The Federal Reserve: Love it or Hate it

[DcifrThs]

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the other stuff i'm debating zygote on is just him not understanding the concepts behind what i'm saying and me having to teach somebody who a) thinks he knows everything, and b) isn't willing to learn but still wants to make braod based factual claims.

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you're the only one using language like this. What does this mean for the question, who, of the two of us, think they know everything and aren't willing to learn?

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i have since expanded my knowlege of the issues in this debate and formulated my thoughts (i ohpe) fairly clearly in my post above.

i am willing to learn and realize i've entered a debate for which i need to be more armed with knowledge than i came in with.

what i keep taking you to task on, and you keep ignoring and not disucssing is your views on speculation. specifically that you implied very succinctly and strongly that if you have any cash or any stocks that you are automatically speculating.

more generally, some people don't seem to understand a) teh basics of why investments in risky assets need to pay more than cash in a capitalist system and b) the difference between zero-sum speculation and positive sum passive investing, so i've (again i hope) clearly explained that in a previous post.

so can you please stick to the discussion at hand and lets forget the hate. i apologize for treating you poorly with my words, i have learned from that mistake and am willing to engage with you on any issue at hand.

so can you now please enumerate your beliefs on speculation and market interactions (or just signify that you disagree/agree/understand/don't understand the arguments i've put forth previously on that topic in this thread)

thanks and here's to a healthyd ebate.

Barron

[Zygote]

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the traditional portfolio of stocks and bonds has a risk adjsuted return (sharpe ratio) of about 0.30-0.35

by taking away equity allocation and moving it to leveraged short term bonds as well as a small amount to commodities (CCFs so they are deleveraged to risk level of equities) in addition to leveraged IL bond allocations and REITs, you can create a portfolio with an expected and historic sharpe ratio of 0.70, which is more than twice as good as the traditional portfolio.

the reason this works is that by using leverage, you can bring other asset classes to the same risk level as equities. since on average, all asset classes can be expected to have between a 0.2 and 0.3 sharpe ratio, you can use leverage to increase the risk level and thus the returns of any asset class (or deleverage an asset class). this is true forall asset classes with the exception of commodities since that is debateable at the present time.

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You seem to misunderstand where i was coming from. I wasn't saying every portfolio with diverse assets must be worse than a less diverse portfolio. I just said, if you're focused on maximizing returns only, you just choose which ever asset you think is the best of all you have, and put all your eggs in that basket. Of the limited cash you have, by definition, if you divert some of this cash to an asset that is less likely to be profitable or an asset with an inverse relationship you must be sacrificing absolute expected value.

The only reason to hedge, which again is defined by finding an inverse relationship, is to minimize risk.

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neither of these is totally right. broad based indices of bonds, stocks, TIPS, etc. can all be expected to outperform risk free allocations due to capitalism.

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I dont know what a risk-free rate is. I dont know how such a thing can exist since there is always some default risk. I see your though point, just saying.

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capitalism returns the taking of risk, otherwise, risk would never be taken. an investor can allocate money to the risk free rate OR to an equity index. if the equity index couldn't be expected to return more than the risk free rate, no investor would put money in companies that require more capital to grow or invest or whatever they want capital for.

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I agree they wouldnt put money in if markets werent expected to beat tbills or watever, with all factors included, but this appears to have little to do with my point - perhaps im not understanding though?

If i want to invest in a stock or index right now the price i pay is the price the public or businesses are willing to sell at. Since the companies wants cash and i want interest, we make a trade at a given price, and if risk reward is generally positive compared to alternatives and there is limited stock then this price rate is competed for and driven up. If the risk reward is generally negative compard to alternatives the stock will go down over time.

If a stock rises over an extensive period of time compared to alternatives this is because early investors of alternatives were unaware of the stocks true potential, otherwise the stock wouldve be driven up earlier, and therefore the stock was mispriced in the past.

Mispricing ill define as being any value other than the true value.

Now adays people think more in advance than they used to which is why we see such high p/e ratios for some equities. This is why google's stock rose so fast for example. If google continues to rise fast for the next 10 years, then the average people 10 years ago were mispricing the expected returns, just like those who werent putting money down on google at $100 were mispricing the expected returns. i dont see how this can be escaped.

All this still remains true if we're talking about a basket of stocks.

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you can allcoate to a diverse set of asset classes and be sure that, over time, you will be rewarded to taking risk by allocating money to those asset classes.

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Are saying you can be 100% certain you will return profits? Please give me a reals world example.

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the construction of your portfolio will determine the relative risk adjusted return, but even an undiversified portfolio will return more than cash, otherwise, nobody would invest in it.

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people at least expect it to return more than cash. this doesnt disprove anything ive said.

If an index keeps rising over time its because investors continue expecting the current equity rates to out perform the alternatives. This indicates that investors are making short term predictions about the market's "risk premium" but past participants were not strong enough in their long term predictions if the index rises over an extensive time.

[Copernicus]

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Dcifr, I think if you make a list of the things that you do and dont agree with about AC (including the specific exceptions) that you will back to neo-classical economics with a list of exceptions that is either smaller in number, that bear less potential cost that than your AC list, or both.

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could you please rephrase that questions/comment/statement in english ... i can't for the life of me figure out what you are trying to say [img]/images/graemlins/confused.gif[/img]

i THINK you may be trying to say that if i made a list of things i don't agree with in AC and compared that to a list of things i don't agree with in traditional economics, that the former list would be shorter than the latter?

is that what you emant?

thanks,
Barron

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No, the reverse, and more important than the size of the list, the potential burdens on the economy/society of those exceptions. Eg. AC has a great disdain for government regulated IP protection. (Im not sure if thats been discussed in threads youve read/participated in.) I think its patently (pun intended) obvious that the current IP systems are vastly more efficient and effective than the proposed AC solutions, which ultimately boil down to individual contracts and enforcement by a DRO. When you measure the cost of those inefficiencies both in pure transaction costs and the dampening of innovation that I am convinced would result, those costs alone are likely to outweigh the cost of the actual deficiencies in the current system.

You may disagree with the magnitude of the costs, I doubt you would disagree with the basic premise that AC's approach to IP is on your "Exception list". However I am almost certain that when you (Dcifr, not the universal "you") balance the potential costs of all of the exceptions, AC will turn out to be orders of magnitude more costly than the current system, even without improvement of the current system.

BTW, have you read Caplan on AE and the purported debunkings of Caplan on Mises? (I say purported because those debunkings don't seem to amount to much more than repeating the differences and jumping up and down saying "no, we're right and you're wrong).

[Zygote]

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what i keep taking you to task on, and you keep ignoring and not disucssing is your views on speculation. specifically that you implied very succinctly and strongly that if you have any cash or any stocks that you are automatically speculating.


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i was defining speculation as the taking of risk on any asset over alternatives.

This is not really an issue as the definitions are more clear now.

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so can you please stick to the discussion at hand and lets forget the hate. i apologize for treating you poorly with my words, i have learned from that mistake and am willing to engage with you on any issue at hand.


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apology accepted. We can now continue like menches.

[Zygote]

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BTW, have you read Caplan on AE and the purported debunkings of Caplan on Mises? (I say purported because those debunkings don't seem to amount to much more than repeating the differences and jumping up and down saying "no, we're right and you're wrong).

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Caplan was challenged on all this and eventually conceded by no more challenges to Block's final clarification.

here are the debates for your own reference:

http://blog.mises.org/archives/000841.asp

http://www.mises.org/journals/qjae/pdf/qjae6_3_5.pdf
http://www.mises.org/journals/qjae/pdf/qjae6_3_4.pdf
http://www.mises.org/journals/jls/19_1/19_1_5.pdf

[adios]

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....You seem to misunderstand where i was coming from. I wasn't saying every portfolio with diverse assets must be worse than a less diverse portfolio. I just said, if you're focused on maximizing returns only, you just choose which ever asset you think is the best of all you have, and put all your eggs in that basket. ....

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I like your posts but unfortunately this is very wrong, you definitely need to read the essay I wrote in BFI 1+ years ago. You can acheive the same returns by leveraging the market portfolio and assume less risk at the same time.

[pvn]

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this stems from the hate for any fiat money system. you can argue this point all day, and logically we can even have a monetary system backed by wine, but in the end i think the flexibility allowed by a fiat system far outweighs the distortions it causes and that the distortions caused by a system backed by anything that can't be quickly increased or decreased will be larger.

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Who benefits from this "flexibility"? Certainly some parties do, but when they do, it's at the expense of others.

The fact that you say something like "we can have a system backed by wine" indicates that you're still limiting your thought to centralized monetary systems where one commodity is deemed by some authority to be "the" standard. There is no need for any such monolithic standard, and the *imposition* of such a standard - even if that imposed standard is gold - is what ACers oppose.

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i believe in a lot of what AC says (free markets, no/limited intervention), but the fed is another institution not responsible to the US Govt and is only connected in so far as its initial funding and the appointments to the board.

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The Fed has a monopoly granted by the government. You nonchalantly refer to the fact that it's "not responsible to the government" as if this were some sort of good thing?! Think about that. What if the phone compnay had a government-granted monopoly AND wasn't accountable to the powers that granted that monopoly? If you asked anyone if that sounds like a good idea, they'd probably look at you like you just grew another head.

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in all other aspects (aside from the fiat money thing/the fed and the "necessary" interventions of the govt), i think AC is very well founded in that the govt, in almost every case, shouldn't hamper markets as govt interventions always have a) unintended concequences, and b) rarely, if ever, been able to even accomplish the final goal of the intervention (currency pegs etc. etc...they all fall apart). protectionism is attrocious etc. etc.

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You say "in almost every case" so I'm wondering what you think are the exceptions to this and more importantly WHY you think those examples deviate from this rule.

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i do hold universal judgement aside and make statements like "almost every" because i think there are times and places for govt intervention. i.e. when a new or small country wants to remove obstacles from its, until then, closed economy, a peg may be necessary to ensure stability and reduce frictions on businesses not used to a floating exchange rate initially. then it might make sense to have a peg for a while.

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I was hoping for an example more relevant to the discussion at hand, such as an argument about why money is magically different than other commodities; why you support government intervention here but not elsewhere.

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also, i firmly and wholeheartedly believe that almost any theory that believes in solid absolutes is too strict, and most likely wrong in that firm belief. as humans, we have been proven wrong in our most highly regarded beliefs time and time again. so anything that says "THIS IS IT" i hold to an exceptionally high standard of proof. there are, of course, exceptions, and those theories that pass that standard of proof for me... (theory of evolution in my mind can say for sure etc.)

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Interesting. I don't propose ANY such solution, I think that "THIS IS IT" is definitely asking for trouble. So why should, for example, the Fed be "IT" and be imposed upon everyone? What you say is a bad idea is EXACTLY what statism leads to - one course of action being selected, subsidized at the expense of others, while those others are violently suppressed. Bush IS IT! Whoops, emocrats in congress ARE IT! Prohibition IS IT! Whoops, getting rid of prohibition IS IT! Say no to drugs IS IT! Inflationary monetary policy IS IT! Whoops, inflationary monetary policy plus some new ideas this time so we don't have the Great Depression again IS IT! Saying no to nation building IS IT! Whoops, sending your kids to invade far away lands and build nations IS IT!

Under a state, every time someone says THIS IS IT! I have to pay for it.

[Zygote]

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....You seem to misunderstand where i was coming from. I wasn't saying every portfolio with diverse assets must be worse than a less diverse portfolio. I just said, if you're focused on maximizing returns only, you just choose which ever asset you think is the best of all you have, and put all your eggs in that basket. ....

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I like your posts but unfortunately this is very wrong, you definitely need to read the essay I wrote in BFI 1+ years ago.

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link?

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Anyway portfolio theory states that the investor is compensated with a risk premium by undertaking market risk only. Individual company risk is not compenstated with a risk premium.

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Why is individual company risk not compensated with risk premium?

I think diversifying is very desirable especially to isolate your predictions/exposure and manage risk but i dont see how you canincrease profits by diversifying your exposure.

Id be very interested in reading your post from BFI though.

[DcifrThs]

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I agree they wouldnt put money in if markets werent expected to beat tbills or watever, with all factors included, but this appears to have little to do with my point - perhaps im not understanding though?

If i want to invest in a stock or index right now the price i pay is the price the public or businesses are willing to sell at. Since the companies wants cash and i want interest, we make a trade at a given price, and if risk reward is generally positive compared to alternatives and there is limited stock then this price rate is competed for and driven up. If the risk reward is generally negative compard to alternatives the stock will go down over time.

If a stock rises over an extensive period of time compared to alternatives this is because early investors of alternatives were unaware of the stocks true potential, otherwise the stock wouldve be driven up earlier, and therefore the stock was mispriced in the past.

Mispricing ill define as being any value other than the true value.

Now adays people think more in advance than they used to which is why we see such high p/e ratios for some equities. This is why google's stock rose so fast for example. If google continues to rise fast for the next 10 years, then the average people 10 years ago were mispricing the expected returns, just like those who werent putting money down on google at $100 were mispricing the expected returns. i dont see how this can be escaped.

All this still remains true if we're talking about a basket of stocks.

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basically you are missing one major point, otherwise i think you're close to getting it.

you say you accept that people need to receive X*tbill returns for investing in the stock market where X>1 by some margin.

so lets say tbills (the risk free asset in this case, though blah blah blah no asset is risk free, no bank deposit is 100% risk free etc...we say risk free as the baseline minimum level of risk one can possibly take with money) return 3% per year over 30 years.

that means that stocks must return 3%*X per year over 30 years.

that means that even if everything was 100% efficiently priced, over 30 years, you would expect a compound return of 242.7% from investing in tbills and (assuming X is 1.8, giving us a 5.4% expected return on stocks) 484.4 % return on stocks.

that means that starting at time t0=100 with a tbill index and a stock index, the total return index price (including divs, coupons reinvested etc. etc.) ending at T30 should be

tbills=242.7
stocks=484.4

that means that stock prices would, over 30 years be expected to increase nearly 5 fold SIMPLY to get people to invest in stocks at any point in time (market highs, lows, etc. doesn't matter). if the stocks returned LESS than X*3%, people wouldn't invest in them.

that return comes from a risk premia transfered from companies (who issues the shares) to the holders of stocks (be it businesses, individual, china, abu dahbi or dubai sovereign wealth funds). no mispricing had to occur in previous periods for the price of stocks to rise by that much.

by yourl ogic, for the price of the total return index of tbills to rise by 2.4x over 30 years, there would have had to have been a market mispricing at time t0 based on t0-n previous time period.

an even clearer example is investing in a 30 year money market account at 3% (forget tbills). are you saying that money market accounts that return $242 for every $100 invested over 30 years were mispriced prior to the investing of the $100?

clearly that isn't the case, the 3% is what is required by depositors in order to put there money there.

similarly, the 5.4% is what is required by stock holders to give their money to companies for the investment/growth etc. programs they needed to take on with that money. no mispricing has to occur in order for investors to make money. the investors had to make money (via dividends and price increases) otherwise companies would not have gotten the shareholders investment in the first place.

this example is tautological and has no bearing on historic or expected returns on tbills or stocks.

do you see that speculation is not passive investing and that no speculation needs to occur at t0 in order to put money in stocks? the ONLY thing debatable here is whether you think that capitalism should pay investors more than the risk free rate (here tbills at 3%) in order to put money in riskier assets like stocks... you can consider that the speculation and be technically correct that any investing in stocks (or anything) is speculating that the risky asset of interest will return more than the risk free rate. but, i don't think thats the speculation you were referring to in the discussion.

Barron

[DcifrThs]

pvn, please read my post on the evolution of monetary systems a few posts up.

then come back to this and if you still have questions on what i'm talking about we can engage further.

thanks,
Barron