UEA Journal

7/29/2019 UEA Journal

1/28


2/28

Letter from the Editor

Dear Reader,

Needless to say, it has been another successful

semester for the Boston University Undergraduate

Economics Association (BU UEA). We have hosted

numerous events covering a wide array of important

economic and political topics, such as the European Union

debt crisis and the United States presidential election. As

the Club discussed the many things that has and will

affect the economy in the past, present and future, we

have had a number of talented students willing to

transcribe their thoughts.

Our writers come from all backgrounds and walks of life. They share a thirst for knowledge and

continuously strive to understand the economic events that unfold from every corner of our world.

These students write with great precision, utilizing tools from Economics, Finance, Philosophy and

History to produce articles of high quality. For instance, one of our writers daringly used Economics to

analyze the controversial NFL referee lockout!

BU UEA is happy to showcase these great pieces that have required a lot of time and effort toprepare. We hope you enjoy the articles from the semester of Fall 2012.

Daniel Christopher CurrieVice President of Editorial ContentBoston University Undergraduate Economics Association


3/28

Table of Contents

WHYANARCHO-CAPITALISM WILLFAIL: AGENCY, TRANSACTIONCOSTS ANDOTHERGOOD STUFF..................................4

ARGUINGAGAINSTMICROCREDIT: FUNDAMENTALLY ANDIDEOLOGICALLY...............................................................10

WHATECONOMISTS CANLEARN FROM THENFLREFEREELOCKOUT........................................................................13

CURRENCYWARS: THEART OFCORNERING THEMARKET......................................................................................17

THEDARKSIDE OFCAPITALISM: GLOBALCLASSWARFARE.....................................................................................23


4/28

4 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff

Why Anarcho-capitalism will Fail: Agency, Transaction Costs andOther Good Stuff

Daniel Christopher Currie

Anarcho-capitalism is always a hot topic of discussion. Many respectable economists debatewhether a free market is enough to allocate resources to their best possible use. On many occasions, it

is considered a sin if the government were to intervene in the economy. Mainstream economists,utilizing neoclassical synthesis, consider the government to be useful in a limited fashion. Thegovernment must exist to provide public goods, law and order and to provide some stability in theeconomic sphere. However, there exists a strand in economics which believes the government to be animpediment to all that is good. Any government involvement is considered violent and intrusive. Thestate (government) is known as a parasite that thrives off the hard work of the masses. Other than thename calling, there is much to this branch of economics. The Austrian School of economics is just one ofthe examples. Even though the zeal for freedom is infectious, it is also a dangerous precursor for badpolicy making. Indeed, the government is needed for transactions to occur in an increasingly globalizedworld. I will hope to show in this article that if the state were nonexistent, then any sort of worthy

transactions would never occur. Transaction costs will prove to be too much of an impediment forpeople to make decisions. I will go through what anarcho-capitalism entails and how transactions wouldtake place in an economy without a government. Then, I will try to refute this by using an agency modelalong with a few explanations for the existence of transaction costs. I hope to show that an economywould face too many problems if a state would cease to exist.

Anarcho-capitalism


5/28


What is anarcho-capitalism in the first place? It is an economy in which the state is non-existentand the free market reigns supreme. Individuals would be responsible for themselves as long as they dono harm unto others.

Any state interference in the economy is considered a use of force that must be condemned at the

first opportunity. Murray Rothbard, David Friedman, and other anarcho-capitalism theorists believe thatanything done by the state can be fulfilled at a lower cost with better quality by the free market. Indeed,advocates for anarcho-capitalism believe it is the provision of the public goods that keeps the state inpower.

Under this theory, law and order can be provided in a free market without the constraints ofhaving to abide by the demands of a single ruler. Law can be set up through customs and traditions asAnarchists maintain that the laws need not be imposed by a central authoritythat is, laid down asauthoritative lawbut can and do arise through customary arrangements and understandings thatevolve over time.1 This means that the customary law that will be most beneficial to the populace willspring up.

John Stuart Mill stated the same exact thing when he went against the detractors ofutilitarianism that this is just like saying: Before acting, one doesnt have the time on each occasion toread through the Old and the New Testaments; so it is impossible for us to guide our conduct byChristianity. The answer to this objection is thatthere has been plenty of time [Emphasis added byauthor], namely, the whole past duration of the human species. During all that time, mankind have beenlearning by experience what sorts of consequences actions are apt to have, this being something onwhich all of morality on life depend, as well as all the prudence.2 So, law through customs andtraditions would enable people to act decently in order to prosper in society.

Reputation

This article states that transactions will not take place in an increasingly globalized state-freeeconomy because of transaction costs. Conversely, Christopher Coyne attested that such transactionswould in fact occur because people would be able to trust reputation. This is what everybusinessperson, entrepreneur and employer wishes to attain in his or her life. The reputation to carryout mutually beneficial transactions in a responsible manner helps a business attain more customers.Coyne explains that in the free market, entrepreneurs, driven by the profit motive, attempt tomaximize profits and minimize losses. In an effort to maintain current market share and gain newmarket share, entrepreneurs attempt to meet customer needs best in terms of product quality, service,

and pricecrucial variables in determining a sellers reputation.3

No firm would cheat, and why would

1 Coyne, Christopher. "Order in the Jungle: Social Interaction without the State."Independent Review . 2.4 (2003):558. Web.2 Mill, John Stuart. "Utilitarianism."Early modern Texts . n. page. 16.3 Coyne, Christopher. "Order in the Jungle: Social Interaction without the State."Independent Review . 2.4 (2003):562 Web.


6/28


they? If they are caught then they will be left with an irreparable reputation. From an entrepreneurspoint of view, the costs are too high to even deviate from an honest standpoint.

Anarchist Robert Murphy echoed these by indicating that arbitrage agencies will be set up tomake sure contracts are followed and the right amount of restitution is paid to the injured party.4 Thiswill enable a market to run smoothly and transactions to take place. There will definitely be a few

individuals who will still try to break the law, but the existence of arbitration (third party) institutionswill catch the perpetrator and make him/her pay restitution to the injured party.

Agency Model

Reputation may be well and good but, we should consider a model that is represented in theLaw & Economics Textbook.5

A simple agency model should suffice to put my point across. Imagine a principal willing toinvest $1. He hands over his money to an investor promising a net gain $1. The investor will pocket $0.5of that gain while the principal would attain his original $1 plus the other half of the net gain: $0.5. Theinvestor could steal the cash and the principal would never see it again. Or, the principal could end thegame immediately by not investing at all. Both parties would attain nothing.

The first number in the bracket is for the principal, and the second for the investor. So, (-1, 1)means that the principal loses - $1, while the investor gains $1.

In this situation, as you can see from the total gains, it would be best for the principal to notinvest. This is because the investors best choice would be to appropriate. Appropriation is justredistribution of funds, while investment would have been an increase in wealth. Thus, the principalsonly option would be to not invest.

4 Murphy, Robert. Chaos Theory . 2. Aurburn: Ludwig Von Mises Institute, 2010. 14. Web..5 Ulen, Thomas, and Robert Cooter.Law & Economics. 6. Boston: Pearson Education Inc., 2012. 283-291. Print.

(0, 0)

(-1, 1)

(0.5, 0.5)Profitable Investment

Invest 1Appropriate

Dont Invest

Principal

Investor


7/28


Now let us introduce contracts that will compensate the principal for the amount that will bestolen and the investor will have to pay damages as well. This is how the situation would unfold:

When the investor is caught appropriating funds, then he must refund the original $1 and pay anadditional $0.5 as damages. This will make the investors best option to make a profitable investment, inwhich both parties would be better off. This is the use of contracts and a strong law system.

Transaction Costs

The reader may affirm that the free market can provide contracts and people will uphold them. Thisis true; however, there exists the problem of transaction costs. Transaction costs are the costs ofexchange. 6 These can take the form of

1. Search Costs: The costs of actually searching for a bargaining partner.2. Bargaining Costs: The specific costs of bargaining. The more information availableto both

parties, the easier the bargaining process.3. Enforcement Costs: The costs of making sure that the promise is being fulfilled.

If these costs were zero then the market would facilitate every transaction and no problems wouldarise. However, we never see this actually take place. The market is fraught with transaction costs,especially with the rise in globalization.

Thus, a law system will have to be created that tries to lower these impediments to bargaining andcontract making. We must structure the economy in such a way that it improves efficiency according tothe Normative Coase Theorem:

Structure the law so as to remove impediments to private agreements. 7

And additionally, we must adhere to the Normative Hobbes Theorem:

Structure the law so as to minimize the harm caused by the failures in private agreements.8

6 Ulen, Thomas, and Robert Cooter.Law & Economics. 6. Boston: Pearson Education Inc., 2012. 88. Print.7 Ibid pg. 92

(0, 0)

(0.5, -0.5)

(0.5, 0.5)Profitable Investment

Invest 1Appropriate.Return investment 1 & paydamages 0.5

Dont Invest

Principal

Investor


8/28


Transaction Costs in Perspective

1) In the market there exists plenty of transaction costs. When trading in foreign markets, itbecomes very difficult to do so because of different cultures, times, and perceptions whichincrease the risk and uncertainty borne by the investor. Indeed, it is known that investors preferinvesting in nations with a strong rule of law and a government able to battle corruption. Thebiggest governments are in those countries that are exposed to international trade 9.

2) The introduction of time could also be a problem. The cost of searching could be the time usedto do something else, which is the definition of opportunity cost. If it takes too long to find anindividual to trade with, then search costs are too high to facilitate the beginnings of bargaining.

3) If people are too emotional during contract signings, then the bargaining costs can rise rapidly.This could happen when asking for a loan to start up your small business or when divorces arepresent. When people are too emotional then they can become hostile and this will increasetransaction costs. Bargaining becomes much more difficult.

4) When bargaining with an individual for a particular product, it becomes difficult to know all thespecifics. Both parties would want to keep the information to themselves so that they can attaina greater surplus from their transaction. This information asymmetry would result intransactions not taking place.Imagine this, if someone is so eager to sell something to you, wouldnt you be skeptical ofbuying the good? Could there be a reason that the seller is so keen to sell the good?

The Need for Government to Facilitate The Law of The Land

Analyzing Christopher Coynes example (above) on the reputation of firms being an important

reason to refrain from doing anything bad, there are many transaction costs that exist that could makebargaining almost impossible. If the transaction costs were higher than the net gain, then no one wouldmake a decision even with high reputation. Uncertainty always exists.

But, if one firm out of the pool of a hundred were to appropriate funds, then all consumers woubecome wary. Consumers would be unwilling to invest or buy from other firms because their trust inthat sector has fallen.

Robert Murphys example is something that prevails in our economy today. Having an arbitrator orfirm that makes sure things are going according to plan is a mainstay in our contemporary economy.However, having one law system can also reduce transaction costs. Imagine the bother to search forfirms that deal with different laws in different areas over different times in a domestic market. Thiswould be an impediment by itself as it increases search costs. There is such a thing as too much choice.

8 Ibid9 Rodrik, Dani.The Globalization Paradox . New York: W.W. Norton & Company, 2012. 13-23. Print.The correlation between government size and per capita income is remarkably tight. Rich countries have betterfunctioning and larger governments when compared to poor ones. (16)


9/28


In the end, we do require Max Webers monopoly of the legitimate use of force. Indeed, it iincredible importance that the government exists because it is a brand name. If a strong governmentmakes sure its citizens uphold the law, then people would be willing to invest. If the rule of law is notstrong enough, then people would be wary. But, just having one law system that exists would lowersearch costs.

The state would make sure to keep in step because keeping the law in such a way maximizes its taxrevenue. Tax revenue is maximized in the long run if a productive populace exists. One of the only waysto attain this is to have a strong legal system.

Christopher Coyne rebutted this by stating that the government would try to maximize psychicincome. As Coyne stated that it is critical to remember, however, that through action people attemptto maximize psychic income. This is not limited to monetary income but includes nonpecuniary forms ofincome as well. Rulers may gain (psychic) income by holding and wielding power even though they maynot maximize monetary revenue by doing so. And, if they do so, their actions may conflict with the ruledgroups interests 10 However, this need not be true because the utilization of democracy will keepgovernments in step. If governments do not listen to their populace, then eventually they will bereplaced. Even if the state is insistent on wielding its power, it will eventually fall if the populace decidesto protest. Where do you think the state gets its power?

In the end, the government is of the utmost importance in order to make sure that transaction costare lowered and the people who appropriate are brought to justice. In a timeless system with rationalexpectations, everything would work in the best possible manner. However, transaction costs andinformation asymmetries are the ways of life. We can never escape them. We must always hope tolower transaction costs and try to make information as public as possible. This is the way for an

economy to grow with a strong legal system by its side.

BibliographyCoyne, Christopher. "Order in the Jungle: Social Interaction without the State."Independent Review . 2.4 (2003):563-564 Web.

Mill, John Stuart. "Utilitarianism." Early modern Texts . n. page. 16.

Murphy, Robert. Chaos Theory . 2. Aurburn: Ludwig Von Mises Institute, 2010. 14. Web..

Rodrik, Dani.The Globalization Paradox . New York: W.W. Norton & Company, 2012. Print.

Ulen, Thomas, and Robert Cooter.Law & Economics. 6. Boston: Pearson Education Inc., 2012. 88. Print

10 Coyne, Christopher. "Order in the Jungle: Social Interaction without the State."Independent Review . 2.4 (2003):563-564 Web.


10/28

10 Arguing against Microcredit: Fundamentally and Ideologically

Arguing against Microcredit: Fundamentally and Ideologically

Justin Bernardo

Muhammad Yunus received the Nobel Peace Prize in 2006 for his establishment of GrameenBank in 1976 the poor peoples bank and subsequently the establishment of microcredit (Oatley315). Microcredit states that microloans relatively small loans can help the very poor escape poverty.According to Yunus, these microloans have a repayment rate of 99% and they have fostered schoolingfor the borrowers children, and, for the most part, helped borrowers escape extreme poverty (317-318,321). This form of business, which he has dubbed a social business, is not focused on maximizingprofits but rather focused on addressing social and economic issues. The model used to support this

theory is one in which entrepreneurs are not defined as one-dimensional individuals seeking profitmaximization, but rather multi-motivated individuals seeking out mutually exclusive goals, one of whichcan be profit maximization and another which can be improvements in social welfare (321 322). Intheory, such business would be self-sustaining and would see investors receiving their initialinvestments back, but nothing more. As presented in his acceptance speech, microcredit is overtlyideological and inconsistent with reality such that Yunus notion of removing poverty permanently wassheer fantasy.


11/28


Like any other acceptance speech, Yunus suffered from confirmation bias, painting his theory ina favorable light by mentioning points that support microfinance theory. With this considered, I find itcurious that Yunus did not mention of other successes in microfinance, considering that there was a 30year gap between the establishment of Grameen Bank and his Nobel Peace Prize acceptance. Sincethen, the amount of institutions issuing microloans, and as a result the amount of microfinance, has

increased substantially. His argument would be stronger had he provided other examples ofmicrofinance success in institutions outside Grameen Bank, yet this was not done in his speech. Apossibility for this could be that microfinance has not had the success that Yunus suggested. Asmentioned by Karol Boudreaux and Tyler Cowen, microloans have not had their desired social effects onthe vast majority of the very poor because microloans have large repayment interest rates, anywherebetween 50% and 100%, making repayments difficult (Oatley 325). If we are to take Yunus calculationthat 99% of borrowers repay their loans (317), some borrowers will ultimately be subject to repaymore than they could possibly afford by the repayment date. If they do repay their loans on time, thenborrowers only benefit during the lifetime of the loan and face the possibility of being harmed after thelifetime of the loan. The logic behind my conclusion here is that in order for microloans to have thesocial welfare benefits that Yunus suggested, the microloans must make improvements in borrowersincome, increasing income by a percentage equal to the total cost of the loan with interest rate growth.The reason for this is that such a growth rate will enable the borrower to repay the loan and not sufferany backlash after the lifetime of the loan. Inability to repay the loan may actually have the oppositeeffect of its intent and worsen their financial conditions by creating debt.

Following this point, Yunus could have mentioned that microcredit loans have improved theoverall welfare among the majority of the poor. Generally, microcredit has resulted in a rise in thepoors income, yet not enough to go above the poverty line as Yunus claims it can.

Very few have managed to remove themselves from poverty by taking out microloans andmaking substantial changes within their incomes. On average, microloans seem to relax the stresses ofpoverty, not end it. As Karol Boudreaux and Tyler Cowen argued, poverty stricken families with themindset of improving their well-being use microloans to afford income producing items, such as cows orother factors of production, but they remain in poverty because much of the income of the targetborrowers is based on seasonal income meaning that their incomes are subject to change annually(i.e., farmers), (Oatley 326). In my mind, microloans act as steps towards escaping poverty, but there islittle that such loans can actually do to improve incomes substantially. In short, the poor remain poor;they just simply have slightly higher incomes. This point may be countered by the fact that such changesin income may actually be a substantial percentage change. When purchasing power is considered, such

a substantial percentage change may actually equate much better living conditions. The logic behind thisis that the purchasing power of a U.S. dime is much more in these very poor countries than in otherdeveloped countries, a point that is fundamental to the theory supporting microfinance.

Of a more fundamental concern, I believe the existence of high interest rates on thesemicroloans is inconsistent with a central component of Yunuss redefinition of entrepreneurship. Highinterest rates suggest a desire to receive profit despite such an institution claiming to be a socialbusiness; recall that social businesses do not aim to maximize profit (Oatley 320-321). To counter,


12/28


Yunus will mention profit-maximizing firms becoming social businesses by having the majority of theseshares owned by the poor thus improving the poors social welfare. I am not sure how feasible this is inreality, so I will concede that point to Yunus; however, the rise of microcredit institutions can be seen asa result of Grameen Banks success as a profitable and self-sustaining institution. Taken in unison, highinterest rates and the sudden rise of microcredit institutions can be seen as primarily motivated by

profit. One step further sees that the motivation of profit maximization and the motivation of socialwelfare advances are one and the same when it is considered that profit maximization in the long runhelps microfinance institutions provide more microloans to a greater number of the worlds poor,thereby keeping true to the mission of curing poverty. With this in mind, Yunus definition of a socialbusiness is inherently flawed and should be redefined as a business that maximizes profit, but with theidea that the profits are used to improve social welfare in poor countries. Like current free marketmodels, entrepreneurs can be safely assumed as one dimensional as their many motivationsultimately require profit maximization (320).

In conclusion, Yunuss idea of microfinance and microcredit is very ideological and inconsistent

with reality. He mentioned ridding the world of poverty, but the way that markets are set up makes thisimpossible. Current markets are based on competition, supply, demand, and incentives for innovation.Poverty is an inherent result of these four factors working in unison. Instead, Yunus could argue forfundamental human rights by which all people are given the right to basic needs and adequate shelter,yet poor people will still exist albeit at a lesser degree of inequality. The reason is simple: people arepaid a wage based on their experience and education, in other words labor competition. As peoplecompete to attain the limited jobs available in the world, those with more experience, certifications, orother qualities will ultimately succeed. Rather than fight to rid poverty it would make more sense ifYunus suggested providing an equal playing field in the form of improving the competitiveness of poorpeople in the labor market. In fact, this is something that Yunus has done in the form of student loans

through Grameen Bank (Oatley 318). This is one way to remove oneself from poverty, but the notionthat poverty can cease to exist is something that is not consistent with the reality of the free marketsystem.

Bibliography

Oatley, Thomas H. "Microcredit Facilitates Development v. Microcredit Does Not Facilitate

Development." Debates in International Political Economy. 2nd ed. Boston: Longman,

2012. 314-29. Print.


13/28

13 What Economists can learn from the NFL Referee Lockout

What Economists can Learn from the NFL Referee Lockout 11

Jacob Aaron Geller

On September 24th, the Green Bay Packers suffered a brutal and controversial loss to theSeattle Seahawks.

Many believe the Hail Mary pass in the final seconds of the game was incorrectly called atouchdown by the game's replacement referees, who were filling in for the NFL's union referees untilthe latter sorted out a labor dispute with the League's owners. The dispute, called a "lockout," camedown to about $3 million in pay raises which the League's team owners initially chose not to grant theunion refs, opting instead to hire replacements, hence "locking out" the regulars.

What does any of this have to do with economics?

Well, the labor dispute behind the pass raises two interesting questions for aspiring economists:1) would the lockout have any adverse effect on Green Bay's economy -- would it lower income or

employment, for example, as fewer people attend the games -- and 2) if so, who is more to blame: theunion refs (who demanded the pay raise) or the team owners (who refused to grant the raise andinstead hired replacements)?

In regards to the first question, Packers quarterback Aaron Rodgers had this to say after thegame:

11 The article has been adapted for this journal.


14/28

14 What Economists can Learn from the NFL Referee Lockout

NFL obviously cares more about saving some money than having the integrity of the gamediminished a little bit... much of our economy out here relies on those 10 home games and the revenuethat's generated from the hundreds of thousands of people who come through each week to either

watch the game or be around the stadium.

Rodgers seemed to think the lockout would damageGreen Bay's economy by driving down game attendance andstadium revenue, as fans lose faith in the integrity of thegames. But is he correct?

The empirical evidence for this claim is actually prettyflimsy.

One way to look at the question is to ask, what is theeffect of football on a local economy during normal times -- thatis, in the absence of a labor dispute? If it's positive, then youmight suspect the effect of a labor dispute to be negative.

The economics-of-football literature seems to point tono effect, or possibly even a negative effect, of football on a local economy in normal times. Onestudy by Baade, Baumann and Matheson found no positive impact of college football on the localeconomy, and that winning records lower per capita income growth. Another study by Baade looked fora sports-induced boost to per capita income or employment, and found neither. Another found that"baseball, football, basketball, and hockey... have an adverse impact on local per capita income for U.S.markets in both the short and long run." The same study also found no impact on tax revenue,and another showed the same thing for college teams. John Siegfried and Andrew Zimbalist havelikewise calculated that most of professional players' salaries aren't spent in the local economy, butrather "leak" into other parts of the country, so there's little boost from having rich players living in yourcity.

Another way to look at the question is to focus directly on what happens in bad times -- whenthere is a labor dispute. Is there an adverse impact then on employment or income then? Twoseparate studies have asked this question and both found that professional sports lockouts do not causeany damage at all to the teams' local economies.

So the relevant literature seems to say that football and other sports in general have no positiveimpact on an economy (and may actually be damaging), and that a lockout in particular has no net

negative impact.

Industry-sponsored studies, however, tend to claim sports franchises and one-time sportingevents (like the Olympics) have huge benefits for local economies. But this short essay by VictorMatheson explains why industry-sponsored studies tend to over-state their case (hint: it has somethingto do withtheir incentives ).


15/28


So why would sports teams tend to have so little positive and lockouts so little negative, impacton a local economy?

For one thing, there is the substitution effect. If local sports are not available, people won'tlavish in poverty; they will simply spend their money on other things, like food, vacations, The

Popinator, and other goods and services, or else they might save and invest it. Idle resources will be putto use onsomething people like. If labor markets are flexible (for example, referees and ticket vendorscan quickly find alternative employment elsewhere), and if people get as much out of other activities asthey do from sports, then the overall impact of a lockout will be small. Some people might stop going toGreen Bay Packers' games because the replacement referees have ruined the integrity of the game, butthe folks who work at the stadium selling beer and tickets will not be permanently unemployed: they'llbe employed elsewhere in or around Green Bay, doing something else of approximately equal value totheir local economy.

Another reason is that demand forsports is inelastic -- that is, people willkeep going to the games no matter what.

This seems likely, as there is only oneprofessional football sports league in thecountry. If you are such a fan of theGreen Bay Packers that you're willing topay good money to attend a game, thereare no close substitutes for Packers gamesand you'll probably keep going even if theofficiating is pretty bad.

There is one study, however,which does find a clear economic benefitfrom football: winning the Super Bowl, inparticular, raises long-run per capitaincome in the winning teams' local economy. This might be what Rodgers, the once-reigning Super BowlMVP, meant by his comments, though I'm not sure if Green Bay, Wisconsin, with just 104,000 residents,is the American city most in need of a Super Bowl stimulus.

What of the second question: even if the economy were adversely affected lets say, bydenying Green Bay a Super Bowl, now that their win record is damaged who is more to blame, theunion refs or the team owners?

Rodgers, ever the aspiring economist, had an answer to this, too:

This is a multi-billion dollar operation against... 35-to-50-year-old guys who want a littleinsurance on the back end, want to be taken care of for the job that they do, believe that their job is animportant part of that shield, the NFL brand.


16/28


Here Rodgers is on much firmer ground. The case for organized labor is at its strongest in thecontext of professional sports. Even libertarians, who are traditionally skeptical or even hostile towardunions, give organized labor a pass (pun intended) in the market for professional sports, because sportsleagues tend to be monopolistic and anti-competitive. I know that sounds strange, but Imean economically anti-competitive, not athletically.

To see why, imagine a competitive market with lots and lots of employers and workers, say themarket for apples. In this situation it could be costly for workers to organize a strong labor union -- theymay become monopolistic, "hoard" labor, seek rents, drive down output, and become inefficientlyexpensive to consumers and employers alike.

Now imagine that it's the other way around the labor market is monopolistic so there is onlyone buyer of labor. In this case, the employer, the NFL team owners, are the only buyer of labor in theprofessional football market. This "monopsony" can be just as costly and inefficient as a monopoly,because the single buyer can get away with under-pricing, and under-supplying, and under-paying forthe labor being bought (namely, good officiating), as there is little or no competition for the labor ofprofessional football referees.

In a situation such as this, the emergence of the single, monopolistic union bargaining with thesingle, monopolistic employer will lead to a bilateral monopoly. In a bilateral monopoly neither side hasany competitive advantage over the other, as each cancels out the others' buying power (in theoryanyway). It's the same as if you and I were negotiating over what portion of the rent we should eachpay on a 2-bedroom apartment, or how to split a check at a restaurant we are on equal terms. So theemergence of a strong labor union moves the market equilibrium from an inefficient monopsony tosomething more closely resembling a competitive marketplace.

The way I look at it, as of Week 3, Aaron Rodgers was 1-2 on the football field, but 1-1economics: yes, the union referees had a strong case in the dispute, but no, the league owner's decisionto lock them out probably didn't hurt Green Bay's economy just their win record.

But I'd be interested to hear what other aspiring young economists think: am I making anyreplacement-ref-type mistakes here? I am a replacement economist after all, a graduate student"subbing in" for the professional economists who really know the playbook.


17/28

17 Currency Wars: The Art of Cornering the Market

Currency Wars: The Art of Cornering the Market

Jeevan

Parameswara

n

Part I: Black Wednesday

On the 16th of September 1992, Chancellor of the Exchequer at the time, Norman Lamontstepped out to admit an embarrassing defeat at the hands of currency speculators, the most notoriousof which happened to be George Soros, billionaire chief of the widely revered Quantum Fund. What hadoccurred was a classic case of cornering the market, in this case one worth billions that had heavyimplications for the average citizen. In October 1990, Britain signed up for the European Exchange RateMechanism(ERM), in many ways, a precursor to todays Euro, pegging its currency to the Deutsche Markwithin an agreed upon band, +/- 6% to the pound. Economic conditions at the time did not favor thismove unfortunately with Britain experiencing a recession in the early 90s. Interest rates were high asthe focus shifted to inflation while the USD was experiencing depreciation, hurting British exports tied to


18/28


the dollar. Currency speculators at the time, led by George Soros and his second in command, StanleyDruckenmiller, forecasted that the pound would ultimately fail to honor the fixed exchange rateagreement. The Soros team also happened to be privy to the war chest the Bank of England (BoE) wassitting on, $44billion. They knew their Quantum Fund could match that. Easily. They were ready to betbig.


19/28


The ERM was set up to stabilize currency fluctuations. Stable currencies were a catalyst forbusiness growth, providing an environment where businesses could operate without the nagging worryof currency risk. With most of Europe having its currency pegged to the German Deutsche Mark,conflicts arose from the newfound inflationary pressure on the German economy. The root of this wasquite simply the higher German interest rate as the Bundesbank sought to combat growing worries of

inflation at the time, with its inflationary mandate naturally taking precedence post World War 2. Higherinterest in Germany meant capital inflows into the country as investors sought the higher returnsoffered by the Germans relative to its neighbors. This had the unfortunate effect of reducing demand forthe other European currencies, Italy and Britain in particular, whose currencies consistently floated nearthe lower bands. This left the concerned parties with two options, either have the Bundesbank cut rates,which did not go down well with the fiercely independent Germans, or have their central banksintervene in the event that the currency moves dangerously close to the lower band. The uniqueproblem Britain faced however was that mortgages in the country were mostly unfixed i.e. they floatedvis a vis overall interest rates. Hence, any rise in interest rates would see some serious consequences toBritish homeowners and spending in general. Soros of course, knew this. He was sure the BoE would notrisk higher interest rates to help raise demand for the sterling should its reserves run out. This wouldleave the BoE with only one option once reserves were depleted down to nothing: a massivedevaluation.

Soros fund began shorting the pound sterling and the Italian lira in 1992. They went ingradually, eventually building up to a short position against the pound sterling worth $1.5 billion. Ineffect, they drove the pounds steady decline, alerting more and more currency speculators to the plightof the pound. Soros and co knew that that the market was king. If they could convince the market tosimultaneously short the pound, the BoE would not stand a chance. Now the problem Norman Lamontand the Bank of England faced was that they were part of the ERM, hence they were obligated to prop

up the pound so it didnt fall below the fluctuation band. However, as more short sellers entered themarket, it became harder and harder for the BoE to continue artificially propping up the pound. Moreand more reserves were being required to save the flailing currency. Soros meanwhile, sensed thetipping point was near. Soon the downward pressure would just became too much, and Soros prophecythat the BoE would exit the ERM and return to a floating pound would come true.

The tide of short selling did not come without warning however. In August 1992 for instance,George H. W. Bushs massive planned buyback of US Dollars failed to make a dent on exchange rates. OnSeptember 8, speculative selling of the Finnish Markka forced its government to abandon its peg. Thenewly floating Markka plunged 15%. A day later, Sweden found itself in a similar position, forcing the

government to raise interest rates to a whopping 75% to stem capital outflows. Italy was the next in thefiring line, but this time the Bundesbank stepped in, offering $15.4 billion worth of reserves.Unfortunately its effort amounted to nothing more than fools hope as traders rapidly overwhelmed theBundesbanks war chest. Traders around the world started to realize currency pegs were a gold minewaiting to happen.

In early September, the BoE attempted to fight fire with fire. They announced that they weregoing to leverage themselves massively in response, adopting the very same strategy used by the enemy


20/28


at the gate. Such threats would have scared off lesser men but not Soros. The BoEs decision to borrow$14 billion simply meant he could now expand his position on the short side of the trade. Hisunwavering confidence remaining intact, he was only incentivized to reach father, bet bigger. OnTuesday, 15th September 1992, Helmut Schlesinger, president of the German Bundesbank, hinted thatthere would be a broad realignment of European currencies in light of the pounds struggle. The remark

triggered contrasting moves on both sides- the short sellers smelled blood, the Bank of Englandprepared to aggressively fill the other side of the trade.

The next morning, the Bank of England started buying in droves, creating a market for shortsellers to further increase the size of their short positions. But the Pound fell. No matter how much theBank of England bought, the pound would not budge in their direction. That morning, 1 billion went topurchasing increasing amounts of pound sterling. At 11am however, slowly starting to realize his lostcause, Lamont turned to interest rates, effectively raising them by 2%, in an attempt to attract hotmoney, which simply refers to investors that move money to higher interest rate climates to generatehigher returns, and perhaps boost demand for the pound. No luck. So, up went interest rates again, this

time by 3 percentage points. Not even close. So at 7.30pm, on a dark day for the BoE, Norman Lamontadmitted the unthinkable, they had lost and would now return to a floating pound.

Ironically, Black Wednesday led to a revival in Britains economic fortunes which really putsBritains decision to join the ERM in the first place into rather harsh perspective. As for Soros, he wasdeep in the money- $1 billion from Black Wednesday alone, $2 billion overall-all in a days work for Mr.Soros.


21/28


Part II: The Battle of The Baht

Fast forward to South East Asia in the mid-1990s. Economic fortunes were up and times weregood in the 90s for Asian economies. The foundation on which they built their economic growthhowever was up for debate. In the 1980s and early 90s, the Asian economies raised interest rates to

attract foreign investments, leading to large capital inflows into the countries. This deviated from thetraditional idea of growing from within i.e. via factor production. Naturally asset bubbles grew as moreand more capital flowed in through the money markets. Investing was a win-win on both sides, investorsenjoyed high returns while South East Asia enjoyed an increasingly prosperous economy from theabundance of foreign investments. In fact, the large capital inflows at the time led to many of theseeconomies becoming the export driven economies they are today.

Five years after his infamous $2 billion triumph over arguably Europes most powerful centralbank, Soros sensed history repeating itself in the East. The Thai Baht in particular, caught his eye. Herewas yet another currency being controlled by an inefficient economy propped on a shaky house of cardswaiting to be toppled. Where the pound sterling had been pegged to the deutsche mark, the Thai Bahtto USD had been set to fluctuate within a 25.2-25.6 band. This was done to provide some measure ofstability for investors. They could simply borrow at low rates from the US and reinvest the capital inThailand for higher interest rates and take home riskless profits, provided the exchange rate remainedfixed. This did however promote massive amounts of leveraging in the economy, which as 2008 proved,is a sure recipe for financial meltdown. Now the caveat to this economic model was simply that if theUSD appreciated, Thailands export based economy would suffer. If it depreciated, so would the Bahtand the foreign investors parking their money in Thailand would be faced with a huge backlash on whathad initially seemed a golden arbitrage opportunity.

In the period leading up to the Thai crisis, its exports were increasingly losing out to the rise ofChina as the main low cost exporter in the region. The omens were looming over the Thais, yet it wentlargely ignored. The Thais were depending on foreign loans to finance its economic growth, whichnaturally begged the what if question- what if foreigners stopped lending? Well, as it turns out, theweak underbelly of the Thai economy would be exposed and it would snowball into a full blown financialcrisis. In 1996, the Bangkok Bank of Commerce (BBC) went under, raising doubts about the Thaiscreditworthiness. The Thai government was in a fix, the banks were suffering due to the high cost offunds but lowering interest rates would cut off the foreign lending which had driven so much of itseconomic growth. The more they probed into their shaky financial system however, the more convincedthey were that interest rates would have to be cut. The implication of lower interest rates would alsounfortunately be a steady outflow of foreign investment, lower demand for the Baht and therefore, adevalued currency.

Currency speculators at the time, notably George Soros of Quantum and Julian Robertson,manager of Tiger fund, believed that the Thai Baht would eventually be forced to abandon its peg anddevalue heavily. In 1997, the players made their moves. In late January 1997, Stanley Druckenmiller,Soros wing man from Black Wednesday sold short $2 billion worth of Thai Baht, putting the Thaigovernment on the defensive. To combat the short sellers, the Thai government used up its foreign


22/28


reserves, then boldly raised interest rates by 3%. This spelled doom for the ailing Thai financial sector ofcourse, since borrowing would become even more expensive. But like a dog chasing its tail, the Bank ofThailand (BoT) was defiantly pursuing its newfound enemy regardless. Higher interest rates were ofcourse meant to hurt those in a short position (the very nature of being short simply implies that onehas to borrow, and borrowing has a cost). The short sellers needed to finance their positions, and

because they were borrowing, they needed to pay higher interest on their position. So the Thaisostensibly ignored the issue of its banks already suffering under present interest rate levels, furtherraising the rates in an attempt to hit the hedge funds where it hurt most-their bottom line. Soros teamhowever had masterfully locked in their trade positions at previous lower interest rates for the following6 months up to July while those who lacked the same foresight were forced to accept the new rates.However, more and more traders started to catch wind of the growing short position against the Baht,firmly believing that a repeat of the pounds collapse was on the cards. Chavalit Yongchaiyudh, PrimeMinister of Thailand at the time, turned his attention to the hedge funds, pinning the blame squarely ontheir shoulders and announcing the Thai government would continue to fight the speculators tooth andnail. Soros in particular bore the brunt, having already gained infamy for breaking the Bank of Englandnot long before. In response to the PMs announcement, the Quantum fund increased its position: $3.5billion short. Julian Robertson (Tiger) and Paul Jones (Tudor Investment), two other notoriouslysuccessful hedge fund bosses also joined in the party, albeit with smaller positions. The worlds biggestplayers had taken their seats at the table. It was a sure sign of things to come.

On May 15, the Thai government had had enough. They announced a two tiered currencysystem, cutting off all links to the offshore market by forbidding any baht lending from within thecountry to foreign entities. A two tiered currency entailed two different exchange rates, one for thosewho bought Baht within domestic markets and one rate for those who bought in offshore markets. As aresult, the Thai Baht temporarily gained big, leaving many funds sitting on gargantuan losses. Suddenly

short positions seemed like a bad idea.

Not if you were on Soros team however. The Thais had claimed to hold reserves greater than$30 billion but in reality, a considerable amount was sitting in undisclosed forward market positions,leaving the available reserves standing at a much smaller amount. If all their past spending on holdingthe Thai Baht/USD peg was further taken into account, it would be clear that they were much closer tothe brink than they let on. Meanwhile, high interest rates in Thailand were further destroying a reelingfinancial sector, with bank after bank defaulting on foreign loans. Foreigners had grown so apprehensiveof the Thai capital controls and its ongoing battle with speculators that they were calling for their moneyback pronto. Naturally most of the debt had to be paid back in USD. Hence, the Thai Baht went on a

downward spiral as borrowers started selling the Baht and buying USD to repay, further draining thereserves of a struggling BoT. In early July, coincidentally when the terms of Quantums low interestfinancing of their short positions would expire, Julian Robertsons Tiger fund put the BoT out of theirmisery, executing a high stake smash and grab- $1 billion short, plunging BoT reserves down to zero. TheBoT was forced to admit defeat and float the Baht, sending it crashing 32% relative to the USD over thefollowing months. As the Asian economies collapsed into the famed 1997 crisis, the funds reaped huge


23/28


profits and the rainmakers took home paychecks that would feed a country or two for a day, but thatwould be beside the point. The rainmakers had done their job. Theyd made it rain.

References

Ciminero, Gary L. (November 24, 1997) A Primer on the Southeast Asian Financial Crisis,wysiwyg://17/http://www.dismal.com/thoughts/asian_crisis.stm

Sussangkarn, Chalongphob (January 16, 1998) Thailands Debt Crisis and Economic Outlook,http://www.nectec.or.th/bureaux/tdri/mep_fore.htm

Budd, Alan, Black Wednesday - A Re-examination of Britain's Experience inthe Exchange Rate Mechanism. IEAOccasional Paper No. 135. Available at SSRN: http://ssrn.com/abstract=734203 orhttp://dx.doi.org/10.2139/ssrn.734203

Byrne, Mark (September 9 2011) Global Currency Wars Sees Swiss Franc Devalue 8.5% Against Gold in Weekhttp://news.goldseek.com/GoldSeek/1315573200.php

Federal Bank of St Louis (November 24 2012) Fred Economic Datahttp://research.stlouisfed.org/fred2/graph/fredgraph.png?bgcolor=%23ffffff&fo=tn&ts=12&id=EXTHUS&scale=Lef t&range=Max&cosd=1981-01-01&coed=2011-09-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=3&ost=-99999&oet=99999&mma=0&fml=1%2Fa&fq=Monthly&fam=avg&fgst=lin&transformation=lin&vintage_date=2011-10-24&revision_date=2011-10-24


24/28

24 The Dark Side of Capitalism: Global Class Warfare

The Dark Side of Capitalism: Global Class Warfare

Ben Denis Shaffer

Globalization is a process that is debated about most frequently in todays world. Just as anyprocess, globalization has its consequences or externalities that we observe in our everyday life, in the

newspapers, on television programs, on the internet and other sources of information. Theconsequences and results of globalization constitute the debates and many, if not all, are important forone to understand how economical, political and social interactions function today in our world.

The focal point of the discussion at this particular event was the negative externality that, assuggested by Charles Duhigg and Dr. Kari Jensen, is the violation of safety standards and immoralpractices during employment of labor resources in some world regions, such as China and Bangladesh.Violation of safety standards was discussed with respect to Apple Corporation and the manufacturing ofsome of Apples popular products, including the iPhone, Mac computers and iPads. Immoral behavior onthe other hand was discussed with respect to Bangladeshs corrupt government and poor economy.

Considering our knowledge of economic theory, we know that the demand in the labor marketis derived from the demand in the consumer market; hence it is suggested that violation of ethics inmanufacturing sectors of countries that produce goods are also derived from our demand for thesegoods. The iPhone is an example that is discussed during this event. Charles Duhigg described someinstances of dangerous conditions to which Chinese workers at Foxconn factories are exposed to.


25/28


Unbearable working hours, various physical injuries and even some deaths are all put on theconscience of the general consumers of iPhones. The fact is that due to development in transportation,communications and innovative manufacturing methods, world markets have merged consequentlyconnecting regional economies. This change in economy is also due to lower barriers of entry tomanufacturing sectors in some world regions, as these results in outsourcing and off-shoring.

Materialism and consumerisms are the words that Dr. Kari Jensen uses to describe themodern United States society. The United States is the greatest aggregate consumer and greatesteconomy in the world, so the behavior of its citizens has particularly great impact. If a generalizationabout the US citizens is close to truth that means that a great responsibility lies in its citizens andresidents. Along with the United States is Western Europe, where countries with large economies suchas Germany, France, United Kingdom, Italy and others are also great global consumers. Another thingthat these countries share is that they are considered to be first world countries and that the standardof living in these countries is much higher than average. A very troubling and unfortunate observationcan be made. It seems that the high standard of living in these countries is achieved at the cost of thirdworld countries, consequently causing the Global Class Warfare.

In Democracy in America Tocqueville makes a number of predictions about the United Statesand how democracy in the US will develop. Amazingly, his predictions and observations are veryrelevant today and help us understand the origins of materialism. In a democracy, the citizens of acountry assume the power or rights. The rights are attained through liberty, and liberty is somethingthat is assumed to be a basic right of every person. This is an oversimplification; however even thissimple logical chain shows that capitalism, a market economy where private ownership is a conditionand freedom to choose what and in what quantities to consume is reality, fits conveniently with the

liberal ideas constituted by democracy. The claim that I will make now is that most people in first worldcountries, the general public, believe the above logic chain. One of the greatest achievements ofdemocracy is that people attain rights. However, one of the great tragedies is that people do not alwaysrealize that with rights, they gain responsibilities.

What I suggest is that the negative externalities of globalization are due to what Tocquevillecalled tyranny of majority, or in other words, the general public in first world countries. Capitalism isdriven by self-interest guided by the invisible hand, at the cost of general interest of third worldcountries. This reveals the Dark Side of capitalism that exists in the global economy and explains whatis meant by Global Class Warfare. If you add national class warfare to this concept, then it becomes

evident that another side effect of globalization is increasing global income inequality added to nationalincome inequality. Perhaps this is why late 20th and early 21st centuries have developed somefantastically wealthy individuals.

This is unfair, unethical and unhealthy for world stability but this does not mean that we shoulddemonize capitalism and turn to some radical alternative. Just like Adam Smith talked about certain


26/28


conditions for capitalism to sustain human indulgence towards greed before the Industrial Revolution,we must consider new conditions for new Global Economic System with free markets.

For a global economy to function there must be global awareness, recognition of responsibilityand a change in mentality. Perhaps it would seem like a nave or utopian idea for the people of theworld to live with no discrimination, respect for all cultures, traditions, history and values, but I canargue that it is not. This will certainly be a long process of cultural globalization but it is bound to happenone day. The reason for my confidence is not just youthful age but also first hand experience. I am aperson who has no nationality, religion or strict tradition. My Israeli citizenship is a formality, as I wasborn there. My Russian residency is also a formality because I lived in Moscow for most of my life. I havgraduated from an International School in Moscow where kids come from over 50 different countries.Under conditions of such a diverse community, cultural boundaries fade and mentality changes. Moralvalues change and most importantly global awareness is developed.

Both of my parents were born in the USSR and it would have been unthinkable for them to thinkthat their children would be who they are now. It was like going to the moon. This is to point out thatworld changes and perhaps the 21st century will be the new Renaissance, the new Industrial Revolution,all under the name of globalization. This is also to remind that apart from negative externalities, such asdiscussed earlier, there are positive results of globalization, which are on the other side of the debates.For example, CERN and the LHC compose arguably the greatest scientific collaboration in history evengreater than the Manhattan Project. The development of some global business centers as in Dubai orglobal R&D hubs like Israel are other positive results of globalization.

Management of globalization is going to be the task of the economist policymakers and

businesses in the future. In this case the economic sense of globalization concept is used. Precisely,globalization can be defined as a process of integration of global economies, which results fromeconomic activity that is entangled with markets in different regions of the world. Should themanagement of globalization be the task of these individuals is a different question? Arguably yes; if wewant to avoid Global Class Warfare and the Dark Side of Capitalism, if we want all people to bebetter off, if we believe in sustainable, environmentally friendly development then globalization mustdefinitely be managed and pursued. For management to begin, however, there are certain requirementswhich I believe are important: increased level and quality of education, restructuring of democracy infirst world countries and re-approaching the ways in which we evaluate the economy where long termvalues, such as the environment and cultural level, is taken into consideration.

Globalization, both economic and cultural must be both praised and pursued. Nonetheless, wemust remain critical thinkers and pursue with caution, realizing potential negative externalities and treatthose as subject to intelligible management.


27/28

S TUDENT W RITERS

Daniel Currie

Daniel is a junior studying Economics and Business Management. Daniel loves to read and playsoccer. He was an avid reader of Austrian Economics. However, he is now enamored by PostKeynesianism and hopes to see heterodox economics taught in all universities. His favorite economist isMilton Friedman and F.A. Hayek. He aspires to either become a successful financier, writer, andeconomist (hopefully a Nobel Laureate!).

Jacob Aaron Geller

Jacob is a Masters Candidate in Economics from Boston University. A Senior Consultant for theBoston University Urban Business Accelerator, he is also an avid blogger for his website called Jacob A.Geller. He also serves as the section editor for Sense and Sustainability, a podcast-cum-blog aboutsustainable development.

Justin Bernardo

Justin Bernardo is a resident of Miami, Florida currently studying Political Science, Economicsand Mathematics at Boston University. He is currently involved in the Boston University UndergraduateEconomics Association as a student writer. He has varied interests in economics, ranging fromenvironmental policy to innovation. He is expected to graduate in 2015.

Jeevan Parameswaran

An avid follower of financial markets, I am hoping to land a gig in trading or investment banking.Not a fan of government regulation, but I accept that Keynesians are probably the most relevant schoolof thought in todays world. Also, I am a massive scrooge with a penchant for terse oversimplificationand I believe there is no greater joy in life than bacon and eggs in the morning. My interests includetrading, writing, reading and lifting.

Ben Denis Shaffer

I am an Israeli citizen and a Russian resident majoring in Economics & Mathematics andminoring in Philosophy at Boston University. I spent my first year of college at Hofstra Universitystudying Mathematical Business and Economics after graduating from an International school inMoscow. At BU, I also play water polo, which is a sport I love. I dont pertain to any religion, schoolthought or movement. Instead I exercise my own thoughts. I hate politics and love Philosophy. Myinterests are in subjects of Physics, technology, innovation, design & art, business, History, Economicsand, of course, Philosophy.


28/28

Boston University Undergraduate Economics [email protected]

UEA Journal

Documents

Transcript of UEA Journal