbooks intended for mass consumption in undergraduate courses carefully and critically is like taking candy from children. The authors of bestselling textbooks aren't trying to give an accurate or comprehensive overview of the principles of their discipline. They aren't trying to give students the basic tools they need to start reading research in the field. Textbooks are sloppy and inaccurate; cursory and question-begging: the image they present of a science is as hopelessly out of date as it is unimaginative and uncontroversial.

If, at best, an introductory textbook gives students a taste of the jargon particular to a disclipline, a taste for its home truths and native ideology, and a sense of superiority for being able to speak at least a little of the private language, a fortiori for economics. No other discipline is so politicized, so ideologized, or indeed so hegemonic in policy discussions -- no other social science's pretensions to scientificity so humored. The language of economics is ubiquitous in the worlds of policy and lawmaking, business and finance, and a congeries of mostly 19th-century vulgarizations of economic propositions is, there, the reigning Weltanschauung.

This is what the economics textbooks 'teach,' and it is our target. It should be remembered that economics textbooks as they exist today are a recent invention: Paul Samuelson’s valuable Economics (1948), path-breaking for the genre, came with a Nobel Prize. The discipline has come a long way since then, most of it in the dismal mode of mercury retrograde. In the preface to his book, Samuelson cites William James' The Principles of Psychology and Richard Courant's Differential and Integral Calculus as models; Marshall too, surely; unfortunately, no such legacy remains today.

Greg Mankiw’s Macroeconomics is first up, as it is the most widely used introductory text at places of higher learning: University of Chicago, MIT, Harvard, et cetera. Smith also said that “if a teacher happens to be a man of sense, it must be an unpleasant thing to him to be conscious, while he is lecturing his students, that he is either speaking or reading nonsense, or what is very little better than nonsense.” Our condolences to those who teach out of this book.

We’ll do a chapter a week—think of it as a critical study guide. We may be harsh at times, but we hope to always be fair: and if Mankiw is pushed to tears by any offense we may cause him, we hope he cries all the way to the bank.

Until then, please enjoy 'stand-up economist' Yoram Bauman's presentation, "The Principles of Economics, translated."

October Themes: Monetary Breakdown

Karl Marx's most famous contribution to the social-scientific lexicon is probably the notion of fetishism, the way in which a single moment of the social process comes to stand in for (and obscure) the others -- like an individual commodity and its market value for the total process of commodity production and value creation. There is no more substantial and enduring fetish than the monetary fetish: the tendency to treat media of payment as if they did not intermediate value but embodied it.

Some groups of people have always been relatively immune to this illusion: money-market traders, for instance, whose bread and butter is the spread between short-term and long-term money. But there are times -- like last month -- when more general stresses make the seams in the process of monetary intermediation obvious to a wider audience.


Black markets and informal currencies

Robert Mugabe's Zimbabwe is likely to replace Weimar Germany as the textbook example of hyperinflation. On October 13th, one Zimbabwe blogger was quoted a 9kg cylinder of white gas at USD27,000 (ZWD340mn) - as the total breakdown of monetary intermediation brought legitimate imports of necessary commodities to a halt. Taxes of up to 75% levied on imports -- in foreign currency -- mean that basic goods imported from neighboring South Africa can cost up to four times as much in Zimbabwe.

Trading in the Zimbabwe dollar, even for ordinary goods like loaves of bread, involves so much inflation risk that even street vendors are demanding payments in foreign exchange and salaries are being paid in easily negotiable basic commodities -- sugar, salt, mealie meal.

Since inflation expectations are constantly changing and foreign exchange risk is incalculable -- and unhedgeable -- basic accounting becomes impossible for businesses of any size and all planning for investment is put on hold. Businesses that demand payments in foreign currencies run the risk of sudden raids by the Reserve Bank of Zimbabwe, which confiscates forex and replaces it with ZWD at the official rate -- far below the real, black market rate. When the RBZ suspended the interbank payment system, ostensibly to limit arbitrage opportunities between the official and black market rates, aid agencies found themselves unable to make payments and provide the subsistence support most ordinary Zimbabweans now need.


Time deposits and liquidity

On October 15, when more stores in Zimbabwe were still pricing goods in ZWD, the UN's IRIN news agency reported that managers were repricing goods several times a day -- and posting three prices for each, one in ZWD, one in USD, and one for ZWD-settlement credit cards. Supermarkets in Zimbabwe have since begun refusing to accept checks and debit cards at all -- the currency depreciates too quickly during the time it takes the payments to clear.

Later in the month, in Russia, this phenomenon of double-pricing for credit resurfaced, with some Russian businesses refusing credit card payments, and at least one bank's ATMs (Sberbank) refusing debit cards from other banks.

In ordinary circumstances, consumers (and indeed most economic actors) behave as if time deposits like checking accounts and consumer credit like credit cards are equivalent to cash. But accepting payments in these media means incurring risk, however small it may ordinarily be -- payment risk (depending on the solvency of the card-issuing institution, or, in extremis, on the continued functioning of the settlement system) and time risk (exposing the payee to the risk that, in this case, the ruble might be devalued in the period between transaction and settlement).

Under pressure, monetary systems "delaminate," so to speak, as ordinarily interchangeable forms of payment -- cash, demand deposits, time deposits, repos -- start to trade separately and sometimes with very different risk premia, surprising even the most sophisticated investors. On a grander and more foreboding scale, the breakdown of the international market in trade finance -- letters of credit -- shows how ordinarily transparent, money-like credit instruments can breakdown in times of crisis. (In an important sense, letters of credit are a more basic kind of money than state-issued paper money, or even physical cash, like copper or gold: long-distance trade on any scale would have been impossible in the early modern world without flourishing markets engaged in the discounting of bills drawn on banking houses far away.)


Prices without money

And in times of crisis, national currencies can start to look more like letters of credit or commercial paper than the other way around. On October 24, credit-default swaps on sovereign debt for Ukraine (26%), Kazakhstan, Russia, Latvia, Indonesia, Argentina (38%), and Pakistan (32%) all traded above 1000bp, with CDS on a number of European sovereigns were trading above 100bp (Italy, Greece, Portugal, and Ireland), with most of the largest industrial economies' debt trading in the range of healthy or slightly stressed corporates. Some of this meteoric rise in CDS spreads is likely due to enterprising buyers expecting to be able to sell protection at even higher rates and take advantage of panic; but there is a very real sense in which, during a period of currency devaluations and debt defaults, obligations issued by a company like McDonald's are safer than obligations issued by a country like Pakistan.

And at the end of the month, Thailand announced it would barter rice directly for oil with Iran, as a shortage of forex (and Iran's political interest in doing as little dollar-denominated business as possible) incentivizes direct trade between countries -- the UN FAO says this kind of international trade may again become common as emerging countries' reserves shrink.


Currency areas and monetary hegemony

It's a general rule that within a single currency area (a loose enough term for a loose enough concept, indicating a qualitatively greater regional intensity of trading relationships) there is unlikely to be more than a single currency: a corollary of the definition of money that sees it as the commodity whose cross-elasticities with all other commodities are lowest. Every one of the vexed attempts by national governments to impose dual currency systems (one soft for internal exchange, one hard for external exchange) falls prey, in the end, to the reality of monetary hegemony. But what about local currencies that, when push comes to shove, turn out to be soft versions of harder neighboring currencies?

October saw the economies of a number of "Euro-margin" countries teetering on the brink of failure, and the provision of large dollar- and Euro-denominated bailout packages from European governments and the IMF. The collapse of the Icelandic economy is only the most spectacular illustration of the plight of a small (that is, relative to a larger, currency-hegemonic neighbor) open economy under pressure. Countries like Iceland and Hungary -- where most consumer debt is actually issued by Eurozone or Swiss banks and denominated in EUR or CHF -- need to stabilize their exchange rates in order to make sure trade necessary to their subsistence continues smoothly. But the costs to their citizens of standard, "Washington consensus" economic restructuring plans can be high: local austerity translating into large transfers of wealth out of the country.

Not that the monetary hegemons are themselves in great shape. The Federal Reserve this month vastly expanded its bilateral currency swap arrangements with G7 nations -- and also, for the first time, made dollar financing directly available to a selected group of emerging central banks. The dollar has remained the global currency of last resort and the Fed the global lender of last resort, as the only realistic competitors stagger under their own challenges: recession and retrenchment in Japan, and internal pressures in the Eurozone. Debt issued by individual Europena countries is trading at vastly different prices, as the market assesses the chances of individual governments still responsible for setting their own fiscal policies -- and bailing out their own banks. What would happen to European Monetary Union if a Eurozone country were to break its macroeconomic covenants is an open question. In the meantime, the lack of a centralized European debt issuer has made it hard for Europe to provide credible support to countries on its borders.

The IMF is, of course, the long-shot global monetary authority of last resort. But it may exhaust its capacity to lend to distressed countries in the near future, leading some commentators to punt the possibility it will issue bonds (which it has never done) or Special Drawing Rights, an exotic international currency based on a weighted basket of major national currencies (1 SDR = $1.48) not issued since the fall of the Soviet Union, in order to fund its operations. But without substantial policy-making independence from Washington, the bank, whose operations have always been funded by its members' quotas, is unlikely ever to be able to shoulder the responsibilities of a genuinely global central bank.

Building Blocks: Introduction to RGGI

Building Blocks aims to provide detailed primers on technical subjects for a non-specialist audience. If there is anything we can do to make them more informative or clearer, please leave a comment.

What is RGGI?

The Regional Greenhouse Gas Initiative (RGGI) is a CO2e cap-and-trade system established for utilities (defined as power generators of 25MW peak capacity or more, about 225 plants) in the Northeastern United States. One permit carries the right to emit one ton of CO2e. Ten states are participating (New York, Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, Rhode Island, and Vermont).

How does the cap work?

Each state gets a certain discretion in setting its own rules for the auctions, but every state has committed to auctioning substantially all of the permits issued, instead of allocating them to different utilities. This is a major difference between the European cap-and-trade system, which allocates substantially all of the permits issued, and, as a result, the European system has depressed prices, made the allocation of permits a political issue subject to lobbying and abuses, and undermined the efficiency of a cap-and-trade system in distributing economic costs. All revenue raised by the auctions is distributed to the states for energy efficiency and renewables development projects.

What is the level of emissions reduction required in RGGI?

Utilities represent about 20% of the CO2e emissions both in the Northeast, and in the U.S. as a whole. As a result, the RGGI is a substantial step toward a comprehensive Northeastern cap-and-trade plan, and it will be hugely important both to prove that cap-and-trade can work in the U.S. and as a model for the nation and the world. Unfortunately, the cap is not very strict, with emissions frozen at 2006 levels until 2014. Then the cap will contract by 2.5% of 2006 levels from 2015-2018, resulting in a drop in emissions of 10% in this sector.

How did the first auction go?

The first RGGI auction for carbon permits was held over the weekend, and results were announced today. It went smoothly, at least. Several states did not finalize rules in time to participate, and will participate in the December auction for the first time. The six states that did participate auctioned off permits that ended up worth about $3.07 per ton of CO2e emitted, roughly one-tenth normal European prices. The $39mn the auction raised for these six states will go for subsidies and investment in renewables and renewables research. The auction sold every permit, against fears that the auction might be undersubscribed because of over-allocation (2006, the baseline year for the cap, turns out to have been a particularly bad year for CO2e emissions).

What is RGGI's role in the future of U.S. carbon regulation?

RGGI is a well-designed model for a U.S. cap-and-trade system, with a good software infrastructure, state-by-state enforcement and discretion, and almost total auctioning of permits. It is already being used as a model for the Western Climate Initiative, a regional cap-and-trade system in the western U.S. and northwestern Canada, comprising seven states and four Canadian provinces. RGGI must prove that: 1) cap-and-trade is highly economically efficient, particuarly on a large scale; 2) the markets can run smoothly and not impact the efficiency of the intraday electricity markets; 3) cap-and-trade can mitigate the economic costs of higher energy prices while redoubling the positive effects of the cap on domestic energy consumption by using its revenues for efficiency and investment.

Further Reading:

The executive summary of RGGI
News from RGGI
The model regulation that the states are following