We Suck at Probabilities

I have often noted (for example, here) that we generally suck at math, to our great detriment.  I have also noted that we are especially poor at dealing with probabilities.  If a weather forecaster says that there is an 80 percent chance of rain and it remains sunny, instead of waiting to see if it rains 80 out of 100 times when his or her forecast called for an 80 percent chance of rain, we race to conclude — perhaps based upon that single instance — that the forecaster isn’t any good. Data trumps our lyin’ eyes, but we don’t routinely see it. Continue reading

The Economy in Six Songs

In his book The World in Six Songs, neuroscientist Daniel Levitan of McGill University seeks to outline and explain our emotional lives and heritage in a mere six songs – songs of friendship, joy, comfort, knowledge, religion and love.  I am attempting a task no less daunting.  I hope to condense and explain our current economic condition in just six songs.

So here goes.

“You know I work all day; to get you money to buy you things.”

For the economy, the “rubber meets the road” precisely at this point. We need more people working so that they can “buy you things” for the economic climate to improve.  In other words, our primary economic problem is a lack of aggregate economic demand. As McKinsey points out, “the single greatest fear among executives everywhere is weak consumer demand for their companies’ products and services.”

The following chart shows velocity as the ratio of the money supply (M2) to nominal GDP. It rose from 1.85 in 2003 to 1.96 in 2006 but has since fallen to a current level of 1.572 as households reduced spending and increased saving while banks and businesses hoard cash. 

 Six Songs 2

Simply put, money needs to get moving again.

 

The Fed is practically giving money away in its attempts to juice the economy — essentially trying to force everyone into equities and giving capital away to try to spur growth.  But it isn’t working.  Meanwhile, savers, retirees and others on fixed incomes are being punished by the low interest rate environment in that no relatively safe yield-producing investment vehicles are available.  Because of the crazy-low interest rates, interest income is down over 30 percent since August, 2008.

Six Songs 4Money for nothing indeed.

 

On the other hand, the plutocrat class continues to outperform.  Republicans say they support equal opportunity and the entrepreneurial spirit while Democrats say they look out for the disaffected.  But pretty much everyone in office forgets their alleged principles in order to get or stay close to those with the money — perhaps to finance the next campaign.  Their principles don’t mean very much when it comes to sucking up to the rich and famous.

Six Songs 1

That’s takin’ care of business at its most crass.

 

The American economy (not to mention the American Dream) is predicated upon the idea that we all have the opportunity to get ahead. Sadly, it doesn’t seem to be working out that way today. Real wages have steadily declined and benefits continue to decline too.

Six Songs 5

It’s not supposed to be “all takin’ and no givin’.”  

 

While corporate earnings and profits are very high, employees are not sharing in that success.  Indeed, those workers with good jobs have to keep working harder and harder without being rewarded for it (see below) — even with job security.

Six Songs 6

That’s working very hard for the money indeed.

 

Even though the recession is said to have ended, the newly employed don’t seem often to have obtained very good jobs.  For example, 20-something college degree holders here in California, where I live, are still finding professional jobs extremely hard to come by more than 3 years into the alleged recovery. At 15 percent, the U-3 unemployment rate for California’s college grads under 30 is nearly twice the national rate, and the most common jobs for those who find them are retail, clerical, and food service positions — hardly dream jobs. And according to the U.S. Census Bureau,  more than half of California’s half-million degree holders in their 20’s are underemployed. In fact, the most popular job for the most populous state’s young professionals is retail store floor sales. 

They may as well be workin’ at the car wash.

Worth Watching

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Facebook and Value

 

I created and published the cartoon above in May, just before Facebook went public at $38 per share.  Today the stock dropped to a new low of $18.14 (and even lower in after hours trading), a 52 percent fall-off in just a few weeks.  I don’t pretend to know where the stock is headed (and I have no interest in it and advise no clients with an interest in it), but the problems I highlighted then still exist (and more).  Facebook is hardly the “next Google.”

Worth Watching

I spoke at Investment Advisor’s 4th Annual Retirement Income Symposium, Now or Never—2011: The Year Baby Boomers Turn 65, on October 17 at the Hilton Boston Back Bay.  My session was entitled “Red Pill Retirement Planning” and focused on the need for what Bob Reynolds, the CEO of Putnam Investments and another speaker at the event calls “assured retirement income.”  A recreation of that presentation (without the fun of a live audience and without the excellent jokes) is available here.  I have made the sources for my presentation available here.  My PowerPoint alone is available here.

Worth Watching

 

A stick bomb is a grouping of sticks — in this case, tongue depressors or ice cream sticks — woven together in a pattern that creates tension, as seen in the video above, so that each stick holds another in place. Once the tension is released at one point, one can achieve surprising results.  It’s a pretty good metaphor for financial crisis.  When an intricate structure is designed such that all the individual components are constrained to stay in place and the tension holding the entire system together is broken, all hell can break loose.  As to when and how such things happen and why they are unpredictable in a “natural” setting, I recommend Mark Buchanan‘s outstanding book, Ubiquity.

H/T to Political Calculations

Worth Watching

It is almost axiomatic in the investment world that our emotions are our enemies.  Indeed, the primary focus of behavioral economics is often viewed not as how to overcome our cognitive biases, but rather how to make investment decisions without emotion and therefore better.  The video above provides a quick summary of the work of Antonio Damasio (in conversation with David Brooks), who has demonstrated that when we make judgments devoid of an emotional component, those judgments are clearly inferior in much the same way decisions devoid of reason are inferior. Damasio has formulated the somatic-marker hypothesis, by which he proposes a mechanism by which emotional processes can guide or bias behavior and particularly decision-making.

According to standard economic theory, human decision-making is stripped of emotions and involves logical reasoning based on costs-benefit calculations. This theory assumes that individuals have unlimited time, knowledge and information processing power and can therefore make perfect decisions. However, practice teaches us quite the opposite.  Indeed, it teaches that we are irrational and — indeed — predictably irrational (per Dan Ariely) due to various cognative biases we all suffer. Thus it is typical for investors to undermine their own success by failing to develop a long-term investment strategy, cuttng profits short while letting losses run so as, buying high/selling low, and chasing the hot new thing.

In contrast to standard economic theory and perhaps even in contrast to behavioral economics, the somatic marker hypothesis proposes that emotions play a critical role in our ability to make fast, rational decisions in complex and uncertain situations.  In other words, our emotions aren’t all bad.

When we make decisions, we evaluate the incentive value of the choices available to us, using both cognitive and emotional processes. When we face complex and conflicting choices, we may be unable to decide using only cognitive processes, which may become overloaded and unable to help us decide.  For example, Damasio discovered that patients with a certain type of brain damage could not use emotions to help guide their decisions based upon what had happened to them in the past.  Consequently, the decisions they made were based upon individual cost-benefit analyses for every given choice situation.  Doing so required very long response times and caused the ultimate decisions to be much poorer (an error at any of the intermediate steps could sabotage the outcome).

The SMH readily makes sense and is consistent with traditional economic approaches if it merely suggests that decision-making in complex and pressured situations improves with an emotional trigger.  However, the research (particularly that related to the Iowa Gambling Task, explained here) suggests further that the central feature of the SMH is that emotion-related signals assist cognitive processes even when they are non-conscious.