The Taylor Rule

Posted by Peter on November 7, 2011
Posted in: Book Reviews, Economics. Tagged: .

Book review: Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, by John B. Taylor.

This book contains a few good ideas, expressed simply and clearly. It explains some of what caused the 2008 financial crisis. But he exaggerates a good deal when he claims he has “provided empirical proof that monetary policy was a key cause of the boom”.

He provides clear evidence that counterparty risk was a more important problem than lack of liquidity, and has some hints about how counterparty risk could have been handled better. But that doesn’t say much about whether policies to deal with liquidity problems were mistaken – I doubt that many of the people pushing those liquidity related policies were denying that counterparty risk was a problem.

I’ve been convinced since before the crisis that having the Fed follow the Taylor Rule would have been better than the monetary policy that we actually had. But the details of the rule seem somewhat arbitrary, and I’m disappointed that the book doesn’t provide much explanation of why the Taylor Rule is better than alternative rules.

I’ve found a link on Taylor’s blog to an article (The Taylor Rule and QE2 By David Papell) which compares it to some alternatives which seem motivated primarily by a desire to rationalize more monetary or fiscal stimulus. But what I want to know is whether it’s possible to create a rule that is more countercyclical without being more inflationary.

I have an intuition that it’s not too hard to improve on the inflation component of the rule. The CPI seems to have many drawbacks, such as being slow to reflect changes. I suspect Taylor’s inflation coefficient of 1.5 is larger than what an ideal rule would use in order to make up for the delays associated with using the CPI. When I’m estimating inflation for my investment decisions, I pay more attention to the ISM price index, the money supply (MZM), commodity prices, and stock prices. And the ISM Purchasing Managers Index should provide more up to date evidence of the “output gap” than GDP figures. A version of the Taylor Rule which emphasized those should react more quickly to changes in the economy.

Bitcoin

Posted by Peter on October 28, 2011
Posted in: Investing. Tagged: .

In the process of researching Bitcoin to help me decide whether to buy some as an investment, I’ve come across some confusion about money in some prominent articles.
This article says:

the demand for Bitcoins is driven by the volume of Bitcoin-denominated transactions.

…

the value of a currency is built on its reputation, and five months of bad news and depreciation have done serious damage.

Money serves several different functions. To be widely accepted, a currency typically needs to serve as a medium of exchange and as a store of value. But gold is a good example of a quasi-currency that functions as a fairly good store of value (at least for people with long time horizons). Bitcoin shows more promise of functioning as a store of value than as a medium of exchange.

If Bitcoin were only a medium of exchange, it might make sense to say the volume of Bitcoin transactions drives the demand for it. But if most people who are buying Bitcoins are hiding them under their mattresses on EMP-resistant media (cd-rom?), the price of Bitcoins can rise indefinitely without an increase in transactions.

It isn’t very useful to lump many beliefs about a currency into a single reputation. Bitcoin has different reputations for different traits.

A currency should have a reputation for being in limited supply and for not having that supply increase too rapidly. I’d say Bitcoin has developed a better reputation for this than the US dollar, and might exceed gold’s reputation.

A currency should be easy to store and transport safely. This is an area where Bitcoin’s reputation is the subject of much confusion. There’s currently an unpleasant tradeoff between secure ways to store Bitcoin and convenient ways to have them available to spend. It make take a major rewrite of operating systems (e.g. to use Capability-based security with a good UI) for it to be possible to have Bitcoins be conveniently accessible but hard to steal. Confusion over the risk of theft has probably driven a fair amount of the recent Bitcoin price volatility. My guess is that it’s better that theft has happened now than after people become more reliant on Bitcoin. It will either drive the creation of more secure software (with benefits much wider than Bitcoin use) or discourage people from relying on insecure ways of handling digital money.

Finally, it’s important that a currency have a reputation for being something that people will value in the future. This is a source of significant uncertainty, because it depends on people’s perceptions of the alternative stores of value, the alternative media of exchange, and the risk of Bitcoin theft. Bitcoin has the potential to be a better store of value than gold, because a transparent algorithm can better guarantee a limited supply than the difficulty of mining a metal. People who started watching Bitcoin prices a few months ago in response to a flurry of publicity attach a low reputation to its prospects as a store of value because the recent price crash is more vivid in their mind than the earlier boom, but that’s a temporary phenomenon that doesn’t deserve much attention.

For most uses as a medium of exchange, Bitcoin doesn’t offer much advantage now. For most transactions, the small cost savings aren’t enough to persuade consumers to give up the ability to dispute a payment, or for stores that accept Bitcoin with an option to dispute payment to offer a discount for Bitcoin purchases. And I expect governments and large financial institutions to create obstacles to its use as a medium of exchange. There are a few small uses where it works better than any existing alternative – e.g. Wikileaks, where the existing financial system refuses to support online payments. Bitcoin anonymity doesn’t appear strong enough to attract people engaged in illegal businesses. Online gambling companies might get some advantage from using Bitcoin if the obstacles to transferring money to gambling sites exceed the obstacles to buying Bitcoin, but I’m guessing the obstacles are and will be at least as large for buying Bitcoin. So I expect very slow adoption of Bitcoin as a medium of exchange.

I do think there’s a nontrivial chance that Bitcoin will become widely used as a store of value, and that might replace a significant amount of demand for gold a decade or two from now. A decline in demand for gold as a store of value might well snowball, as extrapolating that trend would imply that gold becomes a less reliable store of value. That doesn’t yet make me reluctant to buy gold, but a Bitcoin price over 0.1 ounces of gold might make me reconsider.

I will probably invest a small fraction of my net worth in Bitcoin, but I don’t feel any urgency about it.

Kratom

Posted by Peter on October 19, 2011
Posted in: Miscellaneous.

I’ve been experimenting with an herb known as Kratom for the past few months. I’ve been using about a teaspoon of getkratom.com‘s Bali Kratom. It produces as stimulant effect lasting 6 to 8 hours. I feel more alert, positive, and ambitious while on it. I’m probably less able to focus on one task but better at switching tasks.

It has been reported to be addictive, but I haven’t felt that it’s any more addictive than chocolate. One important caveat is that if I use it two days in a row, the effects are dramatically reduced on the second day. That’s probably what leads to addiction – people are tempted to use it every day, which creates a temptation to use much larger quantities. I’ve been restricting my use to once or twice a week, and I’ll try not to increase that frequency.

RNA in our food

Posted by Peter on October 10, 2011
Posted in: Uncategorized. Tagged: , .

What you eat can influence your gene expression.

A post titled Eat Your Grains says:

RNA from our food can survive digestion, sneak into our cells, and control our genes

Researchers studied MicroRNAs from rice that affect cholesterol levels in mice. The effect appears harmful, which is a kind of defense against predation I’d expect from something that hasn’t evolved to cooperate with animals. (Grains have probably evolved some traits that help humans, but only where farmers have long been aware of the traits). Oddly, the researchers say “miRNAs may serve as a novel essential nutrient”, but I expect them to be harmful on average, except in fruits (which have evolved to attract animals).

Interplay

Posted by Peter on September 26, 2011
Posted in: Uncategorized. Tagged: , .

Interplay is something which seems helpful at making me more spontaneous. Interplay is hard to describe, but it has aspects of meditation, dance, yoga and improv.

I’ve been to the SF group twice and the Oakland group once, and I plan to continue attending the SF group occasionally. There are a fair number of other places where you can find Interplay.

A description from SF Interplay site:

Learn to have more ease and openness through improvised movement, story, voice and stillness. The spiritual practice of InterPlay can facilitate deeper connections with the divine, other people and our planet. As improvisation becomes easier in our bodies, we have more access to our own wisdom, making us less afraid of what might cross our path. Rather than reacting with fear and paralysis in the face of what is unknown, we can breathe, dance, and find fullness.

Alexithymia

Posted by Peter on September 5, 2011
Posted in: The Human Mind. Tagged: , , , .

As part of my efforts to improve my relationship skills, I read many of the posts on CharismaTips.com. It’s a site oriented towards male geeks who want better dating skills, but it appears to be useful for a broader range of personal interactions, and is oriented toward geeks.

I ran into more trouble than I expected when I tried to follow this advice:

Make a list of every positive emotion you can think of. For each emotion write down a short headline to a story, moment, or experience, when you felt that emotion.

After much research, I decided that a large part of the problem was connected with Alexithymia. According to Wikipedia it is:

a state of deficiency in understanding, processing, or describing emotions.

  1. difficulty identifying feelings and distinguishing between feelings and the bodily sensations of emotional arousal
  2. difficulty describing feelings to other people
  3. constricted imaginal processes, as evidenced by a scarcity of fantasies
  4. a stimulus-bound, externally oriented cognitive style.

Talking about emotions is reportedly valuable in creating a feeling of closeness with another person, but when I try to think of stories I might tell about emotions, I often come up completely blank, or remember situations where the context suggests I felt something corresponding to an emotion, but for which I’m unable to find a memory of feelings. I think my mood is often best described as neutral, which I gather isn’t the case for most people.

from another paper:

Therefore, alexithymia is viewed as “blindfeel”, the emotional equivalent of blindsight. According to this thesis, alexithymia is a deficit in reaching the conscious awareness and in maintaining the voluntary control of emotions, rather than a disruption in the sensory/perceptual aspect of emotions.

One of the tests for Alexithymia suggests that it is associated with low interest in sex, although I can’t find much evidence on that subject. I certainly feel much less interest in sex than the average person.

I wonder if one of the reasons I don’t form many close relationships with people is that I don’t notice any reactions in me corresponding to what people call “love at first sight”. If I’ve ever felt even mild versions of that, I can’t recall them.

Alexithymia also seems to affect people’s reactions to music:

an apparent reduction in emotional responsiveness to music in the ASD group can be accounted for by the higher mean level of alexithymia in that group.

I don’t notice myself reacting to music by itself, but it does seem to manipulate my emotions when it’s part of a movie.

Alexithymia is clearly a separate phenomenon from Aspergers/autism, but it is reported to occur in 50% to 85% of autistic people. It could be responsible for a significant fraction of the problems autistics have relating to other people. In particular, autism by itself doesn’t seem to cause problems with eye contact:

only the degree of alexithymia, and not autism symptom severity, predicted eye fixation.

There don’t seem to be any good ideas for dealing with Alexithymia, although that might reflect how little research has been done so far rather than any inherent difficulty.

The most promising claim I’ve found is this:

So how did I “cure” myself? It’s a bit of a long story but I will give you some bits of it for now.

One of the things I did was to start to read about feelings. This might have started giving me the vocabulary.

Something else I did was I started taking time to think about my feelings. To reflect on them.

Then I also started to write about them in personal journals.

I’m starting to do this, but it clearly won’t produce clear results soon.

I’ve bought and used a dvd designed to teach people how to recognize emotions in faces. It’s got a lot of potentially useful information in it, but it leaves much to be desired – I’m fairly sure it’s mistaken to list lying as a detectable emotion (guilt or fear of detection are detectable, but the most rigorous studies seem to say that people rarely do much better than chance at detecting lies). I’m unsure whether I’m learning much from it.

Expected Returns

Posted by Peter on August 23, 2011
Posted in: Book Reviews, Investing. Tagged: , .

Book review: Expected Returns: An Investor’s Guide to Harvesting Market Rewards, by Antti Ilmanen.
This book is causing me to change my approach to investing much more than any other book has. It is essential reading for any professional investor.

The foreword starts by describing Ilmanen as insane, and that sounds like a good description of how much effort was needed to write it.

Amateur investors will have trouble understanding it – if you’re not familiar with Sharpe ratios, you should expect to spend a lot of time looking elsewhere for descriptions of many concepts that the book uses. I had a few problems understanding the book – he uses the term information ratio on page 188, but doesn’t explain it until page 491 (and it’s not indexed). I was also somewhat suspicious about how he handled data mining (overfitting) concerns in momentum strategies until I found a decent answer in a non-obvious place (page 404).

The most important benefit of this book is that he has put a lot of thought into identifying which questions investors should be trying to answer. Questions such as whether past performance is a good indicator of future returns, and what would cause a pattern of superior returns to persist or vanish.

Some other interesting topics:

  • why it’s important to distinguish between different types of undiversifiable risk, and how to diversify your strategies so that the timing of losses aren’t highly correlated across those strategies.
  • why earnings per share growth has been and probably will continue to be below GDP growth, contrary to what most forecasts suggest.
  • how to estimate the premium associated with illiquidity
  • why it’s useful to look at changes in correlations between equities

It’s really strange that I ordered this a few weeks after what Amazon lists as the publication date, but it took them nearly 7 weeks to find a copy of it.

Some quotes:

overfitting bias is so insidious that we cannot eliminate it (we cannot “become virgins again” and forget our knowledge)

the leverage of banks will soon be more tightly restricted by new regulations. The practical impact will be more pronounced risk premia for low-volatility assets, more sustained mispricings, and greater opportunities for those who can still apply leverage

European financial crisis

Posted by Peter on August 8, 2011
Posted in: Investing, Politics.

Arnold Kling has a concise summary of the current crisis:

Apparently, the resolution of the debt ceiling restored the dollar’s status as a safe haven in the eyes of the world’s investors. That accelerated the flight from European sovereign debt and European banks. That in turn raised fears in financial markets, driving down stocks, including in the United States.

The European monetary system appears to suffer from the same problems as Bretton Woods.

European voters seem unlikely to tolerate the measures needed to maintain the current system. Yet the breakup will cause enough problems for the banking system that politicians will postpone it as long as possible.

The Ego Tunnel

Posted by Peter on July 25, 2011
Posted in: Book Reviews, The Human Mind. Tagged: , , , .

Book review: The Ego Tunnel: The Science of the Mind and the Myth of the Self, by Thomas Metzinger.

This book describes aspects of consciousness in ways that are often, but not consistently, clear and informative. His ideas are not revolutionary, but will clarify our understanding.

I didn’t find his tunnel metaphor very helpful.

I like his claim that “conscious information is exactly that information that must be made available for every single one of your cognitive capacities at the same time”. That may be an exaggeration, but it describes an important function of consciousness.

He makes surprisingly clear and convincing arguments that there are degrees of consciousness, so that some other species probably have some but not all of what we think of as human consciousness. He gives interesting examples of ways that humans can be partially conscious, e.g. people with Cotard’s Syndrome can deny their own existence.

His discussion of ethical implications of neuroscience points out some important issues to consider, but I’m unimpressed with his conclusion that we shouldn’t create conscious machines. He relies on something resembling the Precautionary Principle that says we should never risk causing suffering in an artificial entity. As far as I can tell, the same reasoning would imply that having children is unethical because they might suffer.

The Frequency of Wars

Posted by Peter on July 6, 2011
Posted in: Politics. Tagged: , .

The frequency of wars (pdf) by Mark Harrison and Nikolaus Wolf has some disturbing claims about the trend in wars. Despite many measures (such as fatalities) showing good trends,

One indicator has moved persistently in the wrong direction. How many countries are at war at any given time? Exploiting the Uppsala dataset on armed conflicts, backdated to 1946 and updated to 2005, Joseph Hewitt has noted upward trends in the annual percentage

That’s not as bad as it sounds, since an increase in the number of countries has played an important role in that trend (recognition of new countries can change the number of countries involved in a given conflict without any change in the violence in a given region). Still, that’s hard to reconcile with the widespread belief that wars are becoming rarer.

They suggest that more effective tax collection has provided governments with the ability to wage more wars than they could afford in the middle ages, and this has had more effect on the frequency of war than changes in the desire for war.

It’s not due to failed states – wealthy countries are as likely to start wars as poor countries. Democracy and international trade don’t by themselves do much if anything to reduce wars – only democracies without term limits engage in fewer wars:

democracies where leaders are subject to term limits are as likely to make war as autocratic states ­ and term limits are increasingly widespread.

Douglas Gibler who suggests that peace and democracy are joint symptoms of stable borders, not the other way around.

Trade and democracy are traditionally thought of as goods, both in themselves, and because they reduce the willingness to go to war, conditional on the national capacity to do so. But the same factors may also have been increasing the capacity for war, and so its frequency.

Martin, Thierry Mayer, and Mathias Thoenig have shown that trade had a double effect on the relative frequency of pairwise conflict. More bilateral trade reduced this frequency, but more multilateral trade raised it. Over time both multilateral and bilateral openness increased on average, but the net effect was positive. For any country pair separated by less than 1,000 kilometers, globalization from 1970 to 2000 raised the probability of conflict by one fifth (from 3.7 to 4.5 percent). On the interpretation of Martin and his co-authors, the same forces that widened the scope of multilateral trade made bilateral war less costly.

Britain relied overwhelmingly on imported calories. Despite this, in two world wars Britain had little difficulty in feeding its people. In contrast, those countries that believed themselves secure [due to abundant local crops] were the first to run short of food.

One encouraging point – starting wars probably isn’t rewarded:

On the record of all wars since 1700, to start one attracts a 60 percent probability of defeat.

Do these claims have any implications for the desirability of seasteading (i.e. could increasing the number of “countries” via seasteading have the same association with increasing frequency of wars as on land)?

It’s unclear whether a seastead that flies the flag of Panama would be an additional country in the relevant sense. They might be more like British colonies for quite a while, although that analogy has unpleasant long-term implications if their relations with their affiliated country deteriorate they way Britains relations with it’s colonies did.

New land-based countries are often the results of conflicts (e.g. Kosovo). Creating seasteads that way appears less feasible.

It’s unclear whether seasteads will have borders sufficiently similar to land-based borders to produce similar disputes over where the border should be.

And the societies that seem most seastead-like (Singapore, Hong Kong, Dubai) seem peaceful.

(HT FuturePundit).