"Reports of My Death Have Been Greatly Exaggerated"

It’s not like there’s been a paucity of interesting and topical subject matter. Really, I have no excuse for not writing recently. Perhaps the general malaise, which has clouded my personal and professional life, is evincing itself in a third avenue. Maybe it’s this damn sinus infection that’s knocked me flat on my back for two weeks. In either scenario, I really have no excuse. I am sorry.

As I write, it’s grey and foggy outside. You could cut the melancholy with a knife. More than snow on Christmas morning or a sunny Memorial Day, today’s weather is so very, very appropriate. The maladies that have plagued my physical body appear to be symptomatic of condition affecting my entire being. I am vexed.

The fragility of friendship and family is a constant reminder of our ultimate isolation. People will always let you down, so wouldn’t it be best to never let them carry you? We die alone, let us then suffer alone.

Enough already. Stay tuned for new content and with any luck an even-keeled Rumrill.

My Last Post on Monetary Policy...For Now...I Hope

In all media outlets, the same topic is being discussed as nauseam: inflation. Inflation? Yes. Interest rate cuts/hikes, the depreciating dollar and relatedly oil price appreciation all speak to monetary policy, which is but one small step removed from inflation. Remember, the Fed's mandate is to strike a balance between economic output/growth and a stable price level.

What I keep coming back to is Milton Friedman's famous assertion that "inflation is always and everywhere a monetary phenomenon." For there to be a general rise in the price level, there must be either growth in the aggregate money supply (M2, M3, whatever), a spike in the velocity of money (think turnover), or both.

With me so far? Good.

Now let's suppose there's a fundamental shift in a key commodity market. Say, oil. All of the sudden, the world realizes China is on an oil bender (the data actually do not say this...yet) or some other plausible story catches the attention of market participants. As a result, the equilibrium price of oil goes up (in the spot market, let's ignore futures). Oil and its derivative products are a key input to our economy (blatantly obvious). Surely an increase in gas prices will boost inflation, right?

Well, let's go back to Milton. Inflaiton is a monetary phenomenon, the overall price level will climb only if more money is pumped into the system. This relationship is separate and distinct from relative price movements among goods/services. In other words, if oil prices go up, consumers will curtail gas purchases. If real estate prices drop, renters might decide to purchase housing assets. What I've described is a reallocation of dollars, a new way to slice the pie. But I haven't said anything about growing (or shrinking) that pie.

Inflation scares me as much as the next guy, don't get me wrong. But I belive discussions regarding the CPI (or any of the other myriad measures of inflation) would sound a lot less dire if we put the matter in its proper (ie, monetary) context. Remember, the CPI was created as a proxy to read changes in the aggregate money stock.

"Influence" Chapter 1

I've decided it'd be a worthwhile endeavor to summarize the key ideas from Robert Cialdini's Influence, a book I recently read. My motivation is twofold: (1) to improve my retention of the content and (2) to spare you, my loyal reader, the trouble of separating the wheat from Cialdini's abundant chaff.

Where possible, I'll also try to infuse the book's tenets with my own personal anecdotes, ideally in a comical fashion. Hopefully this added incentive will keep you sufficiently enticed.

We begin with chapter one, entitled "Weapons of Influence." The core idea:

[Ethologists]...have begun to identify regular, blindly mechanical patterns of action in a wide variety of species. Called fixed-action patterns, they can involve intricate sequences of behavior, such as entire courtship or mating rituals. A fundamental characteristic of these patterns is that the behaviors that compose them occur in virtually the same fashion and in the saem order every time. It is almost as if the patterns were recorded on tapes within the animals...Click and the appropriate tape is activated; whirr and out rolls the standard sequence of bahaviors. The most interesting thing about all this is the way the tapes are activated.

An animal will react to certain trigger features representing one tiny aspect of the totality for which its "tape" was originally recorded. As an example, a mother turkey can be tricked to nurture a paper predator when the doll makes the distinctive chirp of baby turkeys. Without the sound effects, the mother becomes hostile and pecks at the puppet.

Humans too are guilty of relying upon automatic, programmed responses.

In fact, automatic, stereotyped behavior is prevalent in much of human action, because in many cases it is the most efficient form of behaving, and in other cases it is simply necessary...To deal with [our complicated stimulus environmnet], we need shortcuts. We must very often use our stereotypes, our rules of thumb to classify things according to a few key features and then to respond mindlessly when one or another of these trigger features is present.

This is a recurring theme in Cialdini's book: in our brave new world, we're ever more dependent upon the heuristics and shortcuts our low level animal ancestors and cousins never outgrew. Let's call this irony.

Cialdini's beef isn't with our use of time-saving rules of thumb. Rather, he fears "they make us terribly vulnerable to anyone who [knows] how they work."

The three components shared by most of the weapons of automatic influence described in the book:

The nearly mechanical process by which the power within these weapons is activated

The consequent exploitability of this power by anyone who knows how to trigger them

The jujitsu deployment of the power -- exploiters need exert minimal effort by using leverage and have the ability to subtly manipulate without the slightest appearance of manipulation


An example: the contrast principle.

Simply put, if the second item is fairly different from the first, we will tend to see it as more different than it actually is. So if we lift a light object first and then lift a heavy object, we will estimate the second object to be heavier than if we had lifted it without first trying the light one.

From clothiers to used car salesmen, retailers wield this weapon of influence. How? By showing customers high priced items before moving onto the more likely purchase. In negotiation terms, they set a high anchor.

Anyway, I think this principle has even greater implications. If humans are so sensitive (and susceptible) to contrast, it's like our world is two dimensional; binary. Can anyone claim objectivity? A Cialdini points out, myriad studies would lead you to conclude "no." Scary stuff, this.

Stay tuned for chapter two. It'll be less dire, I promise.

Currency, Commodities Revisited

James Hamilton raises and answers an interesting question: what if we'd been on the gold standard?

If the U.S. had decided to go back on the gold standard in 2006, where would we be today?

Parts of the passage read more like speculation than thought experiment, but I was pleased to unearth this nugget:

Now, if the number of dollars you have to surrender to obtain an ounce of gold is fixed by the government's commitment to a gold standard, and the number of umbrellas, or cars, or chairs you'd be willing to surrender for an ounce of gold has gone up, the only way that can be is if the dollar price of umbrellas, cars, and chairs have all fallen. Maintaining a gold standard while the relative price of gold increases requires deflation in the dollar prices of all other goods.

Loyal readers will immediately notice the striking parallel.

Different strokes...

Graphic inflation.

Studies show men think about sex every seven seconds. My mental vice? Monetary policy.

Good Thing I'm Not Vain

While there's no way to win the non-competitive Tour de Cure diabetes fundraiser, I think most would agree being whisked away in an ambulance on mile 16 of 50 constitutes defeat.

On Sunday, after a PowerBar and banana, I ate pavement. An ambulance was coming at my cycling group, causing the rider in front me to brake unexpectedly. Drafting directly behind him, I was unable to avoid a collision. Our wheels locked and I was thrown off my bike into traffic on Highway 29. Luckily, my pops had my back and stopped the approaching big rig from finishing me off. In a bizarre twist, the ambulance, which caused the problem also availed itself as the solution. The EMTs saw the whole thing and were promptly on the scene, instructing me to hold the detached skin to my face while they drove me to the hospital.

I ended up with 19 stitches and a few fractured teeth. My bike took no real damage, though it remains covered in blood. I figure it'll go away on its own with time.

Now, you might expect me to walk away from this near-death experience with a renewed sense of "carpe diem" or perhaps awe at the fragility of life and randomness of death. Poppycock. It'd be analogous to all the recent grads who told me to "enjoy my last semester" and offered no practical advice for doing so. "Enjoy your youth" is sage wisdom I often get from folks in their fifties. Great. Fantastic. Thanks for reminding me of how quickly these years of virility pass and for subtly pointing out there's no way to slow Mother Time's advance.

I'd be a hypocrite if I implored you to "live each moment to its fullest" (or offered some other platitude). I leave you instead with a bit of levity.

Oil and the Dollar

From today's WSJ: Strong Dollar Pushes Oil Lower.

As per convention, oil is a commodity priced in dollars.

Let's suppose for a moment that the fundamental market forces, which determine oil's price (ie, supply and demand) are held constant. If the USD, oil's currency denominator, appreciates (depreciates) then by definition the dollar price of oil will decrease (increase). In effect, the relationship between oil and the dollar (again, ignoring oil's fundamentals) is an accounting identity.

This begs the question, why would the WSJ Commodities desk lead with such an asinine headline? Granted, the article does mention something about XOM reaching an agreement with striking Nigerian workers, which could be a production boon. But this subsidiary story clearly plays second fiddle to the strengthening dollar's overture.

To make an informed judgment about the price of oil, we need to quiet the "noise" introduced by the dollar donimation convention. How? One simple solution would be to offer oil's price in Euro terms alongside its price in dollars and the EUR/USD exchange rate. Suppose: (a) the dollar appreciates against the Euro; (b) the dollar also appreciates against oil; and (c) the Euro price of oil is unchanged. In this scenario, what have we learned about oil in observing its dollar price decline? The answer: nothing we couldn't have gleaned from the WSJ's Currencies column.

I'm not the first person to criticize the media's coverage of oil price movements. If you're interested, Felix Salmon has been tracking other instances of "the oil price denomination fallacy."

WSJ: Cruelty's Currency

Yaroslav Trofimov reports from Honiara, Solomon Islands:

Forget the euro and the yen. In this South Pacific archipelago, people are pouring their savings into another appreciating currency: dolphin teeth.

Islanders demand dolphin teeth for buying brides, a perverse reverse dowry. I wonder if those "weak bidder" bachelorettes fetch a premium in the molars/matrimony market as Mark Gimein might predict. Doubtful.

The "teeth harvesting" process will drop your jaw (no pun intended), so the squeemish are encourged to skip the following block quote:

Organized on particularly calm days several times a year, Malaita dolphin hunts are complicated endeavors, involving dozens of villagers and a flotilla of paddle boats. When a pod of dolphins are spotted frolicking in the ocean, the boats approach them in a semicircle. Then, fishermen start pounding stones and coconut shells under water, producing a rhythm that drives the dolphins into a trancelike state. As the boats close in on the pod, the noise pushes the dolphins toward a particularly swampy stretch of the shore.

"The dolphins see it's dark underneath, think it's deep water, dive and get stuck in the mud," says Mr. Sukufatu. "To subdue them, we cover the breathing hole in their heads with our palms, and push them deeper and deeper into the mud."

Once the dolphins are nearly suffocated, hunters tie strings around their snouts, so as not to damage the teeth in the thrashing, and then hack off their heads with machetes. Then, the teeth are divided among the hunters, while the meat goes to feed the rest of the village, Mr. Sukufatu says.

Isn't it bad enough we catch, kill and can Flipper? Must we also use his cousin's teeth as a medium of exchange and store of value?

Now, don't get me wrong, I value and support the preservation of idigenous traditions just as much as the next Berkeley grad. But we must pause every once in a while and take a fresh look at our vestigial customs and mores through the lens of modernity. (Historical precedent.) Technological advances have empowered modern man to drastically alter his environment -- intentionally or otherwise -- in effect, voiding the check and balance system (arbitrated by Mother Nature) in place during all eras pre-modern. (I recommend the naysayers who claim humans leave no footprint consult the ever-growing list of endangered and threatened species.) I imagine it would be difficult to hunt a species into extinction using a bow and arrow, but an assault rifle certainly lowers the hurdle.

The rules have changed and so must our behavior. The opposite appears to be happening in the Solomon Islands, whose "traditional currency is gaining in prominence now after years of ethnic strife that have undermined the country's economy and rekindled attachment to ancient customs."

Which brings me to the other facet of this interesting article that caught my fancy: commodities as currency. I've never been a fan of the gold standard (despite my praise of Ayn Rand). Obviously, I also frown upon the use of dolphin teeth as a monetary medium. Cruelty issues aside, I just don't see how it makes sense to arbitrarily link an economy's monetary base to the supply of a commodity subject to its own fundamentals and market dynamics. What happens when the islanders run out of dolphins to slaughter? Holding demand constant, the diminshed supply would result in a higher equilibrium price (in terms of real buying power) for dolphin teeth. In other words, the market for goods and services would experience deflation (prices would effectively come down as a dolphin tooth fetched more goods than before).

Then again, perhaps this society of dolphin killers would be getting what it deserved.

For the Nonce

• The album "Now Playing" in my iPod
  
• The book within reach of my bed
  
• The object of my digression
  

Where Have All the Cowboys Gone?

Mark Gimein, a “New York-based writer” (read: non-economist) cites and explains the shortage of available, appealing men in society, though he offers no evidence of this supposed scarcity:

The problem of the eligible bachelor is one of the great riddles of social life.

But why prove a claim when you can simply state it and move on? Well played, Mark.

Anyway, for the sake of argument, let’s assume Mark’s premise holds water – there are fewer attractive, intelligent men in the singles market than we’d expect to observe. The next assumption he asks the reader to make is that women ultimately decide whom and when to marry. Mark does offer one caveat, admitting “this is simplified — in contemporary life, both sides get plenty of chances to be selective…but as a rough-and-ready model, it's not bad.”

Yeah, but it ain’t all that great either, Mark. But I’m getting ahead of myself…

Next we’re asked to consider courtship and marriage in terms of game theory:

You can think of this traditional concept of the search for marriage partners as a kind of an auction. In this auction, some women will be more confident of their prospects, others less so. In game-theory terms, you would call the first group "strong bidders" and the second "weak bidders."
…
[G]ame theory predicts, and empirical studies of auctions bear out, that auctions will often be won by "weak" bidders, who know that they can be outbid and so bid more aggressively, while the "strong" bidders will hold out for a really great deal.

In other words, as unattractive women (“weak bidders”) marry hapless, yet handsome men, the population of eligible bachelors shrinks, while more endowed females (“strong bidders”) who wait for Mr. Right find themselves surrounded by other attractive women and face a dearth of suitors.

Where have all the most appealing men gone? Married young, most of them—and sometimes to women whose most salient characteristic was not their beauty, or passion, or intellect, but their decisiveness.

Does this scene bear any resemblance to reality? Before you answer, allow me to make a prediction. If you’re female, the answer is a resounding “YES,” while if you’re male, it’s the polar opposite. Rather than fan the flames and turn this into a gender feud, let’s take a step back and revisit Mark’s underlying assumptions.

First, do women really have sole discretion over the decision to wed? Perhaps in a Jane Austen novel (though doesn’t the father have to give the daughter away?) but not in today’s world. Mark hints at the weakness of this assumption, which is really the crux of his argument (as we’ll see in a second), but is too quick to dismiss the inherent flaws.

If we relax this constraint (that women monopolize matrimony) Mark’s already contrived connection to game theory is broken. Men and women no longer find themselves in an auction. “Weak bidders” are unable to snatch up unsuspecting blokes and instead enter a market where contracts (wedding vows) are negotiated at arm's length and outcomes are more efficient and equitable.

Are men (eligible or otherwise) indecisive drones waiting for an unattractive, over-eager woman to lead them down the wedding aisle? Hardly. First, men place a great deal of emphasis on physical appearance, which makes a “strong” man and “weak” woman pair seem unlikely. Moreover, one could even argue that an attractive man, able to command the affection of myriad partners, would have an incentive to defer marriage as long as possible. Why buy the cow when you can get the milk (in numerous flavors) for free?

I’m very disappointed in this article and it would appear I am not alone.

An Assortment of Links

• Getting bang for your buck: a shopper's guide to pesticides in produce
  
  
• Peter Thiel gives us an "Optimistic Thought Experiment"
  
  
• On the lighter side -- a friend submitted my relative value trade idea to LSC. I remain long avocados.
  

How Low Can You Go?

At the risk of sounding utterly snobbish, a confession: as an agnostic, apolitical citizen of San Francisco, I seldom find myself interested in the capricious stories hocked by the media. (Tainted Chinese dog food?) It being an election year is a clear exacerbation.

But there is one topical item I unfortunately find all too relevant – the recession (GOOG news reports 70,773 search results for the word today).

The idea of recession has always intrigued me. Why should the myriad participants in an entire economic collective decide in unison to stop working and start saving? Explanatory theories abound, but my understanding is most economists agree recessions occur when, in response to some exogenous shock, people attempt to stockpile cash. The system breaks down when I hoard my $1 and forego buying that coffee (OK, so perhaps $2 would be more realistic) which means you, my friendly coffee purveyor, will not have a dollar (less the applicable costs of production) to hoard yourself.

So what’s the solution?

Again, it would depend upon whom you ask. Most would agree, however, that if the general price level declines (ie, prices deflate) the economy would regain its vigor. Deflation has the effect of reducing the incentive to hoard cash – it’s possible I’ll resume my morning caffeine splurge if it’ll only cost me $0.50. What’s interesting is that the (non-nominal) economic reality pre- and post-price adjustment remains constant: I’m buying the same cup of coffee in both scenarios. Prices merely change to satisfy the whimsical want for cash. (Or do they? Menu costs and the “stickiness” of wages tend to create a price floor, but this concept is worthy of its own post.)

Though an avid coffee consumer, I find I’ve more in common with the coffee vendor than vendee in the above metaphor. A while back (before headlines of recession hit the wire) I decided to sell my car, which I purchased about 18 months ago to permit semi-monthly visits to Santa Rosa. Much to my parent’s chagrin, I’ve since slowed my rate of visitation (I’ve been home once so far in 2008) and I find it difficult to justify owning a car.

Alas, I’ve had no luck in finding a buyer (please email me if you’re interested in a FANTASTIC vehicle) and find myself in the downward spiral of price discovery. It’s a game of limbo and luckily I have a decent amount of financial flexibility. Still, I’d sure like to clear that bar soon.

Connecting the Dots

While driving through the orderly chaos that is Chinatown this afternoon, I noticed a banner hanging before a nondescript storefront. It read: "HALF OFF ALL DOG AND CAT FOOD"

Conventional Wisdom, Conventionally Wrong

I was struck by a WSJ editorial I came across yesterday. The piece, published in 2007 by Matthew Slaughter of Dartmouth's Tuck School of Business (hi, John G.) sheds light on China's alleged trade advantage, commonly attributed to its currency manipulation.

The argument made by Hank Paulson (and a slew of Rust Belt Congressmen) goes something like this: by intervening and aggressively purchasing dollars, China is keeping its currency -- the renminbi -- below the equilibrium price a competitive market would establish. This in turn makes Chinese goods less expensive than American equivalents. Thus, the hollowing of America's manufacturing core (or an equivalent politically-charged metaphor).

Seems fairly straightforward. So much so, I'd posit this concept has become common knowledge, conventional wisdom. Of course, we all know the correlation between conventional wisdom and reality isn't all that high -- remember, the world was flat up until the 15th century (despite what Thomas Friedman might have you believe).

The key to debunking this myth lies in basic economic theory, as articulated by Slaughter.

The exchange rate that matters for trade flows is the real exchange rate -- the nominal exchange rate adjusted for local-currency output prices in both countries. Supply-and-demand pressures in international markets can, and do, alter not just nominal exchange rates, but also nominal prices for goods and services. And these pressures driving the real exchange rate, in turn, reflect the deep forces of comparative advantage such as cross-country differences in technology, tastes and endowments of labor and capital.

If an under-valued currency makes Chinese goods more affordable for Americans, it does so for all (American) market participants. In other words, the weak renminbi increases total demand for Chinese wares, putting upward price pressure on these products in terms of their local currency. Your dollar might fetch too many renminbi than it ought to, but thanks to market dynamics those renminbi will buy fewer goods.

While the issue of China's currency policy is far from moot, it certainly doesn't deserve the attention it receives from Hank, Congress and the media.

I'd like to spend more time contemplating the roll China's large stash of USD-denominated assets plays in this story. If they're sitting on north of $1 trillion in US Treasuries (not to mention the equity in Morgan Stanley, suckers) how powerful is China's incentive to keep the dollar nominally strong and does this compulsion create real inefficiencies?