Monetary reform, anyone?

[Borodog]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]

more generally, let me ask if you think all markets are rational and efficient? if so, to what degree or extent?


[/ QUOTE ]

Dcifr,

This is a tough question as it is so broad. All markets are rational and efficient, but to different extents. There are 3 forms of the efficient market hypothesis, weak, semi-strong, and strong.

In short, weak form efficiency states that prices only have historical data built into them. Semi-strong form states that prices have all publicly availably information built into them. Strong form states that prices have all information, including insider information, built into them. The bulk of the studies on efficient markets support the semi-strong form. In general, highly liquid markets like the treasury bond market and the public equities market are very efficient. Markets with less available information and/or less knowledgeable participants will be less efficient.

[/ QUOTE ]

i think i asked far to broad a question.

overall, i think all markets have pockets of inefficiency at some times. i think on the tails, markets don't act rationally enough to make up strong or even semi strong form efficiency.

further, there are times when an individual market, even during non-extreme events can be quite inefficient (i.e. when 1 player makes the market and that player doesn't care about maximizing profit).

my only point was that markets aren't always efficient, or even semi-strongly efficient. that lack of efficiency/rationality comes from the distribution of players and their pockets.

Barron

[/ QUOTE ]

Barron,

I think this whole discussion is missing the mark. Define "efficiency". In thermodynamics, it's easy. In economics, it's almost impossible. All markets are always "inefficient" to some extent because the capital structure is never "correct"; it never actually matches what consumers want. There are two reasons for this: time and uncertainty. The structure of the capital stock is constantly being torn down and reorganized in response to entrepreneurs' predictions about what consumers will want in the future, sometimes the very far future. This is uncertain. Also, the world changes. Consumers are fickle. New resources are discovered and exploited, etc.

So the capital structure is constantly being torn down and rebuilt, always trying to reach the "correct" state, but never actually getting there because it is a moving target. So markets must always be somewhat "efficient."

The question is not whether or not markets are always "efficient". The question is, can you do better than the market via central planning and intervention, and the answer there is, emphatically, no.

The market is as rationally planned from moment to moment as it is possible. The information regarding the state of the economy, the distribution of all the means of production, as well as the distribution of the wants and needs of all consumers, is distributed throughout society, contained within 6 billion different heads. The most rational way to plan the allocation of scarce reasources is to take advantage of that distribution, and let each market participant allocate the resources under his control to achieve the ends he desires.

To interfere with that process is too attempt to replace the planning of billions with the planning of a tiny cabal. Leaving aside the abuses that will inevitably ensue by placing that concentrated power into the hands of self-interested human beings, they simply cannot do it. As George Reisman pointed out, those few brains are no more capable of planning for billions than their legs are capable of supporting the weight of those billions.

"Irrationality" and mistakes regarding the allocation of resources within markets have costs, and in a free market those costs are born by those who make the mistakes. If they make enough mistakes, they will no longer be allowed by the market to misallocate resources, because they will be broke; they will have no resources under their control to misallocate; that's what losses do.

In an intervened in market, the costs of the mistakes of the central planners are born by everyone but the central planners. Because of this, they suffer no personal losses. They can make losses that must be suffered by society indefinitely. There is no market mechanism to terminate there waste.

[Boris]

Somewhat related to monetary reform, there is an Op-Ed piece in today's WSJ (8-15-07) by Henry Kaufman. I guess he is an old Wall Street warrior. He thinks the multitude of complicated debt securities has created too much confusion amongst buyers and that behemoth investment banks are creating further market distortion. Of course he is talking about the sub-prime lending crisis (if you want to call it a crisis).

For the most part I think the guy is full of shyte. But I think there might be some merit to the argument that really huge investment banks can create market distortions. At the very least I think they have the sales network to push, for some finite period of time, a financial product with a return that doesn't justify its risk. Note that I don't have any direct experience in this world so it's possible I'm way off base.

[The DaveR]

[ QUOTE ]
Somewhat related to monetary reform, there is an Op-Ed piece in today's WSJ (8-15-07) by Henry Kaufman. I guess he is an old Wall Street warrior. He thinks the multitude of complicated debt securities has created too much confusion amongst buyers and that behemoth investment banks are creating further market distortion. Of course he is talking about the sub-prime lending crisis (if you want to call it a crisis).

For the most part I think the guy is full of shyte. But I think there might be some merit to the argument that really huge investment banks can create market distortions. At the very least I think they have the sales network to push, for some finite period of time, a financial product with a return that doesn't justify its risk. Note that I don't have any direct experience in this world so it's possible I'm way off base.

[/ QUOTE ]


The "exotic" subprime structures currently blowing up are at least 10 years old (CDOs) and often substantially older if they're in more vanilla mortgage backed pools (length of time the market has existed, not the actual vintage of currently impaired deals). CDOs also went through a very bad impairment cycle around 2001. Pre-2001 the standard pitchbook was the Moody's Diversity Score (joke) and a simple analysis for equity returns given 0%, 1%, 2%, etc pro rata default scenarios. Post 2001 investors got smarter and it's standard to want to see collateral pools. The notion that the complexity of these securities and the slickness of investment banks is causing the current crisis is convenient for the purposes of easy scapegoating but nonetheless inaccurate I think.

From 2003-2007 credit spreads dropped by about 80% across the board (small blip up a couple years ago for Ford/GM) at the same time that tons of money was driven into funds desperate for yield. CDOs in particular offered significantly higher credit spreads for identical ratings with respect to corporates, and in that spread tightening environment the appetite was huge. The fact that the spread difference strongly implies different risk was probably lost on less seasoned investors but that's right out of elementary finance and skepticism. "Huh, these things say they're the same risk but this is 4 times cheaper???" Smart investors know this. Those that don't, well, the market is vicious.

EDIT: Quick clarity addition.

[pvn]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
Christ man, that's unnecessarily simplifying what I said. i didn't say ALL people are dumb, just some people are, but enough to cause market disruptions if hysteria spreads.

[/ QUOTE ]

So what do you propose to do about these dumb people, then?

[/ QUOTE ]

First thing that comes to mind is to take their money (kidding, kinda). I don't know, do we have to do something about the dumb people? We could educate them I suppose. Are you asking this philosophically or practically?

[/ QUOTE ]

Well, I am a big fan of the "we don't have to do anything" position. However, anyone supporting the fed and using "dumb people" as part of their supporting argument cannot possibly be advocating such a lassiez-faire position.

DUCY?

[/ QUOTE ]

But nobody did that here.

[/ QUOTE ]

O RLY?

[ QUOTE ]
As much as I would like to believe in the power of the free market as much as you do, I see too many irrational actions, by supposedly rational market players, on a day to day basis. And these aren't penny brokers either, these are guys playing with leveraged funds composed of 100s of millions of capital. And if you have ever been on a trading floor on a highly volatile trading day, there IS such thing as herd mentality in the markets.

Yes yes yes this is all personal experience not tested theory. But from what I have seen, putting everything in the hands of the free market would be a dangerous, dangerous option. It is admirable to believe that human behavior is that ideal, but in reality, people do stupid [censored].

[/ QUOTE ]

But see, the thing is, the "free market" is not something that you (not just YOU you) get to "allow". You don't get to put everything into it's hands - it is the default position. There is an unwritten assumption in tw0please's post which I quoted above - that central planning is used to "decide" whether the free market will be implemented or not. Which of course, is totally counter to the concept of a free market. If there is a central planner, there is no free market.

[Leaky Eye]

I missed or forgot about his post. Sorry.

You are correct that the fact that humans behave a certain way is in no way a valid argument for or against any economic system.

You could argue that a given economic system is most efficient in a society of human animals. But that is like, the whole point of economics to begin with.

[DcifrThs]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
[ QUOTE ]

more generally, let me ask if you think all markets are rational and efficient? if so, to what degree or extent?


[/ QUOTE ]

Dcifr,

This is a tough question as it is so broad. All markets are rational and efficient, but to different extents. There are 3 forms of the efficient market hypothesis, weak, semi-strong, and strong.

In short, weak form efficiency states that prices only have historical data built into them. Semi-strong form states that prices have all publicly availably information built into them. Strong form states that prices have all information, including insider information, built into them. The bulk of the studies on efficient markets support the semi-strong form. In general, highly liquid markets like the treasury bond market and the public equities market are very efficient. Markets with less available information and/or less knowledgeable participants will be less efficient.

[/ QUOTE ]

i think i asked far to broad a question.

overall, i think all markets have pockets of inefficiency at some times. i think on the tails, markets don't act rationally enough to make up strong or even semi strong form efficiency.

further, there are times when an individual market, even during non-extreme events can be quite inefficient (i.e. when 1 player makes the market and that player doesn't care about maximizing profit).

my only point was that markets aren't always efficient, or even semi-strongly efficient. that lack of efficiency/rationality comes from the distribution of players and their pockets.

Barron

[/ QUOTE ]

Barron,

I think this whole discussion is missing the mark.

[/ QUOTE ]

well i actually wasn't talking about anything other than the ability for individuals or funds to profit from financial markets in this case.

[ QUOTE ]


Define "efficiency". In thermodynamics, it's easy. In economics, it's almost impossible. All markets are always "inefficient" to some extent because the capital structure is never "correct"; it never actually matches what consumers want.

[/ QUOTE ]

what do you mean the capital structure is never correct?

[ QUOTE ]


There are two reasons for this: time and uncertainty. The structure of the capital stock is constantly being torn down and reorganized in response to entrepreneurs' predictions about what consumers will want in the future, sometimes the very far future.

[/ QUOTE ]

i'm not quite getting what you mean by capital stock and capital structure in these instances. could you clarify them?

[ QUOTE ]


This is uncertain. Also, the world changes. Consumers are fickle. New resources are discovered and exploited, etc.

So the capital structure is constantly being torn down and rebuilt, always trying to reach the "correct" state, but never actually getting there because it is a moving target. So markets must always be somewhat "efficient."

[/ QUOTE ]

efficiency in my mind and what i've learned simply means that the markets reflect all available info. it implies that all actors in the market are rational and profit maximizing.

how does the capital structure being "torn down and rebuilt" affect this? (maybe this will be clear once i know what you mean by those terms in this context)

[ QUOTE ]


The question is not whether or not markets are always "efficient". The question is, can you do better than the market via central planning and intervention, and the answer there is, emphatically, no.

[/ QUOTE ]

that wasn't what i was arguing...but i think i now see what you're getting at.

by capital stock and capital structure you mean the level of interest rates and the supply of money in th eeconomy??

[ QUOTE ]


The market is as rationally planned from moment to moment as it is possible. The information regarding the state of the economy, the distribution of all the means of production, as well as the distribution of the wants and needs of all consumers, is distributed throughout society, contained within 6 billion different heads. The most rational way to plan the allocation of scarce reasources is to take advantage of that distribution, and let each market participant allocate the resources under his control to achieve the ends he desires.

To interfere with that process is too attempt to replace the planning of billions with the planning of a tiny cabal. Leaving aside the abuses that will inevitably ensue by placing that concentrated power into the hands of self-interested human beings, they simply cannot do it. As George Reisman pointed out, those few brains are no more capable of planning for billions than their legs are capable of supporting the weight of those billions.

[/ QUOTE ]

this is probably the best argument i've heard to date against centrally planned monetary systems.

[ QUOTE ]


"Irrationality" and mistakes regarding the allocation of resources within markets have costs, and in a free market those costs are born by those who make the mistakes. If they make enough mistakes, they will no longer be allowed by the market to misallocate resources, because they will be broke;

[/ QUOTE ]

this is a huge oversimplification in terms of some participants. did the principals of LTCM get more money to play with a few years later ?(yup).

are the aramath guys gunna start a new fund ?(yup).

just because you misallocate resources and go broke (or blow up) doesn't mean you won't be able to do it again.

anyways, that is a very small point and just a sidetrack from your overall point which is well stated.

[ QUOTE ]


they will have no resources under their control to misallocate; that's what losses do.

In an intervened in market, the costs of the mistakes of the central planners are born by everyone but the central planners. Because of this, they suffer no personal losses. They can make losses that must be suffered by society indefinitely. There is no market mechanism to terminate there waste.

[/ QUOTE ]

in terms of motives, i don't think your argument holds water here. selection bias is likely to move those who truly care and want to allocate capital efficiently to the positions in which they can do that. it also ends up that some of the smartest minds are in those positions.

the argument above though (the one about 6billion minds vs. a few hundred) is a pretty solid one even against that.

however, your implication that since central planners have no personal losses they are therefore worse than they would be if they did suffer personal losses is wrong imo

good post though and certainly gives me some food for thought. i'd like to read a lot more here as this is turning out to be fairly interesting. any objective (as possible) recommendations? anybody?

Barron

[tw0please]

pvn,

I'm not going to argue this point with you, mostly because I don't know how to. The free market is undeniably a powerful thing, but I haven't studied the background behind your arguments to really understand them completely. Like I said earlier, I took one seminar on libertarianism and I got a taste of Hayek's writings. The overall impression I took away from it was that it is all rather idealistic, but I don't know about the feasibility or how it would work in practice. Are there any modern or historical examples of societies that used your form of economic system (I'm not even sure what to call it)?

[tw0please]

Borodog,

When traditional economists refer to efficiency, it's usually in reference to the concept of Pareto efficiency, a set of allocations in which it is impossible to improve an individual's allocation without making someone else worse off.

Pareto efficiency is the outcome of the free market. However, it must be also understood that a Pareto efficient outcome (because there can be multiple) is not always the most desirable outcome. For example, modern society places value on an equitable distribution of wealth among actors, and since a Pareto efficient market will not balance out inequities among participants, "fairness" is not achievable through the free market alone.

[WillMagic]

barron,

capital stock = factors of production.

capital structure = the allocation of the factors of production.

[WillMagic]

barron, and others who are interested:

really the key two recommendations have to be ludwig von mises' human action and murray rothbard's man, economy, and state. you could also go even further back to stuff by menger and bohm-bawerk, the original austrians, but human action is just so good and so thorough.