The Weather-Predicting Donkey

by Dave Schuler on February 4, 2013

Back when I was a kid there was a novelty item you’d occasionally see at fairs or in souvenir stores—a “weather-predicting donkey”. Just a crude cut-out of a donkey, maybe a little paint for expression, and a piece of string attached to the hindquarters as a tail. The thing would be captioned:

Donkey’s tail dry: Sunny
Donkey’s tail wet: Rain
Donkey’s tail frozen: Cold
Donkey’s tail blows off: Tornado

I do not believe that the statistics produced by, for example, the Bureau of Labor Statistics are quite that crude. I do think, however, that there is an exaggerated sense of how precise the figures that they’re producing are. They might be accurate to the hundred thousand. Or maybe just within that order of magnitude.

There’s still no substitute for street smarts. If you know a lot of people who are unemployed or underemployed, there probably aren’t enough jobs in your neck of the woods whatever the aggregate statistics might say. If there are a lot of “For Sale” signs on your block, it’s a fair indicator of a weak housing market, at least where you live.

I no longer believe that the Dow-Jones Industrial Average measures anything in the real economy. I honestly don’t know what it measures any more.

{ 12 comments… read them below or add one }

jan February 4, 2013 at 1:51 pm

I no longer believe that the Dow-Jones Industrial Average measures anything in the real economy. I honestly don’t know what it measures any more.

But, the DOW has become the cheerful face of the economy for backers of the president. Whenever anyone talks of the ‘dismal’ state of affairs, the retort is, “Yeah, right. Just look at the DOW!”

That RCP srticle posted below, explaining the ‘real’ DOW was an eye-opener for me, as I had not heard of that calculation before.

Drew February 4, 2013 at 2:15 pm

“I no longer believe that the Dow-Jones Industrial Average measures anything in the real economy. I honestly don’t know what it measures any more.”

But I think you do. It is today, and has always been, the discounted cash flow of the components of whatever index you are considering. The numerator of course is the proxy for the economy, corporate earnings. That might be directional, but not precise.

Most of the action is in the denominator. Academics call it a “risk discounting or adjustment” rate. But it would better be described as “what will you pay for a dollar of earnings?”

Why do I say that? When irrational exuberance occurs to be sure corporate earnings may be viewed as too rosy, but its really the risk associated with them that is not properly accounted for. In addition, as I have been pointing out repeatedly (and you can all dismiss it, but at your own financial peril) the Fed, for political and a boneheaded attempt to encourage consumption, has destroyed the term structure of interest rates. Hence, if you are a saver, you get jack in fixed income securities. People are going up the risk curve in an attempt to get a return – “yield chase” as we call it. However, on the proverbial “risk adjusted basis” this is just an absolute travesty.

If Ben Bernanke weren’t a political appointee I bet he wouldn’t do this. If Obama was an honest man I bet he would rail against this. Of course, neither are the case.

This brings me to jan. I remember when lefties screamed and hollered about the economy and employment (heh, with 5.5% unemployment!!) while castigating the DJIA as being totally unreflective of the real economy. Now?? No honesty. Just no honesty.

This is not that complex. Corporate America has throttled down employment and pushed every productivity lever they could to generate earnings. The Fed and their cheering political monkeys have pushed down the discount rate. That’s all the stock market is right now, and its (very bad) policy driven. And if you don’t believe how fragile that is, look at Apple.

Don’t even get me started on housing, or Paul Krugman desiring to double down. Gawd.

Icepick February 4, 2013 at 2:25 pm

I no longer believe that the Dow-Jones Industrial Average measures anything in the real economy. I honestly don’t know what it measures any more.

I think it measures how the chips are divided up for the sharks.

An old poker saying is, “The guy who invented poker was bright, but the guy who invented the chip was a genius.” Looking on-line I see it attributed to Julius “Big Julie” Weintraub, but I’ve heard it attributed to others as well. The point of the quote is that the poker chip increases the level of abstraction for the players. Someone who wouldn’t dream of putting a stack of bills totaling $1,000 into a pot might not hesitate in the heat of the moment to toss in a single chip of baked clay. But the chips themselves have no meaning.

I suspect that stock certificates have no meaning anymore. Really, who owns a big multinational corporation? What does it even mean to state that a share has a given price? Hell, a share price is nothing but an abstraction (nominal dollar value) of another abstraction (a portion of ownership), with both the dollar (or whatever unit of currency you choose to name) and the share being abstractions whose worth are subject to the whims of forces seen and unseen.

Currencies are manipulated by governments (more precisely, by the people that run governments) , central banks, regular banks and extremely powerful individuals (think George Soros), as well as by outside events. Not only the fate of nations hung on the outcome of the Battle of Waterloo, but also the fate of currencies and fortunes! What the Hell does a dollar mean, especially in the fiat era?

Similarly for ones share of a company. What that share represents can be manipulated by boards and CEOs and CFOs through mergers and buybacks and splits and “reverse splits”. The share might represent some fraction of ownership, but that what is owned? That can be changed by manipulating inventory and raw materials, the selling or acquisition of real estate or intellectual property, or even by the decisions of some anonymous manager in some remote office. (How many shareholders of JPM had ever heard of Bruno Michel Iksil before he became known in the press as the London Whale?)

The abstractions keep piling up. And if the shares you hold are in a company whose worth involves something truly nebulous, such as finance or a company driven by intellectual property, the abstractions get worse. What does Apple make? Software and patents? Foxconn builds the stuff with the Apple logo.

Add to that the unreality of HFTs, hedge funds, liquidity transfers from central banks and on and on, and what is it even supposed to mean that the Dow is at 14,000?

jan February 4, 2013 at 2:41 pm

Basically it’s become nothing but monopoly money and little plastic houses — In other words, nothing but a fanciful game.

BTW, good posts, Drew and Ice.

Icepick February 4, 2013 at 2:47 pm

jan, there’s real value to be had, if you have enough of those pieces of monopoly money and plastic houses. But only if you have enough, and only if you get your own little branch off the main flow into your own personal accounts. It’s all about getting a piece of the flow, a piece of the action.

Drew February 4, 2013 at 3:05 pm

“What does it even mean to state that a share has a given price?”

I think this is overwrought, ice. My point is pretty fundamentally different.

“Hell, a share price is nothing but an abstraction (nominal dollar value) of another abstraction (a portion of ownership), with both the dollar (or whatever unit of currency you choose to name) and the share being abstractions whose worth are subject to the whims of forces seen and unseen.”

This is always the case.

My point isn’t that equities have zero association with reality or the economy, its that they are mispriced by explicit policy. And that’s bad policy, in my opinion politically motivated.

If you destroy the term structure of interest rates you induce people to spend rather than save.

With artificially low interest rates you induce people to purchase large number time-financed capital goods. Can you say “house,” “car” or “washing machine?”

This is all about covering up the drag effects of bad past government spending policies, the looming drag of taxation and regulation, and hosing savers – read: wealth. That’s Obama and Bernanke and Geitner in a nutshell. Add inflation and its a done policy.

Its also just plain bad policy, bordering on pure evil.

steve February 4, 2013 at 3:23 pm

@Drew- So you reject fiscal policy AND monetary policy? If we increase the price of borrowing, people will borrow more? It is not just Treasuries sitting there with low yields, we see the same with corporates. The market seems to think that there is little risk in bond issues right now, or maybe the market isnt thinking.

“With artificially low interest rates you induce people to purchase large number time-financed capital goods. Can you say “house,” “car” or “washing machine?”

But people arent buying very many “house,” “car” or “washing machine?”s. For your specific examples, we have the capacity to make a lot more of them, or at least certainly for the first two. We have low utilization of our existing manufacturing ability. Please explain how raising interest rates would either make people buy more or produce more of these three items.

Query- Are there historical examples of an increase in rates slowing the economy? Part 2- Are you really saying monetary policy should be adjusted to provide safe assets?

Steve

jan February 4, 2013 at 5:16 pm

Zero Hedge highlights yet another opinion about real economic growth, via what is happening in today’s housing market. David Stockman’s POV is that “We are in a bubble once again.”

The former CBO Director added that “in a world of medicated money by the central bank, things aren’t what they appear to be,” as he explained there is “no real organic sustainable recovery.”

Stockman further contends, “It’s happening in the most speculative sub-prime markets, where massive amounts of ‘fast money’ is rolling in to buy, to rent, on a speculative basis for a quick trade. And as soon as they conclude prices have moved enough, they’ll be gone as fast as they came.”

He concludes that the American Dream of home-ownership ‘forced’ upon the citizens was a huge policy mistake as he chides, “let the market decide,” as he clearly sees Bernanke recreating yet another speculative bubble.”

I’ve heard the refrain of “Let the market decide before….Oh yeah, it’s usually part and parcel of the small government, less regulatory philosophy and reforms held by conservatives/libertarians.

Drew February 4, 2013 at 6:35 pm

steve

Sometimes you say the strangest things. That’s a truley weird comment. Let’s take it in pieces.

“So you reject fiscal policy AND monetary policy?”

No. I think the stimulative effect of fiscal policy is a) highly suspect and b) prone to rent seeking. Perhaps the two are not mutually exclusive. Let’s take two extremes. We hire people to dig holes and then fill them up. This is a varient of the broken window fallacy. The thought is that the economy will blossom because income is injectd into the economy. It pays no attention to financing costs or productivity of the economic activity. Its bizarre. The other extreme: government spending is the model of efficient use of resources which will increase economic output and employment. Could happen. No data to really support it. The empirical evidence of the recent downturn is not encouraging. But hell, I see the Powerball is over $200 million, maybe I’ll place a dollar…….ya never know….

“If we increase the price of borrowing, people will borrow more?”

C’mon, man. That’s just silly, and a strange posture to take. A physician trying to play capital markets. Of course not. You miss the point. The purpose of capital markets is to collectively and hopefully properly price risk and reward, and thereby allocate capital, not let the Wizard of Oz – and his political influences – do so, or simply provide cheap borrowing. Why not interest rates of zero! (Free beer, too!!) The tax code is manipulated in the exact same fashion as the capital markets are being manipulated. How’s that workin’ out?

“It is not just Treasuries sitting there with low yields, we see the same with corporates. The market seems to think that there is little risk in bond issues right now, or maybe the market isnt thinking.”

No, no, and no. Its gearing off the so called “risk free rate.” That’s my point. Risky assets price off the term structure, and it is corrupted. Now, payday loans still have a huge risk premium, to be sure. Lotto tickets still have an unweildy risk return profile. But the usual suspects in risk assets – you cite corporates, I cite equities; we could go on – are gearing off the fact that people are willing to take less than the risk adjusted premium because they can’t get jack squat in Treasuries, because of a malignant policy.

I’m sorry, steve, that just isn’t right. There is no free lunch.

This is a conscious effort to spur demand at the cost of people who did it right: they saved and lived within their means. Call it CRA/Housing bubble II. Its cruel to the thrifty, cruel to the elderly, beneficial to spendthrifts and ultimately a policy that accrues to the benefit only of those who should be taken out behind the barn and shot: irresponsible politicians and the rent seekers they count on for votes.

Drew February 4, 2013 at 7:08 pm

Heh.

Figuratively, of course…….

steve February 4, 2013 at 8:47 pm

“The purpose of capital markets is to collectively and hopefully properly price risk and reward, and thereby allocate capital, not let the Wizard of Oz – and his political influences – do so, or simply provide cheap borrowing. ”

Yes, yes and yes. Unfortunately for us, markets, rather banks, stopped doing this. They just hedged everything. Incorrectly and inadequately. That said, you imply that markets, and those in them, are incapable of independent judgment. You cant push yields down unless people are willing to buy them. They have been so willing to buy them real returns have been negative at times. This has been true even when QE was not in effect. It is also true for corporates.

What I find odd is that risk is not evaluated on a per purchase basis. That if you are correct, it is too closely linked to safe assets. Or, if I understand your assertion another way, your answer to the second part of my question is yes. You are claiming that rates should be set to provide adequate return to those who want to invest in safe assets. Why is this not malignant? Why must we guarantee safe returns to anyone? How do you do this w/o raising the costs of borrowing? Why would that be good with UE so high?

I knew you reject fiscal policy. After a couple of years here, after one day actually, that is pretty clear, I was just surprised to see you rejecting monetary policy.

“. Call it CRA/Housing bubble II.”

I see assertions, but what is really the evidence for this bubble? Real estate sales are better, but still slow. Real estate prices have barely budged up, though judging by Case-Shiller, may still be a bit high. I will agree that holding rates low is an attempt to spur demand. That is what we have done when the economy is slow. Conversely, when the economy has been perceived as overheating, mostly inflation, rates have been raised. As I said above, you seem to be rejecting what I think are fairly conventional takes on monetary policy.

Steve

sam February 5, 2013 at 11:16 am

” I honestly don’t know what it measures any more.”

Perhaps, given this, nobody can know anymore, Too Fast To Fail: Is High-Speed Trading the Next Wall Street Disaster?

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