Sunday, November 11, 2007

Goolsbee's Obtuse Method of Discounting Progress in Iraq

Should we take note of the fact that Austan Goolsbee, a distinguished economist, totally overlooked the probability that a Democrat might be elected US president next year as one possible discount factor depressing the Iraqi bond market?

Did I mention he’s economic advisor to Barack Obama’s presidential campaign?

Goolsbee posits In the Bond Market, A Bleak Prognosis for Iraq that the global financial markets “have concluded that the long-term prospects for a stable Iraq are very bleak”.

Goolsbee cites the statistical work of Michael Greenstone of MIT who appears to rely on stale data (e.g., “little change in the rate of American and Iraqi military fatalities”) to declare the military surge “since February” a failed effort.

Irrespective of causation, however, both say the market price of Iraqi bonds over time should be a robust proxy indicator of confidence in the future viability of Iraq because bondholders “aren’t politically motivated …All they care about is whether there will be a functioning Iraq in the future such that they will receive their payments.” Recent discounting leads them to conclude that the markets are “pessimistic about the Iraqi government’s chances for survival.”

Yet, even though bondholders are not “politically motivated”, they are motivated by politics. Bondholders chart political prospects to forecast future economic implications. And that's why bonds are a particularly bad metric of recent progress. If bondholders believe a future event, like the election of a Democrat to be president a year from now, could pull the rug out from underneath the government of Iraq, that discount in the value of Iraqi bonds would take place now even if they thought the surge was making progress.

Did these guys even think to chart the fortunes of the “anti-surge” Democrats against the course of Iraqi bond prices?

And mightn’t we view Goolsbee’s NYT piece is an attempt to inoculate his candidate, lest the platform be viewed as an actual cause of lost confidence?

With such spin, dressed-up as dispassionate economic analysis, Goolsbee may have crossed over the line here from “economic” advisor to spin-doctor.

UPDATE: Goolsbee responds: "Actually the Greenstone paper uses the tradesports probabilities of democrats winning the election to show that the confounding explanation you raise is not the source of the big run up in iraqi bond yields. They wouldn't let me discuss that due to space constraints but you should check out the study."

I assume by "They" he means the NYT. Here's a link to Greenstone's 59-page paper.

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