Monday, March 2, 2015

Cullen Roche on Market Efficiency

      Ok, I'm on a role today so I might as well go with it. Greg mentioned Cullen Roche on market efficiency. I found this post Cullen wrote:

     "Paul Samuelson always argued that the markets were micro efficient, but not macro efficient. Indeed, the whole concept of market “efficiency” is becoming increasingly irrelevant in a world where entire economies are becoming so highly correlated.  But this doesn’t change the importance of understanding the discussion and its impact."

      I got to like a quote from Paul Samuelson. Greg draws the distinction between investing and gambling:

     "The problem too many people have is they think of the market as a place to get rich when it is simply a place to try and keep from getting poor while getting some return better than cash under your mattress. Buffett isn't rich because he traded stocks smartly, he's rich because he bought companies and made them printing presses. It was the real returns generated by the businesses he owned that made him rich, not timing the buying and selling of the stocks."

    "Gamblers try and time their buying and selling, and as Keynes pointed out the smart gambler doesn't pick stocks he likes he tries to guess what everyone else will like and gets them first, but investors build real companies."

   Don't get me wrong-I don't want to disaparage gamblers too much as it can be fun. Cullen's argument that on some level we are all in reality 'stock pickers now' makes sense. Keynes himself didn't get reliable profits from gambling if you will until he became a stock picker. Roche:

  "At the aggregate level we have all become “asset pickers”. The distinction between “active” and “passive” investors is largely irrelevant in a world where we all now pick baskets of assets inside the global aggregate. And when one deviates from global cap weighting (roughly the Global Financial Asset Portfolio) you are engaging in a form of asset picking that makes you no different than a stock picker.  You are declaring that you can generate a better risk adjusted return than the global aggregate.  Indexing has become the new stock picking.  Instead of picking 25 stocks in an index we now pick baskets of index funds inside a global aggregate."

     "The idea of “market efficiency” was never very useful to begin with however because it is constructed around a gigantic political strawman. The EMH is essentially a political construct that argues that discretionary intervention is useless because “the market” is smarter than everyone else. It is a political argument against discretionary intervention that was constructed to create a theory of finance that was consistent with an anti government economic theory (Monetarism primarily). In essence, you can’t “beat the market” because the market is so smart. This is silly though. The market will generate the aggregate market return and your real, real return will be the market return minus the rate of inflation, taxes and fees. Taxes and fees alone will reduce the aggregate return by over 35% (if we assume a 10% aggregate return, 1% fees and 25% tax rate). No one will consistently beat “the market” aside from a few lucky outliers. The math just doesn’t work. And the index we are comparing ourselves to is a completely fictitious benchmark because the average real, real return is lower than the pre-tax and pre-fee benchmark to begin with."

   "But the EMH defenders have misconstrued this entire debate to promote a political position constructed by anti government economists at the Chicago School of Economics. Imagine, for instance, that, for the purpose of record keeping, at the end of each NBA basketball game, the NBA reduced the average score of 100 points by 25 %. And then imagine that the coaches reduced the score by another 10%. What the EMH defenders have done is argued that the score of 100 means that the teams are all terrible because they cannot, on average beat this “benchmark”.  There will be outlier teams who sometimes score more than 100 points, but on average these “professional” teams will underperform.  EMH defenders have used this strawman to argue that “active” investors are all terrible.  It’s a completely useless construct that does nothing more than misconstrue the entire premise of the discussion."




MMT Arbitrates the Battle Between Keynes and the Classics

     As I told Greg in a comment I've never understood Marx here:

    "The philosophers have only interpreted the world, in various ways; the point is to change it."

       This apparent elevation of action over contemplation misses something. For one thing, contemplation itself is action. More generally, while we would like to change the world don't we have to understand it first? 

      In any case that's what we're trying to do here. 

      "The Classical economists said that without monopoly markets would clear and there would be no mass unemployment. That is, it’s only a monopolist, such as a labor union, that causes unemployment and excess capacity in general. Keynes, on the other hand, said that even in the absence of monopoly there could be persistent mass unemployment, and then discussed characteristics of the monetary system that caused this to be the case. This ongoing impasse alone, which has continued unabated in academia for over 80 years, is sufficient evidence that neither side has yet to recognize that the currency itself is the monopoly in question."

    Now I don't know that this is true. I mean hello, what about Monetarism? I'm not a Monetarist myself-Market Monetarist or other-but don't they say that money is the issue? 

    Where MMT does differ is that it argues that the government is the monopolist issuer of money while Monetarists along with most mainstream Macro probably believe in some variant of barter or commodity money. 

    However, the MMT passage goes on to say this:

   "It is ME/MMT that recognizes both sides are correct. The classics were correct in stating it was a monopoly that was the cause of unemployment. And Keynes was correct in stating that it was the characteristics of the monetary system as he described them that caused unemployment. And the reason for the continuing disagreement is simply that neither side has yet to specifically recognize that the currency itself is a monopoly causing the unemployment in question. 

    "MEMMT is thus distinguished by its explicit recognition that the currency itself is a monopoly, and that unemployment is the evidence that the currency monopolist is restricting supply. More precisely, unemployment (as defined) is the evidence the currency monopolist is restricting the supply of net financial assets denominated in that currency. It is only government spending (or lending) that adds the financial assets required for the payment of taxes to the economy, and it is payments to that government that removes those financial assets from the economy."

    So the disagreement is over the nature of money-even as the Monetarists focus on the money market they don't agree that the government is the monopolist of this market. 

Scott Sumner, Tony Yates and Warren Mosler on Expectations

     Recently, Sumner and Yates had a debate on expectations. Sumner argues for the idea that monetary policy works with 'long and variable leads'-in contradiction to virtually all received economic theory-not least, of course, Milton Friedman.

    "Suppose you think of monetary policy in the way most people do—as open market operations that change the money supply.  In that case, there may actually be LEADS in monetary policy, i.e. the effect may occur before the cause.  A future money supply change may cause a current change in demand and output."

    "Those who are philosophically inclined may be a bit uncomfortable with the thought of effects occurring before causes.  “Wait” (I can just hear you saying) “it isn’t the future money supply change that causes a current change in spending, it is the CURRENT EXPECTATION of a change in future monetary policy, and future AD.”  OK, I’m willing to go along with that.  We should not describe changes in monetary policy in terms of current changes in the money supply, but rather expected future changes in the money supply.  And of course we also know that it isn’t just the money supply that matters, velocity is equally important.  So what really matters is changes in the expected future level of M*V, or NGDP.  It is changes in expected future NGDP that best characterizes changes in monetary policy, at least if we don’t want effects to occur before causes.  Of course that’s exactly what I have been arguing in my blog for 18 months."

   "And by the way, if we define monetary policy changes in terms of changes in expected future M*V (as we should), and if the fiscal multiplier is estimated under the assumption that monetary policy is held constant, then it is a truism that the expected fiscal multiplier is always precisely zero."

   Tony Yates is not buying it:

   "Backing up, I don’t accept, of course, the premise of this line of thinking at all, that monetary and fiscal policy are perfect substitutes, and therefore that the former can be dispensed with.  But it’s worth bearing in mind that the logic gone through here works for fiscal policy too, both in the models, and in those attempts to identify shocks to fiscal policy today and in the future."

    "Sumner cites Woodford and Krugman as commenting on the potency of expectations, and uses this in support of his thesis that changing expectations changing things refutes the long and variable lags thesis.  But I am quite sure neither of them believe any such thing.  Estimated versions of Woodford’s model (for example, the original Rotemberg-Woodford model) behave just like my account above.  And Krugman is a firm believer in sticky prices, talking interchangeably between IS/LM and New Keynesian models.  Which behave just as I’ve explained above."
     "The only model I know where monetary policy has its entire effect instantaneously is the flexible price rational expectations monetary model.  And in this case there is no point in monetary stabilisation policy at all.  Money has no short-run effects on output.  Optimal policy in this model is to set rates at zero permanently, obeying the Friedman Rule.  If there are real frictions in this model, like financial frictions, there will still be a role for fiscal stabilisation, however."
     "I’m sure these mix-ups would get ironed out if MaMos stopped blogging and chucking words about, and got down to building and simulating quantitative models.  Talking of which…."
     Sumner, of course, got back to him:
     "In my view economists should forget about “building and simulating quantitative models” of the macroeconomy, which are then used for policy determination. Instead we need to encourage the government to create and subsidize trading in NGDP futures markets (more precisely prediction markets) and then use 12-month forward NGDP futures prices as the indicator of the stance of policy, and even better the intermediate target of policy.  It’s a scandal that these markets have not been created and subsidized, and it’s a scandal that the famous macroeconomists out there have not loudly insisted that it needs to be done."
    "If and when we get out of the Stone Age and have highly liquid NGDP and RGDP futures markets, then it would be much easier to explain my views on leads and lags. In that world a change in NGDP futures prices, not a change in the fed funds rate, represents a change in monetary policy. To be more specific:

     "I predict that whenever the 12-month forward NGDP futures prices starts falling significantly, near term NGDP would fall at about the same time, or soon after.  For instance, if we had had a NGDP futures market in 2008, then during the second half of the year you would have seen a sharp fall in 12 month forward NGDP futures.  At roughly the same time or soon afterwards current NGDP would have been falling. In contrast, if the Fed had moved aggressively enough to prevent 12-month forward NGDP prices from falling, then near term NGDP in late 2008 would have been far more stable.  I think that’s roughly consistent with Woodford’s view, although we may differ slightly on the lag between a change in 12-month forward NGDP expectations and a change in actual NGDP.  (Nor would he necessarily accept my views on the potency of monetary policy in 2008.)"

     So the proof about long and variable leads would be apparent if we had a NGDP futures market? Would this market be one with Sumner's Rational Expectations? Yates seems even less impressed:

    "Scott Sumner replies on The Money Illusion here, including some priceless phrases about how his research found that there were in fact, no lags at all between monetary policy changes and their effects, and some other collectibles about there not being a NGDP futures market."

   So we have the libertarian Scott Sumner demanding the government come up with the NGDP futures market the market itself seems totally uninterested in. 

    Meanwhile. even his benefactor, Kevin Duda, admits that he has no idea of such a futures market would work. The knock on it by Mark Sanowski, et al. is that such a market would be too easy to game and that the data would be too noisy. 

    I asked a skeptical commentator at Money Illusion once why the futures market couldn't work as TIPs are a successful market. Here was 'Dervis'' answer:

   "TIPS are not “pegged”

  "Also, The transaction in any other future that I can think of (and I’ve traded most of them), does not result in creating an offsetting (if not greater) opposing transaction. i.e, If I sell a normal future, I know I am weakening a market and benefiting my initial position. Even if I do not sell the entire volume I desired to sell (the market moves away from me), it results in me being P+L positive on my initial transaction. As designed, a sale of an NGDP future results in my actually driving the market right into my face (sale of 1 creates 1,000 opposing me). If I am early, anyone else that sees what I saw (normally would be a benefit to me), again no longer benefits me, as their transactions also pushes the market back to the peg price, without me benefiting."

  "The final point of waiting to trade at the last minute, is essentially the same as if you asked me to early exercise an option with extrinsic value less than carrying cost."
 "With a gun to my head, I ask you to pull the trigger before I ever exercise an option inefficiently. Hell, I’d pull the trigger for you."

   As someone who has traded options on equities I think I know what he means 

   For more on Sanowski's critique of NGDP futures see here.

   Sanwoski does say that he prefers an NGDP target to our current dual mandate whether the futures market would work or not-I've argued this myself.

    As usual in that back and forth, Sumner didn't accept Sanowski as making friendly criticism but took hm as one of the bad guys-a 'hostile Keynesian.'

   One thing I'm glad to hear from Scott regarding Yate's post:

   "The post also speculates on my views on fiscal policy.  Just to be clear, I oppose attempts to force a balanced budget."

    Ok, now Mosler. He criticizes the entire mainstream focus on expectations. 

    "But what we have is a government that doesn’t understand its own monetary operations, so, in America, the seven deadly innocent frauds rule. Our leaders think they need to tax to get the dollars to spend, and what they don’t tax they have to borrow from the likes of China and stick our children with the tab. And they think they have to pay market prices. So from there the policy becomes one of not letting the economy get too good, not letting unemployment get too low, or else we risk a sudden hyperinflation like the Weimar Republic in Germany 100 years or so ago. Sad but true. So today, we sit with unemployment pushing 20% if you count people who can’t find full-time work, maybe 1/3 of our productive capacity going idle, and with a bit of very modest GDP growth - barely enough to keep unemployment from going up. And no one in Washington thinks it’s unreasonable for the Fed to be on guard over inflation and ready to hike rates to keep things from overheating (not that rate hikes do that, but that’s another story)."

     "And what is the mainstream theory about inflation? It’s called “expectations theory.” For all but a few of us, inflation is caused entirely by rising inflation expectations. It works this way: when people think there is going to be inflation, they demand pay increases and rush out to buy things before the price goes up. And that’s what causes inflation. What’s called a “falling output gap,” which means falling unemployment for all practical purposes, is what causes inflation expectations to rise. And foreign monopolists hiking oil prices can make inflation expectations rise, as can people getting scared over budget deficits, or getting scared by the Fed getting scared. So the job of the Fed regarding inflation control becomes managing inflation expectations. That’s why with every Fed speech there’s a section about how they are working hard to control inflation, and how important that is. They also believe that the direction of the economy is dependent on expectations, so they will always forecast “modest growth” or better, which they believe helps to cause that outcome. And they will never publicly forecast a collapse, because they believe that that could cause a collapse all by itself."

    "So for me, our biggest inflation risk now, as in the 1970’s, is energy prices (particularly gasoline). Inflation will come through the cost side, from a price-setting group of producers, and not from market forces or excess demand. Strictly speaking, it’s a relative value story and not an inflation story, at least initially, which then becomes an inflation story as the higher imported costs work their way through our price structure with government doing more than its share of paying those higher prices and thereby redefining its currency downward in the process."

   This is an area where he-and any heterodox economic thinker-is outside the mainstream to the extent they believe that the primary cause of the 70s inflation was oil prices and not demand side. 

    Well we've seen energy prices fall hard since June, 2014 so I guess according to him there's no need for worry-and true enough, we scarcely have any inflation at all now and many more mainstream economists including those in policy circles and at CBs are concerned that inflation is too low.




Warren Mosler on the Job Guarantee and Monetary Policy

     It strikes me when you get into economics how similar a lot of ideas between Left and Right really are-though neither side will ever admit it. So there is more than a little family resemblance between Mosler's claim that recessions are caused by taxes that are too high relative to current spending and Art Laffer's Laffer Curve.


     Nick Rowe recently told me that the only difference he'd take with Mosler here is that he'd argue that recessions come due to tight money. The big difference between MMT and MMers is the pride of place of fiscal vs. monetary policy.

    Morgan Warstler won't ever admit it but his Choose Your Own Boss (CYB) and Auction the Unemployed proposals have a lot of stark similarities with MMT the difference being is that he tries to make his proposal the free market alternative.

    He talks about guaranteed income just like Mosler does. Really, both Left and Right have been coalescing around the idea of a guarantee for a long time but never can come to any agreement back to Friedman's negative income tax in the 70s.

     Here is Mosler on a job guarantee:

     "To optimize output, substantially reduce unemployment, promote price stability and use market forces to immediately promote health-care insurance nationally, the government can offer an $8 per hour job to anyone willing and able to work that includes full federal health-care benefits. To execute this program, the government can first inform its existing agencies that anyone hired at $8 per hour “doesn’t count” for annual budget expenditures. Additionally, these agencies can advertise their need for $8 per hour employees with the local government unemployment office, where anyone willing and able to work can be dispatched to the available job openings. This job will include full benefits, including health care, vacation, etc"

     Note that the fringe benefits push up the wage considerably from $8 an hour. He proposed this I believe when the national minimum wage was $7.25-now the MW is actually $8. My understanding is he thinks this JG wage could be a nominal anchor but how could it be with the MW continuing to rise? The JG too would have to rise with inflation. Back to Mosler:

    "These positions will form a national labor “buffer stock” in the sense that it will be expected that these employees will be prone to being hired away by the private sector when the economy improves. As a buffer stock program, this is highly countercyclical anti-inflationary in a recovery, and anti-deflationary in a slowdown. Furthermore, it allows the market to determine the government deficit, which automatically sets it at a near “neutral” level. In addition to the direct benefits of more output from more workers, the indirect benefits of full employment should be very high as well. These include increased family coherence, reduced domestic violence, less crime, and reduced incarcerations. In particular, teen and minority employment should increase dramatically, hopefully, substantially reducing the current costly levels of unemployment."

     To the extent that this would cancel out the 'reserved army of the unemployed' would this meet the opposition of employers?

     Mosler on monetary policy and interest rates:

     "It is the realm of the Federal Reserve to decide the nation’s interest rates. I see every reason to keep the “risk free” interest rate at a minimum, and let the market decide the subsequent credit spreads as it assesses risk"

     "Since government securities function to support interest rates, and not to finance expenditure, they are not necessary for the operation of government. Therefore, I would instruct the Treasury to immediately cease issuing securities longer than 90 days. This will serve to lower long-term rates and support investment, including housing. Note, the Treasury issuing long term securities and the Fed subsequently buying them, as recently proposed, is functionally identical to the Treasury simply not issuing those securities in the first place."

      Also he advocates leaving ZIRP as the permanent rule-so much for the ZLB argument.

     "I would also instruct the Federal Reserve to maintain a Japan like 0% fed funds rate. This is not inflationary nor is it the cause of currency depreciation, as Japan has demonstrated for over 10 years. Remember, for every $ borrowed in the banking system, there is a $ saved. Therefore, changing rates shifts income from one group to another. The net income effect is zero. Additionally, the non government sector is a net holder of government securities, which means there are that many more dollars saved than borrowed. Lower interest rates mean lower interest income for the non-government sector. Thus, it is only if the borrower’s propensity to consume is substantially higher than that of savers does the effect of lower interest rates become expansionary in any undesirable way. And history has shown this never to be the case. Lower long term rates support investment, which encourages productivity and growth. High risk-free interest rates support those living off of interest payments (called rentiers), thereby reducing the size of the labor force and consequently reducing real national output."

    So no Treasuries older than 90 days and ZIRP. He claims that changing rates has no income effect but simply shifts income from one group to another. This is the opposite of Stephen Williamson who claims that raising rates would actually raise inflation rates and presumably support growth.

    UPDATE: Here's one more thing that every econoimst no matter how liberal or conservative or 'libertarian' or 'socialist' seems to agree on including Mosler here:

    "Today’s governments unofficially use unemployment as their buffer stock policy. The theory is that the price level in general is a function of the level of unemployment, and the way to control inflation is through the employment rate. The tradeoff becomes higher unemployment vs. higher inflation. To say this policy is problematic is a gross understatement, but no one seems to have any alternative that’s worthy of debate."






Warren Mosler and Art Laffer: Birds of a Feather?

     To be sure, I'm deliberately making this sound provocative but as Mosler tells it, Laffer helped him get his original Soft Currency Economics done in the 90s:

     "With my new understanding, I was keenly aware of the risks to the welfare of our nation. I knew that the larger federal deficits were what was fixing the broken economy, but I watched helplessly as our mainstream leaders and the entire media clamored for fiscal responsibility (lower deficits) and were prolonging the agony."

     As I noted in my last post, Mosler says that he got this new understanding as a very successful and wealthy investor looking at investing in Italian government bonds in the early 90s.

     "A few days later when talking to our research analyst, Tom Shulke, it came to me. I said, “Tom, if we buy securities from the Fed or Treasury, functionally there is no difference. We send the funds to the same place (the Federal Reserve) and we own the same thing, a Treasury security, which is nothing more than account at the Fed that pays interest.”

    "Many of my colleagues in the world of hedge fund management were intrigued by the profit potential that might exist in the 2% free lunch that the Government of Italy was offering us. Maurice Samuels, then a portfolio manager at Harvard Management, immediately got on board, and set up meetings for us in Rome with officials of the Italian government to discuss these issues."

     It kind of works out pretty nice for him then if he had both Macro enlightenment and this knowledge made him wildly successful on some big investments in bonds. Again, as I note in the link above, this is not commonplace as even Keynes said he only got successful as an investor when he gave up using his macro knowledge and experience-ie, it didn't help him to know what the CB or Treasury would do tomorrow when deciding how to play currencies. 

    From here he went on to write Soft Currency Economics. 

    "It was then that I began conceiving the academic paper that would become Soft Currency Economics. I discussed it with my previous boss, Ned Janotta, at William Blair. He suggested I talk to Donald Rumsfeld (his college roommate, close friend and business associate), who personally knew many of the country’s leading economists, about getting it published. Shortly after, I got together with “Rummy” for an hour during his only opening that week. We met in the steam room of the Chicago Racquet Club and discussed fiscal and monetary policy. He sent me to Art Laffer who took on the project and assigned Mark McNary to co-author, research and edit the manuscript, which was completed in 1993."

    I've often thought there was something similar between what he says about taxes and what Mosler and Jude Wanniski started saying in the 70s. Mosler says that a recession comes when taxes are too high relative to the current level of speniding. This is basically what the Laffer Curve is-the optimum level of taxes. 

   At least conceptually the ideas are pretty similar. Yet Laffer has become synonymous with the Right and Mosler with the Left. The trouble with Laffer is that in principle there are times it would be legitimate to raise taxes but yet there is no time I;m aware of that he's ever admitted this to be the case. 

   On the other hand, when you look at Mosler, the key is that it's relative to government spending which in practice frees most liberals to focus on the need for higher spending. Yet Mosler's is a good way to look at it-taxes are not as high if you raise government spending or vice versa. 

   So did Mosler and Laffer stay friends? Meanwhile, Mosler's 'epiphany' seems to have led him to some conclusions very similar to the insights of Post Keynesians though he hadn't read people like Minsky, etc. 

   "Warren Mosler, after obtaining his BA in Economics in 1971, entered the financial sector in 1973 as a loan collector in a small savings bank. In 1976 he was an AVP at Banker’s Trust NYC on their ‘bond desk’ before moving Chicago in 1978, where he established the government bond department for William Blair and Co. In 1982 he cofounded Illinois Income Investors, an international investment company that specializes in fixed income relative value investment strategies, and AVM, institutional broker/dealer. In 1993 he authored ‘Soft Currency Economics’ with editorial assistance from economics Professors Mark McNary and Arthur Laffer, which was the beginning of ‘Mosler Economics (ME)’. In 1996, Professor Pavlina Tcherneva, then an under graduate student, published a paper that showed how ‘Soft Currency Economics’ was in fact an extension of the existing Post Keynesian (PK) school of thought:

    “In his essay Soft Currency Economics, he draws from his experience as a practitioner in financial markets in analyzing the underlying forces at work in a modern monetary system. Interestingly, this analysis incorporates several postulates that can be considered logical extensions of Post Keynesian monetary thought. Considering the fact that he had no exposure to the Post Keynesian school of thought before writing his paper, it is fascinating to see the striking similarities between important aspects of his analysis and Post Keynesian monetary theory. Furthermore, Mosler's work deserves serious consideration for the valuable insights into the monetary system that are not currently focused on by the academic world, policymakers, or the general public.”

     "However, rather than being incorporated by the Post Keynesians, both Mosler and SCE were, in general, not well received by Post Keynesians, and most often rejected when not ignored. Those few who did initially recognize the merits of ‘Soft Currency Economics’ included Professors Bill Mitchell, Mat Forstater, L. Randall Wray, Stephanie Kelton and Pavlina Tcherneva who. a few years ago, when ME became popularized as Modern Monetary Theory (MMT), became recognized as MMT professors."

    It does strike me that his healthcare plan sounds pretty conservative actually:

    "My proposal regarding health care is to give everyone over the age of 18 a bank account that has, perhaps, $5,000 in it, to be used for medical purposes. $1,000 is for preventative measures and $4,000 for all other medical expenses. At the end of each year, any unspent funds remaining of the $4,000 portion are paid to that individual as a “cash rebate.” Anything above $5,000 would be covered by a form of Medicare. There would be no restrictions on purchasing private insurance policies."

   "This proposal provides for universal health care, maximizes choice, employs competitive market forces to minimize costs, frees up physician time previously spent in discussion with insurance companies, rewards “good behavior” and reduces insurance company participation. This will greatly reduce demands on the medical system, substantially increasing the supply of available doctor/patient time and makes sure all Americans have health care. To ensure preventative measures are taken, the year-end rebate can be dependent, for example, on the individual getting an annual check up. And though it is federally funded, it can be administered by the states, which could also set standards and requirements."

   "There is no economic school of thought that would suggest health care should be what’s called a “marginal cost of production” means that it is bad for the economy and our entire standard of living to have business pay for health care. This proposal eliminates that problem for the American economy in a way that provides health care for everyone, saves real costs, puts the right incentives in place, promotes choice and directs competitive forces to work in favor of public purpose."

    It sounds like the healthcare insurance market remains private. As for the $5,000, that might be well short of what is needed if someone is sick-though I guess the idea is that Medicare-in some form covers the rest. 



Sunday, March 1, 2015

Warren Mosler vs. Keynes and Jim Cramer on Investing

     I mentioned in my last post that it's striking how a conservative economist like Scott Sumner who's all about the free market really implicitly argues that it's a waste of time to play say the stock market-as the EMH dictates that any gains you get are likely to be short-lived and due to dumb luck. 

     Most conservative economists like him probably tend to be like this-they would never play the market themselves. 

     On the other hand, you have a lot of the MMTer types who always regale us with stories about how well they do in the market-Cullen Roche and Warren Mosler. 

    "I find this paradoxical as Sumner is supposed the be the free market guy, while Mosler is the one who thinks the market suffers from acute inefficiencies that require a comprehensive response from the govt. It's interesting that Keynes too had some very definite views and theories of the market and as is well known, was a very successful investor."

     Yet even comparing say Mosler to Keynes, there's a striking difference. Keynes by his own admission was never successful when he tried to bring his own macro insights and knowledge to investing. 

     You might think that a brilliant macroecomomist would have have an advantage in the market-Keynes in particular would seem to have inside knowledge with the policy circles he rode in. This was someone who worked for the British Treasury and the Exchequer in the 1910s and had the ear of treasury secretaries and central banks the world. over. Yet he himself concluded neither his ability as an economist or his knowledge of events helped much in the currency markets, etc.

    He only became successful when he went to more of a micro approach. This is something that Jim Cramer always says: you shouldn't trade the market as if there is just 1 stock. 

   Mosler though definietly claims that he had an epiphany about how the Fed and Treasury work in the early 90s and this lead him to realize huge gains in the Italian government bond market. 

    "A few days later when talking to our research analyst, Tom Shulke, it came to me. I said, “Tom, if we buy securities from the Fed or Treasury, functionally there is no difference. We send the funds to the same place (the Federal Reserve) and we own the same thing, a Treasury security, which is nothing more than account at the Fed that pays interest.”

    "Many of my colleagues in the world of hedge fund management were intrigued by the profit potential that might exist in the 2% free lunch that the Government of Italy was offering us. Maurice Samuels, then a portfolio manager at Harvard Management, immediately got on board, and set up meetings for us in Rome with officials of the Italian government to discuss these issues

    Again, this is according to conventional wisdom pretty surprising. Even if you do have the best understanding of the macroeconomy that's not supposed to give you any advantage in the market according to things like EMH. 

    UPDATE: I forgot to add Mosler;s conclusion of his 'Italian Epiphany.'

    "Italy did not default, nor was there ever any solvency risk. Insolvency is never an issue with nonconvertible currency and floating exchange rates. We knew that, and now the Italian Government also understood this and was unlikely to “do something stupid,” such as proclaiming a default when there was no actual financial reason to do so. Over the next few years, our funds and happy clients made well over $100 million in profits on these transactions, and we may have saved the Italian Government as well. The awareness of how currencies function operationally inspired this book and hopefully will soon save the world from itself."



Scott Sumner and Warren Mosler as Congenital Opposites

     Obviously on the level of policy or theory the 2 couldn't be more different but what I find interesting is how different the 2 are on a personal level. Yes, I know you can argue to avoid 'personalities' and I agree that intellectual substance deserves the most favored place at the table, but I'm struck by the difference between them personally as well.

     Sumner argues for EMH which means that overtime no one can consistently beat the market except for luck. Even Warren Buffett's success can be chalked up to luck:

     "One of my least favorite maxims is; “the market can stay irrational longer than you can stay solvent.”  I consider that to be a cop out for losers.  If the market is actually irrational, you set up a long term investment strategy to take advantage of that inefficiency.  You don’t gamble everything on one role of the dice.  There should be “anti-EMH” mutual funds that invest on the assumption of market inefficiency, and these should tend to earn above normal rates of return on long term investments."

   "The past five years should have been an absolute gold mine for the anti-EMH types that supposedly dominates the hedge fund industry.  Just think about it.  Shiller says stocks are way too volatile, and the US stock market has been incredibly volatile since 2007.  No need to worry about the market staying irrational for too long, the long run adjustments occurred quite rapidly.  Then we had the mother of all housing bubbles in 2006, another great opportunity for people to rake in profits from market inefficiency.  The year 2008 should have seen extraordinary profits to the hedge fund industry, with all that “irrationality” being corrected.  Instead they lost more than they’d made over the previous decade."

    "One guy did beat the market by betting the housing bubble would collapse, but I recently read that he’s been doing poorly ever since.  And we all know about the unfortunate stock market call by Mr. Roubini  in 2009."

     "The anti-EMH crowd needs to face facts.  Even the smart money can’t beat the market, except by luck."

     "Here’s another article showing the efficiency of markets:

Warren Buffett made a friendly bet four years ago that funds that invest in hedge funds for their clients couldn’t beat the stock market over a decade. So far he’s winning.
The 81-year-old Buffett, who is chairman of the holding companyBerkshire Hathaway Inc. (BRK/A), ended last year neck and neck with the Protégé funds as the Vanguard fund climbed by 2.1 percent and the Protégé hedge funds lost an estimated 3.75 percent.
The first two months of this year pushed the Vanguard fund ahead as stocks returned 9 percent, more than twice the gains of hedge funds.

    "If you do the math the performance gap is around 10%, even larger than four years of the 1.25% annual expense ratio for mutual funds that invest in hedge funds. They’d have been better off throwing darts."

    "But before Buffett gets too cocky, he might want to consider the final sentence of the article:

    "Berkshire Hathaway shares have slumped almost 17 percent since the end of 2007."

    "Ouch! Three years ago I argued that even if markets were perfectly efficient, they would look inefficient. That’s because for every 1,000,000 investors you’d expect one guy to outperform the market for 20 consecutive years. The masses would call that lucky guy a genius, even if he was just an average bloke from Nebraska."

     On the other hand, Mosler never tires of regaling us with how successful he has been at trading bonds and arbitrage. 

     "Illinois Income Investors specialized in fixed income arbitrage, utilizing both actual securities and related derivative products, with a market neutral/0 duration strategy. That meant we promised no interest rate exposure, rates going up or down were not supposed to be a factor in the level of profits. We were paid 35% of the profits but no fixed management fees. Over the next fifteen years, we continued the success we’d had at William Blair and Company. Including the time at Blair, we established a 20-year track record (from 1978 to 1997) with only one losing month, a drop of a tenth of one percent on a mark to market that reversed the next month, and no losing trades that any of us can recall. III was ranked Number One in the world for the highest risk-adjusted spreads by Managed Account Reports through 1997. When I stepped down, Cliff Viner took control of about $3.5 billion in capital and $35 billion in assets. The 1996 drama with the Tokyo Futures exchange along with philosophical differences with a new partner told me it was a good time to take a break."

     I find this paradoxical as Sumner is supposed the be the free market guy, while Mosler is the one who thinks the market suffers from acute inefficiencies that require a comprehensive response from the govt. It's interesting that Keynes too had some very definite views and theories of the market and as is well known, was a very successful investor.

   It seems that most of the conservative RE guys would never do the market-most of them are college professors besides which tend to be a conservative lot personally I mean here rather than politically; ie, cautious-but Keynesian, 'hyperfiscalist' types play the market and believe it can be beaten. 

    The question begs why, if you believe the market wholly rational and price changes to resemble a 'random walk' you would even bother with the market. Nick Rowe says its a paradox: if investors believe the market is rational, if they believe it is irrational it is rational. I can't find the link right now for that. 

    Sumner and Tony Yates have gotten into it now-which I'm kind of jazzed to see.

    I'm glad to see Yates calling him out. However,  Yates  made the following comment on Twitter I have mixed feelings about:

   "MaMoism: throwback 2 the days of 'gentleman' economist who swapped words by the fireside + left the rest of us to work out what they meant."

I have no objection to his calling MMers 'MaMoism' but I guess what I have mixed feelings with is how low a regard he holds intuition. For Yates, it's not just that 'The model makes the man' it's that 'Men don't matter just models.' For one thing, as a layman I don't do models Yet, I do think besides this that he betrays a common attitude in 'modern macro' where unless you have a model you have no voice-a new type of disenfranchisement?

His knocking of the 'gentleman economist' is, of course, directed at Sumner but of course can just as much be directed at Keynes. The irony is that it was during the 'Keynesian Revolution' in America, that this mathematization of econ started. Even as American economist became 'Keynesians' they more and more eschewed Keynes the man and his style. Nothing provokes mainstream Macros more than comments that seem to hinge on 'What Keynes really meant.' For some reason they find that as the most absurd question in the world.

Is the idea supposed to be that intuition doesn't matter or are the models supposed to shine a light on intuition?

On the other hand, Yates said this in the comments section of his own blog which shows why he believes it's so important to say 'Show me the models.'

A commentator had asked him this:

“I’m sure these mix-ups would get ironed out if MaMos stopped blogging and chucking words about, and got down to building and simulating quantitative models.”

    "Wouldn't they just build models that agree with their school of thought, like all model builders?"
      Yates replied thusly:
     "You might be right that some have ulterior motives in building their models. But the beauty of this way of proceeding is that it doesn’t matter. Once it’s built we can all inspect how well it does at matching the data and compare it to other competing models."

       Meanwhile, Ray Lopez-who usually comments over at Money Illusion and Sumner is not a fan of to say the least-Ray does seem to have some Major Freedom qualities and some have claimed that they are one in the same person; however, Ray is much shorter in his comments for one thing-said this:

     "Sumner engages in metaphysics, see his blog post on this topic raised by Yates. Expectations fairy is the key. But this is untestable."

      See that sounds rather Major Freedomlike and clearly like an Internet Austrian who are always accusing others of 'engaging in metaphysics.' Here was Yates' response though:

     "I don’t think it is completely untestable. We can measure expectations and detect their rationality, or lack of it. Usually, such measures fail pretty badly. There are ways of rescuing RE despite these apparent failures, since all tests involve auxiliary assumptions too, but the totality of the evidence makes these rescues highly far-fetched in my view."

      So maybe you're like me and think they go too far in elevating models over intuition but Yates does give an attractive picture of what he thinks models can achieve-a way to really filter out bias.  

      Overall, though I'm enjoying it a little: apparently Sumner's peers aren't so impressed. 

      UPDATE: For more on the mathematicization of economics, see Krugman's piece today.