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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 to prepare. We hope you enjoy the articles from the semester of Fall 2012.

Daniel Christopher Currie Vice President of Editorial Content Boston University Undergraduate Economics Association

Table of Contents
WHY ANARCHO-CAPITALISM WILL FAIL: AGENCY, TRANSACTION COSTS AND OTHER GOOD STUFF..................................4 ARGUING AGAINST MICROCREDIT: FUNDAMENTALLY AND IDEOLOGICALLY ...............................................................10 WHAT ECONOMISTS CAN LEARN FROM THE NFL REFEREE LOCKOUT ........................................................................13 CURRENCY WARS: THE ART OF CORNERING THE MARKET ......................................................................................17 THE DARK SIDE OF CAPITALISM: GLOBAL CLASS WARFARE .....................................................................................23

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

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

Daniel Christopher Currie Anarcho-capitalism is always a hot topic of discussion. Many respectable economists debate whether 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. The government must exist to provide public goods, law and order and to provide some stability in the economic sphere. However, there exists a strand in economics which believes the government to be an impediment to all that is good. Any government involvement is considered violent and intrusive. The state (government) is known as a parasite that thrives off the hard work of the masses. Other than the name calling, there is much to this branch of economics. The Austrian School of economics is just one of the examples. Even though the zeal for freedom is infectious, it is also a dangerous precursor for bad policy making. Indeed, the government is needed for transactions to occur in an increasingly globalized world. 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 for people to make decisions. I will go through what anarcho-capitalism entails and how transactions would take place in an economy without a government. Then, I will try to refute this by using an agency model along with a few explanations for the existence of transaction costs. I hope to show that an economy would face too many problems if a state would cease to exist. Anarcho-capitalism

5 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff What is anarcho-capitalism in the first place? It is an economy in which the state is non-existent and the free market reigns supreme. Individuals would be responsible for themselves as long as they do no 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 that anything 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 in power. Under this theory, law and order can be provided in a free market without the constraints of having to abide by the demands of a single ruler. Law can be set up through customs and traditions as Anarchists maintain that the laws need not be imposed by a central authoritythat is, laid down as authoritative lawbut can and do arise through customary arrangements and understandings that evolve over time.1 This means that the customary law that will be most beneficial to the populace will spring up. John Stuart Mill stated the same exact thing when he went against the detractors of utilitarianism that this is just like saying: Before acting, one doesnt have the time on each occasion to read through the Old and the New Testaments; so it is impossible for us to guide our conduct by Christianity. The answer to this objection is that there has been plenty of time [Emphasis added by author], namely, the whole past duration of the human species. During all that time, mankind have been learning by experience what sorts of consequences actions are apt to have, this being something on which all of morality on life depend, as well as all the prudence.2 So, law through customs and traditions 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-free economy because of transaction costs. Conversely, Christopher Coyne attested that such transactions would in fact occur because people would be able to trust reputation. This is what every businessperson, entrepreneur and employer wishes to attain in his or her life. The reputation to carry out 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 to maximize profits and minimize losses. In an effort to maintain current market share and gain new market 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 <http://www.earlymoderntexts.com/pdf/millutil.pdf>. 3 Coyne, Christopher. "Order in the Jungle: Social Interaction without the State." Independent Review. 2.4 (2003): 562 Web.

6 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff they? If they are caught then they will be left with an irreparable reputation. From an entrepreneurs point 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 to make sure contracts are followed and the right amount of restitution is paid to the injured party.4 This will 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) institutions will 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 the Law & Economics Textbook.5 A simple agency model should suffice to put my point across. Imagine a principal willing to invest $1. He hands over his money to an investor promising a net gain $1. The investor will pocket $0.5 of that gain while the principal would attain his original $1 plus the other half of the net gain: $0.5. The investor could steal the cash and the principal would never see it again. Or, the principal could end the game 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 not invest. This is because the investors best choice would be to appropriate. Appropriation is just redistribution of funds, while investment would have been an increase in wealth. Thus, the principals only option would be to not invest. Principal Dont Invest (0, 0) Invest 1 Appropriate (-1, 1) Investor Profitable Investment (0.5, 0.5)

Murphy, Robert. Chaos Theory. 2. Aurburn: Ludwig Von Mises Institute, 2010. 14. Web. <http://mises.org/books/chaostheory.pdf>. 5 Ulen, Thomas, and Robert Cooter. Law & Economics. 6. Boston: Pearson Education Inc., 2012. 283-291. Print.

7 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff Now let us introduce contracts that will compensate the principal for the amount that will be stolen and the investor will have to pay damages as well. This is how the situation would unfold: Principal Dont Invest (0, 0) Invest 1 Appropriate. Return investment 1 & pay damages 0.5 Investor Profitable Investment

(0.5, 0.5)

(0.5, -0.5)

When the investor is caught appropriating funds, then he must refund the original $1 and pay an additional $0.5 as damages. This will make the investors best option to make a profitable investment, in which 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. This is true; however, there exists the problem of transaction costs. Transaction costs are the costs of exchange.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 available to 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 would arise. 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 and contract making. We must structure the economy in such a way that it improves efficiency according to the 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 7

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

8 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff Transaction Costs in Perspective 1) In the market there exists plenty of transaction costs. When trading in foreign markets, it becomes very difficult to do so because of different cultures, times, and perceptions which increase the risk and uncertainty borne by the investor. Indeed, it is known that investors prefer investing in nations with a strong rule of law and a government able to battle corruption. The biggest governments are in those countries that are exposed to international trade9. 2) The introduction of time could also be a problem. The cost of searching could be the time used to do something else, which is the definition of opportunity cost. If it takes too long to find an individual 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 are present. When people are too emotional then they can become hostile and this will increase transaction costs. Bargaining becomes much more difficult. 4) When bargaining with an individual for a particular product, it becomes difficult to know all the specifics. Both parties would want to keep the information to themselves so that they can attain a greater surplus from their transaction. This information asymmetry would result in transactions not taking place. Imagine this, if someone is so eager to sell something to you, wouldnt you be skeptical of buying 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 make bargaining almost impossible. If the transaction costs were higher than the net gain, then no one would make 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 would become wary. Consumers would be unwilling to invest or buy from other firms because their trust in that sector has fallen. Robert Murphys example is something that prevails in our economy today. Having an arbitrator or a firm 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 for firms that deal with different laws in different areas over different times in a domestic market. This would be an impediment by itself as it increases search costs. There is such a thing as too much choice.
8 9

Ibid 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 better functioning and larger governments when compared to poor ones. (16)

9 Why Anarcho-Capitalism will Fail: Agency, Transaction Costs and Other Good Stuff In the end, we do require Max Webers monopoly of the legitimate use of force. Indeed, it is of incredible importance that the government exists because it is a brand name. If a strong government makes sure its citizens uphold the law, then people would be willing to invest. If the rule of law is not strong enough, then people would be wary. But, just having one law system that exists would lower search costs. The state would make sure to keep in step because keeping the law in such a way maximizes its tax revenue. Tax revenue is maximized in the long run if a productive populace exists. One of the only ways to attain this is to have a strong legal system. Christopher Coyne rebutted this by stating that the government would try to maximize psychic income. As Coyne stated that it is critical to remember, however, that through action people attempt to maximize psychic income. This is not limited to monetary income but includes nonpecuniary forms of income as well. Rulers may gain (psychic) income by holding and wielding power even though they may not maximize monetary revenue by doing so. And, if they do so, their actions may conflict with the ruled groups interests10 However, this need not be true because the utilization of democracy will keep governments in step. If governments do not listen to their populace, then eventually they will be replaced. Even if the state is insistent on wielding its power, it will eventually fall if the populace decides to 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 costs are lowered and the people who appropriate are brought to justice. In a timeless system with rational expectations, everything would work in the best possible manner. However, transaction costs and information asymmetries are the ways of life. We can never escape them. We must always hope to lower 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. Bibliography
Coyne, 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 <http://www.earlymoderntexts.com/pdf/millutil.pdf>. Murphy, Robert. Chaos Theory. 2. Aurburn: Ludwig Von Mises Institute, 2010. 14. Web. <http://mises.org/books/chaostheory.pdf>. 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 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 Grameen Bank in 1976 the poor peoples bank and subsequently the establishment of microcredit (Oatley 315). 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 schooling for 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 maximizing profits 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 profit maximization, but rather multi-motivated individuals seeking out mutually exclusive goals, one of which can be profit maximization and another which can be improvements in social welfare (321 322). In theory, such business would be self-sustaining and would see investors receiving their initial investments back, but nothing more. As presented in his acceptance speech, microcredit is overtly ideological and inconsistent with reality such that Yunus notion of removing poverty permanently was sheer fantasy.

11 Arguing against Microcredit: Fundamentally and Ideologically Like any other acceptance speech, Yunus suffered from confirmation bias, painting his theory in a favorable light by mentioning points that support microfinance theory. With this considered, I find it curious that Yunus did not mention of other successes in microfinance, considering that there was a 30 year gap between the establishment of Grameen Bank and his Nobel Peace Prize acceptance. Since then, 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 of microfinance success in institutions outside Grameen Bank, yet this was not done in his speech. A possibility for this could be that microfinance has not had the success that Yunus suggested. As mentioned by Karol Boudreaux and Tyler Cowen, microloans have not had their desired social effects on the vast majority of the very poor because microloans have large repayment interest rates, anywhere between 50% and 100%, making repayments difficult (Oatley 325). If we are to take Yunus calculation that 99% of borrowers repay their loans (317), some borrowers will ultimately be subject to repay more than they could possibly afford by the repayment date. If they do repay their loans on time, then borrowers only benefit during the lifetime of the loan and face the possibility of being harmed after the lifetime of the loan. The logic behind my conclusion here is that in order for microloans to have the social welfare benefits that Yunus suggested, the microloans must make improvements in borrowers income, 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 suffer any backlash after the lifetime of the loan. Inability to repay the loan may actually have the opposite effect of its intent and worsen their financial conditions by creating debt. Following this point, Yunus could have mentioned that microcredit loans have improved the overall welfare among the majority of the poor. Generally, microcredit has resulted in a rise in the poors 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 and making substantial changes within their incomes. On average, microloans seem to relax the stresses of poverty, not end it. As Karol Boudreaux and Tyler Cowen argued, poverty stricken families with the mindset of improving their well-being use microloans to afford income producing items, such as cows or other factors of production, but they remain in poverty because much of the income of the target borrowers 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 is little 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 changes in 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 this is that the purchasing power of a U.S. dime is much more in these very poor countries than in other developed 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 these microloans is inconsistent with a central component of Yunuss redefinition of entrepreneurship. High interest rates suggest a desire to receive profit despite such an institution claiming to be a social business; recall that social businesses do not aim to maximize profit (Oatley 320-321). To counter,

12 Arguing against Microcredit: Fundamentally and Ideologically Yunus will mention profit-maximizing firms becoming social businesses by having the majority of these shares owned by the poor thus improving the poors social welfare. I am not sure how feasible this is in reality, so I will concede that point to Yunus; however, the rise of microcredit institutions can be seen as a result of Grameen Banks success as a profitable and self-sustaining institution. Taken in unison, high interest 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 social welfare advances are one and the same when it is considered that profit maximization in the long run helps 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 social business is inherently flawed and should be redefined as a business that maximizes profit, but with the idea that the profits are used to improve social welfare in poor countries. Like current free market models, entrepreneurs can be safely assumed as one dimensional as their many motivations ultimately 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 this impossible. 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 for fundamental 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 are paid a wage based on their experience and education, in other words labor competition. As people compete to attain the limited jobs available in the world, those with more experience, certifications, or other qualities will ultimately succeed. Rather than fight to rid poverty it would make more sense if Yunus suggested providing an equal playing field in the form of improving the competitiveness of poor people 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 notion that poverty can cease to exist is something that is not consistent with the reality of the free market system. 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 What Economists can learn from the NFL Referee Lockout

What Economists can Learn from the NFL Referee Lockout11


Jacob Aaron Geller

On September 24th, the Green Bay Packers suffered a brutal and controversial loss to the Seattle Seahawks. Many believe the Hail Mary pass in the final seconds of the game was incorrectly called a touchdown by the game's replacement referees, who were filling in for the NFL's union referees until the latter sorted out a labor dispute with the League's owners. The dispute, called a "lockout," came down to about $3 million in pay raises which the League's team owners initially chose not to grant the union 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: the union refs (who demanded the pay raise) or the team owners (who refused to grant the raise and instead hired replacements)? In regards to the first question, Packers quarterback Aaron Rodgers had this to say after the game:
11

The article has been adapted for this journal.

14 What Economists can Learn from the NFL Referee Lockout NFL obviously cares more about saving some money than having the integrity of the game diminished a little bit... much of our economy out here relies on those 10 home games and the revenue that'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 damage Green Bay's economy by driving down game attendance and stadium revenue, as fans lose faith in the integrity of the games. But is he correct? The empirical evidence for this claim is actually pretty flimsy. One way to look at the question is to ask, what is the effect of football on a local economy during normal times -- that is, in the absence of a labor dispute? If it's positive, then you might suspect the effect of a labor dispute to be negative. The economics-of-football literature seems to point to no effect, or possibly even a negative effect, of football on a local economy in normal times. One study by Baade, Baumann and Matheson found no positive impact of college football on the local economy, and that winning records lower per capita income growth. Another study by Baade looked for a 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 have likewise calculated that most of professional players' salaries aren't spent in the local economy, but rather "leak" into other parts of the country, so there's little boost from having rich players living in your city. Another way to look at the question is to focus directly on what happens in bad times -- when there is a labor dispute. Is there an adverse impact then on employment or income then? Two separate studies have asked this question and both found that professional sports lockouts do not cause any damage at all to the teams' local economies. So the relevant literature seems to say that football and other sports in general have no positive impact 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 sporting events (like the Olympics) have huge benefits for local economies. But this short essay by Victor Matheson explains why industry-sponsored studies tend to over-state their case (hint: it has something to do with their incentives).

15 What Economists can Learn from the NFL Referee Lockout So why would sports teams tend to have so little positive and lockouts so little negative, impact on a local economy? For one thing, there is the substitution effect. If local sports are not available, people won't lavish 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 put to use on something people like. If labor markets are flexible (for example, referees and ticket vendors can quickly find alternative employment elsewhere), and if people get as much out of other activities as they do from sports, then the overall impact of a lockout will be small. Some people might stop going to Green Bay Packers' games because the replacement referees have ruined the integrity of the game, but the folks who work at the stadium selling beer and tickets will not be permanently unemployed: they'll be employed elsewhere in or around Green Bay, doing something else of approximately equal value to their local economy. Another reason is that demand for sports is inelastic -- that is, people will keep going to the games no matter what. This seems likely, as there is only one professional football sports league in the country. If you are such a fan of the Green Bay Packers that you're willing to pay good money to attend a game, there are no close substitutes for Packers games and you'll probably keep going even if the officiating is pretty bad. There is one study, however, which does find a clear economic benefit from football: winning the Super Bowl, in particular, raises long-run per capita income in the winning teams' local economy. This might be what Rodgers, the once-reigning Super Bowl MVP, 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, by denying Green Bay a Super Bowl, now that their win record is damaged who is more to blame, the union 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 little insurance on the back end, want to be taken care of for the job that they do, believe that their job is an important part of that shield, the NFL brand.

16 What Economists can Learn from the NFL Referee Lockout Here Rodgers is on much firmer ground. The case for organized labor is at its strongest in the context of professional sports. Even libertarians, who are traditionally skeptical or even hostile toward unions, give organized labor a pass (pun intended) in the market for professional sports, because sports leagues tend to be monopolistic and anti-competitive. I know that sounds strange, but I mean economically anti-competitive, not athletically. To see why, imagine a competitive market with lots and lots of employers and workers, say the market for apples. In this situation it could be costly for workers to organize a strong labor union -- they may become monopolistic, "hoard" labor, seek rents, drive down output, and become inefficiently expensive to consumers and employers alike. Now imagine that it's the other way around the labor market is monopolistic so there is only one buyer of labor. In this case, the employer, the NFL team owners, are the only buyer of labor in the professional 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 for the labor being bought (namely, good officiating), as there is little or no competition for the labor of professional football referees. In a situation such as this, the emergence of the single, monopolistic union bargaining with the single, monopolistic employer will lead to a bilateral monopoly. In a bilateral monopoly neither side has any competitive advantage over the other, as each cancels out the others' buying power (in theory anyway). It's the same as if you and I were negotiating over what portion of the rent we should each pay on a 2-bedroom apartment, or how to split a check at a restaurant we are on equal terms. So the emergence of a strong labor union moves the market equilibrium from an inefficient monopsony to something 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 1-1 in economics: yes, the union referees had a strong case in the dispute, but no, the league owner's decision to 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 any replacement-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 Currency Wars: The Art of Cornering the Market

Currency Wars: The Art of Cornering the Market


Jeeva n Para mes wara n

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

18 Currency Wars: The Art of Cornering the Market the dollar. Currency speculators at the time, led by George Soros and his second in command, Stanley Druckenmiller, forecasted that the pound would ultimately fail to honor the fixed exchange rate agreement. The Soros team also happened to be privy to the war chest the Bank of England (BoE) was sitting on, $44billion. They knew their Quantum Fund could match that. Easily. They were ready to bet big.

19 Currency Wars: The Art of Cornering the Market The ERM was set up to stabilize currency fluctuations. Stable currencies were a catalyst for business growth, providing an environment where businesses could operate without the nagging worry of 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 was quite 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. Higher interest in Germany meant capital inflows into the country as investors sought the higher returns offered by the Germans relative to its neighbors. This had the unfortunate effect of reducing demand for the other European currencies, Italy and Britain in particular, whose currencies consistently floated near the 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 banks intervene in the event that the currency moves dangerously close to the lower band. The unique problem Britain faced however was that mortgages in the country were mostly unfixed i.e. they floated vis a vis overall interest rates. Hence, any rise in interest rates would see some serious consequences to British homeowners and spending in general. Soros of course, knew this. He was sure the BoE would not risk higher interest rates to help raise demand for the sterling should its reserves run out. This would leave the BoE with only one option once reserves were depleted down to nothing: a massive devaluation. Soros fund began shorting the pound sterling and the Italian lira in 1992. They went in gradually, eventually building up to a short position against the pound sterling worth $1.5 billion. In effect, they drove the pounds steady decline, alerting more and more currency speculators to the plight of the pound. Soros and co knew that that the market was king. If they could convince the market to simultaneously short the pound, the BoE would not stand a chance. Now the problem Norman Lamont and 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 the market, it became harder and harder for the BoE to continue artificially propping up the pound. More and more reserves were being required to save the flailing currency. Soros meanwhile, sensed the tipping point was near. Soon the downward pressure would just became too much, and Soros prophecy that 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. On September 8, speculative selling of the Finnish Markka forced its government to abandon its peg. The newly 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 the firing 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 the Bundesbanks war chest. Traders around the world started to realize currency pegs were a gold mine waiting to happen. In early September, the BoE attempted to fight fire with fire. They announced that they were going to leverage themselves massively in response, adopting the very same strategy used by the enemy

20 Currency Wars: The Art of Cornering the Market 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. His unwavering confidence remaining intact, he was only incentivized to reach father, bet bigger. On Tuesday, 15th September 1992, Helmut Schlesinger, president of the German Bundesbank, hinted that there 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 England prepared to aggressively fill the other side of the trade. The next morning, the Bank of England started buying in droves, creating a market for short sellers to further increase the size of their short positions. But the Pound fell. No matter how much the Bank of England bought, the pound would not budge in their direction. That morning, 1 billion went to purchasing increasing amounts of pound sterling. At 11am however, slowly starting to realize his lost cause, Lamont turned to interest rates, effectively raising them by 2%, in an attempt to attract hot money, which simply refers to investors that move money to higher interest rate climates to generate higher 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 Lamont admitted 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 puts Britains decision to join the ERM in the first place into rather harsh perspective. As for Soros, he was deep in the money- $1 billion from Black Wednesday alone, $2 billion overall-all in a days work for Mr. Soros.

21 Currency Wars: The Art of Cornering the Market Part II: The Battle of The Baht Fast forward to South East Asia in the mid-1990s. Economic fortunes were up and times were good in the 90s for Asian economies. The foundation on which they built their economic growth however 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 the traditional idea of growing from within i.e. via factor production. Naturally asset bubbles grew as more and more capital flowed in through the money markets. Investing was a win-win on both sides, investors enjoyed high returns while South East Asia enjoyed an increasingly prosperous economy from the abundance of foreign investments. In fact, the large capital inflows at the time led to many of these economies becoming the export driven economies they are today. Five years after his infamous $2 billion triumph over arguably Europes most powerful central bank, Soros sensed history repeating itself in the East. The Thai Baht in particular, caught his eye. Here was yet another currency being controlled by an inefficient economy propped on a shaky house of cards waiting to be toppled. Where the pound sterling had been pegged to the deutsche mark, the Thai Baht to USD had been set to fluctuate within a 25.2-25.6 band. This was done to provide some measure of stability for investors. They could simply borrow at low rates from the US and reinvest the capital in Thailand for higher interest rates and take home riskless profits, provided the exchange rate remained fixed. 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 the USD appreciated, Thailands export based economy would suffer. If it depreciated, so would the Baht and the foreign investors parking their money in Thailand would be faced with a huge backlash on what had initially seemed a golden arbitrage opportunity. In the period leading up to the Thai crisis, its exports were increasingly losing out to the rise of China as the main low cost exporter in the region. The omens were looming over the Thais, yet it went largely ignored. The Thais were depending on foreign loans to finance its economic growth, which naturally begged the what if question- what if foreigners stopped lending? Well, as it turns out, the weak underbelly of the Thai economy would be exposed and it would snowball into a full blown financial crisis. In 1996, the Bangkok Bank of Commerce (BBC) went under, raising doubts about the Thais creditworthiness. The Thai government was in a fix, the banks were suffering due to the high cost of funds but lowering interest rates would cut off the foreign lending which had driven so much of its economic growth. The more they probed into their shaky financial system however, the more convinced they were that interest rates would have to be cut. The implication of lower interest rates would also unfortunately be a steady outflow of foreign investment, lower demand for the Baht and therefore, a devalued 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 and devalue 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 Thai government on the defensive. To combat the short sellers, the Thai government used up its foreign

22 Currency Wars: The Art of Cornering the Market reserves, then boldly raised interest rates by 3%. This spelled doom for the ailing Thai financial sector of course, since borrowing would become even more expensive. But like a dog chasing its tail, the Bank of Thailand (BoT) was defiantly pursuing its newfound enemy regardless. Higher interest rates were of course meant to hurt those in a short position (the very nature of being short simply implies that one has 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 Thais ostensibly ignored the issue of its banks already suffering under present interest rate levels, further raising the rates in an attempt to hit the hedge funds where it hurt most-their bottom line. Soros team however had masterfully locked in their trade positions at previous lower interest rates for the following 6 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, Prime Minister of Thailand at the time, turned his attention to the hedge funds, pinning the blame squarely on their shoulders and announcing the Thai government would continue to fight the speculators tooth and nail. Soros in particular bore the brunt, having already gained infamy for breaking the Bank of England not long before. In response to the PMs announcement, the Quantum fund increased its position: $3.5 billion short. Julian Robertson (Tiger) and Paul Jones (Tudor Investment), two other notoriously successful hedge fund bosses also joined in the party, albeit with smaller positions. The worlds biggest players 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 currency system, cutting off all links to the offshore market by forbidding any baht lending from within the country to foreign entities. A two tiered currency entailed two different exchange rates, one for those who bought Baht within domestic markets and one rate for those who bought in offshore markets. As a result, 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 holding the Thai Baht/USD peg was further taken into account, it would be clear that they were much closer to the brink than they let on. Meanwhile, high interest rates in Thailand were further destroying a reeling financial sector, with bank after bank defaulting on foreign loans. Foreigners had grown so apprehensive of the Thai capital controls and its ongoing battle with speculators that they were calling for their money back 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 the reserves of a struggling BoT. In early July, coincidentally when the terms of Quantums low interest financing of their short positions would expire, Julian Robertsons Tiger fund put the BoT out of their misery, executing a high stake smash and grab- $1 billion short, plunging BoT reserves down to zero. The BoT was forced to admit defeat and float the Baht, sending it crashing 32% relative to the USD over the following months. As the Asian economies collapsed into the famed 1997 crisis, the funds reaped huge

23 Currency Wars: The Art of Cornering the Market profits and the rainmakers took home paychecks that would feed a country or two for a day, but that would 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 in the Exchange Rate Mechanism. IEA Occasional Paper No. 135. Available at SSRN: http://ssrn.com/abstract=734203 or http://dx.doi.org/10.2139/ssrn.734203 Byrne, Mark (September 9 2011) Global Currency Wars Sees Swiss Franc Devalue 8.5% Against Gold in Week http://news.goldseek.com/GoldSeek/1315573200.php Federal Bank of St Louis (November 24 2012) Fred Economic Data http://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 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 any process, 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. The consequences and results of globalization constitute the debates and many, if not all, are important for one 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, as suggested by Charles Duhigg and Dr. Kari Jensen, is the violation of safety standards and immoral practices 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 of some of Apples popular products, including the iPhone, Mac computers and iPads. Immoral behavior on the 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 market is derived from the demand in the consumer market; hence it is suggested that violation of ethics in manufacturing sectors of countries that produce goods are also derived from our demand for these goods. The iPhone is an example that is discussed during this event. Charles Duhigg described some instances of dangerous conditions to which Chinese workers at Foxconn factories are exposed to.

25 The Dark Side of Capitalism: Global Class Warfare Unbearable working hours, various physical injuries and even some deaths are all put on the conscience of the general consumers of iPhones. The fact is that due to development in transportation, communications and innovative manufacturing methods, world markets have merged consequently connecting regional economies. This change in economy is also due to lower barriers of entry to manufacturing 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 the modern United States society. The United States is the greatest aggregate consumer and greatest economy in the world, so the behavior of its citizens has particularly great impact. If a generalization about the US citizens is close to truth that means that a great responsibility lies in its citizens and residents. Along with the United States is Western Europe, where countries with large economies such as Germany, France, United Kingdom, Italy and others are also great global consumers. Another thing that these countries share is that they are considered to be first world countries and that the standard of living in these countries is much higher than average. A very troubling and unfortunate observation can be made. It seems that the high standard of living in these countries is achieved at the cost of third world countries, consequently causing the Global Class Warfare. In Democracy in America Tocqueville makes a number of predictions about the United States and how democracy in the US will develop. Amazingly, his predictions and observations are very relevant today and help us understand the origins of materialism. In a democracy, the citizens of a country assume the power or rights. The rights are attained through liberty, and liberty is something that is assumed to be a basic right of every person. This is an oversimplification; however even this simple logical chain shows that capitalism, a market economy where private ownership is a condition and 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 world countries, the general public, believe the above logic chain. One of the greatest achievements of democracy is that people attain rights. However, one of the great tragedies is that people do not always realize that with rights, they gain responsibilities. What I suggest is that the negative externalities of globalization are due to what Tocqueville called tyranny of majority, or in other words, the general public in first world countries. Capitalism is driven by self-interest guided by the invisible hand, at the cost of general interest of third world countries. This reveals the Dark Side of capitalism that exists in the global economy and explains what is 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 national income inequality. Perhaps this is why late 20th and early 21st centuries have developed some fantastically wealthy individuals. This is unfair, unethical and unhealthy for world stability but this does not mean that we should demonize capitalism and turn to some radical alternative. Just like Adam Smith talked about certain

26 The Dark Side of Capitalism: Global Class Warfare 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 responsibility and a change in mentality. Perhaps it would seem like a nave or utopian idea for the people of the world to live with no discrimination, respect for all cultures, traditions, history and values, but I can argue that it is not. This will certainly be a long process of cultural globalization but it is bound to happen one day. The reason for my confidence is not just youthful age but also first hand experience. I am a person who has no nationality, religion or strict tradition. My Israeli citizenship is a formality, as I was born there. My Russian residency is also a formality because I lived in Moscow for most of my life. I have graduated 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. Moral values 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 think that their children would be who they are now. It was like going to the moon. This is to point out that world 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 as discussed 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 even greater than the Manhattan Project. The development of some global business centers as in Dubai or global 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 from economic activity that is entangled with markets in different regions of the world. Should the management of globalization be the task of these individuals is a different question? Arguably yes; if we want to avoid Global Class Warfare and the Dark Side of Capitalism, if we want all people to be better off, if we believe in sustainable, environmentally friendly development then globalization must definitely be managed and pursued. For management to begin, however, there are certain requirements which I believe are important: increased level and quality of education, restructuring of democracy in first world countries and re-approaching the ways in which we evaluate the economy where long term values, such as the environment and cultural level, is taken into consideration. Globalization, both economic and cultural must be both praised and pursued. Nonetheless, we must remain critical thinkers and pursue with caution, realizing potential negative externalities and treat those as subject to intelligible management.

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

Jacob Aaron Geller


Jacob is a Masters Candidate in Economics from Boston University. A Senior Consultant for the Boston 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 about sustainable development.

Justin Bernardo
Justin Bernardo is a resident of Miami, Florida currently studying Political Science, Economics and Mathematics at Boston University. He is currently involved in the Boston University Undergraduate Economics Association as a student writer. He has varied interests in economics, ranging from environmental 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 school of thought in todays world. Also, I am a massive scrooge with a penchant for terse oversimplification and I believe there is no greater joy in life than bacon and eggs in the morning. My interests include trading, writing, reading and lifting.

Ben Denis Shaffer


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

Boston University Undergraduate Economics Association BUUEA.com uea@bu.edu

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