The Politimetrics provides implied probabilities of Clinton or Obama winning in November if they get the nomination, derived from Intrade prices. I’m surprised that it’s been showing recently that the difference in their electabilities has been mostly zero, with occasional indications that Clinton is slightly more electable. Most other sources of information appear to suggest that Obama has more support than Clinton among independents and Republicans.
I just did a little trading to help move the market toward showing Obama as more electable by replacing my small bet against Clinton being nominated with a bet against her becoming president, but the amount I’m willing to trade was small enough that the markets moved in the opposite direction (i.e. showed increased Clinton electability).
What could cause the markets to indicate knowledge that conflicts with what I expect?
It could be that several limitations of Intrade impair market efficiency, such as not making it easy to see what those of us who have noticed the Politimetrics site see, or having margin requirements that are not conducive to exploiting inefficiencies of this nature (even if I were more confident that the market is wrong, the expected return on investment isn’t enough to persuade me to make large trades).
It could be that Obama is sufficiently unusual that there’s more uncertainty in how he will do, so that while the most likely result is that he’d get more votes than Clinton would, there’s a greater chance of a negative surprise with him.
It could be that Clinton is expected to be sufficiently vicious if she’s losing that she would hurt Obama before giving up.
But the history shown on the Politimetrics site has swings that seem unexplained by these guesses.
Economics
Book review: Poverty and Discrimination by Kevin Lang.
This book is designed to make you feel less sure of your knowledge, and it succeeds in that goal. That’s a worthy accomplishment, although it provides much less satisfaction than a book that provides a grand vision for solving problems would. At some abstract intellectual level I liked the book, but my gut feelings often told me that reading the book was unrewarding work that I shouldn’t do unless it was assigned reading for a course I needed.
The book will dissatisfy anyone who wants to view politics as a fight between good and evil. For many issues such as the minimum wage, he provides strong arguments that the effects are small enough that we should doubt whether the issue is worth fighting about.
He gives good explanations of why it’s hard to even have clear concepts of poverty and discrimination by providing examples of how seemingly trivial or unobservable differences can create results that our intuitions say are important to our moral rules.
He provides clear evidence that some discrimination still exists, and then thoroughly explains why there’s large uncertainty about how harmful it is. He presents one moderately unrealistic model in which discrimination is common but doesn’t affect wages. Then he presents a somewhat more realistic model in which a tiny bit of discrimination produces large wage differences. But those wage differences may overstate the harm done, because they’re partly due to minorities spending less on education and to women pursuing careers in lower risk occupations or careers which allow more flexibility to take time off.
There are only a handful of places where I doubted his objectivity.
He reports one study showing evidence of racial discrimination in home loans, but fails to mention any of the contrary evidence such as the Anderson and Vanderhoff paper showing higher marginal default rates for blacks.
The final few pages on policy implications seem poorly thought out compared to the rest of the book (he says that’s the least important chapter of the book). He claims that income taxes on the bottom quintile can be reduced to zero by a 10% increase on the top quintile, but that claim depends on assumptions about how reported income changes in response to tax increases. He doesn’t indicate what assumptions his claim depends on.
He claims “The high rate of incarceration in the United States and the high level of inequality are related.” He gives a plausible theory about why inequality causes the wealthy in some countries to spend a lot protecting their wealth from the poor, but provides no evidence connecting that theory to U.S. incarceration rates.
Early this week, the Federal Reserve Board lowered interest rates at an unexpected time by a surprisingly large amount.
I see three possible explanations, which I think are about equally likely.
- The Fed has evidence that the economy is slowing more than markets have realized.
- The Fed has evidence that some big financial institutions have troubles that are endangering the careers of some influential people, and is bailing out those institutions in hopes that those people will use their influence to enhance the job security of the people in charge of the Fed.
- Bernanke isn’t interested in the kind of publicity he can get by maximizing the total number of rate cuts. He realizes that a steady, predictable series of small rate cuts doesn’t stimulate the economy as well as cutting rates far enough that it isn’t easy to predict that more rate cuts will be needed (for one thing, making further rate cuts predictable creates incentives to postpone borrowing to when rates are lower). If that’s what’s happening, it’s not going to work as well as he would like this time, because the markets think the Fed is following the predictable rate cut strategy that gives them publicity for doing something at the time that the average person is most concerned about recession.
In related news, Singapore has a system which is designed to stabilize the economy rather than to provide politicians with opportunities to claim credit for doing something about the economy.
China is imposing widespread price controls and suffering power shortages which hinder production. If China were like the U.S., I’d say it’s trying to recreate the experience the U.S. had in the early 1970s. But the way Chinese politics work, the central government probably will allow local authorities to use a lot of discretion in enforcing the price controls, so the price controls will probably only produce shortages in a few industries that are dominated by large state-owned firms.
Politimetrics (associated with the Westminster Business School) has sponsored some additional Intrade contracts which will provide information about the impact of the presidential election on the country if they ever get enough liquidity. So far, there’s been no sign that much liquidity will exist.
One reason I (and presumably other traders) haven’t placed many orders is that the contracts deal with individual candidates. Since the value of the new contracts should fluctuate with the probability of the relevant candidate’s winning, and those fluctuations are currently much larger than any other factor affecting the prices, trading them would require any trader who doesn’t accept the market price to frequently monitor the prices of the underlying contracts. Nobody wants to do that unless the contracts already have significant volume.
Even if they had some liquidity, there’s a good deal of risk that the long-shot bias which appears to be common on Intrade would limit my confidence in the value of the information provided by those prices for all but the two or three candidates who are most likely to win in November (i.e. I’d probably believe what they said about Clinton relative to Obama, but I’d doubt they would be useful for voters in Republican primaries).
When it becomes clear who will win each party’s nomination, these problems will be reduced, and I’ll probably place a moderate number of orders on some of these contracts.
It should be possible to design a better user interface for decision markets of this nature so that users could place orders purely on the probable impact of a candidate’s election. Shock response futures come closer to doing that than contracts of the form “X wins and Y happens”, but can probably only indicate the direction of the impact.
I’ve created web pages at https://bayesianinvestor.com/amm/implied.html and https://bayesianinvestor.com/amm/implied4.html (which are currently being updated 4 times a day) which show implied prices (i.e. the price of the conditional contract as a percent of the price of the underlying candidate’s contract) that ought to represent what the markets think the probable effects would be if that candidate wins. Ideally traders could place orders expressed in terms of those implied prices, but that’s nontrivial to implement, and unlikely to happen unless someone pays Intrade a fair amount to create.
I’ve commented on Jed Christiansen’s blog about why I doubt the conditional contracts I’m subsidizing have had enough trading yet to produce valuable information. But the trends suggest there will be enough trading within a few weeks.
I have implemented subsidies to encourage trading of some conditional prediction market contracts that may provide useful information about the consequences of the 2008 presidential election, via a simple automated market maker (using an algorithm described near the end of http://hanson.gmu.edu/ifextropy.html). The subsidized market maker ought to provide incentives for traders to devote more thought to these contracts than they would if the liquidity was less predictable.
Intrade has agreed not to charge any trading or expiry fees on these contracts.
Some places to look for extensive description of the motivations behind these subsidies are here and here.
The contracts are:
-
Oil Futures and PRESIDENT.DEM2008 prices will move in same direction on Election Day
This will use the change in the December 2011 Light Sweet Crude Oil futures
contract from the close before the election (Monday) to the close after the election (Wednesday). A price higher than 50 should suggest that a Democratic victory will cause oil prices to be higher than they otherwise would be, while a price below 50 should suggest that a Democratic victory will cause lower oil prices.
PRESIDENT.DEM2008 refers to the Intrade contract for "Democratic Party Candidate to Win 2008 Presidential Election". -
Treasury bond interest rate futures and PRESIDENT.DEM2008 prices will move in same direction on Election Day
This will use the change in the December 2008 30-year US Treasury Bond futures contract from the close before the election (Monday) to the close after the election (Wednesday). A price higher than 50 should suggest that a Democratic victory will cause bond prices to be higher (and long term interest rates lower) than they otherwise would be, while a price below 50 should suggest that a Democratic victory will cause lower bond prices (and long term interest rates higher) . - Number of US troops in Iraq on 30 June 2010 if a Democrat is elected president in 2008
- NONDEM.PRES-TROOPS.IRAQ: Number of US troops in Iraq on 30 June 2010 if a non-Democrat is elected president in 2008
These are scaled claims whose value will range from 0 if the troop levels are zero to 100 if the troop levels are 200,000 (or more).
- Increase in US Government debt if Democrat elected president in 2008
- Increase in US Government debt if non-Democrat is elected president in 2008
Note that the change in debt is usually quite different from what
is reported as the budget deficit. The debt numbers will be taken from a
source such as the
St. Louis Fed
Series GFDEBTN, Federal Government Debt
These are scaled claims whose value will range from 0 if the debt does not increase to 100 if the debt increases by $1 trillion (or more).
Please read the detailed specifications at Intrade before trading them, as one-line descriptions are not sufficient for you to fully understand them.
For the first two of those contracts, the market maker will enter bids and asks of 38 contracts, and can lose a maximum of $5187.76 on each contract. For the other four contracts, the market maker will enter bids and asks of 115 contracts, and can lose a maximum of $7906.25 on each contract.
I will maintain a web page here devoted to these contracts.
See also this more eloquent description on Overcoming Bias.
Up to two months ago, I was not too excited by the claims of a bubble in the Chinese stock market. Maybe the stocks that trade only in China were at bubble levels, but the ones that trade in the U.S. or Hong Kong still looked like mostly good investments.
Much has changed since then. On October 17, PetroChina rose 14.5%, more than doubling in about two months. That was a one day gain in market capitalization of almost $60 billion, and a two month gain of $247 billion (doubling the market capitalization). I’ve seen similar but less dramatic rises in smaller Chinese stocks that trade in the U.S., but less on the Hong Kong stock exchange.
By comparison, the largest rises in market capitalization that I’ve been able to find in the technology stock bubble of 1999-2000 were a $50 billion one day rise in Microsoft on December 15, 1999, and a $250 billion rise (doubling) in Cisco which took four months.
I’m not saying that Chinese stocks are clearly overvalued yet, and I’m still holding some stocks in smaller Chinese companies that I don’t feel much urgency about selling. But the unusually strong and long lasting Chinese economic expansion, combined with the unusually frothy action in the stock market, are what I’d expect to be causes and symptoms of a bubble.
Bubbles in the U.S. have peaked when real interest rates rise to higher than normal levels. The Chinese government is keeping real interest rates near zero, and seems to think it can keep nominal interest rates stable and reduce inflation. That would be an unusual accomplishment under most circumstances. When combined with a stock market bubble, I suspect it could only be accomplished with drastic restrictions on economic activity, which would involve instabilities that the Chinese government has been trying to avoid by stabilizing things such as interest rates.
Without a rise in interest rates or drastic restrictions of some sort, it’s hard to see what will stop the rise in Chinese stocks. So I’m guessing we’ll see a bigger bubble than the U.S. has experienced. It’s effects will likely extend well beyond China.
Book review: A Farewell to Alms: A Brief Economic History of the World by Gregory Clark
This book provides very interesting descriptions of the Malthusian era, and a surprising explanation of how parts of the world escaped Malthusian conditions starting around 1800. The process involved centuries of wealthier people outreproducing the poor, and passing on traits/culture which were better adapted to modern living. This process almost certainly made some contribution to the industrial revolution, but I can’t find a plausible way to guess the magnitude of the contribution. Clark is not the kind of author I trust to evaluate that magnitude.
His arguments against other explanations of the industrial revolution are unconvincing. His criticisms of institutional explanations imply at most that those explanations are incomplete. But combining those explanations with a normal belief that knowledge/technology matters produces a model against which his criticisms are ineffective. (See Bryan Caplan for more detailed replies about institutional explanations).
He makes interesting claims about how differently we should think about the effects in Malthusian world of phenomena that would be obviously bad today. E.g. he thinks the black plague had good long-term effects. He made me rethink those effects, but he only convinced me that the effects weren’t as bad as commonly believed. His confidence that they were good depends on some unlikely quantitative assumptions about benefits of increased income per capita, and he seems oblivious to the numerous problems with evaluating these assumptions. His comments in the last few pages of the book about how little average happiness has changed over time leads me to doubt that his beliefs are consistent on this subject.
While many parts of the book appear at first glance to be painting a very unpleasant picture of the Malthusian era, he ends up concluding it wasn’t a particularly bad era, and he describes people as being farther from starvation than Robert Fogel indicates in The Escape from Hunger and Premature Death, 1700-2100. Their ability to reach somewhat different conclusions by looking at different sets of evidence implies that there’s more uncertainty than they admit.
He does a neat job of pointing out that economists have often overstated the comparative advantage argument against concerns that labor will be replaced by machines: horses were a clear example of laborers who suffered massive unemployment a century ago when the value of their labor dropped below the cost of their food.
I’ve occasionally heard claims about Africa being poor because it was exploited by Europeans and Americans, and I’ve dismissed those claims because they were clearly based on superstitions.
Recently I’ve come across some scholarly writings on the effects of interactions between these cultures.
A paper on Colonial legacies and economic growth confirms my suspicions that areas which were colonized for longer times have higher economic growth.
As I mentioned recently, the book The Bottom Billion shows a connection between poverty and sale of natural resources, but explains several mechanisms by which the revenues could make bad governments more likely, independent of whether the buyers of those resources exploit the sellers. This suggests it’s not easy to resolve claims that such exploitation caused harm.
The most interesting study is The Long-Term Effects of Africa’s Slave Trade (via Freakonomics and Andrew Sullivan), which demonstrates that slave trade between Africa and other continents between 1400 and 1900 is significantly correlated with poverty now. The paper presents a good argument that the causal connection was mainly increased violent conflict due to rewards for enslaving people from neighboring villages (as opposed to prior forms of slavery which resulted from conquest by ethnic groups from somewhat farther regions). This caused social and ethnic fragmentation and corruption. I have doubts about whether the details of the paper’s causal model are correct, but they appear to be approximately correct.
Book review: The Bottom Billion: Why the Poorest Countries are Failing and What Can Be Done About It by Paul Collier
This very eloquent and mostly thoughtful book about the world’s poorest countries will offend ideologues of all stripes. Collier’s four different explanations for poverty traps (war, presence of natural resources, bad neighbors blocking trade routes, and corruption) clearly place him as a fox rather than a hedgehog without being complex enough that they can rationalize any result (although they can probably rationalize more results than an ideal set of explanations would). He blames both villains in poor countries and thoughtless voters in wealthy countries.
Collier sees that globalization has benefited most nations, but provides plausible mechanisms by which globalization can harm some (e.g. through enabling capital flight).
Collier mostly thinks like a good economist, but his prior work for the World Bank biases him to be overly optimistic about improving such institutions. He recognizes the incentives that cause bureaucrats to be too risk averse, but then makes a cryptic claim that the British government understands the problem and is spending money to fix it. He vaguely implies that this is a venture capital-like fund, but fails to say whether they replicated the key venture capital feature of providing unusually large rewards to employees who produce unusually good results. His silence on this subject leads me to suspect that he’s asking us to blindly trust institutions that have a long track record of avoiding results-oriented incentives.
He also shows misplaced faith in authority when he tries to calculate the value to the world of rescuing a failed state by using George Bush’s calculation that the benefits of installing a good government in Iraq exceeded the expected $100 billion cost. That might be a good argument if Bush had been spending his own money to help Iraq, but his willingness to spend other peoples’ money doesn’t say much.
Collier says it is “surely irresponsible” to leave Somalia with no government. Yet most evidence I’ve seen says Somalia improved by most standard criteria such as life expectancy when it had no government. I don’t know how reliable that evidence is, but Collier’s apparent assumption that we don’t need to look at the evidence makes his opinion suspect.
The book’s biggest shortcoming is the absence of anything resembling footnotes. Collier implies this is too make the book more readable, but he could have put a section of notes at the end referencing individual pages without altering the main text in any way. Instead he only gives a fairly large list of papers he’s written. But I can’t tell without tracking down and reading a large fraction of them which of them if any support his controversial claims (e.g. that giving money to the poorest countries helps them a bit but that doubling it would reach a limit beyond which further money would be wasted).
But his advice is good enough that its value doesn’t depend much on those controversial claims being right. Following his advice to condition aid on results (e.g. sending money to countries when they stop wars, cutting it off if they have a coup or resume war) would provide incentives that would make aid beneficial.
I had previously suspected that large countries have tended to escape poverty more easily in the past few decades because “aid” organizations had enough money to prop up small corrupt governments but not enough to affect a government such as India’s. Collier presents a good alternative theory: being a large country pretty much guarantees access to the sea, and by increasing the number of neighbors, increases the chance of having a neighbor which is open to trade.
Another good tidbit is this point on Fair Trade: farmers “get charity as long as they stay producing the crops that have locked them into poverty.”
Book review: Business Fairy Tales by Cecil W. Jackson.
This book provides a better analysis of financial accounting problems than you can find in the news media. But it’s not thoughtful enough for me to recommend it. The author sounds like an academic who has little experience as an investor.
The book provides little perspective on which mistakes did the most harm. I can’t tell whether the author sees any difference in seriousness of Enron’s inconsistent reports to the SEC about when it adopted mark-to-market accounting and the absence of market prices to guide its so-called mark-to-market accounting (it seems obvious to me that the former is trivial and the latter is outrageous, but I wouldn’t have learned that from reading this book).
I’m also disappointed that the book never takes the perspective of the villains to ask why they thought they could get away with bad accounting. Were they all confident that perpetually rising stock prices would ensure that investors would never complain? Could they have have thought they would make enough money before getting caught to profit even if they were punished? In some cases I can guess why the answer might have been yes to one of these, but in most cases I’m as puzzled as I was before reading the book.
The book suggests a number of signals that investors might look for to detect fraud. But none of them are valuable enough to change the way I read financial reports. A few, such as sales growth not meeting expectations or rising inventory / sales ratios, are valuable signs of an overrated company even though they rarely indicate accounting problems. Most of the signals the book recommends involve things like increases in receivables where there’s no obvious way to distinguish routine fluctuations from changes that indicate problems, so I suspect the number of false alarms would make these signals useless.
I suspect that avoiding the stock market during bubbles is a more practical and effective way of avoiding harm from accounting fraud than trying to follow this book’s advice. I’d guess that 10% of investors will learn to avoid bubbles if they try, but I doubt more than 1% will succeed at identifying fraud. If you do try to identify fraud, pay more attention to people such as Jim Chanos who have found ongoing frauds than to books such as this that only do post-mortem analysis.
The book claims that a benefit of Sarbanes-Oxley is that it restored investor confidence in corporate financial statements. This seems misguided. The stock market decline that prompted Sarbanes-Oxley was largely due to mistaken extrapolations of real trends in internet-related profits. Many investors prefer to exaggerate the role played by fraud because it distracts attention from the mistakes they made at the peak of the bubble. It’s unclear whether increased investor confidence is desirable. Accounting fraud is most common at peaks of bubbles because investor confidence makes it temporarily easier to avoid questions about suspicious accounting practices. Stock markets appear to function best with moderate amounts of suspicion among investors to help keep corporate reports honest.