How Schizo Is Ms. Market These Days?

BofA Merrill Lynch US High Yield Effective Yield© FRED St Louis Fed

I’m confused because it does not seem to me that there is a single Ms. Market out there…

I used to strongly believe that bond and equity markets were tightly coupled by well-defined assessments of risk and a well-specified risk tolerance: take the risk-free rate, and to that the riskiness of a security times the premium per unit of risk, and you got the rate for that security. And as the risk-free rate moved up and down the whole configuration would move up and down, with some widening of spreads as the risk-free rate moved up and contraction as the risk-free rate moved down, but all in a predictable, stable configuration.

Thus safe bond and risky bond and stock prices would move in opposite directions in response to shocks to productivity and profits, and would move together in response to shocks to monetary policy and financial conditions.

Yet that does not seem to be true anymore. Since 2008 the ability of markets to actually make the risk transformation in sufficient volume that is needed for it to make sense to say “the market has a well-specified risk tolerance” seems to have broken down.

Safe bonds to their thing.

Risky bonds do their thing.

Short bonds do their thing.

Long bonds do their thing.

Equities do their thing.

And the spreads between them look like residuals more than relationships. Rather than trade ironing out the market into a single aggregate view, there seem to be three often inconsistent views here…

Should-Read: Ian Dunt: Brexit: What the Hell Happens Now?: Everything You Need to Know about Britain’s Divorce from Europe

Should-Read: Ian Dunt: Brexit: What the Hell Happens Now?: Everything You Need to Know about Britain’s Divorce from Europe: “Britain’s departure from the European Union is filled with propaganda, myth, and half- truth–but the risks are very real…

…Mishandling Brexit could lower our global status, diminish our quality of life, and throw our legal system into turmoil…. Ian Dunt… explains • why leaving the EU is set to make us permanently poorer • how cutting immigration will affect wages and taxes • why leading industries like farming, pharmaceuticals and finance will struggle to function • whether the biggest constitutional change in post-war history will break up the UK
This is the first full public exploration of Brexit, shorn of the wishful thinking of its supporters in Parliament and the media… a portrait of a country about to undergo a period of self-inflicted isolation.

Must-Read: Nancy Folbre: Does the One Percent Deserve What It Gets?

Must-Read: If people’s utility is proportional to the log of their lifetime incomes, then a perfectly competitive market without increasing returns, non-rival or non-excludible goods, or externalities “solves” the social welfare problem of maximizing a weighted sum of individual utility levels in which each individual’s utility is weighted by the value of his or her comprehensive lifetime endowment. What determines your lifetime endowment? The environment in which you are raised and your genetic inheritance that determines your skills, the property you inherit, luck; plus whether your particular environment-genetic-property-luck combination is scarce by nature, the luck of the draw, or by rent-seeking policy; and whether rich people have a strong jones for the things that your comprehensive lifetime endowment gives you a comparative advantage in making.

And if people are more risk averse than log utility–and it really looks like they are–the social welfare problem the market “solves” weights the ex post rich even more highly.

And we haven’t even gotten to the point that virtually nobody well-off is paid their marginal product–subtract them from society and let the market reach a new equilibrium, and in all but the most exceptional cases the drop in output would be only a small fraction of their “compensation”. (The poor, by contrast, are paid their marginal product–or less.)

The answer to the question, “is it sensible for society to maximize a social welfare function in which everybody’s utility is weighted by the ex post value of their comprehensive lifetime endowment?” is “no”.

Where does the idea that it is sensible come from. I think it comes from the opposite of rational thought. It is, psychologically, very important for human happiness for people to convince themselves that they “deserve” what they get–people are very unhappy if they think that they are among the moochers, and very very unhappy if they think that they are among the moochers. Finding a way to believe that this is true–that what is is one’s just karma–is important to many people. Thus it is a form of theology, not social science…

Nancy Folbre: Does the One Percent Deserve What It Gets?: “Years of schooling in neoclassical economic theories predispose [economists] to the view that perfectly competitive markets yield equitable as well as efficient outcomes…

…As a result, they often assess “rent seeking,” or efforts to get rich at someone else’s expense, by comparison with hypothetical market outcomes. Rent seeking becomes just another name for interference with the magic meritocracy of the marketplace. From this perspective, efforts to increase the minimum wage can be considered just as unfair as efforts to challenge compensation practices for corporate chief executives and other well-heeled top managers…

Must-Reads: November 28, 2016


Interesting Reads:

Must-Read: Pseudoerasmus: To Explain Myself on Twitter: My View of Chile

Must-Read: Pseudoerasmus: To Explain Myself on Twitter: My View of Chile: “Chile before Allende had already been a middle-income country… since the 19th century….

But… much like Argentina, Chile had been in relative decline since the early 20th century. Allende was a complete disaster https://pseudoerasmus.com/2015/05/21/the-invisible-blockade-against-allendes-chile/… both a ‘short-term’ disaster of fiscal and monetary management; and a long-term structural disaster of increasingly ‘socialising’ the economy. Allende to some extent was unlucky… but his mismanagement was extreme, Venezuela-like, in the face of the external shock.

Pinochet’s first austerity programme (1973–5) was absolutely necessary in the sense that Chile’s 30% of GDP budget deficit and hyperinflation had to be reversed…. Pinochet was indeed lucky to see rising copper prices during his part of the 1970s…. However, Pinochet also liberalised the capital account, letting in ‘hot money’ capital flows, much of which went into a real estate bubble in the late 1970s. Because of this, Chile faced the debt crisis in the early 1980s just as much as any other Latin American country…. The financial austerity in the face of the debt crisis erased the economic recovery of 1973–82. This was purely Pinochet’s mismanagement and incompetence. He was no better than Mexican presidents, in this regard.

But that’s different from his structural reforms. Those largely survived him, albeit with more redistribution under democratic governments, more ‘light’ industrial policy, as well as capital account controls, which were actually implemented by Pinochet after 1982. Clearly, Chile is much closer to the neoliberal paradigm, albeit with anomalies, than Chile was in 1969 or 1973. Denying that is tantamount to denying that the rest of Latin America is also closer to the neoliberal paradigm today than it was in 1975 or 1980. But there is nothing special about Chile today….

Had an Allende-like regime persisted, Chile would probably be much poorer today. But the actually existing Chile is no closer to convergence with the rich countries than it was in 1930. Moreover, Chile’s GDP/capita is about the same as Argentina’s, but Chile’s median household income is lower, and Chileans work longer hours per year than Argentinians.

Must-Read: Noah Smith (2013): “Just Deserts”

Must-Read: Noah Smith (2013): “Just Deserts”: “‘I get what you get in ten years, in two days.’–Chris Brown…

…Mankiw wants… a value system based on “just deserts”… “people should receive compensation congruent with their contributions”…. I think it’s worthwhile to think through the implications….

Brad CEO… makes $30 million a year…. Mike Clerk, who works at Wal-Mart… $25,000 a year…. So Mike works and works and works, for three years…. Suppose Brad randomly sees Mike’s new Civic in a parking lot and decides that he wants the same car…. Brad will have to work a little less than 5 hours…. Go to a couple meetings, send some emails, and the Civic is his.

Now suppose Mike goes to Greg Mankiw and asks: “Dr. Mankiw, why is it right and just that it took me 4% of my entire lifespan to buy this car, with all my heroic efforts and harsh self-denial, when it took that Brad CEO guy less than a day? I put in every bit as much effort as he does, day after day. Why does he deserve to get things with so much less effort than I put in?” Dr. Mankiw responds:

I am more persuaded by the thesis advanced by Claudia Goldin and Lawrence Katz (2008) in their book The Race between Education and Technology. Goldin and Katz argue that skillbiased technological change continually increases the demand for skilled labor. By itself, this force tends to increase the earnings gap between skilled and unskilled workers, thereby increasing inequality….
“OK,” Mike says. “But why, then, is Brad CEO so much more productive than I am? Where does his $30 million productivity come from?”

Dr. Mankiw responds:

[T]he intergenerational transmission of income has many causes beyond unequal opportunity. In particular, parents and children share genes…. IQ… has a large degree of heritability… IQ is only one dimension of talent, but it is easy to believe that other dimensions, such as self-control, ability to focus, and interpersonal skills, have a degree of genetic heritability as well.

“So let me get this straight,” Mike says. “Brad deserves to be so much richer than me because of ability he was born with?…”

Mike falls off of a ladder…. In the old days, before Mankiw’s “just deserts” theory gained widespread acceptance, Mike would have been able to collect Social Security disability; now, however, the government tells him that he does not deserve disability payments–they constitute an unfair transfer of income from the productive to the unproductive…. Mike cannot go to physical therapy because he cannot afford health insurance, and Medicaid was canceled because Medicaid payments do not constitute… “just deserts”….

Hopefully by now I’ve made my point. It’s easy to say that people deserve to get whatever they can manage to get in a “free” market. But when you start to actually think… you realize that it probably doesn’t fit very closely with most people’s concept of… “just deserts”…. Moral values are just statements of opinion, and Greg Mankiw is certainly entitled to his own. But I somehow doubt that his opinion of “just deserts” will be able to win over a majority of Americans, even among the intellectual classes.

Must-Read: James J. Feigenbaum and Christopher Muller: Lead exposure and violent crime in the early twentieth century

Must-Read: James J. Feigenbaum and Christopher Muller: Lead exposure and violent crime in the early twentieth century: “In the second half of the nineteenth century, many American cities built water systems using lead or iron service pipes…

…Municipal water systems generated significant public health improvements, but these improvements may have been partially offset by the damaging effects of lead exposure through lead water pipes. We study the effect of cities’ use of lead pipes on homicide between 1921 and 1936. Lead water pipes exposed entire city populations to much higher doses of lead than have previously been studied in relation to crime. Our estimates suggest that cities’ use of lead service pipes considerably increased city-level homicide rates [by 24%].

Good Riddance to Fidel Castro…

Good Riddance to Fidel Castro!: Fidel Castro has retired. Good riddance!!

That the Lenin-Trotsky-Stalin Authoritarian Project of which Fidel Castro was the next-to-last exemplar was not an advance toward but a retreat from a better world was obvious long, long ago. Quite early–Kronstadt?–it was clear to all save the dead-enders that the project was a mistake.

As Rosa Luxemburg wrote in “The Russian Revolution”:

Freedom only for the supporters of the government, only for the members of one party — however numerous they may be — is no freedom at all. Freedom is always and exclusively freedom for the one who thinks differently… because all that is instructive, wholesome and purifying in political freedom depends on this essential characteristic….

The tacit assumption underlying the Lenin-Trotsky theory of dictatorship is this: that the socialist transformation is something for which a ready-made formula lies completed in the pocket of the revolutionary party, which needs only to be carried out energetically in practice. This is, unfortunately — or perhaps fortunately — not the case…. What we possess in our program is nothing but a few main signposts which indicate the general direction in which to look….

The socialist system of society should only be, and can only be, an historical product, born out of the school of its own experiences, born in the course of its realization, as a result of the developments of living history… socialism by its very nature cannot be decreed or introduced by ukase. It has as its prerequisite a number of measures of force — against property, etc. The negative, the tearing down, can be decreed; the building up, the positive, cannot. New Territory. A thousand problems.

Only experience is capable of correcting and opening new ways. Only unobstructed, effervescing life falls into a thousand new forms and improvisations, brings to light creative new force, itself corrects all mistaken attempts. The public life of countries with limited freedom is so poverty-stricken, so miserable, so rigid, so unfruitful, precisely because, through the exclusion of democracy, it cuts off the living sources of all spiritual riches and progress….

The whole mass of the people must take part in it. Otherwise, socialism will be decreed from behind a few official desks by a dozen intellectuals…. [Lenin] is completely mistaken in the means he employs. Decree, dictatorial force of the factory overseer, draconian penalties, rule by terror…. It is rule by terror which demoralizes.

When all this is eliminated, what really remains?… Without general elections, without unrestricted freedom of press and assembly, without a free struggle of opinion, life dies out in every public institution, becomes a mere semblance of life, in which only the bureaucracy remains as the active element. Public life gradually falls asleep, a few dozen party leaders of inexhaustible energy and boundless experience direct and rule. Among them, in reality only a dozen outstanding heads do the leading and an elite of the working class is invited from time to time to meetings where they are to applaud the speeches of the leaders, and to approve proposed resolutions unanimously — at bottom, then, a clique affair — a dictatorship, to be sure, not the dictatorship of the proletariat but only the dictatorship of a handful of politicians, that is a dictatorship in the bourgeois sense….

Yes, we can go even further: such conditions must inevitably cause a brutalization of public life: attempted assassinations, shooting of hostages, etc….

That–written some ninety years ago–strikes me as a good epitaph for Castro’s rule.

Must-Reads: November 25, 2016


Interesting Reads: