Rational Fools and Foolish Rationalists

There is this hilarious critique by Amartya Sen of neoclassical economics which pokes fun at the assumption that individuals are rational and that they have stable, known, and reasonable preferences. It comes in the form of a joke: an economist comes across a man trying to cut off his fingers with a pair of scissors. What does the economist do? Naturally, he offers the man a pair of sharper scissors.

The example is supposed to illustrate a readily evident folly of economics, one which Sen, to his credit, has explored in great depth. Obviously, our gut reaction is to stop the man from cutting off his fingers. Obviously, It seems, cutting off his fingers will bring him only misery, and the man is mistaken to believe or act otherwise. The takeaway is that economics needs to contend with the fact that is painfully clear in our daily lives—that we are not perfectly rational or egoistic individuals. They treat consumer preferences as known and stable, they presume individual preferences reflect known utility-functions and accurate estimates of predicted well-being.

We are profoundly foolish, we don’t know what we want or what will make us happy (indeed, a good portion of our lives is arguably an attempt to figure that out by trial and error), and even if we did know what constitutes our well-being, we sure as hell don’t know how to get there. The assumption of rational egoism at the heart of classical and neoclassic economics and other “neo-utilitarian/rational choice” approaches (to quote John Ruggie) to social science is misleading. This critique of the much-maligned Economic Man (often stylized as Homo Economics) is as old as the discipline it targets.

Our preferences and behavior are shaped by socialization and social embeddedness, instrumental adherence to social norms, our sense of identity (which is itself a product of socialization but could be bracketed off as a separate phenomenon), intergenerationally inherited values and culture, the peculiarities of our psychology, a lack of information in the case of “bounded rationality” and so on and so forth.

I. Ideal Types and the Pragmatic Defense of Egoistic Rationality

The response to this charge by modern positive economics is just as clichéd. Obviously, no one thinks about the world in the way that economists imagine. But the assumption of egoistic rationalism is necessary on pragmatic grounds—as Paul Krugman puts it, “abstraction, strategic simplification, is the only way we can impose some intellectual order on the complexity of economic life. And the assumption of rational behavior has been a particularly fruitful simplification.”

This argument was Milton Friedman’s central insight in his famous 1966 treatise, The Methodology of Positive Economics. Friedman goes as far as saying that, “Truly important and significant hypotheses will be found to have “assumptions” that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense) [emphasis added].”

Friedman’s defense of the theoretical rational actor is strikingly similar to Max Weber’s justification for the use of “ideal types”—such as his three models of authority— to understand politics. In Weber’s schema, ideal types are “not a description of reality but [aim’ to give an unambiguous means of expression to such a description . . . An ideal type is formed by the one-sided accentuation of one or more points of view and by the synthesis of a great many diffuse, discrete, more or less present and occasionally absent concrete individual phenomena, which are arranged according to those one-sidedly emphasized viewpoints into a unified analytical construct.” In this way, we can see Friedman as positing homo economicus as an ideal type, a lens to understand the world.

Yet, while a convincing defense of the methodology of positive approaches, ‘the Economic Man” qua ideal type sheds little light on the application of the same assumptions to normative approaches and economic policymaking. In assessing whether to give Sen’s wannabe amputee a sharper pair of scissors, being able to predict the man’s behavior does not tell us whether we ought to intervene or whether his underlying preferences are justified.

II. Bioethics and Amputation

Surprisingly, Bioethics, a discipline far removed from traditional economics, has a lot to say about the analogy chosen by Amartya Sen. In particular, the fact that Sen takes it for granted that the desire to cut off one’s fingers is irrational, that the imagined individual’s amputation will not bring him well-being.

This brings us to Body Integrity Identity Disorder. Body Integrity Identity Disorder denotes a phenomenon wherein individuals experience a mismatch between their physical body and the subjective experience of their own body. Unlike other forms of asomatognosia and similar conditions in which there is a discrepancy between a person’s body and body image, those with BIID do not deny the existence or ownership of the limb in question; the alienation they experience appears somatic in nature. Consequently, individuals with BIID have pursued amputation as way to resolve the tension between physical embodiment and subjective perception.

An important point is that it is not that they hold the false belief that their limb is not theirs (as is seen in the case of somatoparaphrenia or certain cases of depersonalization) but that they vividly experience a sense of disconnect. This contrasts with disorders like Anorexia Nervosa in which there is a discrepancy between body image and physical embodiment but the anorexic is not aware of It. Tim Bayne and Neil Levy in their article on this topic “Amputees by Choice” make a distinction between the somatic/phenomenal component (what we feel and experience) and the doxastic (what we think and how we reason) component of body image, explaining that BIID keeps the latter component of their self-image intact. That is, in the case of BIID, patients recognize that this desire for amputation is “fundamentally irrational”, that there is no basis in reason for this belief. Nevertheless the recognition that BIID defies rational explanation does not alter the reality of what they experience. Moreover. while the sample size is small, an overwhelming majority those that go through with the amputation report substantially improved levels of well-being.

This problematizes Sen’s account, because presents a plausible case in which the man on the street trying to cut his arm off is actually pursuing his conception of the good. In fact, it is not “readily obvious” or self-evident that amputation of a limb will lead to decreased well-being, that it is a wrong path on the pursuit of happiness. A further critique of Sen’s assumptions can be found in the hedonistic adaptability literature, which shows that (and this is a slightly reductive account) that lottery winners a few months after winning were just as happy as paralyzed accident victims after a similar time since their accident.

This need not present a conundrum for the ideational critique of rational assumption in economics. Both can be correct. Rational conceptions of the good diverge and differ radically in society. We do not necessarily know what is good for other people. There is substantial statistical convergence with respect to major sources of well-being that largely emerge out of a shared biology and genetics, but that does not mean that there is an objective and absolute conception of the good life that we can appeal to in all cases. Or that there is a universal roadmap can be used to guide other individuals towards genuine well-being. Yet, at the same time it is clear that humans are foolish, that much of our behavior and beliefs are beautifully irrational, shaped by external and internal forces well out of our immediate control.

The paternalistic account of well-being isn’t correct but neither is the classical liberal one. Indeed, these two perspectives can be understood well as “ideal types.”—providing contrasting lenses that we can use to understand “reality”, but not capturing the entire picture on their own.

Thoughts on rural decline, wage stagnation, white working class backlash, etc.

By Spencer Slagowitz || April 10th, 2017

We at Popular Discourse have not posted in a while, due to the demands of college and work, so to our one reader, we apologize (sorry mom!). Instead of the long formal articles we usually write, I decided to write down some of my current thinking vis a vis rural economic decline, its causes, and its consequences.

  1. Economic activity has shifted from rural america to urban population centers. (Urban population centers have higher productivity rates, urban Americans are beneficiaries of numerous external economies of scale and network externalities as a result of population density (attracts economic opportunity away from rural areas) cities were able to maintain steady growth during recession while rural areas floundered, economic activity of rural towns were centered around participation in a single industry—often those which the US either no longer has a comparative advantage in or those which have become heavily automized.
  2. However, labor mobility (especially amongst aging rural populations) is lower than expected. Migration is an automatic fiscal stabilizer, labor moves to adjust to asymmetric (regional) shocks. But instead of moving when times got rough, inhabitants of rural areas have seen economic activity slowly drown.
  3. Leading to the persistent wage stagnation we see in these areas and (speculatively) the symptoms such a decline in economic activity has produced.
    1. Opioid Abuse
    2. High-rates of suicide (See: Case-Deaton)
    3. Populist/demographic backlash
    4. Lack of dignity
    5. Feelings of being “left behind”
  4. Also see these books/resources as evidence of the symptomatic expression of rural decline…
    1. https://www.amazon.com/Whats-Matter-Kansas-Conservatives-America/dp/080507774X
    2. https://www.amazon.com/Strangers-Their-Own-Land-Mourning/dp/1620972255
    3. https://www.amazon.com/White-Trash-400-Year-History-America/dp/0670785970
    4. https://www.amazon.com/2-00-Day-Living-Nothing-America/dp/054481195X
    5. https://www.amazon.com/Evicted-Poverty-Profit-American-City/dp/0553447432
    6. https://www.amazon.com/Dreamland-True-Americas-Opiate-Epidemic-ebook/dp/B00U19DTS0/ref=tmm_kin_swatch_0?_encoding=UTF8&qid=&sr=
  5. It is not controversial to assert that we and our government bears some sort of moral obligation towards our fellow Americans. Nor is it controversial to suggest that when our nation’s economy leaves behind or ignores rural America, leaving growth to stagnate in those regions and devastating communities for reasons exogenous or out of the control of those very same communities, that there is an imperative to address this arrangement.
  6. Moreover (or perhaps, necessarily), the economic imperative to bring back economic activity to rural areas or to aid rural Americans to move to cities or other areas of high economic activity is incredibly powerful. The health of the macroeconomy as a whole would be improved by higher average wage rates for all americans, by increased aggregate demand, by increased productivity, by linking up rural workers with few opportunities with an increased variety of job and work opportunities. I don’t think this point needs further justification, moreover I think it is quite intuitive that increased economic growth in rural areas or increased economic growth generated by interregional migration helps the United States as a whole.
  7. This discussion has, in the news media and the pundit class, mostly focused on economic decline in rural areas and it’s consequences for the region and for the United States as a whole. But arguably, this same sort of decline and economic stagnation has been experienced by African-American communities in America for decades and to a much higher degree as a consequence of racism, the persistent poverty & mass-incarceration that has resulted from it, and the complex and pernicious interaction between economic and sociological factors that has trapped these communities in a vicious and repugnant cycle. The same moral and economic imperatives, that, according to the commentators and public intellectuals, compel us to address rural economic decline must also compel us towards addressing the persistent poverty and economic decline that has been driven by racism.

On Global Growth Trends, Right-Wing Backlash, and Political Economy: Shouting into the Ether


Nils Gilman, a historian at UC Berkeley, wrote a medium length piece last Monday on the ‘Economic roots of populist rage’, in the America Interest that suggested that the ‘technoglobalist’ consensus of the elites failed repeatedly failed the same segment of society, most poignantly demonstrated by the populist rage of this election cycle, thus necessitating a new socio-economic compact. What follows is my response to that argument, my proverbial rant into the ether.

I am easily in agreement with the premise of this piece—an economic system (or more accurately a whole regime of economic policies that comprise such a ‘system’) that repeatedly leaves the same sector of the population behind is not a socially optimal economic system. Yet, Gilman’s piece is more historical/political analysis than policy proposal—and it is Gilman’s analysis, not his conclusions nor his premise, that ultimately proves faulty.

Firstly, Gilman suggests that economic anxiety is the prime motivator for the current quasi-populist, anti-globalist backlash, in order to argue that failed economic policies have engendered serious ‘political economy’ concerns. This argument seems to suggest that through economic ends may we seek to quell the backlash of the so-called ‘Trumpenproletariat”. Gilman asserts:

In other words, the populist class-based anger we see has a basis in economic reality, and what it means politically is that the United States (and, indeed, almost all the advanced Western countries) needs a new social-political compact

Yet, there are several reasons to doubt that economic concerns are the main motivating factors behind the rise of right wing movements. A Gallup study conducted in early July by Jonathan Rothwell concluded that, “Trump’s popularity cannot be neatly linked to economic hardship. Those who do not view Trump favorably appear to have been just as exposed as others, if not more so, to competition with immigrants and foreign workers, and yet are no more likely to say they have a favorable opinion of Trump than others.” These findings are echoed by political scientist Philip Klinker’s Vox analysis of an ANES (American National Election Studies) pilot survey which observed that, “Attitudes about race, religion, and immigration trump (pun intended) economics.” In any case, as the previous examples show, a lot of recent evidence suggests a plausible disconnect between economic anxiety or loss from trade and support for Trump. This is additionally reinforced by looking to Scandinavian societies, who have enjoyed robust and equitable growth, but still experienced a similar right-wing populist backlash.

Secondarily, at the heart of Gilman’s argument is his presentation of the “empirical economic basis for populist economic-based anger” and his explanation of the roots of current economic trends.To answer the second principle, Gilman poses two questions: “First, why are the gains of the economy so poorly distributed? Second, why has productivity growth slowed so much over the past ten years?” In an effort to answer the first question, Gilman appears to rely on the second’s answer—he asserts:

There actually is a well-known (though not uncontroversial) historical explanation for why we should not be surprised that the past few years have been a period of slowing productivity growth in the old industrial core of the North Atlantic…we have entered the declining-growth stages of the current phase of global capitalism…the theory that capitalism at the technology frontier operates in higher- and lower-growth cycles was originally developed nearly a century ago by the Russian economist Nikolai Kondratiev.

Gilman proceeds to use Kondratiev’s theory of “K Waves” to justify his indictment of ‘turbocaptialism.” But to answer easily what is one of the most contentious and important questions of modern macroeconomics— what has caused current growth patterns & stagnating wages/productivity?— the article compels the reader accept the “K-Waves” hypothesis based on authority alone. This is quite troublesome given its centrality to Gilman’s analysis and the total dearth of supporting economic evidence found in the piece; indeed, instead of providing an economic argument, a large part of the article is simply an historical analysis that, instead of justifying the theory and its applicability in this case, explain how it has played throughout the preceding few decades. An interesting and dare I say, captivating intellectual exercise, but one that is far from compelling.

Thirdly, the article does not respond to or address any of the other predominant theories that concern the roots of current global growth patterns. Given how contentious the debate is and how diverse the promulgated arguments are—the failure to rebut any other theory that could possibly invalidate Gilman’s central thesis raises serious question. From Kenneth Rogoff’s argument about debt overhang, or Larry Summer’s secular stagnation theory—alternate expressions remain wholly ignored, save one exception; in an effort to respond to the most compelling counter-argument to the K-Wave hypothesis, Robert Gordon’s theory of current technological development slowdown, Gilman effectively shrugs and dismisses it as “premature.” Even after conceding that economically significant developments need to be platform technologies, (and, mind you, Gordon suggests that those sorts of technologies simply aren’t being developed), Gilman could have at least fulfilled the necessary burden of proving that the technologies he identifies—additive manufacturing, CRISPR-enabled biotechnology and precision medicine— in order to respond to Gordon, are indeed platform technologies.

Don’t get me wrong, this is a fascination exploration of an important topic and brings very interesting historical context—and I’ll eagerly second the final conclusion of the article that we cannot simply separate the disciplines of political economy and economics—the two are not only intertwined but directly impact each other. In isn’t enough to say that they are simply related, it is more so that they look at different sides and aspects of related phenomenon—that phenomenon being governance and society. To loosely paraphrase John Kenneth Galbraith, one cannot separate the discipline of economics, political economy/political science, sociology/anthropology, philosophy and psychology. But, while the article is fascinating, articulate, and poignant—as an argument, it leaves much to be desired. It gives readers a faulty impression of the relationship between U.S economic policy and the current sociopolitical trends of right-wing backlash, it misidentifies the causes of current global growth, and as a consequence, concludes by giving faulty policy prescriptions

What We’re Reading: April 18th-22nd

Here at Popular Discourse, we read way too much. So, the Editorial Board has compiled the most interesting, most creative, and best articles we’ve read this week. We highly recommend you check them out, and we hope that you enjoy!


538: “Trust Us: Politicians Keep Most Of Their Promises” by Timothy Hill


Vox on Housing Density and Climate Change by Brad Plumer


Wall Street Journal: Economies of Scale in Banking by Greg IP


Foreign Policy.com: “Saudia Arabia is a Great American Ally” by Michael Pregent


New York Times’ The Upshot: “Obamacare seems to Be Reducing People’s Medical Debt”


New York Times’ The Upshot: “Why There’s Hope for the Middle Class (With Help From China)”


Jon Favreau for The Daily Beast: “Why Electing Hillary in ’16 Is More Important Than Electing Obama in ’08”


Andrew Rosenthal for The New York Times’ Taking Note: “Legislation by Stealth, Republican Style”


Vox: “Here’s Obama’s plan to prevent future IT disasters…” by Timothy Lee


David Brooks for The New York Times Opinion: “What Is Inspiration?” http://www.nytimes.com/2016/04/15/opinion/what-is-inspiration.html?rref=collection%2Fcolumn%2Fdavid-brooks

David Brooks for The New York Times Opinion: “The Danger of a Single Story”


Saleh H. Mohamed for The New York Times Opinion: “Democracy Left Out in the Cold”


Matt Flegenheimer for The New York Times: “Ted Cruz’s Conservatism: The Pendulum Swings Consistently Right”


The Economist’s Prospero: “Bernie Sanders, the modern-day Mark Antony” http://www.economist.com/blogs/prospero/2016/04/shakespeare-and-american-elections

Brookings’ Markaz: “What does it mean to sponsor terrorism?”



TPP, TPA, TAA, Angry Democrats, and “The Week that Obama Won”

I like to say that I am economically liberal. For me that means: globalization and trade liberalization are good. If we can involve more people in global trade that will both help developed nations and developing nations. More people will be lifted out of poverty as they get encircled by the ever growing ripples of influence spread out by global trade flows. Globalization prevents conflict, because no one wants to fight someone who keeps giving them money and stuff. Both corporations and workers benefit because the increased availability of jobs in lower income nations allows impoverished people to gain a leg up and begin to enter the middle class while the blue-collar workers in developed Westernized nations can focus on high skilled labor and on intellectual tasks like inventing the products. Overall people benefit. And, if a country starts failing, there are organizations like the IMF and the World Bank that are there to catch them before they fall. Free trade is good. Tariffs and protective taxes shut out countries from the international competition that fosters growth.

The Trans-Pacific Partnership (TPP), is the largest potential trade deal since the formation of the World Trade Organization (WTO), involving twelve Pacific Rim nations that account for 40% of the world’s economy. It is being negotiated on the precedent of NAFTA (North American Free Trade Agreement), the Clinton Administration’s signature trade legislation. The TPP opens Asian markets to US imports and exports, maintains US influence in Asia, hedging against the rise of China, and has the potential to jump-start stalled negotiations in Doha that the WTO hosted in 2001 to break down trade barriers. Great! I love it! Let’s go!

Wait, what. Negotiations have been going on for 12 years. How hard can it be to write a simple trade deal? If I had my way, the TPP would just say- I’ll give you stuff if you give me stuff. But I guess its not that simple. It turns out that TPP is huge. Its like an omnibus bill in Congress- anyone can add pork-barrel amendments or poison pills. Congressmen who don’t want the FTA to pass or don’t have another way to get appropriations for their state’s newest death-ray laser cannon mounted on a statue of a cat attach riders onto the TPP that everyone is just going to have to swallow if we’re going to liberalize trade. Ok fine. So can I at least see what kind of toxic discharge has been dumped onto TPP? I want to know what damage is going to be done. NO?Apparently no one can even READ what it says! People speculate that its probably pretty bad for us- the liberal Center for Economic Policy Research estimated in 2014 that 90 percent of Americans would see a decrease in real wages as a result of TPP. Where’s my money going? Oh wait, I can’t know. Only corporations with stakes in the text as well as some labor unions have seen the text, not the public, nor, most importantly, Congress. And according to an op-ed from Democratic Reps. George Miller (Calif.), Rosa DeLauro (Conn.) and Louise Slaughter (N.Y.), “this agreement would force Americans to compete against workers from nations such as Vietnam, where the minimum wage is $2.75 a day. It threatens to roll back financial regulation, environmental standards and U.S. laws that protect the safety of drugs we take, food we eat and toys we give our children. It would create binding policies on countless subjects, so that Congress and state legislatures would be thwarted from mitigating the pact’s damage.” Ouch.That’s rough.

So now what? The result has been that even liberal Democrats have run like flies from TPP, siding with labor unions who complain loudly that they’re losing money every time some poor sap in Southeast Asia gets a job that no proud American would want to do. House Democrats sabotaged their own bill, slapping President Obama in the face and voting down the TAA (Trade Adjustment Assistance) portion of the TPP- a program that would provide worker retraining for laborers who lost their jobs in the US as a result of the TPP. It seemed that Democrats, already in the minority in Congress, would get pulled to the left much like the Tea Party pulled the GOP way right in 2010 and 2012. A sad end indeed for the hopes of a lame duck president whose greatest achievement in his second term seemed to be the 2015 Correspondents’ Dinner. But our friend in the West Wing was not to be dismayed. President Obama remembered that there are Republicans in Congress. Sure, they have spent the past seven years loudly disavowing and sabotaging Obama, but apparently Democrats hate him even more now. Obama and John Boehner grabbed each other’s hands and pranced into the sunset. The GOP whipped enough votes on the other side of the aisle to smack down the Democratic insurrection before Nancy Pelosi could get a new gavel printed, and in fast succession, the Senate and then the House gave Obama the “fast track” TPA (Trade Promotion Authority). This legislation allows Congress to vote on trade legislation for TPP only as presented- up or down without any pork-barrels or riders. Fantastic. Oh wait. Not only that, but TPA requires disclosure of any agreement 60 days before its signed and way before Congress gets to vote on it. What a win all around.

Interestingly enough, although this alone would have made the past week pretty good for Obama, dry legislation agreements had no place in the news cycle this week. Liberal Americans were hit with a tsunami of good news- Republicans joining in one voice against the Confederate flag flying over the South Carolina State Legislature, the King v. Burwell decision that cemented Obamacare, the Obergefell v. Hodges and other related cases that legalized same-sex marriage in all 50 states, not to mention Obama’s newfound confidence, with his speech on gun control, eulogy for Rev. Clementa Pinckney, and singing Amazing Grace for 5,500 mourners. With all this hullaballoo- as deserving of such as it may be- the momentous heave forward in TPP negotiations has been largely forgotten. I ask that it not be. This is a big win for liberals, just like Obergefell. Let’s not forget that this week has also had massive ramifications for the liberalization of the entire world, in places that are in dire need of it.

South Sudan cries for help, but who hears them?

We are tired of news of conflict. Hotspots have flared around the world, from the Middle East, to China, to the Ukraine and South America. And yet there are more. The African continent roils in chaos, and coup after coup installs dictators on top of dictators. Decolonization has scarred the savannah. Some news has indeed trickled down to the American public, most vividly with the atrocities in Darfur and the terror group Boko Haram’s kidnapping of 200 Nigerian girls in protest of Western education. And yet the worst conflicts are ignored. Sudan’s, Mali’s, Nigeria’s, South Africa’s, the Democratic Republic of the Congo’s, the Central African Republic’s; I have yet to see major news or discussion of. Of the 13 ongoing genocides identified by the Genocide Watch, a human-rights group, seven are in Africa.

The newest nation in the world, South Sudan declared independence only in 2011 following a bloody civil war with Sudan’s Arab north. Born out of chaos, it remains intensely vulnerable. Foreign Policy ranks the country number one on its index of most fragile states. The New York Times reports that 1.5m have fled their homes, nearly half of the population is starving, and although official statistics are impossible to calculate, the dead number in the tens of thousands. South Sudan is in danger of ripping itself apart under the same ethnic tensions that brought about its inception in the first place.

Paradoxically, Africa is the site of most growth. While developed nations grow at rates in the single digits, like the U.S’s 2%, African growth is at an annual rate of 5%. Of the next three billion people to be born on the planet, two billion will be born in Africa. But with that growth comes volatility, some of which is manifested in the nascent South Sudan. download

South Sudan faces a lot of the same problems as the other African nations in the Sahel belt of sub-Saharan Africa. A lack of infrastructure, high temperatures, non arable land, and a dearth of stable government in the wreck of decolonization have combined to exacerbate already existing tensions along ethnic and racial lines. Other countries like Chad and Burkina Faso are also suffering from famine, and Mali is in the middle of a spillover conflict from Libya that has prompted intervention by the French Foreign Legion. Liberia, Guinea, and Sierra Leone have been wracked by the recent Ebola epidemic. And some countries, like Cotê d’Ivoire (the Ivory Coast) are just recovering from devastating civil wars. South Sudan joins the list of listing countries. And developed Western nations would be wrong to ignore yet another country’s plight. In a time when Europe is hit by waves of economic crisis exacerbated by the rise of far-right nationalism as well as heightened threats from the Russian East, and the United States recovers from disastrous missteps in the War on Terror, this is no time to retreat. Everyone has a responsibility to help. USAID, an organization that provides food and resources to crisis spots around the world, has been operating in South Sudan for decades. Its time for the government to help out. The World Bank, International Monetary Fund, and non-government organizations (NGO’s) are there. But nothing has helped, and it would be wrong for the West to stand by. Like it or not, the United States and its allies are the hegemonic power of the world. It is our responsibility to respond to urgent crises because if we do not, we lose two fronts: our own political capital around the world, as well as the lives of our fellow human beings who are in a rough spot and need help. Step up. Raise awareness. And help stop the cycle of violence in an oft-forgot continent that is the cradle of world growth.

The Dolla’ Makes Me Holla!

An article I wrote a while back on U. S monetary policy and the international economic system.

The United States Dollar has held the position of the world’s reserve currency since the implementation of the Bretton-Woods System after the Second World War. Many pundits and other Very Important People Who Know Stuff have often used the term “dollar hegemony” to describe this situation. Currently, two-thirds of the world’s foreign currency reserves are currently held in dollars, and nearly half of international foreign debt securities are held in dollar-denominated assets. Simply put, the U.S dollar is the world’s primary reserve currency. As such, the United States is able to exert a high influence on international financial markets and gains other economic benefits— in other words, “Dollar Hegemony” = Good. However, there is evidence that suggests dollar’s status as a reserve currency is being slowly and systematically diminished. So, this article suggests—ever so sweetly—that in order to maintain the U.S led global economic order and the benefits we receive from it,  our nation’s policymakers must take concrete and substantive action in order to maintain economic supremacy. Ultimately, the “economic order” which governs  growth and development must change to reflect the ever-changing international economy. We don’t seek to do away with the Washington consensus, rather we seek to modify it.

What are these mysterious reserve currencies you speak of?

Countries all over the world hold financial reserves in the form of bonds or money mark instruments denominated in some other currency. Reserves help a country do many things like conduct monetary policy. Nations also hold gold and often Special Drawing Rights issued by the International Monetary Fund. If a country is in poor financial state, international speculators might sell their own holdings of the country’s currency. This will depress the value of this countries’ currency and will result in negative economic impacts. If a country has foreign reserves, it could buy its own currency and sell its foreign currencies to pay for purchases. A currency, which is backed by substantial reserves, is stable and secure. For this reason, most countries are heavily invested in foreign exchange reserves.

The U.S dollar is the most common currency for international reserve because the market for dollar-denominated securities is deep and liquid—treasury securities can be sold quickly, which in a hypothetical financial crisis could help a foreign nation avert disaster. In addition, a substantial amount can be sold or bought without drastically affecting its price; so the value of the bond is not volatile—it won’t shoot up or fall. All in all, the dollar is quite a stable currency, making it an attractive reserve currency, which explains–partly— why even after the fall of Bretton-Woods and the Nixon shock, the U.S remained the world reserve currency.  However, if our country defaulted on its debt, or if our credit was further downgraded, the price of U.S Treasury securities would decrease, since they would be perceived, and rightly so, as more unstable. Why would a country hold a bond or a security if the country which issued the bond is not likely to pay back the money that they borrowed. So, countries would prefer to hold their reserves in another, more valuable asset.

So what’s in it for us? ( Read in the voice of an Italian mobster)

In order to understand why maintaining dollar hegemony is so important, one must first understand the benefits the United State’s gains from it. The dollar’s status as the world reserve currency triggers substantial demand for our securities—foreign countries hold about thirty percent of United State’s debt. Without this demand for United State’s treasury bonds, the interest rate the U.S. Treasury pays would be significantly higher causing private-sector borrowing costs to rise as consumer and corporate debt compete with public debt for investor’s holdings—i.e “crowding out.” Thus, among many many things, the dollar’s status keeps United State’s interests rates low.

Interest rates, on a very basic level, can be understood as the “price” of money. It is the price a borrower pays for the use of loaned money. The rate is represented as a percentage of the principle amount of money borrowed. If interests rates are high, borrowing money would be expensive, and individuals would be discouraged from lending money. However, if interests rates were low, individuals would be encouraged to lend and borrow money. By keeping interests rates low, the dollar’s status as the world’s reserve currency ultimately promotes growth and financial security within the United States. If the Dollar would lose this status, there would be massive inflation, higher interest rates, substantial increases in the cost of food and gasoline, and it would be much more difficult for the United States to finance its debt.

Our Current Situation

Despite the fact that the greenback has long been considered a stable and secure currency, it has become ever more apparent to economists worldwide that the dollar’s domination of international currency reserves is coming to a conclusion. This is representative of and a result of an international rejection of United States economic policy. Policies, that are based on the philosophy of market fundamentalism, the idea that free markets, naturally provide the most efficient outcomes. This economic philosophy was popularized during the Clinton administration, in which policymakers dismantled Depression-/era financial constraints. However, current foreign interpretation like that of Beijing states that this new policy created a “Washington-Wall Street” environment of unsupervised securitization in which the U.S. financial sector became larger, more concentrated, and riskier. From 1980—/2002, U.S. manufacturing fell from 21 percent of GDP to 14 percent, but finance (the biggest and fastest growing) increased from 14 percent to 21 percent. It is this risky and unconstrained growth, which foreign nations believe will continue undermine the security of dollar denominated assets. However, certain economists and politicians have claimed that a different macroeconomic factor is responsible for the decline in the dollar’s power. They find that the FED’s policy of Quantative Easing artificially cheapens the dollar, and reduces its purchasing power. This reduction in the active purchasing power of the dollar is, they claim, the reason for the decline in the dollar’s power. This view centers around one basic belief: that foreign countries are using other currencies because of this reduction of power. However, foreign nations have repeatedly stressed that the reason for utilizing alternate reserve currencies is due to their mistrust of American monetary policy and the doubtfulness concerning the stability of the dollar. It is not the reduction in purchasing power caused by Quantative Easing which in turn causes the diminution of the dollar’s power, but the instability Quantative Easing causes.

Evidence for the decline of the U.S dollar’s power is as follows: China and Japan have struck a deal which will promote the use of their own currencies (rather than the U.S. dollar) when trading with each other. The second reason was taken from the magazine, The Economist, “The five major emerging economies of BRICS — Brazil, Russia, India, China and South Africa — are set to inject greater economic momentum into their grouping by signing two pacts for promoting intra-BRICS trade, which will enable credit facility in local currency for businesses of BRICS countries.” The BRICS countries will shift from utilizing dollars in trade to using their own local currencies. Thirdly, China and Russia already use their own currencies when trading with each other. Furthermore, the United Nations and the IMF continue to push for a new reserve currency. A UN report stated that, “the international community envisions a new global reserve system…that no longer relies on the United States dollar as the single major reserve currency.” U.S power is facing new macroeconomic constraints that derive from a basic and generally underappreciated shift in U.S. engagement with the global macroeconomic order.

What to do, then?

Even if one does not accept the opinion that current policy is flawed, foreign countries perceive that it is. This opinion, will lead to the diminution of the dollar’s influence. States will start to have divergent preferences about the global financial order, something that will reduce U.S. influence, making cooperation on the governance of money and finance more problematic. In particular, many states will search for ways to insulate themselves from the dangers of unmediated global finance. It is the responsibility of United States politicians, economists, and the FED to craft international and domestic economic policies, which will reaffirm the credibility of the dollar as a stable and effective reserve currency.

The FED must first gradually phase out its policy of Quantative Easing. Quantative Easing seeks to keep interest rates low by having the Fed change the composition and sometimes the size of its balance sheet. Renowned economists Paul Krugman explains,” To think of Fed policy in our current situation, once can imagine a financial equilibrium in which there are three assets: short-term Treasuries/monetary base — which are equivalent and yield an approximately zero rate of interest; long-term Treasuries; and mortgage-backed securities. There are two interest rates that clear the markets — the rates on Treasuries and MBS (the third rate is fixed at zero).” In this situation, to boost the economy the fed must reduce private-sector borrowing rates by swapping short-term assets for MBS (mortgage backed securities). However, the FED currently has been buying long-term treasuries. This should theoretically indirectly reduce interest rates on MBS, however in practice this reduction is not adequate enough, and does not function effectively as a policy.

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Social Insecurity and Other Bad Puns

Full disclosure, this was an article I wrote my freshman year and as such it is less than amazing. That said, it still is an interesting take on Social Security Insolvency.

Social Security, the very system that provides vital benefits for elderly and disabled American citizens, is expected to go bankrupt as early as 2018—though most estimates report a later date. If the United States government does not take any action before this point, the elderly and disabled of the US will be effectively deprived of their benefits¬—which, might I add, they worked to deserve. What is at risk here is our economic stability and the integrity of the social compact that has existed since the inception of the program. Policymakers are faced with a unique situation: Social Security ought to be rendered solvent yet it must be maintained is such a manner that Americans are not deprived of their benefits.

What is Social Security? Why do I care about it?

For those who do not know, Social Security is an insurance program—in a rough sense—that provides monetary benefits to American citizens. The system is funded through payroll taxes, taxes based upon and taken from an individual’s wage, and is also the largest expenditure of the federal government’s budget. The benefits that the program provides are divided into three categories: old age, disability, and spouse benefits. These benefits are calculated according to the individual’s income; a worker earning over $110,000 pays 3.4% of his or her payroll while a worker earning under that amount pays 6.8% of his or her payroll. In theory, Social Security is tax neutral. Under such a system, the money given to the US government in the form of the payroll tax will be the same amount given out in benefits to US citizens. In reality, the expenditures of the US government exceed its revenues; the US government is effectively losing money. Each year the US government loses money, for many reasons, like the retirement of the ‘baby boomers’. These losses, simply put, deplete the amount of money in the trust fund. There are many criticisms of the Social Security system other than its fiscal insolvency: it has a regressive tax system that penalizes the poor and a low rate of capital formation. However, despite its flaws, Social Security’s strengths are much more potent. It allows workers to accrue human capital and, in doing so, boosts the economy. The program even helps spur investment and entrepreneurship. It provides an invaluable safety net for the lower and middle class, and improves quality of life for all Americans. It does this provides benefits for the elderly, the retired, and the disabled who may not be able to pay for various necessary expenses. With these benefits in mind, we can conclude that it must not be eliminated despite its insolvency. Instead, it must be reformed so that it becomes an economically feasible policy.

Social Security is not a Ponzi Scheme.

A misconception people usually have about the social security system is that the system is a Ponzi scheme. Pundits throw the term around in order to describe the program’s insecurity—but the use of the word does not tell us anything about the program…and the term isn’t even appropriate. Ponzi schemes are frauds in which the operator promises or credits investors with exceptional returns, supposedly based on the performance of the assets purchased. The organizer acquires no assets, pays maturing promises or other withdrawals with funds from new depositors, and skims money off the top to support lavish personal consumption. Social Security isn’t a Ponzi scheme, as unlike in a Ponzi scheme it does not require continued growth to sustain it…not to mention the obvious fact that there is no intentional fraud. The social security system can be better envisioned as a trust fund rather than a Ponzi scheme. Social Security functions like a trust fund as it provides benefits for an individual when he or she reaches a certain age. It’s not anything like a Ponzi scheme.

So what do we do?

The United States government must stop the annual loss of money. They can do this two fundamental ways: increasing revenue by raising the payroll tax, or decreasing expenses by taking away or reducing benefits. Both these ways will theoretically rebalance the Social Security system. There are many ways, however, to either lower expenses or raise revenues. For example, recently, many congressmen have been supporting a change to private social security accounts, which would theoretically reduce expenditures. There are as well countless ways to reform the social security tax that could increase tax revenues. In looking at which of these solutions is favorable, the stance of the Democratic Party has traditionally been that the benefits provided by the social security should not be harmed or reduced in any way and that the revenues of the social security system should be increased by having the rich shoulder much of the tax. On the other hand, the Republican Party believes that reducing the benefits given by the system should lower the expenditures of the system. Republicans and Democrats have often clashed on the issue of social security and the current United States Congress has been known to be slow in the passing of legislature due to a very apparent lack of bipartisanship. Hopefully, Republicans and Democrats will be able to do the seemingly impossible and compromise on the issue of Social Security before the system goes bankrupt.