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Would You Hire Paul Krugman to Babysit Your Kids?

Friday, March 20, 2015

[UPDATED 28 SEP 2015 - DOW DOWN ~300 - FLIRTING WITH 16,000 & BELOW]

I am reading Princeton economist Paul Krugman's blog more of late and interacting with some of his posts in comments.  This has taken me to an article he wrote for Slate back in 1998.  It was titled "Baby Sitting the Economy: The baby-sitting co-op that went bust teaches us something that could save the world."

I have linked to it here because it is exactly the kind of everyday, real life example of economics that we need so we can engage in some important discussions.  It just strikes me quite a bit differently than it does Krugman because of dynamics it either does not include or ignores.

But let's digest the story first: The idea is that a group of couples in Washington, D.C. (that should suggest pending doom right out of the gate - just like soundtrack of those Friday the 13th movies) have both a supply and a demand.  The supply is represented by the couples staying at home.  They have kids, so looking after a couple others for a night should not pose a problem.  That means they have a 'supply' (babysitting services).  The couples who want to go out for the night represent 'demand' for the 'supply' - they need a babysitter.

So instead of forking out dollars to a teenager to look after the kids, they issued 'scrip' - basically money for their micro economy.  The 'scrip' was tied to time - each 'dollar' (if we want to call it that) represented an hour of babysitting time.  (I find that quite interesting - this is not 'fiat' money because it is tied to an 'asset' we trade all the time at our place of work.)

This looks like a great idea as long as all of the couples have equal opportunities to go out for the evening, and use up those opportunities at a relatively common and stable pace.  The supply of couples at home and the demand of couples on a date even out.  If, for some reason, some couples did not have the opportunity to go out enough, they would amass reserves of this scrip.  Because that would take the scrip out of circulation, more scrip would have to be printed up to keep this economy afloat.

Then the coop decided to assess 'dues'.  (Can you say 'taxes'?)  This is where Krugman's story is most amazing.  I am constantly astonished at how he misses the reality right in front of him.  From his 1998 post:
Now what happened in the... co-op was that, for complicated reasons involving the collection and use of dues (paid in scrip), the number of coupons in circulation became quite low.
Krugman is an academic economist, so of course the reasons have to be 'complicated'.  And the taxes... er... dues... tended to suck the money... er... scrip... supply away from its intended use.

Who knew?

But putting that aside... Krugman continues...
As a result, most couples were anxious to add to their reserves by baby-sitting, reluctant to run them down by going out. But one couple's decision to go out was another's chance to baby-sit; so it became difficult to earn coupons. Knowing this, couples became even more reluctant to use their reserves except on special occasions, reducing baby-sitting opportunities still further.
In other words, opportunities to 'work' were lost, creating a micro example of unemployment, spiraling into a micro example of a recession - which is exactly what Krugman calls this.

As he goes on, though, the problem becomes clear:
Since most of the co-op's members were lawyers, it was difficult to convince them the problem was monetary. They tried to legislate recovery—passing a rule requiring each couple to go out at least twice a month. But eventually the economists prevailed. More coupons were issued, couples became more willing to go out, opportunities to baby-sit multiplied, and everyone was happy. Eventually, of course, the co-op issued too much scrip, leading to different problems ...
And the story stops here for Krugman... a bit convenient, that.

Let's go back to something Krugman apparently did not even notice.  Each 'dollar' of scrip was worth one hour of babysitting time. Krugman does not tell us whether the lawyers suggested that in 'legislation' - but if all of the couples agreed to that just the same, it was the de facto fixed value of the scrip.  This is not 'fiat' money.  It also helps explain what Krugman conveniently leaves hanging here: Exactly what "different problems" were caused by issuing too much scrip?

Think about this for a moment: If you can just print up more scrip, at some point someone is going to start asking how much scrip is out there (the 'quantity' of the scrip supply).  They are going to think that each day offers maybe four hours for going out (let's say 7-11 pm just because that is what my aging memory tells me how long my parents went out on their Wednesday bowling nights back in the day).  They are going to multiply that maybe by five (one work week) and then by 52 (one working year), figure on the number of years they'll need babysitting services and then compare that number to the number of couples - factoring in those multipliers - in their little micro economy.

If the (academic) economists win out and they issue more scrip without reference to what should be an obvious 'one babysitting hour' mathematical constraint, before long it will become apparent that all of the scrip 'in circulation' could not possibly be redeemed by the couples in the economy.  So what, exactly, is each 'dollar' of scrip worth again?

Now let's add in a 'complicating' factor.  Krugman mentions that the 'collection and use' of the dues was a problem.  Let's say the coop's lawyers decided that each couple needed a permit certifying that they knew first aid in case a child was injured in the inevitable horseplay of trying to pull the wool over the eyes of the babysitter. So part of what the taxes... er.... dues... are used for is hiring a staffer to design, publish, accept and review applications for that permit... and then to issue the permit.

Go tell it on the mountain!  A bureaucracy is born to save us from ourselves!

But there are only so many couples in the economy to support this new bureaucrat... er... staffer.  So the staffer designs the form and process in such a manner as to guarantee that processing a permit takes enough time to keep him employed. Before long other regulations all of a sudden seem necessary so other forms can be designed, published, received and their permits processed and issued.  But these built-in disincentives to productivity eventually outstrip those extra scrip the economists recommended be issued.  Then it gets really interesting...

The lawyers add a direct mail expert to the coop staff to hit up New York bankers with children with a bond issue.  The bond is denominated in babysitting scrip.  The bankers with kids buy the bond (they evidently didn't notice that the scrip supply already badly outstripped the ability of the couples in the economy to redeem them). And so the regulatory regime - how ever did they manage going on a date before all of this? - was kept intact and its people employed by this selling of babysitting scrip bonds.

But maybe they did understand that the scrip supply far outstripped the ability of each 'dollar' of scrip to be redeemed for an hour of babysitting.  They saw things for what they were and realized that holding the bond posed a risk.  So they 'securitized' the babysitting scrip bonds and sold the securities on the 'secondary market' - passing that risk off to unsuspecting investors and merrily collecting fees along the way.

But someone was still at the table keeping count of all of this... those bonds ('public' debt - at least for the couples in the coop) became part of the scrip supply - only making worse the problem of figuring out exactly what each 'dollar' of baby sitting scrip was worth.

Krugman does not really explore for us why the coop collapsed.  Might it have been because its scrip became essentially worthless?  At some point everyone would realize it was not really worth one hour, but maybe only one second.  And what good is that when you want to go out on a date?

I'll finish with a couple more extracts from Krugman's article:
If you think this is a silly story, a waste of your time, shame on you. What the Capitol Hill Baby-Sitting Co-op experienced was a real recession. Its story tells you more about what economic slumps are and why they happen than you will get from reading 500 pages of William Greider and a year's worth of Wall Street Journal editorials. And if you are willing to really wrap your mind around the co-op's story, to play with it and draw out its implications, it will change the way you think about the world.
Yes, indeed.  Let's coffee up and wrap our minds around the story, play with it a little (see above) and draw out its implications.

Yo! Prof! Be careful what you wish for!  We just might do this and it just might change the way we think about money - which is what really matters!

Lastly, Krugman says this:
For example, suppose that the U.S. stock market was to crash, threatening to undermine consumer confidence. Would this inevitably mean a disastrous recession? Think of it this way: When consumer confidence declines, it is as if, for some reason, the typical member of the co-op had become less willing to go out, more anxious to accumulate coupons for a rainy day. This could indeed lead to a slump—but need not if the management were alert and responded by simply issuing more coupons. That is exactly what our head coupon issuer Alan Greenspan did in 1987—and what I believe he would do again. So as I said at the beginning, the story of the baby-sitting co-op helps me to remain calm in the face of crisis.
And so here we are...  I wrote this back on March 20th of this year, and today is September 28th.  As of this writing the Dow is off more than 300 points, continuing the slide begun a couple weeks ago and which has revealed the naked impotence of the Federal Reserve for all to see.  A mining company which turned itself into a financial products company (does anyone remember "GE Financial" or "GMAC" - General Motors' financial arm, from the last financial crisis?) named Glencore is teetering. The 'experts' are saying the following:
...Glencore’s equity value could evaporate against its large debt pile unless commodity prices improve or the company launches a substantial restructuring.
Can you say 'bankruptcy'?

The reason this matters is because Glencore sits at the center of the commodities trading world, which has become nothing but a big blackjack table where Big Data is used count the cards.  Literally trillions of dollars are exposed in 'counterparty risk'.  If this sounds familiar, it should. When people began defaulting on mortgages they could never have paid off, trillions of dollars of 'counterparty risk' was what caused the financial crisis and Great Recession.

Yes, you can be forgiven for thinking: "What the hell?  We did it again?"

Only now, with interest rates at zero, there is nothing left for the Federal Reserve to do except 1) push interest rates into the negative; 2) print more money, effectively monetizing the national debt; and then 3) ban cash as a result of the inevitable flight away from the banks.

When I originally posted this, I asked:
But why, we must ask the good professor, could the stock market crash again?  Again, these things are right in front of Krugman but it seems he refuses to look at them.  Could it be because excessively low interest rates caused the banks to 'reach for yield', buying 'junk bonds' - which are just the corporate version of the sub-prime mortgage?  Could it be the bursting of that bubble of bad debt - inflated by easy money - causes the next crash, eroding consumer confidence? 
Could it be because the Shiller P/E ratio is higher now than before the last crisis?  Could it be that with a historic mean of 16.59 the market is incontrovertibly inflated?  And if so, what inflated the market in stocks (and real estate - see the Case/Shiller Home Price Index for a similar picture of real estate) if not the expansion of the money supply?  Krugman said Greenspan needed to create a housing bubble to replace the NASDAQ (dot com) bubble.  What is this?  The junk bond bubble to replace the housing bubble?  Will the good professor please tell us where this ends?
"Babysitting the Economy" is exactly what Krugman says it is.  But if he were to see what's right in front of him and pursue the related questions - like why the coop needed to assess dues to begin with, and how they then used them - it might lead him past booms and busts and directly to the conclusions which are necessary to make financial crises less frequent and less severe.

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