Ken Rogoff asks some good questions about an international meltdown

How well would markets handle the fallout from a sharp slowdown in India or China? How would they react to a dirty nuclear bomb in a US city that triggered a retreat from US assets, and a sudden reluctance on the part of global investors to keep financing America’s 800-plus billion dollar current account deficit? Or a rapid escalation of conflict in the Middle East that encompassed Iran and Saudi Arabia? Or an avian flu pandemic? Global central bank co-operation has markedly improved in recent years, especially through the regular exchange of views that takes place every other month at the Bank for International Settlements. But contrary to market perceptions, global central banks have only very limited instruments for dealing with a genuinely sharp rise in global volatility, particularly one that is geo-politically induced.

Rogoff raises important, and oft-unmentioned, concerns about today’s international financial system in today’s FT. In a world of excess liquidity, we need institutions like the International Monetary Fund to act less like banks, which is what they were founded to be, and more like reinsurers. To change their behaviro will require a drastic redesign.

When I read the Rogoff piece, I couldn’t help but think of Nicholas Taleb’s Black Swan Event, as mentioned in his book, Fooled by Randomness. Why is it that hedge fund managers are so much better prepared for these low-probability, high-payoff events than the international financial system?

For climate change doubters (myself included), a compelling argument for a great economics writer

I often like to drone on about the “cost-benefit analysis” and “discounted present value” of various policy solutions. Like Bjorn Lomborg–who has argued repeatedly that the cost-benefit math does not add up in the case of climate change–I doubt that climate change is as costly or that cleaning it up is as cheap as the wave of reformers argue. Lomborg has argued persuasively (for example, in the Daily Telegraph, or in his amazingly motivational speech, in which Lomborg proves himself the evangelical equal of Jeff Sachs — posted below)  that, given the costs and benefits of addressing global warming today, there are simply better ways to spend our hard-earned tax dollars.  The WSJ has, unsurprisingly, heralded his findings as proof that climate change is overblown or worse, a ploy for Al Gore to get back into politics.

I’ve oft-repeated his basic arguments. But I’ve changed my mind.

Martin Wolf, himself a brilliant economist and an ardent believer in another pet cause of mine, free trade, begins a recent article in the FT by skewering the recent Stern report. I’d urge you to read the entire article to understand why Stern has over-estimated the damage done by climate change, underestimated the costs of addressing climate change, and fiddled with cost-benefit calculation by drastically under-estimating the discount rate human beings use when they make investment decisions.

However, Wolf goes on to make a compellingly simple argument that spending money to address climate change still makes sense. Wolf argues that investing to reverse climate change is an insurance policy, one that any rational, risk-averse “owner” of the world would choose, if such an individual existed

… [T]he problem of climate change should not be viewed as just another investment decision. It is a question of insurance against an uncertain, but possibly world- transforming, outcome. People who insure their houses against fire must expect to lose money, since the insurance company has a profitable business. They do so, because they cannot bear the loss. The same applies if people decide to protect their house against flooding even if the expected cost of flooding (the probability of its happening times the size of the loss) is less than the cost of the protection. Similarly, we could rationally act to reduce the likelihood of severe climate change, even at the price of lowering expected incomes.

I find this argument convincing. Of course, I’d like to see a cost-benefit analysis to back it up– what is the potential magnitude of climate change-induced catastrophe? How much will reducing climate change reduce the odds of such a catastrophe?

Bjorn Lomborg – Hard to resist

Economist Bjorn Lomborg: Global warming is not a priority

Finally, a couple bright lights from the Bush Administration — Health Care & the budget

As friends of mind have heard from me repeatedly, one of the greatest tragedies of the Bush administration is the fact that his incredible uphill battle to fight the Iraq war cost him all of his political capital, without which his entire domestic agenda has been hamstrung. Other than No Child Left Behind, which, like other Bush proposals, had some decent theory behind it but has been a nightmare in practice, Bush’s domestic agenda has been DOA. His only other major success was the nightmarish expansion of Medicare to include prescription drug benefits, a program which many pundits, let alone seniors, still have yet to decipher. Social Security reform and tax reform, the two issues cited frequently by those of us who consider ourselves fiscally conservative and socially liberal and who wanted to support Bush, went nowhere. The spirit of bipartisanship, let alone the political leadership, required to pass these desperately necessary reforms had been simply exhausted in the fight leading up to the Iraq War.

All this makes some of the recent noises from the Bush camp more tragic. It’s a “cruel irony,” says the Economist, that “George Bush has come up with one of the most sensible proposals of his presidency just as the chances of getting it implemented are close to zero.” They are referring to his recent proposals to limit the growth in healthcare spending.

Secondly, Bush presented a budget to Congress which contained some genuinely good ideas, such as progressive indexing, which curbs increases in Social Security spending while making sure that our poorest pensioners don’t get left behind. As described by the FT, “pension benefits for lower income workers grow more rapidly than for higher income workers.” Of course, the jury is still out on progressive indexing, as exemplified by the sharp debate between Richard Pozen, the plan’s designer, and several think-tanks, most notably the Center on Budget and Policy Priorities. I’m not intelligent enough to weigh in on this one, but would suggest that any decision to begin to “index” benefits is likely a smart one, and I am a particular fan of returning Social Security to its Great Society roots–i.e., a safety net to ensure that our poorest retirees do not go hungry, rather than a state-mandated savings plan.

By the way the Bush budget also contained some genuinely bad ideas, such as the exorbitant increase in defense spending. And of course, all the spending in Iraq comes as part of a separate line item.

Terror-Free Oil

An aspiring entrepreneur in Omaha has launched oil sourced only from the U.S. and Canada. The Fair Trade movement has now come to your gas pump.