Short Answers to Hard Problems

"Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong." - H.L. Mencken

What will it take to get health spending under control?

Price transparency. First party payments. Data portability and interoperability. Eventually, computer assisted technicians.

What can be done to help the US middle class?

See above. YIMBY. More learning by doing.

Is there a low risk way to really help refugees?

Charter cities, not camps. 

How do we fix inequality?

Wrong way to frame this question. Stop the rent seekers. More experiments in educational signaling.

What will it take to create peace in the Middle East?

Alternative energy. Nuclear power. Drill baby drill.

How can we reverse the political bifurcation of society?

Destroy the walled gardens. Bet on beliefs. A common enemy.

How do we prevent AI from taking over the world?

We don't.

The GOP's Monetary Weakness

With the election over and Donald Trump's team taking control of the administration, one government agency that people on the right should be worried about is the Federal Reserve. This is an independent institution that is capable of destroying the GOP in the midterms, it can make the reelection of Donald Trump in 2020 very difficult. The irony is that many conservatives, even those who are supportive of both Trump and the GOP, are concerned about the Fed for the wrong reasons and would like to push the Federal Reserve towards policies that will result in electoral losses for Trump and the Republican Party.

Conservatives have historically preferred tighter monetary policy than liberals. Looser monetary policy, in the form of lower interest rates and higher credit creation, can look helpful in the short term while leading to harm in the longer run. The long run harm can be the capital misallocation predicted by Austrian business cycle theory and other theories. It could be the higher probability, however miniscule, that the central bank will eventually be used to monetize debt and spur hyperinflation. Or might just be the simple risk of inflation expectations among the public suddenly becoming unanchored, leading to a return of 1970's style stagflation.

Worries about too loose monetary policies are often well founded, particularly when inflation is getting out of control. But our current environment is one in which inflation has remained subdued for many years. The Personal Consumption Index Price Index remains well below the Fed's target of 2%.

The 5 Year, 5 Year Forward Inflation Expectation Rate is hovering around 2%. The CPI has recently been slightly higher than the PCE price index, so the market is still forecasting that inflation will be below the Federal Reserve's target. 

The Federal Reserve has recently started to act more boldly in hiking rates to normalize monetary policy. It is worrisome that they are acting on forecasts that have been consistently wrong in the same direction. Looking at their end of the year December projections for GDP growth, they have had to continually revise down their growth estimates throughout this cycle. 

They are acting before there is any real inflation and without strong evidence that this time their forecasts of renewed growth and inflation are correct after being wrong for so long. 

The Federal Reserve is tightening policy more than other countries around the world, which has led to a very strong dollar. The US trade weighted dollar index is the strongest it's been in 10 years. 

Many economists are already concerned that programs which encourage exports while discouraging imports will strengthen the dollar and counter some of their potential impact. When we combine that with an aggressive Federal Reserve, the impact of positive steps taken to boost exports can be significantly countered by a strengthening currency.

And tight monetary policy doesn't just strengthen the dollar, it can hasten a cyclical downturn that turns people against the party in control of government. In the early 90's, George H.W. Bush lost for many reasons. But he would not have been vulnerable if the Federal Reserve wasn't hiking rates into his re-election campaign. Perhaps more significant was what was happened in Argentina, where market friendly economic reforms of the 90's were reversed after conservatives drove their country into a depression caused by the Peso's peg to a strengthening dollar through the late 90's and early 00's. They could have unpegged the peso at any time, but they were too busy fighting the last battle against hyperinflation to implement a more reasonable monetary policy.

Trump has mentioned previously that he wants to get rid of the low interest rate environment. If he appoints nominees who are too quick to move in that direction, raising rates before growth and inflation warrant action, it could counteract any economic growth generated by his supply side reforms in the short and medium run. And if that causes electoral losses, the reforms themselves could be reversed and no long run benefit will exist either. As Scott Sumner has said, monetary policy is the Achilles heel of the right.

The Irony of Hanukah

This week we celebrate Hanukah, the miracle of the one-day supply of oil lasting eight nights. It also commemorates the rededication of the Second Temple. It is a wonderful holiday that provides Jewish children with a winter holiday full of presents, rituals, songs, comfort food, games and family time. It is a holiday that is more fully embraced by Reform Jews who want to provide their children with a Christmas-like holiday than by the more observant Jews. Orthodox Jews still see observing the celebration as an important mitzvah, but Hanukah is not among the most important holidays. Rosh Hashanah, Yom Kippur, Passover and even observing the Sabbath are all more significant. 

The miracle of the oil and the rededication of the Second temple came about thanks to the Maccabees. In Hebrew school, I was taught that the Maccabees were the guerilla warriors who fought against the Seleucid empire. It is easy and fun to root for the ingroup against the outgroup. But it wasn't just a war against the Seleucid empire.

The other group that Maccabees fought against were the Jews who were adopting Hellenistic Judaism. According to I, Maccabees, Mattathias, the leader of the Maccabees, started the rebellion by killing a Hellenistic Jew. Hellenistic Jews were the Jews who tried to adopt the local customs. The Maccabees who opposed them wanted to keep the congregation strictly separate from all foreign peoples.

It is somewhat amusing that one of the most popular holiday of Reform Jews is one which celebrates the results of a civil war in which a historical parallel to Orthodox Jews slaughtered the historical parallel to Reform Jews. 

Happy Hanukah!

Trump and the Trade Deficit

When Trump or his supporters mention the trade deficit as a problem, they are treated as ignoramuses. It is assumed that they don’t understand that there are gains from trade and that the idea that countries producing goods or service in which they have a comparative advantage making everyone better off is too complicated for them to understand.

But people complaining about the trade deficit have obviously heard this argument many times before. To harp on this basic point as if they don’t understand it is extremely counterproductive. Some of their favored policies to fix the problems may have too many unintended consequences but they are right to point at our trade deficit as a symptom of significant problems.

In 2015, the current account balance, which includes the balance of trade, net income and cash transfers, was -2.7% of GDP. We are not very close to potential crisis levels. So why are people who understand gains from trade still so worried about trade deficits?

For one, comparative advantages are not stable ratios in the long run. When those who worry about trade deficits look at manufacturing going overseas, they don’t just see a company taking advantage of low priced labor. They see technical knowhow being given to future competitors. The Chinese factory next week is going to lower prices for US consumers and expand profit margins of a US company at the expense of a few workers in the US. A few years later, the foreman leaves and sets up a competitor and starts undercutting the US company’s prices when they sell to the rest of the world. What used to be a comparative advantage for the US vis-à-vis the rest of the world is now one for China.

From a global perspective, everyone is still better off. Chinese workers are rising from poverty and European consumers get even cheaper goods than when they were buying them from the United States. But from a nationalist perspective, America loses. Reducing certain types of technology transfer is not a crazy goal, it’s what needs to be done at some level to keep the United States richer than the rest of the world. There are good and bad ways to reduce the transfer of technology. The best policies to police technology transfer are very complicated as companies have global supply chains and many types of technological expertise are not going to be easy to attain or reattain. And perhaps more difficult for politicians to navigate, there are always rent seeking corporations who would like to charge domestic consumers higher prices in the name of protecting American competitiveness.  

Even many of those in the anti-Trump camp understand the need to prevent technology transfer intuitively when it is framed differently. Many are still lobbying for ways to remove immigration barriers for talented students trained by our world class colleges. Sending those college graduates back to their country of origin transfers technology the same way that moving production overseas does. What’s obvious is that protecting our technological edge is a policy that can make Americans better off when applied properly.

Another aspect of the trade deficit is that it indicates that America is not as efficient as we would like. If companies were less restrained by regulatory hurdles, it’s very possible that the United States would be the low-cost leader in far more categories and exporting far more goods and services than it does now. If the EPA was less stringent it’s obvious that we would be importing fewer commodities because we’d be producing more. And if it happens that whole industries are being threatened in the United States, looking to streamline the regulatory and compliance costs could solve the issue more effectively than implementing tariffs against the new low cost competitors. There are real political tradeoffs when it comes to policies that create our trade deficit, the policy disagreements aren’t about whether there are gains from trade.

Trade deficits aren’t just about production; they are also about consumption. Increasing debt levels, both personal and governmental, allow for consumption in excess of production. US citizens are living better now, but it’s at the expense of a run up in debt and potentially their future quality of life. If economic growth is healthy then kicking the can down the road makes sense, let those richer people of the future deal with the problem. But that’s a big if for many people living in communities who are not finding the same opportunities as their parents in the global market thanks to consistent technology transfers abroad and the increasing cost of doing business in the United States.

Many economists will point out that the United States is a safe haven where people around the world park their money, and that’s a good thing that helps create our trade deficit and current account deficit. But just look at Switzerland, also a widely acknowledged safe haven. They have a trade surplus and current account surplus of around 10% of GDP. It’s nice that everyone wants to invest in the United States, but it would be better if US citizens had even more wealth to invest in the rest of the world.

The trade deficit is a symptom of many underlying problems. There is basically no way that a blanket policy of tariffs to brute force the deficit into a surplus will make things better. But if many of the inefficiencies and problems of the United States economy were fixed the deficit would go away. The trade deficit is representative of real problems and there are things that politicians should be doing to address them. 

I Voted

For most of my life, I've been pretty skeptical of democracy. My basic perspective was if three wolf and a sheep are voting on dinner, should the sheep legitimize their decision to eat him by voting for grass? In this analogy, the sheep would be the productive part of society while the wolves are the rent seekers, big and small. 

The sheep analogy is flawed, because there are not just three wolves and one sheep. There are lots of sheep and lots of wolves. Who is a sheep and who is a wolf can change depending on the issue. While in many cases the sheep are vastly outnumbered it can still be close in other cases. If a sheep wants to have a chance of influencing other sheep and sympathetic wolves to oppose the wolves then they would be well served to have their actions and their words in alignment. The message "Don't vote for the wolves, and in fact it's so broken I'm not even going to vote" is not credible.

And if there is a group of wolves, and those wolves are beatable if the other sheep just recognize the wolves for what they are, then it makes even less sense to mix messages. Right now the group of newly exposed wolves is the rent seeking homeowners. People who own homes that vote to keep the supply of new homes restricted drive up prices of their homes at the expense of anyone looking to rent or buy a house. Anti-construction policies have driven real estate prices in the San Francisco Bay Area up to absurd enough heights that many people are starting to notice. And while the times that a couple of votes can swing a national election are few and far between, there are plenty of opportunities for small groups of voters to swing local elections.

So I voted. I looked at which politicians were pro-growth and gave them my support. I looked at which rent seeking organizations supported or opposed propositions and voted directly against their interests (Unfortunately, sometimes there are rent seekers on both sides).

While the act of voting individually might not be economically rational, there are things that make it slightly less costly. Earlier this year I filed some paperwork with the state government. The justice system figured out where I lived and put me on the list for jury duty, so the downside to registering and voting became really marginal.

Most people would end this post telling the reader to vote. I would like to make the more modest suggestion that if you are already being called for jury duty and like discussing politics, there is little downside to registering to vote before the next election.

Feigned Weakness and Politics

The concept of faking a weakness is an age old strategy. Feigned retreats have been utilized by armies since ancient times. I'm partial to Dan Carlin's description the Mongol use of this tactic. For those who have not yet listened to his excellent telling, the mongols would pretend disarray and retreat and run. Most of the killing in ancient warfare occurred during the retreat, so the Mongols would be chased in a less than fully organized fashion. Once the enemy lines were stretched out in pursuit the Mongols would turn on the pursuing army and deal them a devastating blow.

A similar stratagem is used in modern politics. Every candidate in this day and age has strengths and weaknesses. But the public does not have a large enough attention span to cover multiple topics. The best line of attack is to find a flaw in the candidate that is representative of their many problems and push hard when it appears they are weak. 

Sometimes the weakness is not real. In 2008, some people thought that the allegation that Obama was not born in this country could be that type of attack. This attack was never going to work. Obama might have been ruled a natural born citizen of the United States no matter where he was actually born as his mother was from Wichita, Kansas. Furthermore, the long and short form birth certificates proving that he was born on US soil definitely existed. But rather than fully confront this attack when it first appeared to be growing he feigned retreat. The allegations were called racist and insulting and not worthy of response. 

In fact, the allegations being labeled as racist and insulting created a good incentive for him and his team to not respond immediately. Not responding in Obama's birther case served many purposes. First, it was a refusal to give any respect to a group of crazy people attacking him. Second, it made many of his opponents look bad. Demanding the birth certificate of the first non-full caucasian president appeared quite racist. But more importantly, it filtered some of the most enthusiastic attackers of Obama into focusing on an issue that he knew would not get out of control. At a time when his advisors with Wall Street connections might have been vulnerable to attack or the handling of the stimulus might be critiqued the birther movement's existence encouraged many of his critics to instead focus on running directly into a brick wall. 

Over time, the refusal to fully parry the birther movement created its own suspicion and attracted additional curiosity. The White House was forced to release his longform birth certificate to end it. But between 2008 and April 2011, a lot of his critics were charging at windmills rather than challenging him on policy.

Hillary Clinton's Wall Street speeches could be seen as a similar feigned weakness. When she was fending off Bernie Sanders from the left, the transcripts were a real weakness. But once she was past the primaries and moving towards the center for the general the speeches were no longer a large negative. Their release might impact enthusiasm among younger Bernie supporters, but that's about it. But by refusing to release them she created a feigned weakness for Trump and others to attack her. Considering her long history of controversy, any efforts here only served to reduce time spent on issues where she is potentially vulnerable.

In Clinton's case, Wikileaks released these speech notes sooner than she would have liked. It was unfortunate for her team not because the releases exposed anything too nefarious (though supporters on the left might be upset to learn that she is an anti-pot candidate), but because the emails were a feigned weakness that could soak up a significant percentage of attacks.

So the next time you see a politician refusing to counter an attack that seems easily parried if they are innocent, consider the tactical implications. Perhaps they want more of their critics charging at windmills. 

Or maybe they really are hiding something. They're politicians, after all.

The Falling Stock Holding Period Myth

One common financial fallacy is for people to divide the stocks outstanding by their volume and call that the average holding time. This makes today's average holding period of a stock seem very small, and the resulting chart can be used by those who want to paint today’s stock market as more short term than ever. 

The below tweet is not an atypical example of this phenomena. 

When I found the source of this chart, a newsletter by Alan Newman, the argument that it was buttressing was not surprising. 

“Thus, we are making the case that every year from 1997 may fairly be presumed manic in nature.”

Except that these charts are absolutely the wrong way to look at things. The rise of high frequency trading and the decrease in trading costs thanks to electronic trading has meant that market makers are trading a lot more than they have in the past. Thanks to the improvement in technology, transaction costs for investors have fallen across the board. Measured stock market volatility has also gone down, though there are likely tail risks associated with this volatility decrease such that the worrywarts are not completely wrong. But either way, the rise of high frequency trading says nothing about the changing time preference of today’s investors.

So how should we measure the time horizon of today’s investors? One way is to look at the median holding period of non-market making investors. It turns out that someone has already done this work, it just doesn’t get as much airtime as the average holding period because the data doesn’t tell a crazy story about investors. Martijn Cremers and Ankur Pareek have saved us a lot of trouble, because in 2014 they published a paper introducing the concept of Stock Duration. 

Stock Duration is a measure of how long institutional investors, who have to report their quarterly holdings to the SEC, have held a stock. The paper focuses more on quantitative investment strategy, but they included a measure of Stock Duration over time at the end.

 Source: Martijn Cremers and Ankur Pareek, Short-Term Trading and Stock Return Anomalies: Momentum, Reversal, and Share Issuance April 17, 2014. Figure 1, Panel A.

Their sample looked at the median duration of the largest 1300 stocks most commonly held by institutional investors. And the median stock duration increased during the period when high frequency traders started drastically increasing trading volume.

In another duration focused paper, they analyzed how duration and other factors drove the returns of US mutual funds with over $10 million AUM. In order to accomplish this, they calculated a Fund Duration metric. Fund Duration measures the average holding period of each stock in a fund and requires that a fund have at least two years of history. The aggregate of this metric again counters the narrative that investors are becoming more short term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

When we look directly at mutual funds, they are if anything becoming more long term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

It’s possible that mutual funds are now furiously trading in and out of their stocks between SEC quarterly reporting periods, but the relatively stable fund turnover ratio suggests otherwise. So while investors will always do many stupid short sighted things and many still have incentives driving them towards short term oriented thinking, the somewhat widespread idea that more investors than ever are thinking short term is probably not correct. 

When Contrarianism Works

I recently came across a paper by Cremers, Pareek and Sautner on Stock Duration, Analyst Recommendations, and Overvaluation.  In this paper they look at how stock duration, the holding period of institutional investors, interacts with analyst recommendations.

One of many interesting findings was a twist on the classic finding of stock underperformance or outperformance driving the analyst rating, rather than vice versa:

But interestingly enough, when stock analysts are late to the party of a stock with long term holders, the stocks still tend to do well.

However, when fast money is holding the stock then an analyst's extreme buy recommendation has on average marked the peak of the stock’s outperformance. The return of fading these optimistic short term investors were found to be larger if positions are not entered for at least 3 months after the signal.

On the downside, extremely bearish analysts are often too pessimistic, but the effect is larger when there is a lot of fast money involved. 

So while investors have many reasons to value contrarianism, it’s important to note that fighting against long term bulls does not necessarily result in a favorable outcome. It’s better to be bullish in the face of pessimists. But if you must be bearish make sure that the people on the other side of the trade are the types who are trying to make a quick buck.

Jury Nullification and Camera Credibility

I almost had jury duty this week. I called in the day before and I was told my pool wasn't yet needed. I called in again and eleven in the morning and found out that I was excused from jury duty. This was convenient, but also a little disappointing. I've never had jury duty before and I was hoping that I'd either see what it takes to get out of jury duty or get on a jury and be able to apply jury nullification. 

For those who don't know, jury nullification is the simple concept that if you are sitting on a jury and think that someone might be punished by a stupid law that you don't have to find them guilty. It can also mitigate harm to people who broke the law for a good reason. Maybe Jack Bauer shouldn't be guilty of torture if he stopped that nuclear weapon from detonating. Maybe the man who plots the murder of his daughter's killer should be found guilty of a lesser charge than first degree murder. Or perhaps that patent troll isn't entitled to millions of dollars from a popular company because the patent office screwed up and granted someone an obvious patent*.  In these cases the jurors don't have to tell the judge why they are deciding as they do (infact they probably shouldn't if they don't want a mistrial declared), they just have to find the defendant innocent of the relevant charges. 

There are downsides to jury nullification. Jurors can prevent the implementation of just laws through the same mechanism that jurors use to prevent unjust laws. One negative example is how jury nullification can perpetuate institutionalized bigotry. A jury of racist white people might not convict someone obviously guilty of murdering a minority or vice versa. But as long as the jury system is used according to the US Constitution each juror has the option to apply the principles of jury nullification. It's better if it is applied deliberately by principled citizens. Because in the right hands, jury nullification is one of the final vetoes that citizens have on the actions of an out of control or overly rigid government. 

Recent protests against police behavior have added another way for jurors to make a dent in bad governance. Historically, juries have often trusted police testimony more than that of accused criminals. Giving officers of the law the benefit of the doubt has been historically necessary to allow them to do their jobs.

But today's environment has a very important difference. Body cameras are cheap, ubiquitous and are becoming more widely available to police officers. More importantly, police officers have significant control over when their cameras are turned on or off. So body cameras were somehow not turned on when police officers raided the wrong house and shot a dog. When the Baton Rouge police shot and killed a DVD seller, their body cameras supposedly accidentally fell off. If police officers are acting properly, they should want the cameras on. If police officers would be harmed by what is shown on the camera, then they have an incentive to prevent the emergence of any body camera footage. 

Jurors everywhere need to push back against these incentives and create new ones. Jurors should assume that a police officer's testimony of events that occurred while they were in the field is worthless if their body camera footage is not also available. I'll call this "Camera Credibility" for lack of a better term and because alliteration is fun.

If enough people view cop testimony under the lens of camera credibility then there will be no way prosecutors to keep people with these beliefs off of juries. Police officers will be incentivized to make sure their cameras are operational and will be more likely to release footage that shows shades of grey in order to preserve their overall credibility.

While the proposed policy is implemented by jurors not trusting police officer testimony under certain conditions, this isn't an anti-cop idea. Body cameras are a way for cops to maximize their credibility and protect themselves against false accusations. The word of a police officer backed up by body camera footage will be held with the highest respect. The proposed camera credibility juror strategy would only really impact the small percentage of officers who need to be reigned in as other cops will have a good reason to make sure their unadulterated footage makes it to the courtroom.

Jury nullification applies everywhere that citizens serve on juries, though a juror discussing this idea openly in California will result in the judge removing them from the jury pool. Before jurors are selected, they are questioned in a process known as voir dire. Those who want to actively apply jury nullification need to somehow get through this process and onto a jury while those who want to get out jury duty can enthusiastically discuss their beliefs on the benefits of jury nullification. Either way, it's a good thing to remember.



*Commercial law decisions by juries who disagree with the law have a greater chance of being reversed in a process commonly known as Judgement Notwithstanding the Verdict

Third Parties should think about selling out

If this election season has taught those watching US national elections one thing, it's that it would be nice to have another option. But in a country with a voting system where the candidate with a plurality takes all, the equilibrium number of parties is two.

Just because that number is the equilibrium doesn't mean that this is always the case. And 2016 certainly looks like a year where the political institutions are not in equilibrium. With the population becoming more politically polarized, appealing to both centrists* and fringe elements is getting harder than ever. But the incumbent two parties have economies of scale, ballot access laws and established network effects which provide them with a significant advantage against challengers.

Their biggest advantage of Democrat and Republican party officials is that the challenging parties don't understand the game they are playing. Most people interested in third parties believe the lie that their parties are all about their ideology. 

Politics are as much about ideology as corporations are about making customers happy. It can be important, but there are other variables that matter much more. An ideologically consistent third party is not playing to win. They are playing to convince the major parties that they need to change their policies on the margin to convince people not to cast a protest vote for the third party. 

Third parties are pretty serious about maintaining their ideological consistency. The Green Party has repeatedly fractured in an attempt to remain true to its values. The Libertarian Party is famous for its attempt to excommunicate its members for impurity or extremism even though its members generally agree on the direction that politics should be moving.

In order to play to win a third party would need to start thinking like a major party. They will have to make compromises to bring people that they only partially agree with into their tent. They will need to make compromises with some types of interest groups even as they take the fight to others. They will have to acknowledge the political reality that it takes more than a promised pure application of their favored ideology to sustainably win elections.

This year the Libertarian Party took baby steps towards this view when they nominated Bill Weld as the vice presidential candidate against the desires of some libertarian purists.

In order to stand a chance this election or going forward they are going to have to take stances that are more libertarian than the status quo, but more status quo than what libertarians generally prefer. Most parents will not vote for a group who wants the blanket legalization of an 18 year old's ability to purchase of crack, meth or heroin, but replacing prison with treatment isn't as scary. Baby steps in the right direction should be preferable to giant leaps never taken. And this type of stance will have to be sustained over multiple election cycles without splintering the Libertarian Party.

No third party stands a chance at long term relevance as long as they keep thinking and acting like a third party who just wants some attention for their ideology from the major parties. This is why any potential replacement to the GOP or the Democratic Party is more likely to come from splinter groups within the party than from third parties built around ideological purity. And considering the value of the party's institutions, network and brand, major changes are still more likely to come from a new group achieving internal control of the party than from one of the parties being replaced.

Take the above with a grain of salt. In this political season I should know better than to make an predictions at all about politics. I should probably just directly predict egg on my face. But the main takeaway here is that the people who put ideology first aren't playing the game to win and few people are incentivized to tell them this. 



*It would be nice to come up with a term that differentiates those with views that aren't clearly left or right from the business interests who support whoever can ensure the continuation of their favored specific rent seeking policies. Both of these groups are called centrist but I hold on to an irrational hope that they might one day be separate.