Showing posts with label economics. Show all posts
Showing posts with label economics. Show all posts

Sunday, June 12, 2022

NYC & Cape Cod Travel Observations

I have just returned from a family vacation in Cape Cod which began with a brief, 3-day stay in New York City. We flew into NYC and then rented a car for the drive to the cape. Below I note a few observations from the trip. These are just trivia compared to the wonderful time we had in both locations. Chatham, our regular destination in Cape Cod, again proved to be a splendid escape. 

  • My Lyft driver said as we were crossing the Queensboro Bridge, “the greatest city in the world without a doubt.” He is much better travelled/lived than me—born in Nigeria; lived in Dubai, Shanghai, LA, somewhere in Europe as well as several other worldly locales I don’t recall specifically. Who am I to argue? NYC is indeed world class. It’s ability to overcome so much poor and excessive governance is a tribute to its greatness.
  • NYC is vibrantly crowded—in a very good way. This was refreshing to see as I feared the city might have lost this by an order of magnitude. 
  • Outdoor dining is generally well placed and seemingly here to stay. The outdoor market near Times Square on Saturday was new to me and a treat to walk through.
  • New condo high rises are incredible. These so-called "pencil towers" don't inspire me the way other skyscrapers do, but maybe I'm too caught up in how structurally unsound they appear, which is intended as a feature rather than a bug. Just to me they look like how a child might sketch a cityscape lazily drawing as many tall buildings as possible.
  • Residence Inn Central Park (54th & Broadway) is recommended. Laundry options and convenient location along with great room and views—pics below.
  • Office space use looks still near empty by my anecdotal evidence. These pictures were taken from my room. Of the many elaborate office floors pictured in the neighboring building, only one ever had any occupants other than cleaning crews--cleaning floors that didn't ever have office workers messing them up. The floor with the basketball games and other fun stuff was vacant during the day. Note that the machines were all on 24/7--this should probably count against this firm's ESG rating, LOL

  • Where are the homeless? Michael Shellenberger has a point. Considerably less panhandling total than I encounter in the OKC area with 1/14th the population.
  • Crime and safety never seemed an issue on this trip. While I was in relatively high-income places, the popular narrative from the right still seemed false. We walked about 8 miles per day in various areas: 
    • Times Square (at night!)
    • Greater Midtown area
    • Central Park to the Upper West Side
    • High Line/Chelsea Market to Little Italy/Chinatown
    • I left my family shopping at Rockefeller Center to go pick up the rental car planning on them walking the half mile back by themselves without a second thought. I would have hesitated to do this in downtown OKC. Their journey was uneventful.
  • Memories come serendipitously. On our first night we were caught in a downpour in Times Square. While some of us had rain jackets, we were ill prepared. We stopped into a CVS to buy a couple umbrellas. Still our shoes and socks were quite soaked. This was very much like Boston years ago. No one would plan to get caught in the rain like this, and it would undoubtedly be one of those wouldn't-do-that-again moments. Yet, how can we reconcile that with it also being a wouldn't-trade-that-away moment? We don't get to choose our moments, but we do get to choose how we feel about them and how we take them on. (NB: I still plan on making good on this from the prior post: "The imaginative story we concocted on the train-ride back will be the inspiration for a future post.")
  • Masking is relatively high. ~20-25% of people still mask and those that do do it constantly—inside, outside, between bites. These are the people suffering long COVID. One young man walking down a busy, curvy street in Central Park choose to avoid passing our group in a tunnel under a bridge by walking down the middle of the street. He crossed between speeding cars, walked down the double-yellow line in the shadows of the tunnel holding his Macbook up high as cars whizzed by, and crossed back behind our trail. He seemed to stride with some pride in this moment of horribly bad risk analysis.
  • Book stores are the last holdout on required masks (aside from public transportation where it actually isn’t enforced). Stores in both Greenwich Village, NY and Chatham, Cape Cod strictly adhered to the antiquated ritual.
  • Cape Cod is resilient as well. Hard to tell a difference from my last trip in 2019.
  • Mask use is lower here than NYC. Maybe 15% tops. Very few outside.
  • Police are used for traffic directing around construction. This is something I noticed in Boston a few months back. In Cape Cod four or more police can be found just standing around pointing for cars to drive or wait as construction workers actually work. Definitely a union giveaway—great to see all the crimes have been solved in Massachusetts.
  • People were quite friendly almost everywhere in both places. The northeastern USA's reputation of unfriendliness is again proven quite unwarranted. Distant and reserved, yes. Hostile or gruff, not so much.
  • Rideshare the business model as experienced via Lyft seems strong and competitive. Uber was just a tad more expensive on each prospective trip but highly available as well.
  • Prices are high but a competitive market helps. Cocktails were basically the same price at comparable bars to what I see back home. Food was more expensive but an order of magnitude better when considering availability times quality. As for prices, it is hard to know how much is inflation versus big market, if only I had a restaurant journal… oh wait, I do. 
    • Let's begin by comparing Nom Wah Tea Parlor between my visit in June 2018 and current prices in June 2022. Recreating the order from the prior trip (beer, tea, 3x buns, 2x dumplings, roll, rice, and noodles) yields a total bill of about $69 pre tax & tip. My total bill with tax & tip in 2018 was $68.72. Assuming the tax rate is the same and I tipped the same rate, the total bill difference goes from $68.72 to about $89--about a 30% increase. In comparison NYC-area restaurant prices in general as measured by CPI over this time span are up about 18%. A similar order made at my local option, Mr. Hui, comes to about $93--more expensive and lower quality (sorry, Mr. Hui). My bet is Nom Wah got discovered between then and now, and its prices are reflecting as much. Hence, the 30% increase is a combination of general food inflation and something specific to that restaurant.*
    • One more comparison: The Chatham Squire, which I always hit multiple times per trip. In June 2019 I was there with extended family. Our total bill was $202.05 for which we enjoyed (well, let's just say quite a few drinks) and cioppino, mussels and hummus. Recreating the order in June 2022 makes the total about $253--about a 25% increase.* 
  • Pervasively merchants are directly passing along credit card fees in Cape Cod and to a lesser extent NYC. This has got to be an intermediate solution to a standard menu-price inflation problem. Seems slightly bullish for crypto while obviously creating a distortionary arbitrage for the cash-based consumers. 

  • Employee scarcity didn't seem as bad in Cape Cod as NYC or back home, but the effects were still in evidence. Restricted hours of operation seemed the most obvious sign. Restaurants were otherwise packed. 
The trip was delightful as I could have easily enjoyed double the time in each location. Cape Cod is very relaxing especially the way we do it. If you feel rushed there, you're doing it wrong. Enjoy a few pictures.





































*Take these comparisons with a grain of salt since you really cannot tease out anything from an N=1 sample. 

Sunday, May 29, 2022

Desperately Seeking Alpha

Great investing is generally about taking on the right risks and being compensated properly for risks taken. It is primarily NOT about out trading other investors.  
This is a sister post to Does Active Investing Work in Theory? exploring the two types of active management: alpha seeking and risk-adjusted return matching. The former is the sexy one; for almost all of us the latter is the realistic one. 

Let's make sure when we say "alpha" we all agree on what we are talking about. The term alpha generally means some version of outperformance. Imagine two runners in a 400m race where one finishes half a second ahead of the other. The faster finisher could be said to have .5 seconds of alpha over the opponent. But that is a bit too simplistic. In investing we usually want to know if any apparent outperformance is actually truly outperformance once we consider any inherent differences between competitors including adjusting for risk taken. 

In a fair race there shouldn't be inherent differences in the playing field so to speak. The runners are on the same track travelling at the same time. For investors we don't get such clean, simple comparisons. Even for our runners on an elliptical track the runner on the inside ring will have to start a bit behind the other runner so as to compensate for the less distance of the inner track lane and so the finish line can be a straight line across the track. 

What about risk taken? Pushing the analogy consider if one of the runners was using performance-enhancing drugs. This could be in one of two varieties. In one case they could be banned substances that if caught he would be disqualified. An outside gambler betting on him was taking a greater risk than perhaps he intended. In the other case they could be allowed substances but that have dangerous potential side effects. His risk now is that he runs the race (maybe winning and maybe not) and then suffers a bad health outcome. 

Back to investing, we ideally want to compare the performance of two investors isolating just the set of factors inherent in their investment "skill". I put skill in quotes because we never can be quite sure we are seeing skill or luck or that we have forgotten about an important difference we would have intended to adjust away. 

Most of the time in investing it is risk in its many forms that we want to adjust for. As an example, if I tell you I am a great investor because I have substantially outperformed my S&P 500 benchmark for the past 5 years, you might not be so impressed if I then reveal that it is because my only investment has been the single stock Apple, Inc. Sure, I outperformed in total return, but I took WAY more risk to do so. If that risk adjustment isn't made, we can't say much about this so-called outperformance.

There are other adjustments to consider like if an investor has been using inside information to facilitate his outperformance. The fact that this unethical practice might not be repeatable should make us doubt that this outperformance is replicable. At some point we would have to consider if the inside information advantage was just a different version of luck. 

Alpha seeking in active management is an attempt to outperform the competition, be it other investors or a benchmark index, adjusted for risk. How is this such a daunting task? Don't we hear about great investors all the time doing exactly this? Actually we do not. We hear about some investors' performances when they happen to be outperforming and often that is not true outperformance because they are not risk adjusted. But there is more to say about how difficult this is.

The capital markets (stocks, bonds, etc.) are very efficient markets primarily because they are very thick markets (i.e., there are lots of people participating in them). This is helped by the fact that they are very lucrative to those who perform well in them. The idea that some investors will outperform is a near certainty. The idea that that investor is you or someone you pick to follow is highly unlikely. 

Public capital markets are a ruthless machine viciously and constantly seeking to eliminate any advantage an investor may possess. The more brilliant your new method of discovering and unlocking outperformance, the more quickly and decisively the market will absorb it away from you. And in those cases where apparent persistence in outperformance exists, the more likely a hidden risk difference has yet to be understood.

For active management the sooner one gives up on alpha the happier and more financially successful one will likely be. Instead of trying to outperform adjusted for risk, try to just keep up by taking the right risks. 

A human investor's benchmark isn't a stock index or a bond index or some combination of the two. It is the realistic financial goals they are trying to achieve. These are some combination of consuming well today and being able to consume well tomorrow and for the rest of one's life. For most of us this includes more than ourselves--primarily our family and somewhat our friends and our charitable desires.

Our investment portfolios must be constructed initially and revised regularly to be appropriate for achieving these goals successfully. This is intentionally vague since it isn't something we easily know even for ourselves much less specifically for others. What we can say is that broadly diversified, low-fee investment into marketable securities should help our cause in most cases. 

Hence, the active management of financial assets that I believe desirable for most all investors is simply risk-adjusted return matching. Try to get the market's return adjusted for the risk you want and need to take. Notice two important nuances in that last sentence: the market is more than the stock market and I am framing risk not as something to avoid but rather as something to embrace appropriately. Risk negation isn't a thing. Risk tradeoff is. You are taking and will take risk. PERIOD. 

What risks to take more of and what risks to take less of is the essence of good investing. Being well diversified into low-fee index funds takes care of some of the typical risk factors like concentration risk, market risk, and credit risk, but others persist beyond that first step. In most cases one needs to also consider liquidity risk (being able to use one's financial assets when one needs to), inflation risk (maintaining purchasing power), wipe-out risk (losing so much one is permanently set back to a lower standard of living or truly financially wiped out), bad-discipline risk (letting emotion drive decisions that thwart the long-term plan; this could be the more obvious bailing out at the worst possible moment but also the less obvious overexposure due to complacency or exuberance), and mismatch risk (having an investment portfolio poorly constructed to fit with an investor's specific investment horizon and objectives). These risks push in different directions at different times and with different magnitudes. Active management is a fluid process of balancing and rebalancing risk tradeoffs.

Successful active management is difficult enough before attempting to then add alpha to the objective set. Notice also that attempts at alpha generation might certainly interfere both intentionally and unintentionally with risk management since taking on different risk profiles is both a means and an effect of reaching for alpha.

Leave it up to the professionals to try to generate alpha. You are too smart to lose money they way they do. 







Wednesday, May 25, 2022

What I'm Worried About as a Crypto Investor

Much like throwing a pass in football, there are three general outcomes from crypto investing, and two of them are bad. Namely, aside from maintaining or increasing in value, crypto assets like Bitcoin and Ethereum could become nearly valueless to an investor in two distinct ways. They could go bust or they could fail to reward investors even though they prove valuable to society in general. 

I consider these two bad outcomes distinct since they are so different in every manner except for the ultimate experience for investors. In the one case we have the conjecture that cryptocurrencies are vaporware that are just riding a greater-fool wave that will ultimately come crashing down. Label this one the "worthless" scenario.

In the other case we have the concern that even though crypto and its inseparable blockchain technology are godsends, there is no way to actually profit from their benefits directly. Label this one the "unable-to-capture-worth" scenario. 

Which one you subscribe to or concern yourself with says a lot about your crypto demeanor. For me the second concern is what keeps me up at night. I am a modest investor and a big, enthusiastic supporter. I want it to win and for me to win with it. 

Others are rooting for it to lose because they don't believe or don't want to believe in it or maybe some of both. For these doubters there is often a FOMO element that partially drives the want for crypto's demise. But in many cases these are thoughtful people making intelligent arguments against.

While the case against crypto isn't completely empty, I believe the clock is running out on that perspective. As crypto assets continue to establish themselves now more than a decade into their existence, this view looks more and more like a trivial dismissal similar to thinking the Internet would not amount to much beyond a step up from a fax machine.

Much more likely is that if crypto investors are left holding the bag the value has melted away from investors flowing to the benefit of all of society in general. Tyler Cowen made this case recently in his Bloomberg column:
So you can be bullish on crypto’s future without being bullish on current crypto prices. For a simple analogy, Spotify and YouTube have greatly expanded music’s reach, but overall the price of recorded music has fallen, and many performers earn much less than did their peers in the LP era. Or consider the agriculture sector, defined broadly: It has done very well over the last few centuries, but food prices have fallen rather than risen, due to higher output and greater competition.
I consider the unable-to-capture-worth scenario the serious, thoughtful worry. There are many ways this almost certainly will be true if crypto pans out for the long haul. You can make a great living as a bathroom remodeler or a plumber, but you aren't coming anywhere close to capturing all the value to consumers of indoor plumbing. 

If crypto investing fails, I think it will fail despite succeeding as a technology rather than because of it failing to ever deliver.
 

P.S. I take it as a very positive sign for crypto assets that the serious ones (Bitcoin, Ethereum, etc.) are becoming more and more correlated with the performance of "real" financial assets like stocks and bonds. It is an unfortunate economic fact that assets tend to become more highly correlated together as they mature making investing more difficult as some of the benefits of diversification erode.




Sunday, May 15, 2022

The (False) Law of Conservation of Effort and Reward

Most people seem to think within the framework of a supposed "law of conservation of effort and reward" (LCER) and its corollary "law of conservation of happiness". One might think of these as a spin on the forever-popular and equally incorrect labor theory of value. 

The thinking goes that somehow there should always be a linear and somewhat direct trade-off between work/life balance--that is, the effort one puts into something should be proportional to what one gets out, and there should be a trade-off between the chosen path and the "obvious" alternative path that together net out. Tightly zero sum. 

People resent the very idea that someone could have it all. The working mother should have delinquent kids who don't love her; the investment banker should long for relaxing weekends and be doomed to an unfulfilling life without meaning. 

The problem with these laws is that they conflict starkly with the magical human ability to tap the power of scale and compounding. The dynamics that these forces bring separate man from nature. Animals cannot coordinate nor plan for the future nor command exponential growth in any meaningful sense the way people can. 

Therefore, it should not be any surprise that some people and organizations can get more out of less and excel along multiple dimensions. In thinking about jobs, sometimes the grass is actually almost always greener

Consider how many people look to sports stars and other icons as “great follows” in social media making them big influencers succeeding in a realm outside of their primary area of success. Many adherents to LCER dismiss this as some obviously irrational behavior on the part of those less enlightened than themselves. The truth is these influencers probably are above average in ways that impact both the direct source of their fame (say basketball skills or acting ability) as well as many other areas. IQ becomes more and more important in sports the higher and higher the level. Dumb athletes don't last long at the pro level. 

Jeff Bezos would probably be an above average gardener. The reason he doesn't mow lawns and trim bushes isn't because he wouldn't be very good at it. He might in fact be better than the people who do the job for him at his own house(s). If you think he doesn't do those jobs himself because he is rich, you're right for the wrong reasons. The reason he doesn't is because of the very real law of comparative advantage

At the same time I think that some of what makes amazing people amazing often has a dark side. This might make them a bit eccentric or frustrating or detestable. It varies and is not always the case. This might sound like a contradiction, but I don’t think so. Rather it is part of the complexity and mystery of it all—what distinguishes elites. This is very much in agreement with point #6 here

Arnold Kling makes related points calling this the "convergence assumption":
What I call the convergence assumption is the assumption that everyone is fundamentally the same, so that it is more natural to expect people to develop the same skills and adopt the same values than for divergence to persist.
... 
We are not all the same. This makes moral issues very complicated. When we acknowledge genetic and cultural differences, what is the meaning of equality? When should we suppress differences and when should we accommodate them?
I think that the great appeal of the convergence assumption is that it allows us to avoid the challenge and complexity posed by these problems. But avoiding complexity is not a good approach if the complexity is an important characteristic of the environment.

Exceptional people are generally and not just specifically exceptional. How this maps onto agreement with you will vary along dimensions of morality as well as taste among others. Those differences are not tradeoffs they are making such that in some cosmic justice sense you and they are on equal footing when all is balanced out.  



Wednesday, April 20, 2022

Only Tax Unprofitable Businesses

It is income tax time again. Instead of the usual rant, I have a creative alternative for you to ponder: Only taxing unprofitable businesses. That is if we are stuck on the illogical notion of taxing income per se at all. 

Loyal readers know that we shouldn't tax corporations' profits and that we should not tax incomes in general. Corporations are just fictional middlemen between owners/workers and customers. Taxing their profits or income is just an indirect (inefficient) way to tax those owners, workers, and customers without properly changing their behavior. It would be much, much better to tax businesses as they add value to the production of final goods and services through the use of capital and labor. All of this as being part of a larger scheme to tax resource use rather than resource creation. But I digress.

Let's assume we are going to tax businesses' incomes. How should we do this? 

I propose we reverse the concept and instead of taxing a share of the revenues minus expenses (when R > E) we tax a share of the expenses minus the revenues (when E > R). In other words we only tax unprofitable businesses. 

Here is the reason for the proposal. Revenues are a measure of the benefits that a business has provided. It is an estimate of what value they have brought to the world. Expenses are a measure of the costs they have taken. It is an estimate of what value they have destroyed in an attempt to add value through their business activity. If their expenses exceed their revenues in a given year, for that year at least they have detracted from society by virtue of their activity. 

Perhaps we would need a 3-year average profitability test or carryover provision of 50% of profits from year 1 to year 2 and 25% of profits from year 1 to year 3. I'm open to ideas here. That way we smooth out business cycle and idiosyncratic effects that might otherwise undesirably punish a business in a given year for circumstances beyond its control or for investments made that have long-run payoffs. But let's not lose sight of the goal: taxing firms that cannot turn a profit (i.e., don't add value to the world).

An instant objection is that this would make a startup business unduly expensive potentially stifling economic growth. Just a little understanding of how markets work invalidates this worry. Under this arrangement a tax on an annual net loss simply adds to the cost of capital. If the expected payback is sufficient, the investment will be made. Look at it this way: Is it better that resources are used with tax encouragement (deductibility) on the prospect of future economic value creation (future profitability that would then be taxed) or that resources are used while being taxed (a discouragement to frivolous investment)? The expected return is likely the same in either case*--it is just a matter of when taxes are collected and on whom the burden falls (taxing failure or taxing success). Given that taxes discourage that which is taxed, I know in principle which one I want bearing the burden.

Thus, this method has two key attributes to admire:
  1. It punishes bad investments by taxing failure.
  2. It creates an economic environment that increases the returns to good investments by not taxing success.
A side benefit is that it potentially cleans up accounting--a lot. A great deal of effort (resources) is put into doctoring the books so that a firm looks less profitable than they actually are. This leads to an additional benefit of disincentivizing expenditure that is not actually net profitable. Executive perks, luxury offices, unnecessary equipment, etc. now all carry a burden where once they earned a subsidy. 

Does this have a chance in the hell that is our tax code of coming to fruition? Of course not. And if it did, the later temptation to reverse course would be too great to assume future profits would be tax free. But it is a fun thought experiment that yields a new way to see the economic error in our current taxing ways.







*This is kind of a reverse Ricardian Equivalence whereby known taxes on losses have to be justified by expected profits in the future. As long as the tax rate on losses is not devastatingly high, in which case it would prevent any method of transferring future expected profits to the current day to finance a current tax burden, the tax that would be applied to future profits is instead realized before those profits are themselves realized. This assumption is no different than assuming current tax rates on profits are not so high as to devastate the ability for businesses to earn a profit in our current system. 

Monday, April 4, 2022

The Economics of Immigration in One Lesson

Or perhaps I should say in one equation properly explained . . .

Political thinking: 
    ALL THE STUFF divided by ALL THE WORKERS equals STUFF PER WORKER
The implication of this is more workers means less stuff for workers.

Economic thinking: 
    ALL THE WORKERS multiplied by STUFF PER WORKER equals ALL THE STUFF
The implication of this is more workers or more productivity means more stuff for workers.

Definitions: 
All the stuff = production, the output;
all the workers = resources, the input; 
stuff per worker = productivity, the rate at which we can produce stuff

Allowing more workers (immigration as well as the removal of barriers to entry like licensure laws and minimum wages) is clearly a net good when total output rises. 

The key to consumption is production. The key to mass consumption is mass production.*
(HT: Bryan Caplan)






*Note for minimalists, environmentalists, etc.: Don't get hung up by the term "mass" here. This does not mean "excessive". It means flourishing for the masses. Limitations on production/consumption hit the worst off first and the best off almost never.

Saturday, March 19, 2022

Who You Gonna Call? Trustbusters!

David Henderson has written two very good pieces recently at the Hoover Institution's Defining Ideas. They are a two-part discussion on antitrust: Let Freedom Rein In Big Tech and A Populist Attack on Big Tech. I particularly like his conclusion:
The more regulations there are to enforce a government official’s idea of competition, the more likely it is that those regulations will hamper actual competition. Companies that give their own products and services an advantage in the marketplace are simply harvesting the value of an asset that they took big risks to create. Competition is dynamic, not static. But heavy regulation will make markets more static. Let’s keep competition dynamic by not penalizing successful competitors but by leaving the market open to alternative business models.
Do read the whole thing in both cases. 

He makes many excellent points--ones that I myself had in some notes for a future piece on antitrust. (Of course, he makes them much better and more fully than I could.)

Sometimes one must be patient for competition to work it’s magic. Just because a monopoly, oligopoly, or other sinister market-dominant firm seems entrenched today, does not mean it will always be or that the cost of immediate correction is worth bearing. Forced correction may not even be feasible. 

At any one point in time there are a lot of reasons the world is the way it is. The challenge for the trustbuster is to know with very-high certainty that the current state of the market is suboptimal ("inefficient" is the eye-of-the-beholder term of choice) and that a better world can and should be achieved through government action. 

It is easy to conjure up a hypothetical better world because only in the wild through real-world experience, the so-called market test, do we truly discover all the constraints and tradeoffs. Comparing the unicorn to the horse is always subject to bias--imagined reality almost definitionally engages in willful blindness. But the trustbuster's Dunning-Kruger problem does not end there. The "can be achieved" is naively assumed through hand-waving theory. The "should be achieved" is generally ignored altogether.

In the realm of current worry, Big Tech (dunt, dunt, duh!), see MySpace, Yahoo!, and AOL along with InternetExplorer, Mapquest, Garmin, Blackberry, et al. Then consider Twitter, Facebook, and TikToc, along with Google, Apple, et al.

Also, remember when the government broke up IBM? Yeah, I don’t either. Apologists for activist government regulation will tell you the threat posed by the 13-year case that went nowhere is what reined in the highly-successful company, but this theory only works by willfully ignoring the fabulous work performed by IBM’s various marketplace competitors. Those quick to point out “you didn’t build it” rely on their own wishful agency when the real work is being done by those actually in the field. 

Why in antitrust do we grant so much benefit of the doubt to regulators and so little deference to the world as it is? Are we just that willing and hopeful that a white knight can remake that which we suppose is in error? Is it just because we don't listen to master Yoda?




Saturday, February 19, 2022

Rather Sorry Than Safe



When friends who are interested in "prepping" ask me about planning for doomsday scenarios, I love the looks on their faces when I reply, "I'm planning on being one of the attacking barbarians ravaging the countryside. Thanks for telling me about your hideout." 

Let's consider the perspective of a prepper in regards to prepping for financial disaster. There are always reasons to be fearful about the future, and it doesn't take too much imagination to spin these true risks into worry of cataclysm. As I write, worries about the COVID-19 pandemic are gradually fading only to be replaced by concern of war with Russia vis-à-vis Ukraine.* 

If you don't have a back-up plan, you are naively gallivanting about while the asteroid circles the planet. Yet if you always hunker down in the bomb shelter, you are letting your fears prevent you from enjoying life. Risk inconsistency can be worse than consistent, willful exposure to high risk. If you are prepared for and understand that actions you are taking are likely risking bankruptcy for the chance to strike it rich and possibly very rich, then the risk you are taking may very well be prudent and necessary. Extremely few entrepreneurial efforts with appropriate upside potential do not inherently contain that kind of downside risk. But if you are running a decent risk of bankruptcy just through your spending patterns and arbitrary investment decisions, you are likely not getting enough reward for the risk. In a more technical sense you are not matching potential return with the level of risk. 

Return is the expected compensation for risk taken. It is not guaranteed nor predetermined. A lot can get in the way and almost always it is a spectrum of potential returns (some of them low if not negative) that result in the expected return. Sometimes we qualify return compensation in terms of a required rate of return. Required can really be thought of as minimum acceptable expected return. In highly efficient markets this required return becomes equal to the expected return as any potential return above this required level gets competed away.

Successful decision making in life as with successful investing is not about avoiding risk or taking risk. It is about understanding and managing the many varied risks one is exposed to while getting the proper potential compensations. 

We simply cannot predict the future nor can we entirely remove our exposure to it as good and bad as it will be. Well, I guess there is one way, but if that is your solution, this post isn't for you at all. For those of us who want to go prudently into that good night, remember the old adage:

Don't try to hedge the end of the world. It's only gonna happen once, and regardless of what you do, it won't work out too well for you.



*Calvin: You're sure?

Adam: Positive. The Soviet Union collapsed without a shot being fired. The Cold War is over.

Calvin: That's what everybody believes?

Adam: Yes, sir. It's true.

Calvin: What? Did the Politburo just one day say, "We give up?"

Adam: Yes. That's kind of how it was.

Calvin: Uh-huh.

Calvin: My gosh, those Commies are brilliant! You've got to hand it to 'em! "No, we didn't drop any bombs! Oh yes, our evil empire has collapsed! Poor, poor us!" I bet they've even asked the West for aid! Right?

Adam: Uh, I think they have.

Calvin: Hah! Those cagey rascals! Those sly dissemblers! Those, uh... They've finally pulled the wool over everybody's eyes!

--"Blast From The Past" via IMDB

Tuesday, February 15, 2022

Don't Confuse Poverty For Inflation

Just when they said it was dead and gone, inflation is back loud and clear. The latest reading of the CPI for January 2022 is 7.52%! We haven't seen these levels since the early 80s, or is it since the mid 70s thinking that this is the upswing with more to come? That is a scary thought as inflation didn't peak until 1980 at 14.6%. 


While I believe the Fed has the resolve and know how to tame inflation, that indeed does remain to be seen. However, that isn't the point of this post. 

What is on my mind is a mistake I hear being made often as an apology/excuse for Biden. Since Biden is currently the President, it is the left who is offering this excuse. Had Trump won, I would fully expect the right to be making the same mistake. 

The mistake is thinking Biden (like Trump before him only more so with Biden) does not bear some blame for the inflation numbers we see. The short version is: "It's not Biden's fault; it's the pandemic's." 

Had the apologist said instead, "It's not Biden's fault; it's the Fed's," I would have cut them some more slack. The Fed is ultimately the reason we do or do not have true inflation (a sustained increase in the overall price level relative to the medium of account, USD). 

The pandemic and the policy responses to it have generated enormous supply and demand disruptions. The magnitudes here quite certainly matter. But the price affect from all of that is not inflation. It is a change in relative prices--dramatic as they are, they cannot result in an inflationary outcome without the Fed as an accomplice. Relative prices are the market adjusting to reality finding new price and quantity equilibria. This very necessary process is why price controls don't work causing painful problems themselves.

Here is the thinking that leads the apologist astray: 
  • The pandemic messed everything up where we couldn't work as much, killing production, etc. (negative supply shock).
  • It is no surprise the shelves are bear. (scarcity at current price levels)
  • With fewer things to buy and all the money still out there including all the government support, prices had to go up--same/more dollars chasing fewer goods and services . . . I thought you understood economics, Winkler? 
One problem with that story is that it neglects half of the equation--income. When we produce less, we have less income. We are poorer than before (the economy's output and perhaps its potential output is now materially lower). Understanding that is a glimpse into how a bad event like a pandemic cannot by itself cause inflation--another problem with that story. Inflation comes if the monetary authority, the Fed in our case, fails to properly adjust monetary policy adjusting it downward. 

Negative supply shocks like pandemics increase poverty--or reduce wealth depending on your framing. They make us poorer. Poorer might look like inflation, but it isn't. Consider this:

 

In this chart the farther to the right and/or the lower on the chart a country is, the wealthier it is in terms of how much it works (average annual working hours on the y-axis) for the income it generates (GDP per person on the x-axis log scale). Notice this data is for 2017. For example, Brazil has a per capita GDP of about $14,500 with the average worker working about 1,710 hours per year. The United States enjoys a per capita GDP of about $60,100 with very similar average worker hours, about 1,760. People in America are a lot more productive than people in Brazil.*

Along the vertical we can make another comparison between Hong Kong (GDP = $59,800 & Hours = 2,190) and the U.S. (GDP = $60,100 & Hours = 1,760). Again the U.S. has higher productivity generating about the same income as HK for considerably fewer hours worked. 

Ultimately time is the common currency all humans deal in as it is the one truly binding constraint. Looked at this way we can consider what a really bad supply shock might look like for the U.S. Imagine our total production went from $60,100 all the way down to Brazil's level but hours worked stayed the same. Suddenly the cost of our income (cost being hours worked) is much, much higher. Alternatively, if we now had to work as much as Hong Kongers do for the same income, the cost of our income is again much higher. We are working the same for less income in the first case and working a lot more for the same income in the second. In terms of hours worked is this inflation? No, it is an increase in poverty/massive reduction in wealth. 

Think about it this way: If you suddenly were relocated from the U.S. to Brazil doing the same job, you'd immediately notice that your pay was lower. If you were purely on the average, you'd notice that working your regular 1,700 hours per year only allowed you to buy about a quarter of the goods and services you enjoyed in the U.S. ($14,500/$60,100). You might say, "Wow! Things sure are expensive in Brazil." And you'd be right. But if you then concluded, "They must have had a crazy amount of inflation," you'd be quite wrong obviously. You personally experienced what looks like inflation to you but is really just a negative wealth effect due to the relocation.

People instinctively but mistakenly think bad events will cause inflation by assuming their incomes will remain the same while there will be fewer goods available. But for the entire economy incomes must go down if production goes down since they are the same number. 

So what did Biden (and Trump and Congress) do? Biden trumped Trump by helping Congress to spend a LOT OF MONEY.

Source

The reason spending during Biden's term has been so problematic is that we were largely exiting the pandemic at that time. You don't have to become an adherent to or expert on the fiscal theory of the price level to understand the issue. These greater and greater levels of government spending put more and more pressure on the Fed to constrain monetary policy so that the excess spending did not induce inflationary effects. So far the Fed has not been able to fully offset that spending.

Is the Fed to blame? Yes. Was its job made much harder by what the fiscal authorities (Congress and the President) did? Also, yes. Are there other knock-on effects from the spending and associated government programs the pandemic gave cover to? You bet, and they are likely worse than inflation [please, God, don't let the Fed now say "hold my beer".]


*There is a subtle pro immigration word choice I made here. Notice I didn't say "Americans" or "Brazilians". It is not the people so much as it is the economy they are working in. Relocate those same Brazilians to the United States, and their productivity would magnificently rise as if by magic even though it would for a time still be below current American rates.