Highly linkable

Don Boudreaux and John Cochrane deliver a one-two punch at the idiocy that wrapped up in anti-free trade "energy policy".

The War on Drugs is evil: example #207.

Europe is super cool, BTW.

From Megan McArdle, example #336 why the current tax code including taxing capital hurts us. Sure, it doesn't hurt like jumping on a bicycle with the seat missing, but it hurts.

Escape from New York

I've returned from a jam-packed trip to NYC that was part business and part pleasure. I always find it hard to leave New York without feeling that leaving is a mistake. It is such an amazing place. Very few places on Earth can boast the same wide-range of risk/return opportunity sets. Here are some thoughts:

• To my impression, by a wide margin no other American city is as much an international city. This is an underappreciated quality.
• It is a shame people tend to be too uncreative to appreciate experiences that are not "tourist traps". 
• The success of the city, largely a reflection and exacerbation of the success of American free enterprise, disguises and minimizes the drag of being in the People's Democratic Republic of Bloomberg [insert any prominent former or future mayor as well]. It is hard to see the forest of unintended consequences when dealing so directly with the trees of real-world problems. Viewed in this lens, it becomes easier to excuse the frequent acquiescence to bureaucratic and technocratic power.
• If your only impression of life in NYC was from television sitcoms, you would be missing 75% of it. If it were only from movies, I'd say you are still missing 50%, and most of that corresponds to the prior missing 75%. 
• Goldman Sachs, the business portion of my adventure, is a first-class organization. I am often a critic of the revolving door between government regulators of GS and executive positions at GS along with other regulatory capture issues. Being in the heart of the dragon, one sees clearly how that cozy relationship maintains harmony. Literally, the janitors at GS exude more confidence and professionalism than I've seen among bank presidents. Uniformly both in informal conversations and formal presentations, every representative of GS was quite impressive--not cocky or arrogant, but definitely assured of themselves and their organization and certainly serious. They can and do laugh (when appropriate), but I am certain they physically lack the ability to giggle. 
• I appreciate Goldman for having me as a guest at what was a very good conference filled with good information and entertainment. I now have more respect for them as a money manager, and it is with more confidence that I consider investments with them for my clients. 
• Here is a random thought I had during the conference: Does corporate paternalism and generosity breed acceptance for governmental paternalism? This is similar to the forest/trees thought referenced above. People in these companies are very well taken care of with all ancillary needs provided or sourced, they are used to showing ID cards and having limited access within their firm and even on their floor or in their business group, they work in "safe" environments insulated from the "chaotic" world outside, etc. 
• Depending on your perceptive sensitivity to any given behavior, you can get the feeling that "everyone" in NYC matches that given behavior. For example, everybody jogs. Of course, everyone doesn't. But it is easy to be misled being that there are countless examples of any behavior, activity, etc. to be found. That is one thing >60,000 people per square mile will get you. This goes a long way to explain misconceptions visitors come away with.
• Being in the beautiful jungle of so many choices, a thought I have had previously occurred to me again. A key to happiness is being easy to please. If you can see the good in things (be optimistic) and if you can refrain from pickiness (see things as highly substitutable), you can greatly expand your happiness. In economic terms, the flatter your indifference curves and the looser your budget constraint, the greater your utility potential. 
• Nearby our hotel was a Whole Foods grocery. We have a Whole Foods store in Oklahoma City, but the store in NYC, as a microcosm of so much else, is quite different from the store in OKC. The selection was larger in scope and scale, and the services included delivery for a flat $10 fee. No such delivery option is available in OKC. Discussing this with my wife dovetailed with other grocery economics discussions we have had. We've thought before about the intrinsic differences among stores like Whole Foods and Central Market versus Safeway and the local Crest Market versus Sam's Club and Costco. Not to get too far off on tangents, but this thought problem brings up the difficulty of finding a comparable basket of goods for inflation as well as other comparisons. Back to the central idea, what are people getting out of food shopping? The joy of bargain hunting (optimizing $/calorie) versus the joy of elegant shopping (optimizing the experience per se) could be generalized extremes along what seems a reasonable dimension of quality/quantity tradeoffs (optimizing selection and discovery). At what point is the only physical grocery shopping we do that done as an entertainment (elegant shopping) with the remainder done online including preprogrammed? 
• Enough random thoughts. Here are some pictures from a great trip. Enjoy!

Highly linkable

We begin with a couple of strong ones from Bryan Caplan. Here he goes to the mattresses with free-market economists on the "grave evil" of unemployment.

Next he delivers a one, two punch on the issue of public (especially federal) versus private compensation.

David Friedman weighs in on and perhaps settles the infamous and riling post from Steven Landsburg--that's the post that sounds like New York's hottest club . . . it has everything: pornography, rape, environmental destruction, a midget named "Wharhol" who'll throw Campbell's Soup cans at you . . . Okay, I made that last part up.

Bob Murphy, who often challenge's Landsburg on the topic, discusses one of his amusements in the "science vs. religion" debates.

When it comes to justifying economic development initiatives and incentives, public officials and those seeking favorable treatment from state and local government generally find it easy. And the most common drumbeat is “Jobs! Jobs! Jobs!” But I’ve noticed a trend where it seems the economic profession’s criticisms are affecting a positive change. Alas, I believe the change is chimerical.

We now hear the champions of economic development talking the talk that “not all economic development is created equal” and “there are some developments that are just not worth the price”. But I think this is a sales pitch to quiet the dissent without actually making a change. The mantra is still JOBS!, but now we hear of “primary” or more desirable jobs versus “secondary” or less desirable jobs. The definition of these two alleged distinct types of jobs shows some fundamental misunderstandings of economic analysis.

Here is the idea. Suppose you are an economic planner representing a regionally large, nationally small but important city. Oklahoma City is a good example. Two prospective firms are each considering a new location in one of a few cities, and Oklahoma City has made the short list for both firms. You know what each wants, say it is a ten-year tax break that amounts to $5,000,000, but the problem is because your city operates under strict balanced budget accounting, you are only authorized to give up to $5,000,000 in tax incentives away. That amount may go up or down in a year, but for now that is all you can agree to. Both firms want it, and you know with high certainty that either firm will take it and choose your city but without it the firms will go elsewhere. You want the jobs (because, after all, it is JOBS!); so you must decide to which firm to extend the incentive.

• Firm A is a call center that will have 100 employees who will take calls from around the world to solve computer technology problems for a fee.
• Firm B is a high-end automotive mechanic service employing 100 who will compete with local dealerships to offer high quality auto repair. The customers base is expected to be nearly 100% local.

The average wage and distribution of wages is the same between the two firms.

To the economic planner Firm A is offering “primary” jobs while Firm B is offering “secondary” jobs. Never mind the fact that jobs are not a good but a cost—there is a reason people aspire to retirement and Garfield hates Mondays. Firm A is “bringing in wealth” by exporting the service calls and importing the customers’ payment for service. Firm B is “moving around wealth” by selling auto repair for payment all within the locality. The preference is intuitive since in Firm A’s case revenue is flowing into the city rather than just revolving around the city as with Firm B. But the intuition here is a deeply flawed economic analysis. It stems from fundamentally misunderstanding the economics of exchange.

When a firm adds value to society, it does so by using less resources than it provides. The measure of this is profit. But profit in the case of both firms flows to the owners who may or may not reside in your community. Because you as economic developer are trying to grow quality jobs, you must consider which jobs are more desirable--remember, you only can give the incentive to one firm. Firm A gives up call center services exporting them outside of the community in exchange for money from outside the community which is partially used to pay the 100 employees' wages. Firm B gives up auto repair services for money all of which remains in the community. Firm B is retaining all of the benefit within the community while Firm A is sending away half of the benefit.

To make this clearer we should remove the monetary component, which serves to muddy the analysis. Ultimately, money is a proxy for what it can buy. At its essence exchange is still a bartering process; it's just that half of the barter is anything you want it to be (anything money can buy--so not love, Dr. McDreamy). Let's replace money with food. Perhaps now we can see it clearly: Firm A is sending computer services out of the community in exchange for food while Firm B is facilitating people within the community exchanging auto services for food. Both exchanges are mutually beneficial to the parties involved. But if you are going to prefer the local society over the society at large since you're the local economic developer, then you should prefer Firm B because that firm is retaining all the benefits (goods and services along with gains from trade) within the community.

Greed versus Envy

The White House put out a budget just a couple months late of when it is supposed to, which is a rather good record in comparison to the Senate who hasn't passed a budget in four years. Contained within it was an interesting proposal--capping the amount a person can save for retirement through tax-deferred accounts such as traditional IRAs where taxes are paid only once distributions begin, which is usually during retirement.

The maximum a person could set aside in an IRA would be $3 million--an amount Obama feels is plenty enough. Just when you thought we were doing all we could to punish saving and reward consumption, we get this to up the ante. Here is a voice of concern about the implications for tax-deferred savings accounts in general. Here is another. Seems there might be unintended consequences from the government deciding for us how much deferred consumption is enough.

But you see, deferred consumption amounts to deferred taxation. And that is where the greed angle comes in. Obama would have us believe that greed is good in this case--the greed the government has for tax revenue now rather than later. Yet there are two facts that make me doubt that greed is the true motive here:

1. The proposal is estimated to generate a negligible amount of $9 billion in tax revenue over the next decade--about 3% of 1% of what the federal government plans to spend over that time. 
2. If this were really about accelerating tax payments from the future to the present, then part of the proposal would include allowing unlimited Roth IRA contributions where taxes are paid up front. 

The absence of the second component in the budget makes me think this is more about envy than greed.

The Midas Touch

What a difference a few days make. I planned on making this post last Thursday after a client meeting where the discussion included the pros and cons of an investment allocation to gold. My basic premise is no truer today than it was before gold's plunge in price Monday, but it would have given me a few bonus points to state my thesis on gold before the dramatic sell off.

The case for gold in a portfolio like the case for any precious metal is difficult to make. The theoretical support would be that it is a good inflation hedge, an historical store of value across societies and time, and uncorrelated with most other investments. But that is where the difficulty begins because those beliefs are not as ironclad as goldbugs would have you believe. In fact the most important theoretical support for gold, inflation hedging, seems to be the weakest case of the three. We'll get to that in a second, but first let's consider what gold lacks.

Gold lacks industrial use. It is not a capital good. It is a consumer good. So is bread, Travertine tile, and 55"-LED LCD TVs. Unlike bread, it won't go bad, but also unlike bread, it won't do you a bit of good if you eat it. It is durable like Travertine tile, but a lot more expensive--so much so that someone might try to steal it, which makes it expensive just to protect. One ounce of gold will buy you a pretty good TV. At the margin, I'd rather have the TV. Already there is something funny about using this soft, yellow metal as an investment asset.

Here are two of the top seven Warren Buffett quotes on gold as told by Minyanville:

3. "Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything."

4. "I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils." [Note: The price of gold has changed since this quote was made. The gold would buy much less today.]

The first quote alludes to a chief problem many including myself have with gold as an investment--it has no cash flow. Aside from a potential positive roll yield when the futures market is in backwardation, a gold allocation generates no gains but does have substantial costs to maintain (transactions, storage, and carrying).  And realize that not having a cash flow of any kind (direct to the investor like a dividend or interest payment or indirect to the firm like a profit stream) means we can only value it based on the amorphous idea that someone does and will want it at a future date at a price attractive for us to sell.

Let's now turn to the historical record. To be a good inflation hedge, an asset should have a high correlation to inflation along with relative outperformance of inflation--when inflation is high, the asset is high or higher and when inflation is low, the asset is low or not as low. The first part is crucial. We want our inflation hedge to come through in the clutch. The U.S. left the gold standard in April of 1968 allowing gold to freely float when priced in dollars. It is at this point that it became investable as a theoretical hedge against dollar inflation.

Well, for the period April 1968 through April 2013 gold has only about a 13% correlation to CPI, which is to say they have basically been uncorrelated over this time span. The correlation doesn't improve much in the high inflation days of the late 70s and early 80s. The S&P 500 was even more uncorrelated with CPI at about -10%. But for what it gave up in correlation, it more than overcame in return. [UPDATE: the correlation between gold and CPI for the 1973 - 1985 period is only about 14%.]

Looking at the total return from owning gold to owning the S&P 500 with dividends reinvested over this time span, the comparison is not close. The S&P 500 returned over 6,850% while gold returned over 3,560% (see chart below). [Note: The source for these calculations is the St. Louis Fed's FRED. When using Bloomberg, I get somewhat different results for gold, about 4,400%. I will try to get clarification on this calculation to verify why there is a discrepancy. UPDATE: Looking further into the Bloomberg data it seems that the historical gold price is a composite and that the TR calculation is much closer to the FRED data, about 3,843%.]

This return difference is impressive. While gold was in the lead for two decades, the S&P 500 made a strong comeback to take over. Only the recent run up in gold has helped the yellow metal gain some but not all ground. And notice the long lulls for gold. This is another knock against it. For someone retiring in 1984, it would not have been a very good store of retirement value.

Over the full span the S&P 500 is over 50% higher in value. To understand how big that is think about everything you own and then imagine not having half of it.

Gold beckons you to enter, but there is no disguising what I fear.
To love the gold investment, the golden words poured into my ear,
there must be another whose heart is cold
He loves only gold.

Taxes are the price we pay to live in an insane society

It's that time of year again. Time for all Americans to take Uncle Sam's annual insanity quiz: if you can get through the tax forms and still think it all makes sense, congratulations, you're nuts! Notice that I'm not even criticizing tax rates or tax burdens for being too high. At this point I'm only complaining that the process is bat guano crazy.

There are lots of ways to raise as much revenue as we raise today while being immensely more efficient not to mention being fairer. We don't even have to give up all those wonderful special interest giveaways. There are plenty of ways to subsidize them and incentivize behavior otherwise to support all the various things without which society would break down--like jobs for tax preparers, mortgage interest rebates, 366-day stock holdings, and trains running to nowhere. Or would straightforward, simple subsidies be too obviously indefensible?

Regardless, here are my top alternatives to our current tax nightmare (each would be a wholesale replacement of all that befuddles us today):

• A value-added tax (VAT) applicable to all goods and services--no exceptions.
• A final goods and services sales tax as described here.
• A total compensation payroll tax (this means all wages and benefits including education/training, equity including stock options, and health insurance, et al. would be taxable benefits).

The whole mess reminds me of this:

Today also marks the infamous 2-year anniversary of Black Friday as it is known in the poker community. That is the day that a US Attorney unsealed an indictment against Internet poker companies sloppily labeling online poker a crime, a baseless charge that was later dropped, and shutting down effectively all online poker in the United States. As the cases against those charged with money laundering and bank fraud continue to play out and millions of dollars in player funds sit in limbo, it is not at all surprising that a government-created, quasi-black market attracted shady characters and suboptimal market outcomes. The Poker Players Alliance continues the fight for freedom.