Whip Deflation Now!

Everybody's talking about deflation all of a sudden. I was a month and a half early, I guess. (Okay, okay, it was a footnote, but still.) What I said then was, we won't allow deflation. And we have the means at hand to prevent it.

Of course, monetizing the debt only goes so far when the government keeps making more.

Reckless, Booming Anarchy

"Reckless, booming anarchy," in short, produced fundamental progress. It was not a stable system, racked as it was by bank failures and collapsed business ventures, outrageous speculation and defaulted loans. Yet it was also energetic and inventive, creating permanent economic growth that endured after the froth was blown away.

This is Greider describing the 1830's.

Those who gambled on the future rise of the public lands in the West... were madmen only in the short-run business sense--only in thinking that future prospects could be realized all at once by means of an infinitely expansible credit system--and not in their basic sense of direction. The whirlwind creation of credit, wasteful as it was, had the effect of transferring purchasing power from the passive elements in the economy to the activists.

The classic tradeoff between entrepreneurism and stability.

Hysteresisia

Surowiecki has an interesting take on the obvious up on his New Yorker blog. And I don't mean that in a bad way: it seems economists could usefully spend much of their time reviewing the obvious and why it doesn't fit our overly simplistic economic models.

He notes the fact that when stock prices go down, demand doesn't necessarily increase, it often decreases. The supply and demand curves change based on price changes. He cites Warren Buffet as one person who is mystified by this.

I took a bankruptcy class with Altman (of Altman's-Z fame) once a long time ago. I was surprised to see, when he presented the non-proprietary version of his bankruptcy prediction formula, that one of the terms was the stock price. This felt like cheating to me. But noone can argue against the fact that the price contains information and is predictive.

So it's not surprising that the value of a financial instrument is dependent not only on it's price but on it's change in price. Supply and demand curves should change as the product changes, and what you buy when you buy a share of stock is continuously changing.

Surowiecki concludes by saying

...Investors should be much happier buying when stocks are down... but it seems clear that this is not how most investors are psychologically built. Instead, we like to buy when stocks are rising, and we feel the need to sell when they’re falling. The impulse to do this is very hard to resist, and it is one of the biggest reasons why people, whether they’re investing in individual stocks or mutual funds, find it so hard to make money in the market.

Ah, yes, everybody in the market is irrational. That's a useful insight. Why not, instead, when the data does not agree with your theory, accept that it's the theory that's wrong, not the data.

Low Probability Catastrophes

I was basically writing this exact same thing: economics as a science is a poor excuse for science (hat tip to Kedrosky... again.)

Economics is fascinating, because no one knows anything. Greider, in his excellent Secrets of the Temple said, in 1987:

The ultimate test for soundness for any science was the ability of its rules and theories to predict outcomes, and by that standard, economics was a crude and underdeveloped discipline.

Twenty years later, still as true as it was then. Why are economics and medicine, where our ignorance daily cause huge hardship and lost lives, still relatively medieval in their development while physics and chemistry have been so dynamic? Why can we put people on the moon but we can't cure cancer? Why can we make fabrics that are breathable and waterproof but we can't mitigate the business cycle?

Economics has this virtue over medicine regarding the scientific method: there is a huge amount of experimental data being generated all the time. While it occasionally shows the theory to be correct (for example, Zimbabwe), it usually shows the theory to be completely wrong (for example, the, um, economy.)

The question is, why is this so? Inventing a better economic theory would provide much more in the nature of public or private rewards than, say, inventing a better explanation for why the universe is expanding at the rate it is. Discovering the Higgs boson may win you the Nobel prize, but being able to reliably predict the fluctuations of our GDP would give you some nifty trading profits.

In fact, you don't need to predict GDP very well, you just need to predict it better than the other guys. So, why doesn't somebody? "Cargo cults" aside, I can think of only one reason: we're just not smart enough. Or, same thing, it's just not possible. One thing's for sure: we need to admit how much we don't know. The essence of crisis management is minimizing the damage from low probability catastrophes. As we bounce from one of these to another, we should think about admitting that more than leaping without looking, we're actually blind. Building some slack into the system seems the least we can do.

A Bet on Red

Okay, last post for a while on the economy. Macroeconomics fascinates me, mainly because I think it's about as well-developed as psychohistory, so Monday morning quarterbacking is possible as in no other discipline. But other commentators comment better; if you're really interested, you've found them. This post is simply a long rant aimed at getting it all out of my system so I can go back to prognosticating on marketing.

I have been told there are four virtues: compassion, joy, friendliness and equinamity. Of these, I suppose only equinamity comes naturally to me. Maybe that's why finger-pointing over the current mess seems so completely uninteresting.

If Wall Street borrowed too much and made too risky bets with their money, then they committed the same sins that Main Street does. Complaining that they were well paid to make these mistakes merely points out their customers rewarded those who made these common errors--something that can hardly be blamed on the bankers themselves. Saying, on the other hand, that they were professionals and should have known better shows, in my opinion, a certain lack of self-awareness.

I think Wall Street should have known better. I think everyone should know better. I think anyone who handles money at any point in their life should be taught this:

There's No Free Lunch.

1. If you're borrowing money, you have come under the watchful eye of someone who but for the sake of the law would break your knees as an object lesson, or just for fun. Borrowing money--including using (or even applying for) a credit card or getting a mortgage or a student loan--is a big deal. A BIG deal. You would think that as a movie-going nation we would understand the dire consequences of falling behind on paying off a debt (Get Shorty, American Gangster, The Big Lebowski... need I go on?). Borrowing money is a bad idea. But borrowing money is also a good idea. Buying a car or home or college degree costs more than almost anyone can afford to pay all at once. And, since you use your purchase over the course of time, paying for it over the course of time makes sense. So, good idea, bad idea, what to do? Approach borrowing with the same legal firepower and accounting self-knowledge that you would when making a deal with the devil. And the same expectation that, even if you've thoroughly done the legal and accounting thing, you're probably about to be totally screwed in a completely unforeseen way. (If you haven't done the legal and accounting thing, you'll be totally screwed in a completely mundane way.)

2. I referenced a graph last week showing the growth in per-capita GDP. It's 1.8% a year; not year-in, year-out, but over any medium-term period of time. If you're investing money and expect to earn more than 1.8% a year before tax, ask yourself why you deserve that. Why do you deserve it? What did you do to earn it? You're probably investing in the US economy, which grows at 1.8% per year per person. Why would your investment grow more than that? If you're thinking of buying shares of some stock, are you going to earn more than 1.8% because you are smarter than the scores of people who spend 147 hours a week, 51 weeks a year relentlessly investigating and modelling nothing but that particular stock? Or are you planning to contribute your brainpower and sweat to making the recipient of your investment more successful? If not, then why do you deserve a better return than 1.8% per year, before tax? You know what you do to deserve it? You take a chance. You take some risk. This is a good thing... a wonderful thing. It could be viewed as a joyousness about humanity's potential, a friendliness to your fellow strivers, or compassion for someone trying to lift themselves up. But it shouldn't be. It should be viewed as a bet on red. So next time black comes up, please don't whine.

Aieeee! Redux

I read today that the market is at its lowest level since 2003. As a percentage of GDP (which calculation has the benefits of automatically adjusting for inflation and actual economic growth) it's at its lowest level since 1995. I've updated the graph to show today's change as well as focus in on 1982 to today. At end of Q2-1982 total stock market cap was 37%, its lowest level that I have data for (so, since at least 1952.) It reached 210% end of Q1-2000, went to 107% Q1-2003 and I now estimate it at 94%, a level last seen Q2-1995.


If we return to 37%, the Dow would be at... wait, you do the math: I don't want to know.

Investing in the Real Economy?

I thought this was going to be more comforting than it turned out to be. Although, I have to say that it's a lot more comforting now that I've added today's market close.

GDP and Total Stock Market Capitalization in Real Billions of Dollars

This is a lot less comforting.

Total Stock Market Capitalization as % of GDP

Total market cap as a percent of GDP has reached its lowest level since 1995. But 1995 seems to mark the beginning of some different valuation paradigm. Why? What changed? Is it a real change, or the beginning of what's now ending?

GDP data from the BEA, total stock market capitalization is from the US Census Bureau, except for today's number which I extrapolated from the end of Q2-08 amount using the change in the Wilshire 5000 index.