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Saturday, September 19, 2009

TWO STRIKES FOR KRUGMAN   We pointed two weeks ago to John Cochrane's delicious demolition of Paul Krugman's New York Times Magazine piece on the supposed failure of all forms of economics other than Keynsesian macro. Krugman posted a response of sorts on his NYT blog -- but it was without content, as indeed Cochrane's critique was irrefutable, so all Krugman could do was to try to diminish Cochrane by accusing him over and over of "rage." Now reader Adam Freund points out yet another critique, this one by economist David K. Levine, and on the Huffington Post believe it or not. You have to read the whole scrumptious thing to appreciate just how fine a powder Krugman is getting ground down to in these critiques. Here are my favorite two paragraphs:
But let's turn to what you say are our deeper failures. We "turned a blind eye to the limitations of human rationality that often lead to bubbles and busts." ...There are economists who have devoted their entire careers to studying bubbles. There is a fellow named Stephen Morris. He isn't what you would call a fringe member of the economics profession - he's the editor of Econometrica which, as you know, is one of the leading journals in economics. He has written extensively about bubbles. I take it you aren't familiar with his work. Perhaps you should walk down the hall [at Princeton] and stick your head in his office and ask him about it? Each crisis - in Mexico, in South-east Asia, in Argentina - had generated hundreds of papers examining how and why the crisis took place.

Efficient markets? Where have you been for the last quarter century? The modern theory of how financial markets incorporate information is that they do so imperfectly. The technical device is that of noise traders originating in a 1985 paper of Admati. But I think you knew of the idea earlier. In 1980 when you were a visitor at MIT, you participated in a graduate student which I presented a paper starring noise traders...

Posted by Donald L. Luskin at 3:52 PM | link  

Wednesday, September 16, 2009

OUT OF POCKET, OUT OF LUCK   Insurance maven William Heasley has a nice post on the dangerous fallacy of low out of pocket costs being promised as part of the come-on for Obamacare.
The current Socialized Medicine schemes being presented are being "pitched" as having very limited out-of-pocket costs...

Beyond all the other short comings of the Socialized Medicine Scheme...attempting to "sell" a Socialized Medicine Scheme based on low-loss-cost -participation by the insured merely makes the Plan Cost much more expensive.

Think of it this way, as a sales pitch, having to pay very little out-of-pocket sounds great. However, the less the insured participates in the loss, means the more the insurer participates in the loss. The more loss exposure the insurer is faced with, the higher the premium...

However, the premium cost story gets much uglier. Low out-of-pocket cost which translates into high initial premium cost becomes a cascading price spiral. Why? The low out-of-pocket costs further translates into over utilization. That is, with very little to be paid out-of-pocket, the insured is more apt to seek services. The more services used means more losses incurred meaning premiums must rise to cover the increased losses.

Posted by Donald L. Luskin at 9:27 PM | link  

ECONOMICS HITS ROCK BOTTOM   It just doesn't get more whorish than this, when Nobel laureates betray the integrity of the profession for the feel-good agenda of politicians:
President Nicolas Sarkozy told the French national statistics agency Monday to take greater account of factors like quality of life and the environment when measuring the country’s economic health.

Mr. Sarkozy made the request after accepting a report from a panel of top economists he had charged with reviewing the adequacy of the current standard of fiscal well-being: gross domestic product.

The panel, chaired by two Nobel economists, Joseph E. Stiglitz of Columbia University and Amartya Sen of Harvard University, concluded that G.D.P. was insufficient and that measures of sustainability and human well-being should be included.

An “excessive focus on G.D.P. metrics” also contributed to the onset of the current financial crisis, according to the report. Policy makers cheered rising economic growth while other data, like those that showed the increasing and unsustainable indebtedness of households and businesses, were overlooked, the report found.

“The main message is to get away from G.D.P. fetishism and to understand the limits to it,” Mr. Stiglitz said in an interview. “There are many aspects of our society that are not covered by G.D.P.”

Update... William Heasley notes,
Right! Maybe we should all have a "GDP Mood Ring". Yeah that's the ticket! We probably need a "Jobs Saved Ring" as well.

Posted by Donald L. Luskin at 5:47 PM | link  

THE WORLD ACCORDING TO W, ACCORDING TO "MICK"   My DC-insider pal "Mick Danger" plays Mystery Theatre 3000 with some excerpts from the new tell-all by former White House speechwriter Matt Latimer, Speech-less: Tales of a White House Survivor. Mick's narration is in bold.
On brand management, no doubt applying his Texas-sized ego and his HBS-acquired skills: "Look, I know this probably sounds arrogant to say... but I redefined the Republican Party."

Ah, yeah. The rest of us are busy mopping up.

On Obama: "This is a dangerous world, and this cat isn't remotely qualified to handle it. This guy has no clue, I promise you."

Indeed. Just ask a friend of America who happens to be Honduran, Venezuelan, Columbian, Iranian, Israeli...or American.

On Biden: “If bullshit were currency, Joe Biden would be a billionaire.”


On Palin: "This woman is being put into a position she is not even remotely prepared for...She hasn't spent one day on the national level. Neither has her family. Let's wait and see how she looks five days out."

You called it early. Election day, McCain-Palin got 46% of the popular vote in 2008 which is amazing considering his popularity and her qualifications.

On Gary (remember?) Bauer: "Let me tell you something...I whupped Gary Bauer's ass in 2000. So take out all this movement stuff. There is no movement."

Yeah, true, but so did Bisquick.

Posted by Donald L. Luskin at 4:52 PM | link  

THE GOOD THING ABOUT THE "CASH FOR CLUNKERS" PROGRAM   Think of all the Obama bumperstickers it has taken off the road!

Thanks to William Heasley.

Posted by Donald L. Luskin at 8:31 AM | link  

Tuesday, September 15, 2009

WE SHOOT BACK AT SCHUMER   From the Wall Street Journal this morning:
We are replying to Sen. Chuck Schumer's Sept. 4 letter concerning our Aug. 27 op-ed, "In Defense of 'Flash' Trading."

Sen. Schumer makes the incendiary charge that flash trading "seriously undermines market integrity" by leading to front-running. If it did, then no trader in his right mind would ever enter a flash order, because he would be the first to be victimized. Flash trading is, in fact, a solution to front-running that improves market integrity.

An institutional trader with a million-share order never puts the entire order into the market all at once, for fear of market impact. Typically, a succession of smaller orders is placed in various markets, and at any given time the bulk of the order is not revealed. So of necessity, all other market participants are at an information disadvantage to the trader with the large order. Yet if he puts his entire order into the market at once—say, to buy one million shares—other traders would run ahead of the order by bidding higher prices. Their bids would mask the million-share order, and sellers would only see the smaller, higher bids, and be enticed to sell, not realizing a huge buyer lurked.

To protect against such front-running, traders typically withhold information about their own trading intentions, and there is nothing wrong with that any more than there is in keeping your cards close to your vest when playing poker. New trading technologies such as flash orders and "dark reserve" orders on the New York Stock Exchange—a limit order that is not displayed, to which apparently Sen. Schumer has no objection—are ways of accomplishing this.

Customers, not senators, should decide which of the many new trading technologies they wish to use. If Sen. Schumer is sincerely interested in promoting fairness and liquidity, we suggest he train his fire on the proposals currently being floated in the House of Representatives to impose an 0.25% tax on securities transactions.

Chris Hynes
Edwards, Colo.

Donald L. Luskin
Menlo Park, Calif.

Posted by Donald L. Luskin at 7:04 AM | link  

Monday, September 14, 2009

READ -- NO, SAVOR! -- EVERY WORD OF THIS   University of Chicago professor John Cochrane has written a devestating reply to Paul Krugman's New York Times Magazine piece on the state of macroeconomics. No excerpts can do it justice. You simply have to take 15 minutes to read the whole blessed thing! But here are a few tidbits...
Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. This is a canard that Paul knows better than to pass on, no matter how rhetorically convenient. (I can overlook his mixing up the CAPM and Black-Scholes model, but not this.) There is nothing about “efficiency” that promises “stability.” “Stable” growth would in fact be a major violation of efficiency. Efficient markets did not need to wait for “the memory of 1929 … gradually receding,” nor did we fail to read the newspapers in 1987. Data from the great depression has been included in practically all the tests. In fact, the great “equity premium puzzle” is that if efficient, stock markets don’t seem risky enough to deter more people from investing! Gene Fama’s PhD thesis was on “fat tails” in stock returns...But this difficulty is no surprise. It’s the central prediction of free-market economics, as crystallized by Hayek, that no academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what “fundamental” value is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked.

...Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “Keynes considered it a very bad idea to let such markets…dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a `casino.’” Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.

To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Remember, the SEC couldn’t even find Bernie Madoff when he was handed to them on a silver platter. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent In Fed We Trust makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.

...most surprising, is Krugman’s Luddite attack on mathematics; “economists as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” Models are “gussied up with fancy equations.” I’m old enough to remember when Krugman was young, working out the interactions of game theory and increasing returns in international trade for which he won the Nobel Prize, and the old guard tut-tutted “nice recreational mathematics, but not real-world at all.” How quickly time passes.

Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research -- understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data?

...The level of personal attack in this article, and fudging of the facts to achieve it, is simply amazing.

As one little example (ok, I’m a bit sensitive), take my quotation about carpenters in Nevada. I didn’t write this. It’s a quote, taken out of context, from a article written by a reporter who I spent about 10 hours with patiently trying to explain some basics. (It’s the last time I’ll do that!) I was trying to explain how sectoral shifts contribute to unemployment. Krugman follows it by a lie -- I never asserted that “it take mass unemployment across the whole nation to get carpenters to move out of Nevada.” You can’t even dredge up a quote for that monstrosity.

What’s the point? I don’t think Paul disagrees that sectoral shifts result in some unemployment, so the quote actually makes sense as economics. The only point is to make me, personally, seem heartless -- a pure, personal, calumnious attack, having nothing to do with economics.

Here's a note I sent to Cochrane:
Thank you for your brilliant critique of Krugman’s NYT article on macroeconomics. Some comments…

As you say, Krugman is the master of the out-of-context “gotcha” intended to discredit his enemies. But he’s been a public intellectual himself for so long, he’s left a gigantic paper trail of his own regrettable statements that can be used against him – and fully in context.

I know this well, because for many years I wrote the “Krugman Truth Squad” column for National Review Online, which consisted mostly of catching Krugman at variance with both the facts and his own previous statements.

Your critique brings to mind two juicy ones. First, Krugman’s slam on the mathematization of economics, in preference to more literary investigations, is especially laughable considering how utterly different he felt about the matter back when he was a mathematical economist and not a pundit. Consider this article from his Slate column in October, 1996:

I quote, fully in context:

Academic economics, the stuff that is in the textbooks, is largely based on mathematical reasoning. I hope you think that I am an acceptable writer, but when it comes to economics I speak English as a second language: I think in equations and diagrams, then translate. The opponents of mainstream economics dislike people like me not so much for our conclusions as for our style: They want economics to be what it once was, a field that was comfortable for the basically literary intellectual.

This should sound familiar. More than 40 years ago, the scientist-turned-novelist C.P. Snow wrote his famous essay about the war between the "two cultures," between the essentially literary sensibility that we expect of a card-carrying intellectual and the scientific/mathematical outlook that is arguably the true glory of our civilization. That war goes on; and economics is on the front line. Or to be more precise, it is territory that the literati definitively lost to the nerds only about 30 years ago--and they want it back.

That is what explains the lit-crit style so oddly favored by the leftist critics of mainstream economics. Kuttner and Galbraith know that the quantitative, algebraic reasoning that lies behind modern economics is very difficult to challenge on its own ground. To oppose it they must invoke alternative standards of intellectual authority and legitimacy. In effect, they are saying, "You have Paul Samuelson on your team? Well, we've got Jacques Derrida on ours."


…there are also important ideas that are crystal clear if you can stand algebra, and very difficult to grasp if you can't. International trade in particular happens to be a subject in which a page or two of algebra and diagrams is worth 10 volumes of mere words. That is why it is the particular subfield of economics in which the views of those who understand the subject and those who do not diverge most sharply.

Alas, there is probably no way to resolve this conflict peacefully. It is possible for a very skillful writer to convey in plain English a sense of what serious economics is about, to hide the algebraic skeleton behind a more appealing facade.

Second, if you wanted to draw a little more blood when you mention the irony of Krugman’s hefty speaking fees, we should remember that Krugman has drawn hefty fees from the very institutions he now criticizes. He admits (link on an independent pro-Krugman site, formerly on PK’s own Princeton site, but since removed: ) he was paid $50,000 to advise Enron (he only received $37,500 because the company went bust before making the last payment), and touted the company in Fortune magazine while in that capacity.

Posted by Donald L. Luskin at 12:55 AM | link