Category Archives: Uncategorized

Central Bank Methods for Managing Currency Valuation

In June of 2015 as Chinese stocks crashed, the Chinese central bank, the People’s Bank of China (PBOC), wrote to the United States Federal Reserve to ask for their advice in mitigating a stock market plunge. (Reuters) The specific advice related to how Greenspan dealt with Black Monday in 1987 including how to inject cash into the market and also provide reassuring messages to the market. China, however, was facing three challenges: it had to maintain a currency peg, support equities and target interest rates on the open market. Two months later the PBOC chose to drastically devalue their currency.

The United States and China differ in the policy options available to their Central Banks for two main reasons. First, the United States is restricted in how much it can devalue its own currency without causing global turmoil. Secondly, the United States Federal Reserve is limited in its trading ability by the Federal Reserve Act. Their actions, however, are similar to the PBOC but require different avenues to remain legal.

The Fed and PBOC are also alike in that they require their currency to be stable. The United States benefits from the Dollar being the primary reserve currency, a position which requires a stable currency at least relative to other major currencies. Likewise, China, who wishes the Renminbi to become a major reserve currency, cannot manipulate their currency openly. Therefore, both are constrained in this aspect. However, in a globalized world of free-floating exchange rates, many policy options remain available.

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Driving Forces of the College Bubble

Since the last bubble pop in the housing market, the most discussed bubble has been the college bubble. Not only do economists not agree on whether there is a bubble, but they also don’t agree on what is driving the bubble? [1] Tuition rates and the number of graduating students has quadrupled in the past 30 years, far outpacing inflation and job growth. [2] Yet the opportunity cost of not going to college has never seemed higher. [3] After lost wages and cost of tuition is considered, the difference in earning potential has been calculated to be as high as half a million dollars. This differential is based on the pay gap between college graduates earning 80k and highschool graduates earning 43k. [3] For the most recent graduates, this number does not tell the whole story. In fact, for them the choice is not nearly as simple as the NY Times article “Is College Worth It?” suggests. This paper will address three major flaws with the much touted wage gap calculation and what it says about the underlying supply and demand for degrees.

First, all bubbles confer huge benefits to early entrants, while later entrants are faced with huge risks from entering the over-valued market. Nevertheless, as the bubble peaks, two stories are prevalent; one declaring a bubble exists and another warning of lost rewards for those who don’t buy in. This is the logic mirrored in the pay gap. College degree holders from the 1960s to 1980s were an elite group of around 10% of the population. [2] They came to hold the top positions at US companies, as the stories of mailroom to C-suite success declined. Today with 33% of the population holding a college degree, a degree alone no longer means a management position and elevated salary. These positions now call for a master’s degree. While the high salaries of the early entrants widen the pay gap, new entrants are greeted with a much different market [4]. How different is this market?

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When Goals Limit Solutions

One of the simplest concepts in economics is the rational person trying to achieve a single goal. A consumer trying to buy an ice cream, for example. Most people have goals and most are not as simple as buying ice cream. Still the nature of the goal can have important consequences in how you obtain it. For instance, if you need ice cream but have no money, then robbing an ice cream truck is one of your only alternatives. Having just two dollars expands the number of choices and routes to your goal immensely.

This analogy has a corollary in public choice. Activists often proclaim the need to end practices still prevalent in society. In a recent article on domestic violence in the Guardian, the author concluded: “We need to end domestic violence entirely”. Similar positions have been voiced by law enforcement advocates calling for the end of crime, or environmentalists calling for the end of pollution, or anti-war advocates calling for world peace. Each position is an absolute one; That a negative aspect of society must end.

Two of these positions have been tested. Strong support for harsh criminal penalties in the 1980s and 1990s brought a shift towards mandatory minimums, three-strikes rules, and death penalties. Yet after 20 years, the data and policy studies are not sure what this harsh penalty absolutism has gotten us besides lots of prisoners. (see David and Goliath by Malcolm Gladwell) Ultimately, Gladwell arrives at the economic conclusion that eliminating crime or even reducing it too much can have too high a cost. Essentially, eliminating crime from society suffers from a marginal benefit problem as more criminals are locked up.

Likewise, after numerous studies and suggestions on how governments can reduce pollution and greenhouse gases, little progress has been made. The best solutions are carbon taxes or a carbon market which would allow the trading of “carbon credits”. Neither solution is commensurate with the extremes of the two opposing voices: industry and environmentalists. As a result, even the structure by which future progress might be made is left languishing in sub-committees. The problem with absolutism is that, even if technically possible, the all-or-nothing demands restrict the routes through which progress can be made.

World peace was the choice cause of the 70s. Now it’s a pejorative for all similarly idealistic and unlikely wishes. No one blinks an eye when Obama suggests re-entering Iraq or Putin sends troops into Ukraine. This is the folly of absolutism, idealism is likely to turn to realism and then to satire and then disregard. For progress to be made by a movement, progress must be made while it is still alive. The fault, however, lies not simply in idealism meeting realism but in limiting the paths to success.

By declaring an absolute goal, a lot of possible allies are alienated. Calling for the end of pollution renders pollution-reducing science useless, opposes industry and it’s employees, and makes the jet travelling activists easy targets for scorn. In reality, the scientists working for industry will be the first allies needed to reduce pollution once legislation is enacted; the industry employees would benefit just as much from the lack of pollution literally in their backyards and work places; the industry itself could benefit if efficient solutions saved money as well as reduced pollution; and finally, activists wouldn’t look like hypocritical idealists.

The desired goal, then, in these cases limits the solutions as well as eliminates possible allies. The goal creates the structure of the solution set, and in the absolutist case, a much smaller solution set. Few people, especially moderates, are likely to find these solutions acceptable. The results benefit only a minority. Most cases where the opponents are equally matched (industry vs. environmentalists) nothing happens. On the other hand, where the sides are unmatched (criminals vs. enraged society), extreme positions actually get implemented and hurt society as a whole (as happened in California). Better solutions abound but are not explored because moderates are not the ones calling for change. For the benefit of society, we must end absolutism [wink] and start discussing other routes to the valid goals espoused by these movements.