I’m not sure what more I can say about monetary policy. The 3rd quarter was another huge disappointment. NGDP grew at a 4.2% pace. Not only was it too slow to return us to trend, but we fell even further behind. So AD continues to fall relative to trend, despite a monetary policy that many continue to wrongly call “expansionary,” not to mention a fiscal stimulus that doesn’t seem to even be able to get NGDP up to its normal rate of growth. Yes, we got some real growth for a change, but only because wage cuts are shifting SRAS to the right. You econ teachers out there might want to think about this fact: You know when you teach the options for recovering from a recession? One option is for the government to do nothing, just wait for SRAS to shift right. The self-correcting mechanism. Well that is what is happening now (and probably in the 4th quarter as well.) So today let’s take a break from the dreary subject of demand stimulus, or the lack thereof.
Part 1 Inequality: Et tu Denmark?
I grew up in one of the most egalitarian societies on Earth. In the 1960s Madison had few poor people and even fewer rich people. Almost everyone was white. All classes would mix together in leisure time activities. After I grew up I traveled a lot and noticed that almost everywhere else seemed much less egalitarian. The only places that reminded me of home were Australia and New Zealand. (I’ve never visited the Nordic countries—perhaps they are similar.)
I recall when I first heard about how the Europeans would separate kids at a young age, with the smart ones going to one kind of high school, and the dumber ones going to another. It seemed hardly conceivable—like something out of a dystopian novel.
I had that feeling again when I read this piece from The Economist:
TO UNDERSTAND one of the gulfs separating the Anglo-Saxon world from continental Europe, consider Warren Buffett’s children. Omaha’s sage investor long ago said he would leave most of his fortune to charity, with more modest sums to his offspring. For Mr Buffett, leaving vast wealth to his children would be “anti-social” in a society that “aspires to be a meritocracy.”
In 26 out of 27 European Union countries, Mr Buffett’s plans would not just be shocking, but illegal. The exception is Britain, or rather England and Wales (Scotland has its own, centuries-old legal system, with a strong continental flavour). In continental Europe a big part of an estate (often around half) is reserved for the surviving children of the deceased and must be equally divided between them. This “forced heirship” makes it impossible to disinherit feckless children (though several countries exclude bequests to “unworthy” children, who have for example murdered a parent or two). Such rules also make it hard to reward the deserving by, say, leaving more to a daughter who gave up a career to care for her ailing parents. Finally, “clawback” laws in many countries stop parents from dodging forced heirship by giving assets away while they are still alive. This applies to gifts made in the last years of life (two years in Austria, ten in Germany), or much longer: in some countries, no time limit applies.
So let me get this straight. Suppose there’s some rich old guy in Europe with $10 billion, say a Wallenburg or a Rothschild. He’s got one son who spends all his time on a yacht in the Mediterranean Sea, snorting coke and romping around with gorgeous babes. The old guy hates his son. He is inspired by people like Gates and Buffett and decides to give 90% of his fortune to a foundation that is dedicated to reducing childhood diseases in developing counties. Only 10% will go to his son. And that is illegal? A billion isn’t enough for his son? Even in those supposed egalitarian northern European countries? Even in Denmark? Say it ain’t so.
I always wondered why Europeans gave so little to charity. I thought perhaps they are just selfish. Or maybe they figure there’s a welfare state to handle charity. Now we have an answer. They are not selfish at all; it is illegal to give too much to charity. Indeed in some cases even when still alive one is not allowed to give it all to charity. By the way, what if a rich German went to Africa and handed a 10 euro note to every single person on the continent. And suppose he died 9 years later. Does the German government go to Africa and try to “clawback” all that money? Something tells me I misunderstood what I read, and I will be making a fool of myself like with the multiplier post. But you only live once, so I thought I’d take a shot. I hope my European readers can set me straight.
BTW; On utilitarian grounds even a zero bequest is much too large for the spoiled children of the rich. They have already won life’s lottery merely by growing up in a rich household, with all the advantages that entails. I’d favor a 100% inheritance tax except for one thing. People have a sentimental attachment to their undeserving offspring, and thus an inheritance tax would discourage people from accumulating great fortunes. And remember that great fortunes are accumulated by doing great deeds (at least in market economies.)
Part 2. Those Poor Dinosaurs
Here’s how I think about the EMH. The theory is consistent with basic economic principles. Then, after it was developed, economists went out and did all the obvious tests:
1. Asset prices tend to follow a random walk
2. News is incorporated into asset prices almost immediately.
3. Experts (managed funds) underperform the dartboard (indexed funds.)
Of course it gets boring to keep confirming what we already know. In addition, the EMH goes against our (arrogant) intuition. So lots of young hotshot finance types started going out and finding “anomalies.” There is only one problem, their tests are basically worthless. This is because they used the same data sets to develop the theories as they used to test them. By itself, that makes the test of statistical significance worthless. I’ve harped on that before, so today I’ll focus on another problem; they set the bar for significance way too low. The anomalies were found to be statistically significant if there was less than 1 chance in 20 that the results were random. In some cases the bar was set even lower.
I recall a study in the ultra-prestigious American Economic Review that argued stocks did poorly on rainy days. I seem to recall that the results weren’t even quite significant at the 95% level, so they had to use a one- tail test. What is the a priori reason one would expect lower stock returns on rainy days? I have no idea.
Perhaps my memory is off; I hope a commenter will correct me if I am being unfair to the authors. But here is my point, 95% is a meaningless number. As I argued in earlier posts, people (including economists) grossly underestimate how many extremely improbable events occur. Open your eyes and you will notice them all the time. For instance, I won all of the first 12 games of blackjack that I played (in a casino), despite the fact that the odds were against me in every game.
While reading The Economist last week I came across an even better example, a million in one shot. Many of you know about the massive 10 km diameter asteroid that smashed into the Yucatan Peninsula 65 million years ago, the sort of asteroid that occurs only about one in every 100 million years. It is believed to have led to a long dark winter lasting many years that destroyed most plant life and wiped out the dinosaurs. Except that there is just one problem:
Extensive dating research at Chicxulub, however, now suggests that the object which created that crater actually struck 300,000 years earlier than the dinosaur extinction
But no need to worry, because soon after this discrepancy was discovered scientists found an even bigger once-in-a-100-million-year asteroid hit the earth 300,000 years later. How convenient. This one was 40 km in diameter, and packed 100 times as much energy as the pebble that hit Mexico. And you can’t blame scientists for only recently noticing this 500 km. diameter crater, as it is located in a remote and thinly populated area—India. Just to be clear, I don’t mean to “claim” that there was some sort of “scientific consensus” for the Yucatan asteroid wiping out the dinosaurs:
In truth, agreement on the cause of the mass extinction at the end of the Cretaceous (when not only the dinosaurs, but also a host of other species died) has never been as cut and dried among palaeontologists as it may have appeared to the public. One confounding factor is that the late Cretaceous was also a period of great volcanic activity.
That’s right; not only were there two asteroids but there was also “great volcanic activity.” How great? They don’t say exactly. You’ve probably read about the big eruption in Indonesia during 1815, which put so much material into the atmosphere that New England missed a summer and there were famines on several different continents. Or the far bigger eruption about 60,000 years ago (also in Indonesia) that wiped out 60% of all humans, and nearly killed us all off. Notice how as you look at longer periods of time the eruptions keep getting bigger. How big was the eruption 65 million years ago? I’m not sure, but The Economist says it was “one of the largest periods of vulcanicity in the past billion years.” Unless The Economist is abusing the English language, I’ll take that as more like a one in 100 million year eruption, rather than a one in a million year eruption. In other words, something that would make Yellowstone blowing its top seem like child’s play. And this has also been put forward as a cause of the dinosaur extinction:
Before the discovery of Chicxulub, the climate-changing effects of these eruptions had been put forward as an explanation for the death of the dinosaurs. After its discovery, some argued that even if the eruptions did not cause the extinction, they weakened the biosphere and made it particularly vulnerable to the Chicxulub hammer-blow.
This is starting to sound like The Murder on the Orient Express. So the volcanic activity doesn’t seem to have finished off the dinosaurs, but it softened them up for the Chicxulub hammer blow. But there’s just one problem; as we’ve already seen, the Chicxulub asteroid didn’t finish them off either. Perhaps like the parrot in that Monty Python sketch, they were merely “stunned” and stumbled around for 300,000 years until the 40 km asteroid finished them off. Are you starting to notice something interesting? Three 1 in 100 million year events, each capable of wiping out the dinosaurs, all occurring within a million years of each other, indeed within 300,000 years. What are the odds of that? Of course the first one could have occurred at any time, but if the others are 1/100 events, then we are talking about a 1/10,000 coincidence. Even The Economist took notice:
The picture that is emerging, then, is of a strange set of coincidences. First, two of the biggest impacts in history happened within 300,000 years of each other—a geological eyeblink. Second, they coincided with one of the largest periods of vulcanicity in the past billion years.
But there’s more. That last asteriod; the big one that probably finished off the dinosaurs, hit in a place called the Deccan Traps. And guess what, the Deccan Traps are precisely where the mega-volcanic eruptions occurred:
Third, one of them just happened to strike where these volcanoes were active. Or, to put it another way, what really killed the dinosaurs was a string of the most atrocious bad luck.
Yeah, I’d say that’s bad luck. Those poor dinosaurs. I’m not geologist, but couldn’t a 40 km asteroid hitting a soft spot in the Earth’s crust make the volcanic activity even worse? (The Economist says the Deccan eruptions started well before the dinosaurs became extinct, and hence before the second asteroid hit.) What are the odds of the big one hitting the Deccan Traps? I looked on a map and the Deccan looked about 500,000 square miles to me. And the earth is about 200,000,000 square miles. So maybe 400 to 1? Even if my math is a bit off, I have to agree with The Economist, this is a “strange set of coincidences.” It’s almost like God was favoring the mammals over the dinosaurs just as he favored the Israelites over the Egyptians.
I have a question for you science geeks. (Here I’ll play TV detective Columbo; “there’s just one thing I don’t understand.”) I don’t get how any of this could have made the dinosaurs extinct. If they were filling a useful role in the environment, why wouldn’t they have bounced back after a few thousand years, once the ash was flushed out of the atmosphere and the climate had return to normal? After all, reptiles like crocodiles survived. So why wouldn’t the gators crawl out of those slimy swamps onto the land, and start evolving longer legs so they could run around like raptors?
Note to Krugman, DeLong, and Romm: Please don’t take me for some sort of right-wing dinosaur disaster denier. Someone trying to mock the constantly shifting scientific story about how climate change killed off the dinosaurs. I am certainly not trying to argue that asteriod impact would be a “good thing.” Or to paraphrase General Turgidson in Dr. Strangelove; “I’m not saying that we wouldn’t get our hair mussed” if a 40 km asteroid hit a highly populated area. I’m just trying to figure out why the dinosaurs didn’t rapidly evolve to fill their old niches. If they couldn’t compete with the mammals, doesn’t that mean they were on their way out, asteroid or no asteroid? Just asking.
So my basic point is that we tend to be overly impressed by statistical significance. Long shots happen all the time. But I’m not a Luddite who thinks t-stats mean nothing. If you are testing a hypothesis that is part of a broader research agenda, then a high t-stat may suggest a correlation that is supportive of your hypothesis. But if you have no theory, if you’re just casting about for coincidences, then you are abusing statistical significance. As far as I am concerned the world would be no worse off if every anomaly study ever done was tossed in the trash. We have no objective way of interpreting their findings.
BTW, the only modern equivalent I can think of for the bad luck hitting the dinosaurs would be if just as a once-in-100-year subprime mortgage fiasco was dragging down our financial system, supercharged growth in Asia tripled oil prices, and the Fed got so frightened of inflation that they let NGDP slip to a growth path more than 8% below target. That would be a “strange set of coincidences” indeed.
Part 3: Trains set us free
Imagine hopping on a train in Chicago, arriving in New York less than 4 hours later to have lunch and do some shopping, and then returning to Chicago the same day. The equivalent trip in China will be possible by 2013. Indeed the 4 hour trip from Beijing to Shanghai will actually cover 1300 km (800 miles) which is considerably further than NYC to Chicago. (This summer I rode one of their bullet trains at 203mph on a part of the new track.) And as this article from Newsweek points out, the revolution in Chinese transportation may shake up Chinese society far more than the government expects:
China’s effort to develop medium-size cities across the country, in order to reduce the pressure of massive internal migration on big coastal cities, will also get a boost. The fast-rail links include rapidly expanding light-rail connections around major cities, encouraging moves from central cities to smaller satellite towns, or even commutes from one city to another. Retired people seeking a better environment are beginning to do the same.
Still, there is also the possibility that the unifying aim of the high-speed-rail project could create unexpected challenges for Beijing. Some of the fast-train routes are so popular that many passengers can be forced to stand throughout their journey. Outrage over this has led some media outlets to demand that the state-controlled railway system be opened to competition. “Only when monopoly is replaced by free competition,” said an article in the Chengdu Business Daily, “can we expect real quality train services.” What’s more, improvements in mobility could begin to undermine the Chinese government’s highly restrictive residency regulations, which even today tie people’s right to welfare, health care, and education to the place where they were born or have worked during their adult life. Now, according to Mingzheng Shi, head of New York University’s teaching center in Shanghai and a specialist in China’s urban development, more and more people are moving across old administrative boundaries. “Their concepts of cities and distance are changing,” he says. “People from Shanghai see no problem now in living in cities in southern Jiangsu province, where apartments are cheaper, and then taking the fast train to Shanghai in 20 to 40 minutes.” Large numbers of urban residents moving away from the cities where their welfare entitlements have traditionally been located may prove too much for the household registration system, and could lead to its “eventual complete collapse,” says Shi, removing a vital plank of the state’s traditional mechanism of social control.
Over the longer term, easier travel could be the driving force behind a new understanding of what China can one day become. Chinese officials have long argued that the nation’s vast area and population make it too unwieldy to be suited to multiparty democracy—and this idea has been deeply lodged in the Chinese psyche for generations. This may have been unsurprising in a country where a couple of decades ago it would often take half a day to get to the next town, and where it could easily take four hours to make a phone call from one city to another. Yet once people begin to sense that their country is getting smaller, those obstacles are likely to seem smaller, too. In fact, the effect of the high-speed trains could be that they do bring China together—just not in the way Beijing might have planned.
As Kerry Howley pointed out, transportation can be more than convenient, it can be liberating:
“It was amazing to me how quickly she overturned the power structure within her family,” Leslie Chang writes in Factory Girls, her 2008 book on internal migration within China. Chang is marveling at Min, a 17-year-old who left her family farm to find work in a succession of factories in the rapidly urbanizing city of Dongguan. Had Min never left home, she would have been expected to marry a man from a nearby village, to bear his children, and to accept her place in a tradition that privileges husbands over wives. But months after Min found work in Dongguan, she was already advising her father on financial planning, directing her younger siblings to stay in school, and changing jobs without bothering to ask her parents’ permission.
Chang’s book is full of such women: once-obedient daughters who make a few yuan, then hijack the social hierarchy. Even tiny incomes cash out in revolutionary ways. With little more than 1,000 yuan (about $150) in Min’s pocket, it becomes possible to plan a life independent of her family’s expectations, to conceive of a world where she decides where to live, how to spend her time, and with whom.
Expect very big changes in China over the next 50 years, changes in every aspect of society, and don’t believe anyone who says otherwise.
Part 4: Ghana gold, all gone
On a lighter note, I found this in my local newspaper, the Newton Tab:
On Oct. 20, Newton police met with a victim of an Internet scam, in which the victim reported a person recently died in Ghana and left the victim “two trunks full of gold.”
The victim’s e-mail contact in Ghana, who gave her name as “Vivian Catom,” advised the victim to wire money via Western Union to an account there.
And the victim did so, according to police. The money was needed to cover the cost of the trucks needed to haul two trunks of gold and some “delivery fees.”
The log leaves out how much the victim paid, but does include the advice of police: “ignore these e-mails in the future and to err on the side of caution when dealing with cash transactions with people you have never met and from countries that you have never had any business with in the first place.”
There’s nothing I hate more than taking a day off from work to wait for two trunks of gold, only to have the deliveryman not show up.
Seriously, it doesn’t surprise me that very young or very old people are occasionally scammed by these emails (although doesn’t ‘trunks of gold’ sound like something out of Treasure Island? If I was a scammer I’d at least say something more modern sounding like “strongboxes filled will 24 carat Kruggerrands.”) But I also recall reading a couple years ago about a local attorney who fell for one of these email scams. That’s one lawyer I would not want to have representing me.