Hi Guys,
In 1946, Henry Hazlitt wrote a short book that would become a best selling classic: “Economics in One Lesson”. The book collected a huge readership, and has been reissued numerous times. The “One Lesson” is fully explained in Chapter 1; it is 4 pages of text in its entirety. Here is a Link to the entire book so it takes a little time to download:
http://fee.org/resources/detail/economics-in-one-lesson-2?gclid=CMet8uqeg8UCFREoaQodXCkA_g#calibre_link-34His summary of that One Lesson follows:
“The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”
You might want to sample a practical application of the One Lesson. Chapter by chapter, Hazitt provides many examples. His “Broken Window” (chapter 2) is brilliant. Continue reading as much as you like from the Link above.
So, in Hazlitt’s headlights, economics is a two dimensional problem with time being one parameter, and the integration of all impacts a second parameter. It’s a simple 2 X 2 matrix.
Numerous independent mutual fund studies have similarly concluded that only 2 factors are primary determinants of fund performance: (1) time in game and (2) costs. Hence, a 2 X 2 matrix can be constructed.
In my modeling of this uncomplicated matrix, time is characterized as either short-term or long-term, while costs form the other axis.
Short-term can be viewed as a single year’s return while long-term can be visualized as a 10 to 30 year performance period (you choose your own long-term time measurement depending on your goals). The most straightforward way to model the cost axis is to segregate high cost (active funds) and low cost (Index funds) options.
Likely more than any other non-academic researcher, John Bogle has explored these issues for decades. I’ve used his analyses to fill-out the matrix with approximate numbers. Here is the Link to Bogle’s “The Arithmetic of “All-In” Investment Expenses” that I reference:
http://www.cfapubs.org/doi/pdf/10.2469/faj.v70.n1.1A primary output from Bogle’s work is to scope the total extra costs associated with active fund management beyond Expense Ratio. He identifies and typifies these costs that incrementally add to the conventional Expense Ratio. The extra costs are: (1) transaction costs, (2) cash drag, (3) sales loads when applicable, and (4) excess taxes. Please access his paper for details.
Bogle’s work is approximate and imperfect because some data are unavailable and estimates are required. Depending on how the numbers are generated, and the conservatism buried within each estimate, the extra costs hover both slightly South or slightly North of 2% annually.
Over a short period that 2% increment might not be overwhelming, but when integrated over extended timeframes (like 10, 20, or 30 years), those extra fees are brutal to a portfolio’s end value. Bogle’s illustrative Table Two shows double digit active fund penalties that multiply as the time horizon expands. His Table Three and Figure 1 add further injury when tax considerations are appended.
Separately, very carefully executed Monte Carlo studies demonstrate just how difficult it is to overcome a 2% extra fee handicap. The simulations show how rare it is to overcome a 2% cost differential. In practice, some do it, but many fail. And active manager’s inconsistent persistency over a long-term time horizon is yet another uncertainty that tarnishes their records.
Both Hazlitt and Bogle share a noteworthy common trait. They have the insight and the skill to simplify complex problems without losing the basic message. I admire both gentlemen. Please visit the Links provided.
Please consult the referenced Links for much needed detail. My story is incomplete.
Sorry for my over exuberant title.
Best Regards.
Comments
Well, there are widespread other views of this guy, the one below by an economics historian who held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. {Wow.]
http://economix.blogs.nytimes.com/2013/07/16/inflationphobia-part-ii/
... Bartlett focuses largely on the malign influence of Henry Hazlitt, who was among other things writing many editorials for the New York Times always insisting that the answer to the Great Depression was to encourage big cuts in wages.
[Krugman:]
Hazlitt remains, by the way, a popular figure on the right. ... Hazlitt’s continuing popularity should serve as some kind of lesson to those ... who marvel at the continuing influence of inflation fearmongers; they’ve been wrong about everything for 5 years, so why do they still get treated as authority figures? Well, Hazlitt has been wrong about everything for more than 80 years, and is still regarded as a guru. Bad ideas, it appears, are extremely robust in the face of contrary evidence. The thing is, by the time Hazlitt was penning those editorials demanding wage cuts, Keynes and Fisher had already said everything that needed to be said. Keynes in 1930:
[I]f a particular producer or a particular country cuts wages, then, so long as others do not follow suit, that producer or that country is able to get more of what trade is going. But if wages are cut all round, the purchasing power of the community as a whole is reduced by the same amount as the reduction of costs; and, again, no one is further forward.
And Fisher pointed out in 1933 that a general fall in wages and prices actually makes things worse, by making debtors poorer in real terms; true, creditors are made richer, but because debtors are more likely to cut spending than creditors are to increase it, the overall effect is to deepen the depression.
One implication of all this is ... the paradox of flexibility: making it easier for wages to fall, as Hazlitt demanded then and his modern acolytes demand now, doesn’t just redistribute income away from workers to the wealthy (funny how that happens); it actually worsens the economy as a whole.
+++
Maybe Hazlitt is better in other areas.
Thank you for commenting.
Krugman and Hazlitt are at polar opposite extremes of the economics spectrum. The former is a Keynesian and the latter subscribes to the Austrian school. They likely agree on almost nothing. For brevity, I didn't mention that disparity in my initial post.
I am not anchored to either economic philosophy. None are perfect. Each should be applied in part only, and each is situationally sensitive. That's not a punt, but it does acknowledge the real world.
Added Thought: No economist is ever anywhere near a 100% accuracy forecasting record. In general, their records are dismal. The Irving Fisher that you referenced is sometimes honored with the Best Economist ever accolade. Yet, he's the same guy who just before The Great Crash proclaimed that the stock market had achieved a permanent high. So much for the forecasting ability of our economic wizards. It is an impossible task.
Best Wishes.
A crucial point is that the Great Depression is the first time in American history in which the fall of wages during a depression (recession, panic, whatever you called the previous economic downturns) was resisted by the political powers (Herbert Hoover to be precise). See the book 'America's Great Depression' by Murray Rothbard for the sad details. Or possibly another fine book, 'America Out Of Work' by Richard Vedder.
Ultimately, effective demand consists of what is produced (and anyone who denies Say's Law can feel free to eat or wear paper dollars, bits, gold coins or whatever is being used as a medium of exchange rather than the actual goods and services produced). The expression of the medium of exchange, prices (in this case, wages) ultimately is a stand-in for the products and enables a greater division of labor as well as allowing for the possibility of economic calculation of physically unlike products (see Mises' book 'Human Action' on the latter point. Also see the books by Thomas Sowell and W. H. Hutt on Say's Law. You might also look directly at Say's Law and then look at John Maynard Keynes's alleged refutation of it in his General Theory. This will tell you what 'selective quotation' means once and for all).
Finally, it must be kept in mind that demand comes from what is produced (often described as 'effective demand' to distinguish it from merely wanting something. The difference is being able to buy a new car as opposed to wanting one but not being able to pay for it). If wages are too high to clear the market, unemployment results (not only by way of bankruptcy but also in the elimination of marginal jobs by otherwise surviving companies). The unemployed workers no longer make anything. Therefore the total wages of workers as a whole falls (I'll neglect the usual ceteris paribus qualification here). This has the unfortunate effect of cutting real demand (there is no longer any effective demand coming from the newly unemployed though they no doubt still want things). That fallen demand makes the wages of the remaining employed even more out of balance to the new reality. As a result, unemployment increases again for similar reasons. This is the real 'death spiral' of an economy. They found out in the Thirties.
As I mentioned, before the Great Depression wages had always been allowed to fall. It had long been understood that this was the way that economies recovered, and indeed they always had recovered in relatively short order (this is not to say that human suffering didn't occur). The process is as follows: All effective demand comes from the employed. As soon as someone who is unemployed lowers his asking price to the market clearing level (whatever that is), he is able to find a job. Now working, he is producing something. As a result, the total effective demand rises; the formerly unemployed worker had been contributing nothing to it, now he contributes something to it. Have enough unemployed accepting lower wages and thus increasing total demand and you make the demand for labor in general stronger, thus finally increasing the wages of all. A happy upward spiral ensues (mirror image of the downward spiral) and the recession is over.
On this process see the wonderful book 'The Theory of Idle Resources' by the aforementioned W. H. Hutt. For those who need Nobel Prizewinners to be impressed, see the writings of F. A. Hayek.
I'll finish by noting that price flexibility is necessary for markets to clear and the mad effort to prevent price flexibility (usually done to prevent downward price movements) is the cause of unending mischief, no matter how popular it may be. I should also mention that Hazlitt's is a wonderful book, indeed.
The Hazlitt work has sold over a million copies, has been reissued several times, and has been translated into several foreign languages. These are great measures of some success. Keynes also has similar success. In the stock market, there is a buyer for every sale.
That's serious distribution, serious money, and serious popular support for the Hazlett Classic. If he were alive today, Henry Hazlitt would be sharing your laughter from another perspective.
Best Wishes.
The real world, of course, includes individuals and families harmed. Not saying you do not know this. Suggest you study this history:
http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html
Greenspan's book is ... really terrible on multiple levels. No acceptance of responsibility for anything; he retails the same old Big Lie about how Fannie and Freddie somehow coerced Wall Street into making bad loans; etc., etc. But one point in particular: Greenspan thinks he has discovered a new law: transfers to individuals, even if fully paid for with taxes, reduce national savings one for one. You can bet that this claim will soon be popping up on the right as an established fact. What drives Greenspan’s conclusion is mainly the sharp drop in overall saving during the Great Recession, combined with a temporary spike in transfers as a share of GDP, partly because of unemployment and food stamps, partly because GDP fell. But he wants us to see it as a longterm phenomenon, and of course as a reason to weaken the safety net.
The obvious answer is to look cross-country: European nations have much bigger welfare states than we do; do they have lower savings? No.