Policy Failures in the Absence of a Null-Hypothesis
Aztec Human Sacrifice, Radical Mastectomies and Quantitative Easing
November 30, 2013
I was an investment banker for many years, and one of the standard jokes aptly applied to that profession was:
A new client of a prominent investment bank called up another client – who had recommended him to the firm – and said that his new banker just told him, “trust me”, about a key issue, and then smiled with a kind of enigmatic Mona Lisa smile. This was all new, and the new client asked his friend what did that mean? Easy interpretation replied the old timer, Trust Me, that’s how investment bankers say F___K You.
In the real world, there are only two types of social policy: 1) policy which is tested against both an hypothesis, a bet that something is true, and a null hypothesis, the outcome if the hypothesis isn’t true, and 2) policy which is constructed in such a way that it can never be tested – in short policy based on trust. Not too surprisingly, the vast majority of really bad policies fall into the second group. The proponents of these trust based policies (TBP) always argue that the obvious failure or meaningless sacrifice that TBPs require is always worth the sacrifice and risk – and they try to ensure that they never, never get tested.
I was 19 years old and studying in San Luis Potosi, Mexico when I was first introduced to this concept by a brilliant but whacky Mexican anthropology professor. We were covering the practice of human sacrifice in Aztec culture, particularly around the rain and water gods Tlaloc, Quetzalcoatl, and Xipe Totec. Of these three, Tlaloc was the cruelest, demanding the sacrifice of children, whose tears on the way to an awful death ensured great future rain and successful crops. As our professor pointed out, the sacrifices continued and it always rained – perpetuating the cycle of insanity perpetuated by a bunch of power mad sociopaths – this lady pulled no punches.
Aztec Human Sacrifice from the Codex Magliabenchaino
While she was unabashedly critical of the subsequent behavior of the Spanish, she felt that the termination of human sacrifice – particularly of children – was worth it all.
Recently, I was reading about the brilliant, and drug addled (first cocaine, then morphine) surgeon Dr. William Stewart Halsted and his development of both aseptic surgical practices and radical mastectomy techniques at John Hopkins Hospital. Halsted was one of the founding “Big 4” physicians at John Hopkins and was in on the cutting edge of modern surgical development. Halsted was drawn to surgery after the invention of general anesthesia, and first pioneered the use of aseptic operating conditions – which resulted immediately in vastly reduced post-operative infections and commensurate improvements in outcomes.
Halsted was also drawn to the issue of surgical removal of breast cancer, and the vexatious problems that it presents. He would sometimes remove the cancer with complete success, and in other cases – not obviously different – would perform the same procedure with radically different outcomes – recurrent cancer. It was clear that the cancer was spreading in certain cases, and Halsted reasoned that by removing more adjacent tissue, he could more reliably eliminate the cancer.
This set off an arms race of progressively more aggressive surgeries undertaken on a routine basis. What Halsted had no way of knowing at the time was: 1) cancer found post-metastatic state would invariably spread regardless of the extent of the surgery, and 2) the genetic code of the patient – such as BRCA 1 or 2 mutations – would dramatically increase the probability of recurrent disease regardless of surgical practice. Perversely, the aseptic surgical techniques that Halsted helped pioneer, bolstered his credibility on mastectomy, although one had nothing to do with the other. Halsted, as a high priest of surgery, was given a “kitchen pass” on providing evidence that what he did in mastectomies was actually necessary or beneficial. There was no testing of a null hypothesis, and all limits to mastectomies were removed.
Dr. Halsted at age 69 in 1922
Although Halsted died in 1922, his radical surgical techniques continued unquestioned until the late ‘70’s or early ‘80’s, before advances in the science of oncology and clinical trials in other surgical alternatives ended the needless mutilation of millions of cancer victims.
I was struck by the parallels between these TBPs and the current mis-adventures of the Federal Reserve Board, while listening to a couple of blonde bond bunnies on TV last week. These ladies were prattling on about the timing of the beginning of the famous “taper” – the reduction in $85 billion per month in bond purchases by the Fed, and the beginning of the end of the QE x+1 policy fiasco. Specifically one of them speculated about how low unemployment would need to go before the high priests at the Fed decided to end the policy of mutilation of its balance sheet under its new prospective leader, Janet Yellen.
Like all “successful” TBP fiascos, QE was started with noble purpose – make the economy grow. Not unlike the attempts to make it rain or remove the cancer in the examples above. Mastectomies started as a successful technique to remove a tumor, and morphed into a failure when the purpose was expanded to cure cancer. QE started as a reasonable technique to provide liquidity in a financial crisis, and turned into a faith-based financial tool to combat unemployment.
Tuesday, 19 Nov 2013 | 7:19 PM ET Speaking in Washington, Federal Reserve Chairman Ben Bernanke said that the central bank will adjust its ultra-easy monetary policy according to the health of the economy. Federal Reserve Chairman Ben Bernanke said on Tuesday the Fed would maintain its ultra-easy U.S. monetary policy for as long as needed and only begin to taper bond buying once it is assured that improvements in the labor market would continue.
The highlighted sentence above captures the essence of the lunacy. Is there even a scintilla of evidence that these bond purchases have any impact on unemployment? More importantly, what’s going on with employment – are there jobs? Are people working? Why does the Fed think that buying bonds will produce jobs?
The firm intellectual underpinnings of our high priests of finance is based on a couple of studies, the most recent published November 1, 2013: Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy; Reifschneider, Wascher, and Wilcox.
“However, if—as we suggested earlier—some elements of
aggregate supply are significantly influenced by changes in aggregate demand, they may also be
susceptible to influence from monetary policy. Capital spending provides the clearest example,
and we include a simple simulation showing how monetary policy can mitigate the loss to the
capital stock and thus aggregate supply that results from a broad-based shock to aggregate
demand. But as discussed by Blanchard and Summers (1986), Ball (1999) and Blanchard (2003)
some time ago, and investigated more recently by Stockhammer and Sturn (2012) and Erceg and
Levin (2013), demand shocks can also have long-lasting effects on unemployment duration and
labor force attachment that, in principle, activist monetary policy might be able to check. And
finally, demand shocks and monetary policy may even be able to influence potential output over
the medium term through their effects on new business formation and research and development.”
There is not a single reference in the Study to objective evidence that QE has or will produce jobs – just a bunch of “mays, maybes and mights”. This is just nonsensical speculation from a bunch of economists enjoying the power vacuum created by the combined ineptitude of the Executive and Legislative Branches of government. In point of fact, the actual employment numbers – undistorted by the Treasury – paint a fairly clear picture of employment growth. Total non-farm employment is 137.5 million as of the end of October 2013, versus peak bubble employment levels of 137.6 million in 2007 (US Bureau of Labor Statistics). At least relative to the employment metric, we are fully recovered. The low point during the recession was 129.7 in July of 2010.
The only known fact is that the Fed has exploded its balance sheet from $869 billion in August of 2007 to almost $4 trillion today. This will inevitably produce major economic headwinds in the future, regardless of how the wind down is accomplished. As Ms. Yellen sails to a comfortable confirmation next week as the next Chair of the Fed, I can only wonder how the torch of rainmaking was passed from one Aztec Priest to another.
It is impossible to determine if the bond buying has helped the recovery or impeded its progress. Correlation and causation are very different issues. The only certainty is that under Ms. Yellen, we will continue to buy bonds until it rains.