Sunday, July 26, 2009

History of information transmission….

For those who never saw any of the Burma Shave signs, here is a quick lesson in our history of the 1930's and '40's. Before there were interstates, when everyone drove the old 2 lane roads, Burma Shave signs would be posted all over the countryside in farmers' fields.

They were small red signs with white letters. Five signs, about 100 feet apart, each containing 1 line of a 4 line couplet......and the obligatory 5th sign advertising Burma Shave, a popular shaving cream.

Here are more of the actual signs:


DON'T STICK YOUR ELBOW
OUT SO FAR
IT MAY GO HOME
IN ANOTHER CAR.
BURMA SHAVE

TRAINS DON'T WANDER
ALL OVER THE MAP
'CAUSE NOBODY SITS
IN THE ENGINEER'S LAP
Burma Shave

SHE KISSED THE HAIRBRUSH
BY MISTAKE
SHE THOUGHT IT WAS
HER HUSBAND JAKE
Burma Shave

DON'T LOSE YOUR HEAD
TO GAIN A MINUTE
YOU NEED YOUR HEAD
YOUR BRAINS ARE IN IT
Burma Shave

DROVE TOO LONG
DRIVER SNOOZING
WHAT HAPPENED NEXT
IS NOT AMUSING
Burma Shave

BROTHER SPEEDER
LET'S REHEARSE
ALL TOGETHER
GOOD MORNING, NURSE
Burma Shave

CAUTIOUS RIDER
TO HER RECKLESS DEAR
LET'S HAVE LESS BULL
AND A LITTLE MORE STEER
Burma Shave

SPEED WAS HIGH
WEATHER WAS NOT
TIRES WERE THIN
X MARKS THE SPOT
Burma Shave

THE MIDNIGHT RIDE
OF PAUL FOR BEER
LED TO A WARMER
HEMISPHERE
Burma Shave

AROUND THE CURVE
LICKETY-SPLIT
BEAUTIFUL CAR
WASN'T IT?
Burma Shave

NO MATTER THE PRICE
NO MATTER HOW NEW
THE BEST SAFETY DEVICE
IN THE CAR IS YOU
Burma Shave

A GUY WHO DRIVES
A CAR WIDE OPEN
IS NOT THINKIN'
HE'S JUST HOPIN'
Burma Shave

AT INTERSECTIONS
LOOK EACH WAY
A HARP SOUNDS NICE
BUT IT'S HARD TO PLAY
Burma Shave

BOTH HANDS ON THE WHEEL
EYES ON THE ROAD
THAT'S THE SKILLFUL
DRIVER'S CODE
Burma Shave

THE ONE WHO DRIVES
WHEN HE'S BEEN DRINKING
DEPENDS ON YOU
TO DO HIS THINKING
Burma Shave

CAR IN DITCH
DRIVER IN TREE
THE MOON WAS FULL
AND SO WAS HE.
Burma Shave

PASSING SCHOOL ZONE
TAKE IT SLOW
LET OUR LITTLE
SHAVERS GROW
Burma Shave

Saturday, July 25, 2009

Still puzzled over the non role of history?

This from the NZ Herald this morning….  journalists still don’t get it:

“It's difficult to fathom how a company can report a 66 per cent decline in profit but still see a 12 per cent leap in its share price. But that's just what American heavy equipment maker Caterpillar found this week as investors responded positively to a result better than they had feared and a forecast…”

Investors are of course looking at the present value of expected future earnings. Possibly, just possibly history confirmed the way those expectations were formed…. but that’s all.

Thursday, July 23, 2009

The Failings of Financial Economics… or Financial Economists??

The Economist magazine this week published an editorial plus two supporting articles assessing the state of the art in economics -  that is macro and micro – the latter with an emphasis on finance. As usual it is thoughtful and worth a read and has their on going paranoia about bubbles and asset pricing (what is a bubble?).

In the economics school I come from we used to only partially joke that there was no such discipline as macro economics (you can imagine what we thought of sociology). Even leaving our physics envy to one side there are a couple of fairly obvious problems which I think the Economist misses but the recent recession provides abundant evidence of.

Problems with macro and the policy prescription, cut to their bone seem to me to be:

Macro

1.   a simple fallacy of composition. It is highly unlikely that any model which simply “sums up” the aggregate behaviour of individuals into a “lump” which is seen as not a lot different to the parts is going to provide good explanations let alone predictions. So the idea that aggregate economic behaviour could be summed up then reduced to the simple, single target of monetary policy was ever flawed.

You don’t have to be of the left to recognise that quantitative change is often accompanied by qualitative change – water is H2O whether in the form of ice, steam or potable drinking stuff…. but the chemical model is downright useless for describing the difference between the three.

So too economic behaviour. Doris and her chequebook are not a good proxy for the nation – champagne or no champagne Mr Keynes.

2.   The policy problem. Economist Steven Landsburg calls it the greatest temptation. Hayek called it the Fatal Conceit. The Economist thinks its business as usual and is in awe (for some odd possibly very English deference related reason) of central banks.

Simply put even if macro delivered plausible explanations, nay descriptions would be a start, of aggregate behaviour, the idea that a monopoly of the currency vested in an institution characterised by coercive powers could influence – to a material extent and in a desired direction – the behaviour of individuals is flawed. Fatally flawed.

So macro – and the policy prescription arising there from is not worth barking at. It was never going to get you there. The Greenspan years reflect damn good luck confused with “I did it” ego. Listening to those who disagreed with Greenspan would have produced no better outcome – so no point blaming him.

If there is blame to be laid it goes to the very base… the epistemological assumptions of macro. Very unsexy but think… what are the flaws of reductionism, what is the fallacy of composition, what is an over identified model, how does quantitative change beget qualitative? It is in the bowels of the philosophy of science that the weaknesses lie.

Meantime – since there is simply far too much tenure at stake for anyone to tackle these issues soon – best to place no faith in central bank fiddling, eschew the macro endeavour as much as possible and try desperately not, not to rely on monetary or any other central bank based policy (Keynesian central bank stuff suffers the same problem while killing society with pretended free lunches as well) for trips to higher, greener pastures.

In a classic piece of understatement the NZ Business Roundtable’s Roger Kerr – an grossly under rated economist who is regularly misrepresented as a lobbyist – has it that “monetary policy needs mates”.  As is clear above – I would say, “yes… but better give it away totally thanks.”

Micro

To the credit of the Economist they open their micro salvo by stating very clearly that simply saying “the market is not efficient” is woeful as critique. And so it is – a pathetic  attempt to underwrite the jobs of security analysts without adding much at all.

Even with the greatest investors of our time – Buffett and Munger – we see Charlie M in his wonderful “The Almanac of Poor Charlie” time and again be oh so very careful to say  “the strongest form of market efficiency” does not hold. Wonderful Warren advocates index based investment as likely to be best for 80% of investors.

So – they are saying strong form doesn’t hold. Strong form efficiency was ever only the logical outcome of thinking clearly. That, for goodness sake, is why Eugene Fama allowed of semi strong and weak form efficiency. So the left who would grab at every crash, jump and short run inconsistency whereby an apparent inefficient outcome might be bent into a call for intervention, the securities analysts with job protection uppermost in mind and the fund managers afraid of index investment proving them valueless ought – 40 years on - to go home and have a re think.

We know that there is a kind of triple curse on all investment which works roughly as follows:

1. the market is efficient enough that few, if any, pickings are to be had net of costs

2. to find the pickings you have to look in places where assets are valued inefficiently. In those places there is, by definition, little liquidity – so liquidity risk gets you.

3. to get the returns of the hard to find and illiquid assets up to a respectable level requires leverage – worse its likely leverage in an illiquid market.

So there you have it. No escape. Inefficiencies? For sure – if you look in illiquid places. Returns? For sure if you take enough leverage risk. You want more efficiency – fine – but the pickings will be ever slimmer. People are ever chasing though – the temptation to search is high and so is the risk.

One is tempted to say – pretty much an MM world. Exactly as predicted circa 1958. The closest financial economics ever came to physics – no free lunch is another way of expressing the laws of thermodynamics.

No need for behavioural quirks or irrational humans.

So is micro… at least in financial economics a failure? Far from it. The description and the explanations bear up well. The major, if general predictions are borne out:

Markets are generally too efficient over the long run for people, or the institutions which claim to act faithfully on their behalf, to consistently beat risk and become unjustifiably rich.

The last 18 months have seen unparalleled evidence that this is indeed the case.

The failure for micro has been the same failures physics and the “hard sciences” have suffered. Physics in general and Newton in particular has not, to this writing, made a strong enough case for gravity that the vanity industry which sells anti sagging crèmes, pills and machinery has gone out of business.

None of the quantum physicists has put astrologers out of business. Nor has Einstein – Nobel prize and undoubted genius - got any real traction for the notion that Neil Armstrong got back from the moon younger than he left earth.

What path is the most promising?

Is there a best way ahead and what is it?

There may be. A key reason for the failures of micro and macro to advance has been a singular inability to come to terms with what economists Harold Demsetz and Armen Alchian so long ago called “imperfect worlds”. The world is not perfect. So perfection is the wrong benchmark – especially for expectations of “how things ought to be” and even more dangerously prescriptions of what to do to achieve perfection.

Ronald Coase – in the 1930s produced one way of conceiving of this issue. There are, he noted, always transaction costs… just as in physics the world of assumed vacuums is just that – an assumed world – so the world of economic transactions without haggling, politicking, rent seeking, selfish behaviour and constant costly bickering does not exist outside the economists laboratory.

The Austrians – in the main F.A. Hayek – conceived of it as a “costly information” problem. The costs of gaining enough information – and brilliant teacher of this stuff the late Paul Heyne crystallised the line of thought with his pithy “what’s the point of disclosure if no one is paying attention” – are formidable, and in some cases – like the Central Bank – insurmountable.

To understand more we might focus harder on these issues. To prescribe less and less uselessly economics the discipline might focus on costly information and transaction costs – and how to explain that to more people.

The jury has yet to be assembled on the conclusions for policy if we knew more and if, as a wider society, we had a better understanding of the issue – meantime, and certainly a more than defensible policy in all arenas would be …. less is more – or in the words the Economist is so fond of quoting – First do no harm.

Tuesday, July 21, 2009

Respect Cost as Well as Process

Provocation and the ‘homosexual advance’ defence

Stephen Franks

When the jury delivers its verdict on Clayton Weatherston, whatever it is, those responsible for our criminal justice system should be ashamed. This case has exhibited the gross self  indulgence of this system.

Weatherston was caught covered in blood having taken a knife to the room of a much smaller former girlfriend. The only question was "what’s your excuse".

The court should have asked him that question within a month of arrest, giving him a day at most to put it. Perhaps if the jury thought he’d raised enough uncertainty that they wanted to hear more the case could be adjourned for another month while Weatherston dug up any supporting evidence for his excuse. Another day at most should have been allowed to present that.

Criminal justice insiders have persuaded themselves that their indifference to cost constraints on process is evidence of the supreme importance of what they do. Their exemption from the normal constraints that affect other social institutions is flaunted, instead of being cause for embarrassment.

Eliminating the defence of provocation is not the answer. It can be a legitimate excuse. There may be times when provocation does reduce the moral culpability of murder to manslaughter, when the murderous reaction is what any normal person could feel driven to. But it should not be allowed to work if it only works when coupled with "I was drunk" or " I was a nut case" "he was gay".

The traditional common sense of the law penalises or rejects defences that would be offered by too many people, and be too hard to disprove - as I’ve mentioned before,  the rejection of ‘ignorance of the law’ as a defence is a simple example.

More importantly the courts should balance the incentives to drag out such problematic excuses. Part of the answer is simple. It should not be cost free.

It should be an extremely expensive excuse - to be risked only when any normal person might have reacted similarly. The cost of raising it should be a massive increase in sentence, because of the extra hurt it causes those left behind, and the clear admission it so often makes, of lack of remorse.

The remedies to these grotesque abuses of process are in the hands of the judges.

Monday, July 20, 2009

Better to waltz with Matilda

The recent initiative brought home by Bill English which allows “lost” superannuation savings to be brought back to N.Z and stuck in Kiwi Saver accounts turns out to be an exercise in exchange risk and at best a bit of tidiness.

The applicable Australian tax rate on such funds is 15%. The NZ rate is 19% or 30% – why would you bother? Better to allow the Australians to use your money and pay you a better net of tax return.

Yet another reason to flatten that NZ tax rate.

Sunday, July 12, 2009

Hopeless choice

In the interests of improving educational outcomes – at least in terms of what are currently seen as priorities – the present government is in the process of switching some funding away from what are perceived as hobby centred community education and learning programmes to numeracy and literacy focussed initiatives.

Not unexpectedly there is the usual outcry as the various pros of differing programmes are promoted and lauded – in many cases with more than valid argument while the new policy promoters dish up the hard to argue with apple pie of numeracy and literacy for the young.

In the middle of all this is a Minister – pity her- trying to choose between say (a genuine example) Jack who took a community based cooking class the better to look after his Alzheimer's stricken wife and class of young people whose literacy skills are woeful – while the community at large – a recession notwithstanding – scream that any refusal to fund both is inhumane.

Obviously this is hopeless. The reason it is hopeless is that because government is funding both, other solutions are crowded out and the level of taxation for education on the populace means said populace certainly cannot afford to do for itself.

Even the most modest voucher based system might give Jack back the tax he pays for education and the parents of the illiterate – so that individuals – not collective blocks driven by self interest – can choose what suits them.

The problem here is having the state choose by making the state the provider. Funding the state in these roles impoverishes the would be consumer – the students young and old.

The fundamentals are simple – return the tax raised in the name of education to those to whom it belongs, charge for the courses being offered and the automatic allocation systems which match student and supply aspirations will solve the problem no Minister can.

I fear the level of courage required is well beyond those operating in most western economies – certain those to be found in New Zealand.

Thursday, July 9, 2009

Systems which encourage cheating I

In “Poor Charlie’s Almanac” the great Charlie Munger gives a good example of the need to avoid creating systems which encourage cheating…. workers compensation.

Summarising – stress is real and the misery it causes can be real. So compensating people for workplace stress seems to be a good idea and a noble thing to do. The trouble is in devising a compensation system it’s close to impossible to prevent huge levels of cheating.

Once you reward such cheating he notes, you get crooked lawyers, crooked doctors, crooked unions, crooked employers – all participating in the scheme. The result is a string of disastrous behaviour and the net effect is to create enormous damage.

So it is often much better to let some things go uncompensated – making life hard – than it is to create systems that are easy to cheat.