The Financial Times issued the following report. The moral of the story: money talks and hmmm walks.
Lawmakers ignore special interests clampdown
By Stephanie Kirchgaessner in Denver
Published: August 30 2008 03:42 | Last updated: August 30 2008 03:42
On his path to winning the Democratic nomination, Barack Obama swore that he would change Washington by stamping out the influence of special interests who buy access and favours from the political establishment.
But there was little evidence that change was on the way in Denver. Despite the passage of ethics rules in Congress last year designed to curb the influence of lobbyists and other donors, the Democratic National Convention was funded almost entirely by corporations that pumped tens of millions of dollars into the event, using a loophole in campaign finance rules.
In restaurants and hotels, lawmakers mingled with lobbyists and other donors just as they do in Washington, out of the view of the general public, and seemingly unconcerned by Mr Obama’s stance against lobbyists – he has banned them from donating or taking paid positions on his campaign. Among the dozens of parties were JPMorgan’s salute to women governors, the Recording Industry Association of America’s concert featuring Kanye West, and a brunch hosted by Billy Tauzin, a former congressman who is chief executive of PhRMA, the pharmaceutical lobby group.
As the California delegation headed to a party thrown by AT&T on Monday to cap off the first day of the Democratic convention, they were greeted with goodies. Though these days, even gift bags come with disclaimers.
“We have been advised by counsel that we may not offer complimentary gift bags to public officials,” read a sign on one table.
Another sign said public officials might have to skip the nibbles because of ethics rules. The telecommunications group, a big sponsor of the convention, hosted another party attended by Steny Hoyer, House majority leader, who in June helped craft legislation that protected AT&T from lawsuits related to its alleged participation in the Bush administration’s warrantless eavesdropping programme.
Lawmakers seen at a party hosted by Washington lobbyists Heather and Tony Podesta appeared visibly uncomfortable when asked what they thought about Mr Obama’s stance on lobbyists.
Carl Levin, the Michigan senator, shrugged and said he had not followed the lobbying debate. “They are old friends of mine,” he said of the Podestas.
“The rules are the rules. But sometimes the rules defy commonsense,” said Steve Israel, a Long Island congressman who also attended the brunch. “A PAC [political action committee] can give a $5,000 contribution and discuss that member’s vote, but a $12 lunch where you are talking about the Mets is against the rules.”
Congressman Paul Kanjorski said with a smile that it would be better not to talk about it. For proponents of campaign finance reform, even more problematic than the parties was the corporate sponsorship of the convention itself, and the special access big party donors were given to Mr Obama’s speech.
Experts say that every election cycle raises the cost of access. When President George W. Bush ran for office in 2000, individuals who bundled donations on his behalf were given special status if they raised $100,000 (€68,000, £55,000). Today, campaign finance experts say, bundlers are raising as much as $500,000.
In all, private donations exceeding $112m will pay for about 80 per cent of the combined convention costs in Denver and St Paul, according to a study by the Campaign Finance Institute.
“Both candidates have talked a big game about reducing the influence of special interests,” says Massie Ritsch of the Center for Responsive Politics, which tracks political donations. “But they don’t seem to have done much to rein in their political parties and the corporate subsidies underwriting the conventions that nominate them.”
Saturday, August 30, 2008
Investing the Templeton Way - Book Review
Chapter 1
The chapter is primarily biographical, which details John Templeton's (JT) philosophy of value investing was an extension of his overall lifestyle. It demonstrates how his background influenced his outlook in life. His father a true capitalist who lost all his fortune truly betting everything he had accumulated in the commodities market. His mother, on the other hand, taught him to be curious, self-reliant, and instilled a sense of a greater mission in life through the Christian faith. He was a firm adherer to thrift, believing it was a cornerstone to securing one's well being.
Chapter 2
It details the basic premise from which Templeton believed was the way to obtain bargain stocks. The chapter can be nicely summarized by his observation that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." While this principle may appear easy to exercise, in fact human nature turns contrary to it. The psychological factors that affect markets are stressed nicely. Readers may resort to Nicholas Taleb's book, The Black Swan, which extensively explains these anomalies that shape people and markets.
Chapter 3
It stressed the salutary aspects of considering the universe of stocks, including those emanating from foreign sources. Although not expressing a strict number of different assets, Templeton believed that diversifying "was a good way to protect you from yourself." He emphasized a "bottom-up" approach to foreign investing. That is, once a particular company or companies were identified, one would then assess the macroeconomic environment. I found this advise helpful because my approach is the opposite: review the macroeconomy, spot areas or industries that may be depressed and are poised for a comeback, and then seek good companies. Templeton gives the reader a good rule of thumb on what to focus in terms of foreign economies. He esteemed unfavorably places where government was profligate, operating rules onerous for business, and prevented individual creativity from taking root (e.g. Venezuela).
Chapter 4
It details the analysis JT used that led him to invest in Japan before everyone else. He benefited from the general perception of the extreme pessimism and ignorant views of the country held by the market during the 1950s and 1960s. His analysis revealed that stocks were extremely undervalued in comparison to U.S. stocks. The chapters goes in further details of what made JT an impeccable stock picker: he scrutinized his assumptions and made his own decisions--not based on the "wisdom of crowds." Moreover, he used quantitative measures (e.g. price no longer reflects estimated worth) in comparison to an alternative when to sell a stock. This led him to reduce his Japanese exposure in the early 1980s, just when everyone was beginning to inflate the bubble. But more importantly, this practice prevents an investor to be married to a particular investment.
Chapter 5
Occasionally JT was asked where the best investment prospects lied, he pointed that one should rather ask "where is the outlook most miserable" to find the most promising stocks. This chapter goes into greater detail explaining this philosophy by focusing on how JT concluded that U.S. stocks demonstrated good value, despite that it had been declared that "equities were dead" in the early 1980s. JT used various yardsticks of value to make decisions (e.g. P/E, PEG, P/BK, Enterprise value). But beyond simply calculating these metrics, he relied on his learned acumen to pick apart the assumptions underlying them. One should continually think outside the box because quantitative decision metrics will "eventually cease to work when everyone practices them in unison."
Chapter 6
The chapter gives us a glimpse into the innate irrationality that seems to grip the market more frequently than recognized. JT was able to profit mightily from rightly timing the NASDAQ crash. He noted that "the point of maximum optimism was reached when there were no more buyers left in the market, and the sellers were about to take control"--the opposite logic with respect to the point of maximum pessimism. Thus, JT shorted 84 stocks, each position worth $2.2 million, which ultimately netted about $90+ million in profits. JT gives us his shorting methodology: 1) control your losses, 2) remember rule #1. In order to control losses, establish a a price ceiling, which could be in terms of percentage change, for the stock before covering your position. Similarly, you must establish a point where you'll take profits.
Chapter 7
This chapter is an extension of the previous one. It details the mindset of the "bargain hunter" when dealing with market crisis. Irrespective of its nature and present sentiment, market drops are an ideal situation to take advantage because fear is pervasive. When other are alarmed and panic selling, you must maintain your composure and buy good stocks. After 9/11, JT bought a set of airline stocks that met a certain criteria (one-day price drop of 50%) because he understood that the government would bail-out those firms. Indeed, his expectation came into fruition, and thus was able to make a handsome return on his investment. The last two chapters underscore JT's keep ability of politics and economics that went beyond crunching number. As a result, he was well prepared to take advantage of market volatility.
Chapter 8
In this chapter we learn the analytical process JT exercised when investing in the South Korean economy. Following his disciplines of looking for great bargains in markets that were weighted under pessimism, South Korea was a perfect candidate after the effects of the Asian Crisis. As the book repeats numerously, simply investing in depressed markets without doing your homework is akin to speculating. We are furthered exposed in this chapter to JT's uncanny ability to assess his environment beyond number in such a way that leaves the reader wondering about his/her intelligence. "Bargain hunters who understand history...can appreciate the fact that these patterns repeat themselves over time, again, and again." Indeed, the operative word is "understand", something that very few individuals are capable--irrespective of their training and longevity.
Chapter 9
In this chapter we are encouraged to exercise good judgment to profit in assets outside our immediate purview. While JT was an excellent stock picker, he demonstrates his dexterity in fixed income assets. We are told of his advice of buying bonds prior to the technology stock market crashing. He reasoned that the fall in the market would adversely affect the economy by way of lesser consumption due to a negative wealth effect. JT understood that the Federal Reserve would come to rescue the economy by lowering interest rates. As a result, he undertook a carry trade (i.e. borrow in a cheaper currency and buy an asset denominated in another currency) buying zero-coupon bonds. When the FED lowered the interest rate, the value of the bonds purchased by JT increased in value. We are reminded to look at all assets and position yourself in such a manner so as to benefit your expected market environment.
Chapter 10
This chapter introduces the reader to JT's view on "the sleeping dragon", that is China. At first we are given an a cursory overview of modern Chinese history. Given that JT believes that China will continue to grow, it is a market that one needs to look quite thoroughly. As any country that is growing tremendously, there will be times when valuations will be above and beyond what a bargain hunter feels comfortable. By the early 1980s, JT understood that the Chinese would continue to open their economy, away from communist hold. Indeed, he noted, politically the country leaves much to be desired; but in terms of economic policy, JT thought that in comparison to the U.S. the Chinese has more freedom right now. We are reminded of the extreme pessimism principle for bargain hunter, i.e. mostly sellers are in the market. Only during that time, the best values will be found. As JT stated, "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
The chapter is primarily biographical, which details John Templeton's (JT) philosophy of value investing was an extension of his overall lifestyle. It demonstrates how his background influenced his outlook in life. His father a true capitalist who lost all his fortune truly betting everything he had accumulated in the commodities market. His mother, on the other hand, taught him to be curious, self-reliant, and instilled a sense of a greater mission in life through the Christian faith. He was a firm adherer to thrift, believing it was a cornerstone to securing one's well being.
Chapter 2
It details the basic premise from which Templeton believed was the way to obtain bargain stocks. The chapter can be nicely summarized by his observation that "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." While this principle may appear easy to exercise, in fact human nature turns contrary to it. The psychological factors that affect markets are stressed nicely. Readers may resort to Nicholas Taleb's book, The Black Swan, which extensively explains these anomalies that shape people and markets.
Chapter 3
It stressed the salutary aspects of considering the universe of stocks, including those emanating from foreign sources. Although not expressing a strict number of different assets, Templeton believed that diversifying "was a good way to protect you from yourself." He emphasized a "bottom-up" approach to foreign investing. That is, once a particular company or companies were identified, one would then assess the macroeconomic environment. I found this advise helpful because my approach is the opposite: review the macroeconomy, spot areas or industries that may be depressed and are poised for a comeback, and then seek good companies. Templeton gives the reader a good rule of thumb on what to focus in terms of foreign economies. He esteemed unfavorably places where government was profligate, operating rules onerous for business, and prevented individual creativity from taking root (e.g. Venezuela).
Chapter 4
It details the analysis JT used that led him to invest in Japan before everyone else. He benefited from the general perception of the extreme pessimism and ignorant views of the country held by the market during the 1950s and 1960s. His analysis revealed that stocks were extremely undervalued in comparison to U.S. stocks. The chapters goes in further details of what made JT an impeccable stock picker: he scrutinized his assumptions and made his own decisions--not based on the "wisdom of crowds." Moreover, he used quantitative measures (e.g. price no longer reflects estimated worth) in comparison to an alternative when to sell a stock. This led him to reduce his Japanese exposure in the early 1980s, just when everyone was beginning to inflate the bubble. But more importantly, this practice prevents an investor to be married to a particular investment.
Chapter 5
Occasionally JT was asked where the best investment prospects lied, he pointed that one should rather ask "where is the outlook most miserable" to find the most promising stocks. This chapter goes into greater detail explaining this philosophy by focusing on how JT concluded that U.S. stocks demonstrated good value, despite that it had been declared that "equities were dead" in the early 1980s. JT used various yardsticks of value to make decisions (e.g. P/E, PEG, P/BK, Enterprise value). But beyond simply calculating these metrics, he relied on his learned acumen to pick apart the assumptions underlying them. One should continually think outside the box because quantitative decision metrics will "eventually cease to work when everyone practices them in unison."
Chapter 6
The chapter gives us a glimpse into the innate irrationality that seems to grip the market more frequently than recognized. JT was able to profit mightily from rightly timing the NASDAQ crash. He noted that "the point of maximum optimism was reached when there were no more buyers left in the market, and the sellers were about to take control"--the opposite logic with respect to the point of maximum pessimism. Thus, JT shorted 84 stocks, each position worth $2.2 million, which ultimately netted about $90+ million in profits. JT gives us his shorting methodology: 1) control your losses, 2) remember rule #1. In order to control losses, establish a a price ceiling, which could be in terms of percentage change, for the stock before covering your position. Similarly, you must establish a point where you'll take profits.
Chapter 7
This chapter is an extension of the previous one. It details the mindset of the "bargain hunter" when dealing with market crisis. Irrespective of its nature and present sentiment, market drops are an ideal situation to take advantage because fear is pervasive. When other are alarmed and panic selling, you must maintain your composure and buy good stocks. After 9/11, JT bought a set of airline stocks that met a certain criteria (one-day price drop of 50%) because he understood that the government would bail-out those firms. Indeed, his expectation came into fruition, and thus was able to make a handsome return on his investment. The last two chapters underscore JT's keep ability of politics and economics that went beyond crunching number. As a result, he was well prepared to take advantage of market volatility.
Chapter 8
In this chapter we learn the analytical process JT exercised when investing in the South Korean economy. Following his disciplines of looking for great bargains in markets that were weighted under pessimism, South Korea was a perfect candidate after the effects of the Asian Crisis. As the book repeats numerously, simply investing in depressed markets without doing your homework is akin to speculating. We are furthered exposed in this chapter to JT's uncanny ability to assess his environment beyond number in such a way that leaves the reader wondering about his/her intelligence. "Bargain hunters who understand history...can appreciate the fact that these patterns repeat themselves over time, again, and again." Indeed, the operative word is "understand", something that very few individuals are capable--irrespective of their training and longevity.
Chapter 9
In this chapter we are encouraged to exercise good judgment to profit in assets outside our immediate purview. While JT was an excellent stock picker, he demonstrates his dexterity in fixed income assets. We are told of his advice of buying bonds prior to the technology stock market crashing. He reasoned that the fall in the market would adversely affect the economy by way of lesser consumption due to a negative wealth effect. JT understood that the Federal Reserve would come to rescue the economy by lowering interest rates. As a result, he undertook a carry trade (i.e. borrow in a cheaper currency and buy an asset denominated in another currency) buying zero-coupon bonds. When the FED lowered the interest rate, the value of the bonds purchased by JT increased in value. We are reminded to look at all assets and position yourself in such a manner so as to benefit your expected market environment.
Chapter 10
This chapter introduces the reader to JT's view on "the sleeping dragon", that is China. At first we are given an a cursory overview of modern Chinese history. Given that JT believes that China will continue to grow, it is a market that one needs to look quite thoroughly. As any country that is growing tremendously, there will be times when valuations will be above and beyond what a bargain hunter feels comfortable. By the early 1980s, JT understood that the Chinese would continue to open their economy, away from communist hold. Indeed, he noted, politically the country leaves much to be desired; but in terms of economic policy, JT thought that in comparison to the U.S. the Chinese has more freedom right now. We are reminded of the extreme pessimism principle for bargain hunter, i.e. mostly sellers are in the market. Only during that time, the best values will be found. As JT stated, "bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
Saturday, August 23, 2008
Panic of 1893: Another Example of Politicians Causing A Mess
"History doesn't repeat itself but it does rhyme." - Mark Twain
Indeed, looking back at the antecedents of the Panic of 1893 it seems as if we are reading in half measure the newspaper headlines over the last year. The economic hardship experienced during said depression was incomparable until then in the history of the United States. Politicians, who mascarade their ambitions for power in good intentions, were the progenitors of this economic mess.
During the 1880s, the U.S. economy was growing tremendously thanks in part to the economic shift from an agrarian to industrial society. The U.S. was becoming efficient in producing manufacturing goods that not only were sold locally but also were demanded internationally. The high economic growth and the coincidental increase in aggregate consumption led farmers to take on excessive debt to increase their productive capacity. In addition, the railroad industry had similarly overextended itself, as it believed demand would continue to expand from the people living west of the Mississippi. During this decade we witnessed something that today seems inconceivable: economic growth and deflation. Excessive debt in a deflationary environment, however, is a deadly combination for debt holders, because the value of money that is paid increases with time. Moreover, deflation meant that agricultural products became cheaper, thus producer's profit margins were squeezed. Nonetheless, for the industrialists (i.e. manufacturers) lower prices translated into a bonanza domestically and internationally resulting from greater demand for their products. During that time also, the U.S. (and the rest of the world in fact) operated under the gold standard, which meant that every dollar was backed gold. In other words, every dollar could be redeemed for that precious metal. This fixed exchange rate mechanism implied that monetary policy had limitations: money supply could not be manipulated by politicians without dire consequences. This is important to note because farmers (and other debt holders) wanted an inflationary monetary policy.
The government, seeking to please a voting block ahead of national interests, in 1890 passed the Sherman Silver Purchase Act, which required the federal government to purchase a fixed amount of silver with U.S. notes (i.e. dollars that were backed by gold). The net effect of this action caused the money supply to increase. Since gold had decrease in value relative to silver, widespread fear began to overtake the market that the U.S. would abandon the gold standard. Foreign and domestic holders of U.S. notes began to redeem them for gold. This generated a massive run on banks which ultimately led many to fail. The financial debacle spread to the real economy causing a number of bankruptcies. So the intentions of the government to help a special-interest group turned into a nightmare for everyone. It is estimated that during mid-to-late 1890s, unemployment ranged from about 11% to 18%. This anecdote makes us recognize that surely politicians will claim to exercise good judgment when using someone else's money to bailout others from the consequences of their actions. The notion that the 19th century was completely laissez fair does not hold under closer scrutiny. Today, nothing much has changed with respect to this aspect, as the U.S. federal government continues to want to manage economic expectations under the good stewardship banner. But as the old adage says, "the road to hell is paved with good intentions."
Indeed, looking back at the antecedents of the Panic of 1893 it seems as if we are reading in half measure the newspaper headlines over the last year. The economic hardship experienced during said depression was incomparable until then in the history of the United States. Politicians, who mascarade their ambitions for power in good intentions, were the progenitors of this economic mess.
During the 1880s, the U.S. economy was growing tremendously thanks in part to the economic shift from an agrarian to industrial society. The U.S. was becoming efficient in producing manufacturing goods that not only were sold locally but also were demanded internationally. The high economic growth and the coincidental increase in aggregate consumption led farmers to take on excessive debt to increase their productive capacity. In addition, the railroad industry had similarly overextended itself, as it believed demand would continue to expand from the people living west of the Mississippi. During this decade we witnessed something that today seems inconceivable: economic growth and deflation. Excessive debt in a deflationary environment, however, is a deadly combination for debt holders, because the value of money that is paid increases with time. Moreover, deflation meant that agricultural products became cheaper, thus producer's profit margins were squeezed. Nonetheless, for the industrialists (i.e. manufacturers) lower prices translated into a bonanza domestically and internationally resulting from greater demand for their products. During that time also, the U.S. (and the rest of the world in fact) operated under the gold standard, which meant that every dollar was backed gold. In other words, every dollar could be redeemed for that precious metal. This fixed exchange rate mechanism implied that monetary policy had limitations: money supply could not be manipulated by politicians without dire consequences. This is important to note because farmers (and other debt holders) wanted an inflationary monetary policy.
The government, seeking to please a voting block ahead of national interests, in 1890 passed the Sherman Silver Purchase Act, which required the federal government to purchase a fixed amount of silver with U.S. notes (i.e. dollars that were backed by gold). The net effect of this action caused the money supply to increase. Since gold had decrease in value relative to silver, widespread fear began to overtake the market that the U.S. would abandon the gold standard. Foreign and domestic holders of U.S. notes began to redeem them for gold. This generated a massive run on banks which ultimately led many to fail. The financial debacle spread to the real economy causing a number of bankruptcies. So the intentions of the government to help a special-interest group turned into a nightmare for everyone. It is estimated that during mid-to-late 1890s, unemployment ranged from about 11% to 18%. This anecdote makes us recognize that surely politicians will claim to exercise good judgment when using someone else's money to bailout others from the consequences of their actions. The notion that the 19th century was completely laissez fair does not hold under closer scrutiny. Today, nothing much has changed with respect to this aspect, as the U.S. federal government continues to want to manage economic expectations under the good stewardship banner. But as the old adage says, "the road to hell is paved with good intentions."
Wednesday, August 20, 2008
The Less You Read Newspapers and Watch TV, The Better Off You Are
That may seem counterintuitive, but in fact it is absolutely true. Fischer Black's seminal paper about market noise, written in the 1980s, gives a stellar explanation about this phenomenon (Journal of Finance, Vol 41, pgs 529-543). Noise represents large number of inconsequential events. This is contrasted with information, which relates to small number of significant events. People in general mistake one for the other, and thus make decisions that can ultimately lead to disastrous consequences--or alternatively to serendipitous results. Therefore "noise is what makes our observations imperfect. It keeps us from knowing the expected return of a stock or portfolio...it keeps us from knowing what, if anything, we can do to make things better." In this day and age, what will separate the relative success of one person from another will be predicated on the quality of information, not noise disguised as information. If you have ever walked in a securities trading floor, you will notice impressive databases that provide instantaneous information; much of it, however is simply noise. Traders undoubtedly will make buy and sell decisions supported by what they abstracted from these databases. This is the foundation that supports the view that daily stock price movements embody a voting mechanism. That is, market participants will buy/sell a stock as if casting a vote on the perceived price for a given amount of information (which is really noise).
I equate "noise" to the unfortunate human activity of gossip: There's a lot of it going around, but few of it deserves worthy consideration. However, people generally treat all gossip as credible information and act accordingly based on it. For the average person, irrespective of his or her condition (i.e. wealthy or poor), distinguishing noise and information can be a daunting task. As a result they will tend to gravitate to the "path of least resistance"; that is, to take whatever flashes in a screen from a "reputable" entity as reliable, without actually checking its veracity. Newspapers and television are primary culprits of disseminating it to the general public; so it is best for individuals to stay away from them as much as possible. I believe it is noise the fire that starts euphoric sentiments in the market. In other words, panic selling or ecstatic buying has its roots in discernment from this misinterpreted data. As a result, we become someone, as John Locke said, "reasoning correctly from erroneous premises." This analysis not only applies to stock markets but also to a wide array of human activity.
I equate "noise" to the unfortunate human activity of gossip: There's a lot of it going around, but few of it deserves worthy consideration. However, people generally treat all gossip as credible information and act accordingly based on it. For the average person, irrespective of his or her condition (i.e. wealthy or poor), distinguishing noise and information can be a daunting task. As a result they will tend to gravitate to the "path of least resistance"; that is, to take whatever flashes in a screen from a "reputable" entity as reliable, without actually checking its veracity. Newspapers and television are primary culprits of disseminating it to the general public; so it is best for individuals to stay away from them as much as possible. I believe it is noise the fire that starts euphoric sentiments in the market. In other words, panic selling or ecstatic buying has its roots in discernment from this misinterpreted data. As a result, we become someone, as John Locke said, "reasoning correctly from erroneous premises." This analysis not only applies to stock markets but also to a wide array of human activity.
Monday, August 18, 2008
Why Central Economic Planning Fails
First let me define what i mean by central economic planning: It is a committee of people that is far removed from the actual place of economic activity and are trying to dictate the affairs thereof. For example, a bureaucrat in Washington D.C. decides the appropriate amount of federal money Billings, Montana necessitates to improve its roads (who would know better but the residents of said location); or for the Federal Reserve System to identify the exact interest rate that will equilibrate providers of money with users of money. In order to adequately ascertain the exact amount needed in both cases, the policymakers would need an excessive amount of information extracted from the market. This means that they would have to turn to everyone participating (and even those that do not) in the economy. Even if such information could be obtain (which is impossible) they would still have difficulty collecting it in real time. Even if that impossibility might conceivably be possible they would still be exposed to the vagaries and volatility of individual sentiments. The data, thus, would be quite chaotic.
This is at the heart of what the 1974 Nobel Laureate in Economics, Frederich Hayek, explained in his excellent work, "The Use of Knowledge in Society." We live in an age where scientific knowledge dominates policymaking and assume that this is all to it. But "there is beyond question a body of very important but unorganized knowledge which cannot be possibly call scientific in the sense of knowledge of general rules: the knowledge of the particular circumstance of time and place." In other words, individual transactions will be predicated on the assumption that one has unique information over the other, and thus not reveal it. That is, you are not going to show your edge to your competitor. In order to accept Hayek's view, which i share, one must renounce to all central economic planning because it will ultimately fail. Communism failed because its systems could not capture all data for appropriate decision making. In fact, communism did something that is difficult to accomplish: the value of a final product was less than the sum of the value of its inputs. Socialism fails for the same reason. You may ask, "what about Europe? Socialism seems to work there." The reason it has held up over there is that Europeans get a tremendous defense subsidy from the U.S. Being an empire, the U.S. has taken (whether it likes it or not) on the defense cost of European nations. It has done this since the end of WWII.
But to regress to our main point, policymakers do not consider "the knowledge of the particular circumstance of time and place" because (i think) it requires of them a genuine act of introspection about the consequences of their actions and to consider that they may have the whole thing wrong. This requires them to be humble--hardly a trait of politicians and their subservient bands. But more importantly, acceptance of this knowledge also requires rejection of positivism (see the end of my previous post). Many financial and economic assumptions would immediately come into question, such as the efficient market hypothesis, rational expectations, and Keynesian economics, to name a few. By no means i'm implying we should throw "the bathwater with the baby," but simply to recognize the danger to blindly accepting mathematical or empirical results without critical thinking. The former is no substitute for the latter. In spite of this axiom, we live in a world that believes empiricism is sacred. As long as this continues, there will always be market crashes, country crises, and (in our lifetime) world-wide economic chaos when our monetary system fails. "There is something fundamentally wrong," wrote Hayek, when our analysis does not consider "the unavoidable imperfection of man's knowledge and the consequent need for a process by which knowledge is constantly communicated and acquired." This continues to be true today.
This is at the heart of what the 1974 Nobel Laureate in Economics, Frederich Hayek, explained in his excellent work, "The Use of Knowledge in Society." We live in an age where scientific knowledge dominates policymaking and assume that this is all to it. But "there is beyond question a body of very important but unorganized knowledge which cannot be possibly call scientific in the sense of knowledge of general rules: the knowledge of the particular circumstance of time and place." In other words, individual transactions will be predicated on the assumption that one has unique information over the other, and thus not reveal it. That is, you are not going to show your edge to your competitor. In order to accept Hayek's view, which i share, one must renounce to all central economic planning because it will ultimately fail. Communism failed because its systems could not capture all data for appropriate decision making. In fact, communism did something that is difficult to accomplish: the value of a final product was less than the sum of the value of its inputs. Socialism fails for the same reason. You may ask, "what about Europe? Socialism seems to work there." The reason it has held up over there is that Europeans get a tremendous defense subsidy from the U.S. Being an empire, the U.S. has taken (whether it likes it or not) on the defense cost of European nations. It has done this since the end of WWII.
But to regress to our main point, policymakers do not consider "the knowledge of the particular circumstance of time and place" because (i think) it requires of them a genuine act of introspection about the consequences of their actions and to consider that they may have the whole thing wrong. This requires them to be humble--hardly a trait of politicians and their subservient bands. But more importantly, acceptance of this knowledge also requires rejection of positivism (see the end of my previous post). Many financial and economic assumptions would immediately come into question, such as the efficient market hypothesis, rational expectations, and Keynesian economics, to name a few. By no means i'm implying we should throw "the bathwater with the baby," but simply to recognize the danger to blindly accepting mathematical or empirical results without critical thinking. The former is no substitute for the latter. In spite of this axiom, we live in a world that believes empiricism is sacred. As long as this continues, there will always be market crashes, country crises, and (in our lifetime) world-wide economic chaos when our monetary system fails. "There is something fundamentally wrong," wrote Hayek, when our analysis does not consider "the unavoidable imperfection of man's knowledge and the consequent need for a process by which knowledge is constantly communicated and acquired." This continues to be true today.
Friday, August 15, 2008
Happiness Is In The Eye Of The Beholder
There has been a lot of debate about the economics of happiness. In other words, how much is income related to a person's happiness. A seminal study done by Richard Easterlin in the mid- 1970s revealed (correctly in my mind) that income is a poor indicator of someone's happiness. This became known as the Easterlin Paradox. That is, more income does not necessarily generate more happiness. This meant that achieving a high GDP growth, long view by politicians and economists as the appropriate gauge for welfare, will not guarantee satisfaction in a nation's citizens--which can only mean that there are other non-monetary factors at play. Most economists agree (me included) that income growth causes well-being to increase, but up to a certain imputed point. That is, the utility of money exhibits the form, in mathematical parlance, of a concave function.
However, earlier this year another study by Betsey Stevenson and Justin Wolfers professed the opposite conclusion: more income equals to more happiness. The authors claim that better information gathering sources and enhanced econometric techniques available today in comparison to Easterlin's time heightens the credibility of their results. Yet, a closer inspection of their study reveals that their findings are not what they're cracked up to be. First, the method of data gatherings is primarily surveys (so was Mr. Easterlin's study), which always run the risk of people not being completely honest. Second, unless the same people that Mr. Easterlin's study targeted were interviewed for the recent study--which they were not--the results will be suspect. I'm not saying they are wrong; i'm merely saying there is a doubt about their validity or better they should be taken with a grain of salt.
Third and most importantly, there is evidence that contradicts the authors' results. They mention that Japan's experience "does not undermine the claim that there is a clear link between economic growth and happiness." This conclusion was in contrast to what Easterlin had found in the same country. The authors, however, never mentioned that Japan has the highest suicide rate among developed nations. Furthermore, in Britain, which in particular the authors do not consider, there are nearly as many people who are medically unable to work because of depression or stress than people unemployed. In my view, these evidences severely dent the authors' entire claim.
That said, this debate has deeper roots. It is the idea that through econometrics one can fully assess those aspects of humanity that are impossible to quantify. The current study of finance and economics rests on the idea of positivism, that is "the purpose of science is to stick to what we can observe and measure." If happiness exists, then it must be quantified; if it cannot, then its existence is dubious. This is why it is taught in Econ 101 that we study "positive" economics , that is how things are; in contrast to "normative" economics, which emphasizes the way things ought to be. This means that any ideas about morality are taken out the analysis. It is interesting to note that Adam Smith, before writing The Wealth of Nations, laid out his morality foundation in his less-known work, The Theory of Moral Sentiments. This last work has fallen in the memory hole of modern economists. Happiness exits and money is not the way to measure it. I doubt there will ever be a good proxy to gauge it.
However, earlier this year another study by Betsey Stevenson and Justin Wolfers professed the opposite conclusion: more income equals to more happiness. The authors claim that better information gathering sources and enhanced econometric techniques available today in comparison to Easterlin's time heightens the credibility of their results. Yet, a closer inspection of their study reveals that their findings are not what they're cracked up to be. First, the method of data gatherings is primarily surveys (so was Mr. Easterlin's study), which always run the risk of people not being completely honest. Second, unless the same people that Mr. Easterlin's study targeted were interviewed for the recent study--which they were not--the results will be suspect. I'm not saying they are wrong; i'm merely saying there is a doubt about their validity or better they should be taken with a grain of salt.
Third and most importantly, there is evidence that contradicts the authors' results. They mention that Japan's experience "does not undermine the claim that there is a clear link between economic growth and happiness." This conclusion was in contrast to what Easterlin had found in the same country. The authors, however, never mentioned that Japan has the highest suicide rate among developed nations. Furthermore, in Britain, which in particular the authors do not consider, there are nearly as many people who are medically unable to work because of depression or stress than people unemployed. In my view, these evidences severely dent the authors' entire claim.
That said, this debate has deeper roots. It is the idea that through econometrics one can fully assess those aspects of humanity that are impossible to quantify. The current study of finance and economics rests on the idea of positivism, that is "the purpose of science is to stick to what we can observe and measure." If happiness exists, then it must be quantified; if it cannot, then its existence is dubious. This is why it is taught in Econ 101 that we study "positive" economics , that is how things are; in contrast to "normative" economics, which emphasizes the way things ought to be. This means that any ideas about morality are taken out the analysis. It is interesting to note that Adam Smith, before writing The Wealth of Nations, laid out his morality foundation in his less-known work, The Theory of Moral Sentiments. This last work has fallen in the memory hole of modern economists. Happiness exits and money is not the way to measure it. I doubt there will ever be a good proxy to gauge it.
Wednesday, August 13, 2008
Crowd Mentality: A Look Into Finance and Politics
To truly understand modern politics, investing, or financial risk management one must also understand the characteristics of the crowd mentality. Very few, if any, scholarship on this subject is part of a standard undergraduate or graduate business, economics, or international affairs curriculum--at least based on my experience. This kind of study has been primarily ensconced to the fields of psychology, albeit there have been small inroads being made over the last decade by way of the nascent behavioral economics/finance field. Crowds in and of themselves are not a necessarily a bad thing; rather what is important to note is their motive and objective in achieving a particular objective. People can form crowds to perform a benign service for their local community or can be amassed to undertake the most scandalous actions. I will focus, however, on the aspects of crowds in general.
Nature of Crowd Mentality
The very nature of crowds is one of uncertainty. Their collective wisdom resembles those of animals in the wild: at moments serene but at other times sheer madness can be evident. Perhaps this is what John Maynard Keynes referred to when he made his proclamation that the market was inhabited with "animal spirits." People en masse display a level of intelligence significantly below than the average individual. In fact, crowds can only understand very simple, catch-phrased words like "war on terror," "fighting for democracy", or "real estate prices always go up" without critically analyzing their inherent contradiction. Thus crowds do not exhibit an ability to be thoughtful, but always eradicate those things that stand in the way of what they have already imagined. The very fact that crowds are extremely gullible by words and images, given their lack of mental capacity to reason, they are susceptible to leaders or self-proclaimed experts who will control them to achieve a particular end. Leaders who understand this are able to puppeteer the people by connecting seemingly separate events as cogent evidence of what the crowds already believes.
The moment this happens the leader(s) has the people at his disposal to do whatever he/she desires. For example, during the technology stock market bubble many people believed they were going to get rich because they had bought the next Microsoft, yet no one bothered to understand that most of those businesses were inadequate. "Experts" hailed the "new economy." Initially everyone followed the crowd; prices rose. When irregularities emerged that in fact those business plans were inadequate, stocks were sold. Everyone followed the crowd; stocks fell and the market declined. In its heyday, no news could temper the rosy scenery painted by the market gurus. But in the downturn, positive news could not prevent almost everyone heading for the exits at the same times, thus prices fell through the floor.
Psychological Analysis
Gustave Le Bon, the great French psychologist, described crowds this way: "A crowd thinks in images, and the image itself immediately calls up a series of other images, having no logical connection with the first. We can easily conceive this state by thinking of the fantastic succession of ideas to which we are sometimes led by calling up in our minds any fact. Our reason shows us the incoherence there is in these images, but a crowd is almost blind to this truth, and confuses with the real event what the deforming action of its imagination has superimposed thereon. A crowd scarcely distinguishes between the subjective and the objective. It accepts as real the images evoked in its mind, though they often have only a very distant relation with the observed fact (The Crowd, pgs. 24-25).
A recent article in the Financial Times about the presumptive presidential candidate Barack Obama gives further life to our analysis. In fact, Mr. Obama's current campaign is fascinating to watch. It resembles the dotcom boom/bust or the current real estate housing market experiences, in that glaring contradictions do not appear to molest market participants. Although it appears that his aura of invincibility may be wearing off. The FT article reports in part Mr. Obama's recent strategic European trip to impress upon voters at home of his abilities to maintain foreign support of U.S. activities, despite his non-existent international experience. What is worthwhile to note is a comment made by a former adviser to ex-President Clinton and to the 2000 Presidential campaign of Al Gore, who said the following: "What the last two weeks have shown is that Brack Obama is looking increasingly presidential which was, of course, the whole point of the trip and of yesterday's economic summit...It doesn't matter what else a voter thinks about a candidate, if they cannot imagine you as commander-in-chief then you will not become president. Last week's trip helps voters to imagine Obama in that role."
So there you have it, for those looking in from the outside the view is clear. The same analysis can be applied to most politicians, including John McCain. As someone I read once said, to paraphrase, either you're a contrarian or you're eventually a victim. I prefer the former.
Nature of Crowd Mentality
The very nature of crowds is one of uncertainty. Their collective wisdom resembles those of animals in the wild: at moments serene but at other times sheer madness can be evident. Perhaps this is what John Maynard Keynes referred to when he made his proclamation that the market was inhabited with "animal spirits." People en masse display a level of intelligence significantly below than the average individual. In fact, crowds can only understand very simple, catch-phrased words like "war on terror," "fighting for democracy", or "real estate prices always go up" without critically analyzing their inherent contradiction. Thus crowds do not exhibit an ability to be thoughtful, but always eradicate those things that stand in the way of what they have already imagined. The very fact that crowds are extremely gullible by words and images, given their lack of mental capacity to reason, they are susceptible to leaders or self-proclaimed experts who will control them to achieve a particular end. Leaders who understand this are able to puppeteer the people by connecting seemingly separate events as cogent evidence of what the crowds already believes.
The moment this happens the leader(s) has the people at his disposal to do whatever he/she desires. For example, during the technology stock market bubble many people believed they were going to get rich because they had bought the next Microsoft, yet no one bothered to understand that most of those businesses were inadequate. "Experts" hailed the "new economy." Initially everyone followed the crowd; prices rose. When irregularities emerged that in fact those business plans were inadequate, stocks were sold. Everyone followed the crowd; stocks fell and the market declined. In its heyday, no news could temper the rosy scenery painted by the market gurus. But in the downturn, positive news could not prevent almost everyone heading for the exits at the same times, thus prices fell through the floor.
Psychological Analysis
Gustave Le Bon, the great French psychologist, described crowds this way: "A crowd thinks in images, and the image itself immediately calls up a series of other images, having no logical connection with the first. We can easily conceive this state by thinking of the fantastic succession of ideas to which we are sometimes led by calling up in our minds any fact. Our reason shows us the incoherence there is in these images, but a crowd is almost blind to this truth, and confuses with the real event what the deforming action of its imagination has superimposed thereon. A crowd scarcely distinguishes between the subjective and the objective. It accepts as real the images evoked in its mind, though they often have only a very distant relation with the observed fact (The Crowd, pgs. 24-25).
A recent article in the Financial Times about the presumptive presidential candidate Barack Obama gives further life to our analysis. In fact, Mr. Obama's current campaign is fascinating to watch. It resembles the dotcom boom/bust or the current real estate housing market experiences, in that glaring contradictions do not appear to molest market participants. Although it appears that his aura of invincibility may be wearing off. The FT article reports in part Mr. Obama's recent strategic European trip to impress upon voters at home of his abilities to maintain foreign support of U.S. activities, despite his non-existent international experience. What is worthwhile to note is a comment made by a former adviser to ex-President Clinton and to the 2000 Presidential campaign of Al Gore, who said the following: "What the last two weeks have shown is that Brack Obama is looking increasingly presidential which was, of course, the whole point of the trip and of yesterday's economic summit...It doesn't matter what else a voter thinks about a candidate, if they cannot imagine you as commander-in-chief then you will not become president. Last week's trip helps voters to imagine Obama in that role."
So there you have it, for those looking in from the outside the view is clear. The same analysis can be applied to most politicians, including John McCain. As someone I read once said, to paraphrase, either you're a contrarian or you're eventually a victim. I prefer the former.
Subscribe to:
Posts (Atom)
Posts
