Click here to see my CNBC interview today on St. Louis Fed President Bullard’s comments on possible deflation and the potential need for more quantitative easing by the Fed.

Long ago and far away I taught economic principles and money and banking in night school. Since those three-hour classes came after long hours in my day job, I must admit—against interest as the lawyers say—that I tended to emphasize things that were easier to teach. Nothing was easier than simple Keynesian relationships because of the precision of their arithmetic.

You could stack an investment line and later a government spending line on top of a consumption line and establish equilibrium spending and income by the intersection of the top line with the 45-degree line. Or, you could subtract the consumption line from the 45-degree line and get a saving line that you could plot against the investment line to get the same equilibrium levels. You could compute a multiplier, which was simply the reciprocal of one minus the marginal propensity to consume, or, even more simply, the reciprocal of the marginal propensity to save. And so on.

It was easier to remember these mechanical relationships than it was to remember relevant economic history. Furthermore, if the students had read the history chapter that afternoon, chances are they would recall it better than I did, not having a chance to review it before class. Hence, the emphasis on the easy-to-remember stuff.

I’m reminded of all this by the current debate over whether the Bush tax-rate cuts should be renewed across the board or only for those with incomes below $200,000. We hear over and over that “the rich” have a lower marginal propensity to consume and, thus, smaller multipliers than the multipliers of real people, or no multiplier at all. This is supposed to justify raising taxes on the rich.

Leaving aside whether $200,000 makes one rich and leaving aside that the Keynesian multiplier concept applied economy-wide rather that to the individual, such a conclusion is, as they say, fatally flawed. It is flawed mainly because it confuses saving with hoarding and assumes that income not spent in the first round on consumption is not spent at all, even in subsequent rounds. I only hope my classes didn’t contribute to this confusion, which was the principle theme and flaw of the “under-consumption” theories held by Keynes’ intellectual predecessors.

While lower income people probably do spend a larger percentage of their marginal income on consumption in the short run, the income of higher income people usually gets spent, either directly on physical investment or indirectly on investment after financial intermediation. Buying stocks or bonds or depositing income in a bank or other financial intermediary doesn’t mean money not spent. It just means money not spent in the first round on consumption. It is usually spent in later rounds on investment.

If the marginal propensity to consume were 100 percent, there would be no investment, and, soon, no income.

The new financial reform legislation is massive:  about 2300 pages, 14 titles, 1400 sections. Yet,much of it is not in final form but is yet to be determined. It calls for 47 studies, 74 reports, 7 new government bodies or departments. We won’t know all the rules and the ultimate impact foryears. If the devil is in the details, he (or she) will be revealed only gradually over time.

The blanks yet to be filled in will be a source of uncertainty for some time to come, which is usually considered a negative aspect of the legislation. I don’t disagree. However, there is a positive side to a fill-in-the-blank approach, which may outweigh the negatives. Let me explain, but, first, a little background.

Philip Howard wrote a wonderful book in 1995 titled, The Death of Common Sense. The book chronicled examples of absurd outcomes that resulted when well-meaning people couldn’t overcome the restrictions imposed by laws written in too much detail, leaving no room for flexibility in implementation. As I recall, for example, Mother Teresa couldn’t get approval to build a needed shelter because of a building code that mandated elevators in buildings over a certain height even though the authorities wanted to cooperate with her. A city that had been paying thousand of dollars to have brush removed of a park was unable to accept an offer to be paid thousands of dollars for the same service. Needed porta-potties could not be put into service in strategic locations because of legal requirements for equal treatment that made the cost prohibitive. Similar legal provisions kept lifts for wheel-chairs from being provided on some buses without triggering a requirement that they be provided on all busses. You get the point, even though my memory of these examples may be a little off.

Philip Howard’s point was such problems were caused by laws written deliberately in great detail to take human discretion and judgment out of their enforcement. Lawmakers, over time, have increasingly tried to cover all the bases in their legislation to make sure their intentions are carried out to the letter. They don’t trust future implementers to be faithful to the intent of the law; so they tie their hands, with unintended consequences like those cited above. Broader, less detailed, laws that leave some room for common-sense implementation would avoid such absurdities.

Parts of the financial reform legislation no doubt are too specific and too detailed to permit common-sense implementation. However, the fill-in-the-blank parts presumably give some leeway for the regulators and supervisors to apply some common sense. This is particularly important in this case since the Congress wrote this legislation with punitive motives against “the bankers,” against “Wall Street,” and so on. It was written by people trying to placate and take political advantage of a populist surge that may be based on good motives, but may not be the best basis for fair and effective regulation. In trying to avoid the pitfalls of undesirable unintended consequences, we can only hope.

…………………………………………………………….

*I took these summary stats from an excellent summary of the legislation in Financial Services Insights, a publication of Protiviti, a risk consulting firm. Disclosure: I’m on Protiviti’s Advisory Board.

First, since I know many are wondering, I wasn’t invited to today’s signing of the financial regulation reform legislation.

The President is speaking as I write this. Once again, he, as is the case with many others, is saying that bank failures put the burden on taxpayers. If he, and others, had attended the signing of reform legislation in the mid-1930s, they would realize that the Federal Deposit Insurance Corporation was formed to insure bank deposits. The FDIC’s insurance fund comes from premiums on banks, based on deposits. Since its inception, the FDIC has done a good job and its resolution of bank failures have all been funded from these premiums paid in by banks. The taxpayers, as taxpayers, have not lost a cent in the process over these many decades.

The FDIC is currently running a little short, and is borrowing to supplement its fund. This borrowing will be repaid from premiums paid by banks.

Unfortunately, bank bashing—including misrepresentations—has proven to be good politics. Hence, banks are blamed for the sins of nonbanks and Wall Street investment banks alike, the latter having been regulated by the SEC.

“Banks” and “Wall Street” are terms that are routinely used interchangeably by politically-motivated advocates, despite the fact that there are about 8,000 banks and thrifts serving their customers throughout the country. They, along with their big-city brothers and cousins, will have dramatically higher costs as a result of the huge—2300 pages—financial reform bill being celebrated today.

As I said in an earlier post, banks don’t pay taxes; people pay taxes. The higher costs will have to be passed along to bank customers, and there may not be a direct correlation between the source of the higher costs and the services that will experience higher fees or interest rates. The incidence of the ultimate burden of more regulation is similar to the incidence of the ultimate burden of taxes that go by that name. It depends on the relative inelasticity of demand (insensitivity to price) for the various services.

One of the amazing things about the politics leading up to today’s signing is how important are different names for the same things. Some vowed to withhold their votes if certain “taxes” were included in the bill, while ignoring the fact that regulation itself involves higher costs to taxpayer/customers.

The fate of the financial reform legislation in the Senate apparently depends on whether it contains a tax increase. The conferrees hastily re-convened to remove one tax objected to by Senator Brown. Okay. That was a good move. But let’s not forget a couple of basics: (1) the imposition of massive new regulations on the banking and financial system will raise costs that may not be called taxes, but will have a similar effect. (2) the incidence of that cost-tax probably won’t be what was intended. Banks, like other businesses, will likely pass most of the additional cost onto their customers.

The cost-tax burden of this legislation will probably exceed the burden of previous similar legislation because a primarily goal of this legislation was to stick it to the banks. The legislation was deliberately punitive, designed to appeal to populist impulses. Cost was not considered a necessary evil; it was an intended evil.

A massive new consumer protection bureaucracy may do some good. It may preclude certain financial products that might have done some harm to some people. Making it harder and more expensive for banks to engage in derivatives trading may reduce some risk. But the question in both cases is, at what cost?

It’s hard to have faith that the ration of costs to benefits will be low when higher costs, along with the hoped-for benefits, were a goal of the legislation.

The Beatings Will Continue Until Morale Improves

Paul Krugman argues In today’s (July 5) New York Times that the case for extending the duration of unemployment benefits is stronger when the unemployment rate is higher. Even if empirical studies show that extending benefits reduces slightly the incentive to seek employment, that argument is weaker (and crueler) as the ratio of job seekers to job openings rises to very high levels, as it is now. In effect, by withholding benefits to keep incentives high, we would be trying to incentivize the impossible. Here on the 4th of July week-end, that argument seems “self evident” to me.

This not the only place where standard arguments and standard policies based on standard arguments seem cynical. So does the idea, prominent throughout the financial crisis and its aftermath, that business failure should be punished because the failure obviously was caused by knowingly risky behavior. It’s not just that populist fervor is anti-bailout; it’s also pro-pain and suffering. I submit that the it’s-their-own-fault-so-let-them-suffer-the consequences attitude may be close to fair under normal circumstances, but probably not in the midst of a sever crisis with massive contagion.

For example, if five banks fail during the year, it’s likely there were five separate sets of reasons and that management probably deserves most of the blame. However, that may not be the case if 200 or 2000 banks fail because most held mortgage-backed-securities they thought were safe because of their AAA ratings and because the strict application of mark to market accounting for those securities in a frozen market wiped out their capital on a massive scale.

Some houses collapse because they were “built upon the sand” and some collapse because they were in the path of a tsunami. I’m just saying there is a difference, and that withholding assistance in the latter case can hardly be justified on noble, moral-hazard grounds.

This came to mind as our legislators tied themselves in knots during the financial reform debate trying to eliminate too-big-to-fail without actually helping anyone. Their rhetoric suggested (1) they want to see failures in the future, and (1) they want only pain and suffering to result.

Financial TV has displayed (or reflected) some confusion lately over U.S. and European policies. Europe seems to be adopting “austerity” measures–why haven’t we heard the term ‘root canal’ lately?–while our administration is advocating stimulus for Europe and even more stimulus for the U.S. What’s wrong? Doesn’t economic theory provide the answer and shouldn’t the answer be the same here as in Euroland?

The first step in sorting this out is to acknowledge that the problem to be fixed is not exactly the same in Euroland and the United States. We both need stimulus to boost a weak recovery. We both have growing budget deficits and debt levels that should be reduced. However, the budget and debt piper to be paid has shown up in Europe already, beginning in Greece and affecting all 16 members of the Eurozone through the impact on the Euro.

Stimulus to promote growth in Europe may be needed and be important; deficit reduction in Europe is urgent. We all know from management literature and practice that, like it or not, the urgent must be dealt with before getting to the important.

Deficit reduction and bending the debt growth curve down is also extremely important for the United States. However, it’s not yet as urgent as in Europe. Maybe it’s luck; maybe the dollar’s role as a reserve currency has something to do with it. In addition, we see signs that our recovery may be losing steam, deflation increasingly seems more likely than inflation, and the dollar is rising rather than falling against most currencies, if not against gold.

Meanwhile, in the United States, the impression of an inflationary money growth is finally, but gradually, giving way to recognition that the money supply just isn’t growing that fast. A monetarist looking at graphs of M1 and M2 money growth in the United States over the past year or so would surely worry that monetary policy has been too tight rather than too easy as most people assume.

A massive build-up of excess reserves in the banking system is a sign of banker fear and uncertainty–as was the case in the mid-1930s–rather than a current inflationary threat. If the Fed heeded calls to “mop up” those excess reserves while banks continue to regard them as needed precautionary balances, the consequences would likely be similar to the consequences of that same action in the mid-1930s–that is, not good. It may well be that raising taxes in the middle of what came to be called the great depression did more harm that raising reserve requirements, but so what? They both, along with other policy mistakes, helped turn a great recession into a great depression. Guess what? We don’t have to pick and choose; we should avoid both mistakes.

Euroland is right to place deficit reduction at the top of its priority list. We should place it close to the top. We should be careful, however. Europe’s austerity program, will weaken European demand for U.S. goods and make the weakening economy more variable. We are right to urge them to stimulate their economy only if they can do so without triggering a renewed debt crisis. I don’t think we should risk that outcome.

I know I should have the definitive word on the financial reform bill by now, but I guess I don’t. “Reform” legislation always goes too far, almost by definition; so, I take that to be a given. Given that punishing the banks, especially Wall Street Banks, was a main goal of the exercise, some of the last minute compromises made it less worse than it might have been. This was confirmed Friday morning when investors bid up most major bank stocks two to three percent. This doesn’t mean the legislation will be good for banks; it just means that investors believe that what came out in the end was not as bad as the expectations already embedded in the market prices of bank shares.

The devil is always in the details, of course, and I haven’t seen the details yet. The summaries I have seen aren’t very comprehensive. However, the sheer size of the bill—around 2000 pages, I hear—gives me pause. I can’t help believing that some raising of capital standards and limits on leverage (the ratio of debt to equity) would have been sufficient. They wouldn’t have gotten at the proximate cause of the financial meltdown—the making and securitization of subprime mortgage loans—but they are what weakened many financial institutions and caused the fallout to be much worse than it should have been.

Some derivatives hastened the spread of the panic as well as made the impact worse, but as we saw in the early hours of Thursday morning it’s hard to legislate around something like derivatives, which legislators and most of the rest of us don’t understand. It’s hard not to throw out the babies with the bath water. However, as I read various accounts of the crisis behind the scenes, I must admit that I didn’t get the logic of allowing people without an insurable interest make large bets on whether institutions would fail and bonds would default. If you have some exposure to hedge,  credit default swaps are fine, but, if you don’t have some risk to mitigate, I think maybe all bets should be off. Massive bets against a firm with credit default swaps along with short sales, especially naked short sales, can logically become a self-fulfilling activity, which may or may not have done Bear Stearns in. It least they didn’t help.

So, higher capital standards, some limits on leverage and prohibition of derivatives with no apparent social benefit may have done 90 percent of the good that needed doing with many fewer unintended consequences that are bound to come out of a 2000 page document that no single person has read yet.

On the proximate cause of the crisis, the securitization of bad mortgages, the bill did have a minor provision requiring the lender to keep some skin in the game—five percent. Five percent isn’t much, but even that was given a way around. If your mortgage is plain vanilla with a sensible down payment, perhaps the 5 percent rule will be waived. If course, sensible mortgages would have avoided all this in the first place.

More later.

Working at home has its advantages, especially if you have two TVs within earshot of each other.

History was being made today on C-Span 3 as the Republicans and Democrats working to reconcile the House and Senate versions of financial reform talked past each other without apparent effect.

Meanwhile, the more important event was taking place at Wimbledon on an ESPN channel. As I write this, the score in the fifth set of the featured men’s match is 58-58 in over nine hours of play, and the players are taking a bathroom break. Even though one of the players is a fellow Georgia Bulldog, I don’t much care who wins. A very tall statue should be erected of both players. I’ve never before seen such a display of mental toughness.

I wonder if bathroom privileges should be revoked in the conference committee as a means of hastening progress on financial reform. Seriously.

Years ago I was part of a small Fed entourage that accompanied Chairman Paul Volcker for his Congressional testimony. They kept him for several hours and broke a promise they would let him go in time for his dental appointment. I felt sorry for the Chairman’s missing his dental appointment, but that was not my main concern as I squirmed in my seat.

They just called the Wimbledon match for darkness at 59-59 in the fifth set.

Maybe the Congressional match should also be called for darkness.

There are many ways of looking at the wealth of nations, the well being of families, growth and prosperity. Some focus on macro factors, and some focus on micro factors. One neglected way is to focus on the role of our fathers.

It occurs to me that family histories are very repetitive. For eons nothing much changed as one generation after another scratched a bare existence out of the ground. Life was as hard for each generation as it was for the generation before. For nations, the big change didn’t begin in earnest until the industrial revolution and the division and specialization of labor that Adam Smith described as the main source of the wealth of nations.

Adam Smith didn’t invent relatively free markets as much as he just described what he observed in a way that organized and informed our thinking. He called our tendency to truck and barter innate. Working hard, producing, and trading are what people do naturally when they are free.

I understand that Karl Marx invented the word Capitalism to describe our system, but that’s okay. Capitalism and Freedom go together, and Milton Friedman’s book by that title was the source of my first awakening.

Today I opened a package and found a tee-shirt with Milton Friedman’s face on it. How cool is that?

Year’s ago I tracked down Adam Smith’s grave in Edinburg, at the foot of the Royal Mile. I went into a souvenir shop nearby to see what kind of Adam Smith paraphernalia they had. They had none. Adam who? How sad.

It was even worse than that when I and a group of libertarians celebrated in 2001 the 200th anniversary of Frederick Bastiat’s birth in southern France. We went to his birth site, his country home and the little town square nearby. Everywhere we went we were dogged by a small band of French socialists protesting against us “gangsters” and for the Tobin Tax.

But, once again, I’ve buried my lead. This was not supposed to be about those who contributed to national and world prosperity—Adam Smith, Frederick Bastiat, and Milton Friedman. It was supposed to be about the person most responsible for my prosperity—my Dad.

My Dad never became very prosperous himself, but he was the one who broke the cycle of poverty in our family. He dropped out of school in the 7th or 8th grade and went to work in the local sawmill. He hauled timber or pulpwood out of the mountains in a flat bed truck. He opened a small “filling station” (remember those?) and later a slightly larger “truck stop” where I’m proud to say I grew up—raised by long-haired waitresses is how I tell it now.

That I would go to college was never in question. He would have killed me if I hadn’t. It wasn’t that he wanted me to learn how the world works; he just wanted me to have a better job so “I wouldn’t have to work as hard as he did.” I went off to college and, from his point of view, never came back.

For a few years, he made money at the truck stop, but he was tied to it. He was proud that it was open 24/7, although I don’t think that shorthand term existed then. The money pretty much dried up when an interstate highway bypassed the truck stop, but he kept working to make a go of it. He wanted to leave the truck stop to my sister because he trusted her to keep it and run it. He wanted to leave me a little money because he knew I wouldn’t. In the end, no money was left and the truck stop was an albatross for my sister, who faced impossible odds before she eventually gave up. It’s boarded up now.

I guess the fancy phrase is “creative destruction.” My grandfather and great grandfather were both country blacksmiths. The automobile put them out of business. My Dad lived off cars and trucks until “time, place, and chance” happened to him.

Thanks to my Dad, I went to college and met my wife there. Our two sons went to college. Our granddaughter is—believe it or not—an honors economics major at George Mason University. Our story would be very different if my Dad hadn’t broken the mold.

Happy Father’s Day.

The Federal Reserve has some—make that many—of the best economists in the world who are capable of doing the most sophisticated statistical and econometric studies and using the most sophisticated models for forecasting. The shortcomings of Fed forecasting, in my opinion, are due more to the inherent impossibility of the task than to human failure. People know this.

What some people may not fully appreciate is the valuable supplemental role anecdotal information plays in informing Fed policymaking. I was reminded of this by the latest release of the Fed’s Beige Book. Each Reserve Bank has people who work diligently and systematically in compiling the information that goes into the Beige Book. They don’t just make a few random phone calls to gather on-the-ground information. They have a well-designed formal list of respondents they call regularly to ascertain whether inventories are rising or falling, what’s happening to sales, hiring, pricing power, and many other things. These surveys are structured by industry and by geography.

Reserve Banks take turns compiling and composing the information for the national summary—with staff at the Board of Governors looking over their shoulders. The final result—the Beige Book—is more helpful in detecting early “straws in the wind” than one might expect, especially at inflection or turning points before official statistics record the change.

The Reserve Bank presidents also have regular conversations with members of their Boards of Directors and various advisory committee members, not to mention people in the community they interact with daily. All this anecdotal information, while often more ambiguous than government statistics, is more timely and thus just as valuable.

When I became a policymaker in 1991, this type of information, especially from the directors of our four offices, was particularly valuable in detecting the credit crunch early. If bank lending is turning down, for example, anecdotal information is needed to help sort out whether the primary cause is reluctance to lend, a reduction in loan demand, or what combination of the two.

People on the outside sometimes denigrated such “anecdotal information” not worthy of serious consideration. Once in frustration, I threatened to have a tee shirt made that said on its back “Life is Anecdotal.”

I’ve been retired from the Fed since November 2004, but some of my old contacts still touch base now and then and, of course, I have new ones through my work at NCPA and from my board and advisory work. While the sample is much smaller, and much too small to rely on, I’m hearing some things about banking at the ground level that don’t square with official pronouncements. I keep hearing about the difficulty of business borrowing even at banks they’ve done successful business with for many years. They report that their banker friends are very skittish about the current and future environment, both economic and political, which has made them much more reluctant lenders.

We hear from the top of the regulatory hierarchy that bank examiners should not overreact to the recent problems and shouldn’t be overly conservative in reviewing bank loan and securities portfolios. In particular, I’ve heard they’ve been asked not to write down the value of a performing loan simply because its collateral has declined in value. Even that small degree of forbearance, however, is not evident in practice. We still hear stories of rigid examiner attitudes on such matters.

The consensus seems to be that no examiner and no examination unit want to see a problem develop in the future that they hadn’t anticipated and flagged first. The incentive structure for examiners in the field is one-sided and differs from the incentives facing Chairman Bernanke, for example, during Congressional testimony.

As I railed over and over in blogs, speeches and TV appearances prior to April 2009, the strict application of mark to market accounting to banks had a devastating impact on bank capital during the early stages of the financial crisis. In many cases, banks’ capital was already depleted before the bank started realizing actual losses. Congressional pressure eventually caused FASB (the Financial Accounting Standards Board) to relax slightly their rules on mark to market accounting as applied to banks. They relaxed the rules as little as they could get away with, mainly by not making their modest changes retroactive. It’s like a promising treatment for cancer was developed, but it would only be available to new cases. It was no coincidence, in my opinion, that the stock market recovery, led by financials, coincided with the minor changes in mark to market rules in March 2009.

Now, in a jaw dropping display of hubris, FASB rides again. This time they are proposing tough mark to market standards not only on bank investments, but also on bank loans as well. FASB wants to subject the banks’ entire balance sheet to frequent re-marks. I don’t even know how that could work. What I do know is that bankers are stunned. Just as they are coming out of the old nightmare, they face the prospect of a new one.

This threat also coincides with the possible loss of trust preferred securities as a component of Tier One capital, which recently was added to regulatory reform. I’m omitting many outrages in the war on banks because I’m focusing here only on small community banks. I don’t have room to cite all the threats facing large banks in regulatory reform.

Just as important as the specific threats is the idea of a continuing, relentless war on banks being waged by the administration and Congress to appeal to anti-bank populist sentiment that they helped stoke by their own misinformation.

What misinformation? Well, for starters, the broad use of the word bank—there are about 8,000 of them you know—when referring to the sins of a handful of Wall Street Investment banks. Wall Street Investment banks are not the same as Main Street Commercial Banks, but grand-ma doesn’t know that. Heck, most of my neighbors don’t know that. But those who hope to gain politically from the confusion do know better, which makes their behavior all the worse.

Sometimes, good economics is not rocket science. It’s not brain surgery. Fairy tale economics will suffice. The lesson to be learned is not to kill the goose that lays the golden eggs. It’s that simple. So, will someone please tell me why we still have the continued misinformed and misguided war on banks at a time when bank lending is so much needed to keep the fragile economic recovery going? The statistics tell us that bank lending is inadequate. The anecdotal information tells us why.

It was announced today that the goods and services trade deficit widened to $40.29 billion in April with both exports and imports declining.

The decline in exports and imports is a sign of a weak or weakening world economy. The arithmetic, however, makes our growing trade deficit inevitable as long as our budget deficit is growing. They are not independent of each other. They are two parts of a zero-sum relationship.

Business and personal saving are not sufficient to offset the negative public saving, as measured by the budget deficit. Those three forms of national saving fall short of national investment and have to be supplemented by an inflow of foreign saving. Either that, or domestic investment must decline to match the lower national saving.

 The necessary counterpart to an inflow of foreign capital is a deficit in the current account—the largest component of which is trade in goods and services. This is why the growth in dis-saving as measured by the budget deficit necessarily draws in foreign saving to make up the difference. In effect, the inflow of foreign capital is not financing our trade deficit; our trade deficit is financing the inflow of foreign capital necessary to make up for the growing budget deficit.

 Got it?

If you are looking for good news in this relationship, it is this. Shrinking the budget deficit will help shrink the foreign trade deficit and vice versa. Don’t look for a smaller foreign-trade deficit to reduce the budget deficit any time soon, however, since the recent appreciation of the dollar will tend to widen the foreign deficit from the trade side. A strong dollar right now is good for our pride, but bad for our economic recovery.

 Watch what you pray for.

Congratulations New Graduates

Well, it’s that time of year again, but this time nobody asked me to give a commencement address. Wonder why?

I’m full of good advice for those just starting out in the world of work. I’m full of it because neither of my boys took any of it in their time. I can see the married one now, passing some wisdom along to his kiddos, but I don’t think he realizes where it came from. It’s a good thing he married well. I know he did because both his kiddos are smarter than anyone on my side of the family. We’re from the shallow end of the gene pool.

I often tell new graduates the secret to choosing a spouse—particularly a wife. What you do is watch them ride up an escalator, especially a real tall elevator like some they have in the D.C. subway system. What you hope for is for her to take at least a few steps toward the top—a small sign that she isn’t satisfied just moving along with the crowd. If she passes the escalator test, check to see if she checks luggage on a short plane ride. My wife flunks both those tests, but what is it they say? The exception that proves the rule?

Escalators and moving sidewalks are great metaphors for economic progress. You can make pretty good progress just standing still. A rising tide lifts all boats. The good prospects, however, add a little additional effort of their own.

When we think of our entitlement programs, like Social Security and Medicare, the metaphor is how many people we have pulling the wagon versus how many are riding in the wagon. We have more and more riders relative to pullers, and we need to do something about it. We need to get smarter about our immigration policies, for one thing, and invite more good pullers into our great melting pot. I’d welcome really good pullers from just about anywhere, but I’d start looking in Asia. All the Asians I come into contact with seem to be hard workers and are very smart.

The favorable brain drain our country has enjoyed for decades is diminishing, maybe even reversing. We need to reverse the reversal. For starters, get rid of those crazy limits on H1B visas.

It’s standard advice to tell graduates they will need to work smarter as well as harder. That’s not always easy. Our natural inclination is just to pedal faster if we start slipping behind.

I touched on this theme recently when I suggested that standing over BP—boot to neck—demanding that they try harder or else may not be all that helpful. It’s like the SOB behind you honking his horn while you’re trying desperately to start your stalled car. Offer to honk his horn for him if he will start your car for you.

I pointed out that this self-defeating tendency we have to just try harder is common among sports fans who assume their team would win if they only cared enough and tried hard enough.

Tennis is where you find the answer to smarter not harder, and not just by losing yourself contemplating the spin of the ball. Most of us who learned to play tennis as adults never learned to use topspin, which put a low ceiling on how good we can ever be. Top spin pulls a hard hit ball down into the court. Without top spin, it floats, and you have to ease up to keep the ball in the court. After mastering top spin, you can hit it hard and still keep it within the lines. Unfortunately, top spin can’t be taught to adults. I have personal knowledge of this.

New graduates should start planning for your first-born’s first tennis lessons in about three to four years. Start saving your money.

Let me close with a lesson I learned many years ago, but was reminded of it again last week. The lesson is that the smartest, most successful people you will come into contact with speak very simply and clearly. It’s the novice on the make who tries to impress you with his newly acquired jargon and fancy talk. They are the ones that form the tight circles at receptions and allow only the few they consider worthy to break in. Actually, by self-selecting, they are doing you a great favor. Keep on circling; you can do better.

I did better this week, benefiting from the generosity of a kind hostess. At a dinner, I had the honor of sitting next to one of my heroes. It was Burton Malkiel, author of A Random Walk Down Wall Street, the classic on efficient financial markets. That he was the smartest man in the room went without saying. That he could endure the likes of me through a long dinner without looking over my shoulder and without trying to impress me with his smarts was . . . well, impressive.

You know, graduates, that efficient financial markets are sort of a special case of what some economists call rational expectations. They both say, in effect, that new information is useless, largely because it has already been used.

It’s like “Nobody goes to that restaurant any more; it’s too crowded.”

Congratulations graduates, wherever you are.

Some quotes are too good to ignore, including the following one by my friend Mike Durante, founder of Western Reserve Hedge Fund in Dallas and a former Federal Reserve bank examiner.*

. . . some of us . . . have consistently referred to the hypocrisy of President Obama’s so-termed ‘Comprehensive Financial Reform’ so we never ever ever never ever never again experience a housing crisis again which EXCLUDES HUD, Fannie Mae, Freddie Mac, GMAC, Car Dealers, Chrysler Credit and R/E attorneys. Instead we are to believe we need 3,000 pages that attack credit card transaction fees, derivatives trading, profits and banker compensation as a means to promote no future housing frivolity.

So, here comes the good intending Bob Croker (R-TN) of the Senate Banking Committee offering-up a simple piece of legislation this past week which would require at least a 5% down payment on a mortgage to be acceptable to Fannie and Freddie.

So, here comes the democrats and shoot it DOWN on a straight party line vote 57-42.

Senate Banking Committee Chairman Chris Dodd explained the universally accepted Democrats rationale for voting against down payments on taxpayer-backed mortgages.

Chris Dodd (D-Conn) explained:  “. . . passage of such a requirement would restrict home ownership to only those who can afford it.”

*Speaking of shafts, did you know that it was a former Dallas Fed bank examiner that wrote the Jerry Reed classic,

She Got the Gold Mine (I Got the Shaft)? I didn’t think so.

Don’t worry. I’m not going to connect those dots.

Ogden Nash said that progress is good if it isn’t overdone. I’ve long felt the same about transparency as my following verse indicates.

Watching laws being made has become more distasteful than ever, especially banking laws, in an environment where lawmakers compete to outdo each other in the popular sport of bank bashing. Reasonable, thoughtful, financial reform legislation is probably needed, but being reasonable and thoughtful risks being labeled as soft on banks. Soft on banks and soft on Wall Street are two different things, but such distinctions are risky in the current competition to win the populist of the year award.

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Don’t take this as a defense of BP, but we need to keep reminding ourselves that accidents happen. Accidents not only happen, but “keeping the boot on the neck” of those trying to clean up the mess may not be all that helpful—not to mention the terrible imagery our government is creating with such rhetoric. Government attempts to repeal accidents and treat them as if they were deliberate and exact revenge for political purposes can be very destructive of needed innovation and risk taking.

I’m reminded of the joke about a car stalling in traffic. The guy in the car behind kept honking his horn. The fellow desperately trying to start his car finally went back and offered to honk the other guy’s horn for him if he would start his car. Honking is rarely helpful.

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Why all this angst about too much debt? All you have to do is borrow some money and pay it off. Get a consolidation loan, for Heaven’s sakes.

What am I missing? I keep hearing people on financial TV say things like “The Fed keeps pumping out the dollars,” “The Fed keeps monetizing the debt.”

Then I go look up money-growth charts. I can’t find all this excessive money creation that is monetizing the debt and is about to create a breakout in inflation. Not M1; not M2.

In desperation, I went to the Fed’s H-6 money supply series and committed some arithmetic. As of April 2010, the seasonally adjusted annual rate of M1 growth was 5 percent over the past 3 months; 3.1 percent over the past 6 months and 6.8 percent over the past 12 months. The seasonally adjusted annual rates of M2 growth were respectively -3.1 percent, -0.2 percent and 1.6 percent.

These are hardly excessive growth rates in normal times, much less in an economy with almost 10 percent unemployment, with capacity utilization down from the 80s to the 60s, and with nonbank credit sinking, productivity growing rapidly, and with unit labor cost declining.

Where is all this money we keep hearing about?

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A decade ago, I was invited by the new publication, European Affairs, to write an article on the new Euro. I gave it the title, “The Euro’s Impact on Europe and the United States.” The publishers added the subtitle, “A Skeptical Texan Wishes the Swooning Euro Well.”

The gist of what I said was that the criteria of an optimum currency area—mobile resources inside the area, immobile outside—didn’t seem to fit. I also reviewed the disadvantages of giving up monetary sovereignty. I concluded, as follows, that the real underlying motive for creating the Euro must have been political rather than economic:

“It finally dawned on me that monetary union was a political decision, not an economic one. The loss of some sovereignty was not an unfortunate byproduct of the decision—it was the goal. Economic disadvantages were seen as the cost of political benefits. Monetary union was a defensive bear hug. Well, all right then.”

This assessment was confirmed eloquently Friday by former German Chancellor Helmut Kohl. According to the May 8-9 Wall Street Journal, Mr. Kohl, at his 80^th birthday party, made the following statement:

“Today, I am convinced more than ever that European unification is a question of war and peace for Europe and for us, and the euro is part of our guarantee of peace.”

He issued, according to the WSJ, a thinly veiled critique of Chancellor Merkel’s reluctance to help Greece. He said he couldn’t understand people who act as if Greece doesn’t matter. Instead, Germany must pull out all the stops.

I guess that depends on whether your context is the history books or the next election.  The loss of a regional election by Ms. Merkel over the week-end demonstrated the political point. My guess is that had she held firm against supporting Greece, the week-end would have gone better for her. However, I doubt that the benefit would have lasted much longer had this week-end become the beginning of the end for the Euro. Sometimes you have to do what you have to do, and doing it without dithering is probably the best course to follow.

Being a gentleman, Ben Bernanke probably isn’t enjoying the plight of his European colleagues. Mr. Bernanke, hoping for the best but fearing the worst, went “all in” in responding to the Panic of 2008. He used emergency powers given to the Fed by Congress in the 1930s for exigent circumstances. The circumstances were exigent.

Chairman Bernanke’s reward will likely include the removal of those emergency powers from the Fed’s tool kit and GAO second-guessing of monetary policy decisions, not to mention almost being denied a second term as Chairman. If only he had been more deliberative and taken his time like those much-admired cooler European heads in charge of the Euro.

This week we’ve seen the value of Europe’s more “measured” approach. At least we waited until we arranged to save our banks before starting to trash them. The Europeans were more forthright in making their distaste and reluctance to help Greece public early on. Thanks a lot.

The European authorities managed to turn aid to a small country into a major world-wide crisis with their public reluctance and indecision. If they didn’t want to “bail Greece out” they should have kicked them out of the Euro zone to ease their pain and rid themselves of a nuisance.