Paul Krugman calls Social Security a minor fiscal issue, citing this report in which Social Security spending as a percent of GDP levels off at around 6% in 2030. For someone whose blogging modus operandi is pointing out disingenuous arguments made on the right, Dr. Krugman is skating on thin ice here. The Trustees Report that he uses as the basis of his numbers shows GDP rising 66% between 2010 and 2020, which would be on par with the rise between 1990 and 2000. Huh? Is that what the “-invisible bond vigilantes”- are telling us? The Trustees Report assumes GDP growth of 160% between 2010 and 2030. If we are becoming Japan as Krugman says, maybe the more relevant comparison is the 66% GDP growth seen in Japan 1990-2010. Changing this assumption has a large effect on Social Security as % of GDP.
Now, Dr. Krugman could argue at least two points:
First, even if you assume Japanese-style growth, Social Security would still account for less than 10% of GDP. This however leaves aside the state and municipal versions of the pension problem, that might eventually take the form of demands at the federal level, and in any case are relevant to state taxpayers. It looks like he is telling half the story, and then with only half the numbers. Not to mention Medicare, which perhaps is only a different issue in a pedantic sense, if not in terms of urgency.
Second, if further stimulus were applied as Krugman recommends, we might have a chance of achieving those GDP targets. If however income is now structurally impaired by demographics or other factors, as some argue, those numbers are out of reach pending some new technology. Maybe you can double down on a bad balance sheet if your cash flow assumptions are good, but in this case they seem to be a product of naive empiricism. This is the same sort of empiricism that got pension funds that had assumed 8% annual returns in trouble. Those numbers seem to be picked from the same fictional future world as the GDP projections that Krugman endorsed, and as usual there is a willful blind spot to reasons why the past might not reflect the future.
To be clear, although it would be largely in my self interest, I am not some right-winger bent on ending social security. In my view, the minimum age must be raised. Dr. Krugman rightly points out that this would put a disproportionate burden on low-income workers, which is why I counter that any age hike must be coupled with means testing, which I prefer to higher taxes. Those on the left that argue that means testing would undermine the popularity of the program are absurd partisans. What is the metaphor? That would be like wearing the wrong color shirt to the wrong neighborhood, getting shot and then freaking out that your shirt is ruined, but not going to the hospital. Neither the right nor left would be thrilled with with an age hike / means testing deal, but that’-s what makes a good compromise.
I gave a talk on Thursday night at the New York Investing Club meeting.
The basic points:
Gold does well when real rates of return are low. Real rates describe the price of gold much better than inflation alone. This is because real rates reflect the opportunity cost of holding a relatively useless asset. Part of the reason gold seems irrational is that this extrinsic pricing is unintuitive and largely unappreciated.
Gold does well when liquidity, measured for example by LIBOR, is not especially tight.
Sentiment can be predictive with gold.
The “-extrinsic”- way of thinking is natural in the fx world where all trades are two?sided, and the idealized one?sided currency , e.g. Dollar Index, is a weighted average of two?sided rates. Other examples: the Fed Model and Dividend Discount models explicitly tie together the pricing of equities and interest rates. The housing bubble was to some extent already a mispricing of money in the form of interest rates. What was the “right” price for housing given the price of money?
Do people who claim that assets exhibit “irrational” moves have a clear idea of what level of volatility would be “rational”, especially given such cross?influences? I do not endorse the Dividend Discount Model, but no-one can deny that it is a fundamental model, and it predicts higher volatility when rates are low. Given current levels, a 10% one day drop of the market is by no means absurd. The stock market should also have more idiosyncratic volatility when it is driven by “-top-down”- policy, rather than averaging many “-bottom-ups.”-
There is perhaps a “-long-termism”- fallacy. Even if prices change glacially, if you want to maintain a portfolio limited to 30 stocks out of a universe of 6000, it is easy to see how a sensible person might change the “-best ideas”- list with some frequency. The more prices change, the more frequent portfolio changes would be in order from a valuation standpoint. Again, asset prices are not hermetically sealed, one?sided meanings and values. There is always some discount factor or relative valuation at play.
The easiest way to achieve a shock “20 standard deviation” move is to just not mark (or mis?mark) for a while. Deferral of pricing is much more likely than active trading to originate an explosion large enough to affect the underlying economy. Deferral of pricing, not active trading, played a large role in the corporate credit crisis. Social Security and entitlement programs are also “off balance sheet” debt. At least banks failed to predict the future. Governments failed to predict the past. The basic demographic and longevity trend has been apparent since at least the 1960s.
Demographic trends suggest lower real returns than those seen in the 20th century. Do economists have a demographic blind spot?
Jacqueline Best’-s The Limits of Transparency is carried by sensible concerns on the tension between efficiency and stability, the tension between promoting employment and stable money, and the political implications of seemingly neutral economic policy. However, while economists, market participants and academics will find much that is thought-provoking here, the book does not actually deliver a compelling critique of transparency.
Much more time is spent promoting institutional arrangements of “-constructive ambiguity”- (e.g. Bretton Woods) than pointing out short-falls with transparency. The problem is that what’-s being argued for under the aegis of “-ambiguity”- is just flexibility, mostly in the form of deferring decisions. (Not to mention that institutional arrangements can also become inflexible.) Clearly ambiguity is desirable when it manifests itself as flexibility, but this does not mean that ambiguity is desirable in and of itself. Best makes some pertinent observations (that are, for instance, relevant to CDS dynamics) but tries to wrap them up in a pleasingly ironic theory that alone threatens to undermine her conclusions. Early on, she tells us that she is “-drawing inspiration from both postmodernist and critical theoretical traditions.”- The thematic emphasis on ambiguity is no doubt influenced by such strains of thought, which stress “-the irreducibility of difference.”-
The early Bretton Woods regime is lauded for its ambiguity and “-continuous deferral”- of adjustments, and this points the the fundamental problem in the analysis. While active trading may increase short-term volatility, the author espouses a philosophy of deferral that is actually more dangerous and more at the cause of the financial crisis than active trading. Deferral of pricing creates the illusion of constancy where there is actually change, and enables longer-term booms and busts that are more pernicious and cause longer-lasting pain and dislocation than the “-intersubjective”- spirals the author warns against.
Take an example: traders push CDS prices up, causing the underlying entity’-s borrowing costs to rise, thus ensuring default. This “-intersubjective”- dynamic would not be possible were there not already a fundamental basis for concern over the entity’-s debt —- if the entity had not already irresponsibly deferred its obligations. Which problem is more fundamental? This of course is exactly what happened in the credit crisis, as banks refused to transparently price their holdings. “-Continuous deferral”- is a recipe for less frequent, perhaps, but almost certainly more intense explosions. Is this kind of deferral not at the heart of the impending entitlement crisis, another kind of “-off balance sheet”- debt? It doesn’-t matter if pricing will never have a perfect technical solution, you still try to price up to the point of ambiguity, which, as Best repeats, is always there anyway.
Lastly, the author holds out the Bretton Woods period as one of unsurpassed prosperity while ignoring the corresponding population boom and other factors contemporaneous with the currency regime. For their sake, Keynesians need to heed the demographic winds more closely.
[Originally posted to Amazon, 2/15/10.]
No one who makes a living trading really cares about EMH, but I’-m not sure why failure to predict under EMH is that surprising. Markets do more discounting than predicting. That’-s part of the reason why stocks are volatile —- the last data point tends to be extrapolated into perpetuity. It is true that factors like emotion and momentum additionally move prices, but to me this points to a fundamental challenge in valuation: the idea that there is an “-intrinsic”- value, when in fact all values interact, with prices reflecting structural realities and other prices. The misallocation in the housing bubble was to some extent already a mispricing of money in the form of rates. What was the “-right”- price for housing given the price of money?
The price of money in turn was influenced by the demographic savings glut that previously fueled the tech bubble. At this point, governments failing to predict the past —- the trend of increased longevity —- seems like the biggest problem. The escalated contentiousness in the Senate is, in part, a symptom of this slow motion failure and the “-lower stakes”- for all of us.