Economics & Finance

Maybe it’s because a lot of them are wrong. (1 Euro was worth about 1.22 US dollars when I made this prediction and is worth about 1.27 dollars now.)

It’s a truism that market trends often continue beyond our expectations. This is especially true in currency and interest-rate markets, because these are dominated by governments that have the resources to make markets go where they want them to — at least for a while. The Euro is backed by nothing more than political expectations about the behavior of the European Central Bank; the Euro’s current historically high valuation vs. the dollar is largely a function of the Bush administration’s economic ineptitude and politically-driven dollar bashing. These factors are subject to change and sooner or later the Euro will lose value against the dollar. I don’t know when this will happen or how high it will go first.

UPDATE: Paul Johnson makes a strong case for the Euro’s coming downfall, and argues that the U.S. should cultivate relationships with European countries that share its interests:

I’ve always maintained that the moment France finds theEU to be no longer of use, it will break it up. A German revolt against the payments system could provide that moment. Hostility to the EU is rising in France anyway, to the point where no referendum on the proposed EU constitution can be held there for fear it would be voted down heavily.

U.S. policymakers’ aims should be to forge close links with in-dividual countries that have strong common interests with America in wide areas of policy. Such nations include Britain, obviously (though not Ireland, which is sure to do the opposite of anything Britain does), Spain and Italy. The latter two are deeply resentful of French-German behavior and are anxious to have a powerful friend outside the EU to redress the internal balance of power.

Johnson’s argument isn’t new, but it appears that events may at last be catching up to it.

Lex and I had an exchange of emails about Bush. Lex argued that Bush is doing a great job all around. I agreed he is doing well on the war, but argued that he has been irresponsible on the economy and that I am concerned he might sign a reauthorization of the gun- and high-capacity-magazine ban in Clinton’s 1994 crime bill (which sunsets in 2004). Lex has blogged his response to me, and what follows is an edited version of my rejoinder to his response.

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Chicago Boy WV forwards an AP article that confirms what we all know: equity markets are thin and whippy because volume is down, and volume is down because everyone is waiting for the war.

– This NYT article discusses a report (pdf link) by a pair of economic researchers who think that war in Iraq is likely to have a significant negative effect on world stock markets. This goes against conventional wisdom that markets will rally in response to the war, but (therefore?) I think these guys may be right. It’s noteworthy that the researchers base their inferences on data from Tradesports.com, an Irish online betting exchange that I discussed in previous posts (here and here). The researchers argue that the Tradesports.com contracts may be more reliably predictive than are those on the respected Iowa Electronic Markets:

The Saddam Security is in fact more widely and frequently traded than the typical contract on the Iowa market. Wall Street is over-represented among market participants, and evidence from a variety of sources suggests that these data do in fact reflect underlying war probabilities.

Here’s an article about similar research one of the co-authors did on elections. One of the more interesting sentences:

Wolfers, an assistant professor of economics who as a youth worked for a bookmaker in his native Australia, followed a hunch about the predictive power of betting markets in forecasting the outcome of political elections.

So much for abstract theorizing.

Johnathan Pearce cites Andrew Sullivan’s critical observations about increased federal spending under George W. Bush. Sullivan makes a good point. However, Pearce goes Sullivan one better and decries federal deficits, which are not quite the same issue.

Deficits are actually an important constraint on federal spending. In the ideal world we would have a small and balanced federal budget, but our more likely alternatives are a large federal budget with a deficit or a large federal budget with a surplus. A surplus functions much like a silent tax increase whose proceeds will be spent by Congress (as happened in the 1990s), whereas a deficit leads mainly to additional federal borrowing — which is less destructive to productivity and incentives than are tax increases and may itself create pressure for reduced spending. Surpluses allow legislators to increase spending without incurring the political costs associated with explicit tax increases, while deficits create political pressure to spend less. The question of whether to balance the budget is not trivial, but the main goal should be to reduce the overall level of government spending. Ironically, deficits, because of their negative political consequences, may advance this goal most effectively.

Politicians tend to like surpluses and dislike deficits. That should tell us something.