Tuesday, December 18, 2012

Too Much Faith, Not Too Little

I have long believed that the problem market economies have with statists is misunderstood.

Pro-market folks tend to think that statists just don't understand markets.  And to some extent that's true.  But the real problem is that statists have too much faith in markets.

Wait...too MUCH?  How can that be? (More after the jump...)

Two examples:  I.  ONE.  A colleague of mine at Duke, not a young person, was preparing for retirement in 2008.  But the stock market and housing smack-down nearly wiped him out. 

And then fussed at me.  "Capitalism is terrible!  Look at all the money we lost!  It's unpredictable. How can you defend markets?"

I should have shut up.  A nice person would have shut up, and been sympathetic.  But that's not me, is it?  So, I said, yes, there are fluctuations, but since you are well over 70, surely you were invested safely, right?  I myself was only 50, but I had liquidated all our financial assets and converted everything to cash or very short bonds, in summer of 2007.  So I didn't really lose anything.

He gaped at me.  "I lost 50% of my wealth!  It's clearly not my fault, it's the market that's messed up!"

Turns out Mr. Marxist-breath had 100% of his retirement in "high growth" stocks.  He got absolutely p'wned!  What kind of idiot would (1) be two years from retirement and (2) have all of his wealth in the riskiest part of the stock market?  (Turns out he also had taken out a second mortgage against his grossly-overpriced new house, and used that money to buy stuff.  His mortgage was almost, but not quite, underwater).

It never occurred to him that housing prices, or the stock market, might actually turn down.  He hates markets, but assumed that markets would always provide annual real returns in the range of 10%-15%.  Interestingly, his objection to markets was partly that it is unfair to have so many rich people.  Given his wealth and income in 2006, he had to be in the top 2% of the world-wide income distribution.  So he should be happy!  If he hates the rich, then "the market" got rid of a bunch of wealth, including his.  Now he is much more like a member of the common folk he claims to admire so much.

Wealth is the creation and production of many essentials, and niceties, of life.  Markets are pretty good at producing wealth, in that sesnse.  Wealth is not the constant increase in the value of financial assets, and there is no reason to expect markets to produce that.  Markets are guided by profit AND LOSS.  If you invest in stocks, you are taking a risk.  If you invest all your retirement in stocks at age 70+, you need to understand that you gambling, and your odds are not that great.

II.  Gerard Depardieu goes all "Ayn Rand capital strike" on his home country.  Fantastic.  I bet he doesn't even realize he is riffing on the angry Russian-American lady.

The French government, being statist to the core, actually expect markets to work perfectly, and continue to produce wealth and growth, even as the marginal tax rate climbs upward of 70%.  They believe that people will continue to work, and innovate, even though those workers and innovators cannot expect to be able to retain the right to control the innovation, or the fruits of their labor.


Pelsmin said...

The statists have too much faith in what they think markets are, which doesn't have much in common with what markets really are. They think things work out for everyone who plays in them. But the markets don't care about them. And the markets don't care about now. The markets thrive and rise, on average, in the long run, across all participants. That means winners and losers, with a net gain. Upturns and downturns, with a net increase. No-one to watch over each person and make sure things work out. But doesn't that sum up liberalism? They are more concerned with the individual outcome than the overall trend. And they'll gladly mess up the overall upward trend in the effort to manage the individual outcome. (pls see 99 weeks of enhanced unemployment benefits v. unemployment rate)

Natalie said...

I think the problem in the scenario you laid out first is a dramatic mideducation in financial matters. We have people making investment decisions that never learned basic financial literacy.

I have a range of investments, but treat the 401k as play money. Until my house is paid for, my student loans gone, and I'm debt free, my 401k matters very little. I don't control it, I can't access it, why would I put my free cash there instead of other places?

Most folks assume that everything always goes up. If I pay off my house, it doesn't matter if it goes up or down, I still have a place to live :)

pkd said...

Yes, the professor was foolish. But on the other hand, pulling out of stocks completely strikes me as going too far in the other direction. How do you know when to get back into the market?

Anonymous said...


When you're 70? Maybe never

Ulysses S. Rant said...

Congrats on getting your blog post linked to RealClearMarkets today, KPC...and thanks for the laugh!

I see this all the time among too many of my prosperous liberal friends: they love to to bash markets even as they benefit mightily from them...ESPECIALLY the rigged ones. They trumpet their concerns for the middle class while profiting from shipping their jobs overseas. They claim to want a more stable economic system while investing their money with the Wall Street sharks who crashed that system (so what if they gamble recklessly? they return more than 15% on my money!).

And so on and so forth...to be fair, several of my left-leaning friends, like myself, really do want to see real reform. I appreciate their candor. Less hypocrisy on both sides would go a long way toward helping us solve our serious problems.

I look forward to reading more of your posts, KPC.

Dr. Tufte said...

I think there are two veins that are analogous to your first example.

1) Large numbers of "smart" investors thought there was nothing fishy with Bernie Madoff's numbers. Honestly, I don't think a lot of them are crooks; rather a lot of them had hugely unrealistic expectations about the returns that are possible with no risk.
2) This is similar to the classroom exercise of asking students what they think the incremental margin is for businesses - answers of 50% are common.

Less Antman said...

> If you invest all your retirement in stocks at age 70+, you need to understand that you gambling, and your odds are not that great.

Why do you say that? Using data I have from Jeremy Siegel going back to 1802, a starting draw of 4% of the portfolio adjusting thereafter for inflation would have lasted the 70-year-old until AT LEAST age 100 in 177 of the past 180 30-year rolling periods had he kept it 100% in a US stock index fund, failing only in 1929, 1968, and 1969, at ages 92, 99, and 95 respectively (HE was far more likely to fail in less than 30 years than his portfolio). It would have failed 51 times if kept in Treasury bonds.

I'm not saying a 100% equity portfolio for a 70-year-old is guaranteed to work. It would have been simple and prudent for him to just set aside 2 years of spending money in cash equivalents to be used in the FIRST bear market after retirement.

Still, a strategy that worked over 98% of the time, even without the prudent reserves, does qualify as having great rather than not-great odds, in my opinion.

As for your market timing skills: no comment. I'm willing to admit I can't ever predict the next few months or years, only that the long-term success of the businesses that provide the world's goods and services is probably a wager Pascal would make, given the unlikelihood of any safe havens should they dramatically fail long term.