Friday, August 15, 2014

Quote of the Day

"Central bankers have had enormous responsibilities thrust on them to compensate, essentially, for the failings of the political system. And my worry is we don’t have sufficient tools to do that, but we’re not willing to say it. And, as a result, we push as hard as we can on the existing tools, and they may create more risk in the system."

-- Raghuram Rajan, Governor of the Reserve Bank of India. In other words, he runs India's central bank. The quote is from this interview with him in the FT today (registration may be required). He used to be an economist at the University of Chicago's business school, and is former chief economist of the IMF.

Rajan is famous for a prescient 2005 paper, "Has Financial Development Made the World Riskier?" Larry Summers famously derided him when Rajan presented the paper at the 2005 Jackson Hole conference, but Rajan got the last laugh. (I love stories in which nice guys finish first.)

Friday, July 25, 2014

How to Reduce the Volatility of Your Stock Portfolio, in Five Words

It's easy: don't look at the prices.

I was reading a piece about investing in farmland. The measured volatility of returns on land investments is very low compared to stocks, because you only get prices for land when you appraise it. And you don't do that very often.

Hence, my idea, which is surely worthy of a Nobel Prize, or at least a MacArthur Foundation genius grant, on how to reduce stock market volatility.

Of course, you can afford not to look only if you have not taken out a margin loan. (And that is one more reason not to take out a margin loan.)

I'm not going to hold my breath waiting for the call from Sweden.

Thursday, July 24, 2014

Shadow Banking, Defined

Matt Levine gives a useful definition of "shadow banking" in a recent Bloomberg column:
Roughly speaking, "shadow banking" refers to the parts of the world that are regulated according to the capital markets view -- lots of disclosure regulation, much less capital-and-risk regulation -- but treated by their investors more according to the banking view, where the customers try not to think too hard about the risks. You can see why this would be scary: If regulators aren't worrying about the risks (it's not a bank!), and investors aren't worrying about the risks (ehhhh it's a bank!), then ... no one is worrying about the risks? That seems bad.
Levine's column is on money market funds.

Shades of Donald Rumseld, known knowns, and unknown unknowns. It's o.k. to have a financial product that is regulated. It is also o.k. to have one that is unregulated, and known to be unregulated. But beware the product that is unregulated, but thought by investors to be regulated. That is the problem with retail money market funds.

Money market fund share prices should float, even for individual investors. Stable values should be the province of regulated banks, not mutual funds.

Thursday, June 5, 2014

Recommended Reading

Andrew Smithers is blogging some very good material on stock market valuation at the website of the Financial Times.

(There is no charge to read the Smithers FT blog, but you do have to register. It is well worth it.)

Sunday, April 13, 2014

Must-See TV: "Silicon Valley"

The first episode of Mike Judge's new show, "Silicon Valley," is freely available on YouTube. Really sharp satire. This may be the funniest thing I have seen since "Curb Your Enthusiasm."

Thursday, April 3, 2014

Son of "Why Money has Value"

Last month I posted on why paper money, like the U.S. dollar, has value.

The basic idea is that even though our fiat currency is not backed by gold or silver, we need it to stay out of prison. If we earn anything, we owe taxes, and taxes have to be paid in dollars. So, dollars are a "get-out-of-jail-free" card, as in the game of Monopoly.

I have written an expanded version of this piece for the PBS NewsHour, at Paul Solman's Making Sen$e page. They have just published it today. It goes into a bit more depth.

Friday, March 14, 2014

Why Money has Value

Here's a question I can answer for you: why does a paper-backed currency, like the U.S. dollar, have value?

Because it's a get-out-of-jail-free card. Kind of like in Monopoly.


The U.S. dollar is not backed by gold or silver, but you can use it to keep from getting jailed for failure to pay federal taxes.

It has value is because our courts say it does. And what good is the opinion of a court, which is, after all, just words on paper? Well, if you are condemned to years in jail by a court decision, you will, in fact, spend years in jail. So, yes, court opinions are words on paper, but they mean a lot more than greeting cards.

In the U.S., your income is taxed, and you need to pay the tax in dollars. Even if you earned your income through barter. For example, if you started the year with an old baseball worth $1.00 and, through clever trading, ended the year with a speedboat worth $25,000, you would need to pay income tax, in dollars, on the gain you enjoyed, $24,999. You would need to barter your boat for some dollars in order to pay it.

This is what distinguishes the U.S. dollar from Bitcoin. No one needs bitcoins. They are elegant and, in their way, beautiful, like a work of art. But you do not need them for anything. But Americans need dollars, if they want to stay out of jail. (Yes, I know, we need beauty to be happy. True, but not important here.)

This way of thinking about fiat currency is not a new argument. I do not remember where I encountered it first. It does not get as much "circulation" as it should.

UPDATE 3/14/14: Modern Monetary Theory emphasizes the role of tax obligations in the value of a fiat currency.