Animal Spirits: A notion of Keynes that implied that the willingness of businessmen to take risk was unpredictable and somewhat irrational, leading to booms and busts.? I don’t agree, at least not entirely, but first a word about rationality and economics.
Thinking hurts, at least for most people.? It takes effort, which is why people conserve on doing it.? Instead, they substitute “shortcuts” for thinking that may have some plausibility.
- This has worked in the recent past, so it should work in the near future.
- My friend Fred has done this, and it has worked for him, so it should work for me.
- James Cramer (or Warren Buffett, or fill in your favorite expert, even me) thinks this will work wonderfully, so I will do it as well.
- Everyone is doing this and doing well.? I have missed out on it in the past, so I better get going now.
- The academics say you can’t succeed at beating the market, so I won’t try to do so.
- I’ve read some books on investing, and there is a really simple formula for beating the market.? I’ll follow that method.
- No one hedges that risk, so I won’t either.? The risk can’t be that large.
- The government has always been capable of dealing with economic troubles; they should be capable of dealing with this one as well.
Though my examples come from investing, they apply to other areas of business, finance, and life generally.? Few people like to go back to first principles to think through a problem.? Many follow the crowd, or so-called experts.
As an aside, because people don’t like to think hard, they don’t optimize, as the neoclassical economists posit.? Instead, they choose solutions that they deem to be “pretty good,” and stop their searching.? Searching is a cost.? But neoclassical economists insist? that consumers maximize utility and producers maximize profit anyway.? Why?? If they don’t assume that the math doesn’t work, and they can’t publish something that looks semi-scientific.
Crowd-following is common to humanity.? It takes a lot to stand apart from highly correlated behavior.? I’ve told this story before, but in late 1999, I was talking with my mother (a very good self-taught investor), she told me about many of my cousins who were speculating in tech stocks.? I said to her, “They don’t know anything about investing!”? My mom replied, “Oh, David.? You’re such a fuddy-duddy.? I just bought some Inktomi!”
Now, to set the record straight, that was just 1% (or less) of my mom’s assets, so an occasional flyer is acceptable.? Call it “Mad Money.”? ;)? For my cousins, it was most of their investable assets.? My mom is fine, and the fuddy-duddy did all right also, but the cousins swore off stock investing.
I saw the same thing with people in their 401(k)s and other DC plans in 2002 — no more investing in equities.? Real estate was the place to be. Buy what you know, and residential real estate always goes up.
Before I continue with the residential real estate example, here are two questions I ask in order to decide whether a course of action makes sense:
- What if everyone did this?
- What is the current risk-adjusted free cash flow yield?
The first point should make you remember that any smart strategy can be overdone.? Any business can be overlevered, etc.? We can ask questions about market size, profit capacity and other things to try to determine what a speculative stock or industry could potentially be worth in the long run.? The same thing is true on the bear side — almost everything has some value even in bear market phases.
The second point has value as well.? I use an equation like this:
Free Cash Flow Yield + Necessary Capital Gains Yield = Funding Yield
or:
Necessary Capital Gains Yield = Funding Yield – Free Cash Flow Yield
By necessary capital gains yield [NCGY], I mean what is needed to keep an asset whole.? During “normal times” the NCGY is negative by some amount that reflects the normal risk margin for the asset class.? Near the peaks of bull markets, NCGY goes positive.? Think of real estate investors having to feed their properties.? Rents less expenses are less than the mortgage payments.
At the depths of bear markets, both free cash flow yields and funding yields rise considerably, but the FCF yields more so.? Few are investing, because they are looking through the rear view mirror at the past losses.
Eventually, some enterprising sorts that don’t care about convention see the large negative NCGY, and start putting money to work.? The cycle starts to turn, and things begin to normalize, or at least, begin the next cycle.
-==–=-=-==–=-=-=-=-==–==–=-=-=-=-=-=
By believing in limited rationality for men, and recognizing the boom-bust cycle, do I come to the conclusion that Keynes did about animal spirits?? No, I don’t.? Businessmen may follow trends, but enough of them pay attention to the NCGY of their businesses that they know when future opportunities are good or bad.
In that same sense, if our government is trying to get economic behvavior to “normalize,” perhaps it should look at the constraints that businesses/consumers live under, and ask what could be done to change things.? It is not so much a question of animal spirits, as where people find that they have an advantage.
At this point, where so many find themselves hemmed in by debt, demand falls, and the economy suffers.? Perhaps an approach similar to what Barry Ritholtz has proposed would be useful.? Give each household a voucher that can only be applied against debts.? The indebtedness of the private sector will decline.? Their willingness to spend will rise.? Overleveraged households delever; underleveraged households spend more; the US is that much more indebted.
Though it may seem unduly populist, giving money to each household solves two problems: it reduces household debt problems, and it also reduces credit stress at the banks.? What could be better in this environment?
what happens to the average families grocery bill if .gov prints an amount meaningful enough to impact?
There is no free lunch, and this risks no lunch for many.
Now we place the “radioactive risk” right in basic necessities with your idea. This gives new meaning to the term “hide the sausage.” Indeed, from people who want to eat.
Please address these real world issues at the same time you suggest a print of helocopter money.
I NEVER read from those that support a direct print and handout an aggressive and detailed analysis of its ramifications.
If you disagree, I appreciate a comment detailing and defining the social risks to gifting free money in an amount that has meaningful impact on this massive problem and your rebuttal to them.
It is a pet peeve of mine when I hear ideas like this that fail to address the “other side of the trade”.
I understand emotionally where your coming from and I appreciate that. I have great emotional pain over whats happening right now. I have trouble sleeping, literally.
I rather see .gov stop propping up a failed economic model that naturally -like water running downhill- wants to self immolate. I rather go with it, get ahead of the curve, and create a Phoenix.
I much prefer .gov insure all bank deposits, period. Of any amount. Protect the core for social and financial cohesion. Create communal living areas across the country in every county where jobless and or homeless have their basic needs met: food, water, shelter, clothing, and cleanliness. <—This is .govs real social contract with its people. Avoiding this fosters risk of social disolution through ramping societal acrimony/disillusionment. Include some kind of job/worker program at this site to help coordinate work with local businesses. Remove/dissolve any stigma associated with these living centers.
.Gov works with the heads of VC firms and other real entreprenurs to develop national job retooling and rethinking of our economic model. VC firms are at the germination stage of business. What an excellent tool. .Gov go visit the guys out on Sand Hill Road in Stanford/Woodside, CA.
Lastly, .gov and g7 stop with the free trade bull****. So long as China fails to revalue its currency, protect the environment, and pay above a slave labor wage, the US cannot compete. I am tired of buying foreign at the expense of 4.5M US manufacturing jobs lost over the past seven years. I rather my money go to helping american jobs as this deflationary depression tightens its grip on the US economy. So I buy American now.
Rant/discussion off.
All this will fail to happen. .Gov does everything to fix our FIRE based Humpty Dumpty economic model. Its behind the curve and most sadly and dangerously, it leaves out in the cold the “societal contract” to save its sclerotic, kleoptocratic and pseudo-oligarchic power stucture. I clearly see the societal risk that grows from this – the societal black swan as a fractal/mirror/aftershock of the financial/economic black swan gaining strength now.
I disagree with your solution of free money. I added some other suggestions of my own for color. However, they can add complexity to any discussion you may wish to undertake. If you like to just stick with the print/food issue. I am happy to stay there.
I greatly appreciate your blog. I read it daily among 25 others and its at the top of my list. Your solution struck a nerve with me. So I post to foster a discussion that helps both of us if yu wish to undertake.
Cheers
Tom
Hi David,
Excellent posting as usual. I especially appreciated your comments on behaviour, and the rationality of economic actors.
As for Barry’s proposal, in essence it is a tradeoff: the increased debt burden and interest (at low Treasury rates), compared to the lost utility of society in general if the null hypothesis of doing nothing and letting the deleveraging process work itself out over time.
I can understand the argument: anything that limits Washington’s ability to demonstrate its own special ability to economically suboptimize results and ineffeciently allocate resources is not a bad strategy. But in the end, I still would choose to muddle through, let the process work itself out, and provide the social safety net underneath. And anyways, given your current Administration, best of luck with limiting their desire to meddle in the economy. The voters have spoken…so let them enjoy the consequences.
Thanks for another interesting post.
Steve
you need to read about keynes’s paradox of thrift. In an economy where banks are not lending because of weak balance sheets and consurmers are not spending and therefore the velocity of money is low and the economy weak, the worst macroeconomic policy would be to increase the govt deficit and then give it to consumers only for the purpose of disinvestment….paying down the debt. The multiplier of that will be zero yet the govt debt will go up so all you have done is transfer debt from the govt (which is looking to spend it and stimulate the economy) and giving it to consumers on condition that they not use it for activity that will spur current economic activity. So more govt debt + no increase in economic activity= less tax revenues in the future= more govt debt. Given the level of household debt, the number of foreclosures and the number of people with next to no equity in their homes the likelihood such a grant would repair household balance sheets enough to spur spending is next to zero. If the goal is to stimulate the economy in the near term this is about as far from occams razor as you could get
“Businessmen may follow trends, but enough of them pay attention to the NCGY of their businesses that they know when future opportunities are good or bad.”
this is just another formulation of the efficient market thesis and if true it would mean that all stock prices reflected rational estimates of future financial performance and there would be no booms or busts. I’m with Schiller and the behavioralists on that one,
So if we know this assertion is questionable when it comes to liquid financial markets where transactions are costless why would we think individual businesses, with sunk costs, bureaucracies, illiquidity, imperfect information, and high transaction costs to make major changes in strategy would be any more rational (GM, Kodak, Pan Am Time Warner, Sirius XM, citi, bear, indy mac etc etc etc ) would make decisions based on clear analysis of NCGY
i think they call this a kal v’chomer 🙂
>>>Though it may seem unduly populist, giving money to each household solves two problems: it reduces household debt problems, and it also reduces credit stress at the banks. What could be better in this environment?<<)
Seriously, I was intrigued by the story and would love to get the ending. . .