In recent days Paul Krugman has been flailing a model of the term structure of interest rates and the liquidity trap based on the idea that there is an absolute lower bound of zero percent for nominal interest rates. This may have been true in the distant past, but it is not true anymore. We have seen numerous episodes of negative interest rates, with several outbreaks in the last few months, including on the actual federal funds rate and on 90 US Treasury bills, as well as on Japanese interbank rates in the late 1990s, when their target rate was at 0%. A not widely known episode that went on off and on between August and November of 2003 was in the repo market, which used to be used by the Fed for open market operations, as reported in a New York Fed study from April 2004 by Fleming and Garbade, accessible at http://www.newyorkfed.org/research/current-issues/ci10-5.html. It has only been convention and a left over belief like the old religious view that negative numbers did not exist that has led so many economists and others to think that zero is some absolute lower bound on interest rates. We may well see that bound breached more seriously and frequently in the months ahead, if the economic crisis continues to deepen.
The prejudice against believing in negative interest rates, sometimes viewed as the "price of time," is not unrelated to the long-held opposition to the idea of negative prices. We see them regularly in real life, but they often get assumed away by defining paying for the removal of something (such as excess water) as a different market with a positive price from providing the same good when we want more of it (water for irrigation), even when the same activity does both things (building a dam with an irrigation system). Negative real estate prices often are associated with environmental problems, such as kaput coal mines leaking toxic waste that the owner is responsible for paying the cleanup of. In some countries, brides have a positive price while in some grooms do, although as Michael Perelman recently reported, Herodotus tells us of bride auctions in ancient Babylon where some are sold for positive and some for negative prices in the same auction. The great efforts by the general equilibrium theorists to avoid negative prices (not a problem for Walras) were a waste of time, as were all the huffings about negative surplus value in the Sraffian debates. Time to get over it, especially if we start seeing widespread negative interest rates.
Hidden conclusion here.
Wednesday, December 31, 2008
Tuesday, December 30, 2008
Jeffrey Miron’s Preference for Ineffective Fiscal Policy
Jeffrey Miron claims:
We will likely hear this slogan a lot from conservatives over the next few weeks. Miron’s argument against increasing spending goes something like this:
If Jeffrey Miron is worried that the new Administration is about to push for a bunch of pork barrel projects, maybe he should talk to Lawrence Summers. So let me address instead Miron’s faith in tax cuts as the cure for our lack of aggregate demand.
The underlying Keynesian premise for short-term fiscal stimulus is that we need to accelerate aggregate demand but eventually aggregate demand will be restored either through more consumption (public or private) or more investment. When Miron talks about government purchases crowding-out private spending, he is referring to the period known as the long-run and not the short-term concerns that will be the dominant macroeconomic theme for 2009. If one is a believer of propositions such as the life cycle model of consumption or the Barro-Ricardo equivalence proposition, one would dismiss out of hand this notion that we can accelerate aggregate demand by passing a tax cut today that will one day have to be financed by a tax surcharge. I should hasten to add there are a couple of ways of addressing this critique of tax cuts – one of which Miron hints at:
Of course, this smaller government canard was a rational for the 1981 tax cut and almost every Republican call for tax cuts since. But even when the Republican Party dominated fiscal policy decision making, we never saw any significant reduction in the size of the government.
Some Keynesians would argue that the life cycle or Barro-Ricardo equivalence models of tax cuts and consumption ignore the fact that some households face borrowing constraints. On this score, Miron might consider what Philip Rucker reported yesterday:
In other words, the plan is to give tax cuts to those who may indeed be facing borrowing constraints. I guess Miron might complain that President Obama intends to make these middle class tax cuts permanent by increasing taxes on the wealthy – who likely do not face borrowing constraints. But the redistribution of the tax burden is not likely to have much of a net effect on aggregate demand. Simply put – I do not see how Miron’s call for tax cuts will have as much bang for the buck in terms of accelerating aggregate demand as the set of fiscal proposals being advanced by the President-elect’s economic team.
Is a fiscal stimulus good policy? The answer is no if the stimulus consists of increased spending. The stimulus may be good policy, though, if it consists of lower taxes.
We will likely hear this slogan a lot from conservatives over the next few weeks. Miron’s argument against increasing spending goes something like this:
If the new spending is for projects that are beneficial for society overall, and if the private sector cannot or will not undertake these projects, then the expenditure is worthwhile independent of what it does to fight the recession. A standard example might be repair of the interstate highway system ... Even if certain components of the nation's spending are too low, nothing guarantees that new spending will be directed to these areas. Instead, experience suggests that much will be for repairing "bridges to nowhere," especially those located in the districts of influential legislators. The Keynesian argument for a spending stimulus does not, of course, assume this spending is for projects that have economic or social value. The theory, in fact, suggests that digging ditches and then filling them up is effective at stimulating the economy. This cannot make sense in the long run; government spending must be paid for with taxes, so it ultimately comes at the expense of private spending. Projects that do not make economic sense are then pure waste. Yet the history of government spending indicates the stimulus package will include countless zoos, aquariums, museums, parks and other pork barrel projects for which the private demand does not come close to justifying the investment. In many cases, these projects will persist for decades.
If Jeffrey Miron is worried that the new Administration is about to push for a bunch of pork barrel projects, maybe he should talk to Lawrence Summers. So let me address instead Miron’s faith in tax cuts as the cure for our lack of aggregate demand.
Tax cuts also stimulate demand via the standard Keynesian channels of increased disposable income for consumers
The underlying Keynesian premise for short-term fiscal stimulus is that we need to accelerate aggregate demand but eventually aggregate demand will be restored either through more consumption (public or private) or more investment. When Miron talks about government purchases crowding-out private spending, he is referring to the period known as the long-run and not the short-term concerns that will be the dominant macroeconomic theme for 2009. If one is a believer of propositions such as the life cycle model of consumption or the Barro-Ricardo equivalence proposition, one would dismiss out of hand this notion that we can accelerate aggregate demand by passing a tax cut today that will one day have to be financed by a tax surcharge. I should hasten to add there are a couple of ways of addressing this critique of tax cuts – one of which Miron hints at:
For those who advocate smaller government, the case for a tax cut is easier; short-run increases in the deficit are not a major concern if government should be smaller (and can eventually be reduced in size) in the long run. If the level of spending is too high, the U.S. can have its cake and eat it too: cut taxes now to improve efficiency and stimulate the economy and cut spending later to balance the budget.
Of course, this smaller government canard was a rational for the 1981 tax cut and almost every Republican call for tax cuts since. But even when the Republican Party dominated fiscal policy decision making, we never saw any significant reduction in the size of the government.
Some Keynesians would argue that the life cycle or Barro-Ricardo equivalence models of tax cuts and consumption ignore the fact that some households face borrowing constraints. On this score, Miron might consider what Philip Rucker reported yesterday:
President-elect Barack Obama’s economic stimulus plan will include an immediate tax cut for middle-class families
In other words, the plan is to give tax cuts to those who may indeed be facing borrowing constraints. I guess Miron might complain that President Obama intends to make these middle class tax cuts permanent by increasing taxes on the wealthy – who likely do not face borrowing constraints. But the redistribution of the tax burden is not likely to have much of a net effect on aggregate demand. Simply put – I do not see how Miron’s call for tax cuts will have as much bang for the buck in terms of accelerating aggregate demand as the set of fiscal proposals being advanced by the President-elect’s economic team.
The Mexican Recession and Fiscal Policy
Elisabeth Malkin must not have ever heard of Lord Keynes and his General Theory:
Well – at least she introduced the open economy aspects. With the peso hovering around 10 pesos per dollar until August 1 of this year (since then it has devalued by about 33 percent), fiscal stimulus in the U.S. led us to import more goods from Mexico which should boost Mexican aggregate demand. As an aside, Dean Baker is not been that impressed with Mexico’s real GDP growth.
Malkin goes onto note that the fall in U.S. aggregate demand has led to a fall in Mexican exports with a concern that Mexico that will also suffer a recession. If that is the case, fiscal restraint is precisely the wrong policy to adopt at this time.
Update: I checked with this source to see if it is true that US imports from Mexico have declined. Our graph shows these imports from January 2007 to October 2008. Maybe economists are forecasting a decline but we had not seen it as of a couple of months ago.
But this recession, it is the profligate United States pulling down fiscally disciplined Mexico. Like a host of middle-class countries, from South Africa to Brazil, Mexico is credited by economists with prudent economic policies that reduced debt and tamed inflation, but that has not saved any of them from the pain of a global recession ... When the American economy began to spiral downward, officials here argued that Mexico’s hard-won macroeconomic stability would protect it ... Now, as each week brings more bad news from the United States, those forecasts seem quaintly optimistic. The North American Free Trade Agreement, or Nafta, which so tightly bound Mexico and the United States and turns 15 on Thursday, is helping drag Mexico down with the United States just as it helped bolster it when times were good north of the border. When the American economy was growing, successive governments here counted on foreign investment and exports to generate growth. Exports account for almost a third of Mexico’s gross domestic product. But more than 80 percent of them go to the United States, and when American consumers stop buying, there is no market for Mexican-made big-screen televisions, auto parts or expensive winter fruit.
Well – at least she introduced the open economy aspects. With the peso hovering around 10 pesos per dollar until August 1 of this year (since then it has devalued by about 33 percent), fiscal stimulus in the U.S. led us to import more goods from Mexico which should boost Mexican aggregate demand. As an aside, Dean Baker is not been that impressed with Mexico’s real GDP growth.
Malkin goes onto note that the fall in U.S. aggregate demand has led to a fall in Mexican exports with a concern that Mexico that will also suffer a recession. If that is the case, fiscal restraint is precisely the wrong policy to adopt at this time.
Update: I checked with this source to see if it is true that US imports from Mexico have declined. Our graph shows these imports from January 2007 to October 2008. Maybe economists are forecasting a decline but we had not seen it as of a couple of months ago.
Google Monetizes Public Libraries?
With public libraries reeling under expanded budget cuts, Google's new deal with the publishers seems to threaten public libraries, which offer Internet service.
Karen Coyle's warning about Google's new plan is short enough that I need not summarize it. Google's response seems disingenuous.
Keep in mind that the major university libraries supplied books that were subsidized by public money.
Whatever happened to "do no harm"?
http://www.opencontentalliance.org/2008/12/06/a-raw-deal-for-libraries/
Karen Coyle's warning about Google's new plan is short enough that I need not summarize it. Google's response seems disingenuous.
Keep in mind that the major university libraries supplied books that were subsidized by public money.
Whatever happened to "do no harm"?
http://www.opencontentalliance.org/2008/12/06/a-raw-deal-for-libraries/
Monday, December 29, 2008
Federalize Medicaid!
There has been much justified concern and talk about the fiscal problems of the state and local governments in the current crisis, most of whom have some form of balanced budget rule in place, forcing them to engage in automatic destabilizing policy in the form of cutting spending or raising tax rates as the recession lowers tax revenues. One of the most significant of rising costs that is hitting all the state governments, and has been even when times have been better, has been Medicaid, the needs-based program to pay for the medical care of poorer people. Unlike non-needs based Medicare and Social Security, this program is partly funded by the states as well as the federal government, which also means that poorer states face a larger burden.
Although I have heard nobody propose this, and it would cost a lot of money at the federal level, there is an obvious move here that would help in both the short term and the longer term. Federalize Medicaid! Besides essentially eliminating the fiscal crises of the states, it would also provide a more level playing field in the longer term between the states.
Although I have heard nobody propose this, and it would cost a lot of money at the federal level, there is an obvious move here that would help in both the short term and the longer term. Federalize Medicaid! Besides essentially eliminating the fiscal crises of the states, it would also provide a more level playing field in the longer term between the states.
Do High Income Individuals Have a Lower Marginal Propensity to Consume or a Higher Propensity to Import?
Kevin Drum seems to believe the former:
Kevin seems to be arguing that as income distribution gets more tilted from the poor and middle class towards the rich, consumption as a share of national income will fall. OK, we are currently concerned about an insufficiency of aggregate demand given that the sum of net investment and net exports is barely above zero. During the transitional (perhaps defined as a couple of years) Keynesian period of weak investment demand, we have the paradox of thrift where any upwards shift of the national savings schedule will only deepen the recession.
But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment. And if Kevin is right about the rich having a lower propensity to consume – that is, a higher propensity to save – the old trickle down nonsense about taking from the poor to give to the rich would at least spur more investment demand and long-term growth.
Paul Krugman, however, isn’t buying this assumption:
I’m not sure I’m buying this notion that distributing income from the rich to the poor is going to necessarily reduce our national savings rate either. But here’s a related query related to the Keynesian multiplier related to certain open economy musings by Dani Rodrik:
Let’s postulate for a moment that the rich have a high marginal propensity to consume imported goods than do the poor. Even if redistributing income from the rich to the poor does not increase overall consumption (that is, we as a nation still save the same amount), it might induce less imports and more domestic spending.
One way or another, there's really no way for the economy to grow strongly and consistently unless middle-class consumers spend more, and they can't spend more unless they make more … The only sustainable source of consistent growth is rising median wages. The rich just don't spend enough all by themselves.
Kevin seems to be arguing that as income distribution gets more tilted from the poor and middle class towards the rich, consumption as a share of national income will fall. OK, we are currently concerned about an insufficiency of aggregate demand given that the sum of net investment and net exports is barely above zero. During the transitional (perhaps defined as a couple of years) Keynesian period of weak investment demand, we have the paradox of thrift where any upwards shift of the national savings schedule will only deepen the recession.
But even the most die-hard Keynesians accept the Solow proposition that in the long-run, any increase in national savings will encourage more investment. And if Kevin is right about the rich having a lower propensity to consume – that is, a higher propensity to save – the old trickle down nonsense about taking from the poor to give to the rich would at least spur more investment demand and long-term growth.
Paul Krugman, however, isn’t buying this assumption:
There’s no obvious reason why consumer demand can’t be sustained by the spending of the upper class — $200 dinners and luxury hotels create jobs, the same way that fast food dinners and Motel 6s do. In fact, the prosperity of New York City in the last decade — largely supported off of super-salaried Wall Street types — is a demonstration that you can have an economy sustained by the big spending of the few rather than the modest spending of large numbers of people.
I’m not sure I’m buying this notion that distributing income from the rich to the poor is going to necessarily reduce our national savings rate either. But here’s a related query related to the Keynesian multiplier related to certain open economy musings by Dani Rodrik:
It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care? Being the open economy that it is, I fear that the U.S. will have to confront this dilemma sooner or later. In an environment where the dollar has already appreciated against the Euro and even more significantly against emerging market currencies, fiscal stimulus here will produce an even larger current account deficit. If American consumers decide to spend 40 cents of a dollar of additional income on cheap imports from China and other foreign countries, the multiplier will be a mere 1.3. How long will it take before politicians of all stripes cry foul over the leakage through the trade account and the "gift to foreigners" that this represents? And they will have Keynesian logic on their side.
Let’s postulate for a moment that the rich have a high marginal propensity to consume imported goods than do the poor. Even if redistributing income from the rich to the poor does not increase overall consumption (that is, we as a nation still save the same amount), it might induce less imports and more domestic spending.
Sunday, December 28, 2008
Truism and Consequences
by the Sandwichman
"Any cub productivity theorist can upset the idea by a mere reference to long-time effects on wages; but the unionists were blissfully ignorant of such theories..."
The quote is from Raymond Henry Mussey's "Eight-Hour Theory in the American Federation of Labor" (1927). The image is a page from a letter from John Bates Clark to Franklin H. Giddings in which Clark explains the reason for the delay in publication of his productivity theory of wages.
George Gunton -- who formalized the American Federation of Labor's eight-hour philosophy in a 1889 pamphlet, "The Economic and Social Importance of the Eight-Hour Movement" (which was serialized on EconoSpeak a few months ago) -- was not "blissfully ignorant" of John Bates Clark's productivity theory of wages. On the contrary, Gunton was familiar enough with Clark's theory to write published critiques of it and to detect "impressions" in it of Wood's theory that Clark himself was not entirely aware of.
"Any cub productivity theorist can upset the idea by a mere reference to long-time effects on wages; but the unionists were blissfully ignorant of such theories..."
The quote is from Raymond Henry Mussey's "Eight-Hour Theory in the American Federation of Labor" (1927). The image is a page from a letter from John Bates Clark to Franklin H. Giddings in which Clark explains the reason for the delay in publication of his productivity theory of wages.
..By the way I want to tell you in confidence that George Gunton
wrote to the Columbia people proposing to write for them an article
in criticism of my Wage theory. They wrote asking whether I would
rather have it come out before or after my article in the [Political
Science] Quarterly. This was then expected in Sept. I said let Mr.
G.'s article come in Sept. and let me reply in Dec. After thinking
the thing over for a while they concluded not to publish the
symposium or friendly melee at all, and asked me then to send the
article for Sept. independently. By that time I had concluded I must
for the reasons stated, defer the article till December. Mr. Gunton
said of me "He seems to have been much impressed by Stuart Wood's
article in the Quarterly Journal of Economics." This is a true
statement or guess -- I was impressed by the article. Mr. Gunton
seemed to me to think I was a trifle more dependent than I supposed
I was on my good friend's paper. I wonder just a little whether Mr.
Gunton's impression, if such as I surmise is his impression, is a
natural one. Bah! This is an illustration of the essential
littleness and selfishness of the human heart. What does it matter
whether A or B discovered the major part of an economic law, if so
be that it is a law and does a work in interpreting facts of life?...
George Gunton -- who formalized the American Federation of Labor's eight-hour philosophy in a 1889 pamphlet, "The Economic and Social Importance of the Eight-Hour Movement" (which was serialized on EconoSpeak a few months ago) -- was not "blissfully ignorant" of John Bates Clark's productivity theory of wages. On the contrary, Gunton was familiar enough with Clark's theory to write published critiques of it and to detect "impressions" in it of Wood's theory that Clark himself was not entirely aware of.
How I Misrepresented Nassim Nicholas Taleb On Barbell Strategies
[long, wonkish, and personal]
If one googles "barbell strategy," one mostly finds discussions of a bond-trading strategy (and a related definition) that involves putting half of funds in long term bonds and half in short term bonds, with no money in intermediate term bonds. The money at both ends makes this a "barbell." Whether or not such a strategy makes more money than the "bullet strategy" of buying only intermediate term bonds (or all time horizon bonds) depends on the shape of the term structure of interest rates and how it changes over time. Another variation is for a takeover raider to buy both very large firms and very small ones, but not mid-sized ones. A more general definition of a barbell strategy is one that combines very safe investments with very risky ones, while not buying ones of intermediate riskiness. In his book, The Black Swan (TBS), Nassim Nicholas Taleb recommends (pp. 205-26) a variation on this in which one puts 85-90% of one's assets in "extremely safe assets, like Treasury bills" and the rest in "extremely speculative bets, as leveraged as possible (like options), preferably venture-style portfolio," with a footnote suggesting that this remaining 10-15% involve "as many of these small bets as possible."
In various blogs, including here, I have described his barbell strategy accurately with regard to the first part, but misrepresented the second part as involving specifically buying puts on major crashes. I then criticized this as a strategy that would lose money in most years (although obviously it would make money this year if properly done) based on a paper by Oleg Bonderenko, "Why are Put Options So Expensive," available at http://tigger.uic.edu/~olegb/research.htm. In a link on his website, http://fooledbyrandomness.com/fake.htm, Taleb has sharply criticized me for this (others dumped on there are Tyler Cowen, Robin Hanson, Alan Greenspan, Robert C. Merton, Kenneth Rogoff, and Paul Seabright, for various alleged sins, some more serious in my eyes than others, some not sins at all). In any case, I have now gone back to his book and see that my frequently repeated description of his barbell strategy was a misrepresentation. For this, I apologize to him publicly.
Needless to say, there is more to this than I have said so far, for those of you who are interested, and I will say that quite a bit of what Taleb says on his website involves serious misrepresentations. I would strongly suggest that he alter the inaccurate parts and publicly apologize, as I altered parts of an original posting back on maxspeak over a year ago at his request that was at the origin of all this. So, for those of you who are curious, here is the rest of the story, at least as I see it.
So, in the summer of 2007 I happened to read TBS. I found it mostly very interesting and stimulating, and in general I was then and remain in agreement with most of the ideas in it. I enjoyed (and still do) many of the tales and neologisms he came up with there, although on my second reading I find much of it more superficial and self-contradictory than I did the first time around, although this may reflect a more critical approach given our bad relations since. Anyway, after reading it, and becoming aware that he had a number of technical papers floating around on substantive aspects of it that were unpublished, I sent him a friendly email, praising his book and inviting him to submit any papers he might wish to the journal I edit, the Journal of Economic Behavior and Organization (JEBO). He has posted part of that email on his site.
What he does not note on his site is that his reply to me, somewhat delayed, was a form email telling me that he was too busy to reply to my email. I was not all that surprised by this as this was the time when TBS was on the bestseller list, and I could understand that indeed he might be very busy. He said nothing about JEBO and did not say anything about my invitation.
Now, there is at this point a crucial event that he did not realize. He argues that what followed was due to my "feeling rebuffed" that he had "refused [my] invitation to submit in his technical journal." Well, he had not refused. He had simply said he was too busy to reply, and I was in fact still awaiting a reply. However, I became aware of this paper by Bondarenko and saw some discussions on some blogs by some other people whom he does not attack and whom I shall not bring up who argued that Bondarenko's results showed that Taleb's barbell strategy was a money loser in most years, even if the losses would not be all that great, which is his ultimate defense of the strategy ("My barbell strategy has nothing to do with making money - although it does OK - but with being robust to model error"). It was after seeing this, and also hearing of some bizarre conduct of his regarding another blogger, whom I shall not mention, that I then put up a post on the old maxspeak, the predecessor of this blog.
In that post I spent most of my time praising TBS, something that Taleb has somehow never noticed or commented on, I guess assuming that everybody should praise his book without any questions or criticisms. I then, as had Tyler Cowen in a review in Slate (the reason Tyler is on his bad list), said that the main weakness of the book was that his barbell strategy would lose money most of the time. I went too far and said that he would probably not be able to make much money personally with it and would do better by writing and selling his successful books.
Well, now within 20 minutes of putting this up, I got an email from this guy who was "too busy" to reply to my friendly earlier email. It warned me in pretty strong language that I did not know how he made his money and that I should be careful what I said, pointing out specific wording mentioned above. So, I altered that wording to make the post not say what he definitely would do or not do in terms of making money, but still criticizing him. He then sent me another email in which he essentially threatened to sue me, which he has done to others who criticize his financial strategies (whatever else he is, he is ridiculously thin-skinned). I then put up his emails in the comments section of the post and ripped him harshly for his hypocrisy.
I now realize that part of what happened here was a miscommunication. He did not realize that I had changed my views somewhat on his book because of something I read after I sent my original email. That was unfortunate, because, as I said to him both on the blog and in an email, he and I are very close in views and admire and respect many of the same people, some of whom we share as friends. We actually ought to get along, but fell into a very unpleasant contretemps. In any case, I have continued to blast him here and there until now on all this.
A few substantive remarks beyond all this soap opera, and I shall let this go. One is that whether or not any barbell strategy either makes money or even succeeds in insuring one against big losses while preserving that option of making big money depends on the details of the strategy. He sells it as insurance against black swans (unforeseen events), but its ability to insure depends on having "safe assets" that will be safe even in the event of a black swan. In the case of his specific recommendation of US T-bills as the safe asset, while all the world has run to them in the last few months, it is now very far from clear how safe they are, at their near zero rates, and with the possibility of a major crash of the dollar sitting out there. Great grandma's old "cash in the cookie jar" may well be better, maybe along with some euros and yen and a couple of other currencies. A crash of US government securities could well be the next Black Swan.
The strategy again only will work if not too many people are doing it. If too many people are doing it, then the generalization of Bondarenko's critique will hold: those endpoint assets will be overpriced and money will be made by buying the intermediately risky ones. Also, if everybody does it, the economy will belly up with no financing of those intermediately risky activities that constitute the majority of the economy.
Furthermore, while it is very popular now to attack "economists" in general, Taleb rather makes a hash of things. On the broader part of his website he says somewhere that the only two economists he respects are dead: Hayek and Shackle. However, in TBS we find him praising Keynes, Knight, Minsky, and Kindleberger, all of whom I also admire. He also cites many living economists at least not critically, and some positively, with Robert Shiller probably most frequently. Yes, Merton and Scholes (and Samuelson) all look bad, and yes, the textbooks should stop pushing models based on Gaussian distributions, but by now most of us, and certainly the contributors to and readers of this blog know better.
Finally, he does remain in contradiction with himself in TBS, although he knows this and sort of acts like it is all very cute and philosophical (p. 296: "Half the time I am intellectual, the other half I am a no-nonsense practitioner... Half the time I am shallow, the other half I want to avoid shallowness," etc.). But he does have major contradictions, which make me less inclined to be so charitable about his slams on so many people over pretty trivial stuff (although not all of his slams are over trivial matters). So, he spends most of the book denouncing Gaussian distributions and those who push them (not very many these days, kind of a straw man). He seems to contrast that "Mediocristan" with "Black Swan" world of "Extremistan." But then, he spends time talking about econophysics and his papers with Mandelbrot on multi-fractal distributions and so forth, which he admits are not really either; they are "grey swans." Yes, he does cover his behind, but after all his rhetoric and carrying on, it looks pretty hypocritical.
A final btw. On his site he states that he did not wish to submit to JEBO because of his "no-nonsense orientation [that] clashes with academic resume building." Hmmm. Well, that might be fine, but I do see him publishing in American Statistician, Quantitative Finance (edited by our mutual friend, Jean-Philippe Bouchaud), and currently in the process of co-editing a special issue of the International Journal of Forecasting. Well, I wish him good luck with all that academic resume building (Oh, and I still think that he is a popularizer, although that is not necessarily a bad thing, but no, he will not get a Nobel for his ideas, sorry).
If one googles "barbell strategy," one mostly finds discussions of a bond-trading strategy (and a related definition) that involves putting half of funds in long term bonds and half in short term bonds, with no money in intermediate term bonds. The money at both ends makes this a "barbell." Whether or not such a strategy makes more money than the "bullet strategy" of buying only intermediate term bonds (or all time horizon bonds) depends on the shape of the term structure of interest rates and how it changes over time. Another variation is for a takeover raider to buy both very large firms and very small ones, but not mid-sized ones. A more general definition of a barbell strategy is one that combines very safe investments with very risky ones, while not buying ones of intermediate riskiness. In his book, The Black Swan (TBS), Nassim Nicholas Taleb recommends (pp. 205-26) a variation on this in which one puts 85-90% of one's assets in "extremely safe assets, like Treasury bills" and the rest in "extremely speculative bets, as leveraged as possible (like options), preferably venture-style portfolio," with a footnote suggesting that this remaining 10-15% involve "as many of these small bets as possible."
In various blogs, including here, I have described his barbell strategy accurately with regard to the first part, but misrepresented the second part as involving specifically buying puts on major crashes. I then criticized this as a strategy that would lose money in most years (although obviously it would make money this year if properly done) based on a paper by Oleg Bonderenko, "Why are Put Options So Expensive," available at http://tigger.uic.edu/~olegb/research.htm. In a link on his website, http://fooledbyrandomness.com/fake.htm, Taleb has sharply criticized me for this (others dumped on there are Tyler Cowen, Robin Hanson, Alan Greenspan, Robert C. Merton, Kenneth Rogoff, and Paul Seabright, for various alleged sins, some more serious in my eyes than others, some not sins at all). In any case, I have now gone back to his book and see that my frequently repeated description of his barbell strategy was a misrepresentation. For this, I apologize to him publicly.
Needless to say, there is more to this than I have said so far, for those of you who are interested, and I will say that quite a bit of what Taleb says on his website involves serious misrepresentations. I would strongly suggest that he alter the inaccurate parts and publicly apologize, as I altered parts of an original posting back on maxspeak over a year ago at his request that was at the origin of all this. So, for those of you who are curious, here is the rest of the story, at least as I see it.
So, in the summer of 2007 I happened to read TBS. I found it mostly very interesting and stimulating, and in general I was then and remain in agreement with most of the ideas in it. I enjoyed (and still do) many of the tales and neologisms he came up with there, although on my second reading I find much of it more superficial and self-contradictory than I did the first time around, although this may reflect a more critical approach given our bad relations since. Anyway, after reading it, and becoming aware that he had a number of technical papers floating around on substantive aspects of it that were unpublished, I sent him a friendly email, praising his book and inviting him to submit any papers he might wish to the journal I edit, the Journal of Economic Behavior and Organization (JEBO). He has posted part of that email on his site.
What he does not note on his site is that his reply to me, somewhat delayed, was a form email telling me that he was too busy to reply to my email. I was not all that surprised by this as this was the time when TBS was on the bestseller list, and I could understand that indeed he might be very busy. He said nothing about JEBO and did not say anything about my invitation.
Now, there is at this point a crucial event that he did not realize. He argues that what followed was due to my "feeling rebuffed" that he had "refused [my] invitation to submit in his technical journal." Well, he had not refused. He had simply said he was too busy to reply, and I was in fact still awaiting a reply. However, I became aware of this paper by Bondarenko and saw some discussions on some blogs by some other people whom he does not attack and whom I shall not bring up who argued that Bondarenko's results showed that Taleb's barbell strategy was a money loser in most years, even if the losses would not be all that great, which is his ultimate defense of the strategy ("My barbell strategy has nothing to do with making money - although it does OK - but with being robust to model error"). It was after seeing this, and also hearing of some bizarre conduct of his regarding another blogger, whom I shall not mention, that I then put up a post on the old maxspeak, the predecessor of this blog.
In that post I spent most of my time praising TBS, something that Taleb has somehow never noticed or commented on, I guess assuming that everybody should praise his book without any questions or criticisms. I then, as had Tyler Cowen in a review in Slate (the reason Tyler is on his bad list), said that the main weakness of the book was that his barbell strategy would lose money most of the time. I went too far and said that he would probably not be able to make much money personally with it and would do better by writing and selling his successful books.
Well, now within 20 minutes of putting this up, I got an email from this guy who was "too busy" to reply to my friendly earlier email. It warned me in pretty strong language that I did not know how he made his money and that I should be careful what I said, pointing out specific wording mentioned above. So, I altered that wording to make the post not say what he definitely would do or not do in terms of making money, but still criticizing him. He then sent me another email in which he essentially threatened to sue me, which he has done to others who criticize his financial strategies (whatever else he is, he is ridiculously thin-skinned). I then put up his emails in the comments section of the post and ripped him harshly for his hypocrisy.
I now realize that part of what happened here was a miscommunication. He did not realize that I had changed my views somewhat on his book because of something I read after I sent my original email. That was unfortunate, because, as I said to him both on the blog and in an email, he and I are very close in views and admire and respect many of the same people, some of whom we share as friends. We actually ought to get along, but fell into a very unpleasant contretemps. In any case, I have continued to blast him here and there until now on all this.
A few substantive remarks beyond all this soap opera, and I shall let this go. One is that whether or not any barbell strategy either makes money or even succeeds in insuring one against big losses while preserving that option of making big money depends on the details of the strategy. He sells it as insurance against black swans (unforeseen events), but its ability to insure depends on having "safe assets" that will be safe even in the event of a black swan. In the case of his specific recommendation of US T-bills as the safe asset, while all the world has run to them in the last few months, it is now very far from clear how safe they are, at their near zero rates, and with the possibility of a major crash of the dollar sitting out there. Great grandma's old "cash in the cookie jar" may well be better, maybe along with some euros and yen and a couple of other currencies. A crash of US government securities could well be the next Black Swan.
The strategy again only will work if not too many people are doing it. If too many people are doing it, then the generalization of Bondarenko's critique will hold: those endpoint assets will be overpriced and money will be made by buying the intermediately risky ones. Also, if everybody does it, the economy will belly up with no financing of those intermediately risky activities that constitute the majority of the economy.
Furthermore, while it is very popular now to attack "economists" in general, Taleb rather makes a hash of things. On the broader part of his website he says somewhere that the only two economists he respects are dead: Hayek and Shackle. However, in TBS we find him praising Keynes, Knight, Minsky, and Kindleberger, all of whom I also admire. He also cites many living economists at least not critically, and some positively, with Robert Shiller probably most frequently. Yes, Merton and Scholes (and Samuelson) all look bad, and yes, the textbooks should stop pushing models based on Gaussian distributions, but by now most of us, and certainly the contributors to and readers of this blog know better.
Finally, he does remain in contradiction with himself in TBS, although he knows this and sort of acts like it is all very cute and philosophical (p. 296: "Half the time I am intellectual, the other half I am a no-nonsense practitioner... Half the time I am shallow, the other half I want to avoid shallowness," etc.). But he does have major contradictions, which make me less inclined to be so charitable about his slams on so many people over pretty trivial stuff (although not all of his slams are over trivial matters). So, he spends most of the book denouncing Gaussian distributions and those who push them (not very many these days, kind of a straw man). He seems to contrast that "Mediocristan" with "Black Swan" world of "Extremistan." But then, he spends time talking about econophysics and his papers with Mandelbrot on multi-fractal distributions and so forth, which he admits are not really either; they are "grey swans." Yes, he does cover his behind, but after all his rhetoric and carrying on, it looks pretty hypocritical.
A final btw. On his site he states that he did not wish to submit to JEBO because of his "no-nonsense orientation [that] clashes with academic resume building." Hmmm. Well, that might be fine, but I do see him publishing in American Statistician, Quantitative Finance (edited by our mutual friend, Jean-Philippe Bouchaud), and currently in the process of co-editing a special issue of the International Journal of Forecasting. Well, I wish him good luck with all that academic resume building (Oh, and I still think that he is a popularizer, although that is not necessarily a bad thing, but no, he will not get a Nobel for his ideas, sorry).
Saturday, December 27, 2008
Employment Decline – Casey Mulligan Blames Inward Shift of Labor Supply
Believe it or not this explanation made it in print:
Actually – Mulligan decides not to tell us what specifically induced people to reduce their offering of labor after all. The key item in his first post was referred to his next post? OK. But if there was some supply-side reason why workers decided to reduce their offerings of labor along an unchanged demand curve – wouldn’t that mean real wages would have gone up? Funny thing – Mulligan also fails to talk about this aspect of his bizarre explanation.
Because productivity has been rising — almost as much as the Douglas formula predicts — the decreased employment is explained more by reductions in the supply of labor (the willingness of people to work) and less by the demand for labor (the number of workers that employers need to hire). Why would some people have fewer incentives to take a job in 2008 than they did in 2006 and 2007 (and employers fewer incentives to create jobs)? I will tackle that question in my next post, but even without a specific answer we learn a lot about today’s recession from the conclusion that labor supply – not labor demand – should be blamed. First of all, it suggests that a fundamental solution to the recession would encourage labor supply (perhaps cutting personal income tax rates, so people can keep more of their wages), rather than tinker with demand.
Actually – Mulligan decides not to tell us what specifically induced people to reduce their offering of labor after all. The key item in his first post was referred to his next post? OK. But if there was some supply-side reason why workers decided to reduce their offerings of labor along an unchanged demand curve – wouldn’t that mean real wages would have gone up? Funny thing – Mulligan also fails to talk about this aspect of his bizarre explanation.
Wednesday, December 24, 2008
Financial Regulatory Daisy Chain
I read that Marc Mukasey, son of Atty. Gen. Michael Mukasey, who works for Rudolph Giuliani's law firm, is representing Frank DiPascalli, whom the Wall Street Journal reports is suspected as being in the center of the Madoff scheme. Of course, Madoff himself and his family had numerous connections with regulators.
Now just imagine that Madoff had been a poor person cheating on welfare. How long could he have gotten away with it?
Now just imagine that Madoff had been a poor person cheating on welfare. How long could he have gotten away with it?
Feldstein Advocates Surge in Defense Spending
Martin Feldstein says Defense Spending Would Be Great Stimulus:
Feldstein’s call for some surge in government purchases with a scaling back when we reach full employment strikes me as good macroeconomics. However, we can do the same thing with public schools, bridges, and roads. Of course, I had a similar reaction to something Bill Kristol wrote.
As President-elect Barack Obama and his economic advisers recognize, countering a deep economic recession requires an increase in government spending to offset the sharp decline in consumer outlays and business investment that is now under way. Without that rise in government spending, the economic downturn would be deeper and longer. Although tax cuts for individuals and businesses can help, government spending will have to do the heavy lifting. That's why the Obama team will propose a package of about $300 billion a year in additional federal government outlays and grants to states and local governments ... A temporary rise in DOD spending on supplies, equipment and manpower should be a significant part of that increase in overall government outlays. The same applies to the Department of Homeland Security, to the FBI, and to other parts of the national intelligence community. The increase in government spending needs to be a short-term surge with greater outlays in 2009 and 2010 but then tailing off sharply in 2011 when the economy should be almost back to its prerecession level of activity. Buying military supplies and equipment, including a variety of off-the-shelf dual use items, can easily fit this surge pattern.
Feldstein’s call for some surge in government purchases with a scaling back when we reach full employment strikes me as good macroeconomics. However, we can do the same thing with public schools, bridges, and roads. Of course, I had a similar reaction to something Bill Kristol wrote.
Monday, December 22, 2008
Merry Christmas from the forest in Tasmania
A human being is a part of the whole, called by us the 'Universe' - a part limited in time and space. He experiences himself, his thoughts and feelings, as something separated from the rest - a kind of optical delusion of his consciousness. This delusion is a kind of prison for us, restricting us to our personal desires and to affection for a few persons nearest to us. Our task must be to free ourselves by widening our circle of compassion to embrace all living creatures and the whole of Nature in its beauty.
Albert Einstein
The Hubbard-Mayer Proposal to Nationalize Housing Finance – Can the Government Make Money on Socialism?
James Kwak has a nice discussion of a proposal that Brad DeLong endorses thusly:
According to the Federal Reserve, long-term mortgage rates are near 5.2 percent so the Hubbard-Meyer proposal is to finance them at rates well below current market rates with long-term Treasury rates are near 2.5 percent. How much of this difference represents the expected return premium that Brad hints at versus the expected losses from default, which the government will inherent? I’m not sure but Kwak offers us the following:
While this discussion does not answer the question, it does suggest that default risk today is higher that the historical spreads that Hubbard and Mayer are relying upon.
We are drifting toward nationalizing housing finance. And as long as the government can borrow at the Treasury rate it can buy up and refinance the country's stock of mortgages without paying a dime in the long run. The largest risk-arb operation in history--and since the government can mobilize the entire risk-bearing capacity of America, a very low-risk one
According to the Federal Reserve, long-term mortgage rates are near 5.2 percent so the Hubbard-Meyer proposal is to finance them at rates well below current market rates with long-term Treasury rates are near 2.5 percent. How much of this difference represents the expected return premium that Brad hints at versus the expected losses from default, which the government will inherent? I’m not sure but Kwak offers us the following:
One question is whether the loans will be sustainable. Hubbard and Mayer say that 1.9% is more than enough because the ordinary spread is 1.6%. But these are not ordinary times, and even if the plan does help turn around the economy, we are probably looking at 1-2 more years of rising unemployment and resulting defaults. Furthermore, conforming mortgages rates are already down to 5.2% (thanks in part to the Fed talking rates down), so Fannie and Freddie could face the problem of getting stuck with riskier mortgages while the private sector keeps the better ones.
While this discussion does not answer the question, it does suggest that default risk today is higher that the historical spreads that Hubbard and Mayer are relying upon.
Sunday, December 21, 2008
The Griots
"I was .. out walking toward Lycabettus, crossing for one more time the empty ''bombed'' streets, and the looted stores, having the most confused feelings. As the words of Mao ''Great unrest excellent condition'' suddenly hit my mind..." [1]
"What we face in Greece, it is not a simple reaction to the murdering of the young student Alexis Grigoropoulos, but something that we could describe as a general exegersis, somehow simular to what happened in Los Angeles in 96 or in Brixton in the 80's." [2]
"a group seen by an overwhelming majority in society as monstrous has itself labelled other people as monsters who can be attacked with impunity." [3]
[1] GRIOTS _day 4
Wednesday, 10 December 2008
Pictures from fucked up generation blog
[2] GRIOTS _day 2
Monday 8 December
http://foldedin.blogspot.com/
[3] Folded-in and The making of Balkan wars:The game at Monsters exhibition in Dresden. MONSTERS. Part II: Beat the Monsters!
http://foldedin.blogspot.com/
Thursday, 13 November 2008
Oil and Iraq: The Latest
As the Sunni insurgency in Iraq gradually dies down, ethnic and religious conflicts tied to oil are becoming more central, as reported by Ben Lando at Iraqi Oil Report, http://www.iraqoilreport.com. The northern cities of Mosul, and especially Kirkuk, remain violent, flashpoints partly because the struggle between Kurds, Arabs, and Turkmen for control, also involves control of a major oil producing center, with the Kurdish Regional Government already cutting its own separate oil deals with outside companies. Lando also reports that there is a move on now in southern Basra to vote on attaining autonomy, which would allow that region, where most of the rest of the oil is, to cut its own deals separate from the central government. Meanwhile the collapse of oil prices means the central government will probably go from running a budget surplus this year to a deficit, with cutbacks in reconstruction spending, although having been so far down, Iraq may be in better shape than other oil exporters, such as Russia, who needs $70 per barrel to balance its budget (and has had its stock market drop by 80% this year), or even Saudi Arabia who needs the now-too-high $40 per barrel, same price the oil companies reputedly have used to make their long term production investments.
Speaking of oil prices, this is an area where I was partly right, but did not go nearly far enough. So, in late spring, sometime after the price moved above $120 per barrel, I told a local TV station that it was looking like a speculative bubble, and the price could easily go down, "maybe even below $90 per barrel, although probably not below $70, and we will never see $2 per gallon for gas in the US again." Ooops! Wrong again. At least I recently talked a friend out of buying a six month forward contract on oil when it was at $53 per barrel, warning it could go as low as $25, which may yet also prove too high. But then, in 1930, at the beginning of the Great Depression, after the great East Texas oil field was discovered, the price fell in a six month period from about $1 per barrel to about 5 cents. A similar drop now would take it down to a bit over $7 per barrel from the peak of $147 in July, but then I am not expecting a find of an easy to pump oil field on the magnitude of the now largely depleted East Texas one.
Hidden conclusion here.
Speaking of oil prices, this is an area where I was partly right, but did not go nearly far enough. So, in late spring, sometime after the price moved above $120 per barrel, I told a local TV station that it was looking like a speculative bubble, and the price could easily go down, "maybe even below $90 per barrel, although probably not below $70, and we will never see $2 per gallon for gas in the US again." Ooops! Wrong again. At least I recently talked a friend out of buying a six month forward contract on oil when it was at $53 per barrel, warning it could go as low as $25, which may yet also prove too high. But then, in 1930, at the beginning of the Great Depression, after the great East Texas oil field was discovered, the price fell in a six month period from about $1 per barrel to about 5 cents. A similar drop now would take it down to a bit over $7 per barrel from the peak of $147 in July, but then I am not expecting a find of an easy to pump oil field on the magnitude of the now largely depleted East Texas one.
Hidden conclusion here.
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