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2005 02

Rust or Bust?  The ‘Bubble’ Brigade Tire of Eating Crushed Glass

If they removed the word ‘bubble’ from the English language, Morgan Stanley’s Stephen Roach and Andy Xie would be left with nothing but sycophantic Sinophilia to irk us with. Fortunately, their colleague Richard Berner is much more level headed and has produced a thoughtful discussion of the outlook for US housing and house prices:

Most macro forecasters — crystal ball gazers all — have eaten a lot of ground glass trying to call a top in housing activity in the past two years, including yours truly.  Likewise, home prices have defied all calls, including mine, for a peak in appreciation, not to mention the bears’ forecasts of a sharp decline…

Importantly, however, a precipitous decline is unlikely: Stronger job and income growth should underpin new and replacement demand…And home prices?  I stick to my view that prices henceforth are likely to rust, not bust.

…neither the pace nor the level of prices is prima facie evidence of a bubble.  As I see it, nationwide housing ‘valuations’ are only back to neutral from being undervalued, consistent with my thesis that home prices will rust, not bust, for the next few years.

I make a similar argument about Australian house prices here.

posted on 28 February 2005 by skirchner in Economics

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The Institutional Economics ‘Gloom & Doom Amid Boom’ Competition!

Australia’s January trade balance has come in with the second largest deficit on record, ahead of tomorrow’s Q4 current account deficit.  I notice Trade Minister Mark Vaile has continued Tim Fischer’s old trick of pointing to exports being at record levels.  The relevant measure is of course the exports share of GDP, which would decline if exports did not keep posting new records in level terms.  It takes alot of cheek to claim credit for a secular trend. 

I am running a competition to find the most overwrought commentary or reporting on the January trade balance or Q4 current account.  The person(s) submitting the winning entry shall receive a free copy of Robert Prechter’s super-bearish Conquer the Crash to really keep them lying awake at night (no jokes about second place getting two copies!)  Email or post in comments (registration required, click on ‘register’ at top right).  Competition will be open until Thursday, by which time interest rate hike hysteria will have taken over from current account moral panic.

posted on 28 February 2005 by skirchner in Economics

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Globalisation and Current Account Balances

McKinsey’s Diana Farrell on globalisation and the US current account:

Roughly one-third of the current account deficit results from US-owned subsidiaries abroad…

Trade between foreign affiliates (as offshore subsidiaries are called) and US companies and consumers can either inflate or diminish the current account balance. When Ford or General Motors produce vehicles in Mexico they sell many to American consumers, causing US imports to rise. But they also sell a significant number in Mexico, generating a positive income flow to the US current account, and they use technologies and components produced north of the border, boosting US exports.

Any net negative impact on the trade balance caused by foreign affiliates is more of an accounting anomaly than a cause for economic concern. Methods for measuring the current account date back to the 1940s, when few companies had operations outside their home countries.

A similar argument can be made in relation to Australia.  Since Australia has become a net exporter of direct investment capital in recent years, this implies that at least some of Australia’s current account deficit is being used to fund the globalisation of Australian business.

Meanwhile, Cato’s Dan Griswold argues why the last thing you want is a trade surplus:

By the most basic measures of economic performance - GDP, manufacturing output and the unemployment rate - the US economy performs better in years when the current account deficit is rising than in years when it is shrinking. And it performs especially well in years when the current account deficit is rising most rapidly…

Those who seek the Holy Grail of a trade surplus should be careful what they wish for. Germany last year racked up a global surplus of almost $200bn. Not entirely coincidentally, its unemployment rate reached 11.4 per cent in December and the number of unemployed reached a post-unification high of 5m people. The last time America’s jobless rate was that high was 1982 - when its own current account deficit was a measly $5bn.

America’s trade deficit is essentially an accounting abstraction. Our attention should focus on what really matters - economic growth, job creation, industrial output, and the free and open markets that promote real growth.

posted on 25 February 2005 by skirchner in Economics

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The Myth of US Overstretch

David Levey and Stuart Brown’s article in Foreign Affairs, which we linked to earlier in op-ed form.  Read the whole thing, as they say.

posted on 25 February 2005 by skirchner in Economics

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Another US Current Account Beat-Up

You can’t help but be suspicious of a story reporting on a speech by Australian Treasury Secretary Ken Henry with the headline ‘US deficits risk crash: Treasury.’  My suspicions deepened when the report contained only two direct quotes from Henry. 

Henry’s actual speech is nothing exceptional and does not use the word ‘crash’ once.  The Australian Treasury has in fact argued persuasively for the sustainability of large US current account deficits.

Australia routinely experiences cyclical deteriorations in its current account balance as a share of GDP that make the current US deficit look small by comparison.  The Australian Treasury has long been converted to the consenting adults view of the current account.  If it views the US differently, it is because of the public sector contribution to the US deficit, which is a fiscal policy issue, not an external imbalance problem.

Next week, Australia is likely to report a monster Q4 current account deficit.  I will be running a competition for the most melodramatic and silly reporting of, or commentary on, this number.  Send me your sightings by email or post them in comments.

UPDATE:  Terry McCrann also notes that:

Henry was not setting out to ring the alarm on the “coming crash”, and would probably have been surprised—pleasantly or otherwise—to read words on the front of a national newspaper that would inevitably be dished up to the Prime Minister and/or the Treasurer.

posted on 25 February 2005 by skirchner in Economics

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House Price Inflation without the Froth

When confronted with asset price inflation, many economists are all too ready to declare a ‘bubble,’ which saves them the bother of actually having to think seriously about the economics underlying asset prices.  Fortunately, the BoE MPC’s Kate Barker is not one of these people.  In a speech to the IEA, she carefully examines the relevant fundamentals and puts them in a broader context, noting:

In previous speeches I and other MPC members have set out why it is generally undesirable to target asset prices when setting interest rates – particular reasons being the wide range of uncertainty around the equilibrium for any asset price, and the dangers to credibility of diverting policy from the goal of achieving the Government’s inflation target.

While RBA Governor Macfarlane has also highlighted the dangers of using monetary policy to target asset prices, the RBA’s public comments on house prices and private sector credit growth have diverted attention from its inflation target and confused the public and markets.  The RBA’s mistake was to express a strong (and arguably mistaken) view on house prices and private sector credit growth, but without being willing to actually take responsibility for outcomes in relation to these variables.  This was the right policy choice, but calls for a more agnostic public stance on these issues so as to keep the inflation target centre stage.

(thanks to Mark Harrison for the pointer)

posted on 24 February 2005 by skirchner in Economics

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Markets in Everything: The PAM Rides Again

Remember the Pentagon’s ill-fated Policy Analysis Market?  Intrade is now offering a contract on the timing of US air strikes against states sponsoring terrorism:

The contract will be expired at 100 if the USA officially launch and execute an overt Air Strike against land facilities in any of the listed countries on or before June 30, 2005.

The countries involved and currently listed as States known to sponsor terrorism are: Cuba, Iran, Libya, North Korea, Sudan & Syria.  Only these six countries count for expiry purposes. An overt Air Strike against a land facility will be defined as an air attack officially announced by the Pentagon or the US Department of Defense. It will not include any covert operations, accidental border clash, etc. The contract will be paused and subsequently expired once such an attack has been reported to have taken place against a land facility in any of the named countries.

The contract has yet to trade, but market depth is pointing to an implied probability in the low teens.  This contract would have been more informative if it were based on individual countries, rather than such a disparate group.

posted on 22 February 2005 by skirchner in Economics, Economics/Financial Markets

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More on Pop Austrianism and the Business Cycle

A key element of the pop Austrian critique of contemporary monetary policy is that the inherent unevenness of the process by which newly created base money and inflation work their way through an economy creates a structure of production that a free market economy would not otherwise support (the Ludwig von Mises Institute has plenty of examples of this sort of claim).  In the Austrian view, growth in broad money, credit aggregates and even asset prices is built on a house of cards: fiat money leveraged through fractional reserve banking.  Even those Austrians who accept fractional reserve banking consequently see almost any central bank policy action as inherently destabilising. 

A major problem with this view is that there is no necessary connection between interest rate targeting by central banks and the money base (although in practice they are usually closely linked by the operating procedures currently favoured by monetary authorities).  In principle at least, we could have a market-determined money supply and even non-centralised clearing of overnight inter-bank lending and yet still have a central bank successfully targeting an official short term interest rate through its willingness to buy and sell relevant instruments at given prices.  Unless we define free banking as the complete absence of a central bank, there is no reason why the two institutions could not co-exist.

continue reading

posted on 21 February 2005 by skirchner in Economics

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The US Net IIP: Non-Hysterical Version

Much of the hysteria surrounding the US current account deficit reflects a basic lack of faith in US institutions and growth prospects.  David Levey and Stuart Brown have a refreshingly different perspective:

While the NIIP will continue to grow for many years to come, future dollar depreciation and market adjustments in interest rates and asset prices will mean that its increase will be far less dramatic than many fear. Moreover, focusing exclusively on the NIIP obscures the United States’ institutional, technological and demographic advantages. The classic doomsayer argument - that growing foreign indebtedness results from too little savings by Americans - neglects the fact that savings and investment are seriously undervalued in U.S. economic accounts. When you include capital gains, 401(k) retirement plans, and home values, U.S. domestic saving is around 20 percent of GDP, the same as in most other developed economies. And when you consider “intangible” investment (like new-product development and design experimentation) as part of total, the supposed increase in consumer
spending as a share of GDP turns out to be a statistical artifact.

Indeed, much of the explanation for chronic current account deficits relates to the U.S. economy’s strong fundamentals, not fatal structural flaws.

The country with the world’s strongest external investment position is Japan, which achieved this dubious distinction by trashing its potential growth rate and the returns on domestic investment through state-sponsored forced saving and the overcapitalistion of its economy. 

(thanks to Jack S. for the pointer)

posted on 20 February 2005 by skirchner in Economics

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Steve Hanke’s Currency Board Fetish

Steve Hanke is nothing if not consistent.  His fetish for currency boards seems to have spilled over into a love of almost any fixed exchange rate regime.  He even has the audacity to call the proponents of greater exchange rate flexibility in East Asia mercantilists. 

Hanke’s defence of HK’s currency board relies on financial instability that occurred more than 20 years ago.  The costs HK’s currency board has imposed on its economy in recent years are completely ignored (Singapore has done relatively better because of its more flexible approach to exchange rate management).

In relation to Japan, Hanke maintains:

Japan has been under mercantilist pressure, primarily from the U.S., to ratchet up the yen’s value against the dollar. Tokyo has complied. Consequently, the economy has suffered from strong-yen-induced recessions and hasn’t yet recovered from the enormous deflation of the 1990s. And the mercantilists in the U.S. remain agitated because Japan continues to register large trade surpluses.

Hanke has things exactly backwards.  Japan has not seen a yen-induced recession since 1985-6.  It has been Japan’s mercantilist attempts at resisting the secular appreciation of the yen, by laundering its massive current account surpluses through USD asset markets, that has landed its economy with a massive overhang of excess capacity.  China risks suffering the same fate, especially if its demographics ultimately turn as toxic as those of Japan.

Given the terrible havoc fixed exchange rate regimes have wrought in emerging market economies in recent years, and within the euro zone, it is incredible that anyone still defends them.  It is even more incredible that these hold-outs for Bretton Woods-era monetary regimes can still find a home within classical liberal think tanks.

posted on 18 February 2005 by skirchner in Economics/Financial Markets

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The Anglo-American Model Delivers

I recently came across a forsaken copy of Peter Brain’s (1999) Beyond Meltdown in a second-hand bookstore.  In the course of a diatribe against ‘neo-liberal’ economics and the ‘American’ economic model in Australia, Brain forecast that the Australian economy would enter a prolonged stagnation in the wake of the 2000 Olympics, during which the unemployment rate would return to the double-digit figures seen during the last recession in the early 1990s.

Instead, the Australian economy has gone from strength to strength, with the unemployment rate hitting multi-decade lows, precisely because it has generally avoided the policy prescriptions favoured by the likes of Brain.

The Anglo-American economies currently look a whole lot better than those countries that have followed less liberal policy prescriptions.  Japan has just gone back into recession for the third time since 1998.  Germany is just shy of its third recession in four years.

Meanwhile, the UK, Australia and NZ are all enjoying their lowest unemployment rates in decades.  This is particularly telling, since the ‘neo-liberal’ policies supposedly favoured by the Anglo-American economies are often stereotyped as anti-employment.  The evidence suggests otherwise.

Of course, there is no reason why the Anglo-American economies cannot also experience a downturn in the near future, but even in recession, they will fare much better than those economies outside the Anglo-American bloc, due to their greater commitment to liberal policy prescriptions.

UPDATE:  My Google ad strip is now rather amusingly showing “Discount GDP Forecasts: New and Used GDP Forecasts.”  It is of course an ad for Ebay, not Peter’s book.

posted on 17 February 2005 by skirchner in Economics

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Get Paid for Economics Blogging!

If you are a recent graduate and would like to be paid to work on an economics blog, Peter Jonson at Henry Thornton has a job opportunity for you.

posted on 16 February 2005 by skirchner in Economics

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The House Economics Committee Gets a New Chair

Those of us who argue for greater central bank transparency can only cringe when the Reserve Bank Governor fronts the House Economics Committee.  You have to admire the patience and politeness Governor Macfarlane displays in the face of the Committee’s woeful displays of economic illiteracy and ham-fisted attempts at point scoring. 

Things are not going to get much better under the Committee’s new chair, Bruce Baird, who has rather helpfully put out a press release alerting us to what is on the Committee’s collective mind.  Baird says:

I’m also interested in what incentives the Reserve believes are needed to encourage greater private investment and whether there should be a diversion away from investing in private housing.

This is of course well outside the Governor’s mandate and, dare I suggest, also outside the realm of legitimate public policy concern.  The implication that investment in housing is excessive is particularly galling coming from people whose own homes are, at a wild guess, a cut above average.  It is fine for them to invest in housing, but a dangerous ‘bubble’ when everyone else gets in on the act.

Baird is also a coordinator of the informal government committee, the Friends of Tourism Group.  This sits rather uneasily with his current efforts to deny Singapore Airlines access to the Australia-US route in order to protect Qantas jobs in his electorate, which includes Sydney Airport.  The sort of ‘friend’ tourism could do without.

posted on 16 February 2005 by skirchner in Economics, Politics

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Myth Busting the House Price ‘Bubble’

The prevailing mythology surrounding the Australian economy in recent years is that economic growth has been driven by consumption, which in turn has been driven by a house price boom.  It is true that consumption has largely accounted for headline GDP growth in recent quarters.  But as John Edwards has pointed out, consumption and national saving as a share of GDP have been remarkably steady.  What has changed is the investment share of GDP (including dwelling investment), which in real terms is currently the strongest it has been during the post-war period.  In this context, the deterioration in the current account balance is a cause for celebration, because it represents an investment boom, not a collapse in saving.

In the chart below, I have shown real Sydney house prices and GDP as percentage deviations from their linear trends.  It is remarkable the extent to which the cycle in real house prices has lagged the business cycle.  GDP has been consistently at or above trend since the end of 1997, but real house prices in Sydney only exceeded their own trend from the beginning of 2002, after a decade of below trend growth.  The chart puts the supposed ‘bubble’ in Sydney house prices in cyclical perspective.  Of course, some would argue that the secular trend in house prices is itself a bubble and one can take issue with the detrending methodology, but the notion that house prices have been leading the economy looks rather strained.

If there is anything to the stylised Australian house price cycle (turn of the decade booms, followed by middle of the decade slumps), then the cycle in house prices should bottom at the end of 2006 (as it did in 1986 and 1996), but only after the economy has already slowed for reasons that have little to do with house prices.

image

posted on 15 February 2005 by skirchner in Economics

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Supply-Side Constraints and House Prices

The Economist finally has something to sensible to say on house prices, reporting on research into the effects of supply-side constraints on house prices in US cities.  There is hope for The Economist yet!  The original paper is here.

Meanwhile, David Smith highlights the sorry record of house price crash predictions in the UK:

The first housing-crash story I could find in the present cycle came in 1996, when one Bob Beckman predicted a 20-year fall in prices. There was another batch in 1997, when the fear was that Labour’s election would hit house prices hard.

In 1998 and 1999, when the stock market was booming, there was a steady trickle of housing-crash predictions, building further when the stock-market boom turned to bust in 2000. The September 11 attacks on America persuaded many that housing was about to take a dive and, in the three years since, talk of a housing crash has built up to a crescendo.

David Smith’s skepticism is refreshing.  It is interesting that the debate about house prices in the US, Australia and the UK is very similar, yet so many commentators remain wedded to country-specific explanations for what is clearly a global price shock to this asset class.

posted on 15 February 2005 by skirchner in Economics

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Throw the FIRB on the Bonfire

The FT calls for a Ludwig Erhard-style bonfire of Australian controls, with the FIRB on top of pyre:

the Financial Times called on the Australian Government to overhaul its foreign investment regime and scrap the body that implements it, the Foreign Investment Review Board.

It said the usual suspects, notably “businesses that would find it convenient to have the [WMC] takeover stopped” had lobbied against Xstrata being cleared to have a tilt at WMC, but the real problem was Australia’s foreign investment screening system, which was “a protectionist relic” that sat badly with the Australian Government’s free market principles.

Other nations, including the United States, also screened incoming investments “but few operate regimes that are more opaque, unaccountable or open to political and bureaucratic manipulation”, the FT said, adding that the Government’s power to block deals or conditionally approve deals on “national interest” grounds relied on “a criterion so vague as to justify almost anything”.

Noting that the OECD had recently urged the Australian Government to accelerate the pace of economic reform, the newspaper concluded that “when Canberra next makes a bonfire of costly, perverse and inefficient regulations, the FIRB regime should be at the top of the pile”.

It is unfortunate that it takes a foreign newspaper to give this process some critical scrutiny.  The local press generally view the politicisation of the ownership and control of equity capital as unproblematic.  The above extract is taken from Malcolm Maiden, who also feels compelled to offer at least some defence of the indefensible.

posted on 13 February 2005 by skirchner in Economics

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Ross Gittins: Conspiracy Theorist

Ross detects a conspiracy:

When I wrote in last week’s column that the OECD hadn’t advocated a cut in the top tax rate, I was wrong. It did just that on page 65 of its report, although this proposition didn’t make it into the summary assessment and recommendations. Wonder why.

I don’t know Ross.  Maybe that’s why they call it a ‘summary.’

posted on 12 February 2005 by skirchner in Economics

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Woodside Revisited

Ian Harper on yet another outbreak of capital xenophobia:

As in the case of the Shell/Woodside deal, the Treasurer receives no guidance from the law as to what he should consider when weighing the national interest. The Foreign Investment Review Board will offer advice based on its interpretation of the act but the Treasurer is free to decide for himself what constitutes the national interest and whether XStrata’s ownership of WMC would compromise it.

Harper explores the contradictory logic employed in both episodes.  But the real issue here is not the merits or demerits of foreign ownership in a given case.  It is that the ownership and control of equity capital in Australia is subject to sweeping ministerial discretion, not to mention the bureaucratic discretion exercised by the ACCC.  The rule of law is almost entirely absent, which encourages rent-seeking behaviour and the misallocation of equity capital.

UPDATE:  The Treasurer is being praised for making the ‘right’ decision by not blocking the XStrata bid.  Steve Lewis says it is ‘a decision that will enhance Australia’s reputation as a haven for foreign investment,’ and that ‘…the Howard Government has sent another powerful signal that Australia is open for business.’ 

In fact, the decision sends a signal that any attempt to upset the status quo in relation to the ownership and control of Australian equity capital will have to run the gauntlet of the political process, allowing special interests to seek outcomes they could not otherwise secure in the marketplace.  Rather than praising the outcome, we should be damning the process, which has Australia running the fifth most restrictive FDI regime in the OECD.

posted on 11 February 2005 by skirchner in Economics

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Affiliate News

Affiliate relationships are an important source of support for Institutional Economics, so we will occasionally highlight special offers from affiliate sites.  Elliott Wave International is currently offering some of its services for free for a limited time.

To anticipate the inevitable criticism of technical analysis, I think the efficient markets hypothesis and technical analysis can be reconciled, once we allow for bounded rationality and transaction and information costs.  In this context, the existence of historical dependencies in financial market prices and other market anomalies become readily explicable.  Far from being an illustration of the ‘irrationality’ of markets, such dependencies are an illustration of the essential role markets play as discovery processes in a world that is far from frictionless.

posted on 11 February 2005 by skirchner in Economics/Financial Markets

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The New Institutional Economics

The new site is up and running.  Please email if you experience any difficulties using the address shown on the Contact page, or in comments.

As mentioned previously, comments are only open to registered members (click on ‘Register’ at the top right), but once registered, you need never login in again and you can use your registration to obtain email notification of other comments (email notification of posts in general will unfortunately have to await the next iteration).  New members will need to be approved.  I will not generally approve unidentifiable persons, especially those with free email accounts.  You are welcome to use a screen name to conceal your identity when commenting and can suppress your email address.

Posts from the old site have been turned into pdf files and posted below and in the archives.  This was the quickest way to bring across the old content.  There is still some content to be brought across.

Those who want to read the site via an aggregator can now do so with the various feeds provided at the bottom of the left-hand sidebar.  Note that it may take a while for some sites and search engines to index the new site configuration.  Again, if you experience any problems, let me know.

As readers will be aware, there has been enormous growth in economics-related blogging in the last year or so.  The days when you could count all the economics blogs on one hand have gone and keeping up with all these sites would be a major undertaking.  Fortunately, Professor Bill Parke has taken on the task of aggregating economics blogs at his Economics Roundtable.  Since Bill has done all the work, I have linked to his site, rather than attempting to maintain a comprehensive blog roll of related sites.

I have also put up my Technorati Link Cosmos, which is my rather cheap way of returning the favour if you have taken the trouble to link to me.  Readers should go visit these sites, since they are obviously run by people of taste and discernment!  I have linked to a few other sites of interest, but otherwise intend on maintaining a parsimonious set of links.  My failure to link to your site is not necessarily a comment on its worthiness, just a reflection of the burden blog roll maintenance.

posted on 08 February 2005 by skirchner in Misc

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Changes at Institutional Economics

The web site is undergoing a few changes, which should come on-line in the next week or so.  This also involves a host migration, so there may be some minor discontinuity in service.  The new site will add a number of features readers have been asking for, including permalinks, RSS syndication and comments, among others.

Readers will be familiar with the problems associated with open comments facilities.  As with all problems associated with the public sphere, the solution is to turn public space into private space (privatisation is the solution to everything!)  Those wanting to post comments will need to register as members of the site via a double opt-in email procedure.  While I appreciate that yet another registration is the last thing you all need, it has some advantages, including allowing you to set your own user preferences for things such as email notification of posts.  Members are welcome to use screen names to preserve their anonymity when commenting and can hide their email address, but I will need to be convinced that you are legit before approving your registration.  Since I know many of you personally (or at least know of you), this should hopefully not be a major problem.  If your attempt at registration gets bounced, just send me a note introducing yourself.  Rest assured your email address will not be made available to third parties.

I will make a further announcement when the new site is on-line.

posted on 03 February 2005 by skirchner in Misc

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Capitalist Internationale?

The WSJ’s Bret Stevens reports from the WEF meeting in Davos:

At an Internet café late Thursday night, I am set upon by two Swiss undergrads who earlier in the day had participated in an antiglobalization rally. How, they would like to know, do I justify my presence at this malign gathering of the Capitalist Internationale? O that it were the Capitalist Internationale, I reply. I explain that this year’s Davos is purpose-built to satisfy all of their grievances. They think the Forum’s concern for the poor and the environment is a meaningless gesture at best and probably a devious trick. I think: “The capitalists will sell the rope from which they will hang.”

(Thanks to John Rogers for the pointer).

posted on 01 February 2005 by skirchner in Economics

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