F-35B IOC

F-35B STOVL Variant: Initial Operational Capability

 "In a milestone for the F-35 joint strike fighter, the US Marine Corps today declared the F-35B jump-jet model to have achieved initial operational capability (IOC).

Air Force Secretary Deborah Lee James, whose service is scheduled to be the next to go operational, tweeted out her congratulations.

Prime contractor Lockheed Martin, meanwhile, was less restrained.

'Fifty years from now, historians will look back on the success of the F-35 Program and point to Marine Corps IOC as the milestone that ushered in a new era in military aviation,' the company said in a statement."

Lockheed's over-the-top remark is similar to excessive celebration after a 4th quarter touchdown that puts your team 27 points behind instead of 34.

"With the F-35 hitting this milestone, it is interesting to note Pentagon officials have begun openly talking about reviewing the planned purchase of 2,443 jets across the three services."

I seriously doubt historians will look upon the present Skunk Works with the same reverence they do for the old.

A Drop in the Bucket...

"The latest regulatory push by the Department of Energy might have finally gone too far. The DoE says that loads of dishes can’t use more than 3.1 gallons. This amounts to a further intensification of “green” policies that are really just strategies to wreck the consumer experience.

The agency estimated that this would “save” 240 billion gallons of water over three decades. It would reduce energy consumption by 12 percent. It would save consumers $2 billion in utility bills."

 That was from Jeff Tucker. He states that the projections have three problems: 1) it reduces the utility of a given washing cycle; 2) prices serve as better guides for opportunity costs; and 3) people will respond by using resources in different ways which may result in more water use.

Some interesting back of the envelope calculations in the comments section:

"240 Billion Gallons of water over three decades is 8 Billion per year. According to the Department of the Interior, US Domestic Freshwater Consumption was 270 Bgal/day (or 98,550 Bgal/yr) in 2005. An 8Bgal/year savings would represent a savings of .008% of the water supply....pardon the pun, but that seems like a drop in the bucket."

Quote of the Day

"There are 7,754 windows in the Pentagon, each of which costs $10,000. You do the math."

 OK, that's $77.54M. So how much did the Pentagon cost to build in the first place?

"Construction of the Pentagon was completed in approximately 16 months at a total cost of $83 million.... Ground was broken for construction on September 11, 1941, and the building was dedicated on January 15, 1943."

On an inflation adjusted basis, the Pentagon cost near $750M to build in the '40s.

That means that replacing all the windows today costs roughly 10% of the original construction total! Imagine if that were true for your house.

New Changes to GDP

"A pharmaceutical company develops a new cancer drug. A Hollywood studio creates a box-office blockbuster.  A song writer records a new hit.  On July 31, BEA will begin including the amount of money businesses invest in the production of such intellectual property as part of gross domestic product (GDP).

Why?

The changes reflect updated international guidelines for national economic accounting—the United Nations’ System of National Accounts 2008 (SNA).   It’s important that economic measures keep pace with a changing global economy and that GDP statistics from different countries use a common set of guidelines for comparability.

Australia and Canada already implemented some of the changes outlined in the 2008 SNA. The United States is taking steps later this month. Europe is expected to act next year.

Expenditures for research and development (R&D) and for entertainment, literary, and artistic originals have many of the characteristics of other fixed assets—ownership rights can be established, the assets are long-lasting, and they are used repeatedly in the production process. Thus, the SNA recommends that expenditures on the production of these types of intangible assets, or intellectual property, be treated as fixed investment. That’s consistent with the way we treat the production of tangible assets like a new drill press in a factory.

Annual % Change in Real GDP - St. Louis Fed

BEA will also improve the way we count defined benefit pension plans in the GDP accounts.

Unlike defined contribution plans like 401(k)s, defined benefit pension plans provide a benefit to employees based on factors such as length of service and salary history.

Employers provide these promised benefits to employees through a pension fund. Employers, and in some cases employees, make cash contributions to the fund. In addition, the fund holds financial assets, earns income and capital gains on those assets, and pays out benefits to retirees and beneficiaries.

On July 31, we will switch from a cash accounting method to an accrual accounting method to measure the transactions of defined benefit pension plans. That means we will count the benefits as employees earn them, rather than when employers actually make cash payments to pension plans."

 That was from the BEA's Blog.

The expanded R&D coverage will increase the dollar level of GDP and the effect of the switch to accrual accounting for pensions is to primarily dampen measurement volatility. 

Though we often think that "the numbers don't lie," the complexity -- and art -- of measuring economic activity means that their interpretations are not so clear. The Fed needs others to perceive it to be data-driven to give the appearance of policy rules. I wonder if actual decisions are made in the way that their public guidance implies -- that everything hinges on the next data point. Probably not in practice...

Bloomberg ran a poll where 50% of respondents believed the first rate hike will be in September and only 10% believed it would come in 2016 (there was no answer for "post-2016"). Institutional investors are even more confident in September. 

I'm one of those people who would guess the rate hike comes in 2016. But would I be willing to put my money where my mouth is and buy equities or sell bonds before an announcement? Nah. I think by now it's clear, however, that the Fed's current mechanism of forward guidance doesn't do a great job of coordinating expectations. I would like Janet Yellen to articulate her overall judgement more clearly instead of pitter-pattering around "it depends on the data...."

Krugman's First-Best is only Second-Best

"The ... economic problems facing both the United States and Europe have been quite straightforward and comprehensible....

Except that all the natural answers to our problems have been ruled out politically. Austerians not only block the use of fiscal policy, they drive it in the wrong direction; a rise in the inflation target is impossible given both central-banker prejudices and the power of the goldbug right. Exchange rate adjustment is blocked by the disappearance of European national currencies, plus extreme fear over technical difficulties in reintroducing them.

As a result, we’re stuck with highly problematic second-best policies like quantitative easing and internal devaluation. ... In case you don’t know, “second best” ... comes from a classic 1956  paper by Lipsey and Lancaster, which showed that policies which might seem to distort markets may nonetheless help the economy if markets are already distorted by other factors....

But here we are, with anything resembling first-best macroeconomic policy ruled out by political prejudice."

That was from Paul Krugman via Economists View.

Mr. Krugman sees distortions as the fundamental failure of markets to address social problems -- as opposed to rigidities in the structure of markets which must be overcome. It is therefore not surprising that Krugman's first-best policies, or those intended to address market distortions, are really second-best policies. This is because government expenditures and currency manipulations create new market distortions instead of removing existing ones. Whether or not the additional set of market distortions on top of the existing set is preferable isn't really the question, it is still a second-best policy.

Calling the economic problems facing the US and Europe as "straightforward and comprehensible," when they are anything but, further demonstrates Krugman's conceited disposition. He must have forgotten that the "curious task of economics is to demonstrate to men how little they really know about what they imagine they can design."

Paine, Burke and the Political Economy

"I think Conservatives today don't often enough make the simple point: that [capitalism] has been the best thing that has ever happened to the poor in human history."

"I think if there's a fundamental distinction at the end of the day about how [Edmund] Burke and [Thomas] Paine talk about their visions of government, it's that all of Paine's metaphors are metaphors of emotion. There's a sense of 'that's where we have to go and we need to progress in that direction constantly.' Burke's metaphors are metaphors of space. He thought of government in terms of building a space for society to thrive. That was the role, the purpose, the goal of government.

I think that difference is still very much a difference between Left and Right."

That was from EconTalk with Yuval Levin. 

The "business plan" coherence and simplicity of individual policies developed by the Left makes the connection between means and ends easy to follow -- in theory. In practice achieving desired ends is fraught with difficulties.

Conservatives, on the other hand, do not attempt the "monumental task" of engineering solutions. They emphasize marketplace solutions, which are generally superior to technocratic solutions, but "arise" over an uncertain period of time and in unknown form.   

Yet the practical "reality" is that in times of immediate crisis, people want established authorities to act with measure and competence. This is the challenge of the Right, who, taken at their word, would have advised against a bailout package in 2008. Given the Conservatives' predisposition do "do nothing," they are viewed as callous.

Here are some reasons why an unwavering Conservative cannot maintain political success in today's society: 

At the time of an urgent decision, there is already a lot of momentum behind the status quo such that one must play by those rules; 

Long-term social/economic optimums are constantly thwarted by political short-termism; 

People like immediate answers and action, even when not well-considered and ultimately destructive;

The scale of institutions in Civil Society are limited and a large number of them are currently the responsibility of government in modern societies . 

A little explanation on the last point -- if there is a diverse set of non-government associations which can help manage peoples' affairs, then shocks can be absorbed with relatively little bureaucratic involvement. However, if the central government has a near monopoly on institutions, people must look to the central government for action because there is no where else to turn. Such a situation requires a Captain of action, a calling which does not suit the Conservative.

This from Levine was also interesting:

"Paine had written a book, his last book, called The Age of Reason, which was a scathing attack against organized religion, a scathing denunciation of Christianity. He wrote it while he was in France. And obviously enough it was very poorly received in the United States. And so when he returned, he was very poorly received in the United States. And by the time he died in 1809 he was living in a kind of boarding house in Brooklyn and his funeral was very poorly attended. People certainly still held close the memory of all he had done for the Revolution; and he had a lot of admirers. But he also thought that there was a great risk that he wouldn't be well-treated after his death.

He actually asked in his will to be buried in a Quaker cemetery. His father was a Quaker, though he was not. And the Quakers, again, because of what he had written about Christianity, declined. Refused to allow it. And so he was buried on his farm in New Rochelle. And he actually was just a few years later dug up by--not in the way he expected. He was dug up by an English radical who was a great admirer of his, who wanted to take his body to Britain to build a monument in the town of his birth. He took the body to Britain but the British government didn't allow the monument. Again, Paine had not only argued against Christianity but against monarchy. And so this English radical, William Cobbett, couldn't figure out what to do with Paine. And ultimately we actually don't literally don't know what happened to his remains. The ultimate disposition is not known. Everyone presumes he was buried somewhere in Britain, but no one quite knows where."

Quote of the Day from China

FT: "On Monday, Zhu Baoliang, director of economic forecast department of the State Information Centre, a government research agency, told Reuters the stock market crash was having a deep impact on the real economy and that it was essential for the authorities to cut interest rates and loosen monetary policy further.”

Christopher Balding: First, apparently Mr. Zhu has not talked to his PR and own statistics bureau. China is achieving 7% GDP growth and anyone who says otherwise is mocked and ridiculed by the Global Times and the China Daily. Second, apparently Mr. Zhu needs a basic introduction in macro-economics. Lowering interest rates is going to place enormous stress on the RMB/$ peg and further pushing capital to leave the country. Third, in breaking news, apparently Mr. Zhu has been re-assigned to a county statistics bureau in Inner Mongolia.

China's government is playing wack-a-mole with economic instability.

The previous round of pessimism came in the bond markets where total debt rose from 100% of GDP in 2008 to 250% by the end of 2014, where nonfinancial corporate debt alone stood at $14.2tn. The People’s Bank of China was reported to have injected as much as $294B into the economy late last year and has cut the one-year lending rate four times since then (now at 4.85%).

Money was already leaving the system before the downturn in the stock market. "According to one report, nearly $250b left China in the second quarter when the stock market was booming for most of that time.  Imagine how fast capital will flee if the stock market is not booming."

Just like in the US, investors sought higher returns by shifting from bonds to equities. This inflates asset prices and creates financial instability, as Claudio Borio has trumpeted here, here and here. No wonder the Chinese equities have been on a tear since the debt uncertainty.

 

Dalio Down on China

"Bridgewater is the world's largest hedge fund, and it is advising its investors to get the heck out of China because 'There are now no safe places to invest.'"

"Here are the highlights:

1: Chinese households lost more money than anyone in recent memory.

Retail speculators lost the equivalent of about 1.3% of the country's GDP gambling on stock prices going up. The market went down — and hard — losing about 22% of its value in a month.

They lost more than their American counterparts did during the the tech and finance meltdowns of 2000 and 2008. COMBINED."  

Chinese Households Lost Big on Stock Market Plunge

"2. The dumb money was really dumb.

67% of retail investors had less than a high school education and were borrowing money to trade.

3. Big companies also got caught up in the bubble. 

According to the note, people who should have known better were also taking losses. Dalio says: "We did not properly anticipate the rate of acceleration in the bubble and the rate of unraveling, or realize that the speculation in the markets was so big by established corporate entities as well as the naive speculators."

4. Economic growth is usually terrible after an asset bubble pops

China is targeting 7% GDP growth but very few people believe they can hit that. Dalio just added his voice. The psychological effects of people losing money on the stock market can quickly translate into lower growth and consumer spending.

Dalio said: "We believe the that the stock market was in a bubble that burst, and the fact that this is coming on top of both the debt bubble bursting and the economy transitioning growth from sectors that cannot sustain their growth rates to other sectors is more reason for concern."

5. The Chinese government is trying too hard to prop up the market

The Bridgewater note estimates the Chinese government has spent RMB 380 billion propping up stocks, and has a total war chest of RMB 3.5 trillion at its disposal. While this helps things in the short term, in the medium and longer term it can hurt credibility among investors.

Here's Dalio summing it up: "History has shown that smart investors tend to sell when the government is artificially supporting prices and buy when they are liquidating positions."

And concluding: "I believe that China's policy makers have both considerable resources and skills and the willingness to manage it well, though the new development makes me less confident it can be managed without a painful economic slowdown along the way."

That was from Business Insider.

I think that this stock market episode in China has led Westerners to realize that Chinese institutions and processes are still relatively unsophisticated. I would venture to guess that because the Chinese leadership will not reform their governance model, they will seek to bolster the distortions in the economy for as long as possible (e.g. housing), making the resulting crash far worse.

The Chinese government's stock market bailout support is already $1.9tn. Support to default-prone municipal bonds stands over $3tn. Willingness to do whatever it takes already abounds.

Gen. Stanley McChrystal: In the Spirit of the Austrians

I was pleased to see Gen. Stanley McChrystal speak at the Pentagon today about his new book, “Team of Teams.” His basic argument is that the military, like many human organizations, is built on a rigid hierarchy which prevents adaptability. While technologies, and to a lesser degree human behavior, change quickly, our institutional structures often do not keep pace. Al Qaeda, by contrast, utilizes commercial information systems to maintain a decentralized network which allowed what was previously “impossible,” timely action, coordination and resiliency all-together.

Going into the war, McChrystal and most others saw terrorist cells as a compartmentalized hierarchy which could be “decapitated.” His epiphany came when he sought authorization to kill Al Qaeda’s “2+7” leadership (Abu Musab al-Zarqawi, his deputy and seven commanders). McChrystal said “I then thought about what would happen if we killed the top nine guys in the Pentagon… things would get better!”

Naturally the room of Pentagon employees erupted laughing.

Recreation of Gen. McChrystal's Progress Chart

It appeared to me, however, that Gen. McChrystal tip-toed around the themes F.A. Hayek's essay "Uses of Knowledge in Society." In complex environments, different individuals have heterogeneous pieces of information. The challenge is creating a system where localized knowledge can be shared and synchronized. Hayek and Mises demonstrated how central planning is a poor paradigm for rapid adaptation to changes which occur in particular circumstances of time and place.

Hayek defined “catallaxy,” from the Greek verb “to exchange,” as “the order brought about by the mutual adjustment of many individual economies in a market.” We like markets because the price system transmits important information to all actors which empowers them to make efficient decisions. 

McChrystal has not yet figured out the military’s analogue to the price system. When asked how to bring about his adaptive and decentralized organization, his flimsy answer was Video Teleconferencing (VTC). The VTCs he ran at the Joint Special Operations Command (JSOC) included 7,500 participants for 90 minutes each day.

Clearly this is not the solution. The problem in need of addressing is how to streamline information. 

Prices provide only relevant information to the decision-maker. One doesn’t need up-to-date information on complex supply chain factors or consumer sentiment in order to make decisions on resource intensities. All of that opportunity cost is conveyed through the market price.

VTCs, however, do not streamline information. Everyone gets firehosed with the whole set of information. The fact that McChrystal found coordination through mass VTCs to be far superior to hierarchical dissemination means that there are huge efficiency gains out there for someone who can provide bureaucratic organizations (government as well as large firms) with a “price-like” mechanism.

Too Many Requirements

Leonard Wong, research professor at the U.S. Army War College, finds that there are more requirements placed on U.S. Army officers than available hours to fulfill them. He argues that the proliferation of requirements has had a pernicious effect on honesty.

"When pressed for specifics on how they managed, officers tended to dode the issue with statements such as, 'You gotta make priorities, we met the intent, or we got creative.'"

"Eventually, words and phrases such as 'hand waving, fudging, massaging, or checking the box' would surface to sugarcoat the hard reality that, in order to satisfy compliance with the surfeit of directed requirements from above, officers resort to evasion and deception." 

The zero-defect mentality of the military strengthened the incentive to misreport. Luckily Wong is optimistic about leadership's ability to reform the requirements load in order to maintain a high ethical standard, and this says a lot about the professionalism of the U.S. military. 

What is most intriguing is that these institutional problems arose subtly where actors were largely honest and dedicated. 

Lying became rationalized in a process known as moral fading. Moral fading is the process by which a person doesn’t realize that the decision their making has ethical implications, and therefore doesn’t include ethical criteria in the decision. 

Where one person may see little value in a requirement's accuracy, another may view it as critical. Inconsistency in application makes the collective set of information systemically suspect.

These issues are probably not limited to traditional operations, but also those who manage the defense acquisitions. Many large contracts have more requirements placed on them than the contracting officers can possibly fulfill with 100% certainty. 

Requirements burden affects both government and contracting staff, both of who make tradeoffs on which requirements are met accurately, inaccurately (e.g. through ad hoc allocations), or not at all. Moral fading causes government agents to rationalize non-compliance on certain margins and contractors to slip through the cracks where they can. 

The resulting information is known throughout the system to be of overall suspect quality. When they can, analysts go directly to the contractor to receive what they believe to be their natural and uncorrupted data.

How would one go about researching this topic? There might need to be a survey of control account managers (CAMs) regarding adherence to planning requirements… a survey of contracting officers on which requirements they enforce strictly… Where might this show up in the data? The poor quality of most defense cost data (and the overruns they depict) might be an artifact of moral fading.

The Four Sublimes of Megaprojects

"Why are megaprojects so attractive to decision makers? The answer may be found in the so called “four sublimes” of megaproject management."

Megaproject: Syndey Opera House

 1. "The first of these, the “technological sublime,” is a term variously attributed to  Miller (1965) and Marx (1967) to describe the positive historical reception of technology in American culture during the nineteenth and early twentieth centuries. Frick (2008) introduced the term to the study of megaprojects and here described the technological  sublime as the rapture engineers and technologists get from building large and innovative projects, with their rich opportunities for pushing the boundaries for what technology can do, such as building the tallest building, the longest bridge, the fastest aircraft, the largest wind turbine, or the first of anything."

2. "Flyvbjerg (2012; 2014) proposed three additional sublimes, beginning with the “political sublime,” which here is understood to be the rapture politicians get from building monuments to themselves and for their causes. Megaprojects are manifest, garner attention, and lend an air of pro-activeness to their promoters; moreover, they are media magnets, which appeals to politicians who seem to enjoy few things better than the visibility they get from starting megaprojects, except, perhaps, the ceremonious ribbon-cutting during the opening of one in the company of royals or presidents, who are likely to be present, lured by the unique monumentality and historical import of many megaprojects. This is the type of public exposure that helps get politicians reelected; so, therefore, they actively seek it out."

3. "Next, there is the “economic sublime,” which is the delight business people and trade unions get from making lots of money and jobs from megaprojects. Given the enormous budgets for megaprojects, there are ample funds to go around for all, including contractors, engineers, architects, consultants, construction and transportation workers, bankers, investors, landowners, lawyers, and developers."

4. "Finally, the “aesthetic sublime” is the pleasure designers and people who appreciate good design get from building, using, and looking at something very large that is also iconically beautiful (e.g., San Francisco’s Golden Gate Bridge or Sydney’s Opera House)."

Flyvbjerg's Four Sublimes

That is from Bent Flyvbjerg's "What You Should Know About Megaprojects."

Flyvbjerg recommends breaking up megaprojects into smaller projects where possible, and running the cost estimate through a "de-biaser" where not. He also finds that private megaprojects do not necessarily experience less cost growth. I think this is all a good qualitative analysis of why we get into megaprojects, but what is missing is a reasonable explanation of why honest or independent cost estimates veer on the low side (the Hiding Hand theory is not one). I think the primary reason is that current contracting schemes are poorly structured for megaprojects, allowing for a constant redirection of plans and resources. If this were the case, additional historical data won't always produce better estimates.

Canada's Non-Keynesian History

Adam Smith: "What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom."

Keynes (in essence): What is folly in the conduct of a private family is prudence in the conduct of the affairs of a great nation.

Here is a good overview of how Canada performed well by doing the opposite of Keynes' prescriptions. The author (St. Louis Fed Vice President) seems to think that institutions, not economic doctrine, play the most important role. Some excerpts below:

"In 1993, Jean Chretien's Liberals were elected with a majority government and, with their February 1995 budget, embarked on a period of fiscal tightening."

US/Canada Government Debt as % of GDP

 "So, given those kinds of fiscal cutbacks, maybe you're thinking that we should have seen a contraction in aggregate economic activity in Canada. But that didn't happen."

US/Canada Real GDP (Index, 100 = 1995 Q1)

"Maybe those Canadians cut spending when cyclical conditions were very favorable - we know that Keynesian economics only applies to periods of slack. [There was plenty of slack at the time in Canada, 9.8% unemployment in 1995.]

"But, not so fast. Maybe monetary policy is helping things along? [But that was also not the case.] There is actually a net exchange rate appreciation from 1995 to 2005 [and] it's more or less a wash [between monetary "tightness" in the U.S. and Canada as measured by the short-term overnight rates]."

Krugman would (and does) give a lot of "but this was special because...." arguments after-the-fact (including for the U.S. sequester, the UK, Ireland, Abenomics, the Baltics, etc. etc.).

Austrians of course do the same (e.g. their erroneous prediction of high inflation patched-up because the cash was "tied up in excess reserves").

If there's one thing economists should stay away from, it's pretending that their forecasts have an aura of "science." Too bad that it is through being a false prophet that economists make their money.