Charts that end in tears

Felix Salmon has a great piece about bitcoins. In it, he presents the following chart:

It inspires him to write,

There are a couple of reasons why the [bitcoin] bubble is sure to burst. The first is just that it’s a bubble, and any chart which looks like the one at the top of this post is bound to end in tears at some point.

Now where was it that I last saw a chart which looked similar to the one Salmon thinks is the sign of the Apocalypse? Oh wait...

Soft drinks and GDP

I just read that Coca Cola in Poland employs about 2,700 people and produces 0.002 of Poland's GDP. If this is true, then assuming every worker had productivity on that level, Poland's GDP could be produced by a labor force of about 1.4 million people. (In reality it is almost 18 million people.) Or, equivalently, keeping size of labor force at current level but increasing everyone's productivity to Coke level, Poland's GDP per capita would be well over $100,000.

The customer is always right. But which customer?

How many times have you heard statements to the effect that bond credit ratings must be biased since institutions that issue bonds pay for these ratings? A lot, probably. These statements are shallow, and wrong. The fact that someone pays to be evaluated does not mean that the evaluation must be biased. If you decide to go to grad school, you'll probably have to take the GRE or some other standardized test. For that test, you'll have to pay the testing company. Does this mean your score will be biased in your favor? Definitely not. Why not? Because test scores, as long as they're not biased, provide schools with valuable information about prospective students, so they want those prospective students to be screened that way. If test scores were biased, schools would no longer require them, which means prospective students would not be willing to pay for them anymore. Even though test-takers pay to be tested, testing companies have strong financial incentives to keep test scores as honest as possible.

How come it's not correcting itself?

Sam Wang writes about the deficiencies of Intrade prediction market:

Even when lots of data are available, such as political polls,  InTrade can still fail. One simple reason is bias: InTrade bettors appear to skew Republican. This could explain why there is such a mismatch between the poll-based Obama win probability (>99% for an election today, probably >80% in November) and the InTrade price (equivalent to a probability of about 0.56). This could be excused on the grounds that the election is far off, and there is uncertainty as to what will happen in the next 4 months. However, there is a third flaw. As I’ve written before, InTrade bettors are habitually underconfident in the face of polling data, even on the eve of an election. Even a 10-point lead in a race is insufficient to drive a market-based probability estimate above 80%. This is perplexing since such a lead is basically a sure thing.

A functional market should be self-correcting. Any systematic bias such as underconfidence or leaning Republican creates an arbitrage opportunity which should be expected to draw new bettors until the point when prices adjust and bias disappears. The question is why this isn't happening in this case.

Is the US under-insured?

Numbers below are 2008-2011 averages in 28 OECD countries as per World Development Indicators.

Clever words about stupid words

The stupid stuff is this essay by Stephen King. Of which Mike Munger had this to say:

So my man wants the government to both "fix global warming" and "lower the price of gasoline". Nice work there, Steve. Your political economy is way scarier than your fiction.

Fourteen years and a funeral

The newly elected coalition governing Poland is planning to pass legislation increasing retirement age from 65 to 67. Some guy named Krzysztof Feusette, who writes for the second-largest Polish daily newspaper, is protesting against this in an op-ed Four Years and a Funeral, in which he attempts to show that Polish men will, on average, enjoy retirement for only four years. He compares this figure with its counterparts in other European countries, showing that it is generally much lower.

In order to fully appreciate how much of a goddamn idiot Mr. Feusette is, let's look at the method he uses to arrive at the average length of male retirement. Here's how he does it (make sure you're sitting down when you're reading this): he subtracts retirement age from life expectancy at birth for men. You read that right: at birth. AT BIRTH. Could we make a one-time exception in retirement law for Mr. Feusette, so that this idiot could retire right the fuck now? (Also, when I check the source he cites, I see life expectancy at birth for Polish men to equal 72.3 years and not 71 years.)

For those of you who want to know what the truth is, I'm not sure exactly, because I couldn't find life expectancy data for each age. But it sure isn't even close to four years. In 2007, life expectancy for Polish men at the age of 65 was 14.6 years.

Predictive power

When the financial crisis broke in August 2007, David Viniar, chief financial officer of Goldman Sachs, famously commented that 25-standard deviation events had occurred on several successive days.

Taken literally, this is of course false; no one has ever seen even a single 25-standard deviation event, and no one ever will. What has occurred was probably the most spectacular failure of a mathematical model in the history of mathematical models.

(The source of the quote is here.)

The rest is commentary

The first words of Steven Landsburg's great book The Armchair Economist are:

Most of economics can be summarized in four words: "People respond to incentives." The rest is commentary.

Love the book, hate the line. Sure, technically it's true, but it's true in a way that tautologies are. It's true but completely uninformative. How do they respond to what incentives? The devil's in the commentary. Saying that "People respond to incentives" is the essence of economics is kind of like saying that:

Most of physics can be summarized in four words: "Everything is a wave." 

Most of game theory can be summarized in two words: "People strategize." 

Most of biology can be summarized in five words: "Random mutation and natural selection." 

Most of evolutionary psychology can be summarized in three words: "Cognitive traits evolved." 

Most of statistics can be summarized in eleven words: "When repeated large number of times, random events show predictable patterns."

The rest is just commentary.

Even a broken clock is right twice a day

And so, every once in a while, will be Rush Limbaugh.

Majority, average, what's the difference

So, I was just listening to this here podcast. It started off with a discussion of James Surowiecki's The Wisdom of Crowds which talks about the fact that when you're trying to estimate some quantity, an average over a large number of individual guesses of people picked at random will be closer to the truth than an expert's opinion. The interviewed guest gives an example of Francis Galton's observation that the crowd at a county fair accurately guessed the weight of an ox when their individual guesses were averaged (the average was closer to the ox's true butchered weight than the separate estimates of any of the cattle experts). He then goes on to say that the reason behind this and similar, seemingly magical phenomena, is Condorcet's Jury Theorem: Take a group of people each of whom is more likely to get the right answer than the wrong answer and ask them the question. As size of group increases, the probability that the majority gets the right answer approaches 1 in the limit; the same holds for pluralities. It is also why surveys are accurate.

OK, something's not quite right here. Lots, actually. In the context of the ox example, what does it mean that each group member is "more likely to get the right answer than the wrong answer?" Weight is a continuous variable, so for each group member, the probability that they'll guess the right answer is precisely zero. Grad school was a long time ago, but I seem to remember something about Condorcet's Jury Theorem being applicable only to situations of binary choice (hence the word "Jury" in the name). The average of individual guesses of a continuous quantity, and a majority pick from two alternatives, are very different things. Also, the reason surveys work is Central Limit Theorem and not Condorcet's Jury Theorem. The only thing those have in common is the word "Theorem" in the name.

A big, happy family. Maybe not that happy, but really huge

Speaking of arguments against Polish central bank lending 5 billion euros to the IMF, here's an additional piece of hilarity. In an essay titled Don't Touch Our Currency Reserves, one Tadeusz Swiechowicz goes through the reasons why it's a bad idea for Poland to do this. Here's one of the reasons he lists:

Italians are capable of paying down their government debts themselves. The average household income in Italy is equivalent to 2 million PLN annually. [PLN is code for zloty, the unit of Polish currency--przemek]

A mind-boggling figure indeed, as made up figures tend to be. CIA World Factbook tells me that GDP per capita in Italy is currently around $30,000. Right now, 1 USD buys 3.4 PLN, which means Italian GDP per capita expressed in PLN is 102,000. So apparently, Mr. Swiechowicz believes that the average household size in Italy is almost 20 people.

Consider knowing what you're talking about

This is yet another post in which I decry the depressing stupidity of public debate in Poland, especially when it comes to matters of economics and finance. The recent EU summit, aside from making a large (though rather back-door) policy breakthrough with respect to bailing out illiquid governments, has also proposed that the central banks of EU countries guarantee a loan to the IMF, with the aggregate value of some 200 billion euros. The funds are presumably going to be set aside in order to be used to help eurozone governments facing liquidity problems.

Poland's share in that guarantee is supposed to be somewhere in between 5 and 10 billion euros, and it's going to be funded through Polish central bank's currency reserves (which really means foreign government bonds held by the bank). At any rate, what prompted this note was an argument I've heard from a politician of the opposition party, debating against Poland's participation in this loan: namely, that even though on the face of it we're lending to the IMF, "everyone knows" we'll really be lending to Greece and Italy in order to save the euro, and it is a violation of the constitution to use the central bank of Poland to defend a non-Polish currency.

This was said with a straight face, by someone who used to be a Foreign Minister, about a loan to the IMF. Whose main (and at the time of its birth, only) function is pooling funds from central banks of many countries in order to provide their participants insurance against speculative attacks on their currencies.

Let me rephrase that again: the argument is that we can't be lending this money to the IMF because everyone knows they will use it to protect a foreign currency from speculative attack.

And no one there seems to have anything to say

A new deal is in the works in order to save the eurozone. Judging by rumors, it's not a very good one. No mention of a possibility of establishing the ECB as lender of last resort; no mention of the possibility of eurobonds; plans of establishing credible commitment mechanisms to keeping budget deficits below 3% of GDP; some sort of risk-sharing agreement in the form of an overall debt guarantee; and - last but not least - plans of some sort of credible commitment to not force private sector bondholders to take any losses on any future eurozone bailouts. Now how is a market supposed to work if lenders are sheltered from experiencing negative consequences of bad lending decisions? (The question is rhetorical.) Also, how is the debt guarantee supposed to work? The eurozone doesn't have enough funds to guarantee the debt of, say, Italy without that debt having gone some serious restructuring; and a restructuring of Italian debt under the assumption that private creditors must get 100 eurocents on the euro is economically and politically impossible--the necessary austerity measures would be so severe that it would make much more sense for Italy to simply suffer the consequences of defaulting and leaving the eurozone unilaterally.

So, the Polish government supports the deal unreservedly. On the domestic front, the arguments it offers in favor of it are nothing short of inane. The inanity of them, however, will have to wait until another post. What irks me even more at this moment is the fact that the opposition's response to those shallow arguments are arguments that are generally much, much stupider than what they're criticizing. Here's a small sample.

In a TV interview, the leader of the largest opposition party argued that concerns about the devastating effects a severe recession in the eurozone would have on Polish economy are much exaggerated because "Poland's exports aren't large in relation to its GDP". (The ratio is about 35%, in case you're wondering. And this was said by a guy who was at one point a prime minister, for Pete's sake. Also, below the fold you can find a chart that shows where that 35% locates Poland among OECD countries.)

In another interview, that same guy said that the government's plans of increasing the retirement age for women to 67 years is a terrible idea because Germany is doing the same thing and being Germany's copycats shows our government's "psychological dependence" on our neighbors. How's that for a policy rule: The Germans are doing it, so we can't.

Or how about this: the main economic writer in Poland's largest opposition media outlet begins his essay about the eurozone crisis with the following:

Germany's annual trade surplus of 130 billion euros has to come from somewhere. It comes at the expense of deficits, debt, and eventual bankruptcy of Greece, Portugal, Ireland, Spain and Italy.

In other words, he reveals that he doesn't know what trade surplus is, and can't tell the difference between current account deficit and public debt (hey, genius: how come Germany is in debt to about 84% of its GDP even though it's running all these surpluses?).

These arguments aren't just misguided. They're laughably ignorant.

And then another annoying one: we can't have a fiscal union because that would mean member countries would lose some of their sovereignty. True enough, but then again, countries give up some of their sovereignty left and right, lots of times voluntarily and to their own benefit. Entering a free trade agreement means losing a bit of your sovereignty (namely, sovereignty to set tariffs to whatever you damn well please). And losing that bit of your sovereignty happens to make you better off. I also find it interesting that those same politicians who decry the loss of independence that comes with a voluntary contractual agreement, never seem to have a problem with any type of policy that increases public debt (at least in Poland they don't). Hey, genius: when you take out a loan, what do you think happens to your sovereignty?

Anyway, rant's over for now. The chart I was talking about is below the fold.

Yikes, Europe

(I took these numbers from Megan McArdle, though she is not the original source. I forget who the source is.)

Inflation in the ancient world

In The Montreal Museum of Fine Arts there's a room with an impressive collection of artifacts from ancient Greece and Rome. One of the more interesting of those is a collection of coins minted by rulers of various ancient city-states as well as Roman and Byzantine emperors. There are about thirty coins ordered chronologically in a single row, and as soon as you see it you think, how's that for inflation. As you move forward in time, the coins get progressively smaller and show more visible signs of corrosion. In the younger coins, the corrosion also gets greener, suggesting that the proportion of copper used to make the coins was getting larger. Here's what the oldest coins looked like:

And here are the youngest ones:

Of course, all this could just be coincidence, or bias, either in the sample or in my perception (since they once taught me in school there was massive inflation in the latest years of the Roman empire). Who cares; it's much more fun to think it is what I think it is.

They wouldn't do that, would they?

Let's start off the blog's new incarnation with a fresh installment of the Non Sequitur of the Month.

The largest oppisition party in Poland, called Law and Justice, has recently put forward a vague proposal of a new tax which they call "banking tax". No details are available, but judging from media rumors, it's essentially supposed to be some sort of tax on financial transactions. Predictably, the proposal has been criticized on the grounds that, contrary to Law and Justice's rhetoric, this new tax will be a burden not only on rich financial executives, but also on ordinary customers of banking institutions, since those institutions will most likely respond by raising prices of their services.

Now for the non sequitur part. In a TV interview, Law and Justice's press spokesman responded to this criticism by saying that the whole argument is a "myth," and that the critics must not really trust free markets as much as they say they do because if we have free markets in the banking sector, then banks have to compete for customers and will therefore not try to shift the burden of the new tax on them.

This is exactly like saying that the belief that an increase in world prices of crude oil will drive up prices of gas at the pump is a "myth". After all, car fuel is sold on a free market by multiple distributors who have to compete for customers.

The beauty of this argument is that it's such a pure example of a non sequitur: the conclusion does not follow from the premise. If the Polish banking sector is indeed a competitive free market, then prices of banking services are always equal to their marginal costs. A new tax on a service increases its marginal cost. The end.

Actually, it probably means that...

There actually is a sensible explanation of the markets' behavior during the days immediately following S&P's downgrade. There's no way to know if it's true, but it sure sounds good. Here it is:

While it's hard to figure out what investors are thinking, it's pretty easy to guess what they're not thinking. No one is thinking that the US government defaulting on its debt is even remotely possible. But if no one is afraid of the default risk, why the panic? Well, both the panic and the fact that its main symptom was a rush to buy Treasury bonds can be explained by assuming that S&P's decision convinced a lot of investors that very deep cuts to US federal budget are imminent in the medium run. This means that very soon there might be a shortage of medium-term Treasuries. So if you think those are a good investment, better get them asap.

This must mean that...

Investors around the world reacted to S&P's downgrade of the US credit rating by selling out stocks. They also started buying up a whole bunch of US government bonds (see here how yields on medium to long-term Treasuries were decreasing today). Which makes sense, right? In the time of uncertainty caused by the fact that the US federal government is apparently more likely to default in the medium run than previously thought, it's a good idea to invest in the safest assets around, such as medium-term US government debt.

What, my explanation doesn't make any sense? You tell me then.

Jay-Z and the eurozone crisis

Four years ago there was a period in which the dollar was sharply losing value against the euro. In the eyes of some analysts at the time, the ultimate sign of dollar's inevitable demise was the fact that, in a contemporary video to his song, Jay-Z was flashing stacks of 500-euro bills.

Someone please let Jay-Z know that Ben Franklin called, and he wants an apology.