Random Passages I Found On My Phone (2021)

When reading I annotate and highlight.  Depending on the book or subject, the end product might be a book where the front and back cover are completely worn off and most pages have been read and annotated on numerous occasions.

Irrespective of the book or article, I find it useful to have a writing utensil on hand in case I find something of interest. However, there are times when, for some unknown reason, I have found myself without a means of taking notes.  In those times of trouble I have (apparently) resorted to using my phone to take an image of a passage.  At times I have referred back to those passages for purposes of a presentation or an economic update I was preparing, but more often than not, those images have just been lost to time, buried in the depths of the Photos app, beneath pictures of things that are actually important.  Nevertheless, while without Wi-Fi one evening I was digging through these photo's of passages going back to the pandemic and here is what I found (in chronological order and with my commentary in red):  "Aside from movies, examples of positive-Black Swan businesses are: some segments of publishing, scientific research, and venture capital.  In these businesses, you lose small to make big.....In these businesses you are lucky if you don't know anything- particularly if others don't know anything either, but aren't aware of it.  And you fare best if your ignorance lies, if you are the only one looking at unread books, so to speak.  This dovetails into the "barbell" strategy of taking maximum exposure to the positive Black Swans while remaining paranoid about the negative ones.  For your exposure to the positive Black Swan, you do not need any precise understanding of the structure of uncertainty.  I find it hard to explain that when you have a very limited loss you need to get as aggressive, as speculative, and sometimes as "unreasonable" as you can be."  - Morgan Housel Morgan discusses the barbell strategy as saving like a pessimist while investing like an optimist.  Things will work out in the long run, but you have to be able survive the interim period that is chaos, setbacks, recession for your long term optimism to succeed.  Learn the skills to endure risk, rather than completely avoiding risk.  "It was Strong more than anyone else who invented the modern central banker....how they are seeking to strike the right balance between economic growth and price stability, it is the ghost of Benjamin Strong who hovers above him."  - Lords of Finance Learn more about Ben Strong here   "At some level the markets don't make sense anymore. You are playing poker against the man who can make his own chips. It is a very bad idea."  - Unknown I think the moral of the above quote is that the official sector (government and central banks) can have a major impact on markets. "Obviously not all crises escalate to the extreme outcome of a sovereign default.  Yet advanced economies have not been exempt from their share of currency crashes, bouts of inflation, severe banking crises, and, in an earlier era, even sovereign default." "As Diaz-Alejandro narrates in his classic paper about the Chilean experience of the 1970s and early 1980s, "Goodbye Financial Repression, Hello Financial Crash", financial liberalization simultaneously facilities banks' access to external credit and more risky lending practices at home. After a while, following a boom in lending and asset prices, weaknesses in bank balance sheets become manifest and problems in the banking sector begin.  Often these problems are more advanced in the shakier institutions (such as finance companies) than in the major banks.  The next stage of the crisis unfolds when the central bank begins to provide support for these institutions by extending credit to them. If the exchange rate is heavily managed, a policy inconsistency arises between supporting the exchange rate and acting as lender of last resort to the troubled institution...the central bank may be more reluctant to engage in an "interest rate defense" policy to defend the currency than would be the case if the financial sector was sound....The depreciation or devaluation of the currency as the case may be, complicates the situation in three ways: (1) it exacerbates the problems of the banks that borrowed in foreign currency..(2) it usually worsens inflation...and (3) it increases the odds of external and domestic default if the government has foreign currency denominated debt.  At this stage the banking crisis either peaks..or keeps getting worse as the crisis mounts and the economy marches toward a sovereign default....As regards inflation, the evidence..all points in the direction of a marked deterioration in inflation performance after a default" - This Time is Different Not sure if the above is directly applicable to today, but certainly there are some similarities.  Perhaps this is apropos of the Minsky quote "stability breeds instability" and a reminder that cycles can turn. "How is bitcoin different from other pyramid schemes, say those run in penny-stock boiler rooms?  The only distinguishing characteristics are the record-keeping method - a "proof of work" blockchain - and a large marketing effort that uses the media instead of the telephone." - Unknown This one seems to have aged well.  "If the banking system is content at creating checkable deposits for the government, it's not inflationary, either, because banks must not be interested in the rest of the zoo, shunning rebalancing into risky activities like credit, lending, or replacing lost shadow money globally." - Unkown  There is a distinction between "inside" and "outside" money, a topic most people don't spend any time thinking about.  The term "outside" refers to money that comes from outside the private sector, it is unbacked or fiat.  The term "inside" money exist inside the private sector, like a checking account where your deposit asset is the bank's liability.   In monetarist economic stories both inside and outside money are inflationary, in other theories only outside money matters. "Initially, the problem right now is deflation and not inflation, but deflation. There is too much debt. Growth is too slow and the psychology is wrong because people are saving and not spending." - Jim Rickards Looks like the psychology has flipped on this one over time. "The monetary inflation comes from government spending of the funds raised...QE is increasingly deployed as a means of financing government spending instead of it being directed to stimulate asset prices....the prospect of flooding bond markets with more government debt at an unprecedented scale as dollar bond yields rising they will continue to do so." - Zerohedge article sometime January 2021 This one seemed fairly accurate. "The classic definition of an asset bubble was coined by economist Robert Shiller, who called it an unsustainable condition in which "price increases beget further price increases.  I preferred Warren Buffet's definition: "It's like most trends at the beginning it's driven by fundamentals; in the end, by speculation. It's just like the old adage: 'What the wise man does int he beginning the fool does in the end". - Fed Up by Danielle DiMartino Booth There is a lot of debate whether or not anything is actually a "bubble" ever, but the bottom line is sometimes the benefits of whatever new technology was a "bubble" may come around and payoff to the economy down the line. "..the Federal Reserve exists so the American public can maintain faith in its monetary system" "...the Fed was helping too much. Its insistence of the wealth effect fueled the formation of bubbles...Less intrusive Fed policy would have allowed for the price discovery so essential to market functionality and the prevention of the boom-and-bust cycle that worried von Mises in his day" "Animal spirits, a term famously coined by Keynes in 1936, are catnip to central bankers...In other words, the instinct to do something, anything, is powerful. You could see that being played out by the FOMC." See Bernanke, Ben and "The Courage To Act"  "And they do one big but destructive thing: Namely, they are used to justify endless manipulation and falsification of the of the single most important set of prices in all of capitalism - the price of money and financial assets." - quote attributed to David Stockman in Fed Up Borio and White at the BIS had repeatedly warned that ultra-low rates ultimately lead to misallocation of real resources with consequences for the real economy. One area that economists such as Borio and White cite as a source of concern during period of low interest rates is excessive capital allocation to ‟low-productivity” sectors. "...ownership of stocks is very much a "positive-sum" game.  Indeed, a patient and level-headed monkey, who constructs a portfolio by throwing 50 darts at a board listing all of the S&P 500, will - over time - enjoy dividends and capital gains, just as long as it never gets tempted to make changes in its original "selections."  "...business ownership produce wealth - lots of it...All that's required is the passage of time, an inner calm, ample diversification and a minimization of transactions and fees.  Still, investors must never forget that their expenses are Wall Street's income.  And, unlike my monkey.  Wall Streeters do not work for peanuts." - Berkshire Hathaway Annual Report published in 2021 Two simple messages that are often so hard to implement: (1) over a long period of time businesses will be productive and generate wealth, but that picking winners and losers ex-ante is very difficult, so own the index (2) never interrupt compounding unnecessarily "In order to put industry into motion, three things are requisite: materials to work upon, tools to work with, and the wages or recompence for the sake of which the work is done. Money is neither a material to work upon, nor a tool to work with, and though wages of the workman are commonly paid to him in money, his real revenue, like that of other men, consists, not in the money, but in the money's worth; not in the metal pieces, but in what can be got for them." - Adam Smith, Wealth of Nations "Goods can serve many other purposes besides purchasing money, but money can serve no other purpose besides purchasing goods.  Money therefore, necessarily runs after goods, but goods do not always or necessarily run after money.  The man who buys, does not always mean to sell again, but frequently to use or to consume whereas he who sells always means to buy again...It is not for its own sake that men desire money, but for the sake of what we can purchase with it." - Adam Smith, Wealth of Nations A good reminder as to what money is worth given the rise of inflation. "Based both on how things have worked historically and what is happening now. I am confident that tax changes will also play an important role in driving capital flows to different investment assets and different locations and those movements will influence market movements. If history and logic are a guide, policy makers who are short of money will raise taxes and won't like these capital movements out of debt assets and into other storeholds of wealth assets and other tax domains..these tax changes could be more shocking than expected." - Ray Dalio Remember the calls for wealth taxes?  Given the Fitch downgrade and the level of deficits will we see tax increases in the future, or is the government so divided that nothing will ever get done? "They dispense culture the better to rule.  Beauty? They promote the beauty which enslaves. They create a literate ignorance - easiest thing of all. They leave nothing to chance. Chains! Everything they do forges chains, enslaves. But slaves always revolt." -Frank Herbert, Dune Messiah "At the center of each island is a man. Men learn how to gain and hold personal power. Men are jealous." - Frank Herbert, Dune Messiah "Between depriving a man of one hour from his life and depriving him of his life there exists only a difference of a degree.  You have done violence to him, consumed his energy. Elaborate euphemisms may conceal your intent to kill, but behind any use of power over another the ultimate assumption remains: "I feed on your energy." - Frank Herbert, Dune Messiah "People aren't concerned with love, it's too disordered.  They prefer despotism. Too much freedom breeds chaos...how do you make a despot loveable? ...Ahh, laws.  Law filters chaos...Law- our highest ideal and our basest nature.  Don't look too closely at the law. - Frank Herbert, Dune Messiah Who is feeding on your energy? What are the power structures that keep you from being truly free? What exactly is freedom? "The trouble with massive debt levels is that for every one auction which goes well, there is always another one just around the corner that risks going badly and repricing the entire asset class." - Matt King, Citi A now timely reminder. "...spending beyond a pretty low level of materialism is merely a reflection of ego approaching income, a way to spend money to show people that you have (or had) money....People with enduring personal finance success - not necessarily those with high incomes - tend to have a propensity to not give a damn what others think about them."  "Every bit of savings is like taking a point in the future that would have been owned by someone else and giving it back to yourself."  - Morgan Housel, The Psychology of Money The rise of social media certainly makes it hard for people to resist the need to "keep up with the Jones" at the expense of building wealth.  Housel likes to remind people that the ability to save money gives you options that include the flexibility and control over your time. "Man and his machine intelligences. Which is a parasite on the other? Neither part of the symbiote can now tell. But it is an evil thing, a work of the Anti-Nation. Worse than that that, it is an evolutionary dead end"  "Safety in stagnation. Where are the revolutions in human thought and culture and action.." -  Dan Simmons, Hyperion With the rise of AI and quantum-computing the Hyperion books are worth a read. "The idea that delayed gratification confers some socio-economic advantage to those defer was eventually debunked. The real world is a bit different. Under uncertainty, you must consider taking what you can now, since the person offering you two dollars in one year versus one today might be bankrupt."  So what this idea is about isn't delayed gratification, but the ability to operate without external gratification - or rather, with random gratification.  Have the fortitude to live without promises." - Taleb  Alternatively this might lead one to question whether you are applying the correct discount factor to future promises. "Rhetoric is the art of the incomplete argument, a 'heuristic' device, or story, to point the mind in the right direction.  In a sense all the social sciences are rhetorical. This simply means that he conditions required to make them universally true do not hold, or only hold under special conditions.  They are only partially true." "From this perspective, economic modeling is a persuasive undertaking: it does not aim to discover truth, it tries to persuade people of the truth of its own 'text'.  All reality is 'socially constructed'"  ...There are three valuable implications of this approach.  First, it emphasizes that stories or narratives are the ways in which people try to make sense of complex situations....Second, it points out that belief in the story rests on confidence in the story-teller...Third, whiles stories are not the engines of prediction..they illuminate problems which escape formal modelling.  The question, then, is, whether economic modeling can improve significantly on story-telling or whether it is part of the story-telling."  "Economist should spend less time working out the consequences of rational behaviour under conditions of certainty, and more trying to understand what is reasonable to do in conditions of uncertainty.  This would bring out the rationality and indeed moral worth of forms of behaviour they are now bound to condemn as irrational.  They should also take more care to distinguish situations of imperfect information in which information is contingently incomplete, from situations of uncertainty, in which no complete information is obtainable under any circumstances" - What's Wrong With Economics?, Skidelsky In a paradigm where central bankers are outright telling you that they don't know if their models work or where variables central to their models, such as r-star, are valued at present, it's a good reminder that there are some valid questions and critiques around economics as a field.  It's also an important reminder of the power of parables and story-telling and perhaps in economics the role of expectations. "The ideology of homo economicus together with digital technology suck people out of local communities, and even nations into a 'global village'.  The student of economics needs to balance the economist's enthusiasm for ever-widening markets against the sociological insight that this can be highly disruptive to settled ways of life." "the attempt to create a 'market society' produced a reaction, as society resisted incorporation into the market economy...increasing regulation to contain its disruptive effects....state intervention is not a disruption of the natural order of the market..it is an attempt to prevent markets from destroying the very societies in which they are embedded....Polanyi's critique of market society rests on his belief in the dominance of the social over the economic....specialisation alienates people from society and each other...more of our lives are 'commodified', crowding-out the non-economic values and relations...but human beings are social animals..so while accepting the gains market exchange brings, they devise non-market strategies for protecting society. - What's Wrong With Economics?, Skidelsky Fast forward to 2023 and reading Slouching Towards Utopia by Brad DeLong where a central theme of the book is the contrasting of ideas of Hayek and Polanyi.  Where Hayek's general message was the market giveth and the market taketh away, Polanyi was a believer that the market economy was extremely good at economizing production, but made all other societal rights subservient to property rights, upending the very society the market is made to work for. "Moses Finlay..argues the rapacity of the upper classes was dictated by conventional expenditures for political and military careers, not by a 'maximizing' logic.  Finlay's work brings out the fact that human societies are to a large extent constituted by their 'social imagination'.  This means that they cannot be understood in terms radically alien from those in which they understand themselves. If Ancient Greek craftsman didn't think of themselves as maximizing profit, who are we to say that was what they were 'really' doing?"  "..history should not surrender the uniqueness of its own vision to the econometricians. As Solow writes, in the new economic history you find 'the same integrals, the same regressions, the same substitution of t-values for thought' as you do in economics proper, but with worse data...so we reach a point where 'economics has nothing to learn from economic history but the bad habits it has taught to economic history."  - What's Wrong With Economics?, Skidelsky An interesting conjecture.  "Technological progress is exogeneous and unpredictable...no clear pattern of improvement..swings backwards and forwards along familiar pathways..does not repeat itself exactly, but it rhymes...like pendulums between alternating phases of vigour and decay..each outward movement produces a crisis which leads to a reaction..equilibrium is hard to achieve and unstable...history cannot be used to predict the future, but it can indicate the trends and inevitable reactions against them. Arthur Schlesinger Jr. defined a 'political economy cycle' as a 'continuing shift in national involvement between public purpose and private interest'...Liberal periods when private interest determine policy succumb to the corruption of money; collectivist periods dedicated to public purpose succumb to the corruption of power."   -What's Wrong With Economics?, Skidelsky This sounds very "Fourth Turning" and familiar with today's political economy. "As Keynes well put it, the error of economics lies not in its logical inconsistency, but in the 'lack of...generality in its premises.'  There is a large gap between the account economics gives of human behavior and behavior as it is actually exhibited... Mainstream economists have not looked deeply enough into the 'mind of the horse'. risk refers to all outcomes that can be insured against, uncertainty to those which cannot. Mainstream economics do not recognize this distinction. They believe individuals can accurately calculate the odds of any action turning out one way or the other.  This is because they treat the economy like a closed system. Keynes, to, looked into the 'mind of the horse', but he didn't see maximization, rather an attempt to behave reasonably under different degrees of uncertainty.  His key move was to distinguish rational belief (or expectation) from true belief. Standard rational expectation theory identifies the two, because to have rational expectation of an event is to have accurate knowledge of its probability. ..uncertainty as both Keynes and Knight define it, but which the mainstream denies: a situation where we have no scientific basis for calculating a ratio (probability)."    -What's Wrong With Economics?, Skidelsky So much to ponder as it relates to the assumption of 'rationality' and expectations in economics.  i would venture to guess most people don't think about differences in rational vs. adapative expectations, but some economists do think about differences in rational expectation modeling.

 "an improved ontology - the study of what exists and of the basic constitution and nature of social phenomena - should be the second pillar of reformed economics"

"This methodological invidualistic approach cuts economics off from understanding a large part of human behavior, as a consequence of which it often gives faulty advice."

"It fails to understand the hold of religious national and group loyalties, attachments, identities - all of which Weber calls 'communal' associations - and the extent to which these modify its picture of the maximizing individual; it fails to understand the power of self-understanding and the way social positions shape self-understanding; it fails to under the role of ideas, power, technology in shaping choices, including its own; it fairs to understand the historical contingency of some universal doctrines; and it is indifferent to its own history."

A pretty stunning critique, but likely resonates with anyone who has ever made a choice that didn't necessarily align with what appeared to be their own best economic interest, or to anyone who has ever bought a product because of marketing or a social affiliation.  

"As long as people want more than they've got, economics has no purpose other than to show them how to get the cake to grow more efficiently.  This is its only religion.  Beyond this it has no gospel to preach."

"We can identify three answers to the 'growth of the cake' question.  The first is that the cake just needs to grow without end, since people are permanently dissatisfied with what they have."

"The second, left-wing, position holds the argument that with greater income equality the cake needs to grow less fast.  People are dissastified with their share of the cake they are getting....This introduces an explicit moral argument.  It roots the feeling of dissatification not in individual psychology (envy) but in the social demand for fairness."

"A third, more recent argument emphasizing the long-term cost to the planet, and therefore to future generations, of our relentless pursuit of 'more and more', has led to demands for 'degrowth'"

Perhaps a bit left-wing, but some level of truth to these quotes.  If you don't believe the cake needs to grow without end, then you must believe that either there is some sufficient level of wealth upon which happiness is satisfied, or you must believe in one of his other two answers.

"is economics descriptive or prescriptive? This book suggest that it is intended to be both. Insofar as it is descriptive it is plainly inadequate; but is it not possible that description, may, over time, come to resemble prescription?  That people may actually behave more and more as economists tell them they do behave?"

"To transform human nature, not just describe it, has always been the dream of social engineers, as today it is that of the techno-utopians.  It is the foundation of the doctrine of progress. But how far can it, or should it, be pressed, before humans cease to exist in a recognizable form? And is there something irreducibly human which will resist the ambitions of the engineers of the soul?

Heady to think about the influence economics might have on behavior, but the second quote appears to offer a number of timely questions in the age of AI.

"If economics is to be useful today it will need to modify its belief in the self-regulating market. That free markets contain a principle of order was a huge discovery.  It meant that economic life could be set free from state, municipal, communal and customary direction. But to maintain that market competition in a self-sufficient ordering principle is wrong. Markets are embedded in political institutions and moral beliefs.  In today's world they are inescapably accountable to voters as well as to the market transactors  Market integration across borders is not unworthy goal.  But it should be pressed only as far as, and by means which, the condition of political consent allow.  This is a matter of judgment, not of demonstrative proof.  The only test of good policy should be the Polanyi test: how much disruption and inequality will societies tolerate for the sake of progress?

Political economy questions are extremely interesting.

"we cannot help to remain conscious that for every buyer there is a seller; it is only leveraging, or borrowing, which actually creates new money....in empirical terms we find it striking just how closely asset prices mirror credit creation numbers.  Strangest of all, it really seems to be the flow of borrowing which correlates with the level of asset prices"

-Matt King, Citi

See above for "inside" vs. "outside" money.  

"The conception of homo economicus underpins their picture of human motives is incomplete.  Quite simply it leaves out all the motives for choice and action which fall outside the calculus of human behavior they have set up. As a consequence it fails to predict many outcomes accurately."

"The main target of my attack is 'neoclassical'..or 'mainstream' economics....I distinguish it from 'classical' economics which was a much broader church than its neoclassical successor, both in its view of what social matter consists of and its view of how knowledge is attained. Neoclassical economics narrowed the discipline considerably by claiming that only individuals really exist - organizations are simply constructions of individuals - and their rationality makes their behavior predictable."

"Keynes, one of the greatest economist of all time pointed out the inescapable fact of uncertainty:

    'It is as though the fall of the apple to the ground depended on the apple's motives, on whether it was worthwhile falling to the ground, and whether the ground wanted the apple to fall, and on mistaken calculations on the part of the apple as to how far it was from the center of the earth'

The implications of this are profound. Keynes is saying that humans are not 'programmed' to behave like apples.  Humans are part of complex systems, whose motions cannot be explained by causal laws on which natural science is built."

"My own view is that physics envy drove economists to think of the social world as a potentially perfect machine."

-What's Wrong with Economics, Skidelsky

Some economists have been advocating that there needs to be more of a realization that the economy is a "complex, adaptive, system" that has non-linearities and interconnections whose interactions leads to emergent properties.  Skidelsky goes on to point to non-economic motives for actions such as love, devotion, honor, public service as evidence that not all interactions can be boiled down to subjective calculations and price.

"But people never take the trouble to ask questions, leave alone seeking answers. The average American is from Missouri everywhere and at all times except when he goes to the brokers' offices and looks at the tape, whether it is stocks or commodities. The one game of all games that really requires study before making a play is the one he goes into without his usual highly intelligent preliminary and precautionary doubts. He will risk half his fortune in the stock market with less reflection that he devotes to the selection of a medium-priced automobile." - Reminiscences of a Stock Operator, Lefevre

Seemingly like much of the above, the assumption of rationality is called into question.

"Life is short, and you don't have time to figure out everything on your own.  The wisdom of the past was hard-earned and your dead ancestors may have something useful to tell you."

If you enjoyed this post, leave a note in the comments and maybe the next time I lose power I'll see what words of wisdom I saved on my phone from 2022.

Residential Housing: Is this graph a fair representation of the "cost to buy"?

I have seen some form of this graph going around social media for a few months. This graph shows the cost to buy a home (the mortgage payment) exceeding the cost of renting by ~$1,000.00 / mo. Usually the conclusion reached by the author of the post is that home prices will have to fall, which may or may not prove accurate.  There is a lot to debate in a simple graph like this, including whether the comparison of the properties that underly the data are of similar characteristics (geography, square footage, finishings, age, etc.).  There can also be a debate around whether or not home prices are too high and whether rents will rise or fall.

Those topics might be interesting, but they are not the topic that interest me today.  

What interest me today is solely related to the "cost to buy", the mortgage payment, and whether or not how you frame that monthly payment might influence a person's conclusion around the value of that payment.

A unique feature of the U.S. mortgage market is that loans are generally freely prepayable by the mortgagor/borrower.  In financial terms, the borrower is long an option to prepay. Without getting into all the details, most homeowners will refinance their current mortgages if interest rates fall and they are able to reduce their monthly payments.  The holder of the mortgage loan asset obviously is aware of the fact that their cash flow stream could be curtailed which poses two problems for them: one, they don't know how long they will receive payments and two, if they get prepaid they will now likely have to reinvest in a lower yield environment.  The mortgage originator/lender needs to be compensated for this risk.

In an interest rate environment with higher yields and higher volatility, the value of the prepayment option being sold by the lender to the borrower will rise.  The mortgage borrower will need to pay more in their monthly payment to compensate the lender, but will equally be acquiring a more valuable option, a point that seemingly is never discussed.

The point being, when you decompose mortgage rates, there is a benchmark, or risk free component, typically considered to be the 10-year treasury yield and there is the cost of the call option that allows the borrower to prepay the mortgage without penalty.

My question is, if you represented the above "cost to buy" as a mortgage payment split into two components, the first being the monthly mortgage payment excluding the value of the option (the sum of the benchmark rate and what is known as the Option-adjusted spread) and second being the amount of the monthly payment that is for the option, if that would change any conclusions reached when people read these graphs?  I'm open to hearing thoughts.

I am also sure that someone with a Bloomberg Terminal can find and use the Z-Spread and OAS Spreads to calculate the value of the option embedded in the mortgage rate.