How Do You Value Gold?
Posted by Eddy Elfenbein on April 7th, 2009 at 12:09 pm

I’d welcome any feedback on these questions since I have no idea of the answer: How should one determine the price of gold? What are the variables or ratios that someone ought to use?
I have to say that I have no idea how to make a judgment on the price of gold. It seems to me to completely irrational and that’s why I like to avoid it. With an asset like a bond, you can input a few variables and try to determine if the current yield is too high or too low. Of course, your assumptions may be wrong, but you can plainly see what went wrong.
With stocks, there are all sorts of models to determine value. These can also be wrong, and many are, but at least everyone knows what a P/E Ratio is. But for gold, I have no idea where to start.
Part of this I have to blame on gold bugs who seem to be overwhelmingly irrational and incoherent. I apologize to the more thoughtful gold bulls but your voices are drowned out by the mob.
The only argument I can make out is that gold will go higher because we’re bankrupt and the dollar is worthless. But does that justify any price? At what point could that argument still hold up, yet the price is simply too high? I get the feeling that few gold bugs have ever considered that question.
Are there metrics that you can point to that show how gold’s price should have plunged for over $800 in 1980 to around $250 in 2001, then to over $1,000 last March? My feeling is that a huge weighting to the price of gold is undefinable speculation. It just is and there’s no way to make sense of it.
Any ideas?

Population Growth and Wealth
Posted by Eddy Elfenbein on April 6th, 2009 at 1:52 pm

Matthew Yglesias has an interesting post discussing the relationship between economic growth and population growth. He thinks that it’s possible to have long-term population decline alongside positive economic growth (though he says he’s not in favor of a declining population).
I’m not sure that’s correct. If a population is falling, then outside of war or disease, it must be due to either emigration or lower birth rates. That’s got to have a big impact on growth and innovation. In the other words, the size of GDP itself may boost per-capita GDP. If there’s heavy emigration, I would guess that would take a heavy toll on production since the émigrés would more likely be younger and more entrepreneurial.
If the falling population is due to declining birthrates, then that means the population is getting older. That would probably skew consumption away from innovative sectors. Not to mention that a falling population would place heavy pressure on a country’s social welfare obligations.
Yglesias posts a chart from Gregory Clark’s book, A Farewell to Alms: A Brief Economic History of the World which shows the lower population in pre-modern Britain led to higher wages. Sure, if all my neighbors are dropping dead from the plague my wages will rise, but that’s per-capita wealth which is very different from a growing economy.
The key part is the fitted line on Yglesias’s post that existed before Britain broke free from the Malthusian trap. I assume that the line would have to have a slope less than 0.5 (though it doesn’t appear that way). Either way, I think we can all agree that if another Great Plague comes along, wage growth won’t be a high priority.

Doing Nothing Can Be Very Smart
Posted by Eddy Elfenbein on April 6th, 2009 at 11:11 am

Here’s an interesting note on the Dow Jones Industrial Average (^DJI). Periodically, the gate keepers of the index add or delete stocks to keep things fresh. But if they had simply left the index alone, it would have done far better.
Since 1930, nine of the 30 stocks are still left. Twenty have been bought out or merged and only Bethlehem Steel has gone bust. The index would have finished 2008 at 14,600 instead of 8776. On top of that, the Dow’s weird weighting by price instead of market value also would have hurt you.
I don’t have the numbers on this but my guess is that a lot of the untouched Dow’s gain is due to one stock, IBM (IBM). The company was removed from the index in 1939 and put back in 1979. In those 40 years, IBM gained an astounding 22,000%.
Warren Buffett once said, “Lethargy bordering on sloth remains the cornerstone of our investment style.” Now you can see why.

Shorting Reason
Posted by Eddy Elfenbein on April 5th, 2009 at 10:46 pm

Richard Posner has a good review of Animal Spirits by George Akerlof and Robert Shiller. Here’s a snippet:

As one reads this book, one has the sense that deep down Akerlof and Shiller believe that being rational is the same as being right. That is a mistake. It prevents them from entertaining the possibility that what has now plunged the world into depression is a cascade of mistakes by rational businessmen, government officials, academic economists, consumers, and homebuyers, operating in an unexpectedly fragile economic environment, and that what is retarding recovery is not the “unreasoning fear” of which Franklin Roosevelt famously spoke but the rational fears–the reasoning fear, to use Roosevelt’s idiom–of businesspeople, consumers, and officials who confront economic uncertainties for which no one had prepared them.

I’ve often been critical of Robert Shiller’s work because I think he places too much emphasis on the short comings of investors. It’s true that folks often get carried away with things especially when prices get moving.
The truth is that many times it has been “different this time” or we did “enter a new era.” The speculation usually comes after a major change has taken place. Asset prices don’t easily confirm to a simple morality tale of people getting greedy and overpaying for stuff. If you scratch the surface, you’ll see that there are many concrete reasons (and government policies) that caused the animal spirits.
Just to give one example is that bubbles can often be confirmed by popular memes. The Nifty Fifty craze of the early 1970s specifically focused on companies that fostered social harmony (Xerox, McDonalds, Coke, Polaroid, Disney) which was a natural inclination after the turbulent 1960s.
The bubble of the 1990s seems to have been aided by the growth of the dubious first-mover-advantage theme. I remember being told countless times how some dot-com stock was “just like QWERTY.”
The story was that once a company became an industry standard, it would be the winner that took all. There was even a magazine called the Industry Standard. In 2000, the magazine sold more advertising than any magazine in America.
It didn’t last.

Creditors Need to Take Some Risk
Posted by Eddy Elfenbein on April 4th, 2009 at 11:28 pm

Tyler Cowen has a good op-ed in the NYT pointing out a key factor in the bailouts—the true recipients are the creditors and that might cause future problems:

What the banking system needs is creditors who monitor risk and cut their exposure when that risk is too high. Unlike regulators, creditors and counterparties know the details of a deal and have their own money on the line.
But in both the bailouts and in the new proposals, the government is effectively neutralizing creditors as a force for financial safety. This suggests a scary possibility — that the next regulatory regime could end up even worse than the last.
The more closely a financial institution is regulated, the more it will be assumed that its creditors enjoy federal protection. We may be creating a class of institutions whose borrowing is, in effect, guaranteed by the government.

Weekend Poll
Posted by Eddy Elfenbein on April 3rd, 2009 at 8:00 pm

Update: This question comes from the work of Daniel Kahneman and Amos Tversky, though I changed the amounts in order to experiment.
By pure rules of expected return, people should to take the 50-50 bet for $3000. Although that’s what most folks said, there’s still a significant percentage that chose the guaranteed $1,000. Incidentally, I don’t blame anyone for taking the $1,000. It really comes down to each individual’s risk tolerance.

The Jobless Rate Continues to Grow
Posted by Eddy Elfenbein on April 3rd, 2009 at 10:53 am

I don’t have much to add about today’s awful jobs report. Let me say a few minor things. The official rate was reported as 8.5%. Technically, it was 8.543% which was only about 10,000 jobs away from 8.6%. At the present rate, that’s less than half-a-day’s job cuts. Over the last six months, the unemployment rate has ticked up 0.1% about every week.
Over the last nine years, the unadjusted adult population has grown by 23.3 million. The civilian labor force has grown by just 11.6 million which means that less than half of the increase in population is participating in the jobs market. The number of employed has grown by just 4.2 million. So even the increase that is participating in the job market, only 36% have jobs (bear in mind, I’m talking about the net increase).

Cause Please Meet Effect
Posted by Eddy Elfenbein on April 3rd, 2009 at 9:58 am

February 23, 2004

Greenspan says ARMs might be better deal

May 16, 2007:

Pimco hires Greenspan as consultant

April 4, 2009

PIMCO Distressed Mortgage Fund Down 34%

(HT: Joe W.)

Mark-to-Market Is More Realistic
Posted by Eddy Elfenbein on April 3rd, 2009 at 9:27 am

In honor of yesterday’s decision from FASB, we at Crossing Wall Street would like to review our legacy assets which include; three unicorns, eight hobbits (non-union), a half dozen minotaurs, two mermaids, a couple of CHUDs, several tic-tacs, true love and a smurf.

Forbes and the Flat Tax
Posted by Eddy Elfenbein on April 2nd, 2009 at 3:00 pm

Now at his new perch at Reuters, Felix Salmon tweaks Steve Forbes for the news that Forbes magazine is cutting salaries by 10% for everything over $100,000:

This is taxing the rich! It’s class warfare! Why should those employees earning a six-figure salary be singled out for pay cuts? If you cut their pay, don’t you know that you’re going to reduce their incentive to work hard, and also the incentive for lower-earning employees to aspire to their position? And these are the most productive members of the firm! You’re punishing success! You should be giving the higher-paid employees a pay rise, instead — that will surely boost corporate revenues!
Come on Steve, walk the walk. If the rich can’t be treated equally with the poorer at Forbes, where is the hope for them in this world?

I know he’s joking, but two things. Obviously, a cut in salary isn’t a tax. There’s a major difference between dealing with a private employer and government taxes. With the government, you have no choice.
Secondly, what Forbes is doing isn’t running away from the flat tax — it’s exactly how his flat tax works. Forbes has called for a 17% flat tax on income only above a specific level (that’s changed over the years). You may not like his principles, but in this care Forbes is walking the walk.