Author Archives: Max Huppertz

Don’t Blame Ben!

The Economist has a comment on central banks financing governments in the wake of the financial crisis. Basically, the point is that central banks that did QE bought tons of government bonds. At the same time, at least some of them – the Bank of England, for example, but the Fed as well – wrote their respective governments a yearly check, transferring any profits they made (after paying salaries). They always do that, but now, some of the money they made was from interest earned on their huge government bond positions. So the government paid them interest, they collected it, and at the end of the year sent it back to the government. Which, you know, isn’t too far from monetizing government debt – i.e. financing the government.

But what’s the problem? In the continued absence of hyperinflation, you might conclude that there really isn’t much of an issue here. However, says the Economist:

But another reason why monetisation has always been frowned upon is that it is an easy option. Why should governments finance spending with unpopular taxes or borrow from suspicious bond investors when they can get the money from a friendly central bank? The process makes democratic leaders less accountable; by boosting asset prices, which are mostly owned by the rich, it may well have led to a rise in inequality, without the sanction of any vote. Perhaps in ten or 20 years’ time, recent events will be seen as the moment the world crossed a line.

I have a couple of miscellaneous points on this, and one bigger point on the idea that this promotes inequality.

Why government bonds?

One of the questions we have to ask ourselves in this context is obviously, why only allow the central bank to buy government bonds (and a very limited set of other ‘save’ assets)? We obviously had this discussion in class: the Fed (or BoE, or other central bank of your choice) being able to buy stocks would give them a lot more firepower. They could reduce interest rates that are much further from zero than a three-month T-bill. Beyond that, buying stuff that isn’t issued by the government also means you’re not monetizing government debt. So here’s another argument for giving the Fed freer reign with regards to asset purchases!

Who’s afraid of government financing?

The Fed, BoE, and central banks around the world generally pay their governments yearly checks, even in times when none of their profits come from interest on government bonds. Something has to happen with their profits! Sure, if the US, England or other places had a sovereign wealth fund, that would be one place to put them, and it might be at least semi-autonomous from the government. So that’d be nice. But nobody has those, so not an option right now. But yet another reason to have them!

By the way, in better times, central banks raising interest rates hurts the government, in so far as that it has to pay higher interest on newly issued bonds. So it’s not clear that the government generally benefits from central bank actions, at least not directly (although it does reap the benefits of a smoothly running economy if the central bank does a good job and doesn’t have to worry about the ZLB).

Inequality and all that

The point about QE raising asset prices and helping the rich is actually quite interesting. For one thing, QE also reduces interest rates (that’s just the flip side of higher asset prices), so it’s not quite clear that all rich people benefit from it. Specifically, the classic rentier would actually suffer. On the other hand, people sitting on tons of assets may of course benefit. but the question is: when did they acquire those assets?

If they held them throughout the financial crisis, chances are they’re about back to break-even now, because they probably copped huge capital losses throughout the crisis. If they bought them right in the depth of it, well… smart investment on their part, but some of their profits were certainly subsidized by the central bank. The question is: did the Fed (BoE, any other central bank) have an alternative strategy, given the ZLB? Not in the absence of electronic money. And not doing anything would have prolonged the crisis. It’s not obvious to me that the middle class or the poor would have preferred a longer crisis to what we had. So as long as we’re unwilling to have electronic money – this is as good as it gets!

I think that next time (which I’m sure will be different) we should have a new set of tools at the ready. That may contain a sovereign wealth fund, a more powerful central bank, or electronic money. And maybe that way, expansive monetary policy – which was absolutely necessary, macroeconomically speaking – won’t have as many side-effects as it may have had this time around, and be more effective. But ultimately, it’s difficult to fix the economy without the rich taking their share of the recovery. And more importantly, that’s not the central banks domain; distribution is government’s domain. And if it’s unwilling or unable to act, don’t blame Ben (Bernanke, or really any other central banker)!

Kumquats And Potatoes, Or: Why Brendan Eich Had To Go

In the wake of the discussion about Brendan Eich quitting/being asked to leave his job at Mozilla, Newt Gingrich offered a memorable quote as to what drove Eich’s departure. He called it “the most open, blatant example of the new fascism“, in what may have been one of the fastest breaches of Godwin’s Law by a reasonably well-known person ever. While he may be alone – so far – with his linking Eich’s job loss to fascism, he certainly isn’t alone in calling this an attack on free speech and an infringement on religious liberties.

The New York Times has a piece on the issue; Forbes also has something. The gist of the opinions I’ve heard on this – mostly, but not solely, from people who self-identify as conservatives – is that Brendan Eich had to go because of his own personal (religious) views, and that that’s a travesty and doesn’t jive with the whole “land of the free”-business.

I think that those opinions are wrong. I think that there were good reasons to let Eich go. Most importantly, I think that people forget the difference between having certain personal beliefs and acting on them.

Why is it that Eich had to go? Was it because of his personal belief that gay people shouldn’t enjoy the same set of rights as straight people? I’d say no. The reason was that he supported legislation – the infamous Proposition 8, preventing gay marriages from being legally recognized in California – that tried to sign these beliefs into legally binding rules (that proposition was of course found to be unconstitutional, by the way)!

There is quite a difference between holding the belief that gay people are somehow entitled to fewer rights than straight people – which is a bad enough belief to hold – and signing that into law, effectively denying them those rights.

Imagine a world where there’s only two items of food: kumquats and potatoes (economists love to imagine these things). You like either one or the other (well, actually, some people might like them both, but most of us aren’t that adventurous and prefer one over the other). Say I go ahead and found the “Dedicated International Congregation of Kumquat Supporters” (or DICKS, for short). And I then go ahead and start campaigning to have potato-eaters banned from marrying one another. Maybe because I’m afraid their child will be a potato eater too, and I just can’t stand those dirty spud lovers. Or maybe because I found an old book in which the Lord (of Fruits and Veggies) himself dictates that the sole purpose of marriage is the preparation and consumption of kumquats, and I just know that potato eaters aren’t gonna do that.

Suppose I put it to a vote, and I win, because a majority of people are fellow kumquat lovers and potatophobes, or were equally impressed by the old book. How would you feel as a potato eater? Is it your fault that you like potatoes? Certainly not, you’re just born that way. More importantly, why would we even bother asking whether it’s ‘your fault’ – is there anything wrong with enjoying a good spud? Most definitely not; it’s obviously what makes you happy. And why would I even care? My choice set isn’t affected by you having the right to marry. In fact, the only thing I’ve accomplished is that I’ve made you miserable. Maybe that makes me happy, but then I’m just being a, well… DICKS.

Notice that it doesn’t really matter for potato eaters that I hate them. Even founding DICKS and only letting kumquat eaters in didn’t really affect them. It may make them miserable sometimes knowing that someone would despise them simply because of what makes them happy. But it wouldn’t stop them from leading the life they want to live. It wouldn’t stop them from finding a fellow potato lover, marrying them, preparing all the baked potatoes and fries and gratins and hash browns they ever dreamed of, and forgetting the bigotry of kumquat hardliners like me.

What does affect them is denying them the right to marry. It makes them feel left out. It makes them feel like second class citizens. Hell, it actually makes them second-class citizens! And who knows whether I’d stop there? Maybe I’d introduce legislation that allows your employer to fire you if you like potatoes! The possibilities are endless.

Here’s what John Rawls would have to say about this:

Each person has the same indefeasible claim to a fully adequate scheme of equal basic liberties, which scheme is compatible with the same scheme of liberties for all;

That’s the first principle of Justice (as Fairness). Notice that this doesn’t say that founding DICKS wasn’t okay. I can go absolutely nuts with restricting who may and who may not be a part of it, whose marriage I will or won’t accept in the eyes of the Lord (of Fruits and Veggies), and when members of my faith can and can’t prepare kumquats. That’s because DICKS is an association, not all of society. There can be all sorts of associations. That’s because political liberalism accepts the fact that people have different (political) opinions.

But it means that I can’t sign the principles of my organization, crazy or not, into law. Law governs society. Law is ubiquitous. It’s for everybody. It can’t deny certain rights to people based on the completely arbitrary fact of which food they like. It certainly can’t allow that some people aren’t able to enjoy the same basic liberties that others have.

Back to reality: if you feel like your church of choice shouldn’t have to accept gay marriages – good for you! I think that in the long run, you’ll run out of believers, but hey, your choice. Nobody wants to force you to change your faith. It’s all about legal recognition of same-sex marriage.

But if you believe that you have any right to sign the totally arbitrary and possibly crazy tenets of your faith into law, then you are mistaken. You do not have that right. You cannot have that right. Not if you want to live in a liberal society based on freedom of conscience and personality. Why do you think you’re allowed to have your religious congregation in the first place? Because the rest of society is willing to live and let live. And if you’re not, shame on you, and certainly no power to you (and also no position as CEO of a global, innovative company).

[Revised] Who’s afraid of Isaac Asimov? And should we even be?

Wrote the book based on that robot movie with Will Smith. Or was that the other way around? – Isaac Asimov (image credit)

Evan Soltas had an interesting post about labor market tightness a couple of weeks ago. His main point is that, looking at the quits rate, you might think that labor markets are pretty tight right now. That might be a sign that, overall, there’s not a lot of unused economic capacity, or at least, not a lot of unused capacity that matters (more on that below). If you think that’s the case, you’d reach very different policy conclusions when it comes to monetary tightening than someone who thinks there’s still plenty of slack in the economy.

Quite a few people have given their 2 cents already. John Aziz makes a point about the potential benefits of overshooting: it might create jobs for some of the long-term unemployed.

Evan may have a good reason for disregarding the long-term unemployed. John’s proposal might be all we need. But if neither of the two is completely right, we may be in trouble.

Why does Evan think that the long-term unemployed don’t matter? He says that if they don’t compete with more active members of the labor force, they can’t hold back wage growth or interfere with employer/employee matching (because they won’t keep people from quitting a job they don’t like for one they enjoy). Which is a valid point.

But in the medium to long run, a drop in lower labor force participation seems like somewhat of an issue. And participation is down:

It seems to me that there are three possible reasons for this, and three scenarios how this could play out:

  1. The decrease in labor force participation is transitory. In that case Evan’s assessment is correct, although you could still argue that the possibility to overshoot is a risk worth taking, given its potential benefits.
  2. The decrease is more or less permanent, due to labor market hysteresis. In that case, overshooting alone might do the trick.
  3. The decrease is more or less permanent, and it’s a (labor!) demand trend. In that case, we might have a real issue on our hands.

1) Will it all be over soon?

Evan seems pretty convinced that the long-term unemployed “really can’t matter much in a macroeconomic sense”. I think that statement makes sense only if you assume that, in the long run, labor force participation will return to its pre-crisis level. Else, I would like to see an argument as to why we should ignore the fact that 3% of the total US labor force decided to take some time off. Changes of that magnitude are the ones that tend to matter little now, but a lot if they turn out to be persistent over several years’ time.

2) The UI forever (well, kinda…)

Just so we’re clear: economists have a somewhat peculiar interpretation of the word permanent. When I say that the drop in labor force participation might be permanent, I don’t really mean forever. I mean, “for around ten years or so”. Which is substantially longer than recovering from the recent crisis will take (hopefully, anyway), and thus covers a much longer time span than scenario one. So why might participation be depressed for a whole decade?

There are a few stories you could tell that might lead to scenario two. Maybe people lost a lot of human capital while they were unemployed, and have genuine trouble finding a job. Or maybe, employers regard long-term unemployment as a signal. Long-term unemployment might indicate that you’re not the kind of person people would want to employ. Granted, it might also mean you were just unlucky and got laid off at a time when it was really hard to find a new job. But so long as employers have plenty of ‘good’ applicants to choose from – people who aren’t sending out the long-term unemployment signal – they might be okay with rejecting you anyway.

I’m not sure how likely this scenario is, but if this is the one we’re in, definitely overshoot! Temporarily overheating the economy may raise inflation a little, but it would also mean more job openings and fewer people applying. Making job applicants scarce would provide an incentive for employers to take a closer look at the long-term unemployed, and to figure out whether what happened to them was just bad luck – or whether they’re actually bad apples.

3) Rise of the Robot Lords

What if the long run equilibrium level of employment is actually decreasing over time? Take a look at the bigger picture:

For a while now, there has been stagnation and quite a substantial drop in labor force participation, even before the dot-com bubble. If employers desperately needed these people, wouldn’t you expect them to raise wages and try to lure some of them back into the game?

I know this sounds a little like a sci-fi cliché, but if falling demand for labor due to increased mechanization were responsible for discouraging workers from even trying to find a job, overshooting will at best give a temporary boost to labor force participation. After that, we’re back to the downward trend.

The remedies for this kind of situation are very different from what we need to do in the other two cases. Increasing the general level of education would be a good idea (it generally is, but especially in this case).

Rethinking the social safety net would be another (this is probably worthy of a post of its own, but let me give you my intuition). Many of the labor-intensive industries of today might rethink their business model once robots become more cost-effective. What happens if mechanization puts us into a position where the vast majority of workers in classic manufacturing jobs (cars, steel) – and possibly also a fair few in the service sector (eventually, burger-flipping robots will be the norm) – are no longer needed? And when, at the same time, the new ’employees’ – machines – won’t ever ask for pensions, or unemployment benefits? Well, it seems to me that indefinite unemployment insurance, or a guaranteed basic income, might not be so Utopian in this scenario.

Faced with this kind of affluence, society might well decide that the dangers of ‘paying people to be unemployed‘ are far outweighed by the benefits of getting much closer to what John Rawls would call a well-ordered society. And, especially in a highly educated society, I think we have reason to believe that people actually want to work, instead of being on the dole. As Jeffrey Smith nicely said (referring to Arno Duebel, a German who had been living off unemployment benefits for 36 years straight):

The actual mystery, though, is not the existence of someone like Arno, but rather, given the relative generosity of many European welfare states, their relative scarcity.

By the way, labor force participation isn’t just down for low-skill workers; this may be an issue that affects us all, even those with a college education (albeit to a lesser degree):

image

Like I said, this deserves a post of its own.

Humans good, robots bad?

I think that the third scenario is the one we want to be in. Any kind of job that a robot (or machine in general) can do better then a human – why not let it do it?

But it’s also the most difficult one to come to terms with, politically and ideologically. The left would need to give up part of its struggle for the ‘working class’, at least in the classical meaning of the word – factory workers, hard manual labor, that kind of thing. The right, on the other hand, might need to concede that in this kind of environment, maybe having a basic income won’t annihilate the US economy.

Issues like these would have to be dealt with during the next few years and decades. Or, who knows, maybe we are in scenario one, and Evan is right, or two, and John is right. But if not – and there are good reasons to believe this – we might want to start thinking about the implications.

The League Of Extraordinarily Lucky Gentlemen

The Wall Street Journal offers investment advice. And it’s not good advice either; or at least, it’s not obviously true that it is. In fact, I very much doubt that it is.

But I’m getting ahead of myself. What’s the article about? The author followed 196 investors since 2007, evaluating how much money they made (and lost) and checking whether they managed to beat the market, as measured by the Wilshire 5000 index. And lo and behold, a “select group” did indeed manage to do so! And these people are willing to give advice to you! The Journal stresses that they outperformed the Wilshire 500 not only during the bull market since 2009, but also during the bear market before. Which is quite a feat:

 “almost without exception, the strategies that have made the most money since March 2009 were big losers in the preceding bear market. For example, the five best advisers over the past five years, among the nearly 200 monitored by the Hulbert Financial Digest, lost an average of 58% during that downturn.”

On a side note: the article just acknowledged that past performance by no means implies future performance, right? Or is the intended takeaway here that past losses by no means guarantee future losses? Which is also true, but it’s hard to make one point without also making the other. Strange as it may seem, the author seems to miss the other side of that particular coin.

Anyway, what about that investment advice? Well, all of these exceptional investors seem to agree on one point, namely that “you should remain at or close to fully invested in your equity portfolios.” Now there are probably good reasons why, depending on your particular situation and available alternatives, you should keep whatever money you can spare right now in equity. So I’m not actually too critical of this. Although I would point out that if you ask a group of people who take “$85 to $299” for their services and tell people to buy stocks for a living, “should I buy some stocks, you think?” they’re probably gonna say, “yes (that’ll be 300 bucks, thank you very much)”.

Other than that, all six advisors seem to be invested in… wait, did you say there’s only six of them who managed to beat the market for that whole period?! Out of 196? Why, that’s… about 2.6%! I’m going out on a limb here, but I assume that that number isn’t statistically significant (-ly different from zero). For the record, I’m of course being polemic here, because I don’t have the data in question; most importantly, I don’t know by how much these lucky few beat the market, which would be what you’d really want to look at to determine whether their exceptional gains were due to chance alone.

But I will say this: I’d take a bet that if I took 196 random stock samples from the Wilshire 5000 right now, 2.6% of them could probably beat the market. Actually, I might go on and compile that list once the semester is over. I’m sure Matlab will be up to the task.

I’ve got another one for you: the initial investors probably weren’t even a random sample of all financial advisors out there. Probably, they’re the ‘good ones’. Which means that even the best of the best don’t have an awesome track record by any means, and what are your chances of drawing an advisor from that pool in the first place, let alone one of the 2.6% that manage to outperform the market? I can’t tell you, but I can tell you that they’re worse than 2.6%.

Oh by the way, it’s a little odd that the article doesn’t mention by how much these guys beat the market. Would it have earned you more than $230? (Not that that’s what you’re really interested in. What you really wanna know is, given that you have to pay a fee, is that fee greater than or equal to your chances of finding an advisor that happens to beat the market, which are smaller than 2.6%, times the amount by which he or she is going to beat the market, which the article doesn’t provide? They’ll need to outperform the market by quite a bit to make that work).

But I digress; I fear that I never got to share the great investment advice, but luckily you can just go and read the article. I do have one last thing that bothers me though: if one of those six really, actually had an awesome secret to making boatloads of money, would they ever tell you? Or even risk that, by observing what happens to your portfolio, you’d ever find out? As soon as the world knew, a) their strategy would probably stop working, and b) nobody would pay them 300 bucks for stock advice anymore! So it’d be in those guys best interest, even if there was a pot of gold at the end of the rainbow, to never, ever, let you get more than a faint glimpse of it.

Which, by the way, also means that anybody who’s letting you in on their big investment secrets is probably either irrational, or lying to your face. Both of which seem somewhat underwhelming traits for a stock broker.

Apocalypse, Now?

There’s been a bit of a buzz lately about a working paper by Safa Motesharrei, Jorge Rivas and Eugenia Kalnay about doom, utter destruction, and the apocalypse.

Motesharrei et al. describe a theoretical model – Human and Nature Dynamics, or HANDY, for short – that simulates the rise and fall of societies. It’s not a complicated model, really. All it has is four main equations, two of them describing the population of two classes of people, ‘commoners’ and ‘elites’, one describing ‘nature’, and one to describe the accumulation of ‘wealth’. And, or so people say, it predicts that we shall all perish soon!

I don’t want to go into too much detail here, but these are the equations (in the same order as above):

image

Looks simple enough, doesn’t it? The αCαECC and CE all depend on ωxC and xas well. Basically, α‘s denote death rates, β‘s denote birth rates, x‘s stand for the population of commoners and elites, C‘s are their respective consumption, and ω is accumulated wealth (somewhat of a strange notion of wealth, but more on that below). y is the stock of natural resources, γy(λ – y) is a regeneration term (where γ is a regeneration factor and λ is the maximum possible amount of natural resources – nature’s ‘capacity’), and xCy is a depletion term (where δ is the rate of depletion per worker). You should note here that δxCy is also society’s production.

There’s also some inequality in the model, because elites consume more than commoners:

Where s is a minimum (‘subsistence’) wage, ωth is the minimum level of wealth society needs to feed all its members, and κ≥1 measures inequality in salaries (i.e. elites get κ times more money). If any one of those consumption terms ends up being smaller than one, that group experiences a higher death rate. That’s bad.

The punchline of all this is that, given certain parameter values, this model simulates society’s collapse, either because all commoners starve to death and thus production stops (had I mentioned that only commoners produce in this model? Elites have positions in management, but they don’t really do anything substantial), and everybody dies, or because all of nature is used up, and everybody dies. Usually over time horizons of up to 1000 years.

Now, I’m all for mathematical modelling, and this is kind of a neat model, and it’s very good at producing neat little curves. And quite a few people seem to think that this is kind of a mathematical proof that inequality (a bigger κ will tend to kill you) and unsustainable use of natural resources (a bigger δ will also tend to kill you) will bring about our collective doom.

I think there are some good points to be made about how much inequality is justifiable, but also how much inequality we need to have an efficient economic system; I recommend reading John Rawls. There are also good points to be made about the value of preserving nature, the benefits of a medium-term shift towards more renewable energy sources, climate change, and a lot more things of that persuasion. But I don’t think this model does an awesome job at getting those points across.

For one thing, it’s very much underspecified. Aren’t there any other factors besides inequality and use of natural resources that could influence what happens to a society? What about the political system? What about social mobility (of which, in this model, there is none: you’re born a commoner, you’ll die a commoner)? And what exactly is a ‘society’, exactly? The authors talk about some examples of collapse, like the Roman Empire. So is a society today a nation state? Or ‘the West’? Or the whole world? If I can ruin somebody else’s stock of natural resources without hurting my own, does that still hurt me?

Also, some variables are rather strangely defined. For one thing, why do only commoners produce ‘wealth’? And why do the elites not contribute anything valuable to society? All they do is consume things that commoners have to produce, and at a higher rate at that. Is management really completely worthless? What about the arts, or science? And what is this ‘wealth’, anyway? It’s this strange, durable consumption good that people need to live, but can store pretty much indefinitely (in some scenarios, the commoners all die out, but elites still have a couple of decades left living off of society’s wealth stock. Is it all canned food?! Also, wouldn’t even the high and mighty elites eventually take to farming, if only to save their hide?). Plus, birth rates are constant. Over a thousand years. Seems like quite the assumption. Plus, the authors never really defend their choice of parameter values. It’s not like they estimate what the ‘correct’ values of those would be for today’s world. Or if they do, they don’t say so.

Motesharrei et al. actually acknowledge a lot of this stuff, and say that they’re working on including more of it in future versions of the model. And I’m very much looking forward to seeing that. But in the meantime, it seems to me that a lot of people just see a bunch of equations, and thus assume that this model must be making a very strong point about inequality and sustainability. Really though, it’s just a theoretical model, no more or less so than if it were completely verbal. There’s absolutely nothing empirical about it. I think a lot of the hype so far is math bias, rather than genuine appreciation of the model (which needs more work).

So I’m looking forward to the next revision of this paper, and to seeing the improvements it brings. But until then, please hold off on the ‘math has proven that we shall all die soon’-craze.

Who’s afraid of Isaac Asimov? And should we even be?

Wrote the book based on that robot movie with Will Smith. Or was that the other way around? – Isaac Asimov (image credit)

Evan Soltas had an interesting post about labor market tightness a couple of weeks ago. The main idea is that, looking at the quits rate, you might think that labor markets are pretty tight right now. That might be a sign that, overall, there’s not a lot of unused economic capacity, or at least, not a lot of unused capacity that matters (more on that below). If you think that’s the case, you’d reach very different policy conclusions when it comes to monetary tightening than someone who thinks there’s still plenty of slack in the economy.

Quite a few people have given their 2 cents already. John Aziz makes a point about the potential benefits of overshooting: it might create jobs for some of the long-term unemployed. Evan may have a good reason for disregarding the long-term unemployed. John’s proposal might do the trick. But if neither of those two is true, we may be in trouble.

Why does Evan think that the long-term unemployed don’t matter? If they don’t compete with more active members of the labor force, then they don’t hold back wage growth or interfere with employer/employee matching (because they won’t keep people from quitting a job they don’t like for one they enjoy). Which is a valid point.

But in the medium to long run, a drop in lower labor force participation seems like somewhat of an issue. And participation is down:

It seems to me that there are three possible reasons for this, and three scenarios how this could play out:

  1. The decrease in labor force participation is transitory (in that case Evan’s assessment is correct, although you could still argue – and I would – that the possibility to overshoot is a risk worth taking)
  2. The decrease is more or less permanent (ceteris paribus), but it’s a (labor!) supply shock (in that case, overshooting alone might do the trick)
  3. The decrease is more or less permanent, and it’s a (labor!) demand trend (in that case, we might have a real issue on our hands)

1) Will it all be over soon?

Evan seems pretty convinced that the long-term unemployed “really can’t matter much in a macroeconomic sense”. That statement makes sense only if he assumes that, in the long run, labor force participation will return to its pre-crisis level. Else, I would like to see an argument as to why we should ignore the fact that 3% of the total US labor force decided to take some time off. Percentage point changes of that magnitude are the ones that tend to matter little now, but a lot if they turn out to be persistent over several years’ time.

2) Weird psycho stuff

Scenario number two – as the headline may suggest – seems unlikely to me, and would require some weird hysteresis effects of long-term unemployment. Even if everybody who’s been out of a job for a while today decided to stop looking forever, there’s no good reason why future members of the labor force would do that too. Parents would need to instill in their kids a certainty that they’ll never find work, and shouldn’t even start trying. Or something along those lines.

I really doubt that that’s the one we’re in, but if it is, definitely overshoot – that way, you might be able to shock today’s long-term unemployed out of their lethargy and avoid whatever weird spiral of self-enforcing beliefs you can think of that would make this scenario even work.

3) Rise of the Robot Lords

What if the long run equilibrium level of employment is actually decreasing over time? Take a look at the bigger picture:

For a while now, there has been stagnation and quite a substantial drop in labor force participation, even before the dot-com bubble. If employers desperately needed these people, wouldn’t you expect them to raise wages and try to lure some of them back into the game?

I know this sounds a little like a sci-fi cliché, but if falling demand for labor due to increased mechanization were responsible for discouraging workers from even trying to find a job, overshooting will at best give a temporary boost, and then we’re back to the downward trend.

The remedies for this kind of situation are very different from what we need to do in the other two cases. Increasing the general level of education would be a good idea (it generally is, but especially in this case). Rethinking social security would be another.

I think that the third scenario is the one we want to be in. Any kind of job that a robot (or machine in general) can do better then a human – why not let it do it?

But it’s also the most difficult one to come to terms with, politically and ideologically. The left would need to give up part of it’s struggle for the ‘working class’, at least in the classical meaning of the word – factory workers, hard manual labor, that kind of thing. The right, on the other hand, might need to concede that in this kind of environment, maybe instituting a basic income won’t annihilate the US economy.

Things like that would be issues for the years and decades to come. And the long-term unemployed today deserve our attention just as much as those of tomorrow. Or, who knows, maybe we are in scenario one, and Evan is right. But if not, we may at least want to think about the implications of this. I’ve always thought that the best kind of paper is a theoretical one anyway.

Efficient markets by any other name would smell as sweet

Via the Economist, a nice reminder that it doesn’t make a lot of sense to try and beat the market yourself, and even less sense to pay somebody else to do it (and it’ll cost you dearly). The market’s efficient – it’ll efficiently punish you for trying. I know, somewhat of an old story; you won’t win any shiny gold coins with that one anymore. Yet, people like to tell tales of those exceptional geniuses who defiantly manage to outperform the S&P500 in the epic battle that is the financial market.

On the other hand, you also won’t get any medals anymore for pointing out that many investors seem to behave rather irrationally (for example, they’re willing to pay somebody else to beat the market). Yet we think of the sum total of the chaotic, unpredictable, occasionally (asset) bubbly behavior of those people as a – maybe the one true – efficient market. In finance, it seems to me, familiar words have peculiar meanings.

Beasts of the Stubborn Wilds

Somewhere out there among the canid natives to the wilderness and remote areas of North AmericaEurasia, and North Africa of Wall Street, the mythical market beaters roam. Those who know where the ‘value stocks’ are at. Who have stubbornly resisted efficient market hypotheses. That they exists at all may seem odd for a second, given that I specifically stressed that active trading isn’t a very lucrative prospect. Then, you’ll realize that given the number of people who want to ascend to the ranks of those fabled few, it’s pretty obvious that some of them are gonna make it. It’s just that the overwhelming majority won’t.

There’s another problem: nobody knows who they are! You can’t look at past performance, because that’s not an indicator of future performance. More importantly, it’s no good if you know that somebody outperformed the index for the last ten years. You wanna know that they’re going to do well over the next few years! Unless you found a golden tablet inscribed with the names of all the great hedge fund managers that were, are, and will be, you’re screwed.

Overall, the whole idea of active investing doesn’t seem like a terribly efficient deal. But if people just like playing Leo DeCaprio, why not let them? So long as the underlying market is efficient, we’re golden, right?

The boy who cried grossly overvalued

Because stock returns move around so wildly (while things like GDP usually rise over time), it might seem that the process creating those returns can’t be terribly efficient. They don’t seem to follow a pattern. Paul Samuelson of course resolved that puzzle, proving that prices that incorporate all available information at any point in time will seem to fluctuate randomly. Samuelson was a really smart guy though. Which is why, in that same paper, he also said:

One should not read too much into the established theorem. […] It does not say that speculation […] or that randomness of prices is a good thing. It does not prove that anyone who makes money in speculation […] has accomplished something good for society. All or none of these may be true, but that would require a different investigation.

That part of the paper seems to get less press. Fama and Shiller of course both tried to deliver that ‘different investigation’. Are stock movements unpredictable because they instantly soak up new information? Or do they seem crazy because investing fads and bubbles are simply crazy, crazy things?

I won’t try to resolve that age-old debate here. Although I will say that it doesn’t seem overwhelmingly rational (or even smart) to buy a bunch of dot.com stocks, then have someone tell you that that’s crazy (“those companies are grossly overvalued!”), and then go nuts with fire sales. Unless, of course, you only bought them because someone else (or possibly the same person, if your broker’s really good) told you that dot.com wasn’t crazy at all.

You can’t cheat an honest man with a dictionary

My point is this: how on earth did we ever decide to use the term efficiency in this context?! Of all the wonderful words we have at our disposal to describe what’s going on with stock returns, why did we choose one that makes absolutely no sense? Let me illustrate:

ef·fi·cien·cy

 noun \i-ˈfi-shən-sē\

: the ability to do something or produce something without wasting materials, time, or energy : the quality or degree of being efficient ( technical )

Does that really seem like the perfect description of financial markets, when all we can really say is that stock movements can’t be predicted based on their past values? You know, I don’t wanna go out on a limb here, but it has at times occurred to me that financial markets can, you know, occasionally, I guess, engage in activities that, on the surface, seem rather like a giant waste of materials, time and energy, with an absolute lack of the quality or degree of being efficient.

Here are a few alternatives that I propose to replace the term ‘efficient market hypothesis’ until we have determined which ‘different investigation’ was right:

  • unpredictable markets hypothesis
  • random stuff happens hypothesis
  • index funds rule (on average) hypothesis
  • ARIMA(0,1,0) hypothesis (that last one’s a little too nerdy to really catch on with Wall Street types I fear)

So please, take your pick. I’m also open to suggestions! But let’s find an expression that’s more accurate, and less of an abuse of the English language.

The Euro’s Failure: Never And Nowhere A Monetary Phenomenon

Would probably wish he had a dollar for every time someone uses his quote – Milton Friedman

Frances Coppola published a piece on the Euro’s failure and the ECB’s irrelevance a few days ago (aptly titled, “The ECB is irrelevant and the Euro is a failure”). I generally think it’s a really good read, but I have a problem with it.

When people criticize the Euro, they often say that either institutional deficiencies (i.e. no fiscal union/central government) or nationalism (sometimes misleadingly called ‘cultural differences’, of which the US, too, has plenty) make it impossible to for the Euro to work. I think that’s treating the symptom, not the cause. Cutting out the Euro is not going to cure Europe’s problems.

Coppola makes these two points (institutions & nationalism) as well, and also criticizes the austerity measures imposed across the continent in an attempt to ‘save’ the Eurozone:

We [Europeans] do not have a single language, we still cannot agree where our boundaries should fall and national interests always trump “European” politics. You can’t overturn tribal and cultural identities that go back thousands of years at the stroke of a few politicians’ pens…

…There is no sense of being “in this together”. On the contrary, there is political and social divergence; a sense of superiority from those countries that – for now – are doing well, and growing anger among the populations of those countries that are introducing painful and damaging austerity measures to create the illusion of economic convergence…

Economic convergence is an impossible dream while there is no political or fiscal union…

The Euro is a failed experiment. We should not waste any more effort trying to make it work. It is time to consign it to the dust of history.

Now, I’m right there with you about the apparent lack of cohesion in Europe. A lot of people have a hard time seeing why they should help out their neighbor if he or she doesn’t happen to have the same passport as they do. I also absolutely agree that the European institutions we have aren’t nearly powerful enough to play the role they’d need to play to make a unified currency work.

But why would you, then, say that the Euro is the problem? It seems to me that the problem isn’t a unified currency per se. Without such strong nationalist feelings and within a better institutional framework, the Euro might well work. It’d be very hard to make a consistent argument against the Euro as such, regardless of the institutional and ‘cultural’ environment it’s in (at least without also making one against the Dollar as such).

I see the failure of the Euro as a symptom of a much deeper problem. It’s a symptom of deeply rooted nationalism across Europe. Without that, we could probably have stronger European institutions, and a fair shot at a unified currency. We also probably wouldn’t have seen as much austerity, but then that was nothing but power politics to being with.

I see the failure of the Euro as an indication that we’re not ‘All Europeans now’. That was a nice idea while it lasted, up until the Eurozone crisis, but apparently not true. Which greatly annoys me, because I like to think of myself as a European (actually, I like to think of myself as a cosmopolitanist, and someone who doesn’t really care about nationality, but it’s even harder to rally people around that).

Where am I going with this? Well, if the Euro’s failure is merely the symptom of a deeper issue, then getting rid of the Euro won’t really solve anything. Sure, there would be economic benefits from not having it right now, given the weak institutions and strong nationalism we’re facing.

But it wouldn’t change anything about the fact that many Europeans don’t actually care much about Europe – they care about Germany, England, France, whatever. People attach a great deal of weight to the absolutely random fact that they were born within a certain set of lines on a map and not another. Personally, I find that absolutely ridiculous.

Alright, I can accept that in the short run, we can’t change the fact that people like to be ridiculous, and thus the Euro may be a bad idea now. In the famous Long Run however, I think we’d do well to address the issue of nationalism. And I’m not sure abandoning the Euro now would set the right precedent here, because that’d signal to generations to come that a unified Europe is doomed to fail. It isn’t. But we need to change the way people think about themselves to make it work, and that’s a big change to have to make.

So if we’re going to talk about dissolving the Euro, please don’t say it’s the unified currency as such that is the problem. This is really about nationalism making something like the Euro impossible right now. We have to keep in mind that we’ll be stuck with that nationalism even after the Euro’s gone. That’s the real problem we’ll have to deal with. Nationalism, it seems to me, is never and nowhere a monetary phenomenon.

What Can Your Great-Great-…-Great-Grandparents Do For You?

The Economist has an interesting interview with Gregory Clark, an economic historian at UC Davis, who has recently published a book about social mobility. He claims that it is large, hugely persistent, can’t be influenced by policymakers, and is overall a really big deal.

This might surprise you, since a lot of people like to point out that income mobility in the US isn’t so bad, or at least hasn’t been declining over the last 30 years. Which really isn’t much of a statement, because that might still mean that it’s just been persistently terrible. Whatever you think about income mobility (it’s worth pointing out, for example, that certain regions provide much better chances to ‘move up’ in life), it’s worth noting that social mobility is actually much more than just how much money you make relative to your parents. And that’s at the core of Clark’s book.

Basically, he argues that there’s much more to social status (and the influence that comes with it) than just income. Think about education, for example, or holding public office. Depending on which metric you use, Bill Gates either descended in social status compared to his folks (he doesn’t have a college degree), or easily surpassed them (he’s the richest man in the world, after all).

So Clark developed an index of social status, or as he calls it, ‘social competence’, taking into account several dimensions of it, and tracks how parents’ and kids’ status are related over time. And when I say over time, I mean he goes back to the middle ages (at least wherever records permit). That’s another core part of his study: his time series data stretch back for centuries. I hadn’t thought about this too much, but it’s true that if you only have data on one or two generations of people, it’s quite possible that an increase (or decline) in status from one generation to the next is simply a ‘fluke’ in the data; someone just got lucky for once. So increasing the number of periods you look at is a sensible idea.

So he has this huge data set; what does it tell him? Clark concludes that social mobility is extremely low, both across countries and over time. He also concludes that government policies have no influence on it whatsoever. I haven’t read the book, so I don’t know how valid this concern is, but it seems his analysis comes very close to saying this low mobility is basically justified. Those who are at the top are there because they’re simply ‘better’ than others in terms of their necessarily inherited social competence.

So what now? Despair in the face of a social mobility problem that we can’t overcome? Accept it, because those at the top somehow ‘deserve’ to be there? I want to be very clear here. I’m not spending this much time talking about the book because I agree with his conclusions. I don’t, especially not the last one. I also think that the idea of ‘deserving’ to inherit more social competence and hence power is nonsense, because that would imply that you somehow deserve your parents. I doubt that.

Plus, on a more technical note, there’s no good reason to believe that something that you can track from the middle ages up until today will stick around in the future. Societies have undergone changes over the last 100 years that were more dramatic than anything we’ve seen before. So this data set probably puts too much weight on observations from a time when the whole institutional backdrop of this debate was radically different. Way back when, you could literally inherit your mom’s or dad’s claim to the throne (hell, in some places you still can, unless your mom seems dedicated to outlive you). Because really, what we usually care about isn’t so much average social mobility over time – it’s marginal social mobility right now.

However, there are some really important points to draw from this. One is that quite often, we underestimate the limitations of our data. Looking at what happens from one generation to the next in one country at one point in time isn’t at all the same as saying, “generally, this is how parents’ and kids’ status are related”.

Another, and really the more important one (for me at least) is that when we talk about social mobility and inequality, we often talk about money. We go straight to income inequality and income mobility, as though the only thing that determines whether everybody has the same chance at a good life is determined by how much money they can make. It’s really much more than that (although having a ton of money helps). If we found that even today, quality of life is highly correlated between parents and their children, and perhaps even found that there’s a causal relation there, that should be a big part of our debate.

[Revised] Lies, Damned Lies, And The Wall Street Journal

I never, ever have seen media this way. It’s almost indescribable. Making up stories, refusing to run real stories. It’s making themselves look like utter fools. There’s no journalism, there is no media. There’s pure, full-fledged advocacy here. – Rush Limbaugh

I’ve joked about the WSJ misrepresenting facts that don’t suit its ideology in the past, but what they think they can get away with these days is simply not funny anymore. Let me present to you two recent examples of exceptionally poor journalism in the Journal. One is an article on CBO and the minimum wage, the other on the 2009 stimulus bill. I’ll take them in turns.

As you’ve probably noticed, CBO’s estimates regarding the impact of raising the minimum wage to $10.10 are making the rounds (even on our class blog). Here’s what the Journal has to say about this:

CBO estimated that President Obama’s latest proposal—$10.10 by 2016 from $7.25 today—could cost half a million Americans their jobs…

the CBO estimate [stated that] that 16.5 million workers would get a raise, and that some of those would therefore climb above the federal poverty line…

“many low-income workers are not members of low-income families”…

overall real income would rise by $2 billion,” says the CBO study. That’s out of an economy of $16 trillion…

President Obama is pitching a higher minimum wage as a matter of economic justice […] as the CBO report shows, for many of the poor it will merely push them out of the job market and even deeper into poverty. (emphasis added)

Sounds pretty bad, doesn’t it? The minimum wage will impoverish the United States! And that’s coming from a “Democratic-run budget shop” such as CBO! That’s one devastating report, huh?

Except that when you look at the actual CBO publication, you’ll notice that it’s not just about 500,000 people (potentially) losing their jobs. It’s also about 900,000 people being lifted above the poverty line on net (“some of those”, indeed). So CBO isn’t saying that raising the minimum wage is a crazy idea, and that liberals are really, really stupid for proposing it. It’s saying that there is a trade-off involved. It’s also saying that all told, the total number of people below the poverty line would decline!

All told, there are pros and cons to raising the minimum wage, and we could have a sensible debate about it. That is, if the WSJ wasn’t actively trying to only tell half the story. I’m just waiting for them to change their slogan to ‘fair and balanced‘.

The piece on the stimulus bill is right along the same lines (for a much better discussion than the Journal has to offer, I refer you to our class blog):

The $830 billion spending blowout was sold by the White House as a way to keep unemployment from rising above 8%. But […] 2009 marked the first of four straight years when unemployment averaged more than 8%…

The Obama White House had been egged on by liberal economists like Paul Krugman, who in November of 2008 recommended a stimulus of at least $600 billion…

Those stupid, stupid liberals again, getting their economics all wrong. Except that Krugman has said and continues to say that the stimulus should have been bigger. That’s what proposing a minimum means, you see!

Also, what’s this about 8% unemployment, and how it’s related to stimulus being a big, big failure? Let’s take a look:

This clearly shows that stimulus failed, right? If you can’t see it, you should stop questioning right-wing doctrines, you liberal ignoramus don’t worry: it’s not there. That graph shows no counterfactual whatsoever. There’s no way to infer from this what unemployment would have been like without the stimulus.

I think unemployment would’ve been much higher. I think so because there are models that predict this. I think so because there’s empirical evidence for it. But hey, estimating this stuff is difficult. If you’re using a different model, you might disagree. The Journal, however, simply claims that stimulus is nonsense without giving any justification whatsoever. That’s dishonest, cheap, and if you did it in a term paper, you’d get an F.

The Journal also criticizes that the stimulus money was spent on “stupid” things, such as education and studies about youth drug & alcohol abuse and college sex life. Feel free to form your own opinion about how stupid and pointless that was for a country that’s dealing with dismal PISA scores, 88,000 alcohol-related deaths per year and college rape on the rise.

But of all the nonsense expressed in those two articles, this takes the crown:

The failure of the stimulus was a failure of the neo-Keynesian belief that economies can be jolted into action by a wave of government spending. In fact, people are smart enough to realize that every dollar poured into the economy via government spending must eventually be taken out of the productive economy in the form of taxes. The way to jolt an economy to life and to sustain long-term growth is to create more incentives for people to work, save and invest. (emphasis added)

Not only is this a claim that Ricardian Equivalence is literally true, which is most certainly false. It’s also a claim that you want to encourage people to save more in a depressed economy, which is the complete opposite of what you should be doing (and would’ve cost you points on question nine of the midterm).

All this betrays a deep, deep ignorance of economic theory and evidence, and a lack of journalist ethics. Why are we reading the WSJ again?