VigilantesIf there ever were a time that it was absolutely necessary for the welfare of the commonweal for the bonds to have gone down, it was yesterday. Time after time, the insatiable bond auctions have shown an enormous revulsion before the announcement only to go up big showing big profits for the clients of the flexions on their holdings. But finally yields had their biggest back up, i.e bond prices fell almost 2 points, in 10 years. The vigilantes did not wish to buy the bonds at the lowest yield ever and refused to countenance the movement of productive activity from the common person to the organized blocks that vote based on how much they can get from the trough.

The holdings of treasuries by the banks has been increasing steadily and they have been making a fortune by borrowing at 0% at the window, and buying bonds. Why should they lend when they can make money by buying at a discount at the auction, and then showing an immediate 1 % profit on their 1 trillion or so of holdings. Every 10 billion counts.

What could possibly stop this transer of resources in the future? Only a message that continued agrarian reform, continued transfers with all the negative multipliers, continued new programs, continued expectations of reductions in incentives to start businesses as the rates go up to 35% and more from 28% for the LLC and sub chapter s's that actually start businesses and provide jobs outside of those elicited by increased regulation, the necessity of lobbying at the interior, and jobs to provide clean energy at those proffering the regulations and redistributions, aside from the vigilantes.

I was long the bonds after they fell today and lost as it had never happened like this before. But for once, I was happy to make a contribution to the vigilantes for the greater good. 

Rocky Humbert comments:

U S Senator Tom CoburnAfter a day on the proverbial treadmill, I mount the non-proverbial treadmill with cable-tv clicker in-hand for both relaxation and stimulation of body and mind. I often watch television during this exercise period.

Last night, I allocated my viewing between:

The Housewives of New York City (Bravo) — for insights into fashion, consumption, and a lifestyle that might cause even Ayn Rand to blush;

Re-runs of Jeopardy (Game Show Network) — for factoids and trivia useful for appearing erudite at cocktail parties;

Fox News — watching with hope that Krauthammer might crack a smile — which would be a sign from G_d that there is hope for my children and children's children.

Lest one think that this is all a non-sequitur to The Chair's comment, the final show that I surfed was Cramer — whose guest was Senator Tom Coburn (R-Okla). Both Cramer and Coburn were pounding the table for a meaningful extension of US debt maturities. Cramer wants Treasury to immediately issue $2 Trillion of 30-year bonds; whereas Coburn predicts a Greek-style liquidity crisis within 2 years — and wants Treasury to promptly re-finance existing bills, notes and Fannie/Freddie at long maturities with untold Trillions of issuance. See this article.

According to Bloomberg, over the past several years, the average maturity of US Debt shortened to a 26-year low of 49 months. Geithner is in the process of extending that to 72 months, but if Cramer and Coburn's proposals gain traction, yesterday's auction result will be a pleasant memory. It will be analagous to my accidentally pressing the "MAXIMUM" speed button on my treadmill — with the headphone cord attached to the handlebars and wrapped tightly around my neck.



Nate Robinson dunkOf course the one exception to the beautiful team work that leads to many of Boston's baskets that inevitably will win the series, is that they have won two playoff games with the loose cannon, the braggart small trader who jumps up and down on his colleagues back when he makes a profit or scores a basket, Nate Robinson who is 9 times as likely to lose a game the next time he comes in as win it, the same way when nas goes down 100 at 330 pm, and then reverses 50 in the last half hour, it's ready to lose so big the next time.



 Nobody asked me but the Lakers look very similar to the Knicks to me in their helter skelter approach to getting baskets with the only exception that they have a very good star in Kobe who can fake many ways. There is no rhyme or reason to their play, and when they score a basket it's a fluke three by Kobe or a lucky rebound by Gasol.

Boston on the other hand has a raison d'etre and reminds me of the teams that play the Knicks that always pull away during the fourth quarter.

You can almost see the tug of war between the two teams, like the fight between the bulls and the bears near the end of the day, as the flexions attempt to liquidate the weaks before reversing the next quarter.

Alan Corwin writes:

As a Celtic fan since before the days of Bill Russell, I concur with your analysis and hope it holds up. The Lakers have lots of talent, but it doesn't mesh a lot of the time. The Celts go through frightening stretches where they can't put the ball in the hoop, but they are almost always getting good opportunities.

Red on Roundball is still worth watching. You don't even have to be a basketball fan to appreciate the way his mind attacked the game.

The difference between Nate in Boston and Nate in New York is that Doc Rivers know when to take him out (i.e., most of the time).

Pitt T. Maner adds:

The 5th game should be big–winner would have an advantage.

There is the interesting dynamic of finesse/skill (Kobe) vs. power/inside game (Big Baby Davis).  Actually Davis is quite skillful and almost ballerina-like in those not so easy reverse layups–he shows tremendous heart and desire and considerable improvement over his LSU days (where he was darn good).

Comments this morning were about how can a true 6' 6" guy like Davis go in amongst trees like Odom 6' 10"ish and Gasol (7 footer) and be effective since they know from scouting that you have to overplay Davis to one side.   Answer was  quickness, positioning and "he has a big tuchus"–ha, but its true.  The more space (base) you occupy laterally with mainly muscle the bigger you can play against length.  And he has some of the same cat-like quickness of Barkley.

The Lakers had a chance last night if they make those technical free throw shots and if the referees change the call that went against Kobe when he took an apparent charge.  So it was a bit risky to keep the Celtic 2nd team in there late into the 4th quarter, although they played very well.  Riskier than it looked.  7 or 8 point lead in the NBA is like 3 to 4 for mere mortals.

I suspect that Phil Jackson hasn't shown the Lakers complete hand yet and has some ideas for each game number–situational strategies for game 5, 6 and 7.

With respect to Kobe his fade-a-way shots and 3 pointers look lucky but he is better shooter than one might think–if he goes on a streak watch out.  Hot hand type.

Not quite Bird vs. Magic but its still a very entertaining NBA championship series.  A Game 7 would be great.



Jack SchaeferThere is a beautiful short story by Jack Schaefer about a shepherd who is run off his land by cattle men who don't like the smell and ground after the sheep do their thing. He's from New Jersey, but he loves his sheep. It starts with the sheriff talking, "Yes I gave him the gun. And I guess I'm the only one who knows the story. Let me tell it in my own words." I always cry when I read that story, it's one of the best ever, and I usually am tempted to cry when I lose money on the bonds. But this time the temptation was countered by the greater good involved. I told you why above.



 Scientists reported on Wednesday that bubbles do not just disappear when they pop, but actually deflate in a rapid cascade of bubbles.

The physics behind this bursting effect seems to hold true whether the liquid is as thin as water or as thick as heavy oil, suggesting a universal theory of how bubbles behave when they break.

…He said in order to minimize surface area, a bubble forms an almost perfect hemisphere when it is in contact with a solid or liquid surface. When it pops, it creates a ring of smaller bubbles.



goldI noticed yesterday, even with the latest sell off in equities– Euro, Aussie– most majors against the USD held firm. Was this a signal about an imminent, albeit maybe short term, momentum shift?

Secondly, what great structure the gold market has on this move. It looks interestingly poised at the moment. It failed to take out the recent swing high, resulting in a double top, and now resting on the recent higher degree trendline from its last acceleration at a new velocity. As the double top is fairly close, it's not see as a signal for a massive reversal, but no doubt needs to be respected. There will be a couple of days of tight trading no doubt.

Nick White writes:

GladiatorIs not the currency market the place of greatest despair– a sort of trader's purgatory? I can almost smell the sulfur, feel the rush of steam escaping and hear the screams of those labouring eternally under their use of 500x leverage.

In fact, FX markets and traders make me think of the film Gladiator…relegated out into the midst of some provincial nowhere (my edge is in ZAR/ESS!!!), taken as a slave, forced to fight in the most barbarous and treacherous conditions, with shoddy weapons (TA), plagued utterly and hopelessly by randomness: all for the minutest, tiniest conceivable chance that they might one day win the series of coin tosses, fight in front of the Emperor in Rome, win their freedom, and be allowed to trade something substantive again.in less colourful language: FX seems to me to these days to be all noise, no signal– except in a very precious few situations. 



Using Soybeans in AquacultureLots of different effects from the oil spill will probably work out in the seafood markets. Wild caught is my preference but shrimp prices are headed up according to the TV pundits. Thailand, Vietnam, Indonesia, China, several Latin American and South American countries may have to supply more seafood to the US to make up for the temporary loss of the Gulf of Mexico.

It may benefit the soybean farmers in the SE.

Currently, the greatest demand for soy use in aquaculture rests in the China freshwater sector, which produces 63 percent of global aquaculture. Estimates show the Chinese aquaculture industry uses up to 6.5 million metric tons, or the equivalent of 280 million bushels of soybeans. Soybean meal takes to the lakes, rivers and seas, as well as the barns and feedlots, as the prominent poultry and livestock feed grows in popularity in fish and shrimp diets as well. The growing demand for commercially raised aquatic products presents significant opportunity for soy-based aquaculture feeds for fish and shrimp species.


The amount of soybean meal used for aquaculture in China exceeds the soybean production of Indiana," says Joe Meyer, United Soybean Board (USB) director and a soybean farmer from Williamsburg, Ind. "The soybean checkoff continues to work to expand the aquaculture industries in other areas, such as Southeast Asia, Central America and the Middle East."

A growth industry by some accounts:

"The potential for increased production seems larger for aquaculture than other food producing technologies," concluded Professor Frank Asche at the University of Stavanger, final speaker at the AquaVision conference on Wednesday. Professor Asche reached his conclusion by drawing together results from world-wide market research. Aquaculture is inherently sustainable The Norwegian Professor was co-author of an article on sustainability and global seafood in Science earlier this year. He expects aquaculture to have a long term growth that will make it the dominant seafood supplier within a decade or two — without damaging the eco systems in which it operates. "There is nothing inherently unsustainable with aquaculture as long as the producers choose to operate on a sustainable basis," said Professor Asche.



 The following is not a rhetorical question; I genuinely don't know the answer. The 12 hours of school, music lessons…sports programs–is that really what's going to be best for these kids?

There seem to be fewer and fewer pre-scripted routes to success these days. Alan Corwin wrote about highly skilled database programmers who found themselves obsolete. Medicine has gone from being very cushy to modestly cushy. (A few pathways that might still exist: 1] do well academically/go to law school/ become partner at law firm, 2] get a government job, or 3] be nice to your very wealthy parents) Increasingly you have to invent yourself.

So what happens to regimented and highly educated kids when they grow up? They can hit a passable forehand, play some of Beethoven's piano sonatas, and do integrals (on Matlab), but they grow up and find that what they really need out there is something that's unique, which they don't have. Most of the successful people that I know personally had unstructured lives as children, and they had to figure out for themselves what to do with all that time. Most unsuccessful people though had the same situation! That's why my question is a real one, not a rhetorical one, one in fact that I'm facing with my own children.

Scott Brooks writes:

Having an unstructured life as a child equating into success as an adult depends on your upbringing, parental guidance, and environment. I saw a lot of my friends growing up living unstructured lives because of single family households (mother couldn't do much more than work to support family), alcoholism of one or more parent, or other factors.

I think a lot of these kids would be much better off if they were in a structured environment that allowed them freedoms most of their day (12 hours or more), at least 6 days a week.

The problem is that the kids who need this environment are stuck in some kind of a governmental system whereby the teachers unions control the environment. I believe that is what has lead us to being a country of non-thinking sheeple and is destroying our children today.

Jeff Rollert writes:

Improv is the best training I've had, and I use the trapped time in the car to make the kids do it. Doesn't matter if it is story telling, music, jokes, etc.The only consistent skill I've seen in life that doesn't get obsolete is on-the-fly storytelling.

Jack Tierney comments:

 This is an important question and one that has great significance for the future. Recently I've come across more and more articles regarding this cohort and their predicaments.

The recent spike in student loan defaults has highlighted the fact that many of our "highly educated kids" have gone deeply into debt. Unfortunately, many have been highly educated in specialties that offer little opportunity to secure a wage sufficient to pay off the debt and live in a manner to which they've become accustomed.

In many of these households, the parental unit(s) have also taken on substantial debt to provide the education; unfortunately, their 401Ks and pension plans have been whacked by the market, and chances that junior will be offered a comfortable, all-meals-provided, rent-free existence dwindle daily.

I recently re-read "The Grapes of Wrath" for a discussion group. There was some conversation on whether current events could lead to a re-run of those days; it was suggested that our many undocumented immigrants would supplant the equally powerless and under-educated Okies. I suggested, however, that while both groups presented problems for their times, our well educated but un- or under-employed youth could present a significantly greater one.

During my lifetime it's been rare that major anti-establishment protests have been led and peopled by the under-classes…the poor rarely had enough time or resources to be regular participants or prisoners. Those movements were conducted by an educated but unhappy coterie that was rarely underfed or unqualified for well paying positions. Tomorrow's protest leaders could well be both.

Another disturbing element in this education scam is the adult re- education programs being offered and underwritten by the Feds and the States. There's heavy emphasis on computer skills, auto repair, finance, education, business admin, accounting, and nursing - fields in which there already exist many unemployed but experienced professionals, and others which have little future.

I can appreciate Dr. Pennington's concern. Of my three sons, only one appears to be moderately secure. All are now in their forties, so options are limited and not very promising. For my grand-daughter and grand-son (I have one of those now), I have major concerns as I feel they, too, are being offered yesterday's curricula for yesterday's jobs. Will they be tomorrow's Joads?

Stefan Jovanovich writes:

We already have Steinbeck's world here in California; but the traffic is heading east away from the state. The only people driving to our state are the people behind the wheels of the empty rental vans. (I urge List members to check out the differential rental rates to and from California.) People here are literally packing up and heading out because there is no work; and they know there will not be any.

Not to argue with John but the "anti-establishment protests" in American history have never been led and peopled by the underclasses. The Homestead strike was by the best-paid steel workers who were protesting the hiring of cheaper immigrants who spoke languages other than English. The Reuthers, the founders of the UAW, were skilled machinists; so were the auto workers who staged the sit-down strikes in the 1930s. The poorest workers - the blacks, the hillbillies - had already been laid off. The Wobblies my grandfather knew were skilled miners who had learned their crafts in the European mines before coming to America; the "scabs" (sic) were the Mexicans and poor white Southerners. Now, riots - like the Rodney King uproar - are another thing; then, the underclass comes out to smash windows.



Errors in statistics are usefully classified as type 1 and type 2. A type 1 is a false positive or undue credulity and a type 2 error is a false negative or false skepticism. The greater you try to reduce the level of error in one the greater the likelihood of error in the other.

                                          Don't reject             reject

no effect hypothesis true       correct                type 1 error              

no effect hypothesis false      type 2 error          correct

A useful way of considering the decision making is above. Consider for example the no effect hypothesis that a pill is not healthy. if it's not healthy and you say it's healthy you make a type 1. If it's healthy and you don't say it is healthy you make a type 2.

A certain agency that regulates drugs is famous for only considering the type 1 errors, making sure with endless and ruinous double blinds that type 1 errors are minimized to the excessive making of type 2 errors and keeping off magic bullets that would extend life span and health enormously.

There are many areas where these trade-offs between errors occur. For example in spam filters. You can reject good things, that's type 1. You can accept bad things– that's type 2.

Our own field often has trade-offs like this. The hypothesis that a system or set point for a trade is random is a good null hypothesis. If you accept the system, you're just incurring churning for a worthless randomness. If you don't accept the system, and it's good, why then you've lost some good money.

The decision to expand your business or trading is another area that crops up frequently. If you expand it you might get in over the head. If you dont expand it, you might miss the gold. The movement into a new field, or the engagement of an employee or employer is another frequent trade off of type 1 and type 2, gullible reaching versus excessive caution that frequently arises.

The usual way to trade off between the two types of errors is to consider the cost of both errors, and to balance your decisions based on the relative costs. Considerations relative to randomness, and variability must also be considered. Also, the myriad psychological biases that lead us to place too much reliance on avoiding the two types of errors that the cognitives have contrived with their silly experiments on college students et al.

What other trade-offs of type 1 versus type 2 do you see that mite be of use to market people or others and what better way to consider gullibility versus skepticism do you see?

Alan Millhone writes:

This weekend I will travel to Grove City, Pa for a yearly Checker Tournament. While playing I will have choices to make. Sometimes there's only one way to move. Often times there's more than one way to move or jump. Checker players and Market players need to evaluate all moves or trades before executing. In Checkers if you touch a piece you have to move that piece– often with disastrous results. If you trade on line you need to consider your trade carefully before hitting "send". Tom said, "Move in haste— repent in leisure". 

Victor Niederhoffer adds:

Sharif KhanThe trade-off in errors in games like checkers and chess would be someone offers you a seeming advantage. Your null hypothesis is that it's not worth accepting. If you take the gambit or seeming opportunity when it's really no good you're making a type 1 error.

In checkers I've found that no opportunity that looks good, no opportunity to set a trap for example, is worthwhile against a good player, as good players never make mistakes. You were too gullible. If you don't take the opportunity when it would have been good, you're making a type 2 error. You were too skeptical. I find that in checkers the type 1 errors are much more costly than the type 2 errors, but in chess I don't know enough to say. But among the good players, I think they often are too cautious or too skeptical if they wish to win a world championships. They are too likely to go for the draws. In general, I would say if you want to be the best you have to be ready to make the type 2 errors to a greater extent. But then you always risk going belly up.

The situations are not without personal applicability to myself. It's easier in squash. I played an errorless game. Never made a type 1 error of going for broke with very risky shots. Well, it wasn't that bad. i went for about 5 years without losing a game in a match or so. But it wasn't good enough to beat the infernal Sharif Khan as much as I should. I should have played a much more errorful game, being willing to accept the risky shots and confrontations and hitting it on the rise and changing my infernal errorless slice backhand to a top spin so I could belt the ball through the Khans the way the Cubans who played Jai Lai could. In other words, I didn't make as many type 2 errors as I should have. 

Anatoly Veltman comments:

I remember grandpa coaching me at 5 or so: "always believe a man." If it turns out to be a lie, you'll find ways to extricate. But if you distrusted without good reason to begin with, you risk losing a friend– and that's an ultimate loss.

Jim Sogi adds:

Why do smart people make either type 1 or 2 mistakes? Presumably, and by definition, it is not because of stupidity, so some heuristic must be at play. In type 1, the fear and result is that you look and feel stupid. In type 2, there is less risk of looking and feeling stupid, but you end up being frustrated by the loss of opportunity. The joke around here is "which is worse" –you present a bad and a ridiculously bad alternative. Weighing the cost benefit is faulty because of proven heuristics are lopsided towards avoidance rather than gain. Add in marginal utility considerations and the difficulty is even harder. 

Bill Egan comments:

I will add a twist to the type 1 error problem. I have seen certain extremely intelligent people simply be unable to conceive they might be wrong. This is a problem that gradually gets worse. They have been right 99% of the time because they are so smart, and as time passes, they make bigger and bigger bets because, 'hey, I've been right.' This isn't quite hubris or arrogance because they really are that good. Finally the odds catch up with them.

Roger Longman writes:

Roger LongmanVic,

Love this.

So seems to me the real challenge is figuring the cost of a type 1 or 2 decision.

In the case of the FDA, the costs of a type 2 error are dramatically higher than the cost of a type 1. Those costs aren't financial, or not primarily financial. There's the substantial humiliation cost, for example, of approving a drug that turns out to have some important side-effect (or a side-effect more important to a group of influential people than its benefit to a group of less influential people) and being dragged in front of a congressional committee (Charles Grassley of Iowa has been the grandmaster of this, but he's got plenty of competition). There's the bureaucratic cost of being passed over for a more visible job, or an interesting review opportunity, if your name is associated with a controversial decision.

All of which is to say: of course the FDA errs more on type 2's. And the growing pharmacopeia (much of which is generic and therefore low- cost) only encourages this bias towards type 2 errors, particularly in regard to follow-on drugs (i.e., new molecular entities in the same class as approved drugs). If — the FDA figures, albeit not publicly
– by instinct, as it were — there is already a good drug that helps a majority of people why take the chance that a second drug in the same class will provide more incremental benefit than incremental risk, which — as I note above — comes with disproportionate institutional costs?

There's also an inherent problem with drug development divorced from serious comparative effectiveness (the current system of purchasing drugs, based as much on rebates retained by payers as medical and economic value provided to patients and employers, actually discourages the kind of comparisons common in most sectors of the consumer economy).

Victor Niederhoffer comments:

Longman was editor of Windhover Information Ventures Biomed and is very knowledgeable about the FDA. I wish he had been at Prof Tabarrok 's talk at junta where the positive case for the FDA going out of business was limned with statistics and current studies on deaths caused by lack of approval.



Photo by Dorothea LangeJust ran into a stranger driving a delivery express van out of Kentucky. He asked openly in the service station lobby if the bridge up the road was a toll bridge and one of the attendants replied it was. He then asked if the station had an ATM? I asked him if he needed bridge toll money and he said he did.

I had him follow me to my truck and gave him two toll tickets (worth .50 each). One likely would do it but I gave him two just in case his van was 3/4 ton. Looking back I should have asked him if he was hungry and if so fed him. Here was a fellow without even the spare change to pay for bridge toll. I had never been in that situation till today.





Beijing skylineBeijing is a wonderfully surprising modern city defying expectations. The people seem less stressed, happier, more in tune with each other, and better socialized than in US cities. Prices are amazing. Breakfast for 5 $2.50; Lunch $3 for 5 people, dinner with drinks for five $17. Fancy dinner in fanciest part of town, $100 for five with drinks. Beer $2 at fancy restaurant. Rice liquor at Wu-Mart is under a dollar for a liter of 120 proof tasty liquor. Beer is good German style lager and 50 cents. Juice at street convenience stores in 20 oz bottles is 80 cents.

The Metro is beautiful, clean , fast, modern and the fare is a quarter US and same for the electric modern buses and trolleys. The highways are big, fast, and there are no pot holes. There a very few European and almost no American tourists. 99.8% of tourists are Chinese. Cars are new Mercedes, BMW, Honda, Toyota, Hyundai. I sense less anger and less friction between people even in crowded cities. There are no bums, no litter, no antisocial behaviors. No one has tatoos. There is no "attitude" even among the young. People are less self conscious compared to say LA. The Chinese are spending on infrastructure and frankly are surpassing the US. The airport was huge, clean, and modern. The US cities are really falling behind China. Contrary to expectation, the police and government presence is almost non existent. There are many attractive well dressed women about in the city. There are many bicycles in separate bike lanes on the boulevards. I really like China. Look out for Chinese business to grow.

There are 57 cultural minority groups in China. In western regions China has absorbed many different cultures as different as cowboys and Indians. There are numerous languages and enough difference in dialects in China such that people between provinces cannot understand each other. The cultural gap between older and younger generations is complete. In Beijing they are dancing and singing Tibetan hip hop.

Craig Mee writes:

Even after 6 months living in Bali full time and its surrounding countries, having spent my life in Australia and the UK,  I still especially when driving am always waiting for the "rage". It just doesn't come. I've seen potential fatal near misses and quickly looked at the expressions of those involved, and it never ceases to amaze me…. NOTHING! It's astounding. All's cool. Whether it's religion, social framework, or combination of many things, why everyone holds it together I'm not sure, but it's a pleasant change. 

Jim Sogi replies:

Craig's note on Bali is true for China. After much discussion, I believe it is an intrinsic sense of cooperative society resulting in less friction. Driving is life and death, and even when passing on blind curves the other drivers all back down and let the guy pass or cut in, no rage. Horns blare constantly, but not in anger. This is instinctual behavior at this speed. In the US, it would be fisticuffs or profanity at the least. And there would be no backing down to let the other guy in. It is not just the fear of being noticed by the authorities, though that is a big factor. The Eastern society is more cooperative. Western/European/Judeo/Christian ethos is more confrontational and adversarial. Whether it is based on perceived self rights or not, the net result across society is profound and very very different. 



programmersI talked with several of my former students who are database programmers over the past few weeks. More and more of them are looking for work. There seemed to be a general consensus that these jobs would reappear as soon as the economy recovers. I hated to be the bearer of bad news, especially since I did my best to make them database programmers when they were my students, but these jobs aren't coming back.

The world has changed. It's not that the need for data collection and processing has diminished; it's that in large part, these jobs have been automated out of existence. Ten years ago, if you needed a million lines of database code to support a large database, several programmers worked more than a year to create that code, and often several programmers were needed permanently to maintain that code. That is simply not the case any more.
In the last ten years, code generation has come of age, and the first places to be impacted are the coding activities that followed simple processes. In 2000, a million lines of code represented ten programmer years and an expensive management structure. Today, one programmer can create that same structure in a few hours. The job now simply requires that one lay out the data structure and push a button. Instantly, you have either a complete application or at least the basic structure that everything else will be built upon. If the customer doesn't like it, I can go back to my computer, work for an hour, and show them a completely different implementation.

There are at least a half-dozen commercial products that do this job, and I have written several variations myself. It's a little tedious (like most programming jobs), but nowhere near as tedious as writing database code by hand. Not only does the customer save a fortune on programming costs, but programming errors with expensive consequences rarely get introduced into the automatically generated code.

I would think that any database programmer who has ever seen a code generator work would immediately strive to develop a different expertise (code generation, for example), but the more typical reaction is to assume that the same people who wanted their skills in the past will want them in the future. They are not actually hungry because they have made a good living for many years, but they are going to be very lucky to get anymore income out of their current skills.

The same thing is happening in all kinds of programming. I watched a demo from Alphacet last week which was quite impressive. We had a simple system consisting of several rules, and the Alphacet representative was able to turn those into an automated system AND do some simple backtesting in less than ten minutes. I could easily come up with rules that I would still have to program by hand, but they were prepared with all of the common structures and market data cleaned and organized. I could get the code generated in my choice of six different languages. The bottom line is that another world of good paying jobs is going to disappear.

What is on the horizon that will replace these jobs? I have no idea, but I spend more and more time thinking about code generation and how to maximize its use. We used to have several programmers on staff, and now we do all that work ourselves. For us, that made the difference between able to survive this downturn (so far, knock on wood) and drowning in our own payroll. For my friends in the programming community, it means that there are hard times ahead.



Socks on the handsI believe the absence of routine may be a critical factor in creating failure. All the distractions, including the physical and mental act of taking phone calls is enough to throw a game off. I liked to do very normal things throughout a tournament, as I reached the finals, and I would recommend that for a trader. Whatever you do, don't use the hands and mid level organs before you play.

Nick White comments:

I also hold that routines are essential to success– no doubt about that. But is there some wisdom in allowing for the fact that life throws the odd curve-ball? Are there circumstances whereby following a usual routine will get one badly hurt or killed (market or otherwise)? What ought to be done when a personal disaster strikes 2 minutes after one has placed their largest position and it then gaps half a percent against? What principles of training facilitate adaptation to the wild rather than adaptation to the expected?

One society in history seemed to grasp this - the Spartans. Their routines seemed to emphasize preparation for both the expected and predictable, as well as to develop faculties, skills and resources to deal with that which was difficult to prepare for…in other words, to build up so much personal and corporate redundancy in capabilities that there was very little (bar hubris) that could steal the victory.

Jeff Watson writes:

 Whenever I am in any kind of competition, trading, poker, surfing, whatever I try to follow the same script., In poker, for example, I pick up the cards the same way every time, look at them once and leave them face down on the table. I handle my chips the same way every time and time my reaching for the chips do it in the same manner. I keep the same vacant look on my face and time my eye blinks. I keep conversation at a polite minimum as tremors in a voice can give away tells. I wear a high collared shirt as I don't want a pulsing jugular to be seen. I have several other proprietary methods to minimize any tells and other methods to create false tells. still, according to one of the ex-world champions of poker, I have less tells than anyone he's seen, but the tell I have makes him able to read me like a book. From past results, I believe that he's telling the truth.

Nick White asks: 

Can tells in a closed-form game compare to tells in a wild environment? If one lost a comparably ruinous percentage of bankroll in the market as their poker game, would the displayed tells be the same? Or concealment easier? 



 Could the internet being changing the way markets trade?

It has been mentioned that the average attention span for adults is 15-20mins, and for the internet now less than a minute!

Could this have implications, as younger "playstation" brought up traders take hold?

I only had to look around at the grad next to me sitting on the desk in London, and watch him at the computer to know these boys were quick!

Could this have wider implications particularly in the normal ebs and flow of a normal trading day?

Alan Corwin writes:

Yes, the Internet is changing the way that traders trade. I think everyone realizes that it has, but if history is any guide, we will find out in the future that we had no idea how dramatic the changes have been or how diverse the fallout will be. Even Jules Verne underestimated change, and he was willing to go way out on a limb.

The one prediction that I feel comfortable making is that everything will happen faster. Certainly, that has been the story of the last twenty years, and the emergence of the Internet has accelerated that trend. I am often dazzled and frustrated by the speed at which markets move and change, but 2010-type trading would be mind-shredding to someone trained to think at the pace that the markets moved in the eighties. I can also remember being told in the eighties that the rate of change then was dramatically different than the rate of change ten and twenty years before.

I do think you have hit on one of the clues to the nature of those changes, i.e., attention span. I don't own the PlayStation kind of games myself because they would take over my life, but I have played several of them enough to realize that they all call for rapid execution of complex tasks, both mental and physical. There have always been activities that fostered these skills (most sports, for example), but the constant comparison against the standard of the machine imposes a different kind of discipline and fosters a different array of skills.

The young are built for change and speed because that is their competitive advantage. If we are competing with them as we are with young traders, we can only win by making the most out of experience. The sad news for those of us past middle age is that they will gain experience quicker and more effectively than we can improve our speed.

I have also noted one encouraging aspect of these games. The young devotees look to themselves for the causes of failure and success. I have never heard one of these kids say: "The machine got lucky" or "the machine cheated". It is accepted that they must look to themselves for the resources necessary to beat the machine. None think that the game is too hard or unfair. That's the way winners think. I like that.

Kim Zussman writes: 

By 1998 the internet was in use by >1% of the world, and has penetrated an increasing proportion of the population. Assuming web-based trading has paralleled this trend, here is an attempt to quantify stock market velocity as a function of internet availability.

DJIA 1928-present was used to calculate a proxy for "weekly velocity" = weekly range:

weekly range = (H-L) / {(H+L)/2}

The attached chart shows historical weekly range from 1928-present. Here is comparison of mean weekly range for the internet period (1998-present), and an equal number of weeks from the earliest part of the series (1928-41), when the internet was just a twinkle in Tipper Gore's mother eye:

t-Test: Two-Sample Assuming Unequal Variances

                   no net    internet
Mean           0.0452    0.0561
Variance       0.0006    0.0014
Observations    648    648
Hypothesized Mean Difference    0.0000
df                   1144.0000
t Stat           -6.2125
P(T<=t) one-tail    0.0000

Any Internet effect is overwhelmed by other market issues.

Craig Mee responds:

Thanks Kim and Alan,

When i wrote this, I was specially watching the dax trade and seeing a counter trend pullback, and thinking every market has a short term cycle. iI wonder if this cycle and any variance is directly related to attention span of its players. With Alan's comment "the sad news for those of us past middle age is that they will gain experience quicker and more effectively than we can improve our speed"….maybe we should then trade in a way that works for our personality and also is physical and mentally practical. 



 "Saved by the bell" has an interesting etymology.

There have been many boxing matches whose outcomes have hinged on this principle–coffin survivors less so. Is it a possible outcome, though that may play out in the survival of companies that have been recently pummeled? Rope-a-dope for a few months and everything will be different.

Headline news replaced by winds of hurricane damage or political change. Issues of national security and employment impacts balancing retaliatory actions. Sideline cash unleashed for mergers and acquisitions of struggling participants has been mentioned lately– company life buoys. Will the sinners be added to another companies bottom line?

Who will ring the dinner bell?



 Cotton sat in a three month side way movement after an extended up move.

Finally broke lower and hit the brakes, and you can almost see the skid marks on the track now, as it reversed.

Holy cow, all those shorts scrambling.



 Marc Chandler notes that Chinese companies have been using the dollar as an invoicing currency for exports to Europe: "Consider Hangzhou Natutex Apparel Corp, which produces outdoor fabrics. Europe is the destination of the bulk of its exports, according to press reports. In 2009, an estimate 50% of its sales were invoiced in euros. Reports suggest that it has been cut back to 5%. Several local governments in China have told exporters to be cautious about settling trade contracts in euros and encouraged that if necessary, sign short-term contracts only. This follows a period of time when some of the same governments were encouraging diversification away from the dollar as the invoice vehicle. Local press reports suggests that around three-quarters of China's exports are invoiced in dollars. Shishi Daily, an official newspaper for the export base in the Fujian province recently reported that its exporters have fared well because they followed the government's advice and moved away from using the euro for invoicing purposes."

This is an illustration of how the classical gold standard allowed bilateral trade between companies to adjust pricing. As it would have been under the classical gold standard, China's own legal tender currency has a fixed valuation relative to an external standard; yet its exporters are able to adjust their pricing based on the changes in the overall terms of trade. The adjustment is made by choosing another invoicing currency, but the adjustment could have been made using a pure discount– as would have happened under the classical gold standard.

What the classical gold standard allowed was the very diversity of pricing that is now impossible under a centralized system where government liabilities and bank reserves are an identity. Darwin would not have approved.



Bucharest, RomaniaThis is left wide open for every reader of the site to make the call…

It seems now that you are going to need an intelligent electorate to accept the tough calls, pull their heads in, bunker down, and not cry for mum when all of them knew they shouldn't have their hand in the cookie jar and thus are all responsible for the outcome, (granted banks are a joke) but because there was NO SIGN, saying don't be greedy, it's apparently for the masses, everyone else's fault.

So on this basis, we need a intelligent voting population to be the first to put their hands up, and say let's take the heat and get on with the pain.

So on that basis, and of course there are factors to consider including the currently state of said economies, debt levels, housing booms, and credit excesses….what is the best placed country or countries?

Well, maybe luckily for me I found this through surfing the web. Although it was written in 01, (maybe nothing's changed), someone agrees, albeit on the surface. I'm open to other suggestions….

Finally, Lynn and Vanhanen peer into the future. They predict future growth is most likely in countries with high national IQ scores but currently bad economic systems. The countries of the former Communist Bloc—Russia, Poland, Bulgaria, and Romania, and the People's Republic of China, and Vietnam—are good bets.

Jeff Sasmor answers:

The good old US of A.

I'm not being sarcastic. Not to offend those not living here, but personally, I wouldn't leave even if Palin is the next prez. Wait– I was talking about Michael Palin…

Vancouver, Canada
China may be headed for their 1929 moment. A populace not used to investing in any sort of asset is seeing an exponential tulip phenom that the gov't can't control (yet). It's gone open-loop. And they're too connected to the US to decouple as many like to think. We're too big a market compared to anywhere local for the near-term. And their population wants decent wages– guess how long it will take foreign capital to pull up stakes and move where labor is cheaper– probably Africa as soon as (if/when) nations there wise up and become politically stable. I used to think S. America, but it's not as biz friendly as it used to be where foreign capital is concerned.

Europeans think that the way to solve their problems is to ban shorting– déjà vu– they're hosed.

The world's economy is in for a tough time just about everywhere. I'll pick right here as the place to ride it out. All the political stuff is just noise– psychohistorians take note.

Alan Corwin writes:

I like Canada. They have more resources per capita than any other place on the planet, a relatively sound financial system, and a sense of humor that I can understand. The only time they lose resources is that their citizens move someplace warm when they get enough cash.



a film still from COWC O W

Directed by Guan Hu

Cast: Huang Bo, Yan Ni, a Guernsey

This elegiac film is part comedy in the glorious Jackie Chan tradition, part tragedy—it treats the Japanese invasion of a Chinese village in the second Sino-Japanese war and the after-story with the still breathing remnants of the countryside—and part bromance (buddy-pic) between the protagonist, Huang Bo (Best Actor, Venice International Film Festival; Golden Horse award), and a sweetheart of a black-and-white 'American' cow (Chinese cows are, yes, yellow). It is clearly, too, an anti-war delivery system dressed in an historical epic, but the point is made along the way, no hammer to the head. Before you realize there is a message. The director blends a bleak humanism with a Charlie Chaplinesque tragicomic

Ravishingly photographed in nuanced, chiaroscuro-etched sepia varying with black & white, every frame takes your breath and holds it hostage until replaced by the next eye-pleasing frame. With quiet flash-backs and flash-forwards, COW follows village simpleton Niu Er (Huang) as he reluctantly tends to a stubborn, willful hunk of a cow, amid brigands, Japanese attacks, landmines, hunger and revisits from the enemy, under the impression that he is bound by deed to care for it until the Chinese 8th Battalion comes by to reclaim it. He calls the cow the name of his beloved, murdered villager-wife, the peppery proto-feminist Jiu (I) (played by saucy Yan Ni). Jiu II is a gorgeous hunk of unquartered livestock, immaculately if inadvertently sardonic. The filmmaker captures a brilliant moment in cinema when he photographs the reflected bloom of fiery explosions from afar in the humane cow's glossy right eye. Every scene is a gem of framing and texture, sky and earth, rock and soil, snow and arid war-scarred waste.

Much to marvel at and—slowly—enjoy, this wholly realistic picture of Chinese country life decades ago puts a grin on your face, then beguiles you to the gut, where it soon shivs you at tragic and poignant intervals.

Funny-true story of how Huang Bo got cast in a prior hit. Famed director Ning Hao saw Huang in a film, and thought he was a migrant worker extra, and gave up any hope of hiring him (How do you locate and call a migrant worker? Would he have an agent? Would he live in a house? Would he know how to read?). Only later, when they bumped into each other at the Beijing Film Academy, did he realize Huang wasn't a slobbo hobo.

Go. You have my blessing: Have a COW.

109 minutes; Mandarin; English subtitles



Obama and Bo, the first dogIdeological diversity would make a difference if the different perspectives were delivering reasonable suggestions for correcting the problem and preventing repeats, but so far I have seen none of that. All ideological diversity gives us today is multiple collections of whining idiots lowering the level of discourse. I'm not a fan of the perspectives on CNBC either, but I would give them credit for running a series featuring people who have a clear suggestion or slate of suggestions.

The similarities in the Katrina/BP situations are that clearly neither leader was prepared for the disaster, both leaders were slow and ineffective in their response to the disaster, and no one has yet come up with a solution that will even mitigate a recurrence of similar disasters. I think we're all willing to admit that a President has enough on his plate so that he will get caught by surprise on occasion, but we do want to see a quick recovery from that shock.

I think we can all help our leaders (and they certainly need help) by focusing our discussions on problem resolution and prevention. All discussions of blame and responsibility seem to be a distraction at best.

We may not like the leaders that we have, but there is no good reason to believe that better leadership would have been offered by the other choices that were offered to us. We will continue to get leaders whose common attribute is the ability to raise cash for their campaigns because those are the only people who get to play the game.



 Now here is a good summertime read. Law of the Jungle is a real life action-packed thriller from front to back, the story of American military contractors, and many others, held hostage in the triple-topped canopies of Colombia for years on end.

The story is chock-full of human drama, the will to survive, fear and greed, and best of all for traders, the art of deception on the march towards victory.

Simply put, this book has to be one of the best documentaries on hostage-rescue attempts in all of history.

Having traipsed around the country in the late 70s it is easy to see that the author really knows his stuff and went to great ends to put up a quality piece of writing.



a giant shrimpThis piece illustrates so many things that it must be shared. "Sorrows never in single spies…". Misery loves company. No contingency should be overlooked in efforts to help your position along. And the upside down fixed income trader formerly from Harvard says, "stock investors should brace for higher volatility ". et al.

Steve Ellison comments:

The last time I got my hair cut, it was cut by an older lady from the Mississippi Gulf coast who had lost everything in Katrina and moved west. She told me that many other people who had lost everything fell back on shrimping as the occupation of last resort and are now faced with a second wipeout.



 An evil man in the news. "No one really believes they turned daddy in without a heads up that they were alreading coming for him, right?"

Vince Fulco comments: 

Since this story broke, I have been shocked to find out how many 'average joes' in my childhood community of upstate NY have been devastated by this mad man. Cases in point are a reasonably successful but otherwise unremarkable family doctor who was forced to return back to work full-time at 70 and separately a mid level real estate exec who's dealing with severe clinical depression after his couple of million $ in life savings; generated through scrimping and saving, were completely wiped out. The tentacles of evil reached so far that it does seem to give credence to the 6 degrees of separation theory. It could have been avoidable if following some of the earliest and simplest of universal truths:

1. Don't put all your eggs in one basket

2. If it is too good to be true, it probably is and

3. Trust but verify (often) among numerous others.

Anatoly Veltman comments:

A few aspects don't get enough attention:

1. Majority of those who lost participated of own lure/belief that they were in on special advantage/inside

2. That's one explanation of why many clients don't want to acknowledge that they were; another is that some took out more than put in.

3. Beyond profitable withdrawals, tens of billions more will never be accounted for– kept by investigating insiders.

4. The "reverse Robin Hood" of taking from many to give to few is thriving well past-Madoff: within the entire latest bubble and almost all government actions of present




 The reference to regression towards the mean contains a beautiful discussion of this useful market effect and could only have been written by Stigler himself.

Rocky Humbert writes:

This is particularly relevant to those who bought a beach house on the shores of Lake Wobegon during the real estate boom, because prices only go up, and "you gotta own land, because they ain't making any more of it." See the Lake Wobegon Effect. And, eventually will be relevant to gold — but from $1250 or $2500 or $5000/oz only Didier Sornette and I know. And I ain't tellin' …



 Sunday morning I woke up at 6:00 to run a 10k race that ended up with me taking a short ride in the ambulance to the trauma center after passing out from dehydration.

There was a 5k race and a 10k race part of OKC Corporate Challenge. The 5k runners just run 1 loop and the 10k runners are to do 2 loops of the course.

It is always hot and humid for this race. This year it was even more so than usual. For some unknown reason they did not have water on the course. I went out what I thought was a reasonable pace and kept up with a former college runner 3 or 4 years out of college, but he was doing the 5k. The first loop was only about 18:30.

 I made it to about 6 miles where things started to go terribly wrong. First I apparently turned off Lincoln onto 13th street and was suppose to turn on 10th for the final block. I don't really remember why I missed this turn but deliriousness and wishful thinking do not mix well. Soon after I remember falling down scraping my knees. I got up thinking I only had 1 block to go, tried to continue. I don't think I made it more than 10 meters before I was down again. By now I my stubbornness has kicked in and I am determined to finish. But remember wobbling a few more steps and went down a 3rd time. And got back up. The fourth time I do not even know if I took any step, but I remember thinking I better try walking in the grass, because this falling down was killing my knees. I do not really remember going down the 4th time. From the lump on my head I must have hit my head on the curb. But I do remember calling for help, and could not understand why nobody was coming. I thought I must have been less than 100 meters to the finish. Luckily for me on the corner of 13th and the Lincoln is a hospital and a nurse saw me laying in the curb. Next thing I know I a cursing the medics for not letting me finish and strapping me down.

In retro-spec there were many things I could have done that would have got me through the extra 2/10 of a mile. First I woke up with a little intestinal problem and should have called in a sub. But I wanted to run a 800 meter leg of a 1600 m relay at noon and dropping out meant being ineligible for the relay. Second I drank Gatorade that morning, deviating from my normal routine of drinking only water that close to a race. The nurse said my blood sugar was over 300. Third was the day before. I rested up on my running, but mistakenly thought this meant I could do other activities. I spent most of the morning working outside in the heat. Then I went swimming with my daughter for 30 mins that evening. Also I had Pizza for supper. Each of these dehydrated me. Finally and perhaps most important was I went out too hard. From the turn around, me and the 5k winner had over a minute and a half on the other 5k runners, and who knows how far ahead I was from the next 10k runner.



 There has been a substantial increase in the number of live aboard, small sailboats (and even a houseboat or two) moored in the intracoastal waterway off Palm Beach.

A veritable "raft-up".

Nearby on Peanut Island is the nuclear bomb shelter built for JFK. 



Nadal beats SoderlingI guess that I should stick to the defunct game of hard ball squash in my racket predictions as I thought that Nadals' poor strokes and unusual musculature would make the 3/4 winning probability on his winning the French Open a good coppering. However, he won in strait sets, (in the spirit of Anatoly) and all one can say aside from "j'excuse" is that the indicator worked well with Federer's loss being the tell that the market would go down big to the lows.

Pitt T. Maner III writes:

Soderling had his chances in the 1st set that might have made the match more interesting. He hits hard flat shots that break down most players strokes. But this style goes almost totally against clay court teachings of using top spin to keep the ball high over the net and deep to create a greater margin for error. The hockey-type slap shots work for him if he is on, otherwise it produces a lot of unforced errors. I would not be surprised if Soderling had bandy or hockey in his background.

Soderling inexplicably let several shots go that then dropped in and he was very tentative in coming to the net–nerves I suppose.

If it had been Borg they would be carrying Nadal off the court on a stretcher with IVs because he would have to cover the court for 5.5 hours not 2. Borg and Vilas had rallies that went to over 50 hits in the old days. Soderling was tired after 2 hours? They don't make Swedish players like they used to.

Well maybe he will do better on grass and with shorter points.



Rip Van WinkleA good review of wealth effect to 2002 shows that nothing new was added over 40 years Rip Van Chair was asleep.

Rocky Humbert writes:

I would suggest that any attempt to quantify this relationship based on the history of the past 50 years may be flawed for a wide variety of reasons. Because:

1. Changes in pension plans. An individual's income is allocated between current consumption and investment (where investment is simply deferred consumption.) If an individual relies upon a defined-benefit pension plan, then fluctuations in stock prices will not affect the (perceived) future value of the pension plan. Whereas, if an individual has a defined-contribution pension plan (e.g. 401k), then there is an immediate and visible effect — and short-term price fluctuations may cause an increase/decrease in the allocation of income between consumption and savings. The decline of defined-benefit pension plans over the past fifty years may substantially increase the sensitivity of individuals to asset price changes.

2. Jobs for life. This phenomenon is related to both #1 and #3. The average tenure of employment by a single large corporate employer has declined over the past 50 years. Union and non-union employees at IBM, General Electric and myriad large corporations were accustomed to "jobs for life," and this practice started a secular decline in the 1980's courtesy of Jack Welch at GE, and became the norm when IBM had its first industry-wide layoffs in the 1990's. Even Goldman Sachs never used to fire employees, and this model changed under Steve Friedman and Bob Rubin in the 1990's. The consequences of this strucutral change may have made for a more dynamic/flexible economy, but it should also contribute to a heightened sensitivity by individuals on their job security. I would argue that this phenomenon exacerbates a feedback loop in the economy which was less pronounced 30 years ago.

3. Inflation/wealth effect. There is a measurable (and somewhat illogical) wealth effect when NOMINAL interest rates are extremely low. For example, retiree's hate spending principal, but don't mind spending interest income — even if there is deflation and real interest rates are high. Likewise, I've seen research that show people feel better in a environment of higher nominal returns even if the real, after-tax return is negative. This phenomenon can also be seen in investor preference for high dividend yielding stocks which have a low return-on-equity. (I am guilty of this stock bias too!) I posit that low NOMINAL interest rates were extremely corrosive in Japan, because of this phenomenon, and that contrary to economic theory, had the had BOJ raised short-term rates might have resulted in a counter-logical boost in consumption. Of course, Japan is/was a nation of savers.

4. Changes in expectations. At the end of the 1990's, some surveys showed consensus expected 10-year forward returns on stocks to be 13%. At the depth of March, 2009, similar surveys showed that the expected return was diminimus/negative. I WOULD POSIT THAT CHANGE IN EXPECTATIONS FOR LONG TERM FUTURE NOMINAL RETURNS ARE THE CRUX OF THE STOCK MARKET WEALTH EFFECT. If one makes an investment predicated on a 300% return over ten years, and instead realizes a 30% over ten years, it will have a vastly different wealth/consumption effect, than if an investment is predicated on a 30% return over ten years, and realizes a 25% return over ten years. There are two reasons for this:

(1) The shift from 30% to 300% (1990's) and then 300% to 30% (2000-2010) requires a one-time huge decrease/increase in the amount of income diverted to savings;

(2) There is much less room for disappointment post the reduction in expectations — hence I would argue that there will be less wealth affect with static (low) expectations.

That is, rather than a direct stock price/wealth/consumption effect, one needs to consider the alternative hypothesis that it's really the rise (or fall) in long-term return expectations that we are seeing … and that's both logical, circular and difficult to measure analytically.

Keeping in mind both Keynes and the permanent wealth hypothesis, one needs to accept that much of this is psychological and reflects individuals' long-term confidence.

Just a few thoughts….



 An analyst on CNBC yesterday was saying BP is cheap, and the dividend is secure. His interviewers (are they supposed to have an agenda of their own? Or is this just asking the tough questions?) kept hammering on their idea that it will be politically unacceptable for BP to pay dividends to its shareholders, a line of questioning that drew uncomprehending stares from the analyst.

George Parkanyi comments:

Yeah that makes sense… take a whopping out-sized risk on BP with its huge potential future liabilities, in a world economy and market possibly on the brink, where P&G can lose 35% of its value in 10 minutes, for a dividend. Where do I sign up?

Rocky Humbert comments:

 Here are some questions that one might consider before investing in BP. (No such analysis is required for a skilled trader who claims to be able to systematically buy low and sell high without regard to "fundamentals.")

1. Remediation costs and liability are related to a spill size both by physics, practice and statute. The Exxon Valdez had a defined amount of crude. How much crude will spill from the Deepwater Horizon?

2. What is the law regarding punitive damage penalties if gross negligence can be proven? Is it like a RICO case (4x)? Is it capped by statute? Or can it be unlimited (like an old Joe Jamail lawsuit)?

3. What is the law regarding punitive penalties if there is criminal liability? What is the worst case penalty? If the Goverment files an criminal indictment, what effect(s) will have on their business?

4. What effect will the overhang of litigation have on the cost of BP's financing of their regular business? If there is a risk of a $50+ Billion punitive penalty, what will the credit rating agencies do? And if BP's cost of financing increases by 100-300 basis points, what effect does that have on their exploration budget?

5. If they capped the well today, can one assess the risks of #2, #3, and #4 with certainty?

6. What is the risk/cost of a boycott of their service stations? Did Exxon experience a boycott? And if so, what impact did it have on their downstream operations?

7. What is the tail (in years) of the litigation? Will they be required to post a performance bond? And if so, what assets will they sell to meet the performance bond? More generally, is there a risk that they will have to sell assets to meet other liabilities? Or, can they almost certainty meet the expenses out of current cash flow?

8. How is BP's stock faring versus other companies with exposure (Anadarko, Cameron, etc.)? Will these companies present a unified defense? Or will they be pointing fingers at each other — further concentrating the litigation risk?

9. How has BP's stock performed versus other major oil companies? For example, if BP is down 35%, but Chevron,Exxon,Conoco are also down 15%, which of these companies represents the best relative value, given the facts and probabilities?

10. If I am leaving for a five-year vacation, would I be comfortable purchasing BP at the current price, and not looking at it until I return? Is there any price where I would buy a non-trivial amount of BP and not look at it for five years?

Vince Fulco writes:

 While I am no apologist for BP's seemingly high risk and perhaps incompetent procedures in the Gulf, I am also wondering about the proportionality of the public reaction (to the stock that is, not the beach pollution) vs. the total cost of the disaster. The company's mkt cap is down $70B since the explosion and is currently $115B for a company with $230B-ish in historical assets ($90B estimated in the US) and relatively low non-current debt levels. Moreover the company has a stand alone re-insurance company with $3.5B in assets. They may also have some additional cover which I am disregarding for now. As Ken has stated, halting the dividend brings $7-10B more to pay claims which I assume will have a somewhat long tail, say 3-5 years. And just because Chuck Schumer believes the payout should be halted, doesn't mean he knows anything about corporate finance strategies or management's responsibilities to its owners. More evidence of the worrying 'they came for…' behavior.

Given the rarity of the event, arguably the next comparable disaster naturally might be the Exxon Valdez (other smaller events could be chosen too). The best numbers I could find were a cost of roughly $5-7B stretched out over 20+ years. For argument sake, let's say the cost to BP is 10x as much or $50B; that would be roughly 1.6-1.8x mean operating income of the last 4 years.

I am not considering BPT in the conversation because it is a different animal and Rocky has addressed it well. Lastly, since our current admin seems to be in the business of picking winners and losers, are they ready to and can they kill a formerly $1/4T asset company 40% held by pensioners and retirement funds of our closest ally? It is also notable that LA's governor is already publicly complaining about the effect on jobs if a drilling ban is instituted for any length of time. Double edged sword indeed.

Disclaimer: This is absolutely not a recommendation for anyone but I am long right at these levels and would appreciate reasoned arguments against.

Rocky Humbert adds:

 One more thought on BP as I work through their financials: The company generated free cash flow of about $7 Billion last year and paid $10.5 Billion dividends.

Their next dividend will be announced on about July 27th with an ex-date of 8/4/10. Looking at the pricing of at-the-money options, it appears that the market has priced in a cut of their dividend by 50% (from .84/share to about .44/share).

Any spec-lister who has a variant perception on their dividend policy (either holding it at its current level, or reducing it more than 50%), can execute an direction-neutral options "conversion" to express this view.

In my humble opinion, a 50% cut in the dividend seems entirely reasonable to satisfy all of the different constituencies. And, in assessing the future behavior of the stock, one needs to consider that Mr. Market has already discounted this news.

Before you invest in BPT, I suggest you get an objective estimate of the reserve tail in the Prudoe Bay field. I studied this several years ago and there is a NAV based on the dwindling reserves and foward curve in the crude market at various discount rates.

The field should start tailing off in 2011 or 2012 and the stock will be worthless certainly by 2020 so you need to value not only the current and future crude price but also the decline rate. I'd also suggest that you look at their financing and change of control provisions as well as cross default issues. Lastly, I owned BPT when it was at a substantial discount to its NAV at a large discount rate (versus crude futures), but could not short it when it went to a large premium because the shares could not be borrowed.



One wonders if there is a regression bias effect so that all numbers, indeed all events that are expected to be very much better than the last occurrence tend to disappoint. There are random factors as well as recurring "skill" factors in all such events. The random factors bring the actual number down towards the mean while the skill factors tend to bring it up. Assuming they are both equal in a number like employment, the expected realization is half way between the previous and the predicted.



Here is a cool article
on the Forgotten 'Flash Crash' of 1962. 



 The wealth effect of moves in stock prices relative to consumption needs more detailed study. When I examined the literature 50 years ago, only one or two papers had considered the issue. Now the fake doctor has mentioned it as under examined. I note oats below 200. Copper with a recent 20% decline. And berk near the magical 10000 level, cotton with 10 consecutive days of decline, and oil tipping below 70 bucks as well as the dismal sales of ice cream in Middletown, Delaware as examples of the wealth effect. What academic or consumption analyses or observations can be made to illumine?

Paolo Pezzutti asks:

How does one explain natural gas moving up against the crowd of sell offs? Maybe consumption is not the main factor in price discovery, but rather hedging against oil. How does this influence the real economy and consumers?

Pitt T. Maner offers:

Of possible interest–A recent simulation done for Forbes magazine:

The Underappreciated Impact of Stocks on the Economy

The American consumer is back. Spending by consumers underpins the last two quarters of positive economic output news. (5.6% growth in the fourth quarter of last year; 3.2% in the first quarter of this year.)

Why have consumers apparently stopped taking austerity measures? The most popular explanation–given that job growth and wage increases have been lackluster, and home prices still linger near lows–is what's called the wealth effect. With the stock market (measured by the S&P 500) up 23.5% last year, consumers felt confident enough to finally buy a car or a new wardrobe. (One data point: car sales were up 17% in April from the year before.)

But with the market turning significantly shakier in the last week–the wealth effect could work the other way. We asked Allen Sinai, the prominent economic forecaster, about how important the stock market is to the economic recovery.

"The role of the stock market is underappreciated," he said. And it's not just the wealth effect that ties the two together. There are four ways, Sinai said, that the stock market affects growth. If the market flags this year, so could the broader economy:

1. The wealth effect, as we mentioned

2. Cost-of-capital: Sinai says that when stocks are up, companies can raise the same amount of money by selling fewer shares, which makes it easier to fund expansion.

3. Through financial institutions: A rising market disproportionately makes business better for banks and other large financial institutions, which increases their ability to lend.

4. Taxes: A rising market allows investors to realize capital gains, which means tax revenue and even room for tax cuts.

Sinai ran a simulation for Forbes that shows how the stock market swinging one way or another would affect major economic indicators. A stock swing of 10% would increase or decrease GDP growth by 0.14%–which is significant when you consider that's $58 billion in output that could rise or fall.

A few other examples:

Consumption: A 10% stock market gain would add $78 billion in spending. But a drop would take out $60 billion.

Residential Construction: It could decline by $6.5 billion if there's a 10% correction in the stock market this year.

Realized Capital Gains: Here the effect is the largest. Gains will swing $35 billion up vs. $37.9 down, along with the stock market–explaining a lot about the volatility of these revenue streams for states like New Jersey and California.

A recent paper claiming to use better datasets and stating that tangible wealth trumps financial wealth:

How does household wealth influence consumption? The empirical evidence brought so far by the literature is unclear, mostly because of the low quality of the data more readily available: aggregate data, cross sections and panel datasets lacking important variables all present major shortcomings for a proper analysis of the wealth effect. The aim of our paper is to contribute to the appraisal of the wealth effect using a new, accurate dataset, and employing a proper estimation technique. We perform a pseudo-panel analysis for the USA (1989-2007) combining information from the Consumer Expenditure Survey and the Survey of Consumer Finances. We divide between durables and non durables consumption, and we also investigate the roles of the different components of household wealth, both gross and net. Our estimates indicate that there is a significant tangible wealth effect (between 3 and 6 cents per dollar), confirming the economic importance recognized by some of the previous empirical literature. On the contrary, financial wealth seems to have no significant effects on consumption, even when debt considerations are included in the analysis. In addition, the wealth effect seems to matter more for older households, for which both the house of residence and the rest of the real estate properties positively affect consumption.

Rudolf Hauser adds:

This recent report on VOX by Boston Fed economist Daniel Cooper argues that the extraction of home equity went to consumption to a far lesser extent than some have argued. While I have read the above, I have not yet read the policy paper he wrote at the Boston Fed.

Stefan Jovanovich writes:

The injection of natural gas into oil wells comes not from already collected and stored gas inventory but from the gas in the reservoir that is being produced. It is the gas pressure that allows oil from deep-drilled reservoirs (like the one that blew out in the Gulf) to reach the surface without artificial assist. This gas used to be flared as an unavoidable by-product of oil production.

From Wikipedia :

Oil wells come in many varieties. By produced fluid, there can be wells that produce oil, wells that produce oil and natural gas, or wells that only produce natural gas. Natural gas is almost always a byproduct of producing oil, since the small, light gas carbon chains come out of solution as they undergo pressure reduction from the reservoir to the surface, similar to uncapping a bottle of soda pop where the carbon dioxide effervesces. Unwanted natural gas can be a disposal problem at the well site. If there is not a market for natural gas near the wellhead it is virtually valueless since it must be piped to the end user. Until recently, such unwanted gas was burned off at the wellsite, but due to environmental concerns this practice is becoming less common.[citation needed] Often, unwanted (or 'stranded' gas without a market) gas is pumped back into the reservoir with an 'injection' well for disposal or repressurizing the producing formation.

Check out this link on Natural Gas Production for more info. 



Kissing the Clay in victoryWatching the French Open Womans Final was shocking for any Aussie who had watched Stosur "Demolish", and that she did, three previous number ones on her way to the final. The Italian woman grabbed the opportunity and literally went for broke, and good luck to her, she got the result.

What is interesting is how absent minded Stosur appeared, What happened to her game, her intensity, and the aggressive tennis of the previous few games. Sure Schiavone combatted her well with some mighty deep top spin looping backhands, but there is no doubt bigger questions to be asked, in particularly how one's mind can be prepared for such a proposition.

For both woman it was their first Grand Slam final, and who's to know how they are going to react on the day. Stosur (who had beaten the Italian in their 4 previous meetings), had phone and text messages from all Australian past champions like Evonne Goolagong and Pat Cash, and no doubt many more. (The fact that Italy had no past grand slam champions in tennis ever, may have helped Schiavone).

Should Stosur have turned the phone off and concentrated on routine, discipline and more routine? It appears the case is evident that potentially there is the need for a head doctor, especially with someone totally new, to be brought in for BIG occasions, one off events like this, just to fine tune and set things totally straight.

Samantha StosurIt reminds me of traders who have just made a bundle of cash, p and l looking the best ever…and for some reason everything they have ever been taught or taught themselves goes out the window. They drop the bundle and give back what they made and more in a bout of careless trading.

There was a manager of a prop desk in Singapore who used to buy a book of local cinema tickets every month. If his traders just had their best period for some time, he dished out a ticket, they were off to see a movie. Likewise, if others were under the pump, then they were sent off to see a flick as well. He reckons that book of tickets was the most profitable management decision he ever made. Maybe Stosur could of done with a movie with a slow down of adrenaline, resulting in her accounts having a reval, before stepping on to court.

Paolo Pezzutti comments:

I was quite impressed by Francesca Schiavone's determination and resolution during the French Open Womans Final. Especially during the tie break. No fear to win. Focus on her strengths. Will to dominate the court physically and geometrically. No way for a self-defeated adversary to match the same hunger for victory and glory. Many similarities with trading where self confidence also plays a big role.



The belief that the banking system is the primary driver
of employment is an illusion that only the people who never held a
payables party could believe in:

"We thought we were in recovery coming out of the Depression too and I think some of that was an illusion. The– to your point about small business. The biggest problem with small business today is accounts receivable financing. It's not that they need capital finance, they just can't even say it's inventory. And that's not really a banking business. That's vendors who don't feel comfortable financing their customers anymore. So I would say to Brian and to Chairman Bernanke, look at the numbers. The industry, banking industry is shrinking. The non-bank sources of finance, which are by and large big companies don't have the access to commercial paper. They don't have the ability to raise short-term funds themselves– And therefore, they can't finance it on their balance sheet."



On June 5 , 1933 the United States went off the gold standard.  Would we be better off today if it had not happened? - A Reader.

The classical gold standard, which brought price stability and prosperity to the major countries of the world, ended with the outbreak of World War I in 1914. Price stability was thrown overboard as a goal; fighting the war was deemed more important by the leaders at that time. The gold standard was dead.

What happened next is quite instructive.

In 1924 England (the most important country in the world) decided to restore the gold standard using the same parity for the British pound as before the war. But the price level was a lot higher as a result of the inflation during World War I. Have you ever tried to put on an old pair of blue jeans after you have gained 10 pounds? It is quite painful, especially around the waist and crotch. And so it was: the newly restored gold standard began to put heavy downward pressure on prices and on economic activity. Ultimately this was a major contributor to the severity of the Great Depression.

The 1924 decision is one of the greatest economic policy blunders in history, probably second only to the decision by emperor Diocletian in 301 AD to put price controls on food. It was highly contractionary and backward looking, attempting to restore a status quo that was realistically no longer achievable. They had not carefully thought it through and were doing mostly for reasons of prestige and tradition. Starting in 1932 and 1933 the error had become obvious and countries began to get off the gold standard and they immediately began to experience economic improvement; the worst of the depression was over. Relief at last, the blunder had been corrected.

So June 5, 1933 is not really the end of the gold standard but the end of the ill-advised 1924-1933 attempt to re-establish the gold standard in a mistaken and poorly coordinated manner. And we should all be glad that episode is over.

Stefan Jovanovich opines:

Alex repeats several common misconceptions that are thoroughly embedded in the received wisdom of the current academic age. The post-Civil War advocates of the resumption of the classical gold standard - President Grant being the most notable - were quite clear about what they wanted - the resumption of the absolute right of holders of U.S. Treasury notes to convert their paper dollars to gold at the Constitutional standard. They did not promise or expect the classical gold standard to bring "price stability"; they did not even expect it to bring "prosperity". They expected it to bring a fundamental honesty to the Federal government's accounts by making it impossible for Congress to indulge in serial deficits. (It is no accident that Grant's political opponents challenged his proposals by accusing him of personal dishonesty; if you are going to attack a straightforward plan for keeping straight books, argue that the proponent has been stealing from petty cash.) What seems almost impossible for the well-trained mind of the present to understand (whether educated in New Haven or Cambridge East or West) is that it was the discontinuities of the classical gold standard that were its great strength. The earnest reformers who brought us the Federal Reserve Act and those who are now eager to bring us a world currency and unified central bank share the Marxist illusions that the marketplace fluctuations in prices can be tamed if only the government gained absolute control over money and credit. It is an appealing and enduring fantasy, even if it is also a folly. What the supporters of the classical gold standard understood is that free exchange between people can create wonderments of credit and commerce if there is open competition and the price terms for the ultimate clearing of transactions are not subject to government manipulation. They also understood that governments cannot avoid being monopolies where the question of legal tender is concerned; indeed, the U.S. Constitution itself required that Congress have monopoly power over the United States' money. The only solution was to limit the government authority by requiring its paper to be backed by specie. Hence, the classical gold standard.

One of the complications of dealing with the history classical gold standard is that, while the United States was on the classical gold standard from 1791 onwards, our government, unlike Britain's, never resolved in the 19th century the issue of whether a central bank to have the right to issue notes that were to be accepted by the Treasury (in Britain the Exchequer) as legal tender. The United States had the further complication of bimetallism - dealing with what Gresham had explained to be a logical impossibility, having two legal tenders whose exchange ratios would be fixed. What both Britain and the United States did have in common was the presumption that the fluctuations in relative prices between different countries would be adjusted through discounting of trade bills, not through adjustment of their respective conversion ratios of paper into gold. In that sense both Alan and Alex are right. Britain (along with France, Germany and Austria-Hungary) abandoned the classical gold standard at the onset of WW I; but the United States did remain on the classical gold standard until June 5, 1933. Until that date a person could tender $20 in paper U.S. currency to the Treasury or a national bank and receive an ounce of gold stamped by the U.S. Mint as legal tender.

Alex is also correct in stating that Britain's attempt to do what the United States had done after the Civil War - resume convertibility - was a failure. But the failure came not from the choice of the pre-war ratio but from the assumption that a gold exchange standard could replace private party discounting as a mechanism for adjusting relative prices between countries. The classical gold standard was not restored after World War I. During the war and after its end every country in Europe had exchange controls and limits on specie redemption; even exchanges of specie for paper currency between countries were limited by international agreement. What was "restored" was something that had not existed before the Great War - a gold exchange standard. The gold exchange standard presumed that the terms of international trade would be controlled by coordination between the central banks, not by the marketplace results of private credit transactions. The gold exchange standard allowed central banks to accept each other's paper based on the assurance that the inter-government swaps would be backed by gold, but that guarantee was a fiction. The U.S. had substantially all of the world's gold reserves, just as it did after WW II; Britain's ability to pay its war debts in gold was based on the assumption that Germany would pay its reparations in gold which it would borrow from the United States.

Britain's valuing the pound at the pre-war exchange standard would not have had any ill effects if private credit markets had revived because Britain's trade bills would have been freely discounted. The best way to understand the post-WW I world economy is to see it as comparable to the present situation in the U.S. real estate market; the massive expansion of government debt and guarantees had left the world with an enormous mound of crap paper that could not be written down to its actual value because the pricing mechanisms of the pre-war world had literally been destroyed. It was very much extend and pretend. The abandonment of the gold exchange standard did not, as Alan suggests, revive world economies; Europe's output of consumer goods rose only slightly from 1932 and did not recover to 1929 levels until the 1950s; and the United States' record was not much better. The only production that did increase substantially in the 1930s and 1940s was spending for war.



Jonah Hill and russel Brand in Get him to the greekGet Him to the Greek

Directed by Nicholas Stoller

This week at the movies, we've got rock 'n' roll ribaldry (GET HIM TO THE GREEK, starring Russell Brand, Jonah Hill, Elizabeth Moss and Rose Byrne).
Fans of Jonah Hill (né Feldstein) will recall this fat, funny fur-ball from SUPERBAD (2007) and sundry other comedies where adipose on a featured character is cause for immediate hilarity. Hollywood makes no comedies without a token Zach Galifianakis type in this decade. For those unacquainted with the star vessel of GREEK, Brand is a British comic, actor, editorialist, author and radio and TV host/presenter.

Brand achieved UK mainstream hype for presenting Big Brother's Big Mouth, a popular spin-off, and for his radio broadcasts, among sundry TV series and award rites. Appeared in rom-com FORGETTING SARAH MARSHALL (2008), ST. TRINIAN'S (2007), and BEDTIME STORIES (2008), none a standout. Relevant to his obnoxious persona here, Brand actually carried or participated in major pranks in the Brit media, such as the punk't-type 2008 calls that ended his BBC days. He has walked the walk, talked the talk.

Rose Byrne is a gorgeous Aussie presence from the hit TV thriller, Damages, and in this film has the thankless role of long-time spurned gal-pal of the monomaniacal drug-sozzled Brand, a truly unlikable character, despite his being in nearly every "comic" scene and eructative of many lines of unfortunate and often ugly truth. Clomping over everything and everyone, using and abusing nubile semi-nudes, snorting more faery dust and liquor than there are sands in the Kalahari, Brand fails to win hearts and minds. You just don't much like him. Even as a quirky-megalomanic rock star resisting the efforts of hapless Jonah Hill as promotional intern trying to lasso comeback rocker Brand into appearing at the sold-out Greek theatre in LA for a sold-out blowout.

As he carries on outrageously, corrupting the sweet Hill character, forcing sexual hi-jinks and pixie substances on this naïf, you don't warm to him. Instead, you idly wonder if he's really this bored, this feckless, and whether he mimicked his mojo from Mick Jagger or other Bad Boys. As is customary of late, the crudeness and vulgarity of most of the 'party' scenes disable description and are beyond tasteless.

Does any adult read these scripts before they are stunt-doubled onto remorseless forever?

Another TV cross-over, from the prize-winning prestigious Madison Ave drama, Mad Men, is the excellent Elizabeth Moss, as a physician live-in love of the corpulent Hill. She is a center of normalcy (along with Byrne's character) in a chaotic rampage as Hill and Brand burn rubber and life-journeys from London to Vegas to NYC to LA.
Putting in appearances, among the loud proceedings for musique aficionados, are Christina Aguilera, Mario Lopez, Pink, Kurt Loder, Lars Ulrich and Billy Bush.

Try as it might, cost whatever it cost, this is a weak attempt at replicating the comedic excess of HANGOVER (2009) or evoke even that classic laugh-fest starring an irascible superstar (Peter O'Toole) and hard-put-by ingénue intern, Mark-Linn Baker, in MY FAVORITE YEAR (1982).



Recently I have been discussing lengthening my time horizons with my mentor and was tickled to find this post by GM Davies while perusing other blogs by people who post to Daily Spec. I am definitely one who is seduced by instant gratification and it is difficult for me to sit on a position for any length of time unless my indicators are emphatic about it. One evening after pondering over the theory of ever changing cycles and this post from Mr. Sogi, I found myself looking at all sorts of time intervals in charts to find the structures/setups that I prefer to trade. Lo and behold I have found that many times when a setup I like to trade is not evident in my usual time frames, if I dig a bit and look at odd frames such as one or four minute bar charts instead of two or three, or, say, 34 tick charts instead of 50, 25 or 10, then indications that were invisible in the "normal" or default charts tend to jump out at me. The same thing happens when I look at larger time frames.

One of the beautiful things about the charting tools I use is that they are flexible in this regard and allow me to be creative. Tracking down the cycle that is currently in play is a lot of work but has proven profitable. Kudos to Mr. Sogi and GM Davies for getting me thinking. Kudos to Chair for providing outlet for this incredibly diverse effusion of ideas, and for many other things not least of which is being a tremendous inspiration.



 69 stocks in the S&P 500 are 15 dollars or below. I have an unread copy of Ben Graham's bible with a forward from the sage on the table– there is some dust on the jacket. I was planning on reading it whenever deep values were to someday appear in the market. I am excited by some of these stocks due to yield, book value/price, and PE's. Banks, real estate, news, tech, telecom, industrial are low priced sectors here. There are some nuggets possibly to be found for a value player. It's probably too early for a reading of the Graham, but it is time to consider it.

Here is the list:

AMD- 8.10
AMAT - 12.56
AKS - 13.34
AES - 9.60
AA - 10.84
BSX - 5.74
CPWR - 7.85
CNP - 13.20
CMS - 14.26
CBS - 13.93
CBG - 14.88
C- 3.79
DHI - 11.34
DFS - 12.86
DF - 10.61
DELL - 13.24
EL - 11.11
EK - 5.10
FTR - 8.34
FITB - 12.5
FHN - 11.82
F - 11.5
GT - 11.49
GNW- 14.68
GCI - 13.73
HST - 13.65
HCBK - 12.59
HBAN - 5.83
IPG - 7.84
JNS - 9.95
JDSU - 10.62
JBL- 12.66
KIM - 13.31
KG - 8.05
KEY - 7.77
LUV - 12.02
MWW - 13.35
MU - 8.86
MOT - 6.70
MI - 7.38
MAS - 12.4
NYT - 8.50
NWSA- 12.65
NVDA - 12.10
NSM - 13.70
NOVL - 5.90
NI - 14.35
ODP - 5.32
PHM - 9.82
PFE - 14.76
PCS - 8.63
PBCT - 13.94
Q- 5.21
RE - 7.13
SYMC - 13.92
SVU - 12.68
SLM - 11.00
SLE - 14.24
S - 4.78
TSS - 14.28
TSO - 11.56
TLAB - 6.98
THC- 4.92
TER - 10.51
TE- 14.97
WIN - 10.79
WFR- 10.69
XRX- 8.88
YHOO - 15.00



FeynmanWhy are there tides? How do the planets move? Just a couple questions you will get the answers to in the first of Feynman's wonderful lectures

Prof. Richard Feynman gave a series of lectures on physics at Cornell in 1964, which are called the Messenger lectures. They are now available free on the web courtesy of Bill Gates. Very engaging, only a few equations (at least in the first one that I have watched), so suitable for a general audience teen or older. (These are different than the Feynman lectures on physics, which are a three volume book set with all the equations based on the physics course he taught freshman at CalTech).

For those unfamiliar with Feynman, he played the bongos, drew nude art, enjoyed safecracking, helped create the atomic bomb at Los Alamos as part of the Manhattan Project, won the Nobel Prize in Physics in 1965, and was revered as a teacher of physics.

Chris Cooper comments:

Feynman taught Physics 1 and 2 only for the two years it took to complete the series of lectures which became the three-book text for those courses in the following years when I took them. I still have my copies because even at that age I realized that they were something special. As a senior, star-struck, I took an advanced course in quantum mechanics from Prof. Feynman. Although we had two texts to cover the subject, I was amazed to come to class and watch him explain the topic of the day from an entirely different angle, time after time. That was the class where I best learned my most important lesson– the people who do this are really smart, smarter than I, and they also work much harder than I was willing to. I flunked miserably, confirming my abandonment of dreams of a career in high-energy physics. In retrospect, Prof. Feynman ended up teaching me the most important lesson that I needed to learn at that time, though he never even knew who I was.



I periodically take a fresh look at the so-called "equity risk premium" for various global stock markets. There are many academic articles on this subject that are nearly useless for short-term market-timing, but quite helpful for long-term asset allocation. For example, here are two papers from a Google search on "Equity Risk Premium Across Countries":

Ibbotson, Chen: The Supply of Market Returns (2001) [30 page pdf]


Dimson, Marsh, Staunton: Global Evidence on the Equity Risk Premium, (2002) [17 page pdf]

What is the current situation? Examining the Bloomberg screenshot below, one notes that Japan has by-far the highest nominal risk premium. It's possible that this is due to their JGB yield at 1.28% — and if JGB yields increase by 100-200 basis points, the risk premium will decline by the same amount — reducing the apparent relative cheapness. Nonetheless, I looked at a handful of mega-cap Japanese stocks. When I plugged in a 1% growth rate and lowered the risk-premium to around 10-12%, the "theoretical" value of these stocks increased massively — in many cases predicting more than a doubling in valuation.I am NOT rushing out to blindly buy Japanese stocks, even though Toyota, Honda, Mitsubishi, UFJ, Canon, Sumitomo, Mitsui, Sony etc. model-up incredibly well on a Dividend Discount Model that assumes any positive GDP growth over the next decade.

But one wonders whether we are approaching trough valuations after a 20-year bear market? And, other than slow, trend-following technicals, what approaches would one use to make such a call?

Sushil Kedia adds:

If there is a larger risk premium in Yen terms, is it also the same in terms of Dollars?

What if Tokyo pits are pricing a much stronger Yen ahead in the year? Hungry mind is just generating possible explanations and keen to learn. With the JGB Yields being where they are for years, the real variation comes from the change in interest rates in the US treasuries. Is the Risk Premium in Japan a good way to start thinking of a theses that the interest rates in the world will be rising in other important places including the USA, later in the year?

Kim Zussman comments:

Here is log nikkei in USD. It appears US investors were less driftless than the Japanese.



Inspired by the Berkeley astronomers in The Education of A Speculator, below is a chart of log CPI (monthly, 1928-present, FRED) vs contemporaneous log DJIA monthly closes.

Log CPI ranged between 1.1 and 2.3 during this period. Beginning at the lower left, the downward squiggle was the depression - when CPI declined along with stocks. Then both stocks and CPI rose (irregularly) in tandem, from CPI ~1.13 to 1.5, from the 1940's to the mid 60's. CPI increased from 1.5 in 1965 to 2 in 1983 - a period which saw no net change in stocks, with log DOW stuck below 3. The great bull market 1983-2000 occurred while CPI rose from 2 to 2.2.

The last decade is depicted by the squiggles at the upper right, ending with a miniature retracement of the 1930's style cpi/stock decline followed by increase.



 Harry Browne's book about why the best laid investment plans go wrong has a very precise and useful chapter on how to evaluate forecasters starting with keeping records of the actual forecasts, when they were made what the price was, and what transpired. These are usually very different from the humble self evaluations "we erred on calling the high in silver" we said 1080 but it was 1065. A hilarious review of such is contained in edspec.

Jeff Watson comments:

To me, the value of forecasters, pundits, touts, advisors, mavens, etc lies in the opportunity in fading them. When one says that everyone in the world should be short t bonds, I look at the other side. When a guy rides a motorcycle around Europe and says to buy German stocks and forget about them for 5 years, I take a look at the other side. When the newsletters and blogs tell you to do one thing, the move has already happened or else they're talking their book or gambling. 

Kim Zussman comments:

Years ago, the late Louis Rukeyser published a newsletter which listed picks of various market experts either interviewed on Wall $treet Week or profiled in the letter. Each issue had a running return for each pick, as well as the average - which was usually very good.

I noticed once in a new issue that a stock had been dropped from the list of recommendations, with a note to the effect "manager no longer covers". Also noticed the bad return for this stock had been removed from the running total average. Had you bought all the recommendations, your results would definitely have been worse than reported!

There is a similar problem with extrapolating stock index data from over 30 years ago, before indexing was widely available / utilized. Think of how difficult it would have been to own 500 stocks of the SP500, in correct proportion, adding and deleting simultaneously with the index. This may be an "indexation premium", which ought to be gone by now.



Didier SornetteA friend of mine sent this very interesting link. It's about the work of Didier Sornette.

Victor Niederhoffer comments:

He's an actor  always predicting the end of world, reporting one blade of scissors never expectations, like its 30% likely there will be catastrophic decline but never that it's also 40% likely that there will be an extraordinary rise. Similarities and retrospection galore and a doomsdayist.  

Allen Gillespie writes:

I can't speak to that, but his book does have an interesting section regarding the implications of a zero interest environments and he references Von Neumann and other who wrote in the late 1930s the last time t-bill went to negative yields. The math is such that both U and -U can be solutions and hence jumps (up or down) like the "flash crash" and 1999 become acceptable solutions. That's the problem with ZIRP and QE because what is the value of a continuous stream of rising dividends at near zero discount rates? And what happens when QE stops like it did March 31, and on the fiscal side where the government reached is max transfer payments on April 15? Where despite rates still being near zero there was a exponential relative tightening of monetary conditions. And where did PG and others print? Why just below the last free market lows in 2009 before QE.

So, in effect, he does mention the possibility of a large rise and decline because both U and -U are solutions in a speculative bubble regime driven by ZIRP, QE, and massive explicit moral hazard. In short, things can trade anywhere and the days around the timing of when the Fed finally removes its ridiculous rates low forever language will be interesting as it will represent a 3rd non-traditional tightening. The issue is the Fed will probably need to run QE2 in the background when the debt roll doubles next year and climbs more in 2012 before falling and stabilizing thereafter by which time FNM and FRE might have run through the max losses.

I am not a quant but just a fundamental guy who also has a decent eye for politics, and I think it is relatively simple– the Fed's said "oh sh_t" after Lehman so they have tried to put Humpty Dumpty back together again by running bonds back to par and stocks back to Lehman levels (1166). Prices above that they will not artificially support, far enough below that they will so long as they are allowed to print $$$. The big risk, which cannot be quantified, is that historically it is a POLITICAL event which removes this support mechanism from the markets and that can happen in a day and stocks must fall a lot to find true cash (not bank convergence trade) buyers - those old men with canes who do exist but are becoming fewer.

Also, for the curious given current events– there was a large rise when the U.S. declared neutrality in the third quarter of 1939 only to fall a year later as this laid the ground work for its friends being run over. Isn't GM supposed to be IPOed then - TM problems real? - AIG insured Goldman? BP - the green energy firm - Yukos for the industry anyone - except we can't create a faux back tax - so we will just grab it with environmental taxes that will be coming. As to gold, its takes tighter money to kill a real bubble as 1999 and 2004-2007 showed and while on a relative basis the Fed has tightened with no QE, Europe has eased and until the U.S. can roll its 3 year average maturity debt with large origination years of 2008 and 2009, I am staying long and I bet other are too.

Peter Grieve writes:

The word "econophysicist" alone should be a danger signal, that someone is hubristically applying a certain analytical discipline outside its sphere.

One might as well say "gamophysicist" for "marriage counselor", or "hippophysicist" for the author of a horse betting pamphlet.

I bow to no man in my love of physics, but it only has power in clear cut situations.

Ralph Vince Concurs:


Gimme a break!

"…bubble markets display the tell signs of the human behavior that drives them. In particular, people tend to follow each other and this result in a kind of herding behavior that causes prices to fluctuate in a periodic fashion."

Really? Who would have guessed that!

Ah, Switzerland! Yodeley hee hoo! These guys are always in Switzerland, aren't they? 

Yishen Kuik writes:

Victor may be right– some of Sornette's older (erroneous) predictions which I think appeared on his faculty UCLA website aren't around.

I don't know if someone has consolidated all his predictions to check the batting average, but he certainly may have left out his losers in recent press releases and papers. He seems to have channeled a lot of energy at bringing press attention to his work. I suppose his final objective is the lecture or consulting circuit a la the distinguished expert on derivatives and other professors.



Postcard from Coconut Grove, FLMr. Vince points out the authentic bias that gives the utterances of people who like to yodel and carry guns gravitas. One should extend the opposite to shore resort communities like Fort Lauderdale and San Diego, where the frequent recreational visitors and romantic atmosphere tend to reduce the guard. Laffer frequently memorializes the figures on returns versus state of incorporation as a function of service revenues. And in addition to Delaware, Texas, and Nevada, one should not forget Utah. I would extend the studies to extent of organized labor membership in the state as well as the state of such tells as pump your gas laws, or even augmentations or negations (as in the corridors of the beltway through delays, tests et al) of second amendment carry overs.

Rocky Humbert adds:

Adding to this observation, one should avoid investments where the company or its CEO is domiciled in Coconut Grove, Florida. This might be due to Florida's bankruptcy homestead exemption. Or it might be due to the fact that Coconut Grove is where the "nuts" come from.



 a yurtArbitrary tolls and regulations restrict economic freedom and distort economic development.

In From Poverty to Prosperity, Nick Schultz and Arnold Kling discuss the work of economists like Douglass North whose research shows how institutions promote or hamper prosperity. The authors also discuss the World Bank study which claims some 80% of a country's wealth is in intangible capital. Natural resources and regular capital contribute less to wealth than protocols or recipes that are the evolved spontaneous orders assisting everyday producers and consumers.

New Jersey could create more gas station jobs by insisting tire pressure be checked on every car (also increasing mileage and reducing carbon footprints). This would be a regulation creating thousands of "green" jobs and would raise costs just a bit.

But these bits add up. How many tens of thousands of American engineers now focus each day on green technology projects? How many millions of hours do Americans spend recycling each year in ways that don't increase the value of their waste? How many millions of minutes do people spend now waiting for their mercury lamps to stop blinking, or trying to figure out how to stop them from humming or buzzing?

What percentage of the cost of new housing is lost through antiquated building codes, arbitrary regulations, waiting for building permits, or spent trying to qualify for some weird state or federal "green" certification or subsidy? A friend of mine builds yurts for a movie stars' nonprofit and my sister tells me they are popular in one of the San Juan Islands because land use regulations prevent new housing (so people live in yurts instead). Like the thin buildings in Amsterdam that resulted from taxing building width, we suffer silently and invisibly from myriad prosperity-decreasing taxes and regulations. They raise the price of gasoline (leading us to plan part of our lives to buy gas in a nearby state if we live near a border), they raise the price of ice cream with regulations that raise labor costs and regulation milk production, they dramatically distort the financial system, leading to a stream of barely-tested financial instruments designed in part to avoid regulations limiting past financial innovations.

Millions of solar panels and thousands of windmills have been produced and installed in Western Europe and the U.S. and the great majority cost more to produce and install than the value of energy they produce. If, like the production of organic vegetables, such green energy was funded by green consumers willing to pay more for a product they think more valuable, we would have no particular reason to complain.

Solar panels and windmills may eventually be great technologies to reduce fossil fuel consumption, but today's aren't, they are political technologies thrown on markets through taxes and subsidies. Like politically-protected dirty coal from West Virginia, they distort natural technology development and make people poorer.

Other regulations prohibit coal-fired power plants from upgrading to more cost-effective and cleaner technologies (because regulations both mandate "best available" technologies with upgrades and grandfather in older more polluting technologies).

Deep-ocean drilling using novel technologies is a response by oil companies to being blocked from shallow water and land drilling by politicized governments in Mexico, Venezuela, Russia, Iraq, Iran, Nigeria, the U.S., and other places where plenty of oil and gas is in much easier to find and drill places that are off-limits for political or institutional reasons.

An interview with Shultz and Kling from Reason.tv is posted here.



Patrick Tull, reader of the books on tapeIf one were to begin the series of Patrick O' Brian books, should they be read in the order in which they were written? I'm finding good prices for some of the later books and looking to get through 1 or 2 while I am out of the country for a few weeks without internet access and distractions.

Gibbons Burke comments:

Yes, the series should be read in order, though some recommend that some readers may find that the second book of the series is a better introduction to the canon because there are more scenes on land.

I found it tremendously helpful reading the novels the first time through to have a dictionary and a pocket atlas readily available. Dean King's "A Sea of Words" is a most helpful companion to the series, as are his book of maps detailing the voyages in the novels, "Harbors & High Seas".

Google maps would be an even better resource these days. An iPad with the novels loaded into the Kindle app (they're not yet available in iBookstore), or audiobooks in the iPod app, combined with the Maps app, and the built-in dictionary would be a great way to circumnavigate the canon. Capt. Aubrey, who was ever interested in the latest go-fast sailing tech, might even approve, though it is likely O'Brian would express contempt.

Chris Tucker writes:

When Victor first introduced me to the books I mentioned that I had a bone to pick with him about them and that is that I was staying up until all hours of the night reading and I wasn't getting enough sleep. He wisely recommended that I try books on CD and listen to them while driving or whenever I had time to do so and so I forgave him for depriving me of sleep. I took advantage of the local library to get ahold of the recordings because they are a bit pricey.

If using a library, I find that tapes are actually better than CDs because if there is bad patch on a tape you may miss a few words or perhaps still here them but with derogated quality, but with a CD you may miss an entire track or two. Also important to note if listening to this series on CD or tape, Chair highly recommends, and I emphatically second, that you listen to the series as read by Patrick Tull, who manages to add to the already incredible drama that O'Brian evokes. Books read by Tull are available at RecordedBooks.com here.



The ConstitutionPrivate monopolies like Rockefeller's oil company and Judge Gary's steel company are subject to being nibbled around the edges. There is always some greedy SOB like Andrew Mellon willing to finance Texans who don't want to limit their oil explorations to the Mid-West and some disgruntled employee named Schwab who thinks he has a better way to run a rolling mill; and the consequence is always that the monopolist has to do it better, faster and cheaper to keep his market share. But in a public monopoly there is, as Buffett puts it, a "moat" around any real price or quality competition or substitution; as long as the government requires everyone to have auto insurance, the gecko is safe. We must have compulsory schooling and monopoly government money; how else can civilization survive? No wonder we have an education crisis in America: some fools actually have the insane idea that the students and their parents should be free to choose what it is useful for them to learn. The next thing you know they will be arguing that the 3rd Amendment really does not allow conscription.



It has been very trying two-year ordeal for investors in this space. Prompt futures have been sliding with unprecedented consistency, ever since their top price of $13.69 traded July 1, 2008. Every month since, as each new futures contract came on board, it has been one-way street for it to drop, drop, drop…all the way to $2.40 by September 1, 2009! July 2010 contract, however, traded below $4.00 for only a few lucky deals and basically quintuple-bottomed near $4. No major change in fundamentals is on the horizon, with record supplies and gargantuan inventories still dominating industry research reports.

However, traders are starting to pick up on the "active hurricane season" theme and looking to capitalize on surprise short-covering squeeze this summer. Surprise just because same failed to materialize during financial troubles of 2008, and a huge disappointment of 2009. Should we put money this year on "whatever didn't work last year"?

Craig Mee coments:

Got to love watching a good extended contraction and being ready to pounce… and reload if necessary. 




I've been an entrepreneur for nearly fifty years now with a variety of levels of success. I am a software engineer by training, and most of my software career has involved working with mathematicians. My serial fascinations have been process, measurement, gambling, trading, and financial bubbles, and I have been lucky enough to spend most of my work life on various combinations of these subjects.

For the last fifteen years my partner has been and still is Dr. Ron Schoenberg who I met while creating software for the late Dave Doehlert. Our partnership focuses on trading system research, and our current passion is the application of statistical experiment design to trading systems. We have convinced ourselves that the greatest reservoir of untapped potential lies in discovering the interaction between decision factors rather than in the main effects of these factors, but we have yet to convince anyone else that our work is more than amusing.

Friends and family are convinced that this is another case of mad scientist disease. They may be right because most of the systems that we have created crashed and burned after some period of success, but it is unfair to Ron. I come up with the crazy ideas, and he is the mathematician who tries to turn them into something practical.



 A visit to a New Jersey Gas Station sparks many sad reflections on dead weight loss and its impact on the current position. One sees lines of 20 cars waiting for gas at the stations as gas attendants amble about filling the cars. The cost in wasted time, the alternatives of productive work that could have been done by the attendants and customers in other fields is never seen the same way a dead weight loss impacts the reduction of consumer and producer surplus and other interferences with the natural order of things.

How much of the current malaise comes from such dead weight loss? Many trillions of dollars have been spent for the benefit of the flexions and their clients by the interior folks. This money has been allocated to areas that are green and organized agrarian in input. Yes, the money has been spent and used to buy assets from the above. And there is certainly the dead weight cost of the administrative involved.

But at what cost? Who would have spent this money? How were incentives to start businesses and hire workers and buy things that are useful in the day to day fray affected by this? What rational expectations come into play as to the ultimate impact of these expenses when they have to be paid back? What are the dead weight costs involved, and what goods have not been bought, and what investments in stocks have not been made because of this?

A visit to an ice cream store outside of Kira's graduation ceremony at St. Andrews in Middletown told wonders. They make a very good banana almost as good as Cones. And their peach has as much fresh peach as I've had the pleasure of eating. But they tell me their business is down considerably this year, and they cant figure out why. The owner does a nice job of making balloons outside to keep the kids happy. How many others are in similar predicaments with no explanation as we morph into a European style struggle?

Rocky Humbert writes:

One has sympathy for The Chair as he sits in a long service station queue and laments the NJ no-self-service law. And, as the early summer sun beats down upon his countenance, his thoughts evidently turn to Dead Weight Loss. Since I've started regular daily exercise (including checking my oil and pressure) I've paid more attention to live weight loss and proffer the following alternative hypotheses/observations:

New Jersey has some of the lowest gasoline taxes in the nation. Gasoline in New Jersey costs as much as 40 cents per gallon less than Westchester County, NY. I frequently fill up my gas tank on the NJ side of the George Washington Bridge; and perhaps the Chair's queue is attributable to the arbitrage of high gasoline taxes in surrounding states– rather than the NJ no-self-serve law.

2. The NJ Turnpike is a toll road with limited access. There is scant evidence to suggest that off-highway service stations have longer queues and/or poorer service in New Jersey than in other self-service states. Former Governor Corzine proposed an elimination of the self-service ban in 2006– and it actually ran into popular revolt: "I'm not against a lot of things, but I don't want to pump my own gas. It's part of the Jersey identity. It's our thing," said Rose Maurice. See this article.  

3. New York State and Connecticut both permit self-serve gas stations, however, they both require full service on certain highways. Having had an unfortunate brush with this business, my understanding is:

(1) the number of drivers who leave without paying on highways is much greater than on local roads.

(2) The throughput for a WELL-RUN busy full service station is actually higher than for a self-serve.

(3) Post-9/11, it is believed by Homeland Security that full-service highway gas stations provide a platform for surveillance. Your oil-soaked, slow-moving, non-English speaking gas jockey may actually be a highly-trained FBI agent checking your car for emissions from a concealed nuclear/biological/chemical weapon.

4. Our local town Shell station has four pumps. Two are self-service. Two are full-service. There is only one attendant for the entire station. The full-service pumps charge about $.20/gallon more than the self-serve ones. The station has maintained this model for years, and it suggests that there must be demand amongst the Chanel-clad soccer moms in Land Rovers and the very-important-Dads (in Brioni suits) not to soil their clothes while pumping gas or checking oil. In this example, the full-service pumps are a profit-enhancer, since the attendant would be there anyway.

During a recent visit to Switzerland, I observed that many gas stations have NO attendants and are open 24/7. One simply inserted a credit card, pumped gas and drove away. One should note that (due to taxes) gas in Switzerland is still massively more expensive than the USA, and it is unclear whether the absence of any attendant results in lower prices or higher profits (or both). I suspect that I would feel uncomfortable if there were NO attendants at a US gas station — on a deserted road — at 3:00 am … and the pump isn't working right … and a car filled with four youths and twice as many tattoos pulls in front of my car … and …. involuntary and not-so-politely relieves me of my wallet and luggage. I guess that's another sort of dead weight "loss."

There is no question that the NJ law introduces dead weight loss. However, the Swiss model (at the other extreme) introduces other costs (such as theft, liability risks, soiled clothes, spilled fuel etc) which are difficult to quantify.

While personal choice is usually preferable , my point is that things are almost always more complex than they appear… And policies need to consider an accurate cost/benefit analysis for the world that we actually live in - not a world that we wished we lived in.

Jeff Watson writes:

A prime example of dead weight loss is when a truck makes a delivery to a distant point and has no cargo to bring back to the warehouse wasting time, fuel, and labor. Wal Mart has engineered out much of the dead-load waste and has increased efficiency of its shipping fleet. They have automated their ordering, delivery schedules, and shrunk the number and size of their warehouses, as they consider warehousing a waste of inventory, space, time and labor. Now, with their "Just in time" ordering and shipping, they are able to use their trucks as rolling warehouses, cutting costs in so many ways and passing along the savings to the consumer. They engineer every step of the production of a product, from the manufacturing to the time it leaves the store. Wal Mart's business model is to be admired as they have introduced many products at low cost to people who otherwise couldn't have afforded them.

In addition to their main retail, Wal Mart has taken only 15 years to become the largest purveyor of groceries in the world because they applied their revolutionary methods in dry goods to the otherwise staid food business. The naysayers decry Wal Mart, but I salute them as an example of a company that took a page from Hank Reardon. Walmart is having it's moment right now, and will until something or someone comes along with a better business model. Never fear, there will be a better model, there always an evolution in business as long as man is allowed to be creative and earn a profit with minimal government interference. To those who complain that Walmart is decimating the business of Main Street, in 1920 the A&P Tea Company had 25% of the retail grocery business because it was light years ahead of the general stores of the day with the modern supermarket concept. The populists and anti-trust people took a careful look at A&P but thankfully never broke the company up. Other businesses should salute and try to emulate the way Wal Mart reduces costs, provides careers, brings a good assortment of products to market, and earns the shareholders a good return on investment.

Jeff Sasmor writes:

When I first moved to NJ from southern CA in 1996 I used to get into trouble with the gas station attendants because without really thinking about it I kept trying to operate the pumps myself. Now after being used to the attendants for so long, when I get gasoline in another state I just tend to sit in the car for a while waiting for the attendant till I remember that I have to do it myself. The attendants are nice to have if you don't want to smell like gasoline; and perhaps it's better not to have pregnant ladies handling gasoline pumps and breathing fumes. OTOH, the attendants end up breathing a lot of gasoline fumes. I recall when I was a youth (pattern recognition subroutines running in my brain just fished up that courthouse scene with Fred Gwynne from the great film "My Cousin Vinny") they used to wash your front and rear windows and check the oil on your car. Ah. My wife's car doesn't even have an oil dipstick anymore….

The great Fred Gwynne

Jeff Watson replies to Rocky Humbert:

Rocky, I know I used the term differently than how the economists use it. However, on the ground floor, the truckers use the words "Deadhead, dead load, dead log, or dead weight" interchangeably when referring to the loss experienced when driving with an empty trailer. Aside from excessive DOT regulations, the aforementioned is the biggest complaint of truckers as it eats into the bottom line, at least the ones I talk to who are non-Teamster. The union drivers don't worry about such things as empty trailers and bring a whole new subset of inefficiencies and extra costs into the equation.

Jeff Sasmor writes:

I don't think that the queue is a function of the presence of an attendant. That's an assumption that may seem natural (like a policeman directing traffic slows things down). I've not seen it in practice. Traffic in and out of gas stations is lumpy.

It's not demeaning to women– I can't imagine why anyone would want to get that smelly stuff on their hands if someone else does it and the cost is the same. And for preggos who want to keep away from things that are toxic (even if the exposure is infrequent and small) not pumping your own gas may be a good thing. And you can stay in your car in the rain and when it's cold out.

Personally I like having the attendants.

Sri Viswanath writes:

I liked your idea and explanations of dead weight loss… In my market experiences some observations that have warranted pin pricks include (fat specialists claiming to smooth order flow, short skirted well-heeled quaffed FX brokers, account reps talking about how they can get you special margins, analysts of rating agencies, mortgage brokers with outdated actuarial tables (see Bacon), derivative structured product specialists trying to sell libor cubed or some mathematically elegant swaps). All apologies to Hicks and Mr. Marshall.

It is amazing that the whole market structure can function given its oligopolistic government based subsidies (a la Citi etc) in excess of a lil' lagniappe. One case of classic deadweight loss is charging for exchange prices. Is this ecosystem capable of being quantified of such costs?

Easan Katir writes:

Charging extra to know the score at a baseball game would not sit well with fans. Somehow, the market fans are more docile and pay up. 

Craig Mee Agrees:

You say one case of classic deadweight loss is charging for exchange prices. I couldn't agree more. Isn't this a form of "restraint of trade"!



Happier timesAn excellent trader once told me that relationships are like trades. "Paolo", he said, "If it does not work, it is time to close it and move to the next one…". It is the concept of stop loss, of having the strength to recognize failure and accept its consequences, of learning from our own mistakes without feeling frustrated and miserable. In two words, it means being mature and responsible.

As a trader, I tend not to close my losing positions; it is my main problem. I think this is common to many "wanna-be traders". I want to wait for prices to go back where they were, I do not easily accept taking a loss. Most of the times this works well especially in a choppy environment, but if you find yourself in a fast market you can be badly hit.

Similarily, in life I care much about the friendships and relationships I establish. I feel "betrayed" when I lose a friend who is important to me. It happened recently, when a dear friend decided to discontinue any type of contact with me. At the beginning with some justifications. Eventually not even answering phone calls and emails. I know that with every ending there is a new beginning, that maybe I didn't realize what kind of person this was in the first place, that I may have contributed to the situation, that I don't need this person to be happy. However, you are aware there is something of you that has gone away and will not come back. It is complicity what you miss the most. It is the awareness of having wasted emotional energies on a losing investment. "Paolo, it is a closed book. It is time for the next trade" he told me. I know this is right, but I miss this friend.

Chris Tucker advises:

Paolo, You are not a "wanna-be trader" any more than you are a "wanna-be friend". In both endeavors we are all learners all the time. Setbacks will occur in all facets of our lives and they can be painful, sometimes extremely so, but they are not a reason to condemn ourselves or to give up. It's normal to feel frustrated and miserable as long as you don't dwell there for too long. Nor do I believe that you have wasted your emotional energy. Energy that is put into something or someone you care about is never wasted, it's just that sometimes it fails to yield the benefits we expected. So I don't see you as a "wanna-be trader" but as a "trader in training", just like the rest of us, even the spectacular successes. I find that devoting my focus to finding the lessons to be learned from such things not only helps to assuage the pain associated with them, but also prepares me better for similar scenarios in the future. Perhaps you can ask yourself questions like "What can I learn from this?" or "What positive outcome can there be to this?" 



 Reading through Linchpin by Seth Godin advocates getting away from the quantified.

We measure the quantified because we can. But we should create the unquantified because it's so rare. If you can quantify it, then probably someone before you figured out a why to grind it out. And if you can grind it out, someone can grind it out cheaper than you can. On the other hand, the really valuable stuff, the stuff we pay a lot for, is unquantified. Things like creating joy or security or happiness. No easy measurements for those, thus they are art, and art is always worth more than the predicted.

Henry Gifford comments:

Similar situation with how much energy a boiler takes to heat a buildng. The quantifiable is the least important– the % efficiency while the boiler is operating (% of energy in fuel not going up the chimney, but going into heating the building).

The second most important thing is quantifiable enough to have % numbers on it, but those numbers are hopelessly inaccurate– the annual % of the energy in the fuel not going up the chimney (different from above because of the heat going up the chimney from a boiler that is hot, but not firing). Most of this loss can be avoided, but nobody bothers because the % ratings don't change with improvement.

The most important thing is so hard to quantify there is not even a unit for it– how unevenly the building is heated. The chair helped me put some units on this once, but otherwise, I have never even heard it discussed in my field. Uneven heating means overheating the whole building to satisfy the coldest room, with the overheating costing much more energy than the factors mentioned above.

So, in my field, everyone is running around measuring the least important factor, while the most important factors are not even discussed.

One solution is to focus on solving the problems, (short chimney, thermostat in every room) without being able to predict the resulting saving. But, without prediction, it's a very hard sell. Good for one's own portfolio, harder with other people's portfolios.

Peter Grieve adds:

When people are making purchasing decisions in areas in which they are not expert, there is a strong tendency to reduce things to a few numbers. These numbers are easy to compare, but present a grossly simplified picture. The simplest machine has myriad degrees of freedom, and so does the operating environment. The assessment of the interaction of these two cannot be crammed into four of five numbers.

This is especially true in government procurement, for example weapons systems. The M4A1 carbine is supposed to have an effective range of 300m. I have done a lot of shooting with the civilian version of this weapon, and I can assure you that this one number does not capture much of the essence of the range of the machine. On a hot or cold day? Shot by a master or a bumbler? Standing or prone? Against armored or unarmored targets? Shooting from sunlight or shade?

But this number is easy to compare with corresponding single numbers of other weapons.
Or take chess ratings. Chess strength is a very complicated thing, which cannot be reduced to one number. There are cases in top level chess in which A does well against B, B does well against C, and C does well against A (Nigel D. can help with examples here). Single real numbers are linearly ordered, and no three of them can satisfy A>B>C>A. Single real numbers are not adequate to encapsulate chess strength in its entirety.



Florida's Emerald CoastOil is reportedly 7 miles off the shore of Pensacola Beach. The contrast of crude oil against the canvas of pristine, white sand beaches will have a strong effect on the psyche of the entire region. Thousands of Southerners have for generations spent joyous summer vacations on the Gulf Coast.

The four biggest industries in the Gulf of Mexico are oil, tourism, fishing and shipping, and they account for some $234 billion in economic activity each year, according to a 2007 study done by regional scholars and published by Texas A&M University Press. Two-thirds of that amount is in the United States, with the other third in Mexico. If the Gulf of Mexico were a country, it would be the 29th largest economy in the world.



 "Why use a stethoscope when we can just see it through a cardio exam. Slowly and gradually community hospitals will come to resemble FVA hospitals. We will have universal care like the great nations of Europe. And we'll suffer with double digit unemplyment and smaller houses and cars while we wait for the health care that is our right" et al.

The question is why is every profession, not just legal or medicine or architecture and ours, becoming more and more so that the customer is no longer the pitiless captain?

Vincent Andres answers:

1. More and more poor education (+ other reasons) makes more and more people incapable of doing something truly useful. More and more people cannot do hard jobs or dirty jobs. Nevertheless, in order for the global system to keep up appearances, those peoples have to got an official occupation. The system works well. Everybody deserves a place in the system. The system is able to provide everybody a place in itself.

2. Putting everybody several hours in front of a TV per day is a first solution, but this does not well maintain the appearances of people working. (Although there is clearly a trend admitting as socialy acceptable that people have more and more of their time leisuring.)

3. The only other solution is to adapt the level of "jobs" to the level of people, i.e make the job simpler simpler and simpler. Hard jobs or dirty jobs being forbidden, the only other possibility left is penpushers. So the system has to create millions of such jobs. But this has to be done in a credible way. So complexity is created everywhere where it is possible, in Europe, in France, new laws, rules, etc are created on a weekly basis. (even our judges don't know the law in full today). There is also a multiplication of levels, each level being able to produce its own laws/rules (fractal complexity). This justifies the creation of thousands of offices, agencies, businesses, etc, officialy to cope with this complexity, but /in fine/ truly only to provide jobs, or better said, occupations. The system is a gigantic gas factory, and one of its main function now is to add each day more and more complexity, more and more pipes, in order to justify hiring people to build and maintain those pipes. Each of us deserves a place as an extra in this global spectacle.

Of course such a system is in deficit, ie not sustainable by itself on the long term. No country can survive with ~40% of the population playing theatre. It has to import most of its energy from outside. Hard and dirty jobs have greatly to be done by outsiders.

We are currently living in a moment where energy importing from our outsides becomes a bit more difficult. This system, in which we became more and more simple "extras" is analyzed in Society of the Spectacle by Guy Debord, 1967  (caution: although the book has great ideas, it is not super well written).



Here is the price change for various markets (expressed in US dollars) from the start of the year 2010.


(Source: Bloomberg).

The "YTD Ahead/Behind" is calculated by assigning each market a base index value of 100 as of 12/31/2009, then multiplying this base index value by the respective % change for the year (ex. +20% YTD would produce an index value of 120). After, the average of each league is calculated and subtracted from the individual current index levels to produce the amount ahead/behind.



Doesn't it follow that all the interest over and above what banks and governments pay can never be repaid in aggregate, because it nets out to 0?

Actually the interest in the private sector comes mainly from income generated in the private sector. When I grow a tomato and sell it the income goes to pay off my mortgage (the capital part). The rest of the income goes to me as the compensation for labor part. As long as I can still grow tomatoes I should be able to make those payment every year.

Essentially I am borrowing from future income in order to get current capital. The capital invested in my land allows me to make greater income than if I did not have the additional land. Obviously the above example is about the business use of capital, but the same principal even applies to consumption type loans such as credit cards. As long as there is a sufficient source of income from somewhere to service the debt then it can be repaid.

George Parkanyi elaborates:

I understand how an individual, business, or bank deals in interest in their own micro context. My question is more macro/mathematical. Where does this surplus interest come from in the total pool of "money" that is created by governments and banks? You can't create money out of thin air (or can you?), so that interest over and above government and bank interest paid must be 0 net. What am I missing? (In fact bank interest paid is on deposits that already comes from somewhere, so that money has already been created.)Implication: the global banking system is a de-facto Ponzi scheme in the mathematical sense.

Phil McDonnell replies:

You can't create money out of thin air (or can you?), so that interest over and above government and bank interest paid must be 0 net.

Think of my simple tomato example. It is created out of nothing and has a value. It is mostly hydrocarbons. Where does the carbon come from? It comes from CO2 that Obama calls poisonous but is fresh air that the plants breathe. The hydrogen falls from the sky as rain (H2O). So it is not too much of a stretch to say that tomatoes come out of thin air.

The other thing that you may be missing is that income can increase simply by the artifice of having more transactions - the velocity of money. The quantity of money may be constant at any given point in time but the velocity can rise or fall. If I grow the tomato and sell it that is a transaction (increased velocity) and income to me. If I do not grow the tomato there is no transaction (reduced velocity) and no income to me. The macro formula is:

GDP = V * M

where: V is velocity M is Money supply

The point is that when business is booming the velocity often rises simply because more transactions occur.

Another point that you may be missing is that when a bank loans money, new money is usually created. It does not come from the deposits nor the Fed or the Treasury. The banks create it (out of thin air). They typically keep reserves of about 10%. The banks stopped lending in late 2008. It is terrifying what has happened to the velocity since then.

See this graph and this one. 

George Parkanyi responds:

I understand money to be a proxy for productivity, which roughly equates to the velocity. Like a shark needs to keep swimming constantly to stay alive so must money move. But when a bank creates/lends 1000 dollars, and insists on 1050 coming back, the 50 physically has to come from somewhere. No-one created 1050; they created 1000 (of the currency, not the productivity, to be clear). That 50 has to come from someone else's 1000, which means someone somewhere not only has to default on interest (that doesn't really exist), but on $50 worth of principle in order for the bank to gain 50 in interest.

Ultimately money is continuously being fed out there - but if all the principal in theory were to be repaid, no interest could be, because it was never created. (You'll have to take it in tomatoes).

I agree with you Phil that real productivity is the grown tomato, which can be traded for dental work let's say, but I can see how easy it can be for money - a paper proxy, or scoring system, for productivity - actually to de-couple from the value of the tomato (or root canal). Too much money and you have a $1000 tomato, too little and you'd better start getting used to eating a lot of tomatoes.

Interestingly however, gold would have the same problem, mathematically speaking. It doesn't have any instrinsic value. It's a rock, basically. Given the choice between a handful of gold and a tomato in a starving situation, I'm pretty sure I'd take the tomato. (Though I might use the gold to try to bludgeon a rabbit with - but that would be a long-shot at best.) The ONLY advantage (and perhaps disadvantage) gold has is that you can't just create more out of thin air.

Charles Pennington steps in:

I don't think George is asking how wealth is created–he's asking about the actual number of dollars out there, and trying to understand whether or not some kind of conservation law is broken.

Here's an illustration with an economy that only has these entities:

1) the Fed, 2) a Bank, 3) the Farmer, and 4) the Cowman. To keep it simple, nobody ever, ever holds any cash dollars in their wallets–all money is just a credit to your account in the Bank.

At the start, the bank has $100 in reserves at the fed, and those $100 are all that exist anywhere.

Then the Farmer borrows $500 from the bank, agreeing to pay the bank $600 after 1 year–20% interest. The $500 was created by the bank out of thin air. The Farmer pays the Cowman $500 for some of the Cowman's land and equipment, and then the Farmer starts to grow tomatoes. The Cowman now has $500 on deposit at the bank. The bank is now owed $500 from the Farmer, and it owes $500 to the Cowman.

After one year, the Cowman agrees to buy the Farmer's tomatoes for $650, in order to feed his cows. The Cowman only has $500 on deposit, so he borrows $150 from the bank. Then he pays the Farmer $650. The Farmer pays off his $600 loan from the Bank and deposits an additional $50.

Now the Farmer has no debt and $50 deposited in the bank.

The Cowman now has some tomatoes and a debt of $150 owed to the bank.

The Farmer's deposit minus the Cowman's debt equal minus $100, which is, not coincidentally, the amount of interest paid to the bank. So the interest ended up in the form of a debt to the bank.

The reason that this all sounds so crazy is that the bank just created the $500 out of nothing. That is the privilege of being a bank under the central banking system. A sometime List member points out that banks are the ultimate "GSE" (government sponsored enterprise). Fannie Mae and Freddie Mac are recognized as GSEs, but banks are usually not thought of in that way. They should be.

Rudolf Hauser interrupts:

You are the one making things complex by creating a situation totally divorced from reality. Unless this bank had the power to use force to cause people to accepts its accounts as payment, it would not be able to function. In real life banks started because they kept prudent reserve ratios when accepting gold for deposit. As trust was established, with time they figured out how to lend some of it out safely. This bank you describe would have no trust. But you made the situation more complex by assuming a central bank in addition at the same time you treat a private bank as the central bank. This is like saying the bank has an already accepted currency of $100, that might say be backed by gold at the central bank. That, not the deposits at the bank would be the accepted medium of exchange and is accepted by the public. Why would anyone accept the farmer's check payments if they could not be cashed for an accepted form of money, i.e. those reserve balances, which could well be backed by gold? 

Yishen Kuik submits:

I think of saved money as proportionate voting control over the deployment of available future man hours (either hiring someone to do something or buying something which then sends signals to get people to make more of it in the future).

So all notions of real wealth are inextricably linked to the productivity & quantity of future man hours.

George Parkanyi clarifies:

Charles is the one that has best understood my original question– articulating it as "has some law of conservation been broken?" Exactly.

I define money to be that which you credit or debit on an income statement or balance sheet denominated in a currency.

Because all money created through lending originates as principal, interest must paid from other sources. That means money would have to be created other than by debt issuance, by different mechanisms. Presumably this could happen if the authority allowed to issue money (a government or a bank) either granted money without an obligation to repay, or paid in kind for goods and services. Presumably the government collects taxes to do part of that, which would not create new money. Therefore I see only the following ways a surplus over and above the original face value of total debt issued can happen:

1 - The government/bank pays interest or in kind for goods and services consumed by government/bank by issuing new money

2 - The government or banks forgive debt (the obligation to repay)

3 - The borrower defaults; the money remains "out there" now unencumbered by the obligation to repay. (Essentially bankruptcy is a source of unencumbered money - ironic)

Either way, it seems to involve the voluntary or forced forgiving of principal. So an interesting (at least to me) question becomes - what's the mix? And how does it relate to the health of an economy?

Rudolf Hauser argues:


No law of conservation has been broken. Debt and interest thereon are real transactions. They are a measure of claims on the goods and services produced by human labor. Borrowings are consumed and invested in physical capital and hire of labor and sold. The proceeds of the sale and other income in the case of consumers are where repayment and interest come from. Money is only a transfer form. The goods are sold for money and that money than pays the debt. It only need held for short periods of time. That is you get the money, deposit in your bank and then when it clears you can write a check to pay your debt and interest. With currency you do not even have to wait at all other than to physically go from place of your sale to the place you repay the debt. The same quantity of money can be turned over an infinite number of times. The rate of turnover can change. Hence, all of your assumptions regarding laws of conservation are therefore wrong. 

Sushil Kedia writes:

I strongly refute the contention that banks create money out of thin air. They are only borrowing and lending money.

Money being a store of value can either be created by a guarantee from the State that a piece of paper shall fulfill the promise of returning value on being presented or when through value addition (real and perceived) hard assets or utility producing assets accumulate in an economy that can be considered storage of value and thus a creation of money.

A bank issuing a debt security which can be used by another bank as a collateral for gaining access to the Central Bank created money is in itself not an increase in the "stock" of money.

In that same way if one corporation issued equity shares to another corporation in lieu of the equity shares of the other corporation and both went on to sell these new shares in the market or pawned them or proffered them as collateral they have not raised the "value" of their corporations and hence they have not created a store of value but only smaller containers (number of shares going up and thus book value per share going down) storing the same total amount of value.

That partly explains the rational why its printed on the US Dollar, "In God we trust, rest strictly cash" that eventually the paper money/ fiat money regime is based on an implicit trust that the mints/gummints are backed by God still whether or not they represent the choice of a democracy or elsewhere in the world implants atop anarchies.

However when the velocity of exchange rises, either as explained in the money multiplier formula for GDP or in the trading pits of various securities, the stock of "near moneyness" rises. A year or two ago the lists had discussed where all the money has gone. I argued at that point too that what has gone was never money, but a state of "near moneyness".

So to return to the point, banks are not creating money out of nowhere. Money of cause is getting created since the collapse of Bretton Woods out of nowhere even if it is supposed to be backed by value and wealth. If anyone is creating money out of nowhere it is the Mint. The rest of the humbler souls, including those of the banks are only left holding a Trust in God.

On another yet related note I would say if you got people queue up across Manhattan and kept on passing currency notes down that queue with automated note passing-and-catching machines to reach the highest possible velocity with which money could change hands, it would do nothing to the economy (perhaps that disguised unemployment alone would go up). The real essence of velocity of money being real exchange of real goods and real services it stands to reason that money too needs to be real. For now, we are living with a belief and trust that the currency note in our wallets has real assets backing it and that's the only reason for which it is real. No one else, other than the mint has got this privilege.

Jeff Watson writes in:

The Mises Institute would respectfully disagree with you. Their discussion on fractional reserves says it all. http://mises.org/rothbard/moneyback.asp Of course, the followers of Keynes would probably disagree with this assessment

Many others, including the Fed, congress, Milton Friedman, and other central banks share the opinion of money being created out of thin air via fractional reserves.

"Banks do not really pay out loans from the money they receive as deposits. If they did this, no additional money would be created. What they do when they make loans is to accept promissory notes in exchange for credits to the borrowers' transaction accounts."
- 1960s Chicago Federal Reserve Bank booklet entitled "Modern Money Mechanics

"The process by which banks create money is so simple that the mind is repelled."
- Economist John Kenneth Galbraith "When a bank makes a loan, it simply adds to the borrower's deposit account in the bank by the amount of the loan. The money is not taken from anyone elses deposit; it was not previously paid in to the bank by anyone. It's new money, created by the bank for the use of the borrower."
- Robert B. Anderson, Secretary of the Treasury under Eisenhower, in an interview reported in the August 31, 1959 issue of U.S. News and World Report

"Do private banks issue money today? Yes. Although banks no longer have the right to issue bank notes, they can create money in the form of bank deposits when they lend money to businesses, or buy securities. . . . The important thing to remember is that when banks lend money they don't necessarily take it from anyone else to lend. Thus they 'create' it."
-Congressman Wright Patman, (House Committee on Banking and Currency, 1964)

"The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented."- Sir Josiah Stamp, president of the Bank of England and the second richest man in Britain in the 1920s."Banks create money. That is what they are for. . . . The manufacturing process to make money consists of making an entry in a book. That is all. . . . Each and every time a Bank makes a loan . . . new Bank credit is created — brand new money."- Graham Towers, Governor of the Bank of Canada from 1935 to 1955Maybe these folks are wrong?

Stefan Jovanovich disagrees:

I hate to disagree with Jeff, but the answer is that these folks are wrong. Rothbard never understood what was at the heart of the problem about inflation/money debasement: (1) how do you reconcile the Constitutional requirement that Congress have a monopoly authority to create legal tender with the inescapably desire of human beings to deal in credits with one another? (2) how do you prevent Congress from debasing the Federal Money through extensions of the Federal Debt? Rothbard and the Paulistas think that banks, by their very nature, are somehow the source of the evils of inflation/profligate credit creation. Being, at heart, prohibitionists they have always thought that they could destroy sinfulness by outlawing bank credit itself. Hayek, who was - Gold bless him - anything but a Puritan, knew this was the worst kind of folly (BTW, this explains why Rothbard and most Miesians would like to kick Hayek out of the Austrian club). As Hayek gently pointed out, there is no logical difference between the Misean argument against fractional reserve banking and an argument against trade bills, options, futures, swaps and all the other forms of credit. If the Bank of 100% Reserves cannot create credits against its Money Reserves, then how can Fred's Pizza Parlor be allowed to promise to pay in 30 days for its latest delivery of flour and yeast? Hayek had a logical solution to the problem of monetary debasement/inflation - competing private monies. The problem is that Hayek never explained how the government would determine whose private monies will be accepted as legal tender under our Federal Constitution. (If you think the current favoritism of banks too big to fail is an abuse of government, wait until you have a system where the government can decide whose private money is "good" and whose is "bad".) I think Hayek had problems with the question of legal tender. He knew a great deal about American and British law but tax questions never interested him; and the American notion of fundamentally limited government always escaped him (he was, to the end of his life, a supporter of conscription). Milton Friedman was right about "money being created out of thin air" via fractional reserves, but he failed to understand that it was the government's ability to use its own Credit as reserves for the central bank and its members that was the problem. If the government, with its monopoly legal tender authority, was not disciplined by the requirement that it pay up, on demand, in gold, then Congress would write checks; and the Federal Reserve would cash them. We have had a solution to these problems. It was the one President Grant proposed and pushed through Congress (against the "better judgment" (sic) of both the Republican and Democrat leadership). Grant knew that, if the United States of America restored the Constitutional promise that the Federal government 's Debts will be paid in Money of a specified Weight and Measure - i.e. specie, it would be possible to have a system of competing near-monies through private banking while still preserving the Federal government's legal tender monopoly. Grant forced through the Congress not only the promise that the Federal government would redeem its outstanding greenbacks in gold but also the requirement that the banks authorized to issue Federal bank notes could not use (1) greenbacks, (2) other banks' Federal notes or (3) Federal debt itself (!!!!) as reserves. Only specie could satisfy the banks' reserve requirements. The result was an age where the impossible happened year after year: real incomes rose for Americans, including the flood of new immigrants, while at the same time prices fell. Banks engaged in fractional reserve lending, and some of them did, as always, fail - just as they had under the Scottish free banking system in the 18th century - but there were no system-wide panics. On the contrary, as with the Scottish free banking system, the fact that banks had to clear each other's notes (that they could not hand off the credit risk to a central bank) made them highly sensitive to any profligacy by a counter-party. 

Rocky Humbert disagrees:

I had to disagree with Stefan, but he is mixing microeconomics with political philosophy.
As any economics textbook will attest, Jeff's definitions are consistent with the current state of economic theory. The underlying assumptions in microeconomics may be questionable (as all simplifying models are,) but the math in our fractional reserve banking system is straightforward and leads to logical conclusions.
MV=PY … where money supply x velocity = price x output. (price x output=nominal gdp)

Stefan has written previously about his problems with the separation between money and credit. The fact is that he never really cuts to the practical heart of what makes money useful. If I buy an ice cream cone from Stefan, I can give him, and he may accept, an IOU. That's a creation of credit. But he can't use my IOU to buy cream at the dairy. And he can't deposit my IOU in a bank. And because it's outside of the banking system, that transaction will not affect the money supply as defined. And, so long as other (unrelated) people do not accept that IOU as payment for goods and services it's not money. In a complex economy, it's absolutely essential to have a universal legal tender. And the gov't monopoly doesn't interfere with credit between direct counterparties at all.

A contrary example…. what's the difference between American Express Traveler's Chex and money? Very little. The ONLY difference is that I am NOT legally obligated to accept an Amex Traveler Check as payment for goods and services and I AM required to accept a greenback. (I am not commenting on the nonconvertibility of greenbacks here.)

Rudolf Hauser comments:

Ever since George raised the question of where does interest come from, I have been astonished by the amount of misunderstanding with regard to the issues of money and credit revealed in the discussion that followed. Let me try to clarify some of these issues.

First we have to know what money and credit are. We live in a economy of specialization. Most of what we produce is not used for our own consumption but traded for the goods and services produced by others available in the market economy. As barter is very inefficient and more so the larger the economy becomes, we need a common substance that is widely accepted in trade for any good and service. This not only facilitates transactions but allows for pricing in standard units (rather than say a bushel of wheat buys half a pair of shoes, 3/4s of a bushel of potatoes, a gallon of oil, etc.) and provides a store of value. The use of such money in the form of a commodity (such as gold) or fiat money provides such a service.Money today comes in a variety of levels. First we have money accepted by all governments in exchanges among themselves. Traditionally this has been gold or silver. Today we also have reserve currencies, namely the dollar, that are widely accepted in payment, but that could change if confidence in the value of the dollar were to decline. Then we have money that can be used for transactions among banks. This consists of high-powered money (the monetary base) composed of demand deposits held at the Federal Reserve and currency. These are created when the Fed buys anything with newly a created check given to the selling dealer in the private sector that will eventually give a bank a claim on the Fed (reserves). Then you have narrowly defined money, M1, that is money that is generally accepted in transactions among the general population. When banks buy securities or make loans they pay for them with high powered money. Those payments are then placed in the checking accounts of recipients, creating new deposits, that is, more money. Banks have to keep some of their reserves but expecting that the amounts on deposit with them will not shrink drastically overnight are willing to lend out some of those reserves. That reserve ratio determines, along with a few other factors such as the ratio of high-powered money in the form of currency, the high-powered money multiplier. While M1 money is required for transactions, the need for a private reserve of money can be supplemented by near-moneys, that is items that can quickly be converted to M1 type money with minimal on no cost or depreciation in value. Various items serve this purpose to varying degrees depending on how close to those noted requirements are met. Very close are savings deposits. Short-term time deposits have a lesser degree of "moneyness" (to coin a word). Short-term securities also have a degree of moneyness. You can be assured that the degree of moneyness of commercial paper declined to almost nothing in 2008 before the Fed stepped in to support that market. Ready access to credit might also be considered a factor in reducing the need for more narrow definitions of money.

Money is held to insure that the holder is liquid enough to meet his or her needs to be able to engage in transactions in the near-term to modestly distant future. It is a function of the amount of and degree of moneyness in near-money assets, income and wealth levels, the amount of nominal transactions in the economy, the efficiency of the payments system, the level of real economic activity, opportunity costs, inflation concerns and the degree of perceived risks in the economy and financial markets. When the amount of money supplied exceeds the demand for money, you get inflation. When supply is less than demand you get deflation. When you grow money (or at times contract it) at an appropriate rate relative to real non-inflationary economic activity and the change in demand for money in such an economy, you get a non-inflationary economy. Attaining the latter should be the goal of central banks.

Money is a medium of exchange. MONEY IS NOT CREDIT, AND CREDIT IS NOT MONEY.

As noted, in an economy of specialization, which is what has allowed us to have real economic growth on a per capita basis, people use their time and talent to produce and trade their production or labor for payment in money, which they can then consume or save. Savings is that which is not consumed. It might consist of inventories of goods, goods that are consumed over time such as a car or housing (the annual depreciation thereon is the consumption of such goods) or productive assets which increase productivity of labor and/or are necessary to produce certain goods or services. One can save by buying such assets for oneself or one can provide credit either in the form or a loan or equity investment. (I would classify equity investment in which the shareholder has no active role in the activities of the corporation as in essence a form of credit in which the rewards and return of capital depend on the profitability of the business in the context of this particular analysis.) If such credit is not provided and used one will end up with unwanted inventories. This will necessitate production cutbacks and unemployment and underutilization of productive capital and a reduced amount of economic prosperity. Because most people do not work for themselves and are dependent on jobs to earn a living, it is important that there are entrepreneurs and equity investors willing and able to make the capital investments that will employ people. It should be noted that on the micro level, savers can also lend for the purpose of others consuming more than they currently produce. This changes who consumes and by enabling some to consume more than they would otherwise to increase overall consumption at the cost of those borrowers having less consumption than they otherwise would have from their current incomes in the future when they repay those loans. That repayment need not change overall consumption as those repaid savers might use the return of those funds to consume more. Interest is paid from the profits or equity of the business borrowers and the future income or other assets of non-business borrowers. In the case of government borrowing, it would come from taxes if the overall debt levels are being reduced, which is the exception rather than the usual case.

When one borrows or makes an equity investment, it is made with money. So is a purchase of any good or service. The money is not the credit. It is the medium of exchange in which all transactions are made. The recipient can then buy goods and services with the funds, invest them in capital or financial assets or even use them to hold cash balances. It can also build up cash balances with proceeds from the sale of its goods and services. Money is money no matter what the source (aside from counterfeit money). It is not credit. It is an asset that is used as a medium of exchange and the numerar in which obligations are expressed. A debt could be expressed in barrels of oil. It would still be an obligation. The fact that it is expressed in money does not make money credit or credit money.

Now with those basics noted, with regard to George's question, money is a medium of exchange that is in constant circulation. It is used and passed on. When someone sells goods produced or services, or sells any existing assets, one is paid in money and that money can be used to repay a debt with interest. It is then used by the recipient of that payment to make other transactions. The ability to repay has nothing to do with the amount of money in circulation as long as that overall stock of money is consistent with the overall demand for money. ( A shortage of money led to Shays' Rebellion as debts had to be repaid in money but money was not available for payment for goods and services.)

The Fed does earn interest on the securities it purchases in the process of creating money. It buys outstanding assets but the sellers of those securities now have funds to invest elsewhere. But that would be equally true if those sellers had sold to someone in the private sector. It is the Fed that benefits, but it returns those funds earned in excess of its expenses to the Federal government, which benefits. This has nothing to do with inflation, which is a different sort of tax. If the money created is held in the aggregate because of an increased demand to accommodate a growing level of real production and other factors and the product of money held and velocity not increased relative to the level of real economic activity at an unchanged price level, it will not be inflationary. The dollar sitting idly in your bank account will not be driving up any prices and will result in lower velocity. The bank obtains funds from deposits that increase its liabilities. It is not getting a free ride. The only way it gets a free ride is if it can borrow from the Fed at rates below those it would pay in the private markets. Contrary to the Google video someone posted a link to, banks do not create money out of thin air. All the funds they receive are in the form of high-powered money in the sense if they are in the form of a check that the bank they are drawn on will be paid out in the reserves that bank holds at the Fed and currency of course is high-powered money. So the money banks lend out in loans is obtained by either receiving deposits, selling assets, or borrowing from the markets (non-deposit liabilities) or the Fed. Only the Fed creates money out of thin air.

Sushil writes that "The article below makes too many assumptions. One of which is that a loan taken from a bank is deposited into another bank and the new bank uses this deposit to create more loans. It's simply silly. Mr. X borrows from bank Y at 6% per annum and puts it back in bank Z for a term deposit earning at 4% to go broke? It does not happen in real life." It should be clear by now that that Mr. X will use the money to buy something and that to do so he will have to have a checking account balance and that the person who he buys from will also put that check in his checking or savings account until he or she are ready to spend it. Nor need it be in bank Z but could be in any bank.
George makes reference to a chart on velocity but is really a chart on the money multiplier. As I have noted before on one of these lists that the multiplier refers to a measure of money such as M1 or M2 divided by high-powered money (the monetary base). It has declined sharply because of the increase in excess reserves. You would not have to double money as someone suggested to make up for the decline in velocity because velocity did not drop as much. Using my favorite measure of M2 lagged two quarters, income velocity (GDP/M2t-2) declined a maximum of only 10.65% as of the third quarter of 2009 on a year-over-year basis. This is the inverse in the demand for money. On a quarterly basis it has risen in the past two quarters, implying that the demand for money was declining as confidence was gradually being restored. Banks are keeping such high excess reserves because they still are cautious and a 25 basis return exceeds the cost of Fed funds. If the Fed wanted to increase money growth, it would just have to lower the interest rate it pays on excess reserves. As the Fed funds rate has risen a few basis points the level of excess reserves has peaked.

As to the Rothbard article from the "Freeman" on the Mises Institute website that Jeff references, I have a number of disagreements. One is that Rothbard ignores the rule I noted above that when money supply is less than demand you get deflation. He seems to ignore this when he implies that a flat supply of money would give you no inflation or deflation.

One major problem with a gold system is that real growth might result in more of an increase in the demand for money than can be supplied by gold reserves. A modest amount of deflation can be tolerated as evidenced by real economic growth in the latter part of the 19th century. But because nominal interest rates have a 0% floor, deflation increases the real interest rate and at some point will squeeze out too much capital investment limiting real growth potential.

Contrary to what Rothbard says, you would still have fractional banking under a gold standard. While banks have to pay other banks in high-powered money, which would mainly be gold in his world of no central banks, they are also constantly receiving new deposits and having loans repaid. So banks would only have to hold enough gold to meet what they expect to be the worst net outflow. The major risk is a panic in which a run on all banks for direct holding of gold would create a negative situation. As experience has shown, after a long period of prosperity people tend to become more confident and less prudent in their behavior. There is no reason to expect any difference were we to move to free banking and no central bank in our current culture. One form of money has been repo financing by investment banks. These were backed by collateral that consisted in part in highly rated mortgage paper that turned out to be junk. As confidence waned, rising collateral requirements could not be met and there was a sharp decline in this unmeasured form of money and selling of assets at distress prices that greatly contributed to the financial crisis. Need I say more?

Rothbard fears a run on banks when confidence goes (writing back in 1995) and says the Fed would have to make up the difference between deposit balances and actual liquid reserves that banks hold. He considers this inflationary. Actually this would increase high-powered money but would not change the broader measures of money, just substitute currency for deposits. He is correct that this would be inflationary when the funds are returned to the banking system. But an alert Fed would then contract reserves to offset this reverse inflow and as such it would not have to become inflationary.

I have other disagreements with his case for the impact of ending the Fed that I will not go into since they get us away from the discussion at hand.

Tyler Mclellan adds:


This is excellent. I was going to write a long note, and spent a few days arranging my ideas in order to write concisely on the topic.

You have touched most of the salient points. There is one area though where I think you might not have provided clarity.

"Money is held to insure that the holder is liquid enough to meet his or her needs to be able to engage in transactions in the near-term to modestly distant future"

I think this is not the best way to go about getting at this important idea. The above may be why people choose to hold money, but it is not "what money does". Lets go about it from the opposite point of view, lets say no one had any faith in the government to maintain the purchasing power of money even on very short term time horizons. Now money is a residual, people are forced to hold it to the extent the inconvenience of constantly changing money into goods is still less that the inconvenience of changing goods into other goods.

Now let us posit that the monthly inflation rates are something like 1% and the costs of barter much greater than the resulting "menu costs, etc.." here you have a 12+% annual inflation rate that in no way obviates the usefulness of money as a means of exchange.

But the usefulness of money as a store of value has been significantly diminished. Why does this matter? It matters because there is tremendous demand to hold risk free near term savings. This is because people have a very intuitive sense that there is opportunity cost to doing things, opportunity cost to consuming today and investing in a specific opportunity today.

BUT, this is simply a convention. Aggregate savings has to equal aggregate demanded investment. Excess aggregate demanded savings can only by definition end up being consumed by someone else. If it does not get consumed by someone else, that income will simply disappear.

I have to restate what I said above, because it is the key insight, and something very few people understand. We have huge desire to save risk free near term, but that savings needs to get used up by an equally large desire to consume in the near term or it needs to get used up by matching near term savers with long term demanded investment. If it gets used up by consuming, then in the aggregate sense it is not really saved. If it gets used up by investment, then it is actually saved.

The confusion arise because the store of wealth convention of moneyness is actually quite difficult to get around. What I mean by this is, the false notion that money is a store of wealth is important to allowing demanded savings and either demanded investment or demanded consumption to be successfully intermediated. THIS NEED NOT BE LOGICALLY SO. It is true only because there are very few people who actually want to lend their money, or iphones, or wheat, or gold in exchange for 30 year equity claims or in multi-year consumption smoothing schemes with their children, which in both of these cases would clearly separate the store of value function from the transaction function. (think of how it makes no sense to speak of the transaction usefulness of a 30 year loan in 30 years, we all have an intuitive notion that the currency im paid back in 30 years from now is a CONVENTION, and unrelated to moneyness. If you work backwards to all savings even at small time horizons, you'll realize this is true of even very short term credit provision. What the person has is a claim on the future, and it is never different from that.)

And, to circle back, the reason the convention that money is a store of wealth is so useful, is because this notion actually serves to coordinate economic activity (investment, consumption smoothing, inventories, vender finance) that maximally use the available resources. This doesn't need to be true, it simply is as a result of the above. Hence the illusion that money as a store of credit (I say store of value, and this is where I think Rudolf's approach might prove confusing) creates economic activity comes into being. This is because money as a store of value serves a purpose unrelated to its moneyness. A purpose that has nothing to do with the character of money, but rather has to do with the needs of savers in a complex economy.

With very few exceptions, the FED realizes this, and hence conducts monetary policy with this mantra in mind. paraphrasing fed speak "Generally we dont care about the relative prices of store's of value, and we certainly dont care about the supply of "money" or store's of value outstanding. If the banking system wants to make new loans, we will in aggregate supply infinite overnight money at the interest rate we determine to be useful to achieving our goals. Most of the time the banks wont actually use us to get the actual money because they'll borrow it from each other or from other institutional savers, and the loans they previously made will show up as checking deposits (that is a liability to offset the asset of the loan) anyways. And basically all these banks will perform all sorts of lending price discovery around our offer of unlimited funds for short maturity at a fixed interest rate. they'll have duration curves, risk curves, liquidity curves. But regardless of what they lend to, they'll be taking risk over and above the risk free rate of one form or another. And because the populace generally trusts us to set what rate we'll all get for our massive demand to save short term, the financial markets are just the mechanism of spreading that demanded savings out over the demanded investment and consumption that society actually wants. Society wants to save short term, but borrow long term. But collectively all of us are equal to society, the banks just perform the very useful function we all want. otherwise the demanded savings would not be actualized and all of our income would go down to the point where a new equilibrium emerges.

But, sometimes, our ability to set overnight money is not sufficient to add a "store of value" confidence to other parts of the capital stock. but, hey, we get the joke and realize that even our overnight money isnt actually a store of value. So if by convention people want to believe that it is, why not just extend that imprimatur to other things. Like for example, what if we said that mortgage bonds would be exchangeable with no haircut for overnight money from now until maturity? well then we would build more houses, which is a source of income, and some of that income would in turn be saved in the sense that it would create a real store of value in the form of a long lived assets. maybe also if we finance credit card receivables, etc.. really cheaply then people will actually borrow some of the excess demanded savings and provide a source of income that actually allows that savings to be actualized (although this time not savings in the true sense because at a macro level it is just consumption trading).

Well all of the above is certainly better than all of us planning to save a great deal, but also planning to invest very little and consume very little, which means in aggregate, enough income will have to be destroyed in the form of firing or idling or etc…such that ultimately (after inventory effects wear off) our expenditure and investment is again equal to our income. for truly it cannot ever be different. and of course, the irony being in this case, that actual savings will have gone down in this latter case, which is universally true empirically."

And I as a fed observer say, they certainly understand the above better than this list appears to.

Stefan Jovanovich comments:

Rudolph: In offering legal tender as the definition of money, I was trying to avoid the circularity that is implicit in any discussions about money and credit that are rooted in the German historical school/Keynesian history tale - money as a medium of exchange, a store of value, etc. Leaving aside the fact that sovereignty and seignorage seem to be the actual origins of money, we know from our current experience that there are no practical differences between liquid credits and the ultimate pure M other than the fact that the U.S. Treasury Department will only accept certain Ms in payment and not others. At heart these discussions always end up being theological - how many monies can be counted on the heads of the Federal Reserve governors? — and they avoid the central issue– how can democracies and dictatorships avoid monetary debasements that punish the poor and the thrifty to the benefit of the rich and well-connected? 

Tyler McLellan replies:

Monetary debasement?

Why are we talking about this. We have had the longest, most long standing era of price stability ever in human history since we abandoned monetarism and the gold standard. we might have problems, but debasement is not one of them.

Stefan Jovanovich comments:

In 1880, according to Leslie Stephen, it was the mark of an intelligent economist that he or she did not think "aggregate savings equal(ed) aggregated demanded investment". Savings and investment had to be constantly jostling each other; otherwise, how could prices fluctuate? The classical view - which extends up to Frank Knight and Hayek - was that money was of primary importance because it was the unit in which prices were denominated; and that the risk to trade and invention and enterprise was that the government would corrupt pricing by tampering with money.

We now live in a parallel theoretical universe. The currently fashionable academic answer is, as Tyler just wrote, "that money is a residual", that it is what is left over after all time and goods preferences have settled out and the central bank has finished conducting "monetary policy". Tyler is being too modest. Under his theories even prices are a residual; the goal is not an honest count but to keep the wheel turning - i.e. have all the Ms change hands. Our present monetary system can be described in its simplest terms as (1) the U.S. Treasury auctions debt to the primary dealers who pay for their purchases by having their accounts debited at the Federal Reserve and (2) the U.S. Treasury collects "the money" by having its account at the Fed credited. It is - truly - a perfect merry-go-round. And that is the problem: there is no place where anyone can step off .

There is no reconciling these two views. I would note that "the law" clearly has a bias in favor of supporting the academic fashion. Under the present U.S. Code the mere act of holding cash is considered subversive. Anyone who accumulates a sizable stash of legal tender is subject to property forfeiture under provisions that place the burden of proving that the cash was not obtained by illegal means on the owner, not the government. 4th Amendment? What 4th Amendment? It is actually safer right now to hold specie than currency. You and your bank both have to tell the government every time you receive and they hand over $10K or more in cash; for bullion there are - currently - no such reporting requirements.

I would suggest that any theory that honestly believes that "people are forced to hold (money) to the extent the inconvenience of constantly changing money into goods is still less (than) the inconvenience of changing goods into other goods" needs at least a slight reality check. Those of us who make our living from CICO (cash in cash out) hold money because there is no one cutting us a check each month and we have the unavoidable uncertainty about how many customers will call us because they want our goods instead of someone else's. There is an old story about a peasant soldier who saw running water for the first time and was entranced. It was something he must bring back to his village. Imagine his shock and anger when he discovered that the faucet he had brought home and hammered into the tree outside his hut would not provide water when he opened the valve. Clearly, the solution was to get another faucet.

Charles Pennington provides a chart:

Here is a plot of CPI since 1914 on a semi-log scale and set to 100 in July 1983, with data from FRED. (I don't know why they picked the 7/1983 date to normalize it.)

There's a change in the slope starting around 1982, with the curve
becoming less steep (corresponding to a lower inflation rate).



 This image should match up well with the post that outlined all the money types.

Interesting how everything eventually falls back to gold, which is money (JP morgan said so) and which was outlined as the only form of money sanctioned by the constitution (specie).

And I understand that money = work done. So that money should hold the value of my work for some period of time–the longer that timeframe, the better the money in terms of purchasing power at the time of the trade of my labor for money.

The amounts of money that we talk of now–quadrillions anyone, is seemingly entropic and obscene. If the 1 trillion euro package wasn't enough, maybe the market was looking for 5 trillion to satisfy and upon hearing that number maybe that would have been the "no clothes" obscene moment when everyone would realize that debt has exceeded all expectations.

Lastly, interest can take the form of money or in goods or services as was illustrated in the book by Clausen. Loan to the camel trader secured by a ruby worth more than the loan in case of default. If loan returned on time loan is repaid with interest in coin or whatever agreed upon sum/item. Its interesting to think on these issues with base examples and then the very detailed and complicated ways that modern finance is composed. At somepoint though, every transaction has an end. Every transaction is paid back or defaulted. Every monetary vehicle either works or it doesn't. Money of any type, seashells to cents always has value (0 -?).

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