Update:  I see Matt Yglesias beat me to it.

Before criticizing a Paul Krugman post let me praise his recent post on the Chinese yuan.  I completely agree that the press is overplaying the IMF’s decision to make it a reserve currency.  I did see one report that this might push the Chinese to do more financial reforms, which would be fine.  But countries don’t benefit from reserve currency status anywhere near as much as the media would lead you to believe.

In an earlier post Krugman unintentionally insults Dean Baker:

It’s true that Greenspan and others were busy denying the very possibility of a housing bubble. And it’s also true that anyone suggesting that such a bubble existed was attacked furiously — “You’re only saying that because you hate Bush!” Still, there were a number of economic analysts making the case for a massive bubble. Here’s Dean Baker in 2002. Bill McBride (Calculated Risk) was on the case early and very effectively. I keyed off Baker and McBride, arguing for a bubble in 2004 and making my big statement about the analytics in 2005, that is, if anything a bit earlier than most of the events in the film. I’m still fairly proud of that piece, by the way, because I think I got it very right by emphasizing the importance of breaking apart regional trends.

So the bubble itself was something number crunchers could see without delving into the details of MBS, traveling around Florida, or any of the other drama shown in the film. In fact, I’d say that the housing bubble of the mid-2000s was the most obvious thing I’ve ever seen, and that the refusal of so many people to acknowledge the possibility was a dramatic illustration of motivated reasoning at work.

I hear this claim over and over again, and just don’t understand it.  First let’s consider the Baker claim that 2002 was a bubble.  As the following graph shows, US housing prices are higher than in 2002, even adjusted for inflation.  In nominal terms they are much higher.  So the 2002 bubble claim turned out to be completely incorrect. Krugman needs to stop mentioning Baker’s 2002 prediction, which I’m sure Baker would just as soon forget.

Of course prices then rose much higher, and are still somewhat lower that the 2006 peak, especially when adjusting for inflation. So I can see how someone might claim that 2006 was a bubble (although I don’t agree, because I don’t think bubbles exist.)

But here’s what I don’t get.  Krugman says it was one of the “most obvious” things he’d ever seen.  That’s really odd.  I looked at the other developed countries that had similar price run-ups, and found 11.  Of those 6 stayed up at “bubble” levels and 5 came back down.  If they still reported New Zealand it would have been 7 to 5 against Krugman. How can you claim something is completely obvious, when there is less than a 50-50 chance you will be correct?  If Krugman were British or Canadian he would have been wrong.

But it gets worse.  Almost no one, not even Krugman, thought we’d have a Great Recession. That makes the bubble claim even more dubious.  Does anyone seriously believe that the utter collapse of the Greek economy has nothing to do with the decline in Greek house prices?  That it’s all about bubbles bursting, with no fundamental factors at all?  That seems to be the claim of the bubble mongers. Even in the US, at least a part of the decline was due to the weak economy.  No, I’m not claiming all of it, but at least a portion.  Look at France, which held up pretty well despite a double-dip recession.  You can clearly see the double dip in the French house prices, so no one can tell me that macroeconomic shocks like bad recessions don’t affect house prices.

In conclusion, even ignoring the elephant in the room–the Great Recession–Krugman’s claim that a bubble was obvious makes no sense.  Most housing markets didn’t collapse after similar run ups.  Most are still up near the peak levels of 2006, even adjusted for inflation (and significantly higher in nominal terms.)  But add in the Great Recession, and the bubble claim becomes far weaker.

Of all the cognitive illusions in economics, bubbles are one of the most seductive. But I expect more from an economist who usually sees through these cognitive illusions, and did a good job showing the fallacy of the claim that reserve currencies status has great benefits to an economy.

PS.  In case you have trouble reading the graphs, the 5 countries with big drops are the US, Greece, Italy, Spain and Ireland.  The US drop is even more surprising when you consider that our post-2006 macro performance is more like the 6 winners.  So I could have claimed it was 6 to 1 against Krugman, if I’d put in a dummy variable for “PIIGS” status.  Does any bubble-monger know why Australian, British, Belgian, Canadian, French, New Zealand, and Swedish house prices are still close to the same lofty levels as 2006, or even higher?  What’s different about the US that made a collapse “inevitable”?

(Paging Kevin Erdmann.)

PS.  I also have a post on Krugman over at Econlog, in case you haven’t gotten your fill here.

I have a new post at Econlog that is far more important that this throwaway effort.  I also recommend a recent post on China by David Beckworth, which I initially overlooked.  And excellent posts on the Fed by Tim Duy and Evan Soltas. But if you insist on continuing . . .

Scott Alexander is perturbed that 80% to 90% of doctors don’t know how to answer an extremely simple statistics question like this:

Ten out of every 1,000 women have breast cancer. Of these 10 women with breast cancer, 9 test positive. Of the 990 women without cancer, about 89 nevertheless test positive. A woman tests positive and wants to know whether she has breast cancer for sure, or at least what the chances are. What is the best answer?

(OK, technically 26% got it right, but it was multiple choice with 5 choices—you do the math.)  Nobody who’s taught in college should be surprised by this.  Unless you test students on material that they are told they’ll be tested on, and that they studied for the night before, most students basically can’t answer anything, even 8th grade level questions. Heck, I’d probably get some elementary stat questions wrong (although at least I can do the “story problems” like the one above) Alexander is concerned about the implications of this (here’s he’s referring to another question):

Good news! 42% of doctors can correctly answer a true-false question on p-values! That’s only 8% worse than a coin flip!

And this paragraph is your friendly reminder that six months after this study was published, the FDA decided it was unsafe for individuals to look at their own genome since they might misunderstand the risks involved. Instead, they must rely on their doctor. I am sure that statisticians and math professors making life-changing health or reproductive decisions feel perfectly confident being at the mercy of people whose statistics knowledge is worse than chance.

Obviously I agree.  But the FDA is model of rationality compared to the SEC.  At least with the FDA you can sort of understand the logic of the regulation.  If doctors actually knew what they theoretically should know, what they were taught in college, then they would have more expertise than the average person.  But not even that excuse is true for the regulation of stock pickers:

The Investment Advisers Act of 1940 is a United States federal law that was created to regulate the actions of those giving investment advice for compensation as means to protect the public.

The Act defines an “investment adviser” as anyone who, for compensation engages in the business of advising others about the value of securities or the advisability of investing in, purchasing, or selling securities.

So you go to your investment adviser for stock picking advice, not to some idiot like me. And that’s because your investment advisor is better able to pick the right stocks and mutual funds than I can.  Or at least that’s the theory.  In fact, they do worse than I’d do, in all but a few cases.  The rest of the post will exclude the tiny number of investment advisors that simply tell you to put everything into low cost index funds.

For the rest, the vast majority of regulated investment advisers, they either understand than indexed funds outperform managed accounts, and hence are dishonest, or they don’t understand and are incompetent.  So the SEC regulation virtually forces people like my mother to go to investment advisers who are either knaves or fools.

(On the other hand if doctors profit from needless cancer tests, then maybe medicine isn’t so different from the investment industry.  Maybe the doctors are just pretending not to understand statistics, as a cover.)

Progressives like to talk about the “science” of an issue (at least sometimes, not the science of gender differences, or GMO foods, or taxing capital income, or free trade, or that studies show that voucher schools are cheaper, but at least for global warming.) OK, the science of finance says that indexed funds outperform managed funds.  That stock pickers are no more helpful to investors than soothsayers. So if we force stock pickers to be regulated, why not do the same for palm readers, fortune tellers, soothsayers, tea leaf readers, and all the rest?  Alternatively, is the SEC going after unlicensed stock pickers any different from the leaders of Salem going after witches?  Aren’t both types of prosecution equally “anti-science”?

I recently criticized the view that the Fed might want to consider raising interest rates because a long period of low rates could lead to financial imbalances, such as “reaching for yield.”  I actually have several problems with this view, but focused mostly on the implicit assumption that tighter money would lead to higher interest rates.  That’s not true over the sort of time frame that people are worried about.

Tyler Cowen linked to the post and offered a few comments:

Scott Sumner dissents on reach for yield.  I don’t think easier money will boost the American economy right now.  So I think you just get a loanable funds effect and then possibly a reach for yield.

A few reactions:

1.  I have a rather unconventional view on the question of policy lags, which Tyler is probably referring to in his “right now” remark.  I believe that monetary policy affects RGDP almost immediately, or at least within a few weeks.  This is based on three interrelated claims, which may or may not be true:

a.  Monetary policy immediately affects expected future NGDP growth.  That can be defended either as a definition (I define the stance of policy as expected NGDP growth) or if you prefer it can be defended on EMH/Ratex grounds.  If it affected growth expectations with a lag, then there would be lots of $100 bills on the sidewalk.  I don’t see many.

b.  Changes in expected future NGDP have an almost immediate impact on current NGDP growth.  I can’t prove this, and it’s the weakest link in the chain.  But I strongly believe it to be true.  Someone should do a study correlating changes in expected future NGDP (perhaps 4 quarters forward, consensus forecast) with changes in current NGDP.  I expect a strong correlation.  Thus during periods where the expected future NGDP falls sharply, such as the second half of 2008, current NGDP also falls sharply.

c.  Changes in current NGDP are highly correlated with changes in current RGDP. This is one of those “duh” observations, at least for anyone who pays attention to the data.

Most people believe in long and variable lags, because they associate “monetary policy” with changes in interest rates.  If the Fed created and subsidized trading in a NGDP prediction market, I believe we would quickly discover that my view of policy lags is correct, and the consensus view is wrong.  But even if I were wrong, wouldn’t it be useful to pin down this sort of stylized fact? You’d think so, but my profession seems surprisingly uninterested in these sorts of things.

2.  The loanable funds effect is exactly why I think I’m right.  Faster growth would lead to more demand for loanable funds, and thus higher interest rates.  I wonder if Tyler is referring to the “liquidity effect”, the tendency for monetary injections to lower interest rates in the short run.  If so, I don’t think this effect lasts long enough to justify distorting Fed policy with tight money in order to stop people from “reaching for yield.”

3.  I don’t like the term “reach for yield.”  When the interest rate falls, it’s rational for people to value any given future cash flow at a higher level.  So if rates fall for reasons unrelated to corporate profits or returns on apartments, then stock and real estate prices should rise.  That’s markets working the way they are supposed to.  I believe low interest rates are the new normal of the 21st century (partly but not entirely for Cowenesque “Great Stagnation” reasons), so I’m not at all concerned by higher asset prices.

4.  Tyler is on record predicting a very bad recession in China, and also for being open to arguments that the Fed might want to consider raising interest rates this year.  Each is an eminently reasonable and defensible view.  But surely they can’t both be true?  If China is going into a very bad recession, I can’t even imagine a scenario where the Fed raises rates and then a year later looks back and says, “Yup, we’re sure glad we raised rates.”  Stocks plunged earlier today on just a tiny, tiny piece of bad manufacturing news out of China.  How tiny? Notice that the same low PMI occurred three other times in the past 4 years, without RGDP growth ever falling below 7%.

What would that index look like if Chinese RGDP growth was actually about to turn negative?  What would US stocks look like?

5.  I strongly agree with Lars Christensen’s post, which suggests that the Chinese are making a mistake by trying to prevent the yuan from falling.  I also agree with those who claim that recent events show the Chinese leadership to be less competent in economic affairs than many had imagined.  This is a consequence of development; the problems become trickier than when you are just cleaning up after the Maoist disaster.  They don’t seem to be any better at monetary policy than we are.

6.  Off topic, I probably erred in saying Trump has no chance.  That’s my personal view, but maybe I’m just an old timer who is out of touch with changes in America. After all, Berlusconi was elected three times in Italy.  I saw Trump as just another example of a rabble-rouser like George Wallace or Patrick Buchanan, who rose up and then faded.  That’s still my gut level view, but commenter “John” points out that Trump does have a non-zero chance in prediction markets, and I do claim to be an EMH guy.  More importantly, even though Trump and Sanders are unlikely to even be nominated, I see their rise as bad news for American politics.  I could even see their limited success hurting the stock market slightly, as the prospect for sensible economic and immigration reforms seems ever more distant.  Historically, markets do worse in times when the political situation is adrift.  And at the moment China, the US and Europe all seem to be a long way from the almost effortless competence of the Reagan/Clinton era.

PS.  Japan 2014, Canada 2015.  Another fake “recession” call.  Read about it at Econlog.

Bob Murphy is frustrated, but he’s lashing out at the wrong theory:

I understand the Efficient Markets Hypothesis, and I think it’s a very good way to take a first crack at the markets. The thing that annoys me about many EMH proponents is that they think they are being empirical and scientific, when they often are clearly able to explain any outcome in their framework. Steady growth? Just what EMH predicts. Massive crash? Just what EMH predicts. In practice, the EMH is non-falsifiable, which is ironically the criticism many of its proponents level at others.

The EMH is most certainly “falsifiable.”  It’s been tested in many ways.  Some people even claim that it has been falsified, although I’m not convinced.  In the tests that I think are the most relevant the EMH comes out ahead.  (Stocks respond immediately to news, stocks follow roughly a random walk, indexed funds outperformed managed funds, excess returns are not serially correlated, or not enough to profit from, etc., etc.) I assure you that if stocks responded to news with a 12-hour lag, or were clearly far from being a random walk, even Fama would reject the EMH.  BTW, is ABCT refutable? If so, how?  (I don’t regard refutability as the most important test of a theory–usefulness and coherence are better tests in many fields.)

I think this following passage from Scott is a tad slippery:

Murphy seems to suggest that the fact that Austrian economists were not surprised by the volatility is a point in their favor. But why? Who was surprised? If you had asked me a year ago “Do you expect occasional volatility, up and down?” I would have said yes, and also that I had no idea when that volatility would occur, or in which direction the market would move.

Look, there was nonstop coverage of this on NPR when it happened. They were trotting out all kinds of people, including Austen Goolsbee, to make sure Americans kept their money in Wall Street. I’m not making this up, give me a break.

Monday showed the biggest intraday point swing in history. (Granted, you would want to look at percentage swing for a better comparison, but I can’t find such a ranking.)

And according to this guy’s analysis, by one measure of market volatility-the VVIX-Monday blew the previous record out of the water:

Bob should not rely on NPR for his stock analysis.  And you really should look at percentages, not absolute changes.  He talks like the US just experienced a stock market crash, at a time when the market less than 10% below its all time high! Monday was not a particularly big deal in terms of stock market history.  Yes, the volatility was unusually large by the standards of 2015, but this has been an unusually placid year.  Back in 2008 we had weeks and weeks of non-stop action that was roughly as volatile as Monday.  I’d guess that one could find many hundreds of days throughout stock market history where the stock market fell by as much as it did on Monday.

But let’s say I’m completely wrong, and stocks were historically volatile.  Even then Bob’s wrong, as he completely misunderstood my quote.  By “more of the same” I merely meant the most likely outcome for the market was what we have observed in the past.  There are periods of stability and periods of volatility.  If the S&P is at 2108, and someone asks me where I expect it to be in two weeks, I’d say 2108, or maybe 2109 (to reflect a gradual upward trend.)  But that does NOT mean I actually expect the stock market to equal precisely 2109 in two weeks time.  Rather it reflects the fact that I view it as being equally likely to rise or fall.  I actually think it far more likely that it would be considerably higher or lower than at that specific point estimate.  Bob’s frustrated that I’m not making market forecasts that can be refuted, but that’s because I don’t think it’s possible to forecast the market.

And I feel the same about the business cycle.  The US has recessions every 5 or 10 years, China less often.  We don’t know when the next one is coming.  Usually I’m right, because any given year I say that growth is more likely than a recession, and when the recession actually occurs then I’m wrong.  I was wrong in 2008, as I did not predict a recession in 2007.

Now if last year Bob had said there’d be a crash on August 24, 2015 and it happened, then more power to him.  But as far as I can tell he simply posts “I told you so” blog posts after every minor pull back, before the market again soars to new heights.  Then another modest pullback, and another “I told you so.”  I honestly don’t know what we are to make of all that.  Does the Austrian model provide some key to predicting the stock market?  If not, why talk about stock moves as if they support the model?

If you want to say I’m a broken clock, or that we should wait and see what things look like in three years, etc., that’s fine. But come on, don’t act like predicting “more of the same” two weeks ago is consistent with what just happened.

Bob doesn’t tell his readers that the link is to me discussing the Chinese business cycle, not the US stock market.  Some might even say that’s misleading, as his post implies it applies to the US stock market.  But I won’t complain; I stand by my previous “more of the same” as being a wise prediction, and I’ll apply it to the US, to China, to stocks or business cycles.  Whatever Bob wants.  And if I visit the Sands casino and I predict that the little bouncing ball will land on a red or black, and it ends up on the green 0 or 00, I’ll stand by my prediction that red or black were the most likely outcomes. That I made a wise prediction.

In most areas of life we judge competence by track record.  Doctors, lawyers, engineers, etc.  But that doesn’t work for market forecasters.  Track record tells us nothing about the competence of stock pickers.  It doesn’t tell us whether their future predictions will be better than those with a poor record.  And I think that really frustrates people.  It goes against common sense than past performance is not an indicator of competence. But it just isn’t.  I think that might be why Bob is exasperated by my placid agnosticism.

PS.  Obviously I do know that volatility is serially correlated.  I hope readers don’t think I’m THAT stupid.  Thus it goes without saying that for the Chinese market a “more of the same” prediction two weeks ago implies a prediction of continued high levels of volatility.  Which is what happened.  You may disagree with me, but please don’t assume I’m a complete moron.

Bob Murphy is too kind, suggesting in a new post that today’s events provide vindication for my views.  It’s true that I’ve been saying for some time now that the Fed should not raise rates, and that this is now becoming the conventional wisdom.  It’s true that I’ve been saying that low interest rates and low inflation are the new normal of the 21st century, and the bond market is coming around to that view as well.  But Bob is really being too kind, singling out a promise that was not at all difficult to fulfill.  He quotes this non-prediction from 9 days ago:

I’m a bit more optimistic [about the Chinese economy], as I think the reform process will continue. They’ll avoid the middle-income trap. But they haven’t yet even reached the trap””a lot more growth is ahead. If you want to know when that day of reckoning will finally arrive in China, don’t come here looking for answers. I will miss the collapse, blinded by the EMH, just as I missed every other dramatic economic shock in my entire lifetime. My predictions are boring, and always the same:

“More of the same ahead”

My predictions are usually right, but they get no respect, and don’t deserve any.

Yes, my claim that my Chinese predictions deserve no respect has clearly been vindicated.  It’s easy to claim that asset prices follow a random walk and can’t be predicted; even a kindergartner could do so.  Let me return the favor with a few comments on the bubble-mongers of the world, both real and phony:

1.  If you are real bubble-monger and predicted the Chinese stock market collapse and shorted the Hong Kong market and got rich, then I offer you my congratulations.

2.  If (like me) you failed to predict the collapse, then I offer you my sympathy.

3.  If you are a phony bubble-monger who predicted the China crash, but did not get rich shorting the Hong Kong market, then I have contempt for you.

I think that pretty much covers all the bases.

PS.  Unfortunately in this day and age I must add on a “just kidding” disclaimer.  (Jokes are no laughing matter.)  I actually have contempt for no one and sympathy for everyone.

PPS.  The views of Ben Bernanke pre-Fed were very different from the actions of the Fed under his leadership.  The views of Janet Yellen pre-Fed were very different from the actions of the Fed under her leadership.  I have no idea what Larry Summer’s actions would be if he were currently chair of the Fed.

PPPS.  A brief comment on TIPS spreads.  There is one factor that leads TIPS spreads to underestimate inflation expectations—conventional bonds have more liquidity, and this reduces their yield relative to TIPS.  There are two factors that lead to the TIPS spreads overestimating inflation expectations, the fact that they are indexed to the CPI and not the Fed’s preferred PCE, and the fact that TIPS bond principal only indexes upward over the life of the bond, not downward (during deflation).

PPPPS.  I have a new Econlog post.

PPPPPS.  My claim about not having contempt for anyone is only true about 1% of the time, when I reach Robin Hanson/Scott Alexander/Scott Aaronson/Tyler Cowen/Bryan Caplan/Razib Khan/Miles Kimball levels of dispassionateness.  The other 99% of the time I’m closer to Donald Trump, and hate almost everyone.  But I was in a good mood when I wrote the first PS.