21/10/15: By Current Account Fetish Theory, Russia is Doing Quite Fine...

In charts we live... and in charts we delight.

Here is a neat summary of global current account balances (horizontal axis) against the rate of change in the current account over 12 months through 2Q 2015.

Source: @NickatFP 

6th largest surplus: Russia. Fastest growth in surplus: Russia.  So that petrodollar economy, then... like, say Saudi Arabia?..

Now, think of the favourite theory of 'sustainability' advanced by the likes of the Euro-centric Bruegel and its followers. The said theory rests on sustainability being equivalent to medium-term or long-term external balances... either that theory (underpinning most of the official EU economic mantra) off the rocker or... take a look at the chart again.

No comment beyond.

20/10/15: New Governor of the Central Bank of Ireland

Congratulations to my former colleague at TCD Economics, and my thesis supervisor from years back, Professor Philip Lane on his appointment. Here is a good summary of my view why the Irish Government has made a good choice, via Central Banking

18/10/15: Is Ireland a Euro Periphery Outlier? Some Historical Data

How unique is Ireland within the club of euro peripheral countries? Well, historically, rather unique. Alas, sometimes for the reasons not entirely in our favour.

The following are excerpts from the recent ECB paper titled “Fiscal policy adjustments in the
euro area stressed countries: new evidence from non-linear models with state-varying thresholds”.

Quote: “Fiscal policy authorities of Greece, Ireland, Portugal and Spain are shown to have, on average, historically followed a "spend-and-tax" model of fiscal adjustment, where government spending is decided by the political process, and the burden of correcting fiscal disequilibria is entirely left to the tax instrument.”

Of course, ‘historically’ here means over the period 1960-2013 for all countries, with exception of Spain (1970-2013).

But before then, what were the pre-conditions (thresholds) for taking action? “During the 1960-2013 period for Greece, Ireland and Portugal and during the 1970-2013 period for Spain, we find that the threshold estimate for the budget deficit-to-GDP ratio, which led to different fiscal correction regimes, was on average 4.90% for Greece, 5.10% for Ireland, 3.22% for Portugal and 3.12% for Spain.”

In other words, Ireland had the greatest tolerance - over the entire period - for deficits, opting to wait until average deficit as % of GDP would hit above 5.1%, well above Greece (4.9%) and the rest of the peripheral states.

So now, let’s tackle the more recent period, from the start of the Euro: “When considering the period after 1999, this overall picture worsens for Greece and Portugal and improves for Ireland. Moreover, the results for Ireland and Spain are driven by the financial crisis period. In particular for Ireland, the decoupling dynamics of the government spending reflects the support to the financial sector. In fact, when considering the pre-crisis EMU period between 1999 and 2007, the threshold for fiscal adjustment in Ireland and Spain are estimated to be positive; namely, the regime change took place when the budget balance was in surplus. Conversely, the fiscal deficit-to-GDP thresholds estimated at 5.32% for Greece and 4.08% for Portugal remained rather high.”

The above basically boils down to the following: since 1999, growing economies of Ireland and Spain allowed two countries to substantially reverse pro-cyclicality of deficits and significantly reduce thresholds for budgetary actions. This did not happen in Greece and Portugal. While Ireland gets a pat on the back for pre 2007 period, it is hardly unique in this achievement.

But despite the gains of the 1999-2007, things did not change all that much within the structure of deficits and adjustments. So per ECB paper “Looking at the effects of the economic cycle, we find that fiscal deficit-to-GDP ratio was not reduced in Greece, Ireland and Portugal with the improvement in economic activity. Consequently, during the contractionary times, fiscal corrections became more costly, as tax adjustments became a priority in an attempt to restore fiscal discipline.”

In other words, we were not unique in the way we handled the underlying structure of public spending imbalances, despite having substantially reduced the fiscal action thresholds.

But may be during the peak of the crisis we widened up? Indeed, ECB offers some positive evidence in this direction, but it also argues that the same took place in Spain and Portugal. “The results also suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed in Ireland and Spain, while it was reduced in Portugal. By relaxing the fiscal deficit-to-GDP threshold (in an attempt to stave off deep recessionary pressures) Ireland and Spain relied on business cycle improvements to raise tax revenues. Given the tendency by Portuguese authorities to improve the fiscal imbalances during a financial crisis, these figures make sustainability concerns for Ireland, Portugal and Spain less of an issue compared to Greece, in an historical perspective.”

Which, once more, does not really identify Ireland as a ‘unique’ case amidst the imprudent (but learning) peripherals.

“The results …suggest that during a financial crisis the fiscal deficit-to-GDP threshold was relaxed from 5.10% to 6.99% in Ireland and from 3.12% to 4.00% in Spain, while it was reduced from 3.22% to 1.92% in Portugal.” In other words, Irish Government thresholds actually worsened in the financial crisis, albeit most of that worsening is attributable to the Government decision to rescue Irish banks.

Overall, as table below illustrates, Ireland has managed to perform best during 1999-2007 period in fiscal adjustment thresholds terms, while Spain was the overall best performer in 1999-2013 period and over the entire sample.

My handy addition to the chart are red boxes (highlighting worst performers) and green boxes (best performers) when it comes to budgetary adjustment thresholds.

This completes the arguments about Ireland’s alleged uniqueness as an outlier to the group of peripheral states: with exception of the period during which our property and financial sectors bubbles were inflating to unprecedented proportions, Ireland was pretty much a ‘normal’ peripheral state when it comes to fiscal management. Celtic Tiger et al…

So let's hope the latest Budget 2016 does not return us back to the historical record track...

17/10/15: Let’s talk about the Law of Small Numbers

Wonkishly awesome, folks…

Let’s start with a set up

You decide to will flip a coin 4 times in a row and record the outcome of each flip. After you done flipping, you look at every flip that “immediately followed an outcome of heads, and compute the relative frequency of heads on those flips”.

“Because the coin is fair, [you] of course expect this empirical probability of heads to be equal to the true probability of flipping a heads: 0.5.”

You will be wrong. If you “were to sample one million fair coins and flip each coin 4 times, observing the conditional relative frequency for each coin, on average the relative frequency would be approximately 0.4.”

Two researchers, Joshua Miller and Adam Sanjurjo “demonstrate that in a finite sequence generated by i.i.d. [independent, identically distributed] Bernoulli trials with probability of success p, the relative frequency of success on those trials that immediately follow a streak of one, or more, consecutive successes is expected to be strictly less than p, i.e. the empirical probability of success on such trials is a biased estimator of the true conditional probability of success.”

Which implies

So far, pretty innocuous from the average punter perspective. But wait. “While, in general, the bias does decrease as the sequence gets longer, for a range of sequence (and streak) lengths often used in empirical work it remains substantial, and increases in streak length.” In other words, while empirical probability does approach closer and closer to true conditional probability, it does so in trials so large (so many coins flips) that such convergence does not make much of the difference in our, human, decision making.

And that is pretty pesky for the way we look at probabilistic outcomes and make decisions based on our expectations, whenever our decisions are sequential.

Impact on decision making

“This result has considerable implications for the study of decision making in any environment that involves sequential data”. These implication are:

1. This provides “a structural explanation for the persistence of one of the most well-documented, and robust, systematic errors in beliefs regarding sequential data—that people have an alternation bias (also known as negative recency bias)… — by which they believe, for example, that when observing multiple flips of a fair coin, an outcome of heads is more likely to be followed by a tails than by another heads;
2. It also helps resolve “…the closely related gambler’s fallacy…, in which this alternation bias increases with the length of the streak of heads.”
3. “Further, the result shows that data in the hot hand fallacy literature …has been systematically misinterpreted by researchers; for those trials that immediately follow a streak of successes, observing that the relative frequency of success is equal to the overall base rate of success, is in fact evidence in favor of the hot hand, rather than evidence against it.”

And tangible applications are

So the realisation that “the empirical probability of success on such trials is a biased estimator of the true conditional probability of success” helps explain why “…the inability of the gambler to detect the fallacy of his belief in alternation has an exact parallel with the researcher’s inability to detect his mistake when concluding that experts’ belief in the hot hand is a fallacy.”

But there is more. Per authors, “the result may have implications for evaluation and compensation systems. That a coin is expected to exhibit an alternation “bias” in finite sequences implies that the outcome of a flip can be successfully “predicted” in finite sequences at a rate better than that of chance (if one is free to choose when to predict).”

They offer the following example of this: “suppose that each day a stock index goes either up or down, according to a random walk in which the probability of going up is, say, 0.6. A financial analyst who can predict the next day’s performance on the days she chooses to, and whose predictions are evaluated in terms of how her success rate on predictions in a given month compares to that of chance, can expect to outperform this benchmark… For instance, she can simply predict “up” immediately following down days, or increase her expected relative performance even further by predicting “up” only immediately following longer streaks of consecutive down days.”

Going back to the first example with coin flipping, the law of large numbers implies that as your sampling size (number of coin flips) rises, “…the average empirical probability of heads would approach the true probability. The key to why this is not the case, and to why the bias remains, is that it is not the flip that is treated as the unit of analysis, but rather the sequence of flips from each coin. In particular, if [you] were willing to assume that each sequence had been generated by the same coin, and [you] were to compute the empirical probability by instead pooling together all of those flips that immediately follow a heads, regardless of which coin produced them, then the bias would converge to zero as the number of coins approaches infinity.”

What this means is that “…in treating the sequence as the unit of analysis, the average empirical probability across coins amounts to an unweighted average that does not account for the number of flips that immediately follow a heads in each sequence, and thus leads the data to appear consistent with the gambler’s fallacy.”

Per authors, “the implications for learning are stark: to the extent that decision makers update their beliefs regarding sequential dependence with the (unweighted) empirical probabilities that they observe in finite length sequences, they can never unlearn a belief in the gambler’s fallacy…”

Overall, we have

To sum this up, the authors found “a subtle but substantial bias in a standard measure of the conditional dependence of present outcomes on streaks of past outcomes… The mechanism is a form of selection bias, which leads the empirical probability …to underestimate the true probability of a given outcome, when conditioning on prior outcomes of the same kind. The biased measure has been used prominently in the literature that investigates incorrect beliefs in sequential decision making --- most notably the Gambler's Fallacy and the Hot Hand Fallacy.”

The two fallacies are defined as follows:

• “…People believe outcomes alternate more than they actually do, e.g. for a fair coin, after observing a flip of a tails, people believe that the next flip is more likely to produce a heads than a tails. Further, as a streak of identical outcomes increases in length, people also tend to think that the alternation rate on the outcome that follows becomes even larger, which is known as the gambler’s fallacy”.
• “The hot hand fallacy typically refers to the mistaken belief that success tends to follow success (hot hand), when in fact observed successes are consistent with the typical fluctuations of a chance process.”

After correcting for the bias, the authors show that “the conclusions of some prominent studies in the literature are reversed.” Awesomely wonkish...


Full paper: Miller, Joshua Benjamin and Sanjurjo, Adam, Surprised by the Gambler's and Hot Hand Fallacies? A Truth in the Law of Small Numbers (September 15, 2015). IGIER Working Paper #552. http://ssrn.com/abstract=2627354

17/10/15: ‘Dream Wedding’ Fairy Tales

Working through some papers, I just came across this now nearly classic, but still recent study that I wanted to share with you ages ago, but somehow forgot. So here it is - a brilliant example of empirical economics at its most interesting edge:

The paper evaluates “the association between wedding spending and marriage duration using data from a survey of over 3,000 ever-married persons in the United States.”

Stats informing this study objective are frightening: “In 2014, wedding industry revenues are projected to exceed $50 billion in the United States. According to a national survey conducted annually by the top wedding website TheKnot.com, the average wedding cost was $29,858 in 2013… In 1959, Bride’s recommended that couples set aside 2 months to prepare for their wedding and published a checklist with 22 tasks for them to complete. By the 1990s, the magazine recommended 12 months of wedding preparation and published a checklist with 44 tasks to complete.” Presumably, humanity lost count of months and tasks required to execute a fairytale wedding since then. But, “in 2012, total expenditures on diamond rings were roughly $7 billion in the United States.”

But is any of this ‘happiness industry’ working? “Overall, we find little evidence that expensive weddings and the duration of marriages are positively related. On the contrary, in multivariate analysis, we find evidence that relatively high spending on the engagement ring is inversely associated with marriage duration among male respondents. Relatively high spending on the wedding is inversely associated with marriage duration among female respondents, and relatively low spending on the wedding is positively associated with duration among male and female respondents. Additionally, we find that having high wedding attendance and having a honeymoon (regardless of how much it cost) are generally positively associated with marriage duration.”

Per authors summary: “The wedding industry has consistently sought to link wedding spending with long-lasting marriages. This paper is the first to examine this relationship statistically. We find that marriage duration is either not associated or inversely associated with spending on the engagement ring and wedding ceremony.” Or in other words, you might be able to buy your way into marriage, but you are unlikely to buy your way into a happy union.


Full paper: Francis, Andrew M. and Mialon, Hugo M., ‘A Diamond is Forever’ and Other Fairy Tales: The Relationship between Wedding Expenses and Marriage Duration (September 15, 2014): http://ssrn.com/abstract=2501480. Note, the paper has been since published in the Economic Inquiry (Volume 53, Issue 4, pages 1919–1930, October 2015).

16/10/15: Euro Area Inflation, via Pictet

An interesting chart highlighting the poor prospects for inflationary expectations in both Euro area and the U.S. via Pictet:

5yr/5yr swaps are basically a measure of market expectation for 5 year average inflation starting from 5 years from today, forward (so years 6-10 from today). This is a common referencing point for the ECB technical view of inflation expectations, and as the above clearly shows, we are heading for testing January 2015 lows.

Here’s Picket analysis (comments and emphasis are mine): “In September, headline inflation in the euro area dipped back into negative territory (-0.1% y-o-y) for the first time in six months.

"This weakness must be put into context though as it is primarily due to the steep slide in energy prices. If volatile components (food and energy) are stripped out, core inflation was steady at +0.9% y-o-y. Furthermore, prices of services, which better reflect domestic conditions, rose.

"Nonetheless, falling commodity prices, coupled with the rise in the euro’s trade-weighted value, caused the inflation outlook to worsen. Long-run inflationary expectations, as measured by the break-even swap rate, have been softening steadily since early July and have now reached their lowest level (1.56%) since February this year.

…In parallel, findings from economic and business surveys (PMIs, European Commission surveys) for the third quarter showed decent resilience despite the worries about the Chinese economy. They point to GDP growth of around 0.4% q-o-q in Q3 and Q4.”

Picket projects growth of 1.5% y/y for 2015, “led by domestic demand” that is expected to “continue to benefit from normalisation of the jobs market, subdued inflation, the gradual revival in consumer confidence and an upturn in lending to the private sector.”

In short, sensible view of inflation - low inflation, per Pictet is helping, not hurting the euro economy.

16/10/15: IG Conference: Markets Outlook

My speaking points on the topic of the Markets Outlook for yesterday's IG conference:

Short themes:

Theme 1: Markets pricing in advanced economies: 

- EV/EBITDA ratios signal overvaluation; 

- EBITDA/Interest Expenses ratio is at below 2010 levels (below 14%) despite extremely cheap debt.

A handy Bloomberg chart:

- Global debt cycle has turned – sovereigns are not leveraging as fast or deleveraging, but corporates leveraged up. 

- Much of pricing today reflects migration from equity to debt

- In this environment – long only allocations are problematic.

Theme 2: Emerging markets, especially BRICS

- Idea of 3rd Wave – Goldman’s thesis – is based on two drivers: duration of the crisis (‘this can’t be going for so long…’) and firewalls (‘this can’t spill into the developed economies…’) both of which are 

- There are no fundamentals to support robust recovery view

- Again, allocations are highly problematic.

So short-term summary is poor when it comes to hard numbers:

- World economic growth for 2015-2017 forecast is down from 14.1% in 2012 to 10.9% today

- Euro area economy forecasts are flat: 5% in 2012 and 4.9% today, holding relatively steady compared to the rest of the world solely because Europe is now Japanified

- Advanced economies down from 8.1% to 6.6% - another miserably Japanese-styled performance compared to past averages

- Emerging and developing economies from 19.55 in 2012 to 14.0%.

On inflationary targets and rates: the only way we are going to get to the inflationary expectations consistent with monetary policy normalization, is by literally superficially jacking up prices through Government controlled sectors and/or via regulatory policies. Which is to say that any inflation above, say 1% or so in the Advanced Economies, today, will be consistent with stripping income out of the economy to prime up financials (in the short run) and public purse.

Longer themes:

As much as I love the good story of innovation and technological revolutions, I am afraid to say my fear is that we are heading for the twin secular stagnation scenario:

Supply side stagnation: 

- Technological returns (productivity growth and new value added) are tapering out

- Substitutability of labour is rising and with it, risks to economic systems

- Regionalisation of trade and production are gaining ground and markets fragmentation is going to play a disruptive havoc with our traditional market valuations

- So expect more volatility on flatter trend.

Demand side stagnation: 

- Demographics 

- Savings/investment imbalances, 

- Debt overhang – across both advanced economies and, increasingly also, emerging markets, so we have a Myth of Post Financial Crisis Deleveraging (via BAML)

Global Debt to GDP

2010-2015: 220 to 240%

2000-2010: 190 to 200%

1990-2010: 170 to 190%

Or a handy chart

- Wealth and income inequalities, including intergenerational effects

- Rebalancing of economic growth drivers (human capital focus pushes incomes gap wider and deeper, but also clashes with current taxation and political systems)

Key forward is to expect:

- Flatter growth trend and more volatility around that trend 

- Higher volatility / instability in higher moments 

- Financial imbalances accelerating and amplifying

- Financial imbalances / cycles leading real cycles (Excess Financial Elasticity hypothesis)

- Economic volatility spilling, increasingly, into political volatility (political economy). 

Key strategy points:

- Focus on lower debt levels on companies balance sheets

- Focus on companies actually paying attention to core basics, e.g. earnings, sales, profit margins, as opposed to subscription bases, user counts etc

- Focus on companies with strong regional reach (not only in product markets, but in logistics and production bases)

- Focus on companies with revenues linked to multi-annual contracts

- Go defensive, stay defensive in core allocation

- Go speculative with low leverage only and on a small share of total wealth

- Go speculative trades on uncertainty and long 5-10 percentile under-performers

16/101/5: Millennials: A Power Poverty Gap?

Having discussed the plight of the Millennials' Generation in global context on numerous occasions, I am too familiar with the problems faced by the current 'younger' middle of demographic pyramid. Hence, not surprisingly, I found this article http://www.independent.ie/opinion/ireland-forces-young-people-to-delay-lifes-milestones-31599496.html to be quite a reasonable summation of the modern reality in which the current younger generations can no longer expect to have better quality of life (measured by more traditional metrics) than their predecessors.

I will ignore the set of prescriptive policies at the end of the article - some make sense, others largely represent well-intentioned economic sentimentality. But the key issue is an important one.

And here is a counter-part piece on the Millennials trends in the U.S.: http://www.nielsen.com/us/en/insights/reports/2015/millennials-in-2015-financial-deep-dive.html.

16/10/15: Gold and Bitcoin: Adjacency and Hedging Properties

This week, I spoke at a joint Markets Technicians Association and CAIA seminar hosted by Bloomberg, covering two recent research projects I was involved with on the role of Gold and Bitcoin as safe havens and hedges for other assets.

Here are my slides (omitting section division slides):

The first section was based on the following paper: http://www.sciencedirect.com/science/article/pii/S1057521912001226

A caveat to the above, we are seeing increasing evidence that Gold's hedging properties may be changing over time, especially due to increased financialisation of the asset. In this context, it is worth referencing a recent working paper by Brian M. Lucey et al linked here that I also cited at the seminar.

The Bitcoin section is based on a work-in-progress paper with Cormac Ennis: "Is Bitcoin like Gold? Hedging and Safe Haven Properties of the Virtual Currency". The results of presented below should be treated with serious caution as they are extremely preliminary.

Note: we are extending data set to cover longer period, although even with this extension data coverage for Bitcoin is still suboptimal in both duration and quality. Many thanks to the seminar participant for pointing out two key caveats to the overall data coverage:

1. The 'lumpy' nature of demand around Cypriot banking crisis; and
2. Potential effects on data quality reported for Bitcoin from a small number of high profile pricing events, such as technical glitches and supply/demand shifts linked to large exchanges-linked events (e.g. MtGox).

 Summarising the two papers findings:

16/10/15: Finance@Google 2015

Few weeks back I was taking part in the Finance@Google 2015 conference covering a range of topics from the future trends in Financial Services to more current / shorter-term aspects of the markets for Financial Services (Banking, Insurance and Online Aggregators, amongst a range of other services).

Here are two videos of my presentations:

First: my presentation "Finance at the End of Old Norms" - link here.

Second: my interview "Excuse the Interruption: Financial Expert in the Spotlight" covering a wide range of questions relating to the evolution of Financial Services - link here.

16/10/15: How to Write Perfect Vacuum

Here is one rare occasion where, simultaneously,

1. An academic achieves a certain degree of notoriety laying a claim to authoring just one working paper that no one have seen; and
2. An academic achieves completeness of an argument by not publishing the only paper he claims to have authored that no one have seen.

Consider the following posting on the SSRN site:

Can Philosophy Be Justified in a Time of Crisis?

Nathan J Robinson 

Harvard University

September 3, 2015

Abstract:      

In this paper, I take the position that a large portion of contemporary academic work is an appalling waste of human intelligence that cannot be justified under any mainstream normative ethics. Part I builds a four-step argument for why this is the case, while Part II responds to arguments for the contrary position offered in Cass Sunstein’s “In Defense of Law Reviews.” First, in Part I(A), I make the case that there is a large crisis of suffering in the world today. (Part I does not take me very long.). In Part I(B), I assess various theories of “the role of the intellectual,” concluding that the only role for the intellectual is for the intellectual to cease to exist. In Part I(C), I assess the contemporary state of the academy, showing that, contrary to the theory advanced in Part I(B), many intellectuals insist on continuing to exist. In Part I(D), I propose a new path forward, whereby present-day intellectuals take on a useful social function by spreading truths that help to alleviate the crisis of suffering outlined in Part I(A).

And that's it. 

Point (1). There is no paper enclosed. And I cannot locate a paper anywhere on the web. The author does not seem to have written a single published paper / article / book chapter prior to that with exception of a children's book or beyond a handful of non-academic articles on matters of interest and subject depth of the Huffington Post. The author does not seem to have any specialisation in the subject matters covered in the abstract. 

Point (2). The abstract is bold. But the abstract is also self-contained: if the unique role of an intellectual is to spread "truths that help to alleviate the crisis of suffering", then the role of an intellectual does not include publication of research on themes unrelated to the topic of "alleviating the crisis of suffering". In other words, to complete his own argument by own example, Mr. Robinson is required not to publish his own paper. Which he does. 

And the world is going gaga over a non-published and not-available-anywhere paper... Which is to say, simply, the Huffpo intellectuals go shrill for an abstract. 

Chill, folks... it all might just be a student prank, or a poorly executed attempt at discovering the next Theory of Justice, or neither...or it might just be the denouement to intellectualism: a falsifiable statement that no one will ever be bothered to falsify because... err... it is already refuted by the very existence of an abstract in absence of a paper...

But, really, can we have a paper, Nathan?.. Please, pretty?..

15/10/15: Budget 2016: Tech & Entrepreneurship Perspective

My take on the Budget 2016 from the perspective of tech sector: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

And more of the discussion of the Budget from technology sector and entrepreneurship perspective here: https://www.siliconrepublic.com/video/dr-constantin-gurdgiev-on-budget-2016-stimulating-consumption-by-taking-credit-card-on-future

Thanks to @iia for hosting the event and to the Silicon Republic for putting the discussions into broader public domain.

I covered the Budget in broader setting of economy-wide entrepreneurship and start ups formation here: http://trueeconomics.blogspot.ie/2015/10/141015-there-isnt-ireland-without-mnc.html.