Comments on: Help, I’m surrounded!

By: Scott Sumner

Scott Sumner — Thu, 26 Nov 2009 15:08:47 +0000

123, I read Bob’s post, and fail to see the humor. The EMH said it is hard to predict financial crises, almost no one predicted this financial crisis. What’s so funny about that? I don’t get it.

EMH types don’t defend our current economic system as being optimal. I oppose many of the government policies that helped blow up the housing bubble.

By: 123

123 — Sat, 21 Nov 2009 21:55:20 +0000

Events of last decade will cause many people to abandon EMH. Let’s hope they will be attracted by austrians, not by Krugman. On Landsburg’s blog I saw a link where Robert Murphy laughs at EMH from austrian perspective:
http://mises.org/daily/3835

By: ssumner

ssumner — Mon, 09 Nov 2009 23:33:59 +0000

123, I agree with your first point, although technically it is “rationally expected fundamentals” which of course is harder to pin down than fundamentals.

By: 123

123 — Sun, 08 Nov 2009 13:42:01 +0000

Price spike and collapse are consistent with EMH only when fundamentals also spike and collapse. Often this is not the case.

Other two factors also matter, but their impact is more limited than the effect of the dramatic decline of tax burden.

By: ssumner

ssumner — Sat, 31 Oct 2009 15:27:08 +0000

123, Doesn’t it depend on how you define “bubbles?” According to the usual definition in finance, bubble are not consisten with the EMH. But some people just mean a price spike and collapse, which of course is consistent with the EMH.

I don’t quite agree that the other two factors I mentioned don’t matter. They might not merely affect the level of profits, but also the expected growth rate, if globalization and is expected to continue and labor is expected to get still weaker (which is not improbably given the steady trend since the 1960s for unions to decline as a share of the private workforce.)

By: 123

123 — Sat, 31 Oct 2009 09:11:26 +0000

Scott,

factors you mentioned are important, but only taxation on capital are relevant for the puzzle of increased PE multiples, and it might explain some part of it but not whole.

By: 123

123 — Sat, 31 Oct 2009 09:08:42 +0000

I don’t agree with Rob that bubbles are a feature of EMH. Game theory is relevant for an individual trader if he wants to trade without moving the market, but add together all the traders and you get pure noise that should not create bubbles.

By: ssumner

ssumner — Tue, 20 Oct 2009 12:40:01 +0000

123, Those are good points about gold. i still think the lower real taxes on capital were pretty important in the 1980 to 2000 period, although I don’t really have a sense of exactly how important. The increasing weakness of the labor movement might have been another factor. And the strong globalization push in places like Asia and Mexico might have boosted multinational profits.

rob, You and 123 both know more about the EMH than I do, so I’ll just enjoy learn from your debate. You both have good arguments.

By: rob

rob — Tue, 20 Oct 2009 00:48:45 +0000

123,

Bubbles are not a flaw in the EMH: they are a feature. It is sometimes worthwhile to think of the market in terms of 2 person game theory. For the market to remain unpredictable, it must do what seems like strange things from time to time. Like a smart pitcher in baseball should sometimes throw 6 sliders in a row, so should the market.

You said: “What is odd that 100 heads in a row sequences happen much too often in markets.”

This is hard to be sure of, if you consider non-stationary volatility. The so-called “long tails” in the normal distribution may merely be artifacts of wandering volatility.

By: 123

123 — Sun, 18 Oct 2009 19:58:30 +0000

Share of federal spending is important and lowered returns on stocks. Inflation of 70s maybe confiscated profits of a year or two. But excessive margin debt is much more important explanation. In fact, I’d say that market returns from 1985 to 2000 were great because post 1929 margin debt regulations were circumvented by using derrivative contracts.

I certainly don’t agree with those who use gold to criticize TIPS spreads. First of all, noise trader models imply that bubbles are much more important for long duration assets like gold and stocks, and should be rare in short duration assets like TIPS. There are also some EMH compatible things to mention – TIPS measure American inflation, but gold is sensitive to global inflation, TIPS measure inflation expectations for specific time frame, but gold is sensitive to very long term inflation expectations. Physical gold is also a hedge for confiscatory taxation.

I don’t think that there is a big difference in elasticity of supply of gold and TIPS.