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Arguing Over a Nonexistent Bubble

03 Kasım 2012 Cumartesi

Noah Smith, who is a better human being than I am, recently waded through an anti-Krugman rant to find an interesting nugget: the claim that money is a bubble.

“Is money fundamentally worth nothing more than the paper it’s printed on (or the bytes that keep track of it in a hard drive)?” Mr. Smith, an assistant professor of finance at Stony Brook College wrote on Oct. 21. “It’s an interesting and deep question. But my answer is: No.”

It isn’t, of course; but my explana- tion of why it isn’t is a bit different his, and has wider implications. I’d start by asking, what do we mean when we talk about bubbles? Basically, I’d argue, we mean that people are basing their decisions

on beliefs about the future that are based on recent experience but can’t be fulfilled. For example, people buy houses because they expect home prices to keep rising at a pace that would eventually leave nobody able to buy a first home.

Bubbles don’t have to involve prices. You can have a local construction boom driven by rapid growth in an area’s population and employment, when the main thing driving that rapid growth is ... the local construction boom, which will eventually collapse when enough houses are completed. The point, whether prices are involved or not, is that the expectations of individuals add up to an aggregate impossibility.

This sounds a lot like what happens in a Ponzi scheme, where people are relying on an ever-growing number of new subscribers — such plans are doomed to disaster when the pool of potential suckers runsdry.

Is fiat money a bubble in this sense? Not at all. It’s true that green pieces of paper have no intrinsic value (except that they can be used to pay taxes, which is actually important), so that my willingness to accept green paper you is based only on my belief that I can, in turn, hand that green paper over to someone else. But there’s nothing to prevent that process of monetary circulation going on forever.

So what is fiat money? It is, as the economist Paul Samuelson put it, a “social contrivance.” It’s a convention, which works as long as the future is like the past. Obviously, such conventions can break down — but then so can things like property rights. In fact, you could argue that almost every asset in a modern economy owes its value to social convention; green pieces of paper could become worthless, but then so could any paper claim, which is, after all, worth something only be- cause laws say it is — and laws can be repealed.

And once you realize that a social convention is not at all the same thing as a bubble, several related fallacies fall into place.

Take the common claim on the right that Social Security is a Ponzi scheme because the system has few real assets. It’s true that Social Security is mainly a system in which each generation pays for the previous generation’s retirement, in the expectation that it will receive the same treatment the next gen- eration. But like monetary circulation, this process can go on forever; there’s nothing unsustainable about it (yes, demography, but that’s about the levels of taxes and benefits, not the fundamental nature of the scheme). So there’s nothing Ponziesque at all.

A final thought: the notion that there must be a “fundamental” source for money’s value, although it’s a right-wing trope, bears a strong family resemblance to the Marxist labor theory of value. In each case what people are missing is that value is an emergent property, not an essence: money, and actually everything, has a market value based on the role it plays in our economy. Full stop.


Stephen Williamson, a professor at Washington University, recently made the controversial claim that money is a bubble, sparking a debate among some economists. On his blog, Mr. Williamson defined a bubble as a situation where the price of an asset is higher than its fundamental value — what it is actually worth. He argued that money has no fundamental value, and so is by definition “a pure bubble.”

“The payoffs on my stocks and bonds, and the sale of my house, may be denominated in dollars,” Mr. Williamson wrote, “but that does not mean that the value of those assets is somehow derived the value of money.” He explained that unlike land or commodities, money doesn’t have inherent value, and is just green paper that we’ve all agreedto trade at an artificially inflated price.

In a response, UC Berkeley professor Brad DeLong maintained that money derives fundamental value its liquidity: “Money has a fundamental value because it performs the useful service of enabling transactions. Money is a substitute for trust. In the absence of money, you can transact only with people with whom (a) you have an (unlikely) double coincidence of wants, or (b) you have an ongoing noneconomic relationship that enables you to trust each other to make your credit good.”

Much of this disagreement has focused on the precise definition of a bubble. While some economists categorize bubbles as inherently unsustainable, Mr. Williamson believes that they can sometimes be both sustainable and useful.


In recent years, the online prediction market Intrade has gained prominence as a more accurate means of gauging po- litical races than traditional analyses by pundits.

In prediction markets, bet- tors buy shares of a potential future outcome, such as Barack Obama winning the 2012 presi- dential election, and the value of those shares fluctuates in a manner similar to that seen on the stock market, as buyers and sellers react to breaking news and the perceived probability of a future payout. Once the event transpires, bettors holding the correct outcome receive a pay- out and everyone else loses the value of their shares.

In 2004, while many pundits were predicting a victory for Democratic nominee John Ker- ry based on pre-election polls, Intrade correctly forecasted the winner nationally and in all 50 states. In 2008, Intrade correctly predicted election results in all but two states, and was closer to the final electoral vote count than most pundits.

However, sites like Intrade are not without limitations. A 2009 paper by the economist Da- vid Rothschild confirmed that prediction markets tend to favor of trailing candidates, in a phe- nomenon where bettors seem to overvalue long shots while un- dervaluing favorites. Mr. Roths- child found that after correcting for this bias, prediction markets could be more accurate than tra- ditional polling.

Since Intrade’s predictions influence perceptions of how a candidate’s campaign is pro- gressing, several attempts have been made to game the system. Recently, the election market shifted dramatically but briefly toward Mitt Romney, which led many commentators to speculate that a pro-Romney entity was working to shift the Intrade price.

Meanwhile, the race for the presidency has tightened sig- nificantly. Nationwide surveys show that the candidates have been locked in a statistical tie since the presidential debates, but President Obama has main- tained his lead in the swing states that will ultimately decide the election. Most models still consider him the favorite.

Political Attacks On Impartiality

Nate Silver — whom everyone in- terested in the American presiden- tial election should be reading — re- cently wrote on his FiveThirtyEight blog for The New York Times about being bemused by Intrade’s analy- sis, which is showing a much higher chance of a Mitt Romney victory than his does.

You should probably also know that Mr. Silver is, predictably, being accused of deliberately skewing the numbers — no doubt as part of a grand conspiracy also involving the Bureau of Labor Statistics and Area 51.

If you’re new to this, there are two basic approaches to election analysis at this point. One is in the style of the campaign reporter,

full of impressionist writing about who won the news cycle and who has “momentum” — whatever that means. The other is poll-based. And that mostly means state-level polls at this point: there are more of them, and we have an electoral-college system, not a popular-vote system.

The impressionistic style has been all about Mr. Romney on the rise, a narrative that is to a large part being fed by the Romney cam- paign itself. But the state-level poll- ing doesn’t show it.

In fact, the state polls pretty much say that President Obama would win if the election were held right now, taking Ohio, Wisconsin and Iowa, and quite possibly Virginia. Florida is a dead heat, too. Nor is there any sign of movement in Mr. Romney’s direction after his big post-first-debate bump.

So why is Intrade trending toward Mr. Romney? One possibility is that Mr. Romney’s supporters are trying to manipulate the results — as Mr. Silver points out, other markets and betting forums are much less Romney-friendly. Another is that Intrade traders actually buy the spin cycle.

Whatever is really going on, we’re now getting close to a showdown between styles of political analysis. By inclination, I, of course, trust the nerds. But we’ll soon see.

The War on Objectivity

The economist Brad DeLong pointed me to a recent attack on Mr. Silver in the National Review, titled “Nate Silver’s Flawed Model,” which I think illustrates an impor- tant aspect of what’s really happening in the United States.

For those new to this, Mr. Silver is a sports statistician turned political statistician who has been maintaining a model that takes lots and lots of polling data — most of it at the state level, which is where the presidency gets decided — and converts it into election odds. Like others doing similar exercises, Mr. Silver’s model continued to show an Obama edge even after the first debate in Denver, and has shown that edge widening over the past couple of weeks.

This could be wrong, obviously. And we’ll find out on Election Day. But the methodology has been very clear, and all the election modelers have been faithful to their models, letting the numbers fall where they may.

Yet the right — and we’re not talking about the fringe here, we’re talking about mainstream commen- tators and publications — has been screaming “bias!” They know, just know, that Mr. Silver must be cook- ing the books. How do they know this? Well, his results look good for Mr. Obama, so it must be a cheat. Never mind the fact that Mr. Silver tells us all exactly how he does it, and that he hasn’t changed the for- mula at all.

This is, of course, reminiscent of the attack on the Bureau of Labor Statistics — not to mention the at- tacks on climate science and much more. On the right, apparently, there is no such thing as an objective calculation. Everything must have a political motive.

This is really scary. It means that if these people triumph, science — or any kind of scholarship — will become impossible. Everything must pass a political test; if it isn’t what the right wants to hear, the messenger is subjected to a smear campaign.