About that Bitcoin “bubble”

People have been talking about the Bitcoin “bubble” from the beginning, when the price was just a few dollars per coin.  Each time the price falls sharply they say; “I told you so.”  But when the price then rises again, they don’t say “I was wrong.”

Some claim that a lot of Bitcoins are used in the underground economy.  So if the US government cracked down on that use of Bitcoins then surely the bubble would have to burst, wouldn’t it?  Apparently not this bubble, which seems made out of titanium, not soap:

The value of Bitcoins is on the rise this week, climbing as much as 16%, as a major new vendor, a unit of Chinese Internet giant Baidu (BIDU), began accepting the virtual currency for payments.

Baidu’s Jiasule unit, which provides online security and firewall services, said in a Chinese language post on Oct. 14 that it had started taking Bitcoins.

The price of a Bitcoin traded at the popular Mt.Gox Exchange in Tokyo reached a high of $163 today, up from $140 five days ago. Bitcoins have completely erased the 20% drop suffered earlier this month after U.S. law enforcement authorities shut down the drug-dealing website Silk Road.

Look for more “I told you so” comments the next time there is a sharp decline in the price of this highly volatile asset with difficult to measure fundamentals.

PS.  Speaking of the EMH, Matt Yglesias recently made this observation:

But in many ways. the linkage ought to go the other way around. John Cochrane, celebrating Fama’s Nobel Prize, remarks:

Unhappy investors who lost a lot of money to hedge funds, dot-coms, bank stocks, or mortgage-backed securities can console themselves that they should have listened to Gene Fama, who all along championed the empirical evidence – not the “theory” – that markets are remarkably efficient, so they might as well have held a diversified index.

And indeed this is what people should have done. What’s a bit strange to me is that Cochrane doesn’t see the clear implication here that there are dramatic and remarkably persistent market failures in the financial services industry and that there’s an extremely strong case for paternalistic regulation in this sphere.

Matt’s right that there is a sense in which markets are “inefficient,” but he’s not right about the need for paternalistic regulation.  We really don’t know whether society spends too much money on market research or too little.  People tend to free ride on useful market research that becomes public. There are market failures, but in both directions.  And it’s almost impossible to know how large they are.

Update:  I should have made it clear that Yglesias was talking about the excessive use of costly non-indexed mutual funds, which have a poor performance record.


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47 Responses to “About that Bitcoin “bubble””

  1. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    17. October 2013 at 06:36

    http://www.voxeu.org/sites/default/files/file/DP9494.pdf

    ‘One could imagine that enhanced supervision improves a bank’s internal model, e.g. because it involves additional testing. Since internal models are typically bank specific, however, this would require assuming that the (external) supervisor has skills or information regarding the banks risk-taking that are superior to the skills and the information available to the bank. In our opinion, this is unlikely to be the case.’

  2. Gravatar of benjamin cole benjamin cole
    17. October 2013 at 06:37

    I do wonder if finance and real estate are sui generis…banks think real estate is collateral and will lend 80+% LTV readily in good times (which are boomy for values).
    The dot.com bust was a scratch—only equity was destroyed. But when real estate tumbles, banks are going to hurt bad…
    Might be wise to insulate banks from real estate tumbles somehow…these property nosedives are kinetic…property falls, banks stop lending and property falls more…

  3. Gravatar of Salemicus Salemicus
    17. October 2013 at 06:49

    Cochrane actually wrote a lengthy and excellent blog post here on why the EMH doesn’t in the least imply that we need paternalistic regulation to sort out alleged “market failures” in the financial industry. Perhaps if he actually read it, Yglesias might understand why “Cochrane doesn’t see the clear implication” that seems so obvious to a financial expert like Matt.

  4. Gravatar of ssumner ssumner
    17. October 2013 at 06:56

    Patrick, “unlikely” is an understatement.

    Salemicus, Yes, the Cochrane paper was excellent.

  5. Gravatar of Robert Robert
    17. October 2013 at 07:24

    Is there not a conundrum here?

    Financial markets are efficient, not because they are random but because thete are many active investors trying to make a profit.

    Thus, if investors en masse take a passive approach, the financial markets become inefficient and profit opportunities arise.

    There probrably exists an equilibrium where the cost of research is just met by mutual fund fees, ensuring that on average they don’t outperform.

  6. Gravatar of TravisV TravisV
    17. October 2013 at 07:43

    [Gasp]

    “Pimco’s Bill Gross – Yields Have to Come Up”

    http://www.gurufocus.com/news/231721/pimcos-bill-gross–yields-have-to-come-up

  7. Gravatar of Eorrfu Eorrfu
    17. October 2013 at 08:23

    I wouldn’t wade into the bitcoin wars if I were you. The bubble isn’t really a bubble in the classic sense of the word. Often they just mean it is overvalued based on fundamentals due to some market failure. In the case of bitcoins it seems that the market is not nearly as liquid as it seems and is open to massive manipulation.

    See http://eprint.iacr.org/2012/584.pdf for a good analysis of the trading network that shows how the vast majority of the activity is coordinated.

    I think the problem with bitcoin long run is the money supply grows at a declining rate. Although I wonder if velocity can accelerate to make up for the lack of supply. If velocity is constrained only by a computer then it can be order of magnitudes higher than anything convertible into cash.

  8. Gravatar of Doug M Doug M
    17. October 2013 at 08:57

    Robert,

    “if investors en masse take a passive approach, the financial markets become inefficient and profit opportunities arise.”

    This is not a trivial question…. What percentage of market participants must be active managers to keep the market efficient?

    There are some suggestions if too much of the market is passively invested, it makes markets more prone to bubbly behavior.

  9. Gravatar of John Thacker John Thacker
    17. October 2013 at 09:33

    So, we have plenty of evidence with government directed fund management in pension funds and elsewhere. Does the government hew to passive index investments? Or does it look for every exotic new instrument promising better returns without volatility?

    In practice, some pension plans are well run, some are not. But high fees are pretty common; unsurprising since there’s a principal agent problem.

    From its humble beginnings, Vanguard has grown to a behemoth through indexing. I think that’s had more success than an attempt at government regulation would have, considering the track record of government experts investing.

  10. Gravatar of rbl rbl
    17. October 2013 at 09:55

    (Not my area of expertise, so obviously I may be way off base)
    The Cochrane paper seems to imply that Cochrane thinks that either EMH is false, or there are massive peristant market failures. IE, in assuming there is a large class of active manager who can generate positive alpha he assumes either that the asset prices are wrong, or there is a persistant market failure due to continuous information asymmetries.

  11. Gravatar of Doug M Doug M
    17. October 2013 at 10:05

    John Thacker,

    “Does the government hew to passive index investments? Or does it look for every exotic new instrument promising better returns without volatility?”

    Generally the public employee retirement system “PERS”, hires an army of consultants to tell them what their high level allocation should be (eg US stocks, US bonds, Foreign Stocks — developed or developing?, Hedge Funds, Commodities, Real Estate, etc.) tell them new asset classes that other funds are moving into and recommend managers in each of these asset classes. It will be in some combination of active and passive allocations. And due to their size, they can usually negotiate lower management fees.

  12. Gravatar of John John
    17. October 2013 at 10:47

    RBL: did you read the paper? Part 2a (“Active Management and Fees: The Traditional View”) is about exactly that “puzzle”, and explains why Cochrane does not believe either of those two hypotheses.

  13. Gravatar of rbl rbl
    17. October 2013 at 11:25

    John, yes, Cochrane makes it clear in 2b that the traditional view is not correct, and that a supply-demand view is better. I’m saying that his supply-demand model requires either massive market failures or a rejection of the EMH, and the paper isn’t about
    “why the EMH doesn’t in the least imply that we need paternalistic regulation to sort out alleged “market failures” in the financial industry”
    but about why regulation isn’t needed because either the EMH is false or there is widespread market failure, just not in the area of mutual fund management.

  14. Gravatar of John John
    17. October 2013 at 11:27

    It also seems funny to me that the two industries most decried as needing regulation are the two industries that are most regulated to begin with: health care and finance. Relatively unregulated industries like the internet produce wonders almost daily and suffer from none of the so-called “market failures” of the industries that are de facto run by the government.

    The persistent “market failures” the that Yglesias talks about in the financial markets are really just the market incorporating new information about the government or Federal Reserve introducing idiotic policies.

    Anyone who thinks that the government needs to get more involved in an industry should ask themselves why my smartphone can tell me what traffic is like 50 miles away instantly while the traffic lights on our roads can’t change to let someone go when there are no cars on the road at 2 in the morning. Smart industry, dumb government.

  15. Gravatar of Geoff Geoff
    17. October 2013 at 11:41

    “Look for more “I told you so” comments the next time there is a sharp decline in the price of this highly volatile asset with difficult to measure fundamentals.”

    It’s not “difficult” to measure the fundamentals. We just look to the exchange value of Bitcoins relative to other goods, as such buying and selling on the market is the very source of information that enables us to conclude what the “fundamental” value of Bitcoins happens to be at any given time.

    Medium of exchange is the fundamental characteristic of money-like instruments.

  16. Gravatar of Geoff Geoff
    17. October 2013 at 11:47

    “We really don’t know whether society spends too much money on market research or too little.”

    The premise of this argument makes the advocacy for NGDPLT an invalid one. For NGDPLT, Sumner does claim to “know whether society is spending too much money on [x] or too little.”

    He claims that if “society” is spending anything less than 5% more this year than last year (or whatever other fixed rate of growth), then the market process outcome of total spending must be abolished by a group of coercive individuals who are to force 5% increase in “society’s” spending.

    Of course, if Sumner was consistent, he would argue that we don’t know whether society spends too much money in the aggregate or too little. No, unemployment changes is not a justified premise, because if it were, then we would allegedly know if too much or too little money is spent on market research by observing employment changes in the market research sector. If unemployment goes up, then there is too little spending, etc.

  17. Gravatar of TravisV TravisV
    17. October 2013 at 11:49

    Fascinating theory explaining why IBM’s hardware sales in China crashed 40%+…..

    “NSA Revelations Kill IBM Hardware Sales in China”

    http://www.zerohedge.com/contributed/2013-10-17/nsa-revelations-kill-ibm-hardware-sales-china

  18. Gravatar of John John
    17. October 2013 at 12:15

    Geoff,

    If you are looking at the price as the fundamental then everything is equally difficult to value: gold, paper money, securities, etc. What Scott is getting at is that stocks have fundamentals such as book value. If the total price of a company’s stock falls below book value, there may be a profit in buying all the stock and selling all the company’s assets. Therefore, the book value of the company serves as a fundamental underpinning the price of the stock. There are no such factors with Bitcoin. Bitcoins do not produce anything and only derive their value from the valuations of individuals in exchange. Even something like gold that functions like money has industrial uses underpinning its value. Bitcoins have nothing of this sort and therefore will tend to be highly volatile.

  19. Gravatar of rbl rbl
    17. October 2013 at 12:15

    John, or it could be that some industries are more prone to market failure than others, and thus even with a higher level of regulation more market failures occur. Whether a given industry is overregulated, full of rent-seeking, or whatever is a complex question, not one that can be answered with a simple axiom of buisness good, gov’t bad.
    The reason traffic lights on your roads don’t change for you at 2am is not some sort of magical government incompitence, but a question of cost-benefit analysis. Some lights do have sensors installed, or change to blinking red at certain hours if it is worth the cost. If the government went around and installed sensors at every stoplight in America, conservatives would rightly call it a massive boondoggle and waste of taxpayer funds. The more general reason that the gov’t doesn’t do that much high tech stuff is the same reason iPhones don’t have smoke detectors installed that dispatch Apple’s crack team of firefighters when your house catches on fire. That isn’t their mission. Apple’s goal is to make money selling well-designed gadgets, the purpose of governent is to provide a solution to collective action problems, especially the provision of public goods.
    I will readily admit that many industries are overregulated, and many of the healthcare and financial regulations create or exacerbate market failures. That’s an argment for better policies, not proof that the government can’t do anything.

  20. Gravatar of Geoff Geoff
    17. October 2013 at 12:24

    John:

    “If you are looking at the price as the fundamental then everything is equally difficult to value: gold, paper money, securities, etc.”

    Actually they are equally easy. We just look to the exchange value of those things as well. Gold exchange rate of paper money. Securities exchange rate to gold. Etc.

    “What Scott is getting at is that stocks have fundamentals such as book value.”

    I call that historical value.

    “If the total price of a company’s stock falls below book value, there may be a profit in buying all the stock and selling all the company’s assets.”

    Only if the market value of the assets is at least as high as the book value.

    “Therefore, the book value of the company serves as a fundamental underpinning the price of the stock. There are no such factors with Bitcoin. Bitcoins do not produce anything and only derive their value from the valuations of individuals in exchange. Even something like gold that functions like money has industrial uses underpinning its value. Bitcoins have nothing of this sort and therefore will tend to be highly volatile.”

    Goods don’t have to produce anything for them to have a fundamental value. People produce things anyway. Goods do not. People use goods to produce other goods.

  21. Gravatar of John John
    17. October 2013 at 12:28

    rbl,

    There is nothing magical about government incompetence. Government activities are not run for profit or loss and therefore have no way of tell how they should spend money, no incentive to innovate, and no reason provide good service. After all, they get their money from taxes and don’t have to rely on customers voluntarily handing them money. To make things worse, a government department that fails will only get more money thrown at it which is exactly what it wanted in the first place. Why would someone like Yglesias want this kind of management extended over MORE of the economy? So yes, government stupid, industry smart.

  22. Gravatar of John John
    17. October 2013 at 12:33

    A government agency can’t do any cost-benefit analysis because they don’t make money from the benefits. They make money from taxes. Think about it. Plus, why would you want to innovate when there is no chance of you going out of business? As the head of a government agency, if your innovation works better you don’t reap the reward, if it doesn’t work you look like an idiot and lose your job. The incentive structure deliberately discourages innovation. This is why road technology hasn’t changed in 60 years rather than cost-benefit analysis.

  23. Gravatar of John John
    17. October 2013 at 12:44

    Geoff,

    Yes gold, paper money, and bitcoins are all equally easy or difficult to value. However, I think you are unclear in your understanding of what book value is. Here is the investopedia definition. “The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.” If you wanna make up your own term for this that no one will understand then go right ahead.

    “Only if the market value of the assets is at least as high as the book value.”

    This quote from you is either total nonsense or completely confused. The company’s assets minus liabilities are its book value. If the price of owning the company (meaning buying all of its stock) is less than the company’s book value (assets-liabilities) then you can liquidate the company at a profit.

    Evaluating a company is different than evaluating a piece of paper or an electronic certificate. If you don’t believe that then no one can really help you.

    By the way, Buffet said that gold is the hardest asset to value and that he preferred stocks because for the same amount of money you could own all the gold in the world that would fill up a large room and sit there or you could own all of the farmland and utilities in the United States. Obviously it would be better to have the farmland and utilities since you could live off the dividends forever.

  24. Gravatar of JP Koning JP Koning
    17. October 2013 at 12:53

    “…a sharp decline in the price of this highly volatile asset with difficult to measure fundamentals.”

    If bitcoin is an asset with difficult-to-measure-fundamentals, what about fiat money? Are dollars, pound notes, and yen also assets with difficult-to-measure-fundamentals, or does fiat lack any fundamentals whatsoever?

  25. Gravatar of John John
    17. October 2013 at 13:01

    The most important fundamental of fiat money is a Federal Reserve committed to reducing its value by 2% each year.

  26. Gravatar of Jim Glass Jim Glass
    17. October 2013 at 14:38

    “[Faith in regulation] requires assuming that the (external) supervisor has skills or information regarding the banks risk-taking that are superior to the skills and the information available to the bank. In our opinion, this is unlikely to be the case.”
    ~~~

    Patrick, “unlikely” is an understatement.

    One notes yesterday’s outcome of the case upon which the SEC spent years of effort and millions of dollars trying to collect $750,000 from Marc Cuban, in which the jury ruled for Cuban after pausing only just long enough to add the cost of a good lunch to the government’s bill.

    This being the same SEC whose investigators distributed their resumes around Bernie Madoff’s office when “investigating” complaints against him.

    Yet in spite of endless such experiences, the popular faith in regulation only grows, and the politicians keep expanding it — so that so far today I’ve read three press stories about how this very same SEC’s reach is being massively expanded right now by Dodd-Frank et al.

    http://www.sec.gov/spotlight/dodd-frank.shtml

    “To date, the Commission has put in place a foundation for a framework that will support an entirely new regulatory regime…” (Does anyone dare look at the blueprints?)

    Have the psychologists come up with a name yet for this mass cognitive perversity?

    If not, they should. (Though I can easily imagine why they wouldn’t recognize it themselves.)

  27. Gravatar of Matt Waters Matt Waters
    17. October 2013 at 15:29

    A big issue with EMH arguments is how easily they can go into tautology. Geoff’s argument, as far as I can tell, is the market efficiently says how much somebody, somewhere out there is willing to pay for something. Of course that’s true.

    It is also true that, as Cochrane says, people like to do strange things. There’s a large industry for gambling where the house always wins, among many other industries and products which seem to have no “value.” So it’s tough to say if a market in ANYTHING is “misvaluing” anything, even something with seemingly worthless intrinsic value as a stock certificate, a piece of gold in a vault somewhere you never see or a bitcoin.

    But I will still say there is misvaluing by the market. I say there are two definitions.

    In the more simple one, a wrong value is a price which does not match the returns from assets that a purchase gives you ownership of, based clearly on information publicly available today. The value mismatch cannot be explained as people just have strange tastes, since the higher of the two (price or backing assets) will give you more of whatever it is you want. For purely financial instruments, where fiat money comes in and fiat money goes out, a big difference between those two values (in discounted terms) cannot be explained by taste, unless people enjoy literally burning money. Maybe in a few cases, such as “stock” in the Green Bay Packers, the value of the “investment” is really some sort of good. Maybe, for some companies, investors are happy to get a lower return than available elsewhere because the difference is used by the company for some noble end. But if the investors get utility only from the company increasing wealth so they can get that wealth back and do something else, such mispricings cannot make sense.

    A second definition of a wrong price is when the object by itself has a narrow actual utility and most people buying the assets are looking for resell value rather than for the actual utility. It’s simple to say money has no value, but the savings in transaction costs vs. bartering or having to deal with wildly fluctuating prices give an innate utility to fiat money with stable value. “Stable value” doesn’t mean absolutely fixed value, but having its value change at a steady rate, which can then be adjusted for in contracts for payments in the future. For real-world reasons with sticky wages and zero-bound debt contracts, money cannot ultimately be a “store of value” with constant or increasing value if it’s to be used as a medium of exchange and medium of account. Even if wages did decrease in nominal terms, deflation would stop all debt contracts as long as the equilibrium real interest rates were not significantly positive.

    I say all this to say how bitcoin has failed miserably by comparison if its value is supposed to be as a currency. The utility has not been as a currency, indeed even in the underworld apparently. The real utility may be in satisfying an irrational longing for a risk-free, constant “store of value.” These are the same people who put money in mattresses in the 1960’s because they didn’t trust banks, just to see the value diminish in the 70’s. These people, if they exist, put money into bitcoin and expect it to stay there for a long time. People are too wedded to the idea that if they are paid in fiat dollars, doing nothing with that money forever keeps the value constant. You know, the name of this blog.

    I’m not sure they exist though, at least in sufficient numbers to warrant the price. I would guess the vast majority of people in the market are looking to flip the currency later on. And although there are in fact buyers who have true utility, if the people looking to flip dominate a market, then a numbers game will make the price drop substantially until people with real utility buy enough.

    Or maybe bitcoin has in fact reached an equilibrium price with people who derive pet-rock-like utility from it? It’s hard to tell exactly from evidence, other than my own anecdotes (people I know looking at bitcoin are speculating) and the fact it has failed miserably as a currency. A good study of the make-up of bitcoin buyers and their reasons is not really available. But what one CAN’T argue is that people must really value bitcoin for $150 because they spent $150. You have to distinguish between true utility and speculation and how pure speculation driving a market will ruin the price much sooner than a change in tastes for true, long-term utility.

  28. Gravatar of Matt Waters Matt Waters
    17. October 2013 at 15:39

    Jim,

    I’m not a big fan of such overwhelming “see how regulation/government sucks” arguments. The logical extension is that if all regulation is terrible, then NO regulation is optimal. Is no regulation at all optimal?

    The argument could then be that some regulation is necessary, but we already have so much regulation which fails and any marginal regulation should not be added. This is a lazy mental short-cut, where regulation is transformed into a homogeneous quantity where there’s either “too much” or “too little.”

    Each regulation needs to be argued on its own merits for each. I would personally do nearly none of the regulation of Dodd-Frank, because the real issue is the very large bank accounts ran for corporations, pensions, insurance companies, etc. which became exposed to a bank run after Lehman. Uninsured banking is a true market failure, where the assets could be fundamentally solvent but the bank still run out of cash due to mismatched maturities. In some cases with market failures, although not near all, regulation is a lesser evil with ultimately higher standards of living than a pure free market.

  29. Gravatar of Matt Waters Matt Waters
    17. October 2013 at 15:46

    John,

    “This quote from you is either total nonsense or completely confused. The company’s assets minus liabilities are its book value. If the price of owning the company (meaning buying all of its stock) is less than the company’s book value (assets-liabilities) then you can liquidate the company at a profit.”

    Geoff is very wrong about very many things, but he’s right about market value – liabilities, not book value, mattering in liquidating a company. Warren Buffett joked about how terrible an indicator book value generally is as he had to ultimately pay to shut down Berkshire’s textile operations, even though the operation had supposed high book value.

    What is the market value for a piece of textile equipment? Nobody said it would be easy, which is why accounting uses a more predictable method for valuing assets. The money paid in minus some depreciation schedule is typically far easier than trying to figure out the market price for exact pieces of equipment. It’s even worse when it comes to brands. As Warren Buffett said, goodwill amortization makes no sense for brands which truly have more value than their assets, but a lot of goodwill is indeed worthless. So to create some standards for everyone, goodwill has to amortize over 40 years or something like that.

  30. Gravatar of Matt Waters Matt Waters
    17. October 2013 at 15:53

    “A government agency can’t do any cost-benefit analysis because they don’t make money from the benefits.”

    They can with benefits accruing to the people paying the taxes. In some cases, the benefits can be quite tangible, such as hours saved due to reduced congestion…or not stopping at a red light at 2 AM. The stop light systems which do change on traffic levels need a system of sensors, which aren’t free. A system with Google traffic data based on GPS’s in phones is interesting, but the integration would be very complex for very little value to taxpayers.

    Government is ultimately the expressed will of the taxpayers where there is some market failure and while it is very inefficient and unresponsive, some market failures are still big enough to make it a better option.

  31. Gravatar of Geoff Geoff
    17. October 2013 at 16:11

    John:

    “Yes gold, paper money, and bitcoins are all equally easy or difficult to value.”

    Right, we’re not limited to difficulty. That’s my only point there.

    “However, I think you are unclear in your understanding of what book value is. Here is the investopedia definition. “The net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.” If you wanna make up your own term for this that no one will understand then go right ahead.”

    Well, there is more than one definition of book value, even on investopedia. I was using the first definition as shown on investopedia, and I was having in mind financial securitiy assets. Since we were distinguishing book value from market value, I defined the book value of a security by its historical purchase price.

    Guess we should have clarified that earlier.

    You said: “If the total price of a company’s stock falls below book value, there may be a profit in buying all the stock and selling all the company’s assets.”

    I said: “Only if the market value of the assets is at least as high as the book value.”

    You said: “This quote from you is either total nonsense or completely confused. The company’s assets minus liabilities are its book value.”

    I think you’re confused. If you are thinking about buying the equity of a company and selling the assets at book value in order to make a profit, that suggests the selling price is actually a market price. Thus, only if the market price exceeds the price you paid in the past (what I defined as book value) will you make a profit.

    “If the price of owning the company (meaning buying all of its stock) is less than the company’s book value (assets-liabilities) then you can liquidate the company at a profit.”

    Only if the selling price is greater than the price you paid, i.e. what I define as the book value.

    “Evaluating a company is different than evaluating a piece of paper or an electronic certificate. If you don’t believe that then no one can really help you.”

    The company value definition of book value is different from financial security book value.

    “By the way, Buffet said that gold is the hardest asset to value and that he preferred stocks because for the same amount of money you could own all the gold in the world that would fill up a large room and sit there or you could own all of the farmland and utilities in the United States. Obviously it would be better to have the farmland and utilities since you could live off the dividends forever.”

    Valuing assets is only “difficult” if one is trying to find some sort of ideal non-exchange value that is independent from exchange value (price).

    If I would rather have an ounce of gold than $1500, and I succeed in acquiring an ounce of gold at that price, then the value of the ounce of gold, to me, is worth more than the $1500. This is not “difficult.” Similarly, for the seller of gold, he values the $1500 more than he values the ounce of gold. This is also not “difficult”, if he also does not seek to find an ideal non-exchange value independent of exchange value (price).

    John, we’re talking past each other because we speak a different language of economics. My definitions and theories and arguments are all grounded on praxeology, the study of action. If your definition is abstracted from action, then chances are we’ll talk past each other.

  32. Gravatar of Geoff Geoff
    17. October 2013 at 16:17

    Matt Waters:

    “Geoff is very wrong about very many things”

    Like what? Doesn’t your comment imply that you have somewhere shown how I am wrong about “very many things”?

    “Geoff’s argument, as far as I can tell, is the market efficiently says how much somebody, somewhere out there is willing to pay for something. Of course that’s true.”

    I was saying that as well as other things, specifically the concept of value.

    “In the more simple one, a wrong value is a price which does not match the returns from assets that a purchase gives you ownership of, based clearly on information publicly available today. The value mismatch cannot be explained as people just have strange tastes, since the higher of the two (price or backing assets) will give you more of whatever it is you want.”

    This is a muddled argument. You’re saying the concept of “wrong value” exists, and yet you say it cannot be explained. Well, if you think it exists, you are necessarily defining it in some way.

    You say it is “a price which does not match the returns from assets that a purchase gives you ownership of, based clearly on information publicly available today.”

    How can a price, which is an exchange rate, equal “the returns from assets”?

  33. Gravatar of Geoff Geoff
    17. October 2013 at 16:20

    Matt Waters:

    And doesn’t your argument imply that pricing based on NON-public information is “wrong”?

  34. Gravatar of Geoff Geoff
    17. October 2013 at 16:25

    Matt Waters:

    “They can with benefits accruing to the people paying the taxes.”

    No they can’t. Value is subjectively determined by the individual for themselves, not a small group of coercive individuals living in Washington for everybody else.

  35. Gravatar of Geoff Geoff
    17. October 2013 at 16:26

    Matt Waters:

    “Government is ultimately the expressed will of the taxpayers where there is some market failure and while it is very inefficient and unresponsive, some market failures are still big enough to make it a better option.”

    Which taxpayers?

    What “market failures”?

  36. Gravatar of Matt Waters Matt Waters
    17. October 2013 at 16:53

    Here’s what I mean by value.

    1. Money can be exchanged for goods and services, correct? I’ll post some links to Amazon if you think this is not the case.

    2. Let’s say I give you two options, one is $1.00 and the other is $1,000.

    3. Even if you say that money is worthless or the value of paper money can’t be defined, wouldn’t it be pretty dumb to choose the one dollar option? Even if you don’t value the money itself, 1,000 of those pieces of paper can get more stuff you value than one piece of paper, correct?

    The argument is somewhat muddled to allow for the possibility that people invest in companies for some non-financial reward, like the Green Bay Packers example. But in nearly all cases, people invest because they can get more back than can through keeping the money as money or through other investments. When money worth two Big Macs goes up by 50%, it’s now three Big Macs.

    And let’s say a company will pay out money worth three Big Macs soon but the price is only the equivalent of two Big Macs. Is this not a mispricing? The only way it can’t be is if there’s some disutility that’s worth a Big Mac, the investment is a tobacco company for example. But for nearly all investments where the only concern is value, then the price difference doesn’t make sense.

    Are you dense enough that I should put “big macs” wherever there is “value?” There seems to be a basic misunderstanding with you that money is just a unit and money can be exchanged for goods and services.

    “And doesn’t your argument imply that pricing based on NON-public information is “wrong”?”

    No, just that legally insider information can’t be traded on to the extent that public information can be traded on. If it was legal to trade on non-public information, then market prices would theoretically be bid up or down by the insiders until the price had the public information. If insider information is not traded on and surprises were half good and half bad, then the expected value (number of big macs) of the stock with the non-public information is the same as the stock valued with only the public information.

    “No they can’t. Value is subjectively determined by the individual for themselves, not a small group of coercive individuals living in Washington for everybody else.”

    Who elects this small group of coercive individuals? The individuals with subjective value? Like I said, the benefit is clear in “hours of time saved.” Time saved getting to a destination is valuable, correct? As in you can enjoy an activity you wouldn’t otherwise or you can work more to buy more Big Macs. Is everybody’s time equally valuable? If not hours of time, then what units would you use? Or should government never make any investment whatsoever because benefit could not be exactly calculated?

    “Which taxpayers?”

    The ones who vote.

    “What “market failures”?”

    – Natural Monopolies
    – Free Rider Problems
    – Externalities
    – Asymmetric Information

    Examples include defense, roads, utilities, pollution, and so on. One can look at China or 1970’s LA to see that the free market does not magically produce millions of transactions to pay people to not pollute. The transaction costs are far higher than using the government. Sorry, I meant the transaction Big Macs.

  37. Gravatar of John John
    17. October 2013 at 17:15

    Matt Waters,

    You said, “In some cases, the benefits can be quite tangible, such as hours saved due to reduced congestion…or not stopping at a red light at 2 AM.”

    This is not a tangible benefit in the sense that it allows a cost-benefit analysis. Only profit and loss allow economic calculation. Government functions are not subject to profit and loss and therefore there is no way to tell if they are adding to or impairing society. You can only make guesses over whether your the amount spent on roads is worth a system where you regularly have to commute for two hours in a major city. It’s just a uneducated, blind guess.

    Geoff,

    Believe me I’m speaking the same language as you, I always approach things from a causal-realist/deductive/praxeological perspective. I read all my Mises and Rothbard. They’re my favorite economists. However, I’ve read other things as well that I think have worth. Right here you are simply saying that there is no possible value for something other than what someone is willing to exchange for it. Fine if you wanna see it that way but financial theory does have ways of trying to evaluate the “fundamentals” of an asset that go past day to day market price.

    For instance, which would you rather own, all the gold in the world or all the farmland and utility companies in America. They both have about the same price, but I know I’d damn sure rather own the farms and utility companies. They produce income but gold just sits there and doesn’t give you anything unless you sell it.

  38. Gravatar of Jim Glass Jim Glass
    17. October 2013 at 18:43

    Speaking of the SECs expanding regulatory responsibilities, anybody want to buy some shares in the future earnings of NFL player Arian Foster of the Houston Texans? 🙂

    http://www.sec.gov/Archives/edgar/data/1573683/000104746913009713/a2216998zs-1.htm

  39. Gravatar of Jim Glass Jim Glass
    17. October 2013 at 19:11

    Jim, I’m not a big fan of such overwhelming “see how regulation/government sucks” arguments.

    Matt, I didn’t say anything “sucks”.

    I just gave two actual factual examples of the SEC in action: (1) Its investigators responding to complaints about Bernie Madoff by visiting his offices and handing out their resumes there looking for jobs (Madoff said he was incredulous, he thought they were finally coming to arrest him); and (2) its legal staff spending years and million of dollars to collect $750k from Cuban, and losing over one lunchtime of deliberations.

    If these facts bring the thought to your mind, “see how regulation/government sucks”, that’s *your* mind in action. It would be rude to me to argue, though.

    The logical extension is that if all regulation is terrible, then NO regulation is optimal.

    Um, no. Logic suggests to me three things in response:

    1) You indulge the fallacy of the excluded middle there.

    2) You are trying to change the subject from the advisability of greatly expanding troubled real-world regulation to a cartoon argument about getting rid of all regulation.

    Each regulation needs to be argued on its own merits…

    3) And you invoke a trite truism, “good regulations are good, and bad ones are bad” to ignore the substantive *systematic* point specifically stated in the quotation via Patrick and wonderfully exemplified by the resumes distributed in the Madoff offices: That regulators systematically have less ability than those they regulate — they get much less pay reflecting less skill, less education, less knowledge, fewer work hours put in, less accountability for performance (“government work”), etc.

    Moreover, it is entirely typical that their *motive* in taking the govt regulatory job is hoping to use it to establish the experience, resume and contacts that will get them a higher-paid job among those they regulate, which is their real career goal. I’m a lawyer for many years now, and know this well first hand.

    All of which creates issues about the reasonably expected quality of regulators in action, does it not? (Looking for employment with and references from those you regulate??) Systematic issues.

    It’s nice to say you aren’t biased against regulation, but do you have any concrete answer as to how to get the expected quality of the regulator’s work up to that of those they regulate? Can greatly expanding their power, responsibilities and duties really be that answer??

    Or let me put it this way: Say you hired the SE&C law firm to investigate a competitor you thought was cheating you. It turned out the competitor *was* cheating you, but SE&C didn’t discover that — in fact, it instead tried lure the competitor as a client, replacing you! And SE&C then billed you $1 million of your money to pursue a claim of $100,000 on your behalf, which it lost during a lunch-hour jury deliberation.

    Would your response be: “I’m not biased against my law firm. In fact, I have a whole lot more work I’m going to give them!”?

    I doubt it. More likely you’d fire them pronto, badmouth them to everybody, and very likely sue them for violation of duty and malpractice. (Trying to get hired by the other side!!)

    Which gets to the real point: People accept a much lower standard of performance from public sector workers and organizations than they accept from private sector performers — yet they expect the former to trump and direct the latter!

    If this isn’t cognitive dissonance, what is it?

    During the Fiscal Crisis/Chris Cox years the SEC was pathetic. It was ridiculed by all sides (even the HBO movie on the crisis). Its ignoring all the warnings fed to it about Madoff was just a PR high/lowlight.

    But have you heard of any shake-up at the SEC? People held accountable? Fired? Systems reorganized? Modernized organizational structures? (Like at at private companies that have had similar performance issues: IBM, Apple, etc.).

    No. Of course not. Instead the follow-up is a law giving that same SEC — same people, same system, same incentives — responsibility to create “a foundation for a framework that will support an entirely new regulatory regime” for the entire financial sector, affecting the whole world.

    Reasonably predictable future results? Well … at least they’ll have a lot more places to get out their resumes to!

    Cognitive dissonance … It’s the law!

  40. Gravatar of ssumner ssumner
    17. October 2013 at 19:18

    John, You said;

    “It also seems funny to me that the two industries most decried as needing regulation are the two industries that are most regulated to begin with: health care and finance.”

    Bingo!

    JP, I think the fundamentals for fiat money are pretty clear, at least when rates are positive. The public wants to hold about 1% of GDP in cash to make transactions, maybe a bit more, and then another 1% to 10% in hoards to avoid taxes. That determines the value of the total currency stock. The value of each individual dollar then depends on how many are produced. Yes, that’s only a rough estimate, but with Bitcoins we don’t even know the ballpark we are in. Are they worth $5, $50, or $500? Who knows?

    Jim Glass, I agree about Cuban. Here’s a question. If the government is going to insist on spending a fortune prosecuting these cases, why don’t they insist that firms put promises into writing, if the firms later want the promise enforced in court? This was based on a verbal promise.

  41. Gravatar of Jim Glass Jim Glass
    17. October 2013 at 20:59

    … If the government is going to insist on spending a fortune prosecuting these cases, why don’t they insist that firms put promises into writing, if the firms later want the promise enforced in court? ….

    The firm didn’t want anything enforced, this was all SEC all the way — five years in the courts, three administratively before that, eight years total. For this.

    The “insider trading” prohibitions apply to, well, insiders. Cuban was an outsider. The SEC tried to turn him into an insider because he was on the phone for eight minutes with the company’s CEO, who was an insider. But an insider blabbing doesn’t turn an outsider into an insider. For the outsider to become an insider he has to both acknowledge that he is about to receive confidential information *and* promise not to trade on it. (Note that keeping info confidential and not trading on it are two different things.)

    Obviously, this should be done in writing, because who wants to rely on memory about this double-requirement, oh, eight years later? And it is done in writing all the time. These written agreements are exceedingly common, sometimes absurdly so about crazy trivialities as bureaucracies protect themselves. (I’ve signed these things dozens of times, and haven’t felt I was losing a chance to get rich even once.)

    Here the company’s CEO, in addition to certainly knowing all this, was explicitly advised by his lawyers to at least send Cuban an email about the conversation in advance to meet the acknowledgment requirement and get back the required promise not to trade from Cuban, *if* he wanted to the info to be confidential. But the CEO didn’t bother — he didn’t care. He chose not to, after considering it.

    Then, after the investigation started, *not* in his first interview but during a *later* one, the CEO had a ‘recovered memory’ of Cuban saying verbally “Damn, that’s inside information. Now I’m screwed, I can’t trade”. (This while the CEO was having problems of his own with the SEC and needed to get along with them.) But even that on its face does not meet the two-step requirement, inform the outsider of the confidential info about to arrive and get a promise not to trade on it. So at the first trial the judge dismissed the case, back in 2009.

    Then the govt went up to the Court of Appeals, where the judge in what he described as “a close one” reinstated the case on the theory that a jury might interpret Cuban’s statements as “implicitly” acknowledging the two-step requirement had been met. Or not.

    Well, that was a mighty thin reed to hang the cost and effort of four more years of prosecution upon. We saw how thin yesterday.

    Why did the SEC decide to pour all these years of effort and money into pushing this thin reed, when even if it won it was certain to take a huge loss on money costs and labor that could have been spent on other things? …. Who knows?

    Maybe it’s just that they aren’t spending their own money, so avoiding defeat on your watch (even if you’re just kicking a more costly one onto the next guy’s) is the career-protecting incentive. Who knows?

  42. Gravatar of ssumner ssumner
    18. October 2013 at 05:31

    Jim, Thanks, I entirely agree. But I stand by my statement that things like this should be put in writing, or else the government should not waste time and money on prosecutions.

  43. Gravatar of Jim Glass Jim Glass
    18. October 2013 at 08:15

    things like this should be put in writing, or else the government should not waste time and money on prosecutions.

    The problem with requiring written confidentiality and won’t-trade promises from outsiders to turn them into persons subject to insider trading prohibitions is that the bad guy criminal insiders would never bother to get such written commitments from their co-conspirator outsider buddies and girlfriends, who would then be free to trade away without limit using the inside information given to them.

    So if one thinks that insider trading is bad and should be prohibited, that really doesn’t work. It would restrain only the innocuous accidental insider traders while letting the felons run hog wild.

    OTOH, there is a serious argument that insider trading actually is a good and beneficial thing and should be legal, and that the whole dang exercise of criminalizing it and attempting to prohibit it is but another naive and costly mistake of populist politics.

    E.g., Wonkblog made this case a while back:

    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/07/26/insider-trading-makes-us-richer-better-informed-and-could-prevent-corporate-scandals-legalize-it/

    Insider trading actually was legal until surprisingly recently in the USA, and still is in a number of the other advanced nations.

  44. Gravatar of Matt Waters Matt Waters
    18. October 2013 at 08:46

    Jim,

    That’s certainly a more sound argument than it first seemed to me. Yes, compared to other industries, the SEC is significantly less competent than the workers they regulate. That’s on top of how government will always have issues with inefficiencies in general, which includes things the government should clearly do like the police force.

    The issues of the SEC’s incompetence notwithstanding, the question remains: what regulations specifically should be kept? Which ones specifically should be gotten rid of? What regulations, if any, should be added? What specifically should be changed to make governance more effective? Regulation and government in general is not a homogenous quantity. Yes, there is a big systematic issue with government at any level, but that doesn’t really answer the question of whether some new regulation may still be worth it.

  45. Gravatar of ssumner ssumner
    18. October 2013 at 17:57

    Jim, I agree that insider trading should be legal unless contractually forbidden. But wouldn’t firms have an interest in having their employees sign forms promising not to give information to outsiders in a plot to steal money from the firms other stockholders? I can’t imagine why companies wouldn’t prohibit such behavior from insiders with fiduciary responsibilities. But this is not my area, so maybe I’m overlooking something.

    Matt, In most cases simplicity in regulation leads to less unforeseen side effects than complexity. I’ve met people would make a living taking advantage of regulatory complexity, which opens up rent-seeking avenues.

  46. Gravatar of Geoff Geoff
    20. October 2013 at 15:56

    John:

    “Right here you are simply saying that there is no possible value for something other than what someone is willing to exchange for it.”

    No, that isn’t what I am saying. My argument applies only to exchanges, not that exchanges monopolize all value.

    The owner can value what he owns differently than his potential exchange partners, in that he is willing to part with his property for a price that is too high in the eyes of potential buyers. In this case, we have to look at two values, the exchange value, and the self-use value.

    What I was saying is that there is no “fundamental” value that is different from exchange value. No “fundamental” value is not the same thing as saying no self-use value.

    “Fine if you wanna see it that way but financial theory does have ways of trying to evaluate the “fundamentals” of an asset that go past day to day market price.”

    Nobody said it had to be “day to day” pricing specifically. It could be the price next year.

    Yes, there are models that assume a “fundamental” price different from the market price. But we cannot observe this price. We can only observe market prices, and market prices that just so happen to be equivalent or close to a modelled price that assumes fundamental prices exist.

    “For instance, which would you rather own, all the gold in the world or all the farmland and utility companies in America. They both have about the same price, but I know I’d damn sure rather own the farms and utility companies. They produce income but gold just sits there and doesn’t give you anything unless you sell it.”

    The same thing is true for the farmland and utility companies. They are not worth anything in the market unless they can be used to sell something.

  47. Gravatar of Geoff Geoff
    20. October 2013 at 16:20

    Matt Waters:

    “1. Money can be exchanged for goods and services, correct?”

    “2. Let’s say I give you two options, one is $1.00 and the other is $1,000.”

    “3. Even if you say that money is worthless or the value of paper money can’t be defined, wouldn’t it be pretty dumb to choose the one dollar option? Even if you don’t value the money itself, 1,000 of those pieces of paper can get more stuff you value than one piece of paper, correct?”

    What is the relevance of these statements?

    “The argument is somewhat muddled to allow for the possibility that people invest in companies for some non-financial reward, like the Green Bay Packers example. But in nearly all cases, people invest because they can get more back than can through keeping the money as money or through other investments. When money worth two Big Macs goes up by 50%, it’s now three Big Macs.”

    If this is supposed to be an analogy for the market, then what you said is true only if more Big Macs are produced.

    “And let’s say a company will pay out money worth three Big Macs soon but the price is only the equivalent of two Big Macs. Is this not a mispricing?”

    How can a company give out a single cash flow, but the value of it has two mutually incompatible exchange values?

    How is this an example of “mispricing”? And what is “mispricing” to you?

    “And doesn’t your argument imply that pricing based on NON-public information is “wrong”?”

    “No, just that legally insider information can’t be traded on to the extent that public information can be traded on.”

    That’s obvious. My question is why the distinction between public and non-public information matters when it comes to your conclusion that “correct” pricing requires public information only.

    “If it was legal to trade on non-public information, then market prices would theoretically be bid up or down by the insiders until the price had the public information.”

    The same thing is true for public information. Public information is not instantaneous. Information as it is released is priced into assets over a positive period of time. It’s why we rarely if ever see perfectly vertical price jumps as information is integrated into pricing. Not everyone knows public information, and yet those who lack even public information are nevertheless affecting market prices with their buying and selling.

    “They can with benefits accruing to the people paying the taxes.”

    “No they can’t. Value is subjectively determined by the individual for themselves, not a small group of coercive individuals living in Washington for everybody else.”

    “Who elects this small group of coercive individuals?”

    Who pays taxes and benefits from everything that those taxes pay for?

    “The individuals with subjective value? Like I said, the benefit is clear in “hours of time saved.” Time saved getting to a destination is valuable, correct? As in you can enjoy an activity you wouldn’t otherwise or you can work more to buy more Big Macs. Is everybody’s time equally valuable? If not hours of time, then what units would you use? Or should government never make any investment whatsoever because benefit could not be exactly calculated?”

    The alleged benefits of taxation are not made any clearer by reference to time as an aspect of nature.

    “Which taxpayers?”

    “The ones who vote.”

    Those who vote do not make up the entire market. If you’re going to make claims as to market failures, you can’t point to the existence of 40% of the population and their voting behaviors.

    “What “market failures”?”

    “- Natural Monopolies”

    Natural monopolies are GOOD if every conceivable consumer wants the goods of that producer and no other.

    It would actually be a failure of society to use force to break up a producer who is giving what the market wants so well that the buyers don’t want to buy from any other producer.

    “- Free Rider Problems”

    Free riding does not eradicate the gains to those who act in such a way that their actions benefits others. As long as private property rights are not violated, there is no justification for initiating force to stop alleged free riding.

    “- Externalities”

    There are no unpaid for externalities in a private property society. There is a ban on negative externalities that violate other people’s property rights.

    “- Asymmetric Information”

    This is not a failure. This is a feature of a division of labor society.

    Doctors do not have the same information of the science of computer engineering, and computer engineers do not have the same information of the science of human anatomy, and yet gains can be made through trade.

    Individuals can gain by specializing their knowledge and labor. This IMPLIES “asymmetric information.”

    “Examples include defense, roads, utilities, pollution, and so on.”

    Pollution is a service like the others in your list?

    The services can all be provided without coercion. There is no reason for why roads have to be financed by violence.

    “One can look at China or 1970″²s LA to see that the free market does not magically produce millions of transactions to pay people to not pollute.”

    In these cases, the government failed to protect private property rights. This is not a failure of the free market, for the government bans free market competition in the area of security and protection. It enforces its own monopoly.

    It’s rather funny that you are stating a failure of the government to protect property rights, and yet you communicate it as a failure of a non-existent free market protection.

    For what would happen if a private property owner used force to stop a local factory from spewing pollution onto their property? The government would step in and arrest him! You can’t possibly blame the free market for this. That’s just intellectually dishonest.

    “The transaction costs are far higher than using the government. Sorry, I meant the transaction Big Macs.”

    Transactions costs in food would be zero if the government monopolized all food production, because there would be no food exchanges.

    What is the fetish with transactions costs? It’s like you believe they ipso facto justify violence.

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