Eugene Fama of Chicago Booth School of Business is one of the three winners of the 2013 memorial Nobel prize in economics – and a rare winner of one of these softer prizes whom I consider extremely well-chosen (the efficient market hypothesis will be discussed later).
Yesterday, CNBC's Rick Santelli asked him about the quantitative easing.
The interview has sparked a controversy in a part of the economics blogosphere. Here is the video:
Saw the title, was curious about Fama's views on quantum entanglement. Disappointed :(
ReplyDeleteLOL, has QE ever been used as an acronym for quantum entanglement?
ReplyDeleteI smiled when Fama said to Santelli: "There is so much confusion in what you said, it's difficult to answer."
ReplyDeleteDo you happen to know that feeling, Lubos?! ;-)
Fama is at the University of Chicago's School of Business (business economics) - "Booth" above - not the department of economics that Milton Friedman helped to make famous. Just a detail, Dr. Motl.
ReplyDeleteHi, I've never claimed that they were from the same department. However, what I did claim and do claim is that both of them are counted into the Chicago school of economics
ReplyDeletehttps://en.wikipedia.org/wiki/Chicago_school_economics
Wasn't that the reason for QE? To keep nominal rates from falling below zero and preventing capital flight to the world's mattresses?
ReplyDeleteIf QE is mere asset-swapping, I don't understand why we keep hearing that the Fed has been buying bonds directly from the Treasury.
ReplyDeleteDear Smoking Frog, QE means that the central bank is buying financial assets from commercial banks
ReplyDeletehttps://en.wikipedia.org/wiki/Quantitative_easing
but if one considers the operation that you describe, it would be even more immaterial because both the Fed and the Treasury are just two pockets of the same U.S. taxpayers' funds, so why should it matter if one of them buys something from the other? The U.S. taxpayer owns both; the U.S. government is responsible for both.
Well, one must distinguish short-term and long-term interest rates. None of them will really drop below zero exactly for the reason you mention - one could use mattresses as a better solution.
ReplyDeleteQE is meant to increase the money supply and because the normal monetary policy trying to lower short-term interest rates is already depleted, QE means that they start to buy longer-term bonds, too. This has the effect of lowering the lower-term interest rates as well but the flip side of the same coin is that it adds positive pressure on the short-term bonds because they're being issued to get the cash needed to buy the long-term ones.
Makes sense?
Hi Olena, LOL, way too often. ;-)
ReplyDeleteQE has had an effect on the behavior of a few of my relatives. They're convinced that it's equivalent to the goverment printing huge piles of money and that hyperinflation is just around the corner. Supposedly the only reason the US hasn't yet collapsed into anarchy is because of some unclear left-wing conspiracy. They've stocked up on gold, guns, and MREs.
ReplyDeleteExactly, I too thought this is about something Quantum Enything ?... :-D
ReplyDelete... goint to finish readint the List of superpartmers now :-)
These views are quite close to those of some conservative TRF readers, especially those who worship the gold standard. All such folks are confident that it's extremely important what the payment units look like and how one redistributes them.
ReplyDeleteIn reality, none of these things really matters. America could switch to the Iranian currency and use bones from chickens as coins or banknotes and if there were comparable expectations about the inflation rate and if the swapping were done fairly at the beginning, nothing would really change.
Hahaha, when you look at the list of recent TRF articles in the right side bar, and intentionally misread the two newest ones at the top together, you get
ReplyDeleteEugen Fama is right on QE Gravity (2013)
Quantum Entanglement Gravity ... :-P :-D ;-)!
Impressive observation ;-).
ReplyDeleteWhatever the Fed is doing, the economy is not responding. Unemployment is very high, and the only drops occurred because people left the labor force. Despite very low interest rates, inflation is low, but so is growth. And the low interest rates are raising havoc among individual savers, retirees and pension funds.
ReplyDeleteQE amount to 6% of the American GDP. The fact that it doesn't seem to be doing anything suggests that the economy would be in free-fall without it. Vox Day's opinion that we are in debt deflation and poised for depression seems relevant here. Let's hope he's wrong.
Funny, after seeing this comment, I scrolled to see the part of the sidebar where there are the recent TRF Articles, and thought that I had actually found an article saying "Eugen Fama is right on QE gravity (2013)", and thought that the "2013" was the time stamp or something.
ReplyDeleteI'm going to read this closely as it concerns topics that I've been reading about lately. Looking forward to reading a future article on "efficient markets". What I find curious is that Fama and Robert "Irrational Exuberance" Shiller do not profess some sort of gentleman's agreement where each concedes that the other's hypothesis is perfectly valid in one domain or set of scenarios, while claiming that his own applies the rest of the time. No, they actually tear into each other like WWE wrestlers hopped up on caffeine!
ReplyDeleteWhat irks me, even though I should be used to it by now, is that I have been reading and thinking about this QE (and "tapering") thing for weeks and still I could not write such a long article, at least not without yet more study and reflection. And Luboš does this as a mere afterthought, something squeezed in when he has an hour's free time. More and more he reminds me of Leviathan in the Hellraiser movie, a beam of penetrating blackness that sweeps across the land like the hands of a clock across its face, before which no shelter is possible, no secrets remain concealed, no skeletons unseen. It's ... uncanny.
Dear Eugene, you *could* write such a thing, too!
ReplyDeleteThe Nobel committee was surely trying to achieve some kind of a balance by naming both (and the third one whom I know next to nothing about). Fama has been making fun of Shiller's ability to predict the crises - with his pessimism on prices, Fama said, he could have claimed to predict any crisis given a long enough horizon. ;-)
Shiller's predictions are fun but it's sort of an ad hoc guessing - I don't quite understand the theory behind his proclamations and if he claims one to exist.
Santelli hates QE and has consistently and vociferously railed against if from the beginning. You seem to be very confused about your facts.
ReplyDeleteOK, I don't know which way he cares - I didn't have a clue who Santelli was a few hours ago and I will forget about him in a few hours again - but he's just wrong to care.
ReplyDeleteWow. Were you watching the same clip that I was? Fama claims that the Fed purchasing debt is not a big deal. In his words, buying long term debt to reduce rates is a 'nothing activity.' No wonder the Swedish central bank gave this idiot the prize in memory of Alfred Nobel.
ReplyDeleteThe problem is that Fama is an absolute fool. Any trader or long term fundamentals based investor will tell you that Fama's Fama efficient-market hypothesis theory is useless and obviously wrong. Fama concludes that people like Buffet could not exist because their returns will be random and match that of a general large cap index. But that is clearly not the case. There are many long term investors that have done very well by taking advantage of the fact that the market is not efficient.
Note the obvious problem with Fama's EMH; Fama assumes that successive price changes are independent of changes that took place in the previous period and that the price changes have some probability distribution that is known.
For EMH to be true, all actors in the markets have to interpret information the same way. They also have to be impacted by the knowledge in the same way only must all knowledge be interpreted in the same way and have the same time preferences. As the Fama builds his theory on objectivity. For him all investors are essentially the same. They have the same goals and the same time preferences.
But the assumptions are invalid. We know that people jump on board 'hot' markets precisely because they have gone up in previous periods. We also know that the price changes tend to be greater as one gets to the latter stages of a secular bull or bear market run and that increases tend to be not as great per unit of time as collapses. Spend two hours on CNBC and you see a vast difference in time preferences. Some players are interested in high frequency trading and consider a single day too long a holding period. Others look at the very long term and are quite happy when their favourite stocks are falling in price because they look to acquire as many shares as possible for as little as possible. Some want cash flows. Others want growth and capital gains.
If anything, the clip shows that Santelli's grasp of economics is far better than Fama's. Santelli has spent a lot of time in the trading pits and knows that reality is very different from Eugene Fama's model. Santelli also understands that Fama has little clue about monetary theory. Unlike Fama, he knows that the Fed cannot start to unload long term treasuries without causing a huge rupture. In the trading pits that he covers any sell-off of long term treasuries will destroy the currency. In effect Fama is cheering the path that Gideon Gono made popular in Zimbabwe. That did not work out very well. Sadly, I think that giving the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel to Fama will have one positive effect. It will make people forget that Al Gore, the IPCC, and Obama were awarded the Nobel Peace Prize.
The efficient market hypothesis is the zeroth approximation that is totally critical for the understanding of the markets anywhere.
ReplyDeletePeople like Buffett are bound to exist by chance - much like pieces of a random walk that go up for a while - and aside from Buffett, there are many very similar folks who lost their money and who are not famous although they don't differ too much. I don't claim that one can never find some patterns that seem to go beyond chance. But relying on all these patterns always carries risks so soon or later, the data restore the idea that the profits are random.
You might want to look into what hyperinflation will look like. For a long time you will not see much but general price increases, often hidden by new packaging and changes in portion sizes for processed foods. You will see Dollar stores increase their prices to $1.50 or $2 for many of their goods. In January of this year Wendy's dumped its 99-Cent Menu. McDonald's just announced that it is ending its Dollar Menu. The changes had to be made because the companies had seen a substantial increase in the cost of their inputs as the price of buns, vegetables, meat, condiments, etc., kept going up. A dollar of input cost in 2007 was $1.20 five years later even though billions had been spent on eliminating non-value-added steps from the production, transportation, storage, and distribution processes for all goods.
ReplyDeleteSome of your relatives probably know a few things that you do not. While you will not see hyperinflation until it is too late the pattern will be pretty clear. Things will seem acceptable until faith is lost and within a few months the currency will die.
http://d1w116sruyx1mf.cloudfront.net/ee-assets/channels/cdd_default/GoldPriceInWeimarMarks.jpg
They also probably know that because the USD is the reserve currency there will be a big fight by all central banks to keep it afloat. Other central banks will print money and buy debt just as the Fed does. To provide cover for their activities they might print money and buy debt from each other. The reporting agencies will 'adjust' price gains for 'quality' or manage to ignore categories that used to be counted as a part of the same cost. For example, they can show that the price of flying went down by not counting the fees paid for meals, drinks, or luggage even though they all used to be rolled up into costs from previous comparison periods. But in the end bad accounting and finance cannot save the day and reality will intervene. At that point we will find if the interventionists were right about the Fed's injections of liquidity being benign or if the anti-Fed, hard money types were correct.
There is no central planning in anything I wrote.
ReplyDeleteIn the long run, the preppers will be proven right. Anarchy will descend, neighbor turn against neighbor, cannibalism will make a return. But it could be a couple of centuries before that happens. In the meantime, why not enjoy life to the fullest. It is extremely unlikely that some nightmarish breakdown of social order will occur within the next couple of decades. Converting significant amounts of cash into an illiquid and highly volatile asset such as gold could be a bad choice. A diet of canned food for months is not very healthful nor tasty. But if you like the survivalist lifestyle, then go for it. Whatever floats your boat.
ReplyDeleteHere I would not entirely agree. Perhaps Buffett was lucky initially. But not in the second half of his career. It's not like there is an army of footsoldier-investors who are indistinguishable from one another and at every mile that they advance, a few hit on a cache of weapons and gold by accident while the majority succumb to artillery fire and then everyone's chances are reset to zero at the next iteration. Buffett is doing something right and it probably involves little sophisticated quantitative analysis. His "value investing" principles can be emulated, but the "social capital" he has built up cannot. Powerful people approach him first to offer lucrative investment opportunities, they do not approach his competitors. This isn't illegal, it's not insider trading. It's an example of "network effect" where strength builds upon strength.
ReplyDeleteTo cultivate this appeal, he has built a public persona apart from the hustle of Wall Street. Staying in Omaha, Nebraska, is an essential part of this persona. The world of finance is a cut-throat environment, but CEOs of major corporations see themselves as industrialists not financial people and being popular and well-liked by them is Buffett's recipe for success, I think.
"The efficient market hypothesis is the zeroth approximation that is totally critical for the understanding of the markets anywhere."
ReplyDeleteSorry but the simplifying assumptions make understanding of how markets work by using EMH impossible. (Which is why Santelli, who has decades of experience in the trading pits knows that Fama is just an empty suit who does not know that his understanding is insufficient.)
For EMH to be true knowledge has to be interpreted in the same way by all investors. All those investors have to have the same goals and the same time preferences. The impact of that that knowledge has to be identical among all actors.
Since we have the requirement that all individuals have to interpret knowledge in the same way there is no subjective subjective element from knowledge formation. News would have the same impact on a Keynesian that it would on a Marxist, Austrian, or Monetarist. Is that realistic?
Since the impact has to be the same, that means that all market actors have the same goals, the same time preferences and must interpret the news in an identical way. That certainly is not realistic.
As David Howden shows, (see http://mises.org/journals/qjae/pdf/qjae12_2_1.pdf), LvMises used a similar model to examine the source of entrepreneurial profit and loss a few years before Fama created EFH. Like Fama, Mises did away with the Bergsonian time elements. He did this by making three assumptions; there was no connection between time periods and price changes, the distributions were known, and expectations were homogeneous. To remove friction from the system he assumed that there were no transaction costs. That gives you a static tool with which you can study price formation.
The trouble is that this tool is not realistic. There is no place for an entrepreneur in Fama's markets and there is no way for the factors of production to be coordinated effectively. And since EMH removes future uncertainty there is no room for real information.
If you are interested Howden does a good job explaining the problems with Fama. If you want more I suggest looking at someone like Nassim Taleb, who attacks the use of Gaussian mathematics as the basis of modern finance. As Santelli points out academics like Fama are clueless about how the real markets operate. Their models may work under some circumstances at some times but when something unexpected happens they crash and burn and require that those that used them get bailed out.
If you were objective and cared about the real world you might want to do some reading. If you did you would find that Santelli is a far better economist than Fama.
For a really smart guy you can certainly be clueless at times. What do you think that QE is? It is not the free market. It is central planning by an institution that is given a monopoly over the creation of money in the United States.
ReplyDeleteThe debate is between those that favour central planning and want to Fed to keep intervening in the market and those like Santelli, that want the markets to punish incompetence and lousy judgment so that the economy can finally begin to recover.
Vangel - once again you are doing yeoman's work. Well done! Keep it up! And Good Luck!
ReplyDelete