From the Lecture Hall: The Euro Crisis and U.S. Debt

Every once in a while, I like to talk about things that my economics professors say in class. My last post about my class was on the history of recessions.

As I've said before, a lot of my criticism isn't directed toward my professor's conclusions - rather how they got to those conclusions. An economics class is supposed to push students to explain and prove why something is happening based off of the tools that we know. And I like to blow the whistle when they relax that requirement.

So yesterday, we're brushing over capital utility and interest rates. Throughout class, my professor enjoys diverging from the material and applying what we're learning to the real world. Of course, this being George Mason, those applications often involve anti-liberal, anti-government, pro-liberty themes.

Yesterday's divergence was about Greece and the United States. We were calmly told that the US was on the same path as Greece given our debt-to-GDP ratio (shown below), and that we should invest $45-50k in gold so that we can get out of the country when it collapses. 

I believe what we have here is a breakage of Noah Smith's Principles of Arguing with Economists: Arguments by accounting identity almost never work. 

Accounting identities are mostly just definitions. Very rarely do definitions tell us anything useful about the behavior of variables in the real world. The only exception is when you have a very good understanding of the behavior of all but one of the variables in an accounting identity, in which case the accounting identity acts like a budget constraint. But that is a very rare situation indeed.

My professor says that America will become the next Greece because both dept-to-GDP ratios are on the same path. That sounds like an argument by accounting identity to me.

So that's all scary and everything. But how much is it really telling us? Because while our debt ratios are on the same path, just take a look at U.S. interest rates:

I don't see many people fleeing from U.S. bonds with that trend. I haven't done Macro in a while, so I'm still a little rusty at comparative economics. But what I'm trying to show is that there is more to the Euro crisis than just debt and output. A lot more. Some of these things are applicable to the U.S. (like fiscal policy, interest rates, bond yields) and some of them are not (like the political structure of the EU, monetary unions).

But here's my point. If you're going to tell the class that the U.S. is will become an apocalyptical hell zone in the next few years, don't just casually tell us why. I think we're grown up enough to get the full picture of why you think that's happening. 

Winklevoss Twins have equity in Facebook

Thought that was a pretty funny thing to hear in this interview.

They're also getting involved in the Venture Capital frenzy, investing in early-stage cloud companies.


In all seriousness though, the idea of VC has been going around the blogosphere a lot. Peter Thiel gave a talk about how VC funds work. And showed this graph:

The basic principle is that for a VC fund, there are maybe one or two projects that actually make gains. A vast majority of the projects that are invested in tend to fail. . . I hope that this is something that VC managers (cough Winklevoss Twins cough) realize. Because it plays a big part in how the VC market works. 

Particularly, I wanted to point out Noah Smith's post about a slump in VC returns since the burst of the Dot-com bubble. He references a paper that shows this graph:

The different lines are different data sets showing how well VC funds did relative to Private Market Equivalence (or how well the U.S. public stocks did in general). A PME of greater than 1 means that the VC investment did better than public stocks. If VC's fell below 1, then investors would for sure leave the market.

As you can see, we're in kind of a VC slump. Where gains haven't reached anywhere near the levels reached in the mid-1990s. Of course, there could be a number of reasons why that is.

Maybe the VC fund's of the 1990s got all the low-hanging fruit. That doesn't really seem to surprise me. There really hasn't been any HUGE payoffs from the internet apart from what we already have. Yes, we have social networks, but are they really driving that much economic value other than advertisements? It seems to me that Venture Capital does well when there are big breakthroughs in a certain industry, and there's a vacuum with how to apply those discoveries. In fact, in 2011, less than 30% of VC funds went to software and media industries, and more are going towards energy and biotechnologies. These are trends that I'm glad to see - considering payoffs might actually improve living standards a good deal. It'd be interesting to see what Tyler Cowen thinks in relation to his Great Stagnation theory. 

But overall, I think the problem is that we haven't found some breakthrough way to apply big data or cloud computing. Hopefully these investments will help spur some of those discoveries...

Wall Street then and now

Thomas Philippon, from NYU, has a new paper with this simple abstract:

Despite its fast computers and credit derivatives, the current financial system does not seem better at transferring funds from savers to borrowers than the financial system of 1910.

Now, before even reading the paper, I can already envision my Austrian economics professor starting his explanation of how the government has bogged down efficiency. Which - I would argue against. A lot of regulation has surrounded around making information about transactions more transparent.

Philippon points out that "compensation for financial intermediaries" is at 9% of GDP (an all time high).

Here is more:

Trading costs have decreased (Hasbrouck (2009)), but the costs of active fund management are large. French (2008) estimates that investors spend 0.67% of asset value trying (in vain, by definition) to beat the market. 

In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry's share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone.

I'm not really in a place to give commentary in this issue. Though I'm glad it's being looked at. The real question is why? Trading is up substantially, which is a result of the democratization of finance (i.e. eTrade and such). But are people really better off? I guess the more important question is how much people think they are better off.  Philippson finds that prices aren't any more informative of what's really happening in the markets. (I know, shocking.)