Sunday, March 28, 2010

Why are libertarian so often right-wingers?

I was reading EconLog a couple of days back and it brought back to the surface a question I have been asking myself for a while. Why are libertarians so often associated with the right wing? Specifically, why the Republican Party in the USA. Let us look at the Republicans and the Democrats and evaluate them according to libertarian values:

Economic Issues

Republicans advocate for a "small government" which trusts the market to do what it does best. Goods and services are best priced by a free undistorted market. Republicans also advocate fewer taxes (which is a big bonus when it comes to respecting private property) and an unregulated labor market without price controls or contracting restrictions. That is the conventional wisdom.
However, we should not forget things such as the Republican stance on immigration. Republicans are much more likely than Democrats to oppose open borders. Why? Keep American jobs for Americans. In other words: Knee-jerk protectionism. Libertarians realize that the job market is not a pie that you have to divide between foreigners and locals. Instead, an influx of cheap labor drops prices boosts consumption and helps everyone. (Somebody may have lost their job, but overall, we are better off) Also, who loves those rural voters and throws them farm subsidies as often as possible? Also, it is a historical fact that Republicans are much worst at balancing the budget than Democrats. And eventually, that bill is going to come due...

I would give Economic issues to Republicans by a slight margin.

Foreign Policy

Democrats it's well known are all peace loving hippies. That's a far fetched exaggeration, but recently, the Republicans started two wars where neither accomplished a whole lot. Whether it is Afghanistan or Iraq, it is hard to argue with the fact that the Democrats were a whole lot more committed to peace than the Republicans were. Now, it would be unfair to forget things such as the Balkans war which Clinton jumped in, but comparing the recent records of Republicans and Democrats, the Democrats seem less likely than the Republicans to get involved in wars.

I would give the Foreign Policy issues to the Democrats by a slight margin

Social Issues

This is in my opinion where the big difference is. Whether you are talking about abortion rights, gay rights, minority rights, women's rights, etc, the Democrats can carry this one home easily. The Republicans are a whole lot more likely than the Democrats to tell you what you can or cannot do in your bedroom. And that for me is a deal breaker. If we also look at things such as religious freedom and discrimination, it seems the Republicans would be a whole lot more amenable to racial or religious profiling.

Social issues in my opinion go easily to the Democrats.

So, why is it that Libertarians associate so much with the Republicans? Are the economic issues so immensely important that the slight Republican advantage in that area overshadows everything else? I had that chat with a friend of mine recently who said: "Well, I'm in favor of abortion rights and letting whoever want to marry do so, but I'm a white heterosexual guy. It's not my issue. Economic policy on the other hand affects me a lot." I think some of it may be that point. We are closer ideologically to the Democrats, but the dimensions on which we are more "left-wing" are not those most closely aligned with our self-interest. So we are likely to go with the other side. We'll grumble and kick and scream, but in the end, we'll get seduced by a little bit more of free-market. Now the question is: Should we keep on doing that? Or should we switch to the other side?

The wonders of the Internet

Thanks to Eolas, I just came accross this amazing video by Eric Whitacre. He is a composer and conductor who apparently is also quite the innovator. For his latest piece of music Lux Arumque, instead of putting together a chorus, he used YouTube. He posted the parts online and made a video of himself conducting with piano on the background. Then, anyone who wanted to could make a video of themselves singing one of the parts. The final step involved collating all the videos and sound tracks together to give the impression of a real chorus. Truly the effect is amazing!

Now, just because I have to, I would like to point out that to my understanding, none of the participants in the chorus has received a single dime. They got paid in fame and probably quite a bit of pride. I'm also convinced that if some are attempting to become professional singers, participating in such a project can only be a boost to their career. As for the organizer/composer/conductor Mr. Whitacre, his latest CD which features the piece is probably receiving a boost in sales as we speak, and he probably is gaining quite a lot of fame in the process which I'm sure he'll monetize somehow.

Oh, did I mention the video is free on YouTube?

Sunday, March 7, 2010

Derivatives are not evil

I am quite annoyed and tired of people acting like sheep when it comes to analysing the financial crisis. I just got finished watching a Daily Show episode where some guy named Scott Patterson explained to everyone how quants on Wall Street were all just making models with no relation whatsoever to real asset valuation and creating swaps: "these really toxic assets."

The first part where this is wrong is that asset valuation models were not unrelated to actual assets. A lot of those models actually included real economic indicators and real financial data regarding the health of those companies. Secondly, basing a model on past returns does not mean that you are completely disconnected from the asset. It just means that you trust pricing mechanisms to give you information instead of going to collect the information directly. Is that always a good idea? No! Is it always a bad idea? No!

The second error is referring to all derivatives as though they were these evil monstrous things. Derivatives were used for a lot of different things. Currency swaps are used by companies who export or import to limit their exposure to foreign exchange. In other words, they are using swaps to NOT gamble on foreign exchange rates. Futures are used by companies to ensure that the price they pay for their raw materials will be constant for a certain period of time. Airlines use options on oil to limit their exposure to short term fluctuations on the oil market. These are specifically examples of companies using derivatives to NOT make bets. And yes, unless there is a speculator on the other side to take the risk off your hands, very often that transaction won't be able to happen.

Third, I would like to address the issue of "swaps these really toxic assets." I assume the guy was talking about Credit Default Swaps. Those turned out to be a huge problem for a simple reason: They were heavily traded amongst financial institutions and they were over the counter. What that means is that instead of being bought and sold, positions were closed by writing a new CDS. So let's say Bank A sells a CDS to Bank B. Now Bank B doesn't want a CDS, but it can't sell the one it has. So it writes a new one and sells it to Bank C and so on an so forth. Normally, it works great. Except that if suddenly it's time for Bank A to pay Bank B and Bank A doesn't have the money, Bank A fails. And if Bank B was counting on Bank A's money to pay Bank C, well Bank B might fail too and so on and so forth. And the problem was, nobody knew who owed what to whom. Which meant that there was a lot of fear that maybe the bank you do business with usually might fail despite looking healthy because the people it bought a CDS from can't pay. It's called counterparty risk. It's not that CDS were "really toxic assets." It's that there was a lack of information and a lot of paranoia.

Fourth and last, I want to advise anyone listening to the show to listen to the part when Patterson starts talking about what quants did that was risky. Apparently "hedging" made the list. Hedging is a strategy which consists in... reducing your risk! What part of reducing your risk is really risky? Oh sure, when done improperly, it can blow up in your face, but hedging is by definition NOT risky.

I am to be honest sick and tired of the approximations that people make about the financial crisis. Not everyone has to be a brilliant economist like yours truely, but instead of following everyone like a sheep, think for yourself for a little bit. Find information. You think that derivatives destroyed the world? Look up what derivatives are and learn how they were used. You'll find out that there was a lot of stuff going on and that while some was not prudent by a long shot, a lot of it was quite frankly not a bad idea for the people without the benefit of 20/20 hindsight. It's really easy to point the finger at someone and lynch them with everyone else. It's much harder to try to figure out what complex set of circumstances led to the current situation. And honestly, the comments that guy is making are not encouraging much thought.