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Following Rand Paul to Disaster

May 13th, 2010 at 3:34 pm David Frum | 78 Comments |

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My latest column for The Week looks at the impending victory of Rand Paul in the Kentucky GOP senatorial primary and the message his backers hope to send to the party.

In today’s Republican mood, help politicians who explain practical limits are rejected as weaklings and sell-outs. When [primary candidate] Trey Grayson explains that a Republican majority will not be able to balance the budget in a single year – or that some of the anti-drug programs funded by federal dollars are saving lives – he loses support. When Rand Paul announces that he will never vote for an unbalanced budget, pills today’s angry Republicans hear a man of principle not a petulant grandstander.

You can’t run a country this way of course. Nor (probably) can you win a general election. Especially not with a candidate as deservedly vulnerable as Rand Paul.

Click here to read the rest.

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78 Comments so far ↓

  • WillyP

    rabiner:

    “Real wages are normalized against inflation so of course they don’t increase inflation.”

    Well, tell that to yourself:

    Rabiner // May 14, 2010 at 2:58 pm
    “You ever hear of unintended consequences? As we get closer to full employment, wages must increase to entice people to enter the job market. As wages increase, inflation typically occurs. 1-3% annual inflation is the norm and is a good thing.”

  • Rabiner

    WillyP:

    I said WAGES increase, not REAL WAGES. When you don’t specify REAL it means you are talking about NOMINAL wages. So don’t try to get cute with me, you’ll just lose in the end.

  • WillyP

    lol, rabiner,

    For your own edification, what you meant was “nominal” wages, then.

    Nevertheless, you still have failed to explain your initial statement – “As wages increase, inflation typically occurs.” Using your own definition, which is a strange way to define inflation, your statement does not make sense.

    How does a general rise in nominal wages – which can only be accomplished by “decreasing the purchasing power of each dollar” – i.e., printing more currency – i.e., inflation – cause inflation? You are asserting, basically, that inflation induces itself. Not only is it bad economics, it’s bad logic. It literally makes no sense. It is “non”sense.

    I’d like to be able to conjecture what point you meant to get across, but I can’t even do that.

  • Rabiner

    WillyP:

    There are a few reasons why wage changes can lead to inflation. Wages can increase through a change in negotiation power on behalf of the employee from an extremely tight labor market. This isn’t an increase in productivity on behalf of the employee but rather just increased costs to lure more people into the job market. This will typically lead to an increased cost to customers for that company’s goods.

    The other is when employees ask for wages based on the assumption of inflation in the future. Say employees feel that in the next year they need a 2% increase in wages to keep pace with inflation. This will lead to an actual increase in inflation of 2% + whatever was going to happen that year. This is a concept of Rational Expectations. ( http://www.econlib.org/library/Enc/RationalExpectations.html )

    Printing more money isn’t the only way prices increase. If the money multiplier increases in an economy, than there is technically more dollars circulating in an economy and can lead to inflation.

  • ottovbvs

    WillyP // May 14, 2010 at 3:09 pm

    “otto,
    you’re annoying. “claim to have read.” do you really think i’m so lame as to “claim” to have read Ludwig von Mises? on the “coolness” scale this ranks below trekkies. it’s hardly something i do to win popularity contests, much less approval from Frummies! so spare me your condescension. ”

    ……Silly Willy…..Since you don’t seem to understand the most basic implications of T bill pricing which is the cornerstone of public finance I’d say it was highly unlikely you’ve ever read extensively in this field and even if you have…… you didn’t understand it

    “whether cheap labor is a “good thing” or not is a normative assertion.”

    ……you said it was bad thing…….and re-read your Hayek……he advocated free labor markets!

    ……but carry on I love to see a real bozo squirm

  • ottovbvs

    Mercer // May 14, 2010 at 3:55 pm

    ” downward pressure on wages is a good thing!”

    “So if we received a billion people from Africa to work at a dollar a day it would be great for the American economy?”

    …….this is a totally ridiculous strawman so it’s not worth talking about,,,,,,,,,but most Friedmanite and ‘Austrian” school economists advocate total labor mobility across borders with it’s consequent impact on wages……..obviously productivity is important too but they are not mutually exclusive as the last thirty years demonstrates when there have been huge increases in productivity but real wages for 80% of the country have stagnated!

  • ottovbvs

    Rabiner // May 14, 2010 at 7:14 pm

    …….When it comes to Willy you’re really talking about the proverbial lampshade……..there isn’t a glimmer of understanding, not an iota of illumination, and yet he’s totally convinced he’s a monetary expert…….I’m laughing because it’s a bit like a plot line in one of those 40′s comedies where the patient in the psychiatric institution is convinced he’s one of the doctors

  • Mercer

    “total labor mobility across borders with it’s consequent impact on wages”

    A country with public schooling and Medicaid that has no immigration restrictions on low income earners is inviting fiscal disaster. Look at California for a preview of your open borders utopia.

  • WillyP

    rabiner,
    I don’t know your background, or what you do, or how you are compiling these arguments. I can only say that it literally makes no sense tome. Perhaps to others this makes sense, but I fail to see how. My defect, possibly.

    If I may answer you, the best way to sum up your misunderstanding is that you fail to understand the concept of inflation and how it is accomplished. Inflation, by definition, is an increase in the money supply without commensurate production in return. It is a violation of Say’s “law”; it is demand without the necessary production to support it. It is quite literally economically identical to counterfeiting, regardless of good or bad intentions. I’ll do my best to explain why this is so.

    The assumption you make every time you accept dollars is that you can exchange them for something else, something “real.” More precisely, something other than money. And this is always true when society is on a commodity based money, with the notable exception of exchange involving theft.

    The point I am making is that inflation is a mechanism we describe through this understanding. Expectations do not cause inflation. Expectations cause price fluctuation and the rise in some prices and a lowering of others, but not general price rises. General price rises are characteristic of active inflationary policy. Governments and banks are the two legal providers of counterfeit money, and money alternatives (fiduciary media) respectively.

    In your example, you err when you assume that a labor market experiencing normal price fluctuation is involves inflation. If workers were to demand more, they would first have to justify taking it away from another. It would expand the purchasing power of this fictional group of “workers,” but unless it is desired by society it would never happen. But regardless of frequency, even if it were to happen, it would not cause any inflation. It is unrelated.

    This talk of the “money multiplier” is similarly confused. The money multiplier says that money spent by the government reaches several different hands, an in effect this means that a $10 investment yields something like $90 of GNP. If you give it some thought, this is patently ridiculous. If it were true, then it would be true for everybody and not just governments. Any concept that references “the velocity of money” and uses it to describe how real GDP is enhanced by a higher velocity of money is seriously flawed.

    What is called the velocity of money is the idea that as money changes hands in a successive manner it adds value each time. Well, the truth is that there would be no exchange of money if there were not real goods behind the money. So increasing the “velocity” of money alone, through inflation or deficit spending, can never lead to higher prosperity. The only thing that leads to prosperity (that is, an abundance of goods) is more efficient production that adds value. Inflation, while the policy itself may spur production in some sectors or businesses, necessarily takes away resources from others. Here, you can understand how all costs are truly opportunity costs.

    The important take-away is the inflation violates Say’s law. It destroys important market information by misrepresenting the allocation of resources. It is also the cause of business cycles (a different topic altogether).

    Otto likes to dismiss me as borderline insane. This is somewhat annoying, but also demonstrates his inability to make sense of the Keynesianism he promotes. I would recommend basing your understanding of economics on what you find to be true, rather than what fits with your pre-configured political stance. You’ll find you can actually make sense of and explain phenomena that occur in the world as they happen.

    Otto, of course I know what the interest rate on a T bond represents. It’s the cost the government pays for short term loans. Those interest rates are low a) banks have an unprecedented amount of money loan thanks to TARP and other Federal interventions and b) the private sector, which competes with the government for loans, is highly volatile at the moment, thanks, once again, to government. Let’s look at the data:

    http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/daily_treas_bill_rates_historical.shtml

    Two observations: 1) It is cheaper to borrow money short term than it is long term; in other words, we have an inverted yield curve. 2) Interest rates are creeping up.

    Why an inverted yield curve? Only one reason I can think of: inflation expectations make forecasting more difficult and therefore makes them riskier. This is a direct consequence of inflationary policy. How else could you possibly explain the circumstance where it is actually more expensive to make a short term loan. It rationally violates the law of pure time preference and is not a normal market condition.

    As for the rising interest rates, they’re still far too low. However, when businesses are once again profitable money will move off the sidelines into more attractive investment opportunities, rates will go up significantly. Or they should, at least. Right now the banks are not loaning because they are being paid interest by the Federal Reserve NOT to loan at ultra low rates. They are doing this as long as possible until the economy “recovers.” Unfortunately, how they remove the now $1 trillion extra loan money they injected when markets crashed remains a question. And that’s assuming the economy CAN recover with such low interest rates, which is a suspect assumption. (Briefly, we need higher interest rates right now to promote savings and capital consumption. The credit doses in the past have eroded the real savings base of the nation, which is what we use to fund capital accumulation. In artificially lowering rates, they are doubling down on a bad, and observably failing, policy agenda.) The Federal Reserve and government have painted themselves into the classic inflationist corner.

    But what do I know.

  • Rabiner

    WillyP:

    Inflation is not just about money supply but also the purchasing power of that money. If it was just about money supply then everything would inflate in the same manner, this is obviously not the case. The money supply over the past few years has increased considerably based on government intervention and inflation hasn’t increased by that amount. In the 1970s the money supply didn’t increase that much and inflation soared as the price of energy outpaced everything else. It is a reflection of purchasing power.

    You seem confused about the money multiplier effect. It isn’t just with regards to government spending but rather all spending. And yes, if the money multiplier is 9, then $10 billion in government expenditures would create $90 billion of economic activity since each dollar would on average go through 9 intermediaries. That isn’t complicated economic theory and actually something taught in an AP Macroeconomics course in High School (at least we covered it since it was on the AP exam in 2001).

    If you were curious about my background I have a undergraduate degree in Economics and a Masters degree in Public Policy.

    “Otto likes to dismiss me as borderline insane. This is somewhat annoying, but also demonstrates his inability to make sense of the Keynesianism he promotes. I would recommend basing your understanding of economics on what you find to be true, rather than what fits with your pre-configured political stance. You’ll find you can actually make sense of and explain phenomena that occur in the world as they happen.”

    While I agree that dismissing you as insane rather than your arguments is demeaning but you should realize that Keynesian economics is just as valid an economic theory as Monetarism. Both focus on different aspects and explain different things so they each make sense. Keynesian economics has a flaw of being unable to answer stagflation since inflation theoretically shouldn’t occur in a recession. However Monetarism has its flaws by ignoring the realities of government. I’m far more familiar with Keynesian, Utilitarianism, and Game Theory than I am Monetarism.

  • ottovbvs

    WillyP // May 14, 2010 at 11:07 pm

    “But what do I know.”

    ……….Well you apparently don’t know the implication of low yields on long bonds …….no need for the dissertation on T bills and the digressions into totally unrelated matters which I presume is a smoke screen to avoid addressing the query I put to you……when 20 year bonds from the US and many other European govts have interest rates just over 4% it means the market does not perceive any serious danger during the next ten years of economic implosion in the US or Europe such as you are confidently predicting…….it even means (shock, horror) they don’t perceive our debt problems as particularly onerous or insoluble.

    ” Otto likes to dismiss me as borderline insane. This is somewhat annoying, but also demonstrates his inability to make sense of the Keynesianism he promotes.”

    ………Another of your classic pieces of Gobbledygook Willy…….my disdain arises not from your monetarism (which has some valid theorems that I totally buy into but some that have proved flawed) or my inability to make sense of Keynesianism(whatever that means)…….but rather from your total sense of unreality (viz: confident forecasts of imminent US and European economic implosions) and inability to interpret and synthezize information as demonstrated by my little example of T bill yields and indeed numerous other bits of confused and self contradictory pontificating we’ve heard from you…….I’m certainly not an economist but I have undergrad and masters degrees that give me some grounding and considerable practical business/investing experience (which I actually consider more important) whereas you’re rather obviously a poseur not to be take very seriously…… unlike Rabiner who clearly knows what he’s talking about

  • WillyP

    rabiner,
    I am not speaking in “Monetarist” terms. Monetarism was Milton Friedman’s reformulation of Fisher’s work in the 1920s an 30s, and nobody is a monetarist anymore because it failed as a system. Even Friedman abandoned it.

    What I am describing is natural law, espoused by the Austrian school. It has a very, very long intellectual tradition and was considered the mainstream until Keynes’s largely incoherent General Theory.

    For a good primer on inflation, from my perspective, see here:
    http://mises.org/daily/2914

    otto,
    The rates on 20 yr bonds from governments are, obviously, manipulated. This is why we have central monetary authorities – to manipulate interest rates. That’s the whole, remember. Do you deny this? And furthermore, do you deny that we’re going to have rapidly increasing interest rates shortly?

    I don’t predict “imminent” implosion. Rather, I recognize that if things continue down the path we’re on, implosion is inevitable. The cracks are showing already. Until then we’ll have perpetual crisis and economic malaise. Which accurately describes the times we live in, right now. Or are things just peachy?

    You’re both entitled to disagree completely with my analysis, and obviously do. But to suggest that it’s rambling or inconsistent, or that my theories are not coherently synthesized… well, I’m not the one who thinks that inflating and diverting resources away from the public to gov’t officials is going to solve a problem of dislocation.

    I have, in the past, worked for a firm that provides the largest marketplace for fixed income products, so I do happen to know something about interest bearing financial instruments.

  • WillyP

    A note on interest rates and savings:

    High interest rates are indicative of a small real savings pool. Low interest rates are indicative of a large real savings pool.

    This is true because interest rates are the cost of borrowing from the savings pool. More savings, lower cost of borrowing. Integrated then is the overriding obedience to supply and demand of interest rates.

    Right now, interest rates should be HIGH because we depleted our savings when we LOWERED them following the popping of the dot-come bubble and 9/11. This caused us to deplete our savings, which gave the impression of great prosperity (the “boom years”).

    Instead of allowing the market to correct, with HIGHER rates, we forced the key interest rates, the Fed funds rate, down again to 0% – 0.25% It sits now at 0.25%.

    If we want recovery, we need incentive SAVE in the form of HIGHER rates. In other words, we need TIGHTER credit that facilitates only the most valuable business expansions. The government is trying to keep rates LOW while encouraging lending, which is bound to fail because people only loan money to MAKE money, which is impossible when rates are TOO LOW.

    Remember, HIGH rates reflect LOW savings. LOW rates reflect HIGH savings. We have a DEPLETED, i.e., LOW savings pool, which REQUIRES HIGH RATES to RECOVER. Our government is forcing LOW rates on us, which is frustrating efforts and forestalling recovery.

  • Rabiner

    WillyP:

    I completely disagree with your link stating that inflation is solely a response to the money supply while ignoring other aspects of the economy. It ignores other aspects that can lead to inflationary price increases beyond changes in the money supply. It also ignores that money has a relative price not a constant one that changes as other currencies change and international trade occurs. Money supply is the sole cause of inflation only in a closed economy which does not have outside influences and this type of economy does not exist in the world.

  • Rabiner

    WillyP:

    At least you can correct state the concepts around the loanable funds market though. Although i completely disagree with your assertion that high interest rates would spur a recovery faster than low interest rates.

  • WillyP

    See, one problem with how they teach economics is that they teach you how to correct “problems” without really understanding the underlying market and its functions. This basically leaves you totally ignorant with how your policy prescriptions will actually play out.

    As Friedrich Hayek once said, “Before we can even ask how things might go wrong, we must first explain how they could ever go right.” I would take this to heart.

    For an adequate response to my argument you would have to explain how we ended up in the predicament we’re in, and how lower interest rates would help ameliorate the circumstances. When we’re in this predicament precisely because we used inflation to lower “the” interest rate (or we inflated through a manner which found its outlet in interest rates – take your pick), your claim that lower interest rates are the way out is less than convincing.

    This is business cycle theory. We are in a depression because prices caught up, and they always do. I’m not so into hearing myself talk as otto would have you believe, and in this case there is a lot to say. I would say view this presentation and judge it on its own merits.

    http://www.auburn.edu/~garriro/ppsus.ppt

  • Rabiner

    WillyP:

    Business Cycle Theory doesn’t work if markets have failed like financial markets had in 2008. Its a theory I’m familiar with but has limitation from the power point you linked to. The failure of banks being unable to price their derivatives caused banks to be unable to know their own balance sheets and created a credit freeze.

  • WillyP

    rabiner,
    what do you mean it doesn’t work? it is a cycle, which was caused by induced cheap credit, which led to lengthening chains of production, which led to distortion, which eventually collapsed when the fed raised rates to prevent general price rises.

    derivative products were essentially hedges against the huge amount of bad information introduced by the process of credit expansion. this is what happened and it’s completely explained and explainable referencing austrian business cycle theory. capital based macroeconomics – it’s a lot more powerful than keynesianism.

  • Rabiner

    Austrian business cycle theory doesn’t refer to market failure but rather the business cycle of artificial booms and busts. Recessions according to Austrians are due to malinvestment caused by a distortion in the cost of investment from central banking and artificially low interest rates. What happened in 2008 was two fold: A bust from the housing market (which wouldn’t of led to this bad a recession) and the added effect of a market failure of the derivative market that financial firms attempted to hedge their risky bets to remain solvent. The problem was this second part caused the freezing of capital markets since financial firms and banks were unable to know their own balance sheets to determine if they could afford to loan money.

    And yes I understand that derivatives were designed to reduce risk to the owner by hedging against their bets. However they became so complicated and transactions had such little transparency that no one really knew the risks associated with them and the values of each derivative.

  • WillyP

    rabiner,
    “Austrian business cycle theory doesn’t refer to market failure but rather the business cycle of artificial booms and busts. Recessions according to Austrians are due to malinvestment caused by a distortion in the cost of investment from central banking and artificially low interest rates.”

    Yes, and is this not what happened? An inflated housing bubble, a boom, followed by a bust?????

    The derivative products you are describing were invented to hedge against defaulted-on loans. In other words, created as a hedge against the housing boom, which it seems many people knew to be ultimately unsupportable.

    Credit default swaps, Interest rate swaps – CDS, IRS…

    Both came out of the HOUSING BOOM. Or are you going to tell me they didn’t? I was working at a firm that realized most of their business through trading 3 products: MBS, CDS, IRS. The product growth was incredible in 2006. We now know how it ended.

  • Rabiner

    WillyP:

    I stated specifically that two things happened. One: the booms and bust of a housing bubble like the Austrian Business Cycle describes. Two: A market failure of financial instruments that caused them to become ‘toxic’ assets that could not be priced and not be sold since the value was unknown to everyone. That is not described in the Austrian Business Cycle. While these instruments were created during and as a response to the boom/bust of the housing bubble that failure was a result of a lack of transparency than it was the actual bust.

  • WillyP

    Rabiner,
    For the exotic, unprecedented development of credit derivatives, you’ll need to look at the other two government culprits besides the Fed: Fannie and Freddie.

    If the pricing on mortgage debt instruments and their derivative products were so difficult to predict, then its to the government loan manufacturing process you must look. (Mark Levin actually does an excellent job covering the aspects of the financial crisis one at a time in Liberty and Tyranny.) Here we had underperforming loans implicitly guaranteed by a third party – government – packaged up into investment products and sold to private investors. However, even if Fannie and Freddie were making loans to people who would not normally qualify, and underwriting them to satisfy private sector banks, this alone would and could not describe the existence of a credit bubble. To the extent that something is called a “bubble” rather than mere dislocation (as would result from price floors and ceilings, burdensome regulation, and other mercantilist mechanisms) inflation – the counterfeit process I described earlier – is the driving factor.

    So yes, Fannie and Freddie contributed more directly to the derivative market than the Federal Reserve. Although it is also safe to say that the Federal Reserve significantly increased the magnitude of what Fannie and Freddie were capable of doing alone.

    Even if you don’t buy into my strict terminology, you still agree that the derivative market demonstrated “market failure.” The argument for me here is simple: The government (i.e. Federal Reserve and Fannie and Freddie) created the housing bubble. The housing bubble spawned the derivative market. The derivative market ended in notorious market failure. Therefore, if the government had not created the housing bubble, there would be no derivative market failure.

  • Rabiner

    WillyP:

    At least we’ve come to a conclusion that yes there was market failure. But you’re still grasping at this failure as a result of a bust of a bubble and not due to the lack of transparency in trades that would of allowed people to know the real value of the market. After reading Too Big To Fail (really interesting book in my opinion) I find that the derivative markets would of crashed eventually regardless of housing boom and bust because they would of eventually been heavily invested in a different boom/bust commodity as time went on. The reason for this is they saw no risk to their companies when doing CDS or other financial instruments based on their own computer models. In addition regulators saw no systemic risk based on the interconnectedness caused by derivatives to the economy as a whole so there was regulatory failure (particularly by Christopher Cox and the SEC).

    Saying that: Freddie and Fannie encourage poor lending standards –> banks giving out poor loans –> value of homes increasing = housing bubble is quite correct. However I don’t believe the housing bubble spawned the derivative market at all.

  • msmilack

    I think your argument is brilliant, David. Now, if only the people in power (and voters) would listen to you or wake up before it’s too late. I will never understand the scorch the earth philosophy that propels this movement (“we killed them to save them” comes to mind). The Jim DeMints, Vitters, Palin and their like are our very own
    suicide bombers.

  • nhthinker

    msmilack,

    “I will never understand the scorch the earth philosophy that propels this movement ”

    You, like many liberals, view any sort of “you made your bed, now lie in it” POV as too hard-

    As Americans learn more about what the Paul’s stand for, they continue to recognize the appropriateness of the federal government scaling back. One only has to look at Greece and California to see the end-game of the liberal POV.

    Democratic socialism is much less efficient than communist socialism primarily due to the long term emphasis on entitlement instead of the emphasis on social good.

  • WillyP

    rabiner,
    The products – CREDIT DEFAULT SWAPS and INTEREST RATE SWAPS – were aimed at MORTGAGES.

    Am I missing something here? If they were not developed as a result to the housing boom, did they just appear de novo at precisely the same time the housing bubble inflated?

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