Tuesday, July 6, 2010

Naked Capitalism's Yves Smith, Economic Know-Nothing

I stopped reading Yves Smith's blog, Naked Capitalism, about two weeks after I first heard about it a couple years ago. It quickly became obvious to me that it was Yet-Another-Confused-Capitalism-Bashing-Blog written by Yet-Another-Confused-Clueless-Blogger-Completely-In-Love-With-Her-Own-Misconceptions. Still, other people continue to find Naked Capitalism and the opinionating of Yves Smith to be worth following, making it one of the more popular financial and economic-related blogs on the web, along with Krugman-worshipping Bill McBride's ironically (for a socialist) named Calculated Risk blog.

Therefore, Smith's latest op-ed in the NYT, co-written with Rob Parentau, is a worthy object of shame and ridicule in the hopes that a few more current readers might be transformed into former readers, like me. While it will lead to me quoting and critiquing nearly the entire article, I'm going to just pick out the most offensive (to economic logic) parts and peel the layers of ignorance away one by one, starting with this:
Reductions in deficits have implications for the private sector. Higher taxes draw cash from households and businesses, while lower government expenditures withhold money from the economy.
Hard to know if this is a case of sloppy editing or what but lower government expenditures do not "withhold money from the economy." Aside from operations by the Federal Reserve system and the fractional reserve multiplier, the amount of money in the economy is otherwise constant and does not change based upon the federal government's budget.

Presumably Yves Smith, a dyed-in-the-wool Keynesian, is implying that money not being "pump-primed" through the spending spigots of the federal government would, instead, be hoarded by individual savers and businesses and therefore "withheld" from the economy but either way, it is not the amount of money in an economy that spurs growth and production but rather individual measurement of risk, reward, time preference and desire to produce new goods and services.
Over the past decade and a half, corporations have been saving more and investing less in their own businesses.


The reason for all this saving in the United States is that public companies have become obsessed with quarterly earnings.
When? This accusation-as-explanation is worthless without a time period. Only by knowing "when" it was that this obsession developed can we then seek out possible explanations for this sudden change in business temperament, possibly deriving from a change in rules, regulations or other laws governing corporate management, for example.

You'll notice that this line of reasoning is simply a form of Keynes's "animal spirits" theory with different makeup and a hat. Keynes, like Yves Smith, never provided any explanation for why it was that the animal spirits of investors and businessmen would suddenly and rapidly shift in one direction or another-- it was always mystical and unexplainable, completely detached from any social or legal context.

Also, you'll notice that Smith here attempts to extrapolate an argument for all market participants from a particular subset that are faced with a particular performance benchmark, the quarterly earnings report. Private businesses, which do not have to report quarterly earnings to any shareholders or anyone else and who are therefore essentially completely unconcerned with such fetters of the public company world, nonetheless have been saving and not expanding their businesses as well. This fact is ignored because if it were addressed, Yves Smith's argument would crumble upon its realization.
Some may argue that businesses aren’t investing in growth because the prospects for success are so poor, but American corporate profits are nearly all the way back to their peak, right before the global financial crisis took hold.
Again, this argument completely ignores the plight of private businesses. What's worse, it's self-defeating. Past and even current profitability is not an indication of the potential for future success-- something that should've been obvious to Yves Smith when she observed that corporate profits are almost back to the peak reached "right before the global financial crisis." What were record profits saying then about potential future profits? Answer: absolutely nothing.
Another problem for the economy is that, once the crisis began, families and individuals started tightening their belts, bolstering their bank accounts or trying to pay down borrowings (another form of saving).
Confused and wrong.

Increased savings is not "another problem for the economy" but rather the solution to one of the existing problems-- excessive debt. It's also a perfectly rational response to economic and political uncertainty (which represents higher risk) and anticipation of lower prices in the future. If you are an investor and you realize that your debt-ridden neighbors are scrambling to find dollars to service their debt, you're going to want to hold more of those dollars rather than deploying or spending them because you know they're an appreciating asset. If you are an individual who believes that the liquidation of the existing debt structure will result in some blow-out, clearance prices when the world is "on sale", you're going to want to reserve some dollars for that. And if you're just a little frightened about what to do with your money when you've already been beaten to death in your 401(k) once and you see the politicians are absolutely zany, you're going to want to hold on to a little bit of cash, especially if you're worried you might lose your job soon.

But if you're Yves Smith, then you feel really threatened by this type of individual planning and you're sitting behind your computer concocting elaborate schemes to coerce these individuals into spending every, last red cent.

Oh, and if paying down debt was "another form of saving" then I suppose you could load up a bank account by depositing paid-down-debt, or you could start a business by using all the paid-down-debt as capital to purchase new assets with.

No, wait, you can't do any of those things with paid-down-debt, because paid-down-debt isn't anything-- in fact, it's nothing. And nothing isn't savings.
If households and corporations are trying to save more of their income and spend less, then it is up to the other two sectors of the economy — the government and the import-export sector — to spend more and save less to keep the economy humming. In other words, there needs to be a large trade surplus, a large government deficit or some combination of the two. This isn’t a matter of economic theory; it’s based in simple accounting.
'Course it isn't a matter of economic theory-- Yves doesn't do economic theory because she doesn't know any besides the "economic theory" of totalitarian socialism.

You see, if it were all a matter of simple accounting, you wouldn't even need anybody to make or do anything... you could just add a credit to this side and a debit to the other and... voila! Everything balances. In fact, this is precisely how the Fed creates money, which is probably precisely why Economic Know-Nothings like Yves Smith are such big fans-- it's imbecilically simple.

But don't take my word for it, instead read our friend Bob Murphy on the subject of fallacious national accounting schemes.
That result might not sound bad for the United States, since lower wages and prices would make American goods more competitive abroad. But falling incomes make it even harder for people to make payments on outstanding loans. And if defaults and bankruptcies cascade through the financial system, credit becomes tighter still. Ultimately, there is a danger that deflation — falling wages and prices — will snowball into a depression.
One minute the servicing of debt is threatening deflation. The next minute, the not-servicing of debt is threatening deflation. Yves Smith's solution, of course, is to keep the Ponzi going a bit longer, for what else do you call a system that requires exponentially larger amounts of money being continually injected into it to keep it from collapsing in upon itself?
So instead of pursuing budget retrenchment, policymakers need to create incentives for corporations to reinvest their profits in business operations. One way to do this would be to impose an aggressive tax on retained earnings that are not reinvested within two years. Another approach would be a tax on the turnover of corporate financial investments that would raise the cost of speculating with profits, rather than putting them into the business.

At the same time, the federal government must continue to encourage investment in the economy — ideally by creating incentives for investments in national priorities, like new energy technologies.
Three terrible and misguided ideas in two paragraphs, quite a feat.

Let's start with this "aggressive tax" on retained earnings. First of all, completely unjust to just haphazardly tax people or business organizations of their earnings, for any reason. Second, it's totally arbitrary-- why two years, why not one year, three years, two lunar years, two hours, etc? And what constitutes an "aggressive" tax, 5%, 10%, 50%, 99%? Third, does anyone want to make the argument that savings hoarded by businesses is an economically less efficient use of resources than tax revenues wasted on government boondoggles? What is the government going to do with this new source of revenues, anyway, turn around and "stimulate" the very businesses it stole it from in the first place to "get them spending" again?!

Similar criticisms apply to the second idea-- what corporate financial investments should be targeted, and why? For how long? What's the penalty? How was any of this calculated? As it stands, both of these suggestions are straight out of the Peter Orszag School of Economics, where we throw things at the wall and see what sticks (*note, none of it ever does, sadly).

Finally, what is it with the energy fascism? Was this global financial crisis caused by another Arab oil embargo I didn't get the memo on? Where is the calculation on that gambit?
The entrepreneurial pursuit of profitable growth has been the vital engine of prosperity since the Industrial Revolution. Yet corporate executives are being rewarded for myopia and speculation, undermining the very operation of capitalism. We need tax and regulatory policies to counter this destructive development, along with wider recognition that government deficits, when they counteract corporate savings, are necessary and salutary.
The entrepreneurial pursuit of profit has been the vital engine of prosperity of all time, not just since the Industrial Revolution. You could glean as much from a history book if you opened one up -- I take Yves Smith's apparent ignorance of the merchant economies dating back to ancient Greek and Chinese times as evidence she has not -- but even without knowing much of history it should be obvious from "simple economic theory". The only reason anyone ever takes any action is the hope of gaining a psychic profit from their doing so. But even in terms of material or monetary profits the phenomenon, and thus the important incentive it creates for innovation and continual growth, the profit motive far pre-dates the Industrial Revolution and is obviously present in the economic activities of currently non-industrialized and industrializing societies.

Truly, the only person suffering from myopia in this situation is Yves Smith (and her co-writer). It takes a severe misunderstanding of economic theory as well as the nature and operation of capitalism, which is a time-sensitive process of savings and production dependent upon the independent planning of free individuals within a market economy, to suggest that taxes and regulation might be the solution to what ails us economically. Capitalism depends on free markets, that is the absence of taxes and regulation, for its successful operation, else market participants are apt to miscalculate and misallocate resources.

Such a pitfall is of course exactly what the heavily regulated, heavily taxed US and world economies have stumbled into, a trap whose dangers were exaggerated by the continual manipulations of the money supply by wanton and reckless central bankers. Yet Yves Smith makes her suggestions about what to do as if the market economy previously lived in a vacuum completely devoid of taxes and regulations in the first place.

Message to Yves Smith, Economic Know-Nothing: government deficits are not "necessary and salutary" because they're not a free lunch.


  1. The paragraph that ends with the line "This isn’t a matter of economic theory; it’s based in simple accounting," is Parenteau. I first became acquainted with his work through John Mauldin:


    Mauldin introduced him, "Warning: Rob Parenteau is an Austrian economist." However, we then learn of his prediliction for aggregate equations where household spending/savings is treated the same as government spending/savings. Simply two different sectors, or ledger pages in the same accounting book, right? Then there's one possible solution he suggests to the European Union Trap:

    "There may be ways to thread the needle - Domingo Cavallo's [Argentina] recent proposal to pursue a "fiscal devaluation" by switching the tax burden in Greece away from labor related costs like social security taxes to a higher VAT could be one way to effectively increase competitiveness without enforcing wage deflation (http://www.voxeu.org/index.php?q=node/4666). The cost of exported goods is thereby lowered (as in a currency devaluation) without the need for domestic wage cuts and nominal income deflation, and this introduces the possibility of an improved trade balance with an unchanged fiscal balance."

    Higher taxes, equation rearranging--all the hallmarks of an Austrian economist. What a joke.

  2. BobE,

    You are a scholar and a historian of pseudo-economic thought! I appreciate your contribution.

    I certainly missed the chapters in Mises's Human Action and Rothbard's Man, Economy and State where they went on and on about the importance of balancing all these ledgers.

    That, or those chapters weren't written because Austrian economists realize such concerns are trivial and fallacious.