Archive for the Category Misc.


“Being There” revisited

Five years ago I did a post entitled Being There.  I compared Warren Buffett to the character played by Peter Sellers in the famous film.  I pointed out that people tend to be superstitious.  They don’t accept unusual coincidences.  Thus if someone outperforms the market for 20 years in a row, the general view is that it can’t be luck—after all the odds are a million to one against.  People forget that just as someone must win the lottery, in any group of a million investors it is a logical necessity that there has to be one who is luckier that all the others. Here’s a test I proposed back in 2009:

I suppose this should be testable.  If the EMH is correct then the top ten richest Americans should not see out-sized returns, once they have reached that pinnacle of success.  I have no idea whether the data exists to do this test, but is would be a good way of resolving the issue of whether Buffett just got lucky.  When similar tests are done with successful mutual fund managers, it turns out to be merely dumb luck.

At the time, many commenters claimed that hedge funds had greatly outperformed the market in recent years, disproving the EMH. It’s well known that hedge funds have since done relatively poorly.  But how about Mr. Buffet?  Here’s the NYT:

A new statistical analysis of Mr. Buffett’s long-term record at Berkshire Hathaway has just been done, and it’s come up with some fascinating insights about his abilities, past and present, and about the chances that the rest of us have for beating the market. Using a series of statistical measures, the study suggests that Mr. Buffett has indeed been blessed with an impressively big dose of alpha over a very long career.

But it also reveals something that isn’t impressive at all: For four of the last five years, Mr. Buffett has been doing worse than the typical, no-frills Standard & Poor’s 500-stock index fund — so much worse that it’s unlikely to be a matter of a string of bad luck. Mr. Buffett has begun to behave like an investor with no alpha at all.

Why am I not surprised?  And don’t say, “it’s harder to do well when you are big.” It’s true that it’s harder to do extremely well when you are big, but it’s not hard to outperform the market when you are big, if you truly have “alpha.”  To see why, assume Buffett is only able to find $5 billion in good investments each year, but has $50 billion to manage.  Then put the $5 billion into the good investments, and index fund the other $45 billion.  If he truly had alpha he’d still be outperforming the market.

“It shows how amazingly difficult it is to keep beating the market, even for a master like Warren Buffett,” Mr. Mehta said in an interview. “And it suggests that just about everybody else should just use index funds and not even think about trying to beat the market.”

I certainly agree with the second point, but I disagree with the first point.  It should read: “It shows how difficult it is to keep winning the lottery, even for someone who has already won Megabucks.”

Sometimes people claim my anti-EMH pro-EMH arguments have no testable implications. That’s wrong.  I’ve been doing this for 5 years and again and again I’m being proved right and my critics are wrong:

1.  Back when Bitcoin was $30 I did a post skeptical of “bubble” claims.  The odds were probably at least 10 to one against me being right (as the potential upside was far more than downside, and hence far less likely) but I was right.  Even after the recent drop I’ll be glad to buy any Bitcoins you’d like to sell me at the “bubble” price of $30.

2.  I was skeptical of hedge funds.

3.  I was skeptical of the Oracle of Omaha.

4.  I was skeptical of Robert Shiller’s ability to give useful market timing advice.  He did not recommend buying stocks in March 2009.

5.  I was skeptical of the claim that the 2006 house price boom was a bubble.  We now know that Canada, Australia, New Zealand and Britain did not crash, after similar price run-ups.  This suggests the US crash was not pre-ordained, rather just “one of those things.”

Since I started blogging in early 2009, events have strongly supported my pro-EMH claims.  Anti-EMH models are completely useless.

PS.  Ok, I was wrong about one thing.  Last March I half jokingly said “stock prices have reached what looks like a permanently high plateau,” echoing Irving Fisher’s infamous 1929 prediction.  Yes, I was wrong—stocks have gone much higher over the past 13 months.

PPS.  Noah Smith has the best piece on high frequency trading that I have read so far.  (Tyler Cowen has also had some good stuff.)  Noah says we know almost nothing about whether it is good or bad, and I know far less that Noah.  Which suggests I have negative knowledge.

HT:  Clark Johnson.


The March jobs report

The headline numbers were more of the same, but there are a couple of other data points that refute some recent hypotheses that have been floating around:

1.  Average hourly earnings fell from $24.31 to $24.30.  That’s probably not statistically significant, but it does slightly undercut a recent argument that people have been making.  Hourly wages have been trending up at about 2% per year since 2009. If we are reaching full employment, and/or the Fed’s 2% inflation target, you might expect a modest rise toward a more normal 3%, or a bit higher.  Some observers thought an upswing was starting last month, when the 12-month increase rose to 2.19%.  With this number the 12-month increase is back to 2.06%.  Because Janet Yellen focuses on wage growth, this is a slightly dovish signal for monetary policy. They need to do more to hit their 2% inflation target. BTW, nominal wages are the correct measure of “inflation” for monetary policy purposes.  We care about disequilibrium in the labor market, not the rental market or the oil market.  Good to see Yellen focused on that variable.

2.  Ed Lazear is a very fine economist, but recently wrote a long WSJ opinion piece that is almost entirely based on a simple misconception.

The job-equivalence number is computed simply by taking the total decline in hours and dividing by the average workweek. For example, if the average worker was employed for 34.4 hours and total hours worked declined by 344 hours, the 344 hours would be the equivalent of losing 10 workers’ worth of labor. Thus, although the U.S. economy added about 900,000 jobs since September, the shortened workweek is equivalent to losing about one million jobs during this same period. The difference between the loss of the equivalent of one million jobs and the gain of 900,000 new jobs yields a net effect of the equivalent of 100,000 lost jobs.

.  .  .

What accounts for the declining average workweek? In some instances—but not this one—a minor drop could be the result of a statistical fluke caused by rounding. Because the Bureau of Labor Statistics only reports hours to the nearest 1/10th, a small movement, say, to 34.449 hours from 34.450 hours, would be reported as a reduction in hours worked to 34.4 from 34.5, vastly overstating the loss in worked time. But the six-month decline in the workweek, to 34.2 from 34.5 hours, cannot be the consequence of a rounding error.

Was it the harsh winter in much of the United States? One problem with that explanation is that the numbers are already seasonally adjusted.

Seasonal adjustments reflect an average winter, not a harsh winter.  Thus a “harsh winter” is a quite reasonable explanation for the fall in average weekly hours. Because Lazear misinterpreted the nature of seasonal adjustments, he went on to search for other possible reasons for the decline in average weekly hours, such as the disincentive effects of Obamacare.

Now it looks like the harsh winter did explain the drop in hours—the March numbers bounced back to 34.5, essentially where they have been since 2006, except for a brief dip in 2008-09.  The WSJ needs a follow-up piece on average weekly hours. Consider this my one word submission:


What do the VSP think about the current economy?

This is a sincere question.  Do the Very Serious People think the US economy is deeply depressed, or nearing full employment?  I see conflicting evidence:

1. As far as I can see the policy of tapering has overwhelming support among the VSP, suggesting they think it’s time for the economy to stand on its own two feet, without a crutch from the Fed. Is that correct?

2. As far as I can see most of the press and pundits, and moderate politicians, seem to support an extension of the emergency unemployment benefits? Recall that the proposal would y currently extend them to 73 weeks, which is far more generous than the emergency benefits under Bill Clinton in early 1993, when unemployment was even higher. The call for an emergency extended unemployment benefits program would imply emergency level unemployment rates, where monetary tightening (when inflation is also below target) would be utter madness.

I’m not interested in arguing these two perspectives.  Both are defensible.  Rather I’m trying to get a sense of where the VSP opinion is on this issue. I honestly cannot tell.  Do they think the economy is deeply depressed?  Or not?

PS.  I’m a bit less sure on point two, but a number of GOP lawmakers recently indicated that they would support extended unemployment benefits, which suggests that the center of gravity political was for extension–that’s certainly the overwhelmingly popular view among press and pundits.

PPS.  Totally off topic, but this comment by Greg Mankiw intrigued me:

In this case, the issue is the reduction in capital taxes during the George W. Bush administration.  Paul [Krugman] says that the goal here was “defending the oligarchy’s interests.”

Really? As Paul well knows, there is a large literature in economics suggesting that an optimal tax system imposes much lower taxes on capital income than on wage income (or consumption).

Why should we assume that Paul Krugman is aware of that literature?  You would think he would be aware of the literature—other progressive bloggers like Matt Yglesias and Brad DeLong obviously are.  But I don’t recall reading a single Krugman column that showed any awareness of the need for replacing our current tax system with a progressive consumption tax.  I don’t recall a single post pointing out that taxes on capital should be much lower than taxes on labor income, if not zero.  I don’t recall a single post pointing out that nominal tax rates on capital income are meaningless, and that real tax rates on (for instance) Treasury bonds are now well over 100%.  Or that corporate income is triple taxed, making nominal corporate tax rates utterly meaningless as indicators of progressivity.  Or that Warren Buffet was spouting utter nonsense when he claimed his tax rate was lower than that of his secretary.  If such Krugman posts exist then please show them to me, I’d love to read them.

Either he is unaware of the literature, or he is aware of it and is knowingly spouting misinformation. I’d prefer to be charitable and assume that he’s not aware of the literature.

Could we have had a severe recession without the 2008 financial crisis?

Paul Krugman argues that it would have taken a dramatically different set of policies back in 2007 to prevent the Great Recession, and Brad DeLong argues that a much more modest set of initiatives might have sufficed.  There is much to agree with in both posts.  First here’s Krugman, quoted by DeLong:

What It Would Have Taken: “Think of it this way: what would a really effective set of policies be right now? First… aggressively reverse the fiscal austerity of the last few years…. Monetary policy should accommodate that boost; interest rates should not go up even if inflation goes somewhat above 2 percent. In fact, there’s an overwhelming prudential case for raising the inflation target…. Say for the sake of argument that the right policy is two years of fiscal expansion amounting to 3 percent of GDP each year, plus a permanent rise in the inflation target to 4 percent. These wouldn’t be radical moves in terms of Econ 101 — they are in fact pretty much what textbook models would suggest make sense given what we have learned about macroeconomic vulnerabilities. But they are completely outside the bounds of respectable discussion. That’s the sense in which we are “doomed” to long-term stagnation. We have met the enemy, and it’s not the economic fundamentals, it’s us.

And here’s DeLong’s reply (or more precisely the response of Brad’s Greek friends):

Thrasymakhos: Oh, Krugman’s 100% right about today…

Khremistokles: He is indeed. We are totally tracked…

Thrasymakhos: Very few members of congress or FOMC participants seem to spend any significant time talking to anybody who is not a plutocrat…

Khremistokles: But he is wrong about how aggressive and radical the needed policies back in 2007 were. As a share of GDP, the bad shopping-mall and office-tour debts of Houston, etc, in 1989 were as large as the bad mortgages of 2007…

Thrasymakhos: But back in 1989 the political power of the princes of finance was much less than in 2007…

That’s probably right, but I have trouble with DeLong’s implicit assumption is that the financial crisis caused the Great Recession.  DeLong points out that the recession of 1990-91 was far milder, despite equivalent bad debt (as a share of GDP.)  And that the 1990 crisis was handled better. Krugman’s comment points to one overlooked factor.  In 1990 we did have a de facto 4% inflation target.  The years leading up to 1990 saw Australian-level NGDP growth, if not more.  So even if lending standards tightened sharply in the wake of the 1989-90 crisis, there still would have been no possibility of hitting the zero bound.  Rates fell to about 3% in the recession, still a bit higher than in Australia this time around.  With no zero bound in prospect, there’d be no reason for markets to expect an NGDP collapse.  Elsewhere I’ve argued that growing realization of plunging NGDP tanked the asset markets in the second half of 2008.

Even if we had managed the 2007-08 subprime crisis very well from a regulatory/resolution perspective, there is no question that banks would have tightened lending standards sharply.  That effectively reduces the demand for credit. And of course house prices were plunging even before Lehman, and then we got a “secondary deflation” of house prices when NGDP plunged.  It’s quite plausible that the Wicksellian equilibrium natural rate would have fallen to zero in late 2008, even with a better resolution of the banks.  On the other hand if we’d gone into 2007 with Paul Volcker’s de facto 4% inflation target (a policy he now opposes), then the Great Recession would have been a 1990-style mild recession.

One area where I slightly disagree with Krugman is his focus on inflation.  A 5% NGDPLT target path would have been enough; we didn’t need 4% trend inflation.  Nor do we need fiscal stimulus. On the other hand the supply side fundamentals of the economy were so poor after 2008 (for reason I don’t fully understand) that 5% NGDP growth would have led to some unpleasant stagflation. So we might have gotten Krugman’s 4% inflation anyway.  Indeed if my preferred policy had been adopted, it would have been widely judged a failure, partly because (as DeLong correctly pointed out) almost nobody back in 2007 envisioned a recession as severe as the one we got.

People see bad outcomes, and have trouble envisioning it could have been much worse.  That’s one reason why my preferred policy was not politically feasible in 2008.  But thanks to the NGDP targeting boomlet, it will be somewhat more feasible next time around.  Next time people will be able to envision a worse alternative.

All stabilization policies eventually fail, just as all presidents are judged failures in their 6th year in office.  The trick is to have a modest failure like Clinton or Obama, not a serious failure like FDR or Nixon.  NGDPLT would have given us just that in 2008-09.

PS.  I have a new post on Jeremy Stein over at Econlog.

HT:  TravisV

“Under NGDPLT, it becomes the job of Fiscal policy to control inflation.”

The title of this post was left in a recent comment by Morgan Warstler.  What he means is that NGDPLT takes nominal spending off the table, all that’s left is for the government to try to influence the split between P and Y.  And that means demand policies don’t work, all fiscal policy must be supply-side, aimed at more growth and hence less inflation.

If conservatives understood this then market monetarism would go from being a fringe movement eyed suspiciously by those on the right, to a position where we’d be headline speakers at CPAC.

While we’re at it, Morgan’s wage subsidy scheme makes the minimum wage and welfare obsolete.

PS.  I have a bubble post (with Shiller bleg) over at Econlog.