Politicians vs. Bloggers

After reading Jonathan Chait's posts on Howard Dean I was thinking an interesting post would be how the kinds of things that tend to make someone a successful politician differ from the kinds of things that tend to make someone a successful blogger, like Chait -- and the very different kinds of people that tend to go into each.

One really common way to increase your odds of success as a politician is to be kind of a weasel, or a huge weasel. There are exceptions; you can be very successful through great charisma and competence (Elizabeth Warren), but few people have that kind of charisma and competence.

Note, however, what true weaselness is: Sometimes looking like a weasel is actually doing what you think is best for the country – You support, or go along with, something bad in exchange for helping some greater good get done. Any good politician should do this sometimes, and to some extent. It's unavoidable if you want to optimize the good of 300 million Americans and 7 billion human beings. But the weasels will do this not for the greater good, but for more personal power, prestige, and/or money.

And politicians tend to be people who will go to incredible lengths, often unethical, often that they know really hurt the country and the world, for power and prestige (although there's an argument that women politicians are much less like this [1]). John McCain is a prime example; it's all about him and what he wants, and his personal vendettas, rather than 300 million Americans and 7 billion human beings.

As a blogger, however, there's very rarely big bucks and prestige among the general public. You do it largely because you care, rather than a super drive to win and have power. And you better be smart and do your homework, because your derp, or mistakes, are often immediately attacked by people who largely determine how respected and influential you are. And your audience is way more informed than the average, so you just can't get away with politicians tricks nearly as well.

Of course, I'm not speaking of conservative bloggers, who primarily speak to a bizarro tribal world, and say what their super-rich patrons want them to say.


[1] From the New York Times, 6/11/11:

Research points to a substantial gender gap in the way women and men approach running for office. Women have different reasons for running, are more reluctant to do so and, because there are so few of them in politics, are acutely aware of the scrutiny they draw — all of which seems to lead to differences in the way they handle their jobs once elected.

“The shorthand of it is that women run for office to do something, and men run for office to be somebody,” said Debbie Walsh, director of the Center for American Women and Politics at Rutgers University. “Women run because there is some public issue that they care about, some change they want to make, some issue that is a priority for them, and men tend to run for office because they see this as a career path.”

What about Expenditure Cascades?

Paul Krugman has an interesting post on the question of the causes of the explosion in household debt that was an important factor in our financial and economic crisis:

The president came down pretty much for what we might call a Stiglitzian view (although it’s widely held): debt was driven by rising inequality. The rich were taking an ever-larger share of the pie, but not spending to match, while working Americans took on ever more debt to make ends meet.

What’s the alternative? Minsky: debt exploded because the Great Depression was receding into the mists of forgetfulness, and both lenders and borrowers — enabled and encouraged by financial deregulation — forgot the dangers of leverage.

I'd add to this, importantly, expenditure cascades, from Cornell economist Robert H. Frank.

In an expenditure cascade, the tip-top pulls away in income, and thus spending, so level two notches up their spending to not lose their position and feel bad and embarrassed, and this involves more borrowing/less saving. When level two notches it up, this induces level three to do the same, and so on.

How much pressure do middle class people now feel to put granite, wood, and stainless steel in their perfectly functioning kitchens so they don't feel and look crappy and poor?

The 1/10th of 1% used to drive $120,000 Mercedes, and the 1% used to drive $70,000 Mercedes. Now the 1/10th of 1% are buying $400,000 Rolls Royces, making the 1% feel like their $70,000 Mercedes are crappy and embarrassing, so they save less/borrow more and buy $200,000 Bentleys. Now that the 1% went from $70,000 Mercedes to $200,000 Bentleys, the 5% feel like their $45,000 Mercedes are crappy and embarrassing, so they save less/borrow more and buy $80,000 Mercedes, and so on down the line.

I think expenditure cascades are important to add, especially since positional externalities are the pink elephant of economics.

How about a model just as a simulator/tester, free of the constraints from having to solve for the global optimum?

Please bear with me and read this long quote from a paper in the lifecycle portfolio strategy literature:

The original literature on dynamic portfolio choice, pioneered by Merton (1969,1971) and Samuelson (1969) in continuous time and by Fama (1970) in discrete time, produced many important insights into the properties of optimal portfolio policies. Unfortunately, closed-form solutions are available only for a few special parameterizations of the investor's preferences and return dynamics, as exemplified by Kim and Omberg (1996), Liu (1999a), and Wachter (2002).

The recent literature therefore uses a variety of numerical and approximate solution methods to incorporate realistic features into the dynamic portfolio problem. For example, Brennan, Schwartz, and Lagnado (1997) solve numerically the PDE characterizing the solution to the dynamic optimization. Campbell and Viceira (1999) log-linearize the frst-order conditions and budget constraint to obtain approximate closed-form solutions. Das and Sundaram (2000) and Kogan and Uppal (2001) perform different expansions of the value function for which the problem can be solved analytically. By far the most popular approach involves discretizing the state space, which is done by Balduzzi and Lynch (1999), Brandt (1999), Barberis (2000), and Dammon, Spatt, and Zhang (2001), among many others. Once the state space is discretized, the value function can be evaluated by a choice of quadrature integration (Balduzzi and Lynch), simulations (Barberis), binomial discretizations (Dammon, Spatt, and Zhang), or nonparametric regressions (Brandt), and then the dynamic optimization can be solved by backward recursion.

These numerical and approximate solution methods share some important limitations. Except for the nonparametric approach of Brandt (1999), they assume unrealistically simple return distributions. All of the methods rely on CRRA preferences, or its extension by Epstein and Zin (1989), to eliminate the dependence of the portfolio policies on wealth and thereby make the problem path-independent. Most importantly, the methods cannot handle the large number of state variables with complicated dynamics which arise in many realistic portfolio choice problems. A partial exception is Campbell, Chan, and Viceira (2003), who use log-linearization to solve a problem with many state variables but linear dynamics…

From: Brandt, Michael W., Amit Goyal, Pedro Santa-Clara, and Jonathan R. Stroud, 2005, A simulation approach to dynamic portfolio choice with an application to learning about return predictability, Review of Financial Studies 18, 831–873.

The authors go on to present their new numerical solution method which overcomes a lot of the limitations of old solution methods, and allows more realistic modeling – IF you feel like you can only create a model if you are able to find the global optimal solution to it.

But this is my point. In all of those papers cited on lifetime portfolio choice strategy, the authors put in severe unrealism for one reason, so that they would be able to solve for the perfect globally optimal behavior of the people in the model.

What if, at least for just one paper, let alone a branch of the literature, they said, I’m not going to be severely constrained by the need to calculate the exact utility optimizing behavior. I’m going to create a really really realistic model, say of lifetime portfolio strategy, and use it as a simulator tester. I’ll try various popular and/or intuitive strategies, plug them into the model on my computer and see what expected utility score comes out.

Wouldn’t this be a great way to prove and see which strategies are better than others, with a really realistic model, that could have really complicated realistic utility and other functions – functions which wouldn’t even have to be analytical; they could be highly complicated and realistic empirical functions; functions written with multiple lines of computer code, instead of being limited to one neat compact simple equation.

Sure, such a model might be so complicated and irregular that you’ll never solve for the global optimum with a high degree of confidence, even with numerical methods and supercomputers, but you could test really well how one important and/or popular strategy compares to others in expected utils. You could use your intuition and new understandings in the field to come up with ever better strategies that test higher and higher in utils in the super realistic simulator. You could quickly test hunches in the simulator. Heck, you could even put out a prize for the first person to come out with a strategy that exceeds X expected utils in the simulator.

Why does no one do this in economics or finance? It seems in the physical sciences that they always use simulators to test things, making them as realistic as possible, instead of making them way less realistic in very important ways in order to be able to exactly calculate the perfect global optimum.

Are stocks especially safe for the long run as a hedge against robot/computer unemployment?

Wonkblog has a great interview with Kevin Drum on the dangers of long term, or permanent, unemployment in the future with great advancement of computers and robots. As an adjunct professor of personal finance at the University of Arizona and President of National Personal Finance Education this is a subject I've been studying and thinking about a long time, along with, of course, how to protect yourself and your children. It's very important, and I hope to say a lot about it in the future.

But for right now, there's a big thing I've been conjecturing for a while, and I think I'm ready to at least state it publicly for discussion:

Stocks are widely acknowledged among experts and academics to have a great risk-adjusted average, or "expected", return over the long run, decades, and for some conventional reasons. And I have a hypothesis for the "Equity Premium Puzzle" too, that I haven't heard in the literature or elsewhere, basically that a firm can simply create more value and be more productive when they finance with stock because it gives the ability to think long term and be flexible, without the short term constraints and requirements that come with debt. There is more too it, though, like the particular way it affects the aggregate supply curve of firms. For details, see here.

Now, one big thing that lowers the risk of stocks over the long run, that you often hear, is that, unlike fixed income assets, they move very well with inflation, being claims on real assets and income (See the great book, "Stocks for the Long Run", by Wharton financial economist Jeremy Siegel.)

But there's potentially another big thing; if robots and computers really take off, creating a huge risk of being long term unemployed, then stocks may be a fantastic hedge against this risk. As the better the robots do – the more wealth they create, the more they produce – the more the value of your stocks may explode, because your stocks are robots; they're claims of ownership of corporations' robots and computers. It’s like you own your own robots to create wealth for you personally, and you may not have to own many when each one can produce the equivalent of a well skilled man for a lifetime.

So one of the best ways to protect the future of your children may be to every year put money into your 401k and IRA in a well-diversified stock index fund, not just for your retirement, but for even longer term, for your children when they're 30, 40, 50, and have a family, and it may be very hard for them to find any job that robots can't do for 50 cents per hour, or much less. Then they'll own many of these fantastic robots themselves to year after year make a good income for them.

And, of course, it would be great if you could skip the McMansion and new cars every three or five years, and instead put more into stocks for your children than just the 401k and IRA limits, like starting trusts. Believe me, the kids are a lot better off driving around in older used cars and not having a great room or granite countertops, but having their future insured against devastating long-term unemployment and poverty.

What else do you consider gifts, Romney and Republicans?

So Mitt Romney considers things like health care, which may keep you or your children alive, and relief from often crushing and inescapable college loan debt, gifts.

Is there anything that the government does that they don't consider gifts for moochers?

The government provides free schooling for all children from the ages of five to eighteen. Is this a gift for moochers that Mitt and his fellow Republicans would like to see eliminated – you want your child to be educated, you pay for it? We've already dropped behind most advanced countries in the education of our population; why not just go straight to the bottom. You gotta eliminate those gifts to the takers. Hey, it's not like the long term wealth, health, and strength of a country depend on how educated it's population is.

What about aid to make a high quality college education affordable for the majority? Is that a gift for the takers we should completely eliminate? We've already dropped to 16th in college educated citizens after a generation of Republican dominance. How stupid do Mitt and the Republicans want us to be?

What about free public roads and infrastructure and vaccinations and fire protection? Gifts for the takers that should be eliminated? We should have only toll roads and private roads? Put out the fire yourself; it won't spread to the gated compounds of the rich, and neither will your diseases?

How much should we Hondurusize the country, Republicans, to eliminate all of the gifts?

No Law of One Price in the Presidential Betting Markets?

Uber-Efficent market types love to proclaim how the market is the most efficient and wise at setting the odds for anything, including the Presidential elections. But if that market is so efficient and wise, why does the Law of One Price not even hold?

From Ezra Klein, October 30th:

... BetFair markets give him a 67.8 percent chance, the InTrade markets give him a 61.7 percent chance...

Why wasn't this arbitraged away? You could put $61.70 on Obama winning at InTrade, with a $100 payoff with a win, and $32.20 on Romney winning at BetFair with a $100 payoff. And for a total of $93.90 you could get a guaranteed $100 a week later.

Why didn't people jump on this until it was bid away? According to Daily Kos:

The gamblers know about the existence of Intrade. They talk about how it isn't worth it to them to try to take advantage of the market inefficiency. They detail the process involved with trying to get a deposit on...

The gamblers also know about the existence of 538. Most knew Nate's work from baseball prior to politics. His work was very helpful for gamblers. Those people who tailed him profited. He has done some good work in other sports like soccer as well. He had models for entertainment betting as well (film awards and such). His work on politics made a lot of people money too. Senate races and presidential race in specific states were mispriced. (This was partially a loss-leader for the big websites, a known mispricing without that much exposure. Offer Senate races priced at 95% when they were really closer to 100%, but only at low limits. Max win from any race was $50. You'd have to tie up a grand to get that $50. Many sportsbettors had thousands tied up as they took all the huge favorites available.) Even by blindly following his numbers, you made money.

Update: Ravij Sethi informed me of a great post at overcommingbias on why arbitrage is difficult, and limited, to enforce the Law of One Price. Quoting:

Some noteworthy aspects of the situation are:

    – Americans can’t deposit money into Intrade using credit and debit cards – they have to use bank transfers.
    – Bank transfers take at least two days to arrive and cost over $20.
    – Everyone else can choose between cards and bank transfers.
    – Cards are instantaneous and free (if denominated in US dollars anyway) but have a $2,000 deposit limit in the first month, and $5,000 thereafter.
    – It takes at least a day, probably two, to open a new Intrade account and have it approved.
    – There are other significant barriers to entry – knowing about the issue, learning about the fees, opening an account with another betting agency and finally having the time and confidence to correctly place the hedge.
    – Intrade seems very widely covered by the US media.

Want to Understand the Intuition for Wallace Neutrality (QE Can't Work), and Why it's Wrong in the Real World?

This refers to Neil Wallace’s 1981 AER paper, “A Modigliani-Miller theorem for open-market operations”. The paper has been influential today, as it has been used as a reason why quantitative easing can’t work. Here are some example quotes:

"No, in a liquidity trap, if the Fed purchases gold, it does not change the price of gold, just as it will not change the prices of Treasury bonds if it purchases them." – Stephen Williamson

"The Fed can buy all the government debt it wants right now, and that will be irrelevant, for inflation or anything else." – Stephen Williamson

"If it were up to me, I would have given Wallace the [Nobel] prize a long time ago, and I think Sargent would say the same. However, not everyone in the profession is aware of Wallace's contributions, and people who are aware don't necessarily get as excited about them as I do." – Stephen Williamson

"...the influence of Wallace neutrality thinking on the Fed is clear from the emphasis the Fed has put on telling the world what it is going to do with interest rates in the future...I have a series of other posts also discussing Wallace neutrality. In fact, essentially all of my posts listed under Monetary Policy in the June 2012 Table of Contents are about Wallace neutrality." – Miles Kimball

In Wallace’s model, when the Fed prints money and buys up an asset with it, this affects no asset’s price, and doesn’t even change inflation! Amazing claims, but they’re mathematically proven to be true – in Wallace’s model, and with the accompanying assumptions. So the big question is, even in a model, how can claims like this make sense? What could be the intuition for that?

For the vast majority of well-educated laypeople, the paper is impenetrable, foreboding math, and I’d say this is, to a large extent, true of economists not specialized in this area. I have a very mathematical economics background (see, for example here), and it took a lot of time and effort for me to really penetrate and understand this paper. It’s extremely terse, with very little explanation and derivation for non-specialists.

I had hoped to find someone who could explain the intuition on the internet, especially in the economics blogosphere. But after a lot of looking, and a lot of asking, I couldn’t find anything that really did it for me (The closest by far was this post from Brad DeLong.) So, I made the decision a couple of months ago to spend whatever time I could come by reading, studying, understanding, decoding, deciphering, this paper. Here are my current conclusions:

In the paper's model, the government's particular printing of more dollars and buying an asset has no effect on the price of any asset, and no effect on inflation either, but let's look at the particulars:

The government prints dollars and buys the single consumption good, which I like to call c's. It holds the consumption good for one period, storing it (investing it, or putting it into production) at the return x, the same return the private sector, or anyone else, gets for storing (investing in production) c's.

Then, at the end of that period, it takes all of those stored (invested) c's, plus whatever return it got for them at x, and uses it all to buy back dollars at the then prevailing rate of dollars for c's.

Now, note that Wallace does not say this explicitly, but if you study the equations and think about what they imply, you can see, and prove, that this is what must be happening. I spent a lot of time doing this (It would have been nice if he wasn't so amazingly terse and had explained/derived this – and a lot more).

Now, in this economy it's very simple. You either consume c's, or you store (invest) them. You can buy (or sell) state-contingent contracts to get a c in a particular state next period (People, who are clones with perfect information, foresight, and rationality, only live two periods, a young period and an old period.), but those contracts are backed-up just by one thing, storage of c's (or next periods economy-wide endowment, which is analogous to GDP not counting savings and their return).

So, in this model it's simply a case that when government prints money, it's just storing c's for one period. People are going to want to store a certain amount of c's anyway, because that's utility maximizing to help smooth consumption. What the government essentially does in this model is say, hey, store your c's with us instead of at the private storage facility. Give us a c, and we'll give you some dollars, which are like a receipt, or bond. We'll then store the c's – we won't consume them, we won't use them for anything (these are crucial assumptions of Wallace, required to get his stunning results) – We will just hold them in storage (implied in the equations, not stated explicitly).

Next period, you give us back those dollars, and we give you back your c's, plus some return (from the dollar per c price changing over that period). In equilibrium, the return from storing c's via the dollar route must be equal to the return from storing c's via the private storage facility route. Or at least the return must be worth the same amount at the equilibrium state prices; so either way you go you can arrange at the same cost in today c's, the same exact next period payoff in any state that can occur.

Note that dollars in this model are just zero-coupon bonds. Wallace assumes no value of dollars in lowering transactions costs, in convenience, or in liquidity. Transactions, liquidity, and convenience costs are zero in his model. People will hold no dollars (buy no dollars with their c's) unless their value appreciation will be equal (at the equilibrium state-prices) to if they stored their c's privately.

So essentially in the Wallace model the "open market operation", the QE, the printing of dollars, is just the government offering storage of c's that's exactly equivalent to what the private sector is offering, at no better a price (or maybe an epsilon better to get people to switch).

So what happens? Private storing (investing or utilizing in production) of c's goes down, and government storing (investing or utilizing in production) of c's goes up by an equivalent amount (and both the private sector and government get the same return from storing: x). No prices change, and people's consumption in youth and old age doesn't change.

It is analogous to Miller-Modigliani, in that if a corporation increases its debt holding, then shareholders will just decrease their personal debt holding by an equivalent amount, so that their total debt stays exactly where it was, which was the amount they had previously calculated to be utility maximizing for them (And there's a lot of very unrealistic and material assumptions that go with this that have been long acknowledged as such in academic and practitioner finance; when you learn Miller-Modigliani, at the bachelors, masters, and PhD levels – which I have –  they always start by teaching the model and its strong assumptions, and then go into the various reasons why it far from holds in reality. This is long accepted in academic finance; pick up any text that covers MM.)

There is one more powerful intuition that I'd like to note that's buried implicitly in this model:

Suppose dollars are printed and used to buy 10 year T-bonds. Or gold, like in the Stephen Williamson quote at the beginning of this post. And everybody knows (making a Wallace-like assumption) that in five years the T-bonds or gold will be sold back for dollars. We're making all of the perfect assumptions here: For all investors, perfect information, perfect foresight, perfect analysis, perfect rationality, perfect liquidity,...

Now, what is the price of gold? How is it calculated in this world of perfects?

Well, as a financial asset it's worth only what it's future cash flows are. Suppose you are going to hold onto the gold and sell it in one year. Then, what it's worth is its price in one year (which you know at least in every state – perfect foresight) discounted back to the present at the appropriate discount rate.

But suppose this: During that year that you will be holding the gold in your vault, you are told the government will borrow your gold for five minutes, take it out of your vault, and replace it with green slips of paper with dead presidents, then five minutes later they will take back the green slips and replace back your gold in the vault. Do you really care? This doesn't affect how much you will get for the gold when you sell it in a year, and as a financial asset that's all you care about when you decide how much gold is worth today.

If you're going to hold the gold for ten years, and sell it then, then you only care about what the price of gold will be in ten years. And the price of gold in ten years only depends on what the supply and demand for gold is in ten years. If the government takes 100 million ounces of gold out of private vaults, and put it in its vaults, then puts it back in the private vaults three years later, this has no effect on the supply of gold in ten years. So in ten years the price of gold is the same. And if gold will be the same price in ten years, then it will be worth the same price today for someone who's not going to sell for ten years anyway.

But what if you're going to hold the gold for less than ten years, for only one year, say? Here, I could see how you could do like an overlapping generations model kind of thing and say it still doesn't make a difference.

But I think the bottom line intuition is – with these very strong assumptions – if the price of gold, or zero coupon T-bonds, is the discounted value of what their price will be in ten years. And their price in ten years is based on their supply and demand in ten years. Then, if the government just holds it in its vault for a few of those intermediate years and then releases it, there will be the same supply of it in ten years, and thus it will have the same price in ten years. And if it will have the same price in ten years, then it will have the same price today (ceterus paribus, and with the typical assumptions of perfect frictionlessness, rationality, foresight, etc.). 

Here's a concise, and perhaps clearer version of this:

The government buys 100 million ounces of gold in a QE. The assumption is, of perfect foresight, perfect everything investors, that over the next several years, unemployment will go down and the Fed will reverse course, and then sell all of those 100 million ounces back again. Thus, the supply of gold in 10 years will be exactly the same as if the QE had never occurred. The gold just temporarily sits in government vaults (or with government ownership papers), rather than private ones, then goes back to the private vaults – no difference at all in 10 years. So, in 10 years the supply of gold is exactly the same, so the price of gold in 10 years will be exactly the same. If the price of gold in 10 years will be exactly the same, then its price today will be exactly the same, since with prefect foresight, perfect analysis, etc. investors, the today price is just the discounted 10 years from now price.

Next post, part II, I'll get to the problems when thinking if this actually occurs with QE in the real world: