Tyler Cowen, Richard Rorty, and the truth about wealth

In several recent posts Tyler Cowen has tried to draw a distinction between how much wealth we believed we had, and how much wealth we really had.  I was somewhat skeptical of his argument, but also thought it had some merit.  Indeed in an earlier post (not posted yet!) I tried to distinguish between wealth we correctly thought we had, which was later lost due to bad policy (1929), and wealth we thought we had, that we never really had (2006.)  Now I have doubts about my argument, indeed I think we might both be wrong.  But I’m not sure.

Consider the following 5 scenarios:

1.  The bank makes a typo, which leads you to believe you have more money than you actually have.  The typo is eventually corrected.

2.  Your family believes it owns 10 1933 $20 gold pieces, worth $80 million.  Later you find out the government has a different view.

3.  The public believes it has lots of housing wealth in 2006, but there was never any prospect that these values could be maintained.

4.  The public believes it has lots of housing wealth in 2006, but later an immigration crackdown followed by tight money reduces housing prices.

5.  The public believes it is very wealthy in 1929, but later the Fed cuts NGDP in half and caused mass unemployment.

A few days ago I thought there was a clear distinction between case 1 and case 5.  Now I don’t know where to draw the line.  Indeed I don’t know if there is a line to be drawn.

I’d like to say the public really was wealthy in 1929, and that later decisions by the Fed destroyed that wealth.  But is that a scientific way of looking at things?  At levels about subatomic particles, we tend to assume that things follow deterministic laws.  Why couldn’t someone argue:  “That national wealth in 1929 was never real, because the Fed is a part of our economy.  It was a dysfunctional institution in 1929, so it was only a matter of time before they screwed up.  We just didn’t know it yet.”

Rorty argued that when people say “Most people think X is true, but I believe Y is true,” they actually mean “most people think X is true, but I predict that in the future people will come to believe Y is true.”  Rorty saw no distinction between what is true, and what we believe is true.

Rorty also believed; “That which has no practical implications, has no philosophical implications.”  So what are the practical implications of the distinction between believing one is wealthy, and actually being wealthy?  Obviously society acts on the basis of beliefs.  So for most people it is a distinction without any significance.  Like the difference between saying I believe X, and I believe X is true.   On the other hand the skeptic who believes the wealth is phony (i.e. predicts it will later be seen as phony), would obviously see practical implications for his belief.  Indeed policy implications.

Imagine I’m debating Tyler Cowen on the question of whether the 2006 wealth was real in 2006.  What’s at stake?  I might argue that the wealth was 100% real, but later policies like immigration crackdown and tight money reduced the wealth later on.  The practical implication is that we might want to reconsider those policies.  Or, one could argue that the extra wealth was only 40% real and the other 60% was irrational exuberance.  In that case the policy implication might shift slightly.  It doesn’t mean easier money couldn’t have helped a bit, but you’d also want to put in place banking regulations robust enough to prevent housing bubbles from damaging the banking system.  Indeed you might also want to do that if the problem was 100% the Fed’s fault, but the necessity would be greater if optimal monetary policy couldn’t solve the problem.

Are we rich if we believe we are rich?  I can’t answer that question.  Rorty would say beliefs are all we have.  Yet he also allows for dissenting voices.  Just because most people get swept up in the housing bubble, and believe ranch houses in San Bernardino are worth $500,000, doesn’t mean Shiller, Krugman, Baker and Roubini have to believe that.  One the other hand, current market values have a very practical implication, they’re what we can sell things for.  In that sense they are real.

Each day that goes by we find out that the previous day’s value of the S&P 500 was wrong, as new information comes in.  Or maybe it was right; maybe it was “true,” based on what we knew at the time.  What’s the TRUE value of the S&P 500?  God only knows.

PS.  I just noticed an interesting shift in wording between the first and second posts that I linked to above.  First post:

We were not as wealthy as we thought we were.

And second post:

We are not as wealthy as we thought we were

See the difference?  If applied to someone in 1933 talking about 1929, I’d have once said the first was false, and the second was true.  Now I don’t know what to think.  I wish Rorty was still alive to help me out.  Now I feel alone in the universe, with no one to provide true answers.

PS.  The second Cowen post that I linked to above didn’t make sense to me.  I left a comment over there—maybe someone can explain the connection to AD.


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58 Responses to “Tyler Cowen, Richard Rorty, and the truth about wealth”

  1. Gravatar of Philo Philo
    9. July 2011 at 06:49

    Rorty still lurks; I thought you had forgotten about him! I said I wouldn’t do this, but (it seems) I spoke falsely:

    “Rorty argued that when people say ‘Most people think X is true, but I believe Y is true’, they actually mean ‘most people think X is true, but I predict that in the future people will come to believe Y is true’. Rorty saw no distinction between what is true, and what we believe is true.” Rorty didn’t argue this; he just asserted it, to see if it would fly. Among philosophers, it (mostly) hasn’t.

    What “we” believe to be true changes over time; what really is true does not. To identify truth with (*general*) belief, you would have to specify a particular time. Peirce tried specifying *infinity*–the limit to which general belief tends in the infinitely long run; but there is not likely to be an infinitely long run, and even if there were there is no reason to expect belief to approach a limit (supposing we could make sense of the implicit metric on beliefs that is being presupposed). But no particular time (e.g., Jan. 1, 2012, noon GMT) would have any plausibility.

    But none of this is really relevant to the interesting topic of (real) wealth.

  2. Gravatar of Meets Meets
    9. July 2011 at 07:38

    Scott, in a previous post, you wrote: “Krugman and I both see it as a fall in the Wicksellian equilibrium interest rate, to unusually low levels. I attribute it to some combination of savings glut and lack of good investment opportunities.”

    In 2006, we believed there were plenty of good investment opportunities. Did the fact that we believed that make it true? I don’t think so. And easy money can’t save us from this incorrect belief, which led us to buy more houses and give ourselves bigger entitlements.

    I believe Tyler’s point about wealth and yours about good investment opportunities are closely related.

  3. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 07:46

    Philo, The term ‘truth’ refers to statements, not reality. I think you are saying that reality doesn’t change, only our perceptions of reality. But we have no knowledge of whether our perceptions mirror reality, we simply have our perceptions, which are occasionally replaced by more persuasive perceptions, or more useful perceptions.

    In my view the best way to understand Rorty’s view of truth is to look at his denial of the distinction between subjective beliefs and objective beliefs. There is no qualitative distinction, merely more or less useful and persuasive beliefs. But it’s always beliefs, we never pull back the curtain for a God’s eye view of reality.

    Consider two cave men talking to each other. One says “It’s my subjective belief that Fred is cheating on his wife, but it’s an objective fact that the sun goes around the earth.”

    No, both are subjective beliefs. We now know more than they did, but we will never go beyond subjective beliefs.

    You said;

    “I thought you had forgotten about him! I said I wouldn’t do this, but (it seems) I spoke falsely:’

    When you said it, I don’t doubt that you believed it to be true.

  4. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 07:56

    Meets, I am not calling for easy money, I am calling for a stable money policy. I am saying we shouldn’t adopt an extremely contractionary policy at the exact moment when even Tyler Cowen insists it is important for the non-overbuilt industries to grow, and absorb workers from overbuilt sectors. And Tyler Cowen agrees.

    Suppose your family made bad investments, and went bankrupt. Would you get everyone together and say “it’s time for a nice long vacation.” No, you’d buckle down and work harder than ever. We overbuilt housing. The solution is to move workers into other growing fields, producing useful products–where what’s useful is determined solely by market forces, not the government (which is why I oppose fiscal stimulus.) You do that best with a monetary policy that doesn’t distort market decisions. And economists like Hayek and myself believe that neutral monetary policy is NGDP targeting.

    Instead we have tight money and 9.2% unemployment–a tragic waste of human resources.

  5. Gravatar of Meets Meets
    9. July 2011 at 08:19

    Scott, I’m a longtime reader of your blog, and I agree wtih you on monetary policy.

    But weren’t we still were wrong about our investment opportunites? As a society did not foresee those opportunities drying up so quickly.

    Even if the FED did proper monetary policy as your recommend, didn’t we make an error about our long-term prospects, and in reality we’re in for a period of sustained lower growth? (At least until the next technological advance, which could usher in higher growth).

    I don’t think it’s either a typo or a FED error. But it’s an error.

  6. Gravatar of Alexander Hudson Alexander Hudson
    9. July 2011 at 08:28

    “Are we rich if we believe we our rich?”

    On some level, I think this has to be true. The economic value of something is determined by people’s willingness to pay for it, right? The iPad represents value added because the end product, a slick-looking tablet, is considered more useful and/or valuable then the starting products (a bunch of sand and aluminum). But if everything thought the iPad was a worthless piece of junk, then this would not be the case.

    Let’s say everyone absolutely loved some new widget. Widget-making takes off to such a massive extent that a lot of people’s wealth is tied up in making bigger, better, cheaper widgets. If everyone continues to love widgets, no problem, right? We get better and better at making widgets, so in our view we’re getting wealthier. We’re getting wealthier because we’re able to produce more of the “stuff” that we like/want (in this case, widgets). But what if all of a sudden, unexpectedly, people started to hate widgets? Suddenly you can’t sell widgets and all the wealth tied up in widget-making vanishes. Before, our ability to make tons of widgets meant we were rich, because we viewed widgets as something that was valuable. But now that we hate widgets, our widget-making ability is useless.

    On some level, isn’t this all just in our minds?

  7. Gravatar of Jason Jason
    9. July 2011 at 08:36

    This is a very interesting post.

    I was thinking about it and wondering if somehow the information transmitted by prices is different among the several cases. However, I think I’ve come to the conclusion that the money in #1 is just as real as the money in #5.

    Consider:

    A) The bank makes a typo giving some accounts more money that is eventually corrected.

    B) Someone at the bank mischievously gives some accounts more money by a “deliberate typo” that is eventually corrected.

    C) The bank decides to give some accounts more money by fiat and then stop that policy after generating extra ATM fees.

    In A), we have a random fluctuation. A high frequency trading scheme where a person has several accounts and carefully measures the statistics and transfers money can come out ahead.

    In B), some private information (the mischievous one) could allow some to take advantage.

    In C), we have an expectations problem assuming the bank announces its intentions publicly. But the extra ATM fees will allow the bank to charge less in annual fees to everyone given that some people will spend more because they think this scheme will work.

    I submit (but am unable to prove at this point) that the amount of extra wealth generated in A, B and C are the same (or have the same limits under specific conditions). Human behavior probably makes some of these in practice have better returns.

  8. Gravatar of Indy Indy
    9. July 2011 at 09:06

    In Micro, one often uses the model of an individual smoothing consumption over his lifetime by, say, going into debt early on, then paying it off, then accumulating savings, and then retiring and drawing down those savings.

    Two aspects of the situation are usually discussed.

    First, how does the rational individual go about forming his utility optimization strategy. The answer depends on forming some kind of probabilistic model of his expected future sequence of real income.

    The second question is “What is the reaction to an unexpected shock?” That is, how does the individual react and adjust his optimization strategy to a sudden and dramatic shift in his expected future real income sequence? The examples I’ve read have been “A sudden unexpected inheritance” or “loss of job” or “big losses in the Stock market” and so on.

    And it’s just completely straight-forward to see what happens – when an individual experiences a negative real shock he adjusts his real consumption to a lower smooth level. It’s also straight-forward to ask “What are the consequences of a positive-shock which lingers for a few years, followed by an equal but opposite negative-shock?” which reflect some of the example you wrote up above.

    What happens then is that, during the positive-shock phase, people raise their consumption, but following the status-quo-ante restoration, people not only lower their consumption to the previous levels, but even lower than that, in order to compensate for the “excess consumption” they partook of in the windfall-phase.

    I’ve known a few people on the West Coast whose experience of the housing bubble and its aftermath runs precisely to this script, so it seems to me to lend Cowen’s idea a great deal of plausibility.

    A “negative shock” is not a philosophically complex or ambiguous concept and I don’t understand it to be different from “new information which significantly alters one’s expected future real income sequence upon receipt” which is also equivalent to Cowen’s phrasing.

  9. Gravatar of tenthring tenthring
    9. July 2011 at 09:17

    New money created by the fed is being fed into unproductive bubble sectors I.e. Banking. Therefore easy money will perpetuate imbalance rather then cause new industries to flourish.

  10. Gravatar of q q
    9. July 2011 at 09:41

    if I have $10M in the bank and die tomorrow before spending it, was I really rich today? i’d say NO.

  11. Gravatar of Craig Austin Craig Austin
    9. July 2011 at 09:51

    Where is the post I submitted?

  12. Gravatar of Craig Austin Craig Austin
    9. July 2011 at 09:52

    I mean where is the comment I submitted a about an hour or two ago.

  13. Gravatar of Tim Tim
    9. July 2011 at 10:00

    How about someone who buys a lottery ticket and is really sure that today is their lucky day? Is their perceived wealth different from that of someone who owns a stock with a high quoted price at a time when the market is closed?

  14. Gravatar of Cy Cy
    9. July 2011 at 10:09

    Your second link to Tyler is sending me to the double eagle article. I’d like to read the one that doesn’t make sense. :-)

  15. Gravatar of steve steve
    9. July 2011 at 10:30

    I would say, “We are not as wealthy as we were” in the 1929 case. Basically, I would say the price as reflected in the market is always correct at the time (since you can sell it.), and if you have perfect market timing you can preserve your wealth against any storm. (except perhaps in the case were the government disagrees about you owning something.)

    Of course no one has perfect foresight or market timing, so ones wealth changes even without some action on your part. I don’t see this as a big mystery.

  16. Gravatar of Peter Kuchirka Peter Kuchirka
    9. July 2011 at 10:48

    Money and quantum mechanics must be closely related. Money and wave-particles are only real, have value, if spent or measured.

  17. Gravatar of Richard Ebeling Richard Ebeling
    9. July 2011 at 11:09

    The distinction between what is considered true and what is true is central to many things in economic analysis.

    For example: “The monetary authority has increased the supply of loanable funds in the banking system and, as a result, pushed the “money rate” of interest below what (if not for the monetary expansion) would have been a market rate of interest closer or at the “natural rate” of interest (in Wicksellian terms). As a consequence, borrowers have been “misinformed” about the availability of “real savings” in the economy, and have undertaken investment projects requiring real resources and time horizons for which actual savings is not great enough to bring all of these investment projects to sustainable completion. Thus, it will be discovered at some point in the process that the investment boom generated by the monetary expansion and market interest rate reduction contains the seeds of an investment downturn.”

    Talk in terms such as these — in terms of what people may believe to the actual situation (that they think is “true”) versus what is the underlying actual situation (what is “true”) is done all the time in economics.

    A minimum wage being above what is (and would be without the minimum wage in affect) the “actual” market clearing wage (the “real” underlying supply and demand conditions). Or what the “real” level of output would be of a product or resource, if not for a production subsidy from the government to a company or industry.

    We understand reasons for market errors, and a wide variety of “unintended consequences” from appreciating and using such a distinction between what people believe to be true (and upon which they make their choices and undertake actions) and what is “actually” true, and which they will discover at some point in their market interactions and decisions with others.

    We all act on what we believe to be the case (“true”), but unless we presume that all agents possess perfect and complete knowledge, they experience discoveries of what is “true” that they did not originally think was so.

    So I am not persuaded by Rorty’s argument, or its useful in much of economic analysis.

    Richard Ebeling

  18. Gravatar of Matt Waters Matt Waters
    9. July 2011 at 11:52

    I don’t think the “real” level of wealth is that difficult of a concept. Barring some sort of massive default, our level of wealth long term will correlate with GDP. And it’s relatively straightforward to figure out GDP, C+I+G-NX.

    Wealth, however, comes in many different forms. A stock broker in Massachusetts may make $200,000 a year, but part of that “wealth” goes to taxes which pay highway patrolmen $150,000 a year or for significant defense spending. A significant part of the “wealth” also pays for expensive and inefficient health care with very screwed up incentives. The litigious society also constitutes part of that “wealth,” as that stock broker has to pay more for everything to defend against lawsuits.

    So looking at disposable incomes, or incomes after taxes, health care and other things which do not directly add to our standard of living, there has been a great stagnation. Some of it may be due to declining innovation, as Tyler Cowen argues. However, a lot of it is due to the reshaping incentives in the economy to reward those who do not increase our standard of living.

    This is what Tyler means when he says “we are not as rich as we thought we were.” With more of our income going to health care, defense, education, prisons, lawyers, etc., we responded by trying to find ways other than income to sustain our standard of living. It’s unfortunate that Tyler took the innovation angle (which may have some truth to it), rather than arguing for reform to make our economy more focused on useful production.

    In the 1929 case, a huge proportion of our workforce became idle due to 25% unemployment. If we had full production, most of the decline in wealth wouldn’t have happened. Americans in 1929 probably were “as rich as they thought they were.” But you can’t create wealth without working.

  19. Gravatar of Nathan Tankus Nathan Tankus
    9. July 2011 at 12:29

    while i think this post is a laudable attempt at making sense of the crisis, i think you’ve gotten mixed up in logical headwinds. i will attempt to put my 2 cents into the mix that i hope can shed some light. first we must ask a very basic question. what is wealth? as basic as it is, it’s also complicated. is wealth all the land, labor, infrastructure and physical capital a country has? if so we obviously didn’t lose wealth in 2008 because the physical people, things etc are all the same. if anything we’ve started to slowly lose wealth as investment has slowed and labor skills (from unemployment) have disintegrated. this seems to empiricist however. and doesn’t get to the main point Tyler is making. he’s talking about nominal wealth. so now we have the concept of money. if money balances and financial assets are wealth then physical assets are only wealth to the extent that they can produce money balances. in 2006 homeowners thought that their homes could produce much larger money balances then they could in 2008. in that sense people thought they were much less wealthier in 2008 then 2006. this is true but it’s also perception. the same physical building still exists. if money is wealth then we’re not as wealthy. if physical assets and production are wealth, we’re about as wealthy and only losing wealth because of high unemployment and low investment. either way it seems to me that higher aggregate demand would alleviate this scenario and I’m having trouble understanding why Tyler seems to think that there is some unique part of this problem that can’t be solved by targeted fiscal policy.

  20. Gravatar of nostrum nostrum
    9. July 2011 at 13:36

    Matt Waters,

    “So looking at disposable incomes, or incomes after taxes…there has been a great stagnation.”

    Governments collect taxes to provide you with able-bodied police and security personnel. Thus you and your family members sleep comfortably without being scared of the housebreaking bogeymen at night. That enhances your safety, and therfeore longevity–which is one measure of a good standard of living.

  21. Gravatar of woupiestek woupiestek
    9. July 2011 at 14:10

    Wealth is subjective, therefore the validity of a statement like “we were not as wealthy as we thought we were” depends on the person who states it. Subjective propositions cannot be true by themselves… if you ask me 😉

  22. Gravatar of Steve Steve
    9. July 2011 at 14:18

    Here’s the most important thing to keep in mind:

    Wealth is subjective and may be an illusion.

    DEBTS ARE REAL. They don’t just disappear the way wealth does…

  23. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 14:53

    Meets, Yes, you are partly right, but it’s hard to say how much. How much of the damage was self-inflicted? (monetary policy, immigration crackdown, etc)

    Alexander, Makes sense to me–it’s the extreme cases I have trouble with–like the bank error that is later corrected. Were we ever wealthy in that case? But on the other hand I see no philosophically defensible dividing line.

    Jason, Yes, the more I think about it, the harder time I have coming up with clear distinctions.

    Indy, Now you are getting into the pragmatic implications of all this–which is much clearer. In some cases it may not matter whether it was wealth we never really had, but thought we had, or wealth we really had but lost. As you suggest, economists have already worked out the consumption path implications.

    tenthring, But money is tight, not easy.

    q, I’d say yes–you died a rich man (which is not the right way to die.)

    Craig, New commenters must be approved, which I do several times a day.

    Tim, No it’s be the same, but it would be rather silly to assume you’d win a lottery. (Of course it’d be harder to sell than stock.

    More to come . . .

  24. Gravatar of Matt Waters Matt Waters
    9. July 2011 at 15:44

    “Governments collect taxes to provide you with able-bodied police and security personnel. Thus you and your family members sleep comfortably without being scared of the housebreaking bogeymen at night. That enhances your safety, and therfeore longevity-which is one measure of a good standard of living.”

    Yes, that’s all true. I don’t want to come off as some crazy-eyed libertarian who thinks all government spending is useless. Actually, I’m probably to the left of Scott on the optimal size of government.

    However, the size of government has increased dramatically the past 10 years. With defense, education, spending on prisons, Medicare/Medicaid, etc. all taken in, we spend much more of our wealth on government programs. We also spend much more on health care than before. If employers did not have such a massive hidden health insurance cost, we would have more take-home income.

    Whether or not we should spend so much on defense and health care, it is undeniable that those sectors have reduced our discretionary income. The utility of health care costs increasing 10%/year is another discussion, but the health care spending undeniably takes spending from somewhere else.

  25. Gravatar of J Thomas J Thomas
    9. July 2011 at 16:09

    You ask about the difference between being really wealthy versus only thinking you are.

    I say, if people will do things for you, that’s wealth. If you can get them to supply you with food, supply you with a place to live, cook for you, etc etc etc then that is the wealth that matters.

    If they suddenly stop doing that, then suddenly you are not wealthy.

    In 1928 people were doing a whole lot for each other. By 1931 they had lost a lot of organization — 25% of the workforce wanted to contribute but couldn’t find opportunities, and got minimal cooperation in return. And as a result some people were richer than before. A lot of other people were desperate to do stuff for them and wanted less in return. Lobster was cheaper, filet mignon was cheaper, caviar was cheaper, labor to build mansions was cheaper, wood and stone and concrete to build mansions were cheaper, etc. If you were a financier who lost everything in 1929 then you were poor. If you were a financier who was on the other side of those losing bets, then you were far richer than before.

    If you think people do things for you but they don’t, then you falsely believe you are rich. You call a cab and the cab does not come. You try to buy food and the grocery store throws you out or has you arrested. Etc.

    The amount of cooperation people actually do is partly observable. If you buy a hamburger, you can tell whether you get a hamburger. You don’t know whether the cook spat into it.

    Should we say that French aristocrats who thought they were rich, but who were later beheaded by the Revolution were really not rich at all? No. They were rich while people did stuff for them, and they stopped being rich when people stopped doing what they wanted.

    What if you’re running a scam and you’re rich now but it’s inevitable you will be caught and persecuted? Then you’re rich now. If you aren’t running a scam but somebody with the second sight knows that you’ll have tragedy later, then it’s the same except you’re fae and there’s no scientific reason to believe them.

  26. Gravatar of davver davver
    9. July 2011 at 16:29

    This is not complicated.

    If I grow corn and I think I have 10 bushels of corn to last me the winter, but then I open the barn door and there is no corn, I’m going to starve. I can’t just imagine there is corn in the barn, or start trading imaginary corn futures and then pretend there is corn there. Either there is or isn’t corn in the barn and you’ve got to come face to face with reality come wintertime.

  27. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 17:02

    Cy, I used to collect coins, so I liked that article.

    Steve, I don’t see 1929 as a big mystery either, but it’s hard to come up with a way of thinking about this that applies to all cases.

    Peter, Interesting analogy.

    Richard, I certainly don’t accept that Austrian view. It implies there is a chosen elite of Austrians who see what is really going on, and all the rest of us schmucks are fooled by the Fed. I don’t think the Fed fools people.

    Matt, I think you are mixing two issues:

    1. Is real GDP growth stagnating? (And real GDP is not easy to measure.)

    2. Are asset price increases real wealth gains?

    Wealth and GDP are correlated, but not perfectly.

    Nathan, There is much more to wealth than land, labor and capital. When China adopted market reforms in 1979 wealth immediately soared, with little change in land, labor and capital.

    woupiestek, Everything is subjective.

    Steve, You said;

    “DEBTS ARE REAL. They don’t just disappear the way wealth does…”

    Tell that to Germans who had big Reichmark debts in 1920. They sure disappeared fast.

    davver, Everyone agrees that when you discover the barn is empty, you have no wealth–that’s not the question.

  28. Gravatar of Scott Sumner Scott Sumner
    9. July 2011 at 17:04

    J. Thomas, That seems reasonable, but see some of the other comments as well.

  29. Gravatar of Nathan Tankus Nathan Tankus
    9. July 2011 at 18:02

    “Nathan, There is much more to wealth than land, labor and capital. When China adopted market reforms in 1979 wealth immediately soared, with little change in land, labor and capital.” is there? i think we’re still confusing two issues. the way physical wealth is organized and the actual physical wealth. first of all wealth implies a stock of things rather then a flow of income (whether physical income or money income). increases to the stock of physical wealth must come from either a flow of investment (private or public) or the purchase of it from another country. the way wealth is organized, utilized and controlled is a somewhat different issue. when this is done well it results in more rapidly growing flows of output and larger increases in stocks of wealth (without of course, the destruction of natural wealth and with externalities and fraudulent behavior kept to a minimum). ultimately the better coordination, utilization and control of wealth needs the wealth itself to be effective. i guess however, this all depends on your definition of wealth or which came first, the stock or the flow.

  30. Gravatar of Matthew C. Matthew C.
    9. July 2011 at 19:26

    A great thought experiment. I’ll play on that riff some more.

    Consider a Madoff fund investor with $5 million in the fund in 2007. He considers himself wealthy and well prepared for retirement. Suddenly, in a moment, he discovers himself penniless, or nearly so.

    Now consider a person with a half million invested in Reichsmark bonds in Germany in 1917. This person feels on top of the world. By 1923, his bonds aren’t enough to buy a single sheet of toilet paper.

    Now imagine a person with a 15 million dollar 401K invested in a money market fund (he is planning to retire in 2016). He feels ready to retire and well off. Unfortunately, all his money consists of USG Fiat currency. And the USG can’t possibly meet its obligations without cranking up the printing presses. . .

  31. Gravatar of Philo Philo
    9. July 2011 at 20:25

    The present value of anything is the sum (the integral over time?) of the appropriately time-discounted (and risk-discounted?) values that it is expected to be capable of yielding in the future. Expected by whom? By society; by “the market.”

    I think you and Tyler would be debating the reasonableness of the expectations underlying the market values of housing in 2006. Since I more or less accept the EMH, I will award the victory in this debate to you; Tyler, like all those who rattle on about this or that “bubble,” is just playing Monday morning quarterback.

  32. Gravatar of Philo Philo
    9. July 2011 at 20:31

    You wrote: “The bank makes a typo, which leads you to believe you have more money than you actually have. The typo is eventually corrected.” I don’t see that the second sentence is relevant to the question how much wealth you had at the time referred to in the first sentence. What is relevant to valuing your bank account now is the reasonable current expectation about how much good it can be made to yield you in the future. What is relevant is not whether the typo is, in fact, eventually corrected, but *the currently reasonable probability* that it will eventually be corrected.

  33. Gravatar of Philo Philo
    9. July 2011 at 20:32

    “What’s the TRUE value of the S&P 500? God only knows.” No, anybody with access to the news media can know: the market value (at a given time) is the “true” value (at that time). (Or don’t you believe in the EMH?)

  34. Gravatar of Nathan Tankus Nathan Tankus
    9. July 2011 at 20:56

    @philo i think it’s very clear from this discussion that most people involved in this debate do not accept EMH or at least have problems with it because reality has seemed to contradict it’s predictions. whether or not this is valid is obviously arguable, but i find it in bad taste to call people out with statements like “No, anybody with access to the news media can know: the market value (at a given time) is the “true” value (at that time). (Or don’t you believe in the EMH?)”

  35. Gravatar of Cy Cy
    9. July 2011 at 21:04

    The coin article is interesting. But you have two links to it. You say “The second Cowen post that I linked to above” but there’s only one link to an article by Tyler, and two links to the coin article. I assume the “recent posts” link in your first sentence is supposed to be going to some Tyler Cowen article?

  36. Gravatar of Doc Merlin Doc Merlin
    9. July 2011 at 22:18

    “”What’s the TRUE value of the S&P 500? God only knows.” No, anybody with access to the news media can know: the market value (at a given time) is the “true” value (at that time). (Or don’t you believe in the EMH?)”

    Complete nonsense, its the marginal PRICE. Actually attempting to buy S&P companies would change the price substantially.

  37. Gravatar of Lorenzo from Oz Lorenzo from Oz
    10. July 2011 at 01:08

    Since I do not believe in intrinsic value, I am happy that wealth is whatever the market value is at the time. That changes. So?

    Now, if you want to talk about the difference between expectations and what actually happened, that is of clear interest. That frames the debate in a useful way. “Real and believed wealth” does not.

  38. Gravatar of Lorenzo from Oz Lorenzo from Oz
    10. July 2011 at 01:12

    I accept that there are asset price bubbles, which can only happen because we cannot reliably and systematically predict turning points in advance. They happen because expectations of capital gains get factored into (indeed, drive) asset prices. But those expectations are real, the prices they generate are real. When those expectations evaporate, the prices collapse. That means the expectations overshoot, it does not make them, or the prices they generate, “unreal”. They are all too real, they are just not stable/indefinitely persistent, a different thing.

  39. Gravatar of Lorenzo from Oz Lorenzo from Oz
    10. July 2011 at 01:24

    And please no more invocations of Rorty’s tiresome efforts to turn epistemology into sociology; a neo-Kantian turn motivated by the same reason as Kant’s original nonsense: to shore up faith in the face of evidence-based critique. Kant wanted to protect religious faith in the face of Enlightenment critiques, Rorty wanted to get confidence-in-ever-larger-government faith in the face of the failure of command economics. Both of them play on the ambiguity in the concept of ‘truth’ between a characteristic of beliefs, propositions, concepts, thoughts and what is. Yes, there is no way to guarantee what we believe is true. That does not mean we cannot usefully talk about the connection between our beliefs and reality.

  40. Gravatar of Scott Sumner Scott Sumner
    10. July 2011 at 08:24

    Nathan, That’s a very odd definition. It would suggest that Sudan has great land wealth, even though the land is not effectively utilized. I don’t buy it, and I don’t think many others do either. But you are right, we are arguing over definitions, which is a waste of time.

    Matthew, The Madoff case may be even more interesting than you indicated. Some people got their money back from Madoff before the crash (with large cap gains), and now the courts are going after them, claiming they never should have been paid back–they want them to share their gains with the losers.

    Thus our legal system is also wrestling with this question.

    Philo, You raise some good points. Maybe the mistake we make is as follows. “Wealth” is never, ever, anything more than perceived wealth.

    Just as scientific theories are never, ever more than perceived scientific theories. Both wealth and scientific theories can be revised, as new information comes in. Then we have new perceived scientific theories, and new perceived levels of wealth. There is never any objective fact of the matter, just increasing well-informed perceptions, always subject to further revisions.

    Cy, Thanks, I just fixed it.

    Doc Merlin, You said;

    “Complete nonsense, its the marginal PRICE. Actually attempting to buy S&P companies would change the price substantially.”

    Ah, but trying to sell it all would change the price in the opposite direction. So the market price is our best estimate. A nice compromise.

    Lorenzo, Rorty’s philosophy is pragmatic, which means pro-capitalism, if capitalism works best. That’s precisely why Rorty got less socialist as he got older, and new evidence came in. We should celebrate that fact.

    You said;

    “That does not mean we cannot usefully talk about the connection between our beliefs and reality.”

    I completely agree, but I see his point differently. We shouldn’t divide up our beliefs into subjective beliefs and objective reality. They are all beliefs about reality. To say something is true, is nothing more than saying we believe it is true. How could it be otherwise?

  41. Gravatar of J Thomas J Thomas
    10. July 2011 at 08:29

    “If I grow corn and I think I have 10 bushels of corn to last me the winter, but then I open the barn door and there is no corn, I’m going to starve.”

    Davver, yes, if you find out that the corn you thought you had is not there, then you have to hustle.

    So, what if the corn really is there, but an invading army takes it? You had it, it really was there, but now it isn’t. What if it’s defending army that takes it and issues you scrip that in theory you can cash in for something of value? Practically the same thing. What if a sinkhole develops in the ground and swallows your barn? What if the police falsely accuse you of murder and get you executed, or life in prison, and your corn rots in the barn while the real murderer lives the life of Riley? At least that way the government will feed you something for awhile.

    But I’m not sure these philosophical musings will really help us. Sure, anything you think you have might evaporate, including your life. So what?

    I see a murky difference between things that happen to you that nobody could have predicted, versus things that you should have predicted.

    You mostly can’t predict invading armies, but to the extent you can predict them you can bury some of your corn in caches they won’t find, and hope they don’t torture you to make you tell them.

    You can’t predict how bad inflation will get, but you can buy gold coins and bury them in your back yard and hope that you can legally sell them for food or emigration when times get tough. If you think it will get bad.

    It will always sadden me that I saw the eventual housing crash from 2002 and even earlier, but I found no good way to make money off it. I could have participated on the assumption that I would get out in time, but it’s hard to do that. When the time comes to sell out, you pay taxes on all your winnings, that you don’t pay if you hope it will last one more round…. And betting that you know just when the crash will come loses quicker than betting it never comes.

    Like an extremely slow-motion train wreck. You just sit there and watch it happen, with no way to make a profit off of it. Life hardly gets sadder than that.

  42. Gravatar of J Thomas J Thomas
    10. July 2011 at 08:41

    Doc Merlin, You said;

    “Complete nonsense, its the marginal PRICE. Actually attempting to buy S&P companies would change the price substantially.”

    Ah, but trying to sell it all would change the price in the opposite direction. So the market price is our best estimate. A nice compromise.

    So, if more are eager to buy than are eager to sell, the price ought to rise. And vice versa. Subject to manipulation by speculators who hope to fleece momentum investors.

    What does this tell us about true value? Absent deliberate manipulation, we have some sort of balance between the fool who will pay the most versus the fool who will sell for the least? And that’s who determines the nice compromise?

    At best, market price gives us an estimate of the balance of some public’s opinions about value.

  43. Gravatar of Gordon Gordon
    10. July 2011 at 11:09

    Scott, you might have missed Richard’s point, which I didn’t see as having anything to do with whether the Austrian theory is correct. I thought his point was that the idea that there is a true state affairs and then there is what we believe the true state of affairs to be is common in economic analysis.

    If people believed that tennis balls were a nourishing diet for human beings that would not make nourishing tennis balls the true state of affairs. If Rorty thought otherwise he was mistaken. (I don’t see how Rorty deals with situations that do not meet our expectations. It can’t simply be that people have conflicting beliefs, because even if everyone started with the idea that tennis balls were nourishing, expectations would still fail.)

    However, it might be that in the case of wealth, what we believe *is* the true state of affairs or at least influences the true state of affairs in a crucial way.

  44. Gravatar of ssumner ssumner
    10. July 2011 at 11:43

    J. Thomas, You said;

    “It will always sadden me that I saw the eventual housing crash from 2002 and even earlier, but I found no good way to make money off it.”

    Don’t be sad, if you thought houses were overpriced in 2002 you were probably wrong. It’s lucky you had no way to sell houses short in 2002. Where I live houses are worth more than in 2002, and that’s true for many other areas too.

    You said;

    “At best, market price gives us an estimate of the balance of some public’s opinions about value.”

    As it should, there can be no other sensible meaning for “true value.” Indeed the word true is redundant.

    Gordon, You are badly misinterpreting Rorty, one of the greatest philosophers of the past 50 years. He didn’t believe tennis balls were nourishing just because some fool believed that. That would be crazy.

    You said;

    “I thought his point was that the idea that there is a true state affairs and then there is what we believe the true state of affairs to be is common in economic analysis.”

    This is an odd way to put things. The word “true” doesn’t apply to states of affairs, but to statements. We say that statements are either true or false, not reality is true or false. All statements are expressions of belief. So it makes no sense to say, “I believe this is true, but actually something else is true.” You could say, “I believe this is true, but my friend believes something else is true.” Or “I believe this is true, but I used to believe something else is true.” The point is that we in economics deal with beliefs, and nothing but beliefs.

    We have no access to any reality, above and beyond our beliefs.

  45. Gravatar of Gordon Gordon
    10. July 2011 at 13:13

    Scott, first, I was not interpreting Rorty; I stated a hypothetical. Rorty’s actual beliefs are somewhat obscure to me (and that is not entirely due to my lack of effort or ability). Second, I am well aware of the esteem in which Rorty has been held for many years. Third, by “true” I only meant “actual”; my apologies for not being more precise in this context. Fourth, I am too modest to think that all of my beliefs are true, so I do in fact say “There is an X such that I believe that X is true, but actually something else is true.” Fifth, we may make statements we do not believe in order to test them. Sixth, when, e.g., I miss the step at the top of the stairs, I quite suddenly “access” a reality quite different from my prior beliefs. I hope that the same thing can happen in economics, but perhaps not.

  46. Gravatar of Philo Philo
    10. July 2011 at 16:29

    @ Nathan Tankus:
    You wrote that “reality has seemed to contradict its (the EMH’s) predictions.” But the EMH gives us probability distributions, not absolute predictions. Obviously, if I say there’s a 51% chance it will rain tomorrow, and tomorrow it doesn’t rain, reality hasn’t contradicted my prediction, because I didn’t make a prediction. And a similar point is still valid even if I had given 99% as the probability. Yes, we might want to call *that* a “prediction,” in which case it was *contradicted* by reality. Nevertheless, 99% may have been the best estimate of the probability on the available evidence; my performance as a weather “forecaster” may have been perfect.

  47. Gravatar of Frank Youell Frank Youell
    10. July 2011 at 20:37

    Immigration crackdown after 2006? Really? In what country? Certainly not the U.S.

    If you disagree, please try to provide some actual quantitative data showing a material change in immigration policy from 2006 onwards. Rhetoric? Yes. Substantive change? Not so much.

    In the 1950s, Eisenhower deported 1-2 million illegals (estimates vary widely) using just 1000 agents in 3 months. That was a real policy shift.

    No comparable actions have taken place in our time.

  48. Gravatar of Nick Nick
    11. July 2011 at 04:46

    It seems like you are looking for a metaphysical understanding of economics. You are not going to find that in Rorty; he’s a pragmatist – it’s a little bit like asking an agnostic which religion should you believe in.

    Your dissonance is most likely caused by a misguided belief in dualism. When talking about market prices, you have a grudging respect, that “In that sense they are real.” while asking in all seriousness “What’s the TRUE value of the S&P 500?” You have it exactly backwards – there is no TRUE value OTHER than the market price, any more than what makes a rock is its “rock”-ness, or a tree its “tree”-ness.

    An economist is to empiricism as a fish is to water – you are so surrounded by your metaphysics that you cannot see it. To crack out of this rut, I recommend Whitehead’s process-relational philosophy as a good American, (post-)modern philosophy fully compatible with the good things that come out of using the scientific method, without the metaphysical dead ends that it runs into. If you are adventurous, you can look to the continent, especially Elie Ayache’s The Blank Swan, where he also tries to break away from Being (e.g. “rock”-ness of a rock, “TRUE” value of the S&P 500) as the ontological foundation. He even generates the theory from an options-theoretic framework (replicating portfolios and stochastic calculus and all!). Good luck.

  49. Gravatar of On Mistaken Wealth — Mutual Information On Mistaken Wealth — Mutual Information
    11. July 2011 at 07:07

    […] Sumner wrote a very interesting post about what it means to have thought we were wealthier than we were/are. I’ll leave aside the […]

  50. Gravatar of luispedro luispedro
    11. July 2011 at 07:12

    I took a while, but I wrote a reply too long to fit into this box. I think there is a problem with trying to reason from a single agent to society, as it often does not aggregate (one person’s loss is another’s gain: if your house lost value, I’m richer when I want to buy it; there is no societal loss).

    http://www.mutualinformation.org/2011/07/on-mistaken-wealth/

  51. Gravatar of ssumner ssumner
    11. July 2011 at 18:44

    Gordon, On your 4th point Rorty would say you are predicting that with more information you would revise at least one of your views. Rorty would have no problem with that.

    Your 5th point is right.

    Rorty would certainly agree with the point (#6) about the top step.

    I wish it happened more often in economics.

    Frank, My recent post on a problem for EC101 links to an article that discusses data relating to the immigration crackdown.

    Nick, Actually I’m a pragmatist just like Rorty, so I wasn’t looking for any deep metaphysical ideas. I was having fun playing around with ideas, showing how our instincts don’t mesh with pragmatism. I agree that the market price is the only meaningful value of the S&P 500.

    Luispedro, I agree, and you might want to look at some Nick Rowe posts on that point. He has a new one. But housing built that has no buyer may have less market value than the cost of construction. As we realize that fact, perceived wealth falls.

  52. Gravatar of J Thomas J Thomas
    12. July 2011 at 10:30

    SSumner, I correctly predicted that there would be a great big housing boom with inflated prices, and then a bust. I did not see how I could profit from that prediction.

    If I could time it right I might have sold houses just before the bust, and then the same year bought up the same or others for lower prices. I couldn’t time it that well.

    Also, my opinion is that housing is still mostly overvalued. It’s mostly underinsulated, with no solar heating of any sort, too much wood, etc. Consumer housing has always had a low rate of innovation, partly because of government standards, but this is absurd. It won’t take a whole lot of regulatory change plus financial stress, before most of these obsolete structures will be hard to sell.

    Sometimes you can’t win. Sometimes the best you can do is play “Let’s you and him fight”.

  53. Gravatar of J Thomas J Thomas
    12. July 2011 at 10:41

    “(one person’s loss is another’s gain: if your house lost value, I’m richer when I want to buy it; there is no societal loss).”

    Luispedro, this is similar to the broken window argument. If my house gets a broken window there is no societal loss because it has less value when you want to buy it.

    But it does have less value. And I will pay money to replace the broken window, and all the work done toward that — the people who poured and cut the glass, the people who transported it, the people who mined the coal to heat the glass, etc — could have gone to something new and better if it wasn’t used to replace something that broke.

    Say the agreed value goes down when nothing else has changed, it is entirely subjective and arbitrary. Then we still have a peculiar situation. People cooperate partly from the promise of reward. And they trust the people who offer them rewards because they believe those people actually have stuff they can reward people with. To some extent people will accept the promise of future rewards, when they think that promise is likely to be fulfilled. So employees may accept stock or stock options as part payment when they think their company will succeed. But mostly people like to believe in collateral for loans etc.

    And if people for entirely subjective reasons agree that the collateral is worth less, then that same collateral creates less cooperation. It’s kind of peculiar when you think about it. Probably we should create a better way.

  54. Gravatar of Frank Youell Frank Youell
    12. July 2011 at 17:08

    I checked the EC101 link. The only quantitative statement is an assertion that

    “Laws restricting illegal immigrants’ rights or making it tougher for employers to hire them have passed in more than a dozen states since 2006.”

    Several points. None of the 12 states is that large. NY, CA, and TX have not passed any such legislation. Many of the laws came well after 2006 (some are quite recent). Illegals can still go to the other 38 states.

    This doesn’t amount to much of an “immigration crackdown” from a quantitative perspective.

  55. Gravatar of luispedro luispedro
    12. July 2011 at 18:46

    @J Thomas : (normally something else is meant by ‘broken windows’). No, in the language of my post, a broken window aggregates: if everyone has a broken window, everyone is worse off. While, house price declines do not : if house prices decline, absent nominal rigidities, everyone stays the same. There has been no change in the real world (unlike with a broken window).

  56. Gravatar of J Thomas J Thomas
    13. July 2011 at 05:21

    Luispedro, there has been a change in the real world. People who used to command cooperation from others now command less cooperation. No one else gets the ability to command more cooperation to balance it.

    We often think of reputation, face etc as a zero-sum game. If one person has a great reputation and then loses it, everybody else’s reputations must have gone up to match. But it doesn’t really work that way, does it?

    If I own a house and I want to start a business, I can use the house as collateral for a loan to get started. The less collateral I have, the harder it is for me to start that business. And that doesn’t make it any easier for somebody else to get the loan instead of me, either. Somebody with no collateral can compete with me better than before, but he hasn’t actually been helped nearly as much as I have been hurt.

    It’s only when we look at it as zero-sum, as if the opportunity for someone else to buy my cheap house exactly balances out my loss, that it looks like my loss is your gain.

  57. Gravatar of Scott Sumner Scott Sumner
    13. July 2011 at 06:42

    J Thomas, You said;

    “If I could time it right I might have sold houses just before the bust, and then the same year bought up the same or others for lower prices. I couldn’t time it that well.”

    If you can’t time it, the “prediction” is worthless. I “predict” that someday stocks will rise a lot, then fall.

    Frank, Bush greatly tightened immigration enforcement in the later part of his term, that’s common knowledge. But for the purpose of this post, it makes no difference why immigration slowed.

  58. Gravatar of anon anon
    13. July 2011 at 07:03

    J Thomas, it’s a wash. People who bought a house are obviously worse off, but future buyers will be able to afford better quality housing. Yes, homes can be used as collateral for a loan, but this is also true of other assets. In fact, holding liquid assets allows folks to self-finance at negligible cost.

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