The Only Winning Move

I’m fascinated by this internet buzz going on right now as a result of Eugene Fama announcing in a New Yorker interview that he had cancelled his subscription to The Economist. You see, Fama is the progenitor of the now much-derided Efficient Markets Hypothesis - which basically says … well, actually what’s so fascinating about the public debate is that no one is really sure exactly what it says. It’s one of those things that if you just hear about it, you think you know what it’s on about, but when you sit down with pen and paper and try to quantify it, you realize it was saying something much more subtle that what you at first surmised. I’m enjoying this debate vicariously (I’m just an Economics major wannabe) because I see a lot of this in my own field Linguistics too: people taking straw man versions of something someone (usually Chomsky) said and getting all smug that they’ve seen through his preposterous claims. But of course, if the claims were really that preposterous, they’d hardly have caught on in the first place. Sometimes it happens, of course, that a scholar makes a preposterous claim as a kind of double bluff - trusting that everyone will trust that he is too smart to make the claim he seems to be making and in fact is making, and so taking him to have said something else entirely. To be fair, Chomsky banks on that a lot too. More often than not, though, it’s just the standard version. If an obviously capable scholar is making a claim that seems completely preposterous, then probably he ISN’T making quite the claim you take him to be making, and you need to go actually do your homework, and figure out what the claim actually is before shaking your stick at it.

That’s what seems to be going on with the Efficient Markets Hypothesis. A lot of people seem to have just read the name and assumed that it means “market prices are always completely accurate about the real value of something.” Which is, admittedly, the first thing that pops into your mind when you hear the name “Efficient Markets Hypothesis.” It seems to be claiming that markets are, well, efficient. And the most obvious reading of “efficiency” applied to “market” is “has accurate prices.”

But this is a straw man, and it’s easy to see that it’s a straw man if you think about it for any amount of time. The market mechanism - which involves negotiation toward a convergent price between buyers and sellers, CANNOT be “efficient” in this way. It just can’t. The market value of things has to fluctuate before it settles on its convergent value, or else the myriad market actors aren’t getting their individual input into what the price should be. So that means that at best the Efficient Markets Hypothesis claims that only after a certain timelag will prices approximate “value.” Unfortunately, the necessary existence of that timelag gives the Paul Krugmans and Brad DeLongs of the world ample opportunity to claim that markets are irrational, out of touch with “fundamentals.”

But actually, I’m not even sure the Efficient Markets Hypothesis is saying that after a given timelag the market price will be right. What it in fact seems to be saying is something along the lines of Market Quantum Mechanics - that market prices are simply the lowest we can go in trying to get at the “real value” of something; there is no finer analysis. There is no reference chart whereon we could look up the real value of something and compare it to the market value and check that the market got it right. Becuase of course if that were true, then someone would be obligated to come up with the “Efficient Chart Hypothesis,” which claimed that the chart was always the best guess we had, and some other gadfly - let’s call him Pohl Crookman - would rail against the “chart fundamentalists” who believed whatever the chart said.

There is an associated empirical test - which Scott Sumner sums up thusly:

Unless your Nostradamus-like ability to spot fundamental values does give useful predictions of where asset prices are going, with at least more than a 50/50 chance of success, then the theory of bubbles you have developed is essentially worthless. It would have no utility, for investors and more importantly for regulators.

That is to say, if you really can spot a “bubble” when you see it because you really do have access to some notion of market fundamentals that, interestingly enough, the market itself lags on, and you really do believe that the market eventually has to respond to these fundamentals (i.e. asset bubbles burst eventually), then this is a very useful thing for you because you stand to make a staggering profit on your insight. Or, more crudely, “put your money where your mouth is.”

For me, though, this is where the debate gets circular. OK, so this would seem to be a good falsification test for the Efficient Markets Hypothesis. If you can reliably spot bubbles, then you do indeed have something like the chart mentioned above, and I suppose therefore you have some basis for saying that markets are not so efficient - or at least that they’re less efficient than your magic chart. But I still have two problems with this. On the one hand, it still makes the Efficient Markets Hypothesis self-fulfilling in at least the following way: the opponent being challenged to demonstrate better than 50/50 ability to spot bubbles by selling bubble stocks short, or whatever, still has to have faith, to accept the challenge, that market prices eventually converge to their fundamentals. If he didn’t believe that, he wouldn’t believe that he could make a profit by selling the market short (because that depends on being able to sell a stock above its market value at a fixed date - i.e. is a bet that the market will have “realized” by that point that the stock is “overvalued”). So the challenge actually charges its opponents with believing in a kind of market efficiency, just at a different time resolution. And of course, even that is a bit unfair to the opponents, because probably what they’re bundling in with their claim that markets are inefficient is that while we can know that a bubble will burst, we can’t know when it will burst, and that this is in fact a hallmark of “irrational” speculative bubbles. On the other hand, if proponents of the Efficient Markets Hypothesis are really claiming that there is no better source of information about where prices are going than the market itself, then it skirts dangerously close to being self-defeating in the following sense: by essentially claiming that there is no such thing as a “market fundamental,” then investment becomes an exercise in futility; you either get lucky or you don’t.

The big question is: for the market to be measuring “value” at all, does value have to be the kind of thing that exists independently of the market? Not exactly, no. We measure length in terms of other lengths, there doesn’t seem to be any reason why we can’t meausre the (estimated near-future) value of a company in terms of the price of its stock. But we DO need reassurance that the thing the price of the stock is measuring is something that’s really out there independent of the stock price. If the Efficient Markets Hypothesis is claiming that it’s not, then it’s no more useful than the asset bubble theories Sumner is mocking.

I assume that Fama is intelligent, that his reputation is deserved, and that the Efficient Markets Hypothesis is saying something useful. To be completely honest about this, I’d have to read all the primary literature for myself, of course - which is available on Fama’s website, incidentally. But barring that kind of time investment outside my area of specialty, I choose to simply note my questions.

(1) In what way is the debate over the Efficient Markets Hypothesis more than simply a scuffle over timing? That is, in what way is it more substantive than a debate over the time horizon by which market prices have to have come in line with fundamentals, such that EMH people claim this time is relatively short and asset bubble people that it can be arbitrarily long?
(2) Does the Efficient Markets Hypothesis have a concept of a market fundamental that the market is meant to be measuring, and if so, what is it?
(3) What would happen if one of the asset bubble proponents met Sumner’s challenge? What if someone figured out a reliable way to predict bubbles and published his system? Wouldn’t this simply render the market efficient about that asset, allowing Sumner to claim the ability of the asset bubble proponent to predict bubbles as evidence in favor of the EMH? And if his theory stopped working at some point in the future, would THAT then be hugely ironic evidence against the EMH? Ironic in the sense that it would then be the inability, rather than the ability, of the person who believed in bubbles to predict them that confirmed that the market was sometimes out of touch with fundamentals?

In sum, I choose to believe that the EMH says this - because I can’t think of any way to make it more meaningful:

The most efficient systematic measure of value is the market. All other measures of value, though some are potentially superior, are fragmented. It is because the market assembles fragmented information that it is, on the whole, the best we can hope for in terms of a central value register. This does not mean that it is never wrong, nor that it never fluctuates, nor even that its fluctuations are always indicators of real, underlying changes in value. It is just a statement that a better systematic measure of value will never be found.

If that’s what it means, I can make sense of it. Otherwise, I’m not sure this debate is going anywhere other than round in circles.

Leading line in an AP article:

President Hugo Chavez announced a 25-percent increase in Venezuela’s minimum wage Friday to try to blunt the effects of soaring inflation…

Just. Wow.

And yet. Well, as much fun as it is to poke fun at Third World despots and their staggering ignorance of basic Economics*, would the average Democrat’s response to 25% inflation here in the US really be any different? And indeed, back in the 1970s was the UK’s response to 16% inflation really any different? Callaghan’s working strategy there at the end that got so rudely interrupted by Mrs. Thatcher’s Big Win was to try to get public sector employees to accept yearly wage hikes that were slightly less than the rate of inflation (i.e. to take minor pay cuts for a time) “for the good of the country.” Which it was, and it was working, but it’s only a new policy idea if you’ve been letting public sector wage hikes outpace inflation for years.

No, I’m not worried that we’ll see Chavez levels of stupidity in the US any time soon. But that’s ONLY because we’re staffed by lots of experts who know better. The point is that your average human’s understanding of Economics is pretty dim, and his instincts actually run counter to what we’ve learned over the last two hundred years. And so there are problems with any form of government that takes an eminently average person like Chavez and lets him run things according to his gut. And so there are also problems with any form of government that leaves too much up to “the people” to make economic policy decisions. Despotism is bad, and populism is bad, and that’s why we prefer technocratic Republics where people vote and experts advise and politicians balance the interests of the two.

*Of course, if you increase the general wage level by 25%, prices will need to rise to compensate. Which just … contributes to inflation. Not to mention unemployement. The relief is at best temporary, and over the long term the policy is indeed destructive.

An interesting lesson in how ideology colors our interpretation of events can be had by reading this Cafe Hayek entry and this Paul Krugman column back-to-back. The Cafe Hayek entry is a Russ Roberts titled “Why Such Extreme Leverage?” - and it argues that the narrative that banks and financial institutions caused the financial crisis through their reckless stupidity is too credulous. Banks are staffed by capable people, and they don’t - simply don’t - take risks amounting to 98 cents on the dollar. A 2 per cent hedge for rainy days is not good enough for anyone but the stupidest of the stupid - so, Roberts concludes, we can safely assume they wouldn’t have done it if not for the implicit federal guarantee of bailout. Ergo, it’s the government’s fault for creating the moral hazard in the first place.

Paul Krugman’s column is called “Percents and Sensibility” and makes the same argument the other way around. The actions of the Fed were not nearly drastic enough to explain the magnitude of the crisis. So the Fed held interests rates maybe as much as 2% too low for a couple of years. What about this suggests a massive collapse in the financial industry? A Brad DeLong quote in the essay estimates this would at most account for a 6% decline in housing prices, and obviously we’ve seen something much greater than that. Here’s the money quote:

…none of the proposed evil deeds of policy makers were remotely large enough to cause problems of this magnitude unless markets vastly overreacted. [emphasis in original]

Both men seem to be taking something on faith. Roberts takes on faith that market actors are (mostly) rational, and so any catastrophic market failure such as the precipitous drop in asset prices over the last couple of years will necessarily have been caused by some kind of outside weighting of their calculations. He takes as given that market actors made by and large the right calls (at least, the individually beneficial calls) with the information they were given, and so putting the puzzle together means finding the piece that makes these decisions seem rational, and government seems the most likely culprit. Krugman takes on faith that the market as a whole can be wrong, that it is in fact a fragile and overly sensitive thing - that those missteps that cannot be explained by government policy foulups are entirely explained by market actor irrationality. That this is a satisfactory end to the discussion for Krugman is made apparent by his conclusion - which is that:

… if our financial system is so high-strung, so manic-depressive, that low rates for a few years can inflate a monstrous bubble, while a few discouraging words from high officials can send them into a tailspin, this doesn’t make the case that policy must walk on eggshells, forgoing any attempt to fight prolonged unemployment. Instead, it makes the case for much, much stronger financial regulation.

It is typical to end these kinds of comparisons by saying that there’s something in each story - but in this case I find Roberts’ account much more honest, even-handed and compelling than Krugman’s. Roberts’ account is a retread of the old saw that “to the rational mind, nothing is inexplicable, merely unexplained.” He’s confident that there is an explanation out there somewhere, we just have to find it. Naturally, he has an opinion about what the explanation probably is, but my impression is that it wouldn’t take to much poking and prodding to get Roberts to admit that it’s still an empirical question, and that the implicit government guarantee he talks about is but one possible explanation, and may merely form a part of a more complex final explanation. Krugman, by contrast, doesn’t even seem interested in an explanation. For him, the irrationality of markets is a given, he is interested in this latest crisis only to the extent that it bolsters this view of markets, and no further investigation need be done.

If you spend time independently thinking about which view of markets makes more sense - Roberts’ view that they’re basically rational and robust, or Krugman’s view that they’re basically irrational and fragile to the point that if the government sneezes they catch swine flu - I think you will find yourself more drawn to Roberts’ account. Roberts is offering the Economist’s version of Eric Raymond’s maxim from software development that “given enough eyeballs, all bugs are shallow”. That is, bugs happen - are, in fact, inevitable - but when you have millions of people reading the source code, as you do in an open source project, it’s hard to imagine that even the most complex escape notice for long. This is true no matter how long and complicated the code is - because even if no one person knows the whole program, there are experts on parts of the program who talk to each other, share information, and can put the relevant pieces together to ferret out what’s going wrong. In the market, bugs are incorrect pricing that leads to misallocation of resources (investment money). But given the sheer staggering number of participants in the economy, some person or combination of persons is eventually going to spot the error and fix it, and profit by fixing it. So it stretches credulity to imagine that the market stays irrational for long. In Krugman’s world, however, if one person is unable to spot the bug, then everyone will be similarly unable, and those few who maybe do see the error will be unable to react, presumably due to the overwhelming economic pressure exerted by the people fouling up. Put differently, Roberts seems to see the market as a collection of conscious and independent actors who reflect on what they do, where Krugman seems to see it as a machine that reacts in fixed ways to given stimuli, government officials being much more aware of what’s going on in it than the people participating directly. Perhaps it is layering my own interpretation on top of Roberts and Krugman to add that Roberts seems to see financial renumeration as a powerful motivator in the sense that it rewards innovative thinking, where Krugman seems to see it as a hazard, because it binds otherwise independently innovative people to follow potentially dangerous trends. In Roberts’ market, actors are fully conscious of what they’re doing and do what they want; in Krugman’s market, they are only semi-conscious, farming much of their decision-making out to what the financial trends suggest.

Which version you find more compelling probably comes down to how comfortable you are with Krugman’s handwaving over what can cause a large group of otherwise rational, informed, and intelligent people to collectively make the wrong choices. To me, it seems implausible that a self-organizing system ever could make the wrong choices for very long. Suboptimal choices, perhaps, but not demonstrably incorrect ones. The only thing that could force roughly every actor in a large group to head the wrong way is some kind of outside pressure on that group - something that affects the entire system, and each part in the same way. That would be the government. Or perhaps some kind of human cognitive deficit - one of those things that trips us up because we’re evolved to live in small herds, but in fact live in large, impersonal societies. Since I can’t imagine what kind of cognitive deficit would create an asset bubble, I’m inclined to give Roberts the go ahead to investigate the possibility that the government caused the whole mess by signaling inapropriate guarantees. Krugman disqualifies himself by not even speculating on what the cause could be. Because even if you’re in a position to believe that a self-organized group can be so catastrophically wrong about soemthing so simple and so fundamental to its survival - which I am not - you would need some theory about what went wrong before you could design the regulations Krugman is calling for. Indeed, one of the reasons I find free market theorists in general more persuasive than their pro-regulation opponents is that they are less credulous and less glib. Which is to say, I am a lot more comfortable with Roberts’ “this is a puzzle, I have a theory about what the solution is, so let’s investigate it” than with Krugman’s “something went wrong - call the witchdoctor!”

Scott Sumner has an interesting post in which he doubts the existence of bubbles. Not the existence of the phenomena that people have termed “bubbles,” but rather that the term is meaningful or coherent. He’s kind enough to spell it out clearly:

The term ‘bubble’ is really just shorthand for saying: “I don’t know the cause.”

I’m not so sure. I think a more accurate way to say it would be “the term ‘bubble’ is really just shorthand for saying: ‘market fundamentals can’t explain the cause.’”

Every science needs a term like this - even, it turns out, the hard physical sciences - and that’s because all descriptions of reality overlap. Every science runs up against taints from the outside that it has to explain but that aren’t quite covered in its vocabulary. And this is unavoidable because of the way science works. It is impossible for any one person - or group of persons - to study everything, and so we divide the labor of inquiry into fields, each with their own subfields, and individuals with their own specialties within those subfields. But reality is not so divided, and so these fields overlap. Where does Biology start and Chemistry stop? In order to get a handle on his own field of specialty, a researcher has to abstract away from distractions accounting for which is properly someone else’s job. But that doesn’t mean these distractions don’t affect his data from time to time. In software design, Joel Spolsky likes to call it The Law of Leaky Abstractions; I wonder if I can generalize that term?

As someone whose primary profession is Computational Natural Language Syntax, I think I appreciate this more than most - because my field relies on a lot more abstraction than most. I’m joining a long list of people trying their damndest and failing since 1957 to write a full-coverage grammar of even just English, let alone the thousands of other languages people speak. The main reason, probably, that we continue to fail is because no human language, probably, has an explicit grammar that can be written down in a bundle of inviolable rules. The reason we try anyway is because English nevertheless behaves for the most part as though it has such a ruleset.

Which means, at some level of abstraction, that it does.

No seriously - and this is where I envy people in other professions because researchers in other sciences don’t seem to have as much of a problem with that notion as Linguists do. I mean what I say: at some level of abstraction, English has the kind of grammar I’m trying to write. But English also interfaces with all other mind modules, and it is implemented in a machine (the brain) that doesn’t operate according to rewrite rules, and, to borrow Joel’s term, the implementation details of operating a rule-based thing in a collection of neurons slip though: the rules are a leaky abstraction. We get things like frequency effects, slips of the tongue, fixed/frozen forms, and all manner of other things that don’t obey our best attempts to lay down the rules and are nevertheless valid and interpretable English utterances. Separating these things - knowing what to encode in a rule and what to leave to Phonetics, Psychology and Sociology - is damn hard. And so we get Chomsky’s much-derided Competence-Performance distinction, and all the sneering from the Phonetics side of the hall that anything we can’t explain we sweep under the rug as “Performance.”

Well of course we do! And that’s because it isn’t our job to explain everything about Language! We concentrate on the grammar, and others can concentrate on how things get communicated, and hopefully someday when both our fields are mature enough we’ll merge them together.

I think bubbles are something similar in Economics. Just like “performance” in Syntax, “bubble” is imprecise, perhaps, but I don’t think it’s so imprecise as to be a catchall. We know bubbles when we see them, and Classical Economics can describe at least parts of the bubble phenomenon. But like Grammar, Classical Macroeconomics is a leaky abstraction. Just like Grammar tries to abstract away from lots of implementation details like neurons and larynxes, Classical Macroeconomics tries to abstract away from the psychologies of the individual decisionmakers. Not entirely, mind you - but just enough that details of the implementation will leak through. Large scale economics, like language, is implemented in a medium (in this case, the world population of mostly-but-not-completely rational actors) that is partly, but not entirely, evolved for it. And Macroeconomics studies large-scale economics from a point of view that’s useful, but not quite right. Like Grammar, the laws of Economics are very real at a certain level of abstraction. Nevertheless, there is no place in the individual actors that you can point to where they exist. Waving my hands over a couple of steps, it follows that sometimes prices will rise not because of a rise in value, but just because of a quirk of the interface of the economic system with the other systems of human interaction. And, just like Grammarians are annoyed by postfix adjectives in English (”a Chess junkie extraordinaire”), Economists will be annoyed by bubbles - and that’s because PART of the description for them is to be found in Classical Economics, and they are pretty clearly the kind of thing that Economics is tasked with explaining, but at least some of what accounts for them is outside the traditional definition of the field.

They’re going to be hard to study. And they probaby can’t be studied to anyone’s satisfaction by traditional Economists. And so the people who end up doing the definitive work on bubbles will probably end up having to get some training in Sociology. But that doesn’t mean that bubbles just shorthand for saying “I don’t know the cause.” They’re not even shorthand for saying “Classical Economics knows only part of the cause.” The real problem is that they’re at the interface, something that we’re only just learning how to study.

Things like this demonstrate why it’s ultimately futile for the government to enforce a currency monopoly - and they also demonstrate another quirk of human nature, a maladaption similar, in a way, to our apparently inability to think of organizations and individuals as separate categories.

The story is about a company that’s lighting some fire under the credit card companies by issuing one-off debit cards that act like credit cards. You prepay them, and they only charge the merchant 0.5% at point of sale - compared with about 2% for regular credit cards. American Express has just acquired the company for a huge sum as a way of expanding their business.

Now - this is interesting for two reasons. First the boring one: it’s a nice demonstration of just how unnecessary government intervention in the credit markets actually is. I hear a lot of talk these days about the need to regulate the credit card companies to keep interest rates down. Sounds to me like the market it getting around to doing just that faster than the government, and more effectively.

Second - it’s interesting to me that this doesn’t show up on the government’s radar as an “illegal private currency.” It’s every bit as much of a currency as the much-prosecuted Liberty Dollars, right? I mean, just like with Liberty Dollars, you buy some of these from the merchant at a markup, and take them to participating stores where you can exchange them for goods and/or services. And yet in the case of Liberty Dollars the government shits its wad coughing up all kinds of specious arguments (no pun intended, really) to sic the dogs on them, but when it’s an electronic card that doesn’t call itself a “dollar” or come on printed currency-like paper, everything’s peachy. Which just demonstrates another unfortunate human tendency, actually - the undue focus on trappings rather than substance. Apparently you can issue alternate currency so long as you don’t make it look like that’s what you’re doing. Which doesn’t say much for the so-called “experts” at the Secret Service, actually, but no matter. Private currencies are an unambiguous good, so if turning up the heat slowly rather than quickly lets us boil this frog, let’s do it!

Matt Yglesias has a post up today about healthcare in Sweden that unintentionally highlights a lot of the wrongheaded thinking on this issue. Here’s one choice quote:

In a turn of phrase that I expect we’ll never see in an official U.S. government document, I’m told that “Swedish health and medical care is based on the principles that care should be provided on equal terms and according to need, that it should be under democratic control and financed on the basis of solidarity.”

He’s right that that choice phrasing will never appear in a US government document, but he needs to explain how it is, exactly, that our current system fails to meet the actual criteria stated here? Last I checked, healthcare in the US is provided on equal terms. No one is turned away because of religious affiliation, race, socioeconomic class, creed, or even, at least in the case of emergency care, ability to pay. Medical care is also provided according to need. When you go into a doctor’s office or emergency room, there is no auction according to which services go to the highest bidder. Rather, there’s a triage procedure according to which the most pressing cases are handled first. The same is true of handing out donated organs for transplants. It is, in fact, expressly forbidden by law for there to be financial incentives in the organ trade. As far as I know, our healthcare system is also under democratic control. Medicare is the biggest portion of the federal budget, and I’ve never seen a government official shy away from regulating the healthcare system or the insurance industries that pay for it. The government micromanages even treatment decisions these days, telling doctors what and how much to prescribe, at a minimum, for certain conditions. I guess the only description we might not meet is the last one: I’m pretty sure our system is not “financed on the basis of solidarity.” But since I also can’t say I really know what the hell that even means, I won’t swear it isn’t.

Here’s another good bit:

People need to pay a token amount to receive medical care. The point of this isn’t really to raise revenue, it’s to create the correct incentives for people to seek care at the correct point on the hierarchy. Thus, it’s cheaper for a patient to go to primary care than to go to a hospital, so if you want to see a doctor you go to primary care and only bother with the hospital if the primary care personnel say they can’t help you. Out of pocket costs of this sort are capped at 900 SEK per year, which is about $125, so we’re really talking about a nominal fee.

BIG SIGH. Look, something can’t “create the correct incentives for people to seek care at the correct point on the hierarchy” and be “a token ammount” both at the same time. I mean, were you born stupid or something? Here’s how this works: a high price will discourage a potential buyer from consuming something only if the cost (at least as the potential buyer perceives it) is higher than the benefit he expects to receive from his consumption. So, for example, I enjoy consuming caviar, but since it costs $8/jar at the grocery up the street, I rarely ever buy it. If it cost half that, I would buy it every week. The pleasure of eating caviar makes it worth my while to incur an oppotunity cost (i.e. giving up all those other things I could have bought with my $8) once in a while. But as a graduate student I’m relatively poor, and so there are usually better uses to put my $8 to, and so I usually don’t buy caviar. The point being that this is only true because the price is high - which is to say, NOT “a token amount.” Either the charge for healthcare services is high enough to make people realistically consider the alternatives, i.e. is a real cost, or it is not, and it does not make them consider the alternatives and is thereby ineffective at “creating the correct incentives for …” anything, really.

These snippets do a good job illustrating my major complaints with the “YAY Public Option” crowd. From the first quote: a lot of people who complain about the US healthcare system - which is admittedly in need of improvement - don’t have the first clue what’s actually wrong with it, nor, apparently, can they be bothered to find out. They are arguing against a fantasy version of the US healthcare system out of some dystopian science fiction novel where the poor suffer endlessly while the rich extend their lives indefinitely through cybernetic mods … or something. I agree that there are a lot of problems with the US healthcare system, but I think it would be easier to start addressing them if people would actually address them - starting with the fact that the US system ALREADY IS a highly-regulated system. We have something like socialist healthcare here already. In fact, our system is only a couple of short steps away from a German- or a Dutch-style system (and the missing steps are roughly what Obama proposes). A coherent position for the left to take on this would be “we have government-run healthcare already, it’s just that it was implemented half-heartedly over a long period of time with no guiding plan in mind and so is a kludge, and the govenrment would like to streamline the system in the hopes of keeping costs down.” But they won’t put it in these terms for two reasons: (1) it would put the idea of deregulation on the table and (2) even if they could magically make (1) go away, the focus of the discussion would probably shift in favor of a longer process of having an independent agency audit the healthcare system over a period of 1-2 years and come up with recommendations for ways to make the regulations more coherent. It’s obvious why (1) is not good for the left. (2) should be something they could agree with, but it’s just not as much fun as feeling generous with other people’s money. Much better to list some sob stories about people without insurance and then pat yourself on the back for having personally taken care of it - just by voting!

From the second quote: the sheer economic ignorance that accompanies these discussions. In particular, the lack of appreciation for what it is that’s hard about price fixing. It’s like we’re on a boat and they’re trying to drive it as though it were a car. But as much as they would like it to, price fixing doesn’t give fine-grained control, and to the extent that you’re going to do it at all (which you probably shouldn’t), you have to be REALLY CAREFUL with it, because each price you change affects incentives that spill over into other areas of the economy and come back to bite you in unexpected ways. Price fixing is hard precisely because value is subjective - and because there are a HUGE amount of things being traded off against each other that have to be taken into account. Leftists love to say things like “of course there should be a fee - because we get that we can’t just hand out scarce resources, but it should be a fee that everyone can easily afford,” and are apparently unaware that the second conjunct contradicts the first.

I don’t know too much about healthcare - but here’s what I do know. The problems with the US system are not market failures, they are the failures of an incoherent regulatory system, and to the extent that we’re going to allow the government to “reform” this regulatory system I would really like people like Matt Yglesias who don’t seem to understand how prices work to pack up and go home. The overall point being that if privatization is off the table - as it seems to be - then at the very least we could leave a complex and important issue like this to the experts. I am not interested in healthcare plans designed and/or voted on by people who think “token” prices can affect behavior and who want ANYTHING financed “on the basis of solidarity.” Just pack it up and go home, kid.

There are hundreds of ways to be unscientific, but one of the most common is misunderstanding the relationship between theory and practice. Here’s a quote I found on Facebook today - apparently originally from this cogsci paper - that is illustrative of the problem:

Opportunity costs be damned, some trade-offs should never be proposed, some statistical truths never used, and some lines of causal/counterfactual inquiry never pursued.

So on the one hand, this seems to want to have done with the economic way of thinking (”opportunity costs be damned”), but on the other hand, it frames itself in economic terms (opportunity costs, trade-offs). It reads like someone who understands the use of science to a point, but wants to keep some things off limits. Indeed, if you read the paper (which is a summary of “sacred values” research), that is what is intended. This is meant to characterize the religious mindset, which it notes without argument is important to the functioning of human society.

I wonder. I agree that this is religion pure. There are, in general, two classes of superficially science-friendly anti-scientism, which we could call the religious objection and the hyperscience objection. The hyperscience objection is that mindset that thinks that data can speak for itself without a theoretical framework in which to be interpreted - radicial empricists. These people think they’re more scientific than scientists, and they constantly rail against all the “formalism” in science - but in fact they don’t have a goddamned clue what science is all about. Science is NOT simply listing facts - it’s all in the method of interpreting those facts. Just performing some lab tests is not science, in other words - it has to be a controlled experiment with a stated aim to count.

The religious objection is what’s being characterized above. It basically takes a bunch of things that the individual wants to believe for whatever reason and ropes them off limits to inquiry. Specifically, I think the religious thinker doesn’t object to any scientific methods or particular datapoints, he just refuses to reach certain conclusions, no matter how clearly they follow from the data. In general, I don’t mind the religious objectors as much as the hyperscience objectors. Religious people are capable of being - and frequently are - quite scientific, they just have their limits, and at least they are honest enough to admit that those limits exist, and kind enough to tell the rest of us what they are.

I think the limits are often hastily adopted, though, and that’s what I want to complain about. The quoted material is a case in point. It reads like someone who wants to say that there are limits to what economic models can explain about human decisionmaking, but in fact it’s not obvious from the statement that one need depart from the model. There is a way of stating the concern within an economic framework: just say that some costs are infinite.

I should think that there are a number of advantages to this. First, saying that some costs are infinite, rather than saying that thinking about some opportunity costs is “off limits,” begs the question of what happens when two things of infinite value come into conflict in a way that folding your arms doesn’t - and so it invites the thinker to address an important question he was trying to avoid. Second, it avoids the false dichotomy of choosing between “theory” and “reality.” People like to talk about “theory” as though it were some dry, abstract thing that has nothing to do with real life. They’re right that it’s dry and abstract, but wrong that it has nothing to do with real life. The crux of the first point is that theory is valuable because it makes one’s assumptions explicit and thereby points toward important areas of inquiry. And anyone who understands the crux of the first point will have no trouble with the second: theory exists to help us think more clearly about experience; it is neither confusing about experience nor removed from it, but merely a disciplined way of approaching it.

It is clear to me that humans are moving away from explicit religion. But dropping out of church and giving up on God doesn’t mean you’ve left religious thinking behind; the roots run deep. We see this all the time in politics, for example - someone declaring off limits or taboo certain key arguments their opponents need to make their case as a way of short-circuiting the debate. For example, “if it will save even one life, it’s worth it, because you can’t put a price on human life!” It sounds nice, but it’s bollocks, first because you can put a price on human life, at least in terms of other lives, second because their opponents generally aren’t advocating anything like pricing lives in the first place, and third because the speaker of such lines is always very much aware that whatever it is he or she is advocating does have a cost, and they’re bringing this up precisely to avoid discussion of that cost. Just because Marx said it doesn’t make it wrong: religion is the opiate of the masses, and this kind of thinking is lazy and self-defeating.

As an undergrad I took a bioethics class that was cotaught by a philosopy and a biology professor, and the biology professor was not only a Baptist, but he was also openly hostile to any philosophical approach to Ethics. He had been teaching the class alone (for pre-med students) for years, and somehow they’d talked him into sharing it with the Philosophy Department the year I was in it. He clearly thought of it as a way of just talking about weird medical cases to get pre-med students used to thinking about them; he didn’t seem to much like the idea of taking a systematic approach to moral decisionmaking. Which is really weird for a scientist, when you think about it. If you know that you have a class of students who are frequently going to be faced with a lot of very tough ethical decisions, WHY NOT teach them to approach these decisions systematically? The last day of class he and the other professor reserved for giving their own opinions about the issues uninterrupted, and Dr. Shull used his to rail against Philosophy, more or less. At some point he said “now honestly, show of hands, how many of you will really take into account what Kant thinks when making decisions?” Mine was the only hand to go up - which is a point of personal pride, but also a point of disappointment in the others. Shull seems to think that considering what Kant would say is some kind of weakness, as though I can’t think for myself - but to me just the opposite is true. When I want medical treatment, I consult an expert. When I want my car fixed I consult an expert. Why wouldn’t I be willing to consult an expert about moral issues? And indeed, I’m not so much consulting an expert as internalizing his advice and applying it, or not, as it suits me. It doesn’t mean I have to adopt everything Kant says without review, but I find the systematic approach to thinking about moral questions helpful - primarily because it gives me a vocabulary to make my own moral assumptions explicit, like any good theory should - and I think a lot of nonsense in interpersonal relationships and political discussions could be avoided if more people were willing to take systematic approaches to moral questions. At some point I raised my hand to make a counterpoint, and although he hesitated, he stuck to his guns and didn’t recognize me, the floor having been reserved on the last day of class for professors’ rants. But I think my question was a good one, and I would like to hear an answer from a religious person at some point. The question was, “if you just justify everything by an appeal to your feelings, how do you ever expect people to discuss and reach compromises on things since we can’t question each others’ feelings?” Feelings are for friends and family, they’re not for the general public. When someone is deliberately putting something off limits to discussion, they’re generally, in my experience, covering up a fraud. I DID say Dr. Shull was a Baptist…

The truth is, opportunity costs are always important to consider, and while we should perhaps avoid discussion of some trade-offs where possible, we shouldn’t put them off-limits entirely. There is no need to fear statistical truths so long as we understand what statistics really say, and the only lines of counterfactual that shouldn’t be pursued are the absurd or misleading. It’s all on the table, so let’s discuss it. Ostriches stick their heads in the sand to avoid seeing predators, but that doesn’t make the danger go away.

Libertarians have a lot to answer for. I don’t mean that in the colloquial sense of having done a lot of wrong - I just mean that when you’re a fringe political philosophy, you’re starting with a lot of really different assumptions than everyone else, and so you don’t have the luxury, as, say, Democrats and Republicans do, of simply expounding on your policy proposals. Before you can even talk about policy, you have to justify your worldview - or at the very least clean out a lot of misconceptions your counterparty has about you.

I smacked into another reminder of this over lunch on Wednesday. A friend of mine (also a Libertarian) wanted to know my standard response to the sadly common straw man that without minimum wage laws and maximum work week mandates, workers would toil away at 12-hour shifts six days a week with barely enough renumeration to feed themselves, as was ostensibly the case in 1900. Caught off guard, my response was correct but woefully inadequate: I muttered something (this might even be a direct quote) about how “it’s got to do with worker productivity.” Fine if you’re familiar with economic jargon - but of course people already familiar with the economic jargon are not my target audience! They already know the arguments I’m shorthanding.

Libertarians miss tons of opportunities like this all the time. Someone asks a sincere question out of the blue, and you have a golden oppotunity to set the record straight about a bunch of stuff, only you DON’T because you haven’t rehearsed the argument recently. It’s the same affliction that we see so often in professors in technical fields (especially Math- and Computer-related, it seems). By the time the professor is in a position to pass on his knowledge to students, the concepts are alread so much old hat to him that he can’t remember what the difficult points were, let alone how to explain them coherently. It’s obvious to HIM that, say, functional programming languages are superior to imperative langauges, but when asked to justify this position he mumbles something about “scope ambiguities” which is incoherent without examples, and of course he can’t think of any off the top of his head. It’s a lecture that has to be prepared for.

OK, I’ve had two days. Here’s a concise version of why I believe that we didn’t need minimum wage laws and overtime restrictions to ensure decent working conditions and decent pay for our workers.

I think where people go wrong on this question is in comparing conditions in factories now to conditions in factories then. Post hoc ergo propter hoc, people - it’s a fallacy. Just because minimum wage laws passed and then working conditions improved, it doesn’t follow that minimum wage laws are the cause of the improvement. And in fact, there’s plenty of counterevidence: working conditions were improving before the federal minimum wage passed, so it’s actually unlikely that the change in statute had anything at all to do with it. Probably all it achieved was increasing unemployment a bit - which in 1938 was exactly the WRONG time to be throwing people out of even low-paying work. What can I say? Democrats have never cared about the little guy past election day.

Ah, but WHY do working conditions improve on their own? As I said, it has to do with productivity. Now for what that actually means. A worker is more productive when he produces more per unit of time. Simple, right? And workers become more productive primarily through innovation. Either they get better at their jobs or, more commonly and dramatically, someone invents something that enables them to do their jobs more effectively. Now, if you’re the factory owner and your workers get more productive because of a new manufacturing technique that you introduced, how do you take advantage of this? Well, you can (a) produce more of the thing and lower the cost to consumers, undercutting your competition and providing the public with more affordable goods. Or you can (b) produce the same amount as you did before but pay fewer workers to do this, also lowering the cost to consumers. Or you can (c) do some combination of (a) and (b) - cutting a few workers and also producing more. Or maybe the market is such that you can (d) lay off some people, produce exactly as much as before, and simply pocket the difference for yourself.

Here’s the catch. In all cases but (d), the price of your goods to the general public goes down. Which means, in effect, that you’ve given all the workers in the country a slight pay increase - because the money they earn now buys more than it used to. And it’s easy to see that as time passes and it’s not just your factory but every factory that makes productivity gains, workers are able to buy more and more with the same amount of money year after year. Among the things that smart workers can do with this surplus is squirrel it away for rainy days, which, when you think about it, gives them more bargaining power vis-a-vis their bosses. A worker who absolutely depends on his next pay check to even survive doesn’t have much bargaining power. But if you can go three months or even a year without work, you have a lot. And remember, the neat thing about productivity gains is that they benefit the whole economy - so it’s not just a handful of workers who are able to save more, it’s ALL of them. Over time, this puts employers in a difficult position - because labor is a traded service like any other. When faced with an entire workforce that can get by without working for a couple of months, they have to offer more money and better working conditions to entice anyone to sign on at all. And it is in this way that productivity gains find their way into workers’ pockets.

But what about case (d)? After all, this is the “cutthroat capitalist” strawman that most Socialists have in mind when they’re scaring people into supporting economic idiocy like the minimum wage. Well, let’s think about this. Presumably the factory owner wants to cut jobs and keep output steady so that he can have more money for himself - which is to say, he’s greedy. Fine - there are plenty of such people. But why does he want this money? As far as I can see, there are two broad categories of reasons: he might want to consume more stuff (food, prostitutes, houses, cars, whatever he’s in to), or he might just get a kick out of having a large bank balance. If it’s the first, he’s going to spend his money, which means the money goes to some other industry that employs people, and these people now have it to spend - yay for them. So he lays off some of his workers, but enables people in other industries to employ more, as it were. OR - if it’s the second case, he’ll know that it’s smarter to reinvest his money - because then he’ll make even more - as opposed to sewing it in a matress, in which case it just sits there and never gets bigger (indeed, if there’s any inflation at all, it in fact gets smaller). If he invests his money, of course, then he gives it to other people who open new factories and - YUP! - employ more people. Either way, his money continues to employ people - even if they don’t work at his factory anymore. Now I guess there’s a third option - he’s just spiteful and enjoys hurting people, and so he keeps his money sewed in the matress just to make sure it can never, ever benefit anyone. I have never, ever - and I mean not ever - met anyone like this outside of a Charles Dickens novel - and neither have you. But for the sake of argument, let’s assume there are such creatures somewhere. Here’s what happens in a market economy: either their goods benefit people and people buy them, or they don’t and they don’t. Competition will eventually force him to lower his prices or go out of business, so even if he’s trying REALLY HARD to make life miserable for people, he won’t be able to do it for long. Either his factory closes, he makes no more money, and his workers go on to find better jobs, or else he grudgingly cuts his prices, thus passing the productivity benefits on to the larger economy after all.

That’s the main lesson about Capitalism, kids: there’s just no way for evil to win. The deck is stacked in favor of good - of productivity, technology, and healthier, easier lives. Even the guy who actively TRIES to use Capitalism for evil - call him Uncle Scrooge - can’t get away with it without the government’s help.

So it’s actually inconceivable to me that the minimum wage has anything to do with anything, really. Productivity gains may benefit some people more than others, but they benefit everyone, and there’s just no way around this. So you on the left need to relax. Even if you do nothing - actually, ESPECIALLY if you do nothing - the benefits of innovation will spread to everyone. Barring really stupid life choices - which, as a matter of both principle and practicality I do believe people should be allowed to make - everyone gets richer as time goes by. The trick is to realize that money and value are not always the same thing. What’s important isn’t the number at the bottom of the pay check but how much that number allows you to buy (just ask anyone currently living in Zimbabwe what the point of being a paper millionaire is when there is no bread for sale at the grocery). The sooner Democrats and Republicans master this simple fact, the more dedication there will be to eliminating unnecessary inflation - which is the REAL enemy of the worker, and the only effective trick in the playbook of anyone who wants to deceive people into thinking they’re better off when actually they’re not (*cough* Keynes *cough*).

Libertarians have a lot to answer for on this issue, but nothing to apologize for, because it is WE who are the real friends of the working man, and WE who are the real friends of the factory owners too. And that is because WE are the only ones who see that the long-term interests of both the workers and the factory owners are aligned in favor of productivity gains. At best, the minimum wage simply puts into law a number that was in the cards anyway. At worst, it throws people out of work when some employers can’t afford to pay the new non-optional rate, or else raises prices on goods to cover the new rate, thus effectively lowering everyone’s wages. What it has never done in all of history is helped more people than it’s hurt. Let it go.

So why do so many people get this wrong? Well, as I said earlier, I think it’s because they’re making the wrong comparison. They’re comparing conditions in factories in 1900 to conditions in factories in 2000 and pitying the workers of 1900 on that basis. What’s important to remember is that workers in 1900 were never in a position to make the same comparison. They chose the jobs they chose on the basis of comparing their available options and going with the one that seemed best. As for why so many of them flocked to the factories - I can only think that it was because farming was in general even worse. At school you get all kinds of romantic notions about life on farms, but in reality it just plain sucked. Surviving the winter was a struggle, and summer was endless, back-breaking work. Life expectancy - assuming you made it past 4, which most people didn’t - was in the 50s. You were born, and you worked until you died. Factory life might have been hard by comparison with modern factories, but it doesn’t even begin to follow from that that it was a step down from everything else available at the time.

I think Socialists tend to forget that before you can redistribute stuff, someone has to make it. In the modern world of technological wonders, it’s easy to fool yourself into thinking that stuff just comes from nowhere. But reality is that it’s a long, uphill struggle to get to the level of productivity we have today. So it’s just folly to look at 2000 and wonder why people couldn’t live like we do back in 1900. All the stuff we enjoy and take for granted hadn’t been produced yet, that’s why! You can’t consume stuff that isn’t there, just like you can’t apply for cushy office jobs that don’t exist.

A good way to put this in perspective, I think, is to think about North Korea. Media portrayals of the place are of some kind of hellhole of unending suffering - and yet North Koreans themselves seem to be quite happy. What gives? Again, the problem is one of which comparison you’re making. North Koreans don’t get to see the rest of the world, so as far as any of them know they have it pretty good. And - wouldn’t you know it - compared to their grandparents they actually do! Korea circa 1940 was basically just a mudhole. Even the DPRK is an improvement. The operative word here, of course, is ‘even.’ The injustice of North Korea isn’t that Kim Jong Il is forcibly starving people on some absolute scale. Rather, it’s that they’re doing so much worse than they COULD be doing under a better government. They’re doing better than their grandparents any way you look at it - it’s only shitty when you compare it with the rest of the world. Of course, it’s the comparison with the rest of the world that’s relevant, which is why their regime spends so much of its GDP keeping its people isolated.

I often wonder how much worse we’re doing than we could be under a less socialist economy, and it makes me really angry.

From a conversation from the other day, I ran across a pretty cool analogy for inflation.

Say you’re trying to lose weight. And say you drink a lot of beer. Now, my personal philosophy on weightloss is you exercise like mad and don’t worry too much about calories, but a lot of people do it the other way around. They count their calories religiously and use that to define a minimum for exercise. So, say you’re one of these people. One temptation you might succumb to is to lie to yourself about how many calories there are in beer - to discourage yourself from overdrinking, to stay “on the safe side.” So, you look it up online and find that beers range from 120 to 190 calories a bottle. Since you’re not exactly sure about your own brands, you “play it safe” and decide to count beer as 250 a bottle. Which is good, right? Because then if you set a calorie limit for yourself for the day, the fact that you overestimate how much is in beer will make it less likely for you to go over your limit.

Here’s where the catch comes in. Suppose you eat a one-off thing for a couple of weeks that you didn’t give a fudge factor to when you started calorie counting - like Hershey’s Kisses maybe. Read the bag and Hershey’s Kisses are about 25 calories a pop. So, according to your inflated beer price, you can eat 10 of them for every one beer you don’t drink. AH, but there’s the rub! That beer count is actually A LIE. In reality, a beer is only equivalent to probably 7 Kisses. And yet, there you are blithely eating 10, thinking that foregoing your evening beer makes it all OK. Keep this up a couple of weeks, and you may start to wonder why your weight isn’t dropping as quickly as you expected it to - or even as quickly as it was the week before. Heck, maybe it even stopped dropping at all!

Inflation is that kind of thing too. Just like lying about the calorie “price” of beer can cause you to overestimate how much candy you can eat without breaking your diet, lying about the price of money causes all kinds of estimation errors in how much general goods and services are worth in terms of each other. The Fed hands out more paper money, and everyone thinks they can afford more than they really can.

Ah, you say, but what if I KNOW that, and so I add a fudge factor to each new food that I decide to start eating? So, instead of believing the bag and calculating Kisses at 25 calories, I know that I’m in the habit of lying to myself and so I call it 35 instead. OK - well, obviously that’s better. It’s more realistic. And in fact if we divide 250 - the bogus beer calorie count - by 35 - the bogus Kiss calorie count - we come up with the right number of 7 Kisses. So in this case, it all comes out in the wash, and you haven’t done yourself any harm.

The problem with this as a general rule of thumb, though, should be obvious. It was just lucky that we happened to fudge Kisses at the “right” rate to get an accurate count of how many there are to a beer. If we’d done 30 instead of 35, for example, we’d have eaten 8 or even 9 Kisses. Still better than the 10 from before, but more total calories than we expected to be eating all the same. The point is that if you make a habit of lying to yourself about things, it gets harder and harder in subtle ways to know what the truth of stuff is. And when you think about compounding these misestimations not over the weekly calorie intake of a single individual but over the entire mass of transactions that make up a multi-trillion dollar economy, it’s easy to see how a couple of fudges here and there can quickly get pretty expensive.

We as a society are obviously in the situation where we’re aware that we’re systematically lying to ourselves about what prices are. Nearly everyone calculates with an inflation rate of 3-5% in mind when they make investments, draw up payrolls, etc. And most people have grasped the idea of buying in bulk now to save money later. But 8 Kisses is still one more than you should be eating, even if it’s not as bad as eating 10. Just like a little bit of anticipated inflation is still worse than no inflation at all. Fudging about everything is more consistent than only fudging about some things, but nothing is as consistent as just calling things like they are.

Since yesterday’s post pointed to a good read on the financial crisis, how ’bout a bad one for today?

This article is both right and wrong. The gist of it is that Doug Kaye heard a program on Fresh Air that explained to him that Credit Default Swaps are like betting - which they are. Basically, it works like this. You are an institution, and someone is in debt to you (say, you are a mortgage lender, and the person under one of your mortgage loans is in debt to you). You can now “sell” that debt to someone else in any number of forms; this is a credit default swap. The form that Kaye is talking about is similar to buying insurance. If you’re the institution that owns the debt, you might talk someone into paying you a premium on it at fixed intervals, and if the debt goes bad, then you now owe them a one-off payment. If the debt matures as expected, well, bully for you, you pocketed extra money (on top of the interest you were presumably already making on the debt). The current crisis is largely blamed on a bigger-than-expected number of these credit default swaps turning bad (turning out to be “toxic,” in the jargon).

So yes, at least this form of CDS is like betting. The creditor institution “bets” that the debt will mature; the investor “bets” that the debt will default.

Where I can’t follow is this bit:

These really are bets and the reason they’ve brought down our econoy is that there’s no limit to the number of bets that can be placed on a single underlying mortgage or traunch. As a simplistic example, for a $300,000 mortgage AIG can sell as many bets as it wants. Since the bets aren’t backed by the mortgage itself, let alone the collateral (the real estate), there could be tens of millions of dollars riding on that single mortgage. It’s not just the kind of leverage we’re used to in which you borrow money in order to make ore investments. No, these aren’t *investments* — they’re *bets*. And just like in Las Vegas, the amount that can be bet on something isn’t limited by the value of that thing.

So let’s pick some nits here. While it might be true in principle that the amount that can be bet is unlimited, it’s hardly true in practice. No one (rational) is going to sell $10million worth of CDS security on a $300,000 mortgage! Assuming the basis (the percentage of the one-off payout that your investor pays you per annum for the privilege of “betting” - call it his ante) is 5%, then your expected loss (the amount of money you stand to lose discounted by the likelihood that the mortgage will get paid on time) is already higher than the value of the mortgage itself! And this is to say nothing of the fact that you’ll actually pay out $10million if the mortgage goes bad. So as I said, no rational person would do this. That’s not to say that there aren’t irrational players in the market - but even an irrational player will have a hard time making this sell for a number of reasons. First, how do you manage to sell $10million worth of security on a $300,000 mortgage? I guess it’s prettty easy to sell the first $100,000 chunk. Your investor will pay you $5,000 a year on the chance of getting $100,000 if the mortgage defaults. Since you’ve only sold the one chunk, and since that chunk is worth less than the mortgage itself, it must seem like a pretty good deal. But what if you turn around and try to sell another 100 of these? Obviously, people are going to notice that you’re pretty damn confident that the mortgage is going to be repaid (after all, you’ve just put $10million on the table on a $300,000 pot that says it will), and they’ll be less willing to take your bet. In order to get people to buy them, you’ll have to sell at lower and lower basis rates, thus increasing your expected (future) losses. And if the basis rate gets low enough, no one will even buy them at all no matter how cheap because they’ll be close to completely certain that they won’t get their payout. A really low basis rate is a market signal that you’re hugely overleveraged, and people don’t like to lend to people who won’t be able to pay back. So sure, it’s like Vegas. Where he’s got it wrong is that even in Vegas the amount that can be bet on something IS limited, in some sense, by the value of the thing being bet on. At the very least, it’s limited by our confidence in our opponent’s ability to make good on his bet, and that confidence has a lot to do with how much he “raised,” and whether we think his decisions are rational. If the pot contains $300 and someone raises to $10,000, you FOLD - because the risk of losing $10,000 is more serious than the expected gain of $300. Only in highly extraordinary circumstances does anyone take such a bet, even if you think the dude is bluffing.

But I think my real objection to this piece is an objection to the idea that betting is intrinsically worthless. It’s not. Betting is an extremely valuable instrument in a free market. It DOES serve a purpose, and that purpose is delivering infomration. Think about why you bet outside of Vegas and you’ll see what I mean. If someone makes an outlandish claim and you know he’s wrong, what do you do? Well, ideally you both break and go check it out on the internet, I suppose, but life happens in real time, and if you need the matter resolved now (probably to establish your dominance in the conversation or whatever), betting is a good way to do it. Talk is cheap, and betting is a way to make someone take responsibiilty for his statements. You bet he’s wrong, and if he knows he’s wrong he’ll likely back down. If he’s not sure, he might bet, but how much he bets will have a lot to do with exactly what his level of confidence is. If he’s very confident, you might back down. If he’s not so confident, you negotiate an amount that’s comensurate with each of your feelings on the issue. This negotiation process contains a lot of information both about how things are actually likely to be in the real world, and also how confident each of you are in your statements. The point here - again - is that betting isn’t done on thin air. It’s resolved according to rules and done with prior (but incomplete) information on both parties to the transaction. Since information in a market is distributed, “betting” can be a good way to aggregate it (see basically any of Robin Hanson’s papers for more detailed treatment of the idea). And since debt is inherently uncertain, the usefulness of such a tool in this domain is immediately obvious.

In any case, one is at pains to see what Kaye’s distinction between “betting” and “investing” rests on. Surely an investment is also a bet that a given enterprise will succeed? One doesn’t typically wantonly give one’s money to anyone who asks for it provided only that the beggar promises to “do something in the real world” with it! Typically, we first need some convincing that his venture will succeed, and then we need some kind of interest payment as a hedge against - what else? - the uncertainty that he actually will end up succeeding.

What went wrong with Credit Default Swaps is NOT that there is anything wrong with “betting,” and certainly not that there is a blazing white line between “betting” and “investing” such that the former is fantasy and the latter grounded. What went wrong is that the government polluted the enterprise by issuing implicit guarantees on mortgages that no rational person would have otherwise negotiated. The appropriate analogy is not Vegas as it actually is, but rather some perverse parallel universe “Vegas” where someone puts $300 in the pot, someone else comes along, looks over his shoulder and says “sheesh, you got fuck all! 2-clubs, 6-diamonds and three spades showing on the table, but I’ll bet $10,000 you win anyway,” and everyone else is confused about what to do until the casino owner comes along and says “don’t worry about whether he’s got the $10grand - I’ll back him up if he doesn’t.” At which point, OF COURSE everyone bets. But that’s a fantasy version of Vegas, and it’s obvious to anyone who’s passed junior high math why.

The trouble isn’t with “betting,” Mr. Kaye, it’s with a bookie being given an unlimited line of credit and yours and my expense and without our consent. “Betting” is what markets are all about. Working is what markets do when the government gets out of their way. When the government goes around to all the tables deciding who wins and loses - THAT’S when things get decoupled from reality. Only then.

In closing let me take the time to agree with this one of Mr. Kaye’s statements:

IOW, all of these bailouts are in order to cover the losses of bookies and to make sure that those who gambled get their payoffs.

Yes, that’s mostly right - and it’s every bit as immoral as it sounds. I would just like to add that none of the bets would’ve been anything like as high as they were if the bookie hadn’t known from the get-go that the government had his back.

To steal a phrase from the NRA - people don’t wreck economies, governments do.