Penis Length, LIBOR & Soviet Growth

Healthy markets require solid data based on reality.

It is hard enough to determine what, when and how to invest even with solid data. We live in an unpredictable and chaotic world, and the last thing that investors need is misinformation and distortions. That is why the LIBOR manipulation scandal is so infuriating; as banks skewed the figures, they skewed entire marketplaces. The level of economic distortion is incalculable — as LIBOR is used to price hundreds of trillions of assets, the effects cascaded across the entire financial system and the wider world. An unquantifiable number of good trades were made bad, and vice verse. Yet in truth we should not expect anything else from a self-reported system like LIBOR. Without real checks and balances to make sure that the data is sturdy, data should be treated as completely unreliable.

Unsurprisingly, it is emerging that many more self-reported figures may have been skewed by self-reporting bullshittery.

The Telegraph noted:

The Libor scandal could be repeated in a number of other “self-certifying” markets where prices are determined, he said

“Self-certification is clearly open to abuse, so this could occur elsewhere,” he said.

A Financial Services Authority inquiry into Libor should be extended to other self-certifying markets, he said. The Treasury said last night that the review, led by Martin Wheatley, was free to examine markets other than Libor.

An expansion of the FSA review could take in a number of other interest-rate-related data as well as some complex financial instruments measuring the difference between banks’ borrowing costs and that of the US government.[i.e. the Ted spread]. Some markets in gold and oil are also based on self-certification.

This all reminds me of this:

When humans have an incentive to exaggerate or lie — either to bolster their ego by lying about penis size, or to cream an easy profit by rigging rates — it seems they have a propensity to do so.

Hopefully there will be one beneficial side-effect of the LIBOR rigging — self-reporting will die. It seems inevitable that market participants will pay a premium for solid, independent data. But sadly, any auditor can be bribed. And in a generation’s time, the LIBOR-rigging scandal of 2008 (and probably much earlier) may just be an antique detail known to only a savvy few. Scepticism, caution and portfolio robustification will always remain essential tools for savvy investors who don’t want to lose their shirt and shoes.

It was scepticism that was the difference between economists who refused to buy into the notion of Soviet prosperity in spite of impressive (and entirely self-reported) figures emerging from the Soviet Union, and those Western economists like Paul Samuelson (perhaps spurred on by ideological fervour) who predicted again and again in textbooks spanning thirty years that the USSR would overtake the USA in GDP:

Alex Tabarrok notes:

In the 1961 edition of his famous textbook of economic principles, Paul Samuelson wrote that GNP in the Soviet Union was about half that in the United States but the Soviet Union was growing faster.  As a result, one could comfortably forecast that Soviet GNP would exceed that of the United States by as early as 1984 or perhaps by as late as 1997 and in any event Soviet GNP would greatly catch-up to U.S. GNP.  A poor forecast — but it gets worse because in subsequent editions Samuelson presented the same analysis again and again except the overtaking time was always pushed further into the future so by 1980 the dates were 2002 to 2012.  In subsequent editions, Samuelson provided no acknowledgment of his past failure to predict and little commentary beyond remarks about “bad weather” in the Soviet Union.

The reason for his prediction? Apparently, bad data.

“No incentive to amend data to show strong Russian proletarian outperforms weak American capitalist, Comrade!”

Matthew Ashton writes:

To his credit Samuelson was always fairly open about it when his predictions failed to come true, stating that he was using the best data available at the time and he changed his mind as the evidence changed. I’d argue that in some cases, especially concerning evidence coming out of the Soviet Union, he possibly should have been a bit more sceptical as to its accuracy, however almost everyone in economics is guilty of that.

One can only wonder how bad the state of misreporting, fraud and delusion is in the various economies where central planning plays an even larger role than here in the West.

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More Americans Fear Iran Than Soviet Russia


From the Atlantic:

According to the November 1985 poll, 76 percent of Americans viewed the Soviet Union as a “very serious” or “moderately serious” threat. Only 32 percent of respondents classified the Evil Empire as a “very serious” threat. This week, CNN released a poll asking the same question, this time about Iran and other hostile nations. It estimates that 81 percent of Americans believe Iran is a “very serious” or “moderately serious” threat, with 48 percent calling it “very serious.” 

The problem with that?

Iran — according to the CIA, the IAEA and Mossad — does not have any nuclear weapons.

In 1985, 39,000 Soviet nuclear warheads were pointed at the rest of the world, enough of them ready on push-button alert to destroy the United States near-instantaneously and many times over.

Certainly, Americans are free to be concerned about whatever they want. But let’s just say that a 39,000 warhead disparity — as well as the fact that the Soviet Union was one of the largest, most powerful militaries in world history, and one that successfully defeated Nazi Germany, while Iran’s last war with Iraq ended as a pathetic stalemate —  puts today’s reality into perspective.

UPDATE:

In the interests of inciting some fierce debate, here’s my back-of-an-envelope estimate of the top nation states that are a threat to America’s national interest:

  1. America
  2. China
  3. Russia
  4. Pakistan
  5. Iran

Abstraction & Reality

Brad DeLong alleges that critics of fractional reserve banking and fiat money suffer from (at best) a mental disorder (or, at worst, anti-semitism).

From Brad DeLong:

I think that the deep point of view underlying von Mises’s — and von Hayek, and Marx, and Ron Paul — complaint against fiat money in general and monetary management of the business cycle in particular is this: that value comes from human sweat and toil, not from being clever. Thus it is fine for money to have value if it is 100% backed by gold dug from the earth by sweat and machines and muscles (even if there is no state of the possible future world in which people actually want to exchange their pieces of paper for the gold that supposedly backs it). But it is not fine for money to have value simply because it is useful for buying things. There is, von Mises — and Marx, and von Hayek, and Ron Paul — think, something profoundly wrong on an economic and on a moral level with procedures that create value that is not backed by, in Marx’s case, human labor, and in von Mises’s and von Hayek’s case human entrepreneurial ingenuity. And in its scarier moments some of the trains of thought emanating from this deep point of view slide over to: “good German engineers (and workers); bad Jewish financiers” (and “good Russian Stakhanovites, bad Jewish Trotskyite intellectuals”).

Now I cannot speak for any of those named, but I am a critic of aspects of fractional reserve banking, and monetary management of the business cycle.

As I wrote last month:

Fractional reserve banking… means that the money supply is not in fact determined by the central bank (or by gold miners, politicians or economists, etc) but mostly by lenders. The problem is the fragility of any such a system to liquidity crises. If 10% of investors decide to withdraw funds at the same time, banks will quickly be illiquid. If 20% of investors do, bank failures will usually pile up. The system’s stability is contingent on society’s ability to not panic.

It is my belief that this fragility has been totally overlooked. Many have fallen into the lulling notion that the only thing we have to fear is fear itself — and that that fear can be conquered by rationality. This is to ignore man’s animal nature: the unforeseen, the unexpected, and the wild (all of which occur very, very frequently in nature and markets) make humans fearful, and panicky — not by choice, but by impulse. This is the culmination of millions of years of evolution — primeval reality is unconquerable, immutable and obvious. More than half a century after Roosevelt and Keynes markets still crash, fortunes are lost, and millions of grown men and women still tremble in irrational, primitive fear.

The textbook answer to this is that a lender of last resort should fix this problem by ensuring that enough new money is disbursed into the system for it to remain liquid, and confidence regained. The recent reality, though, has been that rather than fixing the problems, policy  — both in Japan in the 1990s, and now in the West — has resulted in zombification. Governments chose to keep bad banks going. Almost all the new money the government created has gone to shore up the balance sheets of irresponsible bankers. Now those banks sit on piles of idle cash while other businesses starve or cannot get started for want of credit.

As I noted earlier:

Vast sums spent on rescue packages to keep the zombie system alive might have been available to the market to increase the intellectual capabilities of the youth, or to support basic research and development, or to build better physical infrastructure, or to create new and innovative companies and products.

Zombification kills competition, too: when companies fail, it leaves a gap in the market that has to be filled, either by an expanding competitor, or by a new business. With failures now being kept on life-support, gaps in the market are fewer.

In other words, fractional reserve banking seems to lead to fragile systems that are hard to fix when they go awry. Now, I will readily admit that perhaps I am railing against a system that I can’t change or ban. Banning fractional reserve banking, or shadow banking or the various forms exogenous money creation will probably just drive it underground. Certainly, a pure gold standard has never prevented it. Perhaps full-reserve banking or the Chicago Plan may be some kind of panacea, but these ideas remain untested.

So — for me at least — the problem is not where money comes from, or whether it is backed by gold, or backed by labour, or entrepreneurship, or the Flying Spaghetti Monster. It is the managerialists’ mundane and matter-of-fact ignorance of the depth, the richness, the randomness, and the texture of reality – not captured by models that focus solely on money. The problem for me is that I see a fragile system and I want to fix it. But I am not sure I have the tools…

European Leaders Scrabble For Agreement

From the BBC:

The outline of a large and ambitious eurozone rescue plan is taking shape, reports from the International Monetary Fund (IMF) in Washington suggest.

It is expected to involve a 50% write-down of Greece’s massive government debt, the BBC’s business editor Robert Peston says.

The plan also envisages an increase in the size of the eurozone bailout fund to 2 trillion euros (£1.7tn; $2.7tn).

European governments hope to have measures agreed in five to six weeks.

The bizarre thing is that the real issue is not whether or not some agreement can be reached, but whether or not any agreement will really have any real effect on the state of the European financial system. I am extremely dubious that the thrifty Scandinavian and Germanic nations will commit huge swathes of their wealth to save the Mediterranean ones. But even if an expanded EFSF can be brought together to successfully bail out Greece and recapitalise European banks who have to write down significant chunks of Greek debt, there is no guarantee whatever that any of these measures will address the underlying fracture in European budgeting. Namely, that European governments are spending like they are monetarily sovereign — in other words, behaving as if they can print as much money as they want to cover debts — when they are not.

Of course, there is no real guarantee that Europe will even effectively stabilise its banking system.

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