From: John Mauldin [mailto:wave@frontlinethoughts.com]
Sent: 25 April 2009 06:01
To: Borjabrela
Subject: Back to the Future Recession - John Mauldin's Weekly E-Letter (Excerpts)
MV=PQ. This is an important equation, right up there with E=MC2. M (money or the supply of money) times V (velocity -- which is how fast the money goes through the system -- if you have seven kids it goes faster than if you have one) is equal to P (the price of money in terms of inflation or deflation) times Q (roughly standing for the Quantity of production, or GDP).
So what happens is, if we increase the supply of money and velocity stays the same, and if GDP does not grow, that means we'll have inflation, because this equation always balances. But if you reduce velocity (which is happening today) and if you don't increase the supply of money, you are going to see deflation.
We are in the middle of a Great Experiment, the one truly great experiment of this time; so the economists are fascinated. We have Keynes versus von Mises versus Irving Fisher versus Friedman, and they all have theories about what you should do after depressions and what works.
Let's get back to our discussion of the Great Experiment. Von Mises said there is nothing you can do about a deleveraging cycle, you basically just let it all go to hell and then pick up the pieces. The hair-shirt economists, I call the Austrians: just let it drop, take your medicine, take your 15-20% unemployment, and just deal with it, because you'll be able to come back faster from the lower base. By the way, to von Mises, the velocity of money was a meaningless concept. Gold was where you should have had your money to begin with.
Then there is Friedman, who produced his great work that says inflation is always and everywhere a monetary phenomenon. He had his studies to prove it. But when he did his studies, in the 30 years that he analyzed, the velocity of money was remarkably stable. So of course, inflation had a 1-to-1 correlation with money supply.
Fisher says, "The velocity of money is important." For Fisher, debt deflation controlled all other economic variables. It was the driving economic force. You're going to have to rationalize all your debts. There's nothing you can do about it; but what you do is, do as much as you can to provide a soft landing for the people who lose their jobs. Do whatever you can to get them along and to keep the system working, but you are still going to have to go through a credit reorganization. We are going to find out in 5-6 years who was right. That is the experiment we are living through. My bet's on Fisher, just for the record.
So how did we get it so wrong? How did we get here? Let's go back to first principles: Ideas have consequences. And bad ideas tend to have bad consequences. We've taught two generations of financial managers theories that were patently absurd. Rob Arnott is going to be here later with us for the panel discussion. Rob recalls standing in front of 200 academics, professors in schools that teach economics. He asked them, "How many of you believe in the efficient market hypothesis?" Something like two or three raised their hands. "How many of you teach it?" All of them raised their hands.
The future is going to look different, yet we think we can model it. The models are bullshit. (That's a technical economics term that requires advanced degrees to use.) They just are. Now you can take some comfort from them, and you have to try and figure stuff out, and you look for correlations. That's what I do, and we all do that. I confess I use models every day.
Good letter from John Mauldin.
I disagree with the bashing of the efficient markets hypothesis. In my opinion the Market (which is the grouping of all people who can enter into voluntary transactions) is the largest group of human beings that can be formed and achieves optimal efficiency in the LONG RUN. The issue is to try and model the short future with the efficient markets hypothesis because the behavioural markets hypothesis (carrot and stick markets) may work in the SHORT RUN.
MV = PQ formula seems correct. The solution to the current economical problems is accountability as usual. No one wants to be responsible for the wrong amount of M and lots of hypocresy exists around the increase of P (the largest theft in History). So let private suppliers of money which pay for their own mistakes supplying money (excessive credit or random price movements) and you will most likely get a stable P and an appropriate M.
Love and freedom.
3 comments:
If markets are efficient, why do companies spend so much money on brand? I have on my desk a bottle of evian water, it cost me £1 an astronomical multiple of the near perfect substitute of tap water. It exists, and I purchased it, merely because it's brand appeals to my lifestyle choices and my perception of myself. In no way, in either the amount of packaging it uses or the distance it has travelled, could it be considered the most efficient solution.
The point about efficient market hypothesis is this, even collectively, mankind is capable of acting irrationally and against their own self interest. From the major world religions to alternative medicines, to totalitarian ideologies and quack medicines examples predominate of whole populations who ignore available evidence to act deliberately to their own detriment. I don't mean to imply that human beings are completely irrational either - in most situations in which the required information is available and simple to understand and in the absence of obscuring ideologies such as religion or branding you can be assured of the selection of the best solution. The point therefore is this - trust in the market is necessary but not sufficient, checks and balances on it's extremes of behaviour are required both by the elected representatives of a democracy and a technocratic portion of society with skills and knowledge in excess of the general public.
I'm reading Hayek's 'Denationalisation of Money' at the moment and I'll let you know what I think of the private supply of money when I've finished.
Adam
You are absolutely right in the points you make about the mankind. As I usually say, my father and I lost our trust in mankind long ago.
As I told you most discussions occur because people are talking about different things and the first thing they should do is defining the concept their debating. Here you argue against the "efficiency" concept thinking it implies "all rational, perfect, know-it-all decisions". Nein!! Efficiency for a process simply means that that process achieves objectives using the resources better than anything else that exists at the same time. Even though you may think of other more efficient processes in theory, but that cannot be built at that time.
No one is saying the Market is God, I am saying that the Market maximises the probability of achieving the optimal efficiency for the simple reason that it is the largest group of minds thinking. And whatever you think, there will be no sub-group of self-called leaders, technicians, policy-makers or priests that can equal the Market. Because the Market is the whole Mankind when it is let to act voluntarily (which never happens because of the so-called governments spoil their actions).
Mankind is capable of acting irrationally and against their own self-interest; granted. But also individuals as you show with your bottle of Evian. But that is a decision you have taken yourself. There is nothing above that. You have your internal motivations and take your own decisions and the sum of 7 billion decision-makers will always be better than 20 decision-makers in the G20 as it has been clearly shown in the mismanagement of this crisis. The Spanish prime-minister recognised that they don't know about economy; however, he takes the economic decisions according to his socialist ideology (and that is why Spain is going down the cliff).
With the additional inconvenience that individuals can be evil and unfair as well. So are you telling me that I should put more faith in 20 guys rather than in 7 billion guys? No way. I DO NOT TRUST PEOPLE, and that is why I want to put in place the highest amounts of checks and balances that be possible: GIVE THE POWER TO 7 BILLION PEOPLE SO THEY CAN CHECK THEMSELVES, not to 200 hundred more clever than the average.
The crisis are caused by the market functioning with the flawed rules and distortions of the circumstances that those 200 policy-makers and technocrats "with knowledge in excess of the average" put in place. That is why it isn't efficient. However constrained, the market has shown perfectly in this crisis that it can rectify quickly and purge the bad investments. And it has been the intervention of the governments what it has made impossible to do that well (socialisation of losses, nationalisation, whimsy action, more price distorsion with money-printing initiatives, lobby-led stimulation).
When families have found they have too much debt, they have immediately done the sensible thing: rein in their consumption and save more. What does the governments (policy-makers and technocrats "cleverer than the average") do when they have found debt is unmanageable? Spend more and get more indebted, because some intelligent guy in Cambridge proposed a discredited theory that suits them to increase their power. And you are asking me to trust them? Hahahaha, keep dreaming, Adam!
Spanish people may not be able to count beyond 20, but the combined experience and intelligence of the 45 million Spanish souls is a lot more than Keynes, Hayek, and whoever else you want to add put together.
My argument was not one for misanthropy, you might have lost faith in mankind, but I still retain a belief in man's capacity for moral, intellectual and material progress. My definition of efficiency requires neither infallibility nor omniscience and I'm happy to use your definition, and so it is clearly seen that my bottle of water doesn't "achieves objectives using the resources better than anything else that exists at the same time.", this is a market supplied solution and not one that is likely to fail as long as it's brand continues.
I'd like to point out that I'm not advocating outright technocracy in place of your free market anarchism, but It simply isn't true to say no sub-group could out perform the market. The market on-mass has marched into mania with ordinary people seeing no reason not to leverage themselves up to the hilt and only a sub-set of economists predicting disaster. 20 Vince Cables would have outperformed 7 Billion in the management of world finances, but that doesn't mean I would have passed complete control to my 20 Vince Cables. The market does tend to produce the best result, but is also prone to manias of excess (and would be even in the complete absence of government intervention) and so the power to intervene and regulate is required by our elected representatives and their appointed bodies. This of course requires bodies with clear statements of belief and standards of academic rigour, if you think this impossible outside of private institutions then I would invite you to consider the nature of Oxford and Cambridge university.
On your point about Spain not fairing well in the current economic crisis, it doesn't seem to be only left wing countries that are suffering...
I disagree with your assertion that government law makings is ultimately responsible for the present crisis, there is enough blame to go round and markets, government and the public all have to shoulder some of the burden. It is true that the market did show that it could react quickly, not by purging itself of bad investments, but by the complete loss of the necessary financial sector. Without government intervention we would not be facing not a recession but a depression, look at the failure to recapitalise after 29 and what happened there.
I haven't time to debate Keynes's, but I would point out that he was discredited before this financial crisis and was resurrected when he was found necessary. I think it unlikely a magnification of their power is the reason government spending has increased, the national debt here is now a major news story and likely to cost the labour government votes - the government has often tried to everything it can to avoid increasing the national debt for this reason.
Won't have time to reply again today but feel free to email back. :)
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