A small observation about the Efficient Markets Hypothesis

We’re always amused by the manner in which all too many people don’t think through the implications of their own beliefs and contentions. In this specific case we’re talking about the Efficient Markets Hypothesis. Which comes in three flavours weak, semi-strong and strong. Which, roughly enough and in sequence, imply that all generally known information is in prices, all public information is in prices and all things known by anyone at all are in prices.

It tends to be that the more right-ish economically that you are the further along that spectrum your beliefs. Near every economist will run with the weak version, not all that many with the strong.

We also have the idea that there can be too much finance in an economy. That some to a lot of it is mere paper shuffling which produces no value. This belief is stronger the further left-ish your economic views, generally at least.

Which is, to us, interesting. Because the less market prices reflect knowledge then the more we require a finance industry to process data into information, no? That being what those financial markets do, give us a price based upon the trades that people make given their knowledge base. That is, if we believe the strong version of the EMH then we only need a small finance industry because not much processing of that information is necessary because it’s all already reflected in prices. Equally, if you hold with the weak version then a large finance industry should be necessary.

Yet - in general of course - the views are aligned entirely opposite. Those who believe the weak want a smaller finance industry, those the strong are just fine with what we’ve got.

Sure, we’ve our own thoughts on this - the strong holds because we have a large finance industry which rather aligns us with Robert Shiller on the point - but we do still think it’s interesting that the general positions don’t quite match up at either end of the respective arguments.

Richard Arkwright, industrial pioneer

Richard Arkwright, described as the "father of the modern industrial factory system," was born on December 23rd, 1732. Without formal schooling, he was taught to read and write by his cousin, then apprenticed to a barber. He was inventive from the beginning, creasing a new waterproof dye for the then-fashionable wigs.

He created a spinning frame to mechanize the thread-making by using wood and metal cylinders to replace people's fingers. It was initially powered by horses, and with a partner, Arkwright started up a horse-drawn factory at Nottingham. He took on investors from the stocking industry to set up the world's first water-powered textile mill at Cromford, employing 200 people to perform both carding and spinning. His new carding machine made thin, strong cotton thread to feed what were now called Arkwright's water frames.

His insight was to realize that mass-produced yarn could be made by applying external power, initially water, to semi-skilled labour operating machines. He was very much an entrepreneur as well an inventor, setting up  a series of water mills across the Easy Midlands. He built cottages near his Cromford mill to accommodate the weavers and their families he attracted, employing whole families, including children, in his factories.

He also pioneered the use of steam power, using a steam engine at Wirksworth to refill the mill pond used to drive the water wheel that powered his machines. He employed thousands of people, and helped shape the early industrialized North of England, as well as helping to set up mills at Lanarkshire in Scotland. He was not popular. His attempt to secure a "grand patent" on his processes was rejected after dragging on for years, and one of his mills was destroyed in the anti-machinery riots of 1779. He was knighted for his work, however, and left a huge fortune of half a million pounds when he died.

Like the other pioneers of England's Industrial Revolution, he was breaking new ground. He changed the face of England, and then the world. Previous generations had looked forward to doing what their parents had done, but now, because of men like Arkwright, each generation would have to live in a world completely different from that of its predecessors.

His innovations caused upset as his machines made traditional crafts obsolete. His factories broke the closed shop of guilds and apprenticeships that had enabled craftsmen to fix prices. His methods produced cheap and affordable yarns that brought to ordinary people what had previously been affordable only to the well-to-do.

The system that he pioneered created wealth on an undreamed of scale, and lifted first England, then the world, out of the subsistence and starvation of a rural economy, and onto the upward path to create the resources that would later pay for sanitation and medicine, and then for education.

There are scholarships in his name that fund hundred of students to achieve the qualifications for university entrance and apprenticeships, especially in engineering. But his real memorial is the modern world itself, the world he entered as a pioneer and an innovator, and helped to shape.

It's a very odd definition of success

The aim of an economic system is to produce enough of something while still being able to produce the maximal amount of everything else. Producing too much of the one thing means that we are producing, well, too much of that and are thus gaining not as much of everything else as we could be getting. We are therefore poorer.

Which makes this a very odd definition of success:

Thousands of homes across Britain were offered the chance to earn extra money this month by turning their electric vehicles on to charge overnight or setting a timer on their laundry load. Customers on a new breed of “smart” tariff were effectively paid to help make use of the UK’s abundant wind power generation, which reached a record 16GW of electricity, to make up 45% of the generation mix for the first time.

It is an early glimpse of the increasingly important role that cheap, renewable energy will play in the decade ahead – and a timely reminder to the new government of the huge potential that could be harnessed with the right policies to support one of the UK’s fastest-growing industries.

Devoting resources to producing something in such glut that we quite literally could not give it away? We’re fine with dealing with whatever dangers it might be that climate change sends our way, even reducing them if that’s the correct option. But spraying societal wealth down the drain just doesn’t seem to be the correct response to anything at all.

First flight of the Blackbird

In great secrecy on December 22nd, 1964, one of the most awesome planes ever built was rolled out at Air Force Plant 42 in California, and took its first flight. On that very first flight it achieved a speed of Mach 3.4. This was the SR-71 Blackbird, a plane that played an honoured role in the Cold War

Wars are often started through uncertainty, when a potential aggressor is uncertain of the response. This makes intelligence extremely important; you need to know your enemy's capabilities. Behind the Iron Curtain NATO needed to assess the USSR's capabilities, and what aggressive potential it had. The US initially used the U2 spy plane, but it was becoming vulnerable to interception by missiles, and a successor was needed.

Kelly Johnson at Lockheed's "Skunk Works," created the SR-71. Its shape was designed to reflect radar beams, it was coated in radar-absorbent iron-ferrite paint, and its fuel was mixed to minimize exhaust trails. It could fly at over Mach 3 at 80,000 feet, and was able to outrun any enemy aircraft and missiles. It gathered massive reconnaissance on its many flights, identifying potential enemy positions and military assets. Its appearance was thrillingly exotic, and breathtakingly elegant. It became an icon.

It had ground-breaking technology. It was 85% heat-resistant titanium, with windows of quartz. During flights its exterior could exceed 500F, and when it landed, it had a long period to cool down before the crew could leave it or the ground crew could approach it. It leaked fuel on the runway at take-off because the tanks were designed to expand and seal with the heat once it was flying up to speed.

Its twin J58 engines needed vehicle-mounted starter engines to get them going, and moved to partial ramjet mode at high speeds and altitudes. It was soon breaking records for speeds and altitudes, though many remained long classified. It once established a New York to London record flight time of 1 hour and 54 minutes.

32 Blackbirds were built, and although 12 were damaged or lost in accidents, none was lost to enemy action, even though it was in harm's way many times. During the Vietnam war years, over 800 enemy missiles were fired at it, none successfully. It had missile attacks against it over Libya and North Korea, but it outran them all.

It served with the US Air Force for 32 years, from 1964 to 1998, and NASA operated the two last airworthy Blackbirds until 1999. Its missions helped keep the peace by keeping NATO apprised of possible enemy capabilities and deployment. It was finally superseded by reconnaissance satellites, but its career reminds us of the constant need to be on our guard, to be alert to possible enemy plans, and to construct defences to meet new offensive capabilities that our potential adversaries develop. The price of liberty is eternal vigilance, and the Blackbird performed an essential part of that vigilance. On the 55th anniversary of its maiden flight, we salute it.

The Keynesian ratchet

Note that we say ratchet, although racket is also a useful description.

Approximately 700,000 Americans will soon lose their benefits as the government tightens the regulations around stable work requirements for recipients, stretching the already scarce resources of the communities that Waide’s operation helps.

Those communities are often African American, raising the prospect that Trump’s move will put extra stress on minority families. Approximately one in three households using Snap benefits are African American. In general, African American households are more likely to experience food insecurity, according to the Center on Budget and Policy Priorities. In 2016, Snap helped more than 13 million African American households put food on the table, according to data from the US agriculture department’s fiscal year 2016 Snap Households Characteristic data.

Snap is food stamps, one of the major pieces of US spending upon - or for the benefit of perhaps - the poor.

One observation is that if it is black Americans who will lose most from this reduction in the program then it must be black Americans who gain most from it at present. Given the social background in the US insisting that welfare aids blacks most might not be the wisest political idea ever.

But that’s not our point here - nor is whether the current, past or future levels of Snap are correct in the overall sense. Rather, that ratchet.

For Snap eligibility was greatly expanded in those dark economic days of the first Obama Administration. We can argue that that was the correct economic response too, in that Keynesian manner. Increase the deficit, get money into the hands of the people who will spend it, thereby boosting the economy. We could even call it a version of Milton Friedman’s helicopter money.

OK. But implicit in that justification is that when the dark days have gone - possibly when there’s no longer an Obama Administration - then that stimulation of the economy should cease. But note what happens when this is suggested. Instead of a general agreement that we’re finished now with Keynesian stimulus we have the shouting that we’re stealing crusts from starveling babies.

That’s the Keynesian ratchet. Even if it is true that there should be deficit paid for stimulus the justification for the increased spending changes when it becomes time to reduce it again. So that the spending never is - or never should be - reduced in those better economic times.

All of which is rather why we agree with the later Keynes himself. Assume, again, that the stimulus should happen - we’re not sure we do agree with this but make that assumption. It should be done by cutting taxation, not increasing spending. Again as Keynes suggested, by cutting social security (national insurance for the UK) taxes. The benefit of this being that the clamour to revive state revenues, when the crisis is past, will be rather greater than that to reduce state spending.

That is, pro-poor tax cuts in recession will alleviate the problem without becoming a permanent part of the economic settlement. We abolish the ratchet.

Of course, we’re pro-pro-poor tax cuts all the time anyway but that’s a rather more structural matter.

Benjamin Disraeli, a strange Prime Minister

On December 21st, 1804, was born a man destined to become one of Britain's strangest Prime Ministers. This was Benjamin Disraeli. His background was ordinary, middle class, though he later romanticized it. Born and raised initially Jewish, his father renounced Judaism after a dispute with his synagogue, converted to Christianity, and had all four of his children baptized as Anglicans when young Benjamin was 12. This opened up the possibility of a political career, since Jews could not at that time take the Christian oath of allegiance without converting, at least nominally. In his 20th year, Disraeli changed the spelling of his name from D'Israeli to Disraeli.

As an MP, Disraeli was extrovert, even flashy. At times he wore white kid gloves with rings outside them. He was drawn to glamour and glitter, and loved celebrity. He wrote novels, including his famous political novels. In which his ideas were expressed by fictional characters.

Initially in Parliament he backed the landowning aristocrats in opposing Robert Peel's attempt to open the country to cheap imports by repealing the Corn Laws, laws which protected the incomes of the landowning classes. When the laws were repealed, Disraeli helped bring down Peel and split the party. When he later became first Chancellor, then Prime Minister, however, he refused to repeal them.

In office he followed Peel's policy of bidding for the support of voters newly-enfranchised by electoral reforms. He enacted measures to protect and assist workers, often in opposition to the merchant and manufacturing class who found Gladstone's Liberals more to their political taste. It was the age-old combination of king and peasants versus the barons that he was constructing, only in this case it was Tories and workers versus bosses.

Disraeli lowered taxes on malt to lower the cost of the workers' beer, and refused to reimpose the Corn Laws when efficient transatlantic freight, enabled by newly-efficient steam engines, brought in cheap harvests from the American mid-west. He passed Acts to support public health and education, and to enable low-cost housing to be built. He called it a "One Nation" policy, but it more resembled class politics designed to give his party a sold base among the new voters.

The icing on top of his cake was imperialism, hugely popular among the working classes. They might come low in the national pecking order, but they took immense pride in being members of the world's mightiest empire. Queen Victoria liked it, too, and preferred Disraeli to the somewhat cold and stern Gladstone. "She liked flattery," said Disraeli, "and I laid it on with a trowel."

There is a parallel with recent UK events, in that the Prime Minister, Boris Johnson, seems to be forming a similar coalition, bidding for support in what were once the Labour heartlands of the Northern and Midland working classes. Like Disraeli, he appeals to the basic patriotism they embrace. His message is one of an independent and proud Britain that stands up to bullying and threats from overseas.

Whether Johnson will be as successful as Disraeli in forging and maintaining that coalition against the bubble politics of the urban and academic elite, as Disraeli did against the merchants and manufacturers, remains to be seen. As ever, time will tell, though the early portents look promising.

WeWork and Robert Shiller on the Efficient Markets Hypothesis

WeWork was and is, as well as being a hugely amusing tale of hubris, a lesson in the efficient markets hypothesis, the EMH.

As we might recall the little joke - economists aren’t all that good at this humour thing - the Nobel was awarded to Eugene Fama, Lars Peter Hansen and Robert Shiller, one for proving the EMH, the second for doing the maths, the third for disproving it. Which isn’t quite the way it did work. Shiller refined the idea.

That EMH not being a statement that markets are always the efficient way of doing things, nor that everything should be done by markets in order to be efficient. Rather, that markets are efficient at processing information. Thus things that are known are already in market prices.

Shiller’s addition was that this is only true when everyone in that market can trade their view. Thus, given the difficulty of going short housing the persistence and extremity of the American housing boom. And so his proposal that to limit future such problems there should be a futures market in house prices where people could bet on price falls. That would get the views of bears into market prices.

At which point, a comment on WeWork:

One of the great mysteries of modern finance is how to make money when you know there’s a bubble, or at least how to get much, much richer than everyone else. The obvious way is to bet against the bubble, but this is difficult, as its expansion can easily outlast one’s ability to finance the wager. It’s even harder if the bubble is primarily happening in the private markets, where it is very difficult, if not impossible, to directly bet against the fortunes of a company that you think is overvalued.

Quite so, it was the exposure of WeWork to those wider financial markets that precipitated the implosion. You know, the financial markets where a couple of months after the IPO people could go short the shares and thereby communicate their view that it was a dog. That echoing back in time to mean there was no IPO.

This also explaining why the EMH does indeed imply, even if not directly state, that markets are efficient ways of doing things. For the alternative to markets is command and control, usually by government. Which isn’t ever subject to that same reality confirming pressure of the opinions of those who are quite sure it’s a dog.

We offer HS2 as a confirmation of that contention. It’s only because it’s not subject to the oversight is people risking their own money that it’s lasted this long, isn’t it.

Building the Unity Bridge

As part of his campaign for the 2019 Conservative Party leadership election Boris Johnson suggested that he supported the construction of the bridge, describing himself as "an enthusiast for that idea", and adding that he believed it would be best "championed by local people with local consent and interest, backed by local business."

In September, 2019, the UK government had requested civil servants in the Treasury and Department for Transport undertake a cost and risk analysis of the proposed bridge, with special attention to be paid to possible funding options. The Department for Transport had reportedly already produced a factual paper on the subject for a former transport secretary. When asked to comment on the project the Secretary of State for Business, Energy and Industrial Strategy said the UK had "amazing ambitions for the future." 

The Independent's Europe Correspondent suggested that the UK was lagging behind by not taking the construction of the bridge seriously, suggesting that other countries had already invested in such bridges. The newspaper cited the example of Japan's islands of Honshu and Hokkaido, which are linked by the Seikan Tunnel which exceeds the length of the proposed bridge. It also cited the examples of the Fehmarn Belt Fixed Link and the Helsinki-Tallinn Tunnel as evidence that the UK was lagging behind comparative European nations. 

While addressing supporters for the bridge in Northern Ireland UK Prime Minister Boris Johnson is quoted as having said "With infrastructure projects, finance is not the issue, the issue is political will, the issue is getting the business community to see that this could be something that works for them, the issue is getting popular demand and popular consent for a great infrastructure project - and that is why you need Stormont."  

In late September, 2019, a group of engineers wrote to the National Geographic magazine agreeing that it was "technically possible and far from unrealistic to build" the bridge. The architect, Alan Dunlop, has suggested two possible routes: a 12-mile span covering the shortest gap from Mull of Kintyre, or a Southern route from Portpatrick to Larne. The Northern one might be too remote, whereas the Southern one is closer to Belfast, and has current road infrastructure.

The depth, rather than the length, poses difficulties, but none that cannot be overcome. Dunlop suggests it might be constructed like an oil rig, anchored to the sea bed by cables. While seas in the area can be rough, he points out that the Hong Kong-Zhuhai-Macau Bridge, a 34-mile series of cable-stayed bridges, an undersea tunnel and four artificial islands, which opened in China last year, “was designed and built to withstand typhoons.” Furthermore, his route is in shallower water to the North of the undersea dump of post-World War II munitions.

The Unity Bridge is technically feasible, and would unite the UK with a land crossing. Furthermore, it would also establish a land crossing between the Republic of Ireland and its EU partners. Lorries or trains could cross Northern Ireland, and head down to use the Channel Tunnel in the South. Some Irish and EU traders would find the bridge and tunnel tolls cheaper than loading and unloading ships. 

The venture would be a bold one, creating thousands of jobs where they ae most needed. It would, furthermore, be a symbol of the nation’s new-found confidence. And it would be a physical link tying Northern Ireland to the rest of the Union it is part of. It could be built, and it should be.

Flying Tigers in action

The American volunteer flyers who fought for China against the Japanese invasion were known as the ‘Flying Tigers.’ They saw their first combat on December 20th, 1941. They had originally thought this would be earlier, but various delays meant that it happened a few days after the US and Japan were officially at war.

The Tigers, officially the American Volunteer Group (AVG), were the brainchild of Claire L Chennault, a retired US officer working in China. He’d acted as military advisor to Chiang Kai-shek, then as director of the Chinese Flight School. 100 volunteers were all recruited from US air forces, officially discharged so they could become civilian volunteers to fight with the Chinese. They were employed for “training and instruction” by a civilian military contractor (CAMCO), which paid them roughly twice what their US pay would have been.

Chennault took charge of the purchase of 100 Curtiss P-40 ‘Tomahawk’ fighter planes. They were marked in Chinese colours, and painted with the distinctive shark face up front after pilots has seen a photo of an RAF P-40 similarly decorated. Chennault was a good tactical commander, and trained his pilots to take advantage of the P-40’s rugged strengths. It featured armour and self-sealing fuel tanks, and had a higher diving speed that most Japanese fighters.

Chennault forbade his flyers from engaging the more nimble enemy in a turning fight, but trained them to dive into attack, then pull away for another attack. His early warning system had Chinese villagers give warning of oncoming planes so his own planes could have an altitude advantage when they arrived. Although this manoeuvre went against US and RAF teaching, he’s seen the Soviets use it successfully. It worked, and saw his Flying Tigers credited with downing 296 enemy aircraft for the loss on only 14 of his own pilots. When his pilots eventually returned to the US, they found a bonus of $500 had been paid into their bank accounts for every enemy plane they shot down.

At a time when Japanese forces were streaming seemingly unchecked across Asia in a series of victories and conquests, news of the successes enjoyed by the Flying Tigers provided America with a much-needed morale boost, showing that the Japanese enemy could be beaten. It also cemented in the minds of Americans that the Chinese were allies facing a common enemy. A friend pf mine at St Andrews used to display a Coca-Cola poster from the period showing US pilots fraternizing with Chinese soldiers by drinking Coke together, with the caption, “Have a Coke - Good winds have blown you here.”

It was neither the first time, not the last, when brave Americans have fought for the freedom of other peoples. It was Jefferson’s US Navy that took on and ultimately routed the Libyan pirates wreaking havoc on Mediterranean shipping in the early 1800s. It was US forces that tipped the balance in two World Wars, and it was a US-led coalition that liberated Kuwait in Operation Desert Storm. What was different about the Flying Tigers was that they were volunteers, fighting an enemy superior in numbers and equipment.

The Flying Tigers received many honours American and Chinese. About to celebrate their 50th reunion in 1992, they were retroactively recognized as members of the U.S. military services during the seven months in combat against the Japanese. Their team was then awarded a Presidential Unit Citation for "professionalism, dedication to duty, and extraordinary heroism." And in 1996 their pilots received the Distinguished Flying Cross and their ground crew were all awarded the Bronze Star Medal.

It's just such an odd contention

The idea of recreating victory gardens seems to interest various people and given that we’re all liberals around here why not? If digging the front lawn for vegetables is what turns you on then have at it. It’s just that in one piece of praise for the idea we find this claim:

Together, we helped meet each other’s basic needs through an exchange, rather than using money.

Clearly the implication here is that exchange without the use of money is in some manner more moral. Or better, outstanding in some way. Which is the bit that we think such an odd contention.

For without money you can only exchange with those you actually know. What money as a medium of exchange allows is to do those exchanges with people you don’t know. The web of cooperation can extend - a la “I Pencil” - to all members of our species, not just to those in the immediate vicinity.

So why is it moral, better in some manner, to only be cooperating with those few who share your geography, culture, location? We do have reasonable authority for the idea that all men are our brother so why shouldn’t we use the means, money, that allows us to cooperate and exchange with them all?

It just seems so dreadfully odd to insist that voluntary exchange is wondrous but that it’s righteous to limit it.