After a longer break than I’d planned, I’m back for the second and final instalment of my series on the efficient markets hypothesis and its implications for Social Security reform and other issues. The first instalment is here.
Last time, I pointed out that, under the strong assumptions needed for the efficient markets hypothesis to hold, the diversion of social security funds to personal accounts makes no difference at all, since everyone can already choose their optimal portfolio, borrowing if necessary to finance equity investments. A more realistic version with borrowing constraints or high borrowing costs implies that either private accounts or diversification of the holdings of the Social Security Fund can be beneficial, and also that a range of other government interventions will be beneficial. (See also Matt Yglesias
In this post I want to look at the case I think is actually relevant, namely, where the efficient markets hypothesis is violated in so many ways as to be a poor guide to economic policy of any kind.
To begin with, why do I think this is the relevant case? Because the efficient markets hypothesis is way out in its predictions of the key variables it is supposed to explain: the relative prices of bonds and equity and the volatility of asset prices. Compared to the EMH, asset prices are several times too volatile, average returns to equity are several times too high and real rates of interest are much lower than they should be.
In addition, even defenders of EMH admit that the vast majority of the markets that would be required for the hypothesis too hold either don’t exist or are subject to large transactions costs. I’ve already mentioned the transactions costs of borrowing, but an equally important factor is the absence of insurance against job loss or business failure caused by recessions. In effect, defenders of the EMH look at the complexity and sophistication of corporate capital markets and assume that all the other risks and contingencies in the economy are irrelevant.
On the assumption that the difference between rates of return to equity and to government debt are largely due to market failure, the immediate implication is that the government should hold more equity, use its tax power to spread the resulting risk, and thereby achieve a massive risk arbitrage. One way to achieve this is for the Social Security Fund to invest in equity, as was proposed under Clinton. Alternatively, if the central bank holds foreign reserves for whatever reason, there’s a case for holding equity as well as debt, and it looks as if this is happening. Finally, the government can own enterprises outright, for example in the infrastructure sector.
Each of these approaches to public holdings of equity has advantages and disadvantages. Holding a diversified portfolio of small shareholdings raises the problems of ethical investment: what if some members of the public object to investments in some particular company. Ted raised this issue a while back in relation to the default portfolio for private accounts, and its equally acute in relation to diversification of the Social Security Fund.
Investments by governments in overseas equity raise a bunch of political issues in both the investing and target countries.
Finally, direct ownership raises all the issues that have been tossed about in debates over nationalisation and privatisation for decades.
All of these points imply that there are limits to the optimal public holding of equity, though there’s no good theory on this (or on the related question of the optimal level, if any, of gearing for the public sector). In any case, as public holdings of equity increase, the rate of return will fall and the rate of interest will rise, ultimately eliminating the equity premium. So we end up with the mixed economy we all know and (some of us) love.
But as long as governments can realise an average return on equity investments that exceeds their cost of debt, adjusted by the (small) cost of risk in an efficient equilibrium, there’s a case for more public investment, either direct or portfolio.
I’m running another ‘cash for comment’ appeal, over at my blog. For each comment on this post on my blog I’ll give $1A to Medecins Sans Frontieres, and express a preference for projects related to the The Global Fund to fight against AIDS, tuberculosis and malaria. The appeal closes 6pm Sunday, Queensland time. To be clear, you have to comment on my blog, not on CT to get counted
Thanks to everyone who bought through Amazon. With tsunami reconstruction funds cash-flush, I ended up donating another $250 (on top of the original $500+) to the Doctors Without Borders general emergency relief fund. Thanks in particular to whoever bought the expensive stuff lately. Although I regret to inform that Amazon capped the commission on the tasty G4 Powerbook at $25. I think you got a pretty good deal anyway. I hope you are happy with your sleek new machine. I'll give again in a month and a half. Whatever accrues over the quarter.
Good deal at Amazon. 43 volumes of original Twilight Zone DVDs on sale for $4.99 each. I recommend volume 2. It's got Shatner as the salesman who sees the gremlin on the plane wing. Plus a post-apocalypse Burgess Meredith bookworm. Plus "The Monsters Are Due On Maple Street". Plus some other thing. Plus, on a more serious note, I'm still doing the thing where I advance my Amazon Associates proceeds to tsunami disaster relief, which is still needed. I've raised a little over $600 so far and am getting ready to cut another check. (The Singapore Red Cross wanted to raise S$1 million and they have raised S$48 million. I'm still hoping to hit US $1000 before the quarter ends.) If you haven't just plain donated - say, to the American Red Cross - it's still a very good time to do so. I'll just stick another Amazon search box under the fold. If you were going to buy anyway, buy in a way that helps disaster victims. It makes sense.
After three days, my Amazon fundraiser has worked modestly. Tomorrow I'm writing a $250 check to the Singapore Red Cross. (That's $100 from me, $150 from you, guestimating a bit. Special thanks to the proud owner of a new and expensive camera lens.) Please feel free to continue buying. If there is something you were going to buy anyway, it makes good sense to do so in a way that helps.
I have seen the Red Cross praised as exemplary and criticized as burdened with inefficient, overpaid bureaucrats. (No doubt there are good discussions going on out there about this very issue. I just haven't been reading the blogs for a few days.) I figure the Singaporean branch is as likely as any to have useful local knowledge and connections. Not to mention we live here. Feel free to critique my choice of charities, as I haven't signed the check yet.
UPDATE: Thanks, whoever ordered four spanking new LaCie terabyte drives! (I'm assuming one person bought all four. What do you need that space for, mystery reader?) Thanks also to the new owners of various moderately pricey DVD collections. I had a busy day. By the time I actually wrote the check to the Singapore Red Cross tonight it was for S$850.00 (US $518.) I'm sort of hoping at this rate I can write another check that big by Feb 1. Give generously. Buy generously.
That's very interesting. Do you know, I have a DVD for Mad Monkey Kung Fu, starring Lau Kar-leung (a.k.a. Liu Chia Liang, a.k.a. General Fu who fights Jacky Chan in Drunken Master II.) Sadly, Mad Monkey is Region 3 only and unavailable from Amazon. But if you get the chance, snark out on it. You should check out the sequel, Drunken Monkey. Good Unforgiven Fu - that's kicking people while wearing a duster. The usual Indestructible Old Man Fu. Again only Region 3. (Sigh. You poor folks never get to see any good movies.) But here's a nice site with links to cool trailers and galleries. As I quoted somewhere or other "a monkey that is inebriated is most funny."
Speaking of linguistically distinctive wisdom, Language Hat linked a couple days back to a really funny Poul Anderson essay, "Uncleftish Beholding". What if English were purged of non-Germanic words and neologisms sprang up all Ursprunglich-like?
For most of its being, mankind did not know what things are made of, but could only guess. With the growth of worldken, we began to learn, and today we have a beholding of stuff and work that watching bears out, both in the workstead and in daily life.
The underlying kinds of stuff are the *firststuffs*, which link together in sundry ways to give rise to the rest. Formerly we knew of ninety-two firststuffs, from waterstuff, the lightest and barest, to ymirstuff, the heaviest. Now we have made more, such as aegirstuff and helstuff.
The firststuffs have their being as motes called *unclefts*. These are mightly small; one seedweight of waterstuff holds a tale of them like unto two followed by twenty-two naughts. Most unclefts link together to make what are called *bulkbits*.
Reminds me of my post on Anatole France's dialogue on philosophy of language: "The breath is seated by the shining one in the bushel of the part it takes in what is altogether loosed," etc.
Oh, and if you want to verify for yourself that English is a tonal language, buy The Big Red One for cheap! No, actually what you want are a bunch of 50%+ marked-down Fox TV DVD sets. Buffy. Futurama. X-Files. Good deals! As low as $14.95 for the first season of Buffy. Buy and you'll be helping disaster victims! That's good!
Well, that oughta hold 'em for a while. I figured if we all just posted about disaster relief round the clock, Whizbang would figure out that the reason liberals post so much about the need to help tsunami victims is that the left is uninterested in abstract ideas and debate. (Guy doesn't miss a trick.) That why I said all this brainy stuff.
My buy generously post below was unclear. (I was assuming folks understand how Amazon Associates works. Silly assumption.) You don't have to buy the very items I linked. You can click any link and then search around and buy anything. I just tossed out a basket of big ticket bestsellers because direct link %'s are a little higher. Buy anything from Amazon through me and at least 5.75% of what you pay goes to me, which I (informally, not in any legally problematic way) pledge to give to disaster relief. My point wasn't that the time is perfect to buy glitzy DVD's - sorry if that seemed crass. I meant: buy something. I've stuck a convenient Amazon searchbox under the fold. Go ahead and use it.
Once again, I encourage other bloggers with Amazon Associates to follow suit. (I see Henry has already done so. Good!) The quarter is ending. Shake that little jar of change you were planning to spend on silly stuff. Give for something serious. Henry has pledged to keep up the giving through next quarter. I am happy to do the same. The logic of this is very sound. By doing this we are in effect giving immediately and agreeing to carry a little bit of debt for a short time, since the money is needed now. It would be very nice if many bloggers did this, announced it, then folks made a point of buying the stuff they were going to buy from Amazon anyway through them. (Of course this is informal, so the bloggers could just pocket the money. But if the blogger is someone you personally trust not to be such a bastard as to steal petty cash from disaster victims, the level of broken pledges should be low.)
So Belle and I are donating the humble proceeds from our Amazon Associates Account for the quarter. So far that comes to almost exactly $100. A nice round number to pony up for starters. Given that I have resolved to donate x, where x = my commissions, you might consider buying some Amazon products through my Associates account. Hint, hint. Just look under the fold. I'm not an incorporated charity or anything, so don't come demanding financial statements. But most of us are gonna buy some Amazon gear this year, am I right? So buy it now and - as it so happens - I'll fire off a check to a reputable charity come the 1st of January [make that January 3, after the weekend]. The bigger the better. (I haven't decided which charity is best, if that makes a difference to you.) Then I'll fire off another check two weeks after that to equal whatever amount rolls in late. Then I'll decide what to do. So if you click to buy after two weeks into the New Year, I'm not promising I'll still be in the sending checks to charities business. But I'm not intending to turn a profit here, I do solemnly swear. And if you don't trust me, don't click. Easy. (I hereby disavow legal obligation to you, is what I'm saying. You're buying from Amazon. I'm just stating a personal plan.)
I hereby encourage other bloggers - those of you who have hopeful little Amazon begging bowls put out - to follow suit. Pledge your proceeds for the quarter, joe blogger, even if it's only a few bucks. Say so, so your readers can sweeten the pot. We're big on chat, we bloggers. But chat isn't exactly what certain folks need at the moment. [UPDATE: I probably wasn't clear about this. You can buy any old thing from Amazon using any of the links below and I'll get a commission. Once you are there, just buy what you want. It's just there are extra % points if you buy the very thing on the button. Sorry for confusion.]
My advice: just click that box above and give straight! When finished, proceed below and buy the stuff you were thinking about buying anyway. Clicking through the long thin box immediately below will result in a commision to me of 6.75% of the sticker price. And, as I have said, my check to a reputable charity on January 1st will = the amount of my commisions. (Again, I am not a charity. I'm just a person informing you of a personal resolution to give. I hereby make no contracts. You do business with Amazon. I do what I want with the money. But I'm an honest guy. Get it? I'm just saying this in case there's some annoying legal angle I'm not seeing.)
If you see any specific item you would like in the smaller boxes below, click direct and the commision goes up to 8.25%. Not too shabby. I'm tossing out suggestions for a bunch of indulgent DVD collections, for lack of a more likely plan. Think of it as a golden opportunity to buy extravagantly with less guilt, if that helps open your wallet; if you didn't get what you wanted for X-Mas, for example.
And one last thing: if by very odd chance, this works really well - well, I'd be very very happy. But I'm just a guy who can't personally give past a certain amount, then wait months to get reimbursed, if you see what I mean. If some flukey internet ball starts rolling in response to this post and the Amazon account goes through the roof, I resolve to cut the whole thing short and sort it out as sanely as I can, and most definitely not in the direction of personal gain. (Not that I really expect that. But I just thought I should state the obvious.)
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