Elephantstrunk

Emmanuel Derman will be relieved to know that I agree with him when he says of his favourite (Harry Kat I think) approach to hedge fund replication:

But it requires so much statistics on such poor data that it’s hard to swallow.

But he doesn’t get off the hook that easily, I want more. If the problem with replicating hedge fund returns is that you don’t know what they are, how do you know that you want them? There is something odd about the whole approach. Trading strategies can reproduce all sorts of things, is some correlation to dimly perceived hedge fund behaviour really the exciting option? Is there no better saleable payoff or characteristic that can be wrung out of systematic trading of equities? How would you tell if a payoff added value when priced with models that say it has none?mom horny
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More aggressive but fatuous baiting of Dani Rodrik from Alex Tabarrok.

I was going to point out that Tabarrok can’t decide whether it is Pareto efficiency or creative destruction that makes markets good and that his example of the motor car opens the floodgates but Lee Arnold, Samson and Barkley Rosser do a better job of it.

They do give him too much credit on his claim that the First Fundamental Theorem of Welfare Economics supplies sufficient but not necessary conditions for a market to achieve efficiency. It is sort of true but if that was all it did it would be hardly worth comment. He’s driving camels though the eye of the needle.

In fact it is noticeable that almost everyone commenter displaying familiarity with the theorem disagrees with him.

The extremely uncharitable reading of Rodrik’s very frank posting will not convince anyone who doesn’t already agree with Tabarrok but along with earlier stuff from Tabarrok and his colleague Don Boudreaux it looks like the combination of obfuscation, pettifogging, innuendo and disingenuity dealt to Paul Krugman.

There is notably no attempt to address Rodrik’s principal point that sometimes explicit government intervention has worked better than policies that at least superficially look laissez-faire with international development being a major one. Still Na Pratica slips in a proper reading of Rodrik before Max the Wise delivers an impressive illustration of Godwin’s law. If I could read Portugese I think I would be a regular reader of Na Prática a Teoria é Outra.

Or more specifically, is lifting trade restrictions the most important thing a developing country can do?

There’s more heat (and inappropriately macho language) than light in the ringside seats for the econoblog death match between Dani Rodrik and Don Boudreaux.

Dani Rodrik says that free trade may not be the best prescription for the development of developing countries. Don Boudreaux asks why, if trade barriers are good for countries, are they not also good within countries? I think they are talking about different things. I, and at a guess also Profs Rodrik and Boudreaux, think that free markets are a good thing. Rodrik however says with considerable evidence that free trade, as policy prescription is, from the Boston Tea Party to modern China, manifestly not how most successful economies got that way. That significant point is allowed to pass without protest despite being the foundation of his argument.

Boudreaux doesn’t really believe in states. For him free trade is between individuals and states are just an interference with that so it is natural for him to see any suggestion that trade restriction between states might have value as opening the floodgates and so to attempt a reductio ad absurdum by reasoning that if they work between states then should also work within states. For me this is a substantial blind spot. Trade between states doesn’t have the safety nets it has within states nor the years of development. They are also not in fact absent, tax transfers from blue states to red states, from London to Scotland, planning of ports, regional development budgets and so on. I’m sure Prof. Boudreaux is against those too but they do make a difference. I count that one for Rodrik.

When Rodrik tries to summarise the conditions where he thinks trade restriction could perhaps be beneficial and one of them is that labour productivity is low. DeLong pounces on that arguing that productivity can only be low if the institutions are poor and that if the institutions are poor bad things will happen if they play with trade restrictions, look an North Korea and Zimbabwe for example. But China has low productivity and bad institutions and the worst you could say about its economy is that some people think that it could be doing even better. Before that the same could have been said about Malaysia, Japan, South Korea and even the United States.

I think they are projecting the concerns of ultra developed economies onto other economies. Lack of government imposed trade restrictions is not the only prerequisite for a successful economy. It is at least possible to imagine that political stability might be more important than dropping a trade restriction, even from a purely economic point of view.

At this point strength of the claims of DeLong and Boudreaux depend upon what they are talking about. Do they mean what should happen in a very ideal world? If so they mght be right but are not talking about the same problem as Rodrik. Does DeLong mean to offer advice to developing countries? If so he might have a point but will have a hard time being heard because only countries with poor institutions need advice and they can’t be trusted to take it or implement it properly. Even freer trade can be implemented badly. If he means that developed world governments and internatinal development agencies should make it a priority he has to face the fact that it’s been tried, it doesn’t work and other things do.

A corny analogy. In most sports a competent practitioner watching another player will most likely be able to spot a dozen faults. Most of those observations are useless. Telling the player about them all ony serves to confuse and misprioritise. In contrast a good coach will directly address only one or two, the coachee will be able to do something about the ones addressed and often the others will sort themselves out. Helping developing countries is likely similar. I think Rodrik is essentially saying “first things first” and if that means leaving freer trade to another day then so be it. That’s not saying that trade restrictions are the answer, just that free trade by itself isn’t either. In contrast DeLong is saying they should start from somewhere else and Boudreaux is dreaming of Utopia.

[Edit: William Polley also thinks Rodrik is still standing]

State pensions for the rich and private pensions for the poor is this season’s pension panacea.

Legal pressure on the government over Equitable Life, the Ombudsman’s report, the FAS and PPF and renewed umbrage over Gordon Brown’s removal of a tax break from still highly favoured pension investment all effectively demand that the government guarantee pension arrangements made entirely privately. It receives an awful lot of support from the conservative press and comes despite fierce opposition to the minimum funding requirement and Stephen Yeo’s remarkably upright position that it is not one of the top three suspects in the murder of the final salary pension scheme.

Meanwhile conservative thinktanks and neoliberal economists want to replace state pensions with equity investments.

Pension law comes up short in important places but pensioners are being held to ransom the government is not the kidnapper.

Free Exchange asks:

What madman would support expanded use of fixed-rate mortgages?

and then descends into nonsense. Let’s see:

Economically, a preference for fixed-rate mortgages makes absolutely no sense. Let’s say you’re a mortgage lender considering lending out some money for the next thirty years. You have to be worried that if you lend money out at a fixed rate, inflation will increase, eating into the value of your loan.

A bold statement to begin with. If you are lending money at a fixed rate you are also hopeful that inflation and real rates might fall. It’s not a one way street.

Either you or the buyer can assume the inflation risk. But whoever assumes it is going to have to be paid to do so; the lender, by charging a higher rate for the loan; the borrower, by getting a lower interest rate.

Even in this oversimple model it’s a matter of which way up you are, not of the risk being either in one place or another.

For fixed-rate mortgages to be a consistently better deal for borrowers, you have to assume that borrowers, as a group, are much better at assessing the future of interest rates than bankers are. If that were true, bankers could be systematically underpricing their fixed-rate loans because they mistakenly believe that interest-rates in the future will be lower than they actually will be.

No. no, no! There’s such a high concentration of wrongness it’s hard to know where to start. Fixed rate borrowing is in fact quite popular, are the borrowers all mad? Rates are set by a market that is in fact pretty efficient. Anyone advocating individuals not behave the way institutions do bears the burden of proof and any such argument gets into the details of the behaviour of other personal cash flows.

There are also other ways that a fixed rate mortgage could be better for borrowers. Greater price transparency could make the fixed rate mortgage market more competitive and margins tighter. Risk is also not a zero sum game. Which type of risk better suits a borrower’s overall portfolio? It could well be the fixed one systematically. That is maybe borrowers shouldn’t like fluctuating mortgage payments.

And then the goalposts start doing shuttle runs:

One could argue that bankers are in a better position to bear the risk, because they have more instruments available to hedge. But this is true only if people are borrowing right up to the very edges of their ability to pay. This was an enormous problem during the housing bubble, but it was not particularly a feature of adjustable rate mortgages. Adjustable rate mortgages are the focus of the problem because they were the easiest vehicle for foolish borrowers and foolish lenders to push homebuyers to the very edges of their income in buying a house. But absent the ARMs, one can easily think of many other ways to get buyers into homes they can’t really afford—no money down, interest-only payments for the first two years, and so forth. I don’t think you can reasonably read Greenspan’s words as suggesting that people ought to buy houses their incomes won’t support.

Lefties worried about over zealous central bank rate setting often appear to be putting great faith in the solidity of the Phillips curve and therefore also appear naive. Listen to pundits talk about wage settlements when guessing what a central bank is going to do next and it becomes harder to dismiss their concerns. There is an effective cap on the growth of average wages and it is impossible to imagine how labour’s share could grow in such an environment and indeed how it could fail to ratchet down.

My straw partisans are in want of a policy prescription because loosening monetary policy on its own won’t help. As elusive as the NAIRU is, there is clearly a real constraint lurking. But if a simple objective of full employment won’t work for monetary policy, where are the good goals? In the absence of alternatives a fixed level of inflation seems a far more humane target than does a fixed, non-zero, level of unemployment. Doing that has brought low interest rates and inflation and, in the long run, lower interest rates. On that basis it is hard to argue that the way central banks have gone about targeting inflation has been either ineffective or in itself responsible for raising unemployment.

If there isn’t much to be gained by managing the target differently and attempting to get directly to ful employment by correct setting of interest rates is either naive or dangerously optimistic, does monetary policy have anything to do with growing inequality and the decline of labour’s share of capital returns?

When monthly house price inflation figures often surpass annual annual consumer price inflation there is a problem. Assets and capital goods in general don’t count for much in inflation statistics. On the other hand if wages exceed inflation by much, central banks crack down. The central bank therefore sits very heavily on wages but not at all on capital gains. The likely consequencestatic wages and ballooning asset prices, is very much in-line with recent experience.

If asst prices were included in inflation figures, sometimes rising wages would offset falling asset prices and there would be more than one thing to squash in an overheating economy.

So why aren’t assets included in inflation figures? Obviously it could be a conspiracy but there are other reasons too.

• Calculating aggregated price indices is hard enough without asset prices.
• In the short term asset prices wouldn’t make that much difference to policy.
• Asset prices are too volatile.
• Assets are stores of future value which should be discounted at the real rate and the futue value should be independent of inflation.
• They are included anyway through their rental price.
• It’s hard to know what assets to include.

None of these points is entirely without merit but some are now needless labour saving, and all put together seem to me less compelling than the reasons for including asset prices.wrong but many of the objections ges, not fundamental objections. In contrast asset prices balloon. Especially where supply is relatively inelastic as with property and real estate, this amounts to a massive redistribution of wealth which is just as inefficient as when governments do that kind of stuff,

Ignoring asset prices in inflation figures systematically biases monetary policy in favour of capital. Not by much but over time the effects are enormous.

A reason to read The Guardian

The Economist on ethical food didn’t go down well

Microfinance puzzling

From The Economist’s blog:

A LITTLE while back, Sir Partha Dasgupta, an economist well known for his work on development, caused a stir in the blogosphere by suggesting that the Stern report on global warming had been insufficiently attentive to the question of inequality in its selection of a discount rate for future damage.  The relative wealth or poverty of those who will be affected (now or in the future) matters in calculating how much of the burden of global warming (or of averting global warming) each should be asked to bear.

I thought of Sir Dasgupta this weekend, as some programme or another mentioned the fact that the Senate Democrats in America intend to make raising the minimum wage one of their first priorities when they take over Congress this January.

The Economist goes Globish.

These must be the last days.

First neo-con Pangloss Amity Shlaes declares that taxes don’t affect behaviour all that much.

Then today’s Economist says:

People who want to make the world a better place cannot do so by shifting their shopping habits: transforming the planet requires duller disciplines, like politics.

The leader is almost worthless but the full article is interesting if less than curious.

A little while ago I wrote about Tyler Cowen and Jane Galt partly because they were uncritically triumphalist about the US economy. Today the news brings the following headlines:

• Eurozone unemployment falls to record low
• Dollar slides further on US manufacturing data
• Economic Storm Signals

This doesn’t prove anything much but it does make it look perverse to take for granted that the the US economy is stronger than Europe’s. Playing by the rules of Tyler Cowen’s comments there is a lot of fun to be had.

Here goes. Jane and Tyler have got it all wrong. The major advantage of the US has been its abundant natural resources and the scale of its single market. This applies to computer making, investment banking, pharmaceuticals, plane building and Hollywood. Now however it is clear that its scale has been trumped. Soon the EU, China and India will all beat it on scale. Computer making is already mostly done in Taiwan and China, the EU is on level terms in planes and Boeing has transferred considerable technology to China. Pharmaceuticals is a struggling industry and is no longer the driver of medicine and the US is not a healthy country. Investment banking is increasingly moving to London and Hong Kong with New York looking more like Tokyo all the time — large but staid and inward looking. Hollywood ought to be the last to go but already we have Martin Scorsese making me-too versions of Chinese films.

That will leave a lot of old aged old money USians using borrowed money to pay Mexicans to build houses for them and care for them in their unhealthy old ages and little growth outside those two sectors.
Or maybe not