Friday, April 10, 2015

Odds & Ends and IMH

This Wall Street Journal article (HT: Benjamin Cole at Historinhas) is like a chapter out of Gulliver's Travels.  I mean, literally, you could stick this scene on a floating island, and paste it into the book, word for word.  It's full of stuff like this:
The Treasury Department’s report to Congress on the exchange-rate policies of major trading partners called on policy makers “to use the full set of policy tools at their disposal.”
“Not only has global growth failed to accelerate, but there is worry that the composition of global output is increasingly unbalanced,” it said. “The global economy should not again rely on the U.S. to be the only engine of demand.”
Not since the last semi-annual currency report has so much "reasoning from a price change" been used to say so little with such authority.  Some observers believe that central banks don't have that much influence over inflation.  I disagree with that.  But, I can see how it could seem true, or be true.  We could give Treasury officials and central bank officials around the world big computer terminals with a lot of buttons and levers, but not connect them to anything, just have random colors and numbers flash on the screen as they pull and push on them.  Then we could occasionally tell them what a great job they are doing, or chastise them for pulling too many levers.  It wouldn't look much different than the world we have today.  What's the difference between trying to describe a web of exchanges we can't begin to understand and just making stuff up?

The first line of the article:
The Obama administration chastised Europe and Japan for excessive reliance on monetary policy to revive stagnant growth....
This seems like strong form IMH.

Maybe Office Space is a better place for this scene than Gulliver's Travels.

"Um...Yeah...So, Germany, we're going to need you to work over the weekend to get those TPS reports in.  M'kay?"

On the topic of EMH and IMH, here is a Harvard Business Review article that discusses recent research that shows inside information can lead to worse decisions.  This doesn't surprise me.  I have always thought that the difference between weak form efficient markets and strong form efficient markets was less stark than it is generally perceived.

We tend to think in terms of clear episodes, like a bio-tech firm getting FDA approval for a new drug, or something like that.  But, the vast, vast majority of investment information and decisions are bathed in a complex set of factors that make simple information very difficult to value in isolation.  Insiders are frequently very poor traders.

Financial speculation depends greatly on discipline and perspective.  And the denominator in the valuation of perpetual streams of cash flows is very important, even while it is wholly unknowable.  If you haven't honed those things carefully, gaining new information can very easily lead you to give more weight to incorrect perceptions.

I used to think this was limited to the nooks and crannies of the investment space - little microcaps that just didn't get enough attention for markets to work out efficient expectations.  But, even in something as big as the money supply and the housing market, it is interesting how if one begins in 2006 with two very different ideas about what is happening (a "bubble" where prices are unrelated to underlying value vs. a rise in nominal intrinsic values coming from high demand for low risk savings vehicles as a hedge against a quickly evolving global economy), then practically all of the new information one would have seen since then (assisted by ever-present confirmation bias) would seem to serve to confirm your narrative.  You would become more confident in either narrative as time passes.

One of Robin Hanson's general themes is that we have a biological predisposition to be sincerely the most confident about things that are the most incorrect, if we are socially primed to believe them.  So, the good news is that it isn't such a disadvantage to lack inside information.  The bad news is that we are all equipped with our own very powerful miscalculator.


  1. This post is fun, but it would be even more fun (and a lot more work for you) if you took the WSJ article apart, maybe focusing on the phrases that sound wise but are in fact total nonsense, such as:

    > "There is certainly a concern that Japan and Germany trying boost their
    > economies through an increase in exports rather than an increase in
    > domestic demand will lead to an increasingly unbalanced recovery, and
    > could lead to trade tensions as well," said Mister Fancy-Pants ex-IMF
    > guy.

    This sort of wrong-headed thinking is so harmful. When aggregate demand falls below aggregate supply, you get an output gap and needless unemployment. The solution is more aggregate demand, i.e., monetary expansion. Whether the buyer is local or foreign is just not under your control, it's up to the market. If you end up matching AD to AS by increasing exports, so be it. If that means there is now insufficient demand in some country you're selling to, guess what? They can expand their money supply too! And *everyone* is better off as a result. This is not beggar-thy-neighbor. This is sensible monetary policy in different currency zones working together to make the world better.

    What is wrong with these people?


    Kenneth Duda
    Menlo Park, CA

  2. Nice post. I am surprised at the Harvard Business Review finding, and here is why: The vast majority of mergers do not work out from the buyer side. If you own stock in a company making a big acquisition, sell.

    Why is this? I always assumed it was because the sellers always have 100 times the info of the buyers. They know which key salespeople will leave, which promising technologies are actually duds, about the asbestos in every square inch of company HQ.

    Even when you sell your house, do you tell the buyers, "I did the cheapest roof repair possible and that roof will leak again in another season." Or about the mysterious leaking oil drum you found two feet down in the backyard? Although maybe that is just Jimmy Hoffa.

    Now some corporate buyers say they will get synergy. Maybe so, but the numbers do not show it.

    This makes me think there is some value to inside information.

    1. Insiders of the seller would seem to have an easy choice. But I think you might have a good example of the problem if we think about the buyer. Someone who finds out that the buyer is making a strategic acquisition might fixate on that and ignore minor details like the price.

  3. TravisV here.

    Kevin, I thought I'd run the following quick thoughts by you:

    (1) On the one hand, in your post "Returns to capital aren't high," you suggest that total real returns to capital tend to be pretty stable over the long-term at about 8%.

    (2) Real interest rates are currently ultra-ultra-ultra low relative to the historical norm, which suggests that over the next ten years, total real returns to capital are expected to be substantially lower than 8%.

    Do you agree with me that that historical trend of 8% is highly unlikely to persist over the next ten years?

    1. Return to capital mostly reflects returns to risk. When I say it's stable over the long term, I am talking about total return to corporate assets - think of the S&P500 if it was all equity, no debt. Interest rates are about the split of those returns between equity and debt holders. Equity premiums are very high right now.

      If total future returns to capital disappoint, it will be because of low growth, not because today's prices reflect an unusual level of required returns.

      Returns to treasuries will be low. Returns to housing capital would be low, if the prices were in equilibrium, but income to home owners is at the high end of historical ranges. But, these asset classes are separate from my comments regarding returns to at risk capital, which would include some diversified mix of corporate equity and debt.

      Does that make sense to you?