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Thoughts from the Frontline

Three Men Make a Tiger

November 5, 2012

Choose your language

I am just a poor boy.
Though my story's seldom told,
I have squandered my resistance
For a pocketful of mumbles,
Such are promises
All lies and jest
Still, a man hears what he wants to hear
And disregards the rest.

     – From “The Boxer,” by Paul Simon

In a few hours we will know the outcome of the US elections (hopefully without a repeat of 2000!). So, given that eventuality, why should we bother to explore the rather significant disparity in the models being used to create the polls to predict the outcome of the elections? Because doing so will help us understand why the models we use to predict the effects on our investments of market behavior and macroeconomics so often fail us, and why we should approach the use of such models with a full measure of wariness and skepticism. Yet, at the same time, we should understand when the models may actually be useful, and how to use them.

We all like to think of ourselves as completely rational human beings, ruled by logic and reasonable analysis; but sadly we are not hard-wired for logic. We bring all sorts of biases to our decisions, and even the very way in which we process information in our human brains creates its own set of biases. We are hard-wired to see what we expect to see, and so we not only fail to see the forest for the trees but are equally prone to miss the trees while gazing at the forest. We all too often see what we think we should see (which is one of the reasons it is so hard to edit your own writing!).

So, this week, let’s continue our examination of the problems with models, but this time through the lens of political polls.

The Post-Election Summit

Speaking of elections, nearly everyone believes that this election will have a major impact on the economy and our investments. And it’s not just about who will be president but also what the US Senate will look like. To address these questions, I am organizing (with a lot of help) a free internet “summit” called “The Post-Election Economy: A Clear-Eyed Analysis of the Risks and Opportunities for Investors.” My…

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Nov. 10, 2012, 6:41 p.m.

I agree with Mr. Gave’s thinking and since I am not a trained economist, it appeals to my common sense. Along with the recent article by Mr. Grice, the effects of the fiscal policy of the Federal Reserve regarding the dollar are the actual cause of much that is happening around us in our society every day.  How can it be stopped, what can be done, and who will do it?  Roger Pazul,  Sun Lakes, AZ

Jeff Little

Nov. 8, 2012, 7:42 p.m.

I agree with the comments on odds-making and Goodings comment on employer pay.

However you have to keep things in context.  If a rich person believes taxes are too low and pays extra, the biggest impact is that they will become less relevant in the next business cycle.  If he pushes rules through a higher tax bracket, then he can have the economic effects of higher taxes without falling behind the Jones’s.

One of the least well understood concepts in economics is tragedy of the commons.  People are aware of the obvious impact of wealth inequality, which is when the rich get more the poor get less, but they miss the obvious secondary consideration.  If you have a commons grass area and the cows of the rich graze it to nothing, then who really bears the brunt of the loss?  People with cows, of course!

Similarly, by at least one measurement, the rich would lose the most by plunging the country into Great Depression II.  To misquote Bob Dylan, “When you got everything you got everything to lose!”  This doesn’t hold true if you measure using the misery index, but it is true enough that rich people would be well advised to follow the “The early loss is usually the smallest” rule if they should be confronted with evidence that there is truly a tragedy of the commons situation with respect to the economy.

Of course this seems to be one of those areas where what you believe depends mostly on which economists you listen too, and I believe, but can’t prove, that much of this effect is the tail wagging the dog effect where economists who are useful gain favor over those that are merely accurate.  Certainly the confirmation bias that John mentions is a big factor in expanding consensus after you have achieved it (in whatever your peer group happens to be…).

But I think there is a tragedy of the commons problem and I think that there is extremely solid, objective evidence to that point.  The first thing to point out to that vein is not only is our political systems a commons, meaning that lobbying access to our rules can eventually accumulate the effect that we have no more ability to fix broken rules or change government when it reaches excessive extremes, but our consumer market is also a commons in that if we push consumption up to high while pushing wages that pay for that consumption too low, then we might end up with a situation in which we fatally injure our middle class ability to consume as we almost did in 1929-1932. 

More directly, we have each individual capitalist benefiting most by having a large separation between the revenues they take in and the wages they pay out, whereas each capitalist will benefit most when the revenues that all capitalists take in minus revenues that all capitalists pay out is as small as possible, to ensure that there are dollars free to grow with assets and to participate in the next round of consumption.  This is a classic tragedy of the commons situation in that a well-managed middle class that is protected from overgrazing will be the source of a strong economy for years to come, but that first has to come with fences and rules. 

Of course in addition to having a market for their products, the rich also get a second benefit from having a strong middle class.  It is a well known oddity in software that the more expensive a software product is, the more bugs it has.  The reason is each line of code is exercised by far more users in cheap software, so each developer writing high-end code would have to be far more skilled and have a far higher testing budget in order to just reach the same level of reliability.  Since more expensive in software usually means that it’s a niche product with fewer customers, it is extremely hard to reach the same standard.  Similarly, if the middle class went away, then each rich person would represent a far higher percentage of the total use of each product, regardless of the price they can pay, and therefore each will find a far greater number of bugs.  It is even worse than that because as you decrease the target market size, even if you ratchet up the cost to compensate, each model is a far bigger jump to the next model, meaning that supplier risk is far higher.  A lot of products that would be made for a middle class simply would not be made at all if the middle class went away.

All of this leads to what could be an astonishing conclusion if you haven’t been paying attention so far.  Rather than the principle economic battle between the bottom 99% who want to participate fairly in utilizing the value they create vs the 1% who want to retain the largest consumption capability for themselves, even if they don’t really use it, the actual economic battle is an alliance between those in the 99% who act in their own interest and those in the 1% who act in their own *long term* interest against those members of both groups that act with thoughtless selfishness.

Education is not *a* tool for fixing this; it is *the* tool to put together a strong working group for building a better society.

Lucas Fairborn 48391

Nov. 8, 2012, 8:28 a.m.

Mr. Mauldin’s pre-election survey was very surprising.  He dismisses Nate Silver’s rigorous analysis of poll data and ignores the market exchanges that allow for betting on results.  Instead, he bases his election conclusion on flimsy evidence such on where Romney was spending money advertising.  I expect better Mr. Mauldin!

Pavel Lacko

Nov. 5, 2012, 8:45 a.m.

I agree with Michael Green. Bookmakers and/or betting exchanges have better forecasting abilities than opinion polls and there have been studies showing just that. When real money is on stake, people sharpen their ears and intellect. As I write, on the eve of the election, on Betfair you get 1.29 on Obama and 4.30 on Romney (sorry I’m from a decimal odds country). It translates to 77% chance for Obama and 23% for Romney to win.

Michael Green 25963

Nov. 5, 2012, 5:57 a.m.

If you really think Romney will win, your friends in London can get bookmaker odds of 18/5 today.  Could be your first and best post-election investment.  On the other hand, I always look at the bookmakers if I want to know what will happen rather than what I would like to happen.  Nate Silver and the bookmakers seem to have consistently been fairly close.  Other meta-analyses have been very different.
Interestingly appears to be part owned by News International via Sky BSB.  So that while Fox News says one thing, Oddschecker says that is not where the money is going.

Richard Gooding

Nov. 5, 2012, 3:56 a.m.

A few thoughts I have been having about the economic mess the US is in. First, if entrepreneurs create jobs, who creates wealth? The people they employee create the wealth. The difference between what the entrepreneur pays their workers for what the work do is where profits come from. Second, the whole debate on how to revitalize the economy is grounded tax policy—tax cuts lead to job creation vs.  tax increases can create government jobs or transfer payments. Why is no one talking about how to increase consumer demand? Create more disposable income? How do we get people to buy more stuff without going into debt? Forget tax policy, if every employer gave every employee a 10% pay increase the economy would start moving. That is what Henry Ford did to get people to buy his cars. In my opinion, the whole reason we are in this mess is entrepreneurs are sucking up all the wealth generated by their employees. Now we are to a point where their employees do not have any money to spend and many of them went into debt spending money they did not have. The rich have gotten wealthier at the expense of those that create the wealth. They are killing the golden goose. An alternative to increased taxes would be for every business to give their employees a pay increase. Would you rather have a 10% tax increase imposed on you by the Federal government (with questionable benefit) or give your employees a 10% pay increase which will go directly into the economy (plus many other benefits)? We need to create more consumer demand which means consumers need more money to spend.