Should-Read: Is “smart money” in the business of making money by leaning against noise traders? Or is “smart money” in the business of making money by figuring out when information about fundamentals is slowly diffusing through the marketplace to fundamentals-based investors? Why, you may ask, if “smart money” is smart doesn’t it simply determine fundamental values, and then buy and hold? The reason is that “smart money” are actually smart managers who need to show a return in the short term. Thus betting against noise traders and front-running information diffusion are the only strategies that promise to do that. Provided you can tell the time to do one from the time to do the other, that is: Dan Davies (2009): Capital Decimation Partners: “Another thing falling into the category ‘jolly useful things I learned at London Business School…

…Anthony Neuberger’s options & futures class drummed this into you-the derivatives market is essentially a financial services market, where you hire someone else to carry out a trading strategy on your behalf, on the assumption that they have economies of scale in doing so. This is most obvious in the case of portfolio insurance… but it’s of utterly general application; every derivatives payoff structure defines a trading strategy…. Think about the trades you’d execute if you were replicating….

If we think about the options in payoff terms, a long call option is equivalent to buying insurance, and a written put is equivalent to selling insurance. If we think about them in trading terms, however, a long call is like a stop-loss, while a short put is like… well, who in the market is a structural buyer when the world is selling, and a structural seller when the world is buying? Answer-among other people, the market-maker, specialist or equivalent liquidity provider. Someone who’s providing liquidity to the market more or less has to do this, or they’re not providing liquidity. And this gives the first hint of a clue, because it does suggest that not all “Capital Decimation Partners” are mugs, no matter what Nassim Nicholas Taleb thinks….

For an informed trader in a market where the true value of the security is reasonably stable, “buying dips and selling rallies” is almost always going to be the right thing to do. And this is the strategy which is bound to show up on any statistical test (including Lo’s own proposed measure) as being equivalent to a put-writing strategy, or Capital Decimation Partners. The point that I want to make here is that if you’ve got a good actuarial estimate of the risks, writing insurance is the right thing to do—a good trader will very likely give a false positive on any measure which is meant to distinguish “genuine” talent from “mere” put-writing…. The thing that will sort the sheep from the goats, however, is what happens when V changes. Say there’s a sudden stepwise change in V, so that it moves to a tenth of its previous value. On reasonable assumptions about the stochastic process for P, P is going to start moving downwards. But this time, you really don’t want to be buying this dip, because it’s not a “dip”, it’s a shift down…. The skill of running a specialist book is entirely in realising when “normal” provision of liquidity has become a dangerous game, and when the price needs to be marked up or down to a new level.

In fact, this isn’t just the skill of being a market-maker-it’s a hell of a lot of the whole skill of investing. The technical analysts will tell you, if you stop sneering and making hilarious jokes about astrology long enough to let them, that securities tend to spend about two-thirds of their time in trading ranges and one-third of their time in trends. Which would be consistent with a wide variety of sensible market microstructure models under which true value changed slowly, and as a result to specific and infrequent events (say, because it was determined by economic processes which shifted regimes as a result of historic, nonergodic processes). Investment talent of the sort that you want to look for in a hedge fund manager, resides in being able to know, ahead of the rest of the market, when underlying value is going to change, and to adapt trading structure accordingly…

Should-Read: It could have gone so much easier with more reflation in Germany. A one percent per year German inflation target is no way to run a railroad for general prosperity: Paul Krugman: Notes on European Recovery: “Since 201,,, we’ve seen significant growth in Europe, with the fastest growth occurring in the areas (other than Greece) that were hardest hit by the euro crisis, especially Spain…

…So what turned around in Europe? One important answer was three words from Mario Draghi: “whatever it takes”. The ECB’s promise to buy government bonds if necessary almost instantly ended a panic in southern European bond markets, drastically narrowing the spread against Germany and setting the stage for growth. The other thing that happened was internal devaluation…. Spain, in particular, gradually squeezed down its labor costs relative to the euro area as a whole. This has in turn fueled a big export boom, especially in autos. So is all well that ends well? No. Southern Europe paid a terrible price during the crisis years. The fact that internal devaluation eventually works, after years of high unemployment, is neither a surprise nor a vindication of the huge suffering during the interim. If there was a surprise, it was political: the willingness of political elites to pay this price rather than break with the euro. Still, it’s important to be aware that Europe 2018 looks very different from Europe 2013. For now, at least, Europe is back as a functioning economic system…

Should-Read: More economist self-flagellation and self-justification. I kinda think the discussion would be healthier if it recognized, as Samuel Jackson says in Pulp Fiction: “The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men…”: Dan Davies, Simon Wren-Lewis, and Policy Sketchbook: “Saying nothing about the importance of financial linkages and imbalances because they didn’t know they were there does not exactly get the profession off the hook!!!”:

@dsquareddigest: A very large proportion of the economics profession should have said “our models are clearly inadequate so we will work hard on improving our understanding, in the meantime please listen to this small subset of us who appear to have been right”.

@sjwrenlewis: A very large proportion of the economics profession said nothing about finance and the chance of a crisis, and that includes all the trade economists that should have been listened to over Brexit.

@dsquareddigest: Saying nothing about the importance of financial linkages and imbalances because they didn’t know they were there does not exactly get the profession off the hook!!!

@policysketch: Isn’t the comms challenge here to explain that there are some things we know and many we don’t? A challenge made harder (to continue the medical analogy) by the fact that while some economists are giving out vaccinations and painkillers, others are treating dementia with leeches.

@dsquareddigest: The comms challenge is to understand that this is basically a marketing task trying to get our view over, not a settled science where we can just call people idiots for not listening to us. Not helped by the fact that economists like to call themselves “professionals”, but reject all associated concepts of ethics, standards and discipline…

Should-Read: Ima gonna archive this to jeer at in the future! Yes. BitCoin is a bubble. It is a mania of irrational crowds. It is not a financial market that is serving as a rational social calculating mechanism. It is not a market in which prices are being set by rational von Neumann optimizing agents. It is not even a market with short-selling constraints in which rational speculators are exploiting a non-rational herd: John Cochrane: The Grumpy Economist: Bitcoin and Bubbles: “So, what’s up with Bitcoin? Is it a ‘bubble?’ A mania of irrational crowds?…

…It strikes me as a fairly pure instance of a regularly occurring phenomenon in financial markets…. The convenience yield… it facilitates tax evasion, and allows for illegal voluntary transactions such as drugs and bribes…. On top of this “fundamental” demand, we can add a “speculative” demand…. You can make so much money in a volatile market over a week, if you get on the right side of volatility…. In sum, what’s going on with Bitcoin seems to me like a perfectly “normal” phenomenon. Intersect a convenience yield and speculative demand with a temporarily limited supply, plus temporarily limited supply of substitutes, and limits on short-selling, and you get a price surge…. Other theories, such as madness of crowds, do not explain that correlation…

Continue reading “Should-Read: John Cochrane: The Grumpy Economist: Bitcoin and Bubbles“ →

Should-Read: Max Roser: When will the world reach ‘peak child’?: “The world has probably not reached ‘peak child’ yet…

…However, we are likely very close to a long flat peak; the number of children in the world will not increase much more. We are close to the peak…. The number of children in the long-run will depend on how successful the world will be in providing education–in particular to women–in the short-run. This is because women that are better educated tend to have fewer children. If we are successful in providing accessible education for all in the near-term, there will be fewer children–and therefore less demand for education–in the future…. How the size of the population will change in different world regions. Crucial will be the African continent: fast development in Africa will slow down population growth, whereas slow development would leave African countries in an extended period of fast population growth. The latter scenario could see the African population growing 5-fold over the 21st century…

Should-Read: Hans and Ola Rosling: Ignorance: “The mission of Gapminder Foundation is to fight devastating ignorance with a fact-based worldview that everyone can understand…

…We started the Ignorance Project to investigate what the public know and don’t know about basic global patterns and macro-trends. We use surveys to ask representative groups of people simple questions about key-aspects of global development.When we find large knowledge-gaps, we know what teaching materials we should develop. The first results from surveys in UK and Sweden were published in 2013. As the project evolves we will investigate many more countries. The test questions and results will be made freely available under Creative Commons Attribution License…

Should-Read: That the minority of academic economists who opposed fiscal stimulus from 2009-2011 were able to carry the day in the public sphere from 2010 on is a deep indictment of the economics profession—but more so of journalism, IMHO at least: Simon Wren-Lewis: Academic knowledge about economic policy is not just another opinion: “Why don’t we look at what has happened since the financial crisis…

Macroeconomists, having learnt the lessons of the 1930s, immediately recommended that policy makers do three things after the crisis: cut interest rates sharply, embark on fiscal stimulus and bailout banks. Policy makers took that advice in 2009, and as a result we avoided another Great Depression. Many said that rising government debt was sure to send interest rates on that debt rising: academic economists using basic ideas from Keynes said they would not and they were proved right. Many others said that Quantitative Easing (central banks creating money to buy government debt) would cause hyperinflation, but again academic economists looking at more modern New Keynesian models said that was nonsense and again they were right.

You might claim that in all this economists were just advocating what was obvious. The acid test came in and after 2010, when fiscal stimulus turned to austerity. What evidence we have suggests this move was opposed by a majority of academic economists, a majority that grew over time. There was a minority that supported austerity, at least for a time, and they gained a lot of publicity because politicians latched on to what they had to say. But the majority followed both textbook and state of art economics, and this majority was right. The recovery would have been stronger and faster if politicians had gone with this majority…

Should-Read: There are many jobs the disabled could do. But they are almost always not their old pre-disability jobs. Anyone who wants to “fix” SSDI needs to think very long and hard about how to match newly disabled people who can no longer do their old jobs with new types of jobs they could do. And, no, Rand Paul’s back does not really hurt. Nor is he anxious: Dylan Matthews: In defense of Social Security Disability Insurance: “When Americans get too sick or injured to work, this program helps them survive…

…“Over half the people on disability are either anxious or their back hurts,” Sen. Rand Paul (R-KY) said in 2015. “Join the club. Who doesn’t get up a little anxious for work every day and their back hurts?” It’s a common line from conservative politicians: that the Social Security Disability Insurance program is just welfare for people too lazy to work. Many of those politicians haven’t spent much time at all actually talking to the people they’re denouncing—people like Randy Pitts.

Before his body started to fail him, Pitts, a 43-year-old in Lake County, Tennessee, was a public servant. He loved his job as a 911 dispatcher for the county’s emergency services; he recounts with pride the story of the day he kept residents calm as trees crashed around them in an ice storm. He was elected county commissioner, a position he used to champion solar power. Then in 2013, Pitts, who already had moderate arthritis and herniated discs in his back, was diagnosed with renal failure, an extreme form of kidney disease—the beginning of a chain of events that would leave Pitts and his family dependent on Social Security Disability Insurance (SSDI), which offers assistance for workers who develop disabilities and illnesses that render them incapable of working any longer.

Pitts’s renal failure led to a medical emergency that left him with what a doctor told him was likely post-traumatic stress disorder. Too weak to stand and talk, he campaigned for reelection but narrowly lost his seat. At his dispatcher job, he struggled to remain calm and form clear sentences to reassure callers. In 2015, struggling mentally and physically, he had to give up his job; these days, he’s unable to dress himself without help from his teenage son. Pitts’s son works, as does his daughter, who is in college. But the family’s major lifeline is the $1,196 per month Pitts gets through Social Security Disability Insurance — which has been, over the past several years, under intense political assault from the likes of Sen. Paul…

Should-Read: I think the estimable Jared Bernstein is just wrong here, for reasons he knows—and in fact sets out in the “caveat” section of his post: Jared Bernstein: The new asymmetric risk: “Given that we cannot confidently assert that we are at full employment or full capacity… this hyper-Keynesian experiment is worth undertaking…

…Caveat time, and there are good ones which I take seriously…. This particular fiscal stimulus has lousy multipliers. Some of the spending in the budget deal may end up supporting useful infrastructure projects and providing much needed disaster relief—worthy expenditures that could help tighten the job market in places where it’s still slack. But the regressive tax cut is terribly targeted, and any fiscal stimulus is less potent when the Fed is pushing in the other direction, albeit slowly…. The bang-for-the-buck here is sure to be weak…

Fiscal space should be used, but it should be used and used up only for good policies that do the job, not for pointless regressive tax cuts.