This Is the End


Markets, Risk and Human Interaction

November 30, 2010


November 30, 2010
This reflects my personal opinion, not the views of the SEC or its staff.
Sarah Palin's "Being There" ascendancy may strike some as absurd, but it provides a case study for what now counts as news. Today, going viral matters more than the information itself. The object lesson that Palin brings to politics is something we should fear for the financial markets, where going viral can transform information from being the bedrock of market efficiency to a source of irrationality, even crisis.

For example, the most important lesson to come out of robo-signing is not the fiasco itself. The incomplete and flawed documentation for foreclosures has been well known for over a year, as have the practices of “endorsing in blank”, inaccurate reporting of remittances, inflating appraisals and applicant earnings, to name a few. The robo-signing revelation is just one more shoe to drop. The important lesson is that it is a shoe that gained legs, so to speak; that went viral, topping the list for news, blog repackaging, and possible Congressional hearings. As a result, robo-signing is the item that had an impact on financial stocks which could have occurred based on any number of problems that were already known.
More broadly, the lesson from Palin and robo-signing is that we are entering a new age for the way information affects the markets, an age when going viral matters more than the information itself. Information has gone from being illuminating to being a source of risk, and not because of content, but because of the vagaries of what might gain traction.
To put this into perspective, follow the path of the role of information in the markets.
The age of private information. There was a time when information gave an advantage, when there was an edge to getting information ahead of others. Rothschild famously received early news of the British victory at Waterloo; commodities traders hired teams to wander the cocoa fields on Ghana counting pods; equity managers used their influence to get a jump on earnings announcements.
The age of too much information. The push toward transparency eroded this advantage. But the requirements for transparency throw out so much information that it is difficult to find what is relevant. Information can hide in plain sight; if every drug may cause nausea, insomnia and drowsiness, then we get to the point of, “I have to list everything I can think of, but you know the game. Just ignore it and try the stuff out”. The echo chamber of reposting adds noise to any news that is worth repeating, and much that is not.
The age of viral information. Information is moving from being the bedrock of market efficiency to a source of crisis. The risk for the market is not the news itself, but what news gets drilled home through so many channels that people act on it; we cannot anticipate when information might go viral and sweep the markets.. For retail markets – the municipal bond market and money market immediately come to mind – it is easy to envision a “USA Today effect”, to use an anachronistic expression, causing a run on the bank.
The greatest concern lies in information going viral that is inconsequential. For those in the market who are on top of the news and its implications, the question no longer is simply one of when others will finally get around to looking at the information and see that it is important. It is also a question of whether something irrelevant will catch the fancy of the cloud. Look at Sarah Palin and see the logical end to the inane You Tube videos that capture the imagination of the nation, or the ranks of the “famous for being nothing” reality show celebrities that Palin has elected to join.
The new, viral world means more surprises and more volatility; and not because of market shocks precipitated by content, but because of the randomness in what might happen to catch on and reverberate through the internet.

November 22, 2010

Secular Deflation

November 22, 2010

This reflects my personal opinion, not the views of the SEC or its staff.
My last post posited a future world where technology-driven production and consumption lead to a secular drop in demand, and with it a drop in employment, resulting in what I called a consumption trap:
We are in the year 2025. Because of advances in production technology, much of the path from extracting the required renewable resources through to the production and distribution of most of the items we demand can be accomplished with automated methods overseen by a small cadre of engineers.
The main items we demand, beyond food, clothing and shelter, are the nth generation game systems. Computer games have progressed to the point where they are approaching the level of Nozick’s experience machine. They allow us to be anyone we want in whatever world we want, accompanied by whomever we want, all with full sensory feedback. Given our evolved interests, most of us are spending a fraction of our income on consumption. There just isn’t a lot that we demand.
We are a society that basically eats, sleeps, works and then veges out. Many of us now have our own prefabricated SmallHouse® (McMansions are a thing of the past; no one needs all that space, and, like mink stoles post-Mad Men, social norms regard these as the extravagances of a bygone era). That plus a car, food (the former rarely used, and both produced very inexpensively), our two-hundred dollar experience machine games, and we are happy as a clam.
This world creates consumption trap because we are not consuming enough to generate full employment. And such a world comes with a corollary: secular deflation.
We all know that technology is perpetually in deflation mode. On a per unit of consumption basis – whether measured by the cost of processing one instruction or storing one bit of data – the cost of speed and storage is cut in half every year or so. That makes even roaring inflation look like a crawl.
And, it makes life difficult for the Bureau of Labor Statistics folks who have to figure out CPI. This deflation in technology can overwhelm the inflation in other areas of the economy, where a ten or twenty percent rise is something of note. There are two ways the BLS can keep the relentless price deflation in technology from dominating CPI.
One way is to act as if computers do not represent much of consumption. This route is hard to take, given, first of all, that it is obvious that we all spend a reasonable amount on computers and their peripherals, and second, that with prices dropping by orders of magnitude, consumption would have to be suppressed to a rounding error in order to staunch its effect. It would be one thing to understate our consumption of computers, another to act like computers didn’t even exist.
The second way is not to look at the per unit price of computations and data storage, but look at the price of computers without regard to how much they can do. This is the route that the BLS has taken. The BLS defines high, mainstream and low quality computers, and prices each of those. No matter that the low quality computer now is a hundred times better than the high quality one of ten years ago. And, of course, what constitutes these quality levels is up for grabs. Maybe in the bowels of the calculations, the mainstream computer is defined as the one that costs a bit more than the mainstream one of five years ago. Or, maybe I’m being too cynical.
And to be fair, this approach is not totally foreign in other products. Both houses and cars have improved over the past hundred years, and they also are priced based on the standard item at any given time. But a car continues to provide a way for a small group to travel from place A to B, albeit more comfortably and safely, and a house still keeps a roof over the head of one family, even if it does so with fewer drafts and more efficient floor plans. If a car morphed over time into a vehicle that could transport thousands of people simultaneously to their various destinations in fractions of a second, I doubt that anyone would be able to keep it in the “car” column of the CPI calculation with a straight face.
Whatever the mechanism used to corral the inherent deflation in computers, it starts to break at the seams the more the world becomes integrally related to the cost of units of CPU and memory, where CPU and memory permeate what we consume directly, through our experience machines and the like, and indirectly as a principal factor in producing whatever else we need to keep us alive while we stay plugged in. In that world, the trick of using high, medium and low cost computers to hide the inexorable decline in the prices of computations and memory won’t work anymore. If these prices drop by orders of magnitude, we are going to have a negative number for CPI even if health care, housing and food go up by ten or twenty percent.