I had the opportunity to observe market psychology first hand during the past couple of weeks. My friend, Howard S. Katz, had called a market top in gold this past Monday when gold was about $950. He also called a bottom in stocks and shifted from gold stocks into construction stocks. The first few days after Howard's call, gold continued to go up. It hit $1002 toward the end of the week. The stock market had become very volatile as bulls and bears battled in response to Fed easing. Subscribers to Howard's newsletter contacted Howard to argue that he had called the top too early. I mentioned Howard's call to a few MBA students and they too argued that he had been too early.
It is very difficult to call a turn precisely, but to make it more so, social pressure opposes a correct call. The gold market indeed topped at about $1000 and the construction stocks are up about 50% since Howard's call. I'm not sure how he does it (he uses technical analysis which is Greek to me), and I don't believe that contra-opinion is necessarily right. Delusional markets can continue for several years or more. Look at politics.
One thing is certain. If you are right about a change in market patterns there is going to be alot of argument against your position and not too much social support. It takes confidence in addition to the rare insight. The insight alone is rare enough. The combination of courage wtih insight is difficult to sustain.
The same is likely true of ideas. It takes guts to tell the truth.
Monday, March 24, 2008
Organizational Learning and the Progressive Model
The natural evolution of organizational learning should over time shift the relationship between business and government from more to less. Early in their history, capitalist firms lacked the ability to think and plan strategically; to research markets; to assess competition. Over time, the professionalization of management, the development of tools and learning processes, new methods of management and new planning processes and models not only provide businesses with tools that were not available to them in the 19th century, but also are less accessible to government because the personnel are not available. In David Ames Wells's time, Wells did not believe that firms could strategically plan investment; could perform market research; could persuade workers to purchase consumer goods; or could assess the long run profitability of a plant or business unit. By the 1960s, John Kenneth Galbraith overstating the case argued that firms plan and manage demand. Clearly the role of the state must change in response to the evolution of managerial knowledge. But the state's role can change only if it develops sophistication about the same processes that the firms learn about. But of course such learning is beyond the budget, the ability and the organizational flexibility of government agencies. Hence, the role of government will quickly become outdated.
The problem facing government is not just a matter of organizational learning. It is a matter of being able to anticipate the insights, deviations and failures of ever-evolving organizations. Such learning is so far beyond the ability of government, that government will inevitably prove to be disruptive to firms' learning processes.
An example is the case of Enron. Enron's failure was in large part due to its accounting emphasis on mark to market accounting. But mark to market accounting was the very policy that the SEC approved in response to Jeff Skilling's application. Another example is the California degregulation of the power market. The state adopted a regulatory system that facilitated Enron's and other power firms' manipulation of the power grid that caused massive power outages.
The results of the relationship between a state which aims to guide organizations that learn at a faster rate than the state does is one of four things. One, the state becomes irrelevant and adopts a de facto laissez faire approach. Two, the state enforces its prerogatives to control or influence industry and limits organizational learning and economic progress. Three the state attempts to ritually mimic firms' organizational learning and its supposed role of providing support to industry, squandering resources while in fact adopting a laissez faire approach. Four, the state becomes captive or subject to the influence of the industry and competing interest groups, resulting in policies that reflect political power and economic resources rather than rationality.
Government has adopted all three approaches. In human resource regulation such as OSHA and ERISA, the federal government has adopted costly regulation that has done little to improve safety or security, reducing economic opportunity. With respect to education, education schools continue to advocate progressive education approaches that reduce educational outcomes. In finance, the state has gradually backed off various regulations but continues to maintain regulation that makes it difficult for entrepreneurial financial firms to compete. In most fields the fourth likelihood has occurred. The brokerage of special interests has become a key characteristic of the American economy.
The problem facing government is not just a matter of organizational learning. It is a matter of being able to anticipate the insights, deviations and failures of ever-evolving organizations. Such learning is so far beyond the ability of government, that government will inevitably prove to be disruptive to firms' learning processes.
An example is the case of Enron. Enron's failure was in large part due to its accounting emphasis on mark to market accounting. But mark to market accounting was the very policy that the SEC approved in response to Jeff Skilling's application. Another example is the California degregulation of the power market. The state adopted a regulatory system that facilitated Enron's and other power firms' manipulation of the power grid that caused massive power outages.
The results of the relationship between a state which aims to guide organizations that learn at a faster rate than the state does is one of four things. One, the state becomes irrelevant and adopts a de facto laissez faire approach. Two, the state enforces its prerogatives to control or influence industry and limits organizational learning and economic progress. Three the state attempts to ritually mimic firms' organizational learning and its supposed role of providing support to industry, squandering resources while in fact adopting a laissez faire approach. Four, the state becomes captive or subject to the influence of the industry and competing interest groups, resulting in policies that reflect political power and economic resources rather than rationality.
Government has adopted all three approaches. In human resource regulation such as OSHA and ERISA, the federal government has adopted costly regulation that has done little to improve safety or security, reducing economic opportunity. With respect to education, education schools continue to advocate progressive education approaches that reduce educational outcomes. In finance, the state has gradually backed off various regulations but continues to maintain regulation that makes it difficult for entrepreneurial financial firms to compete. In most fields the fourth likelihood has occurred. The brokerage of special interests has become a key characteristic of the American economy.
Saturday, March 22, 2008
Howard S. Katz's Portfolio Returns 20% in Two Weeks
I have been subscribing to Howard S. Katz's newsletter The One Handed Economist for about 3 years. Howard tracks what a "conservative" portfolio. He bases his analysis on Austrian economics as well as technical analysis. The portfolio tracks from 1999. During this period the major stock indexes have gone up and down but now are not much higher than in 1999. In contrast, by the first week of March 2008 Howard's conservative portfolio was up about 115% over the nine-year period. Howard's latest edition came out a few minutes ago. In the past two weeks his portfolio went up better than 20%. It was about 215 in early March when he called a top in precious metals. He moved into several construction stocks which brought the portfolio up to 260. Wow! This was the kind of thing that until now I had read about but not directly experienced. Yay Howard!
Firms' Goals and Pricing
Walter Nicholson. Intermediate Microeconomics and Its Application Third Edition. Dryden Press, 1983.
I have decided to treat myself to review some basic economics this evening. It's been 20 years since I looked at my last economics textbook. What better way to brush up than my 1983 copy of Walter Nicholson's Intermediate Microeconomics and Its Application textbook? In this blog I will briefly review his thoughts on costs.
Costs (chapter 9)
Economists view historical costs as sunk costs. The implicit cost of a machine is what someone else would pay for it, i.e., its "rental rate". To minimize production costs firms choose inputs such that the rate of technical substitution is equal to the ratio of input costs. Thus if wages are w and machinery rental rates are v then:
Rate of Technical Substitution = wage rate/rental rate = w / v
That is, the rate of technical substitution is the rate at which one input may be traded off against another in the production process while holding output constant and that rate is the same rate at which they are traded in the open market.
In other words, the rate of technical substitution of labor for capital is the ratio of the
marginal product (labor)/ marginal product (capital)
so that each input should provide the same additional output per dollar spent and if they don't, firms will trade some of the less productive input for the more productive.
Short versus Long Run
In the short run production capacity is fixed. In the long run production can be curtailed. Fixed costs are fixed in the short run.
Short run average total costs = (total costs) / (total output)
while
Short run marginal costs = (change in total costs) / (change in output)
In the very short run price purely rations demand. This is because supply cannot be increased. But generally in the longer run there is a supply response to changing demand. In the short run (longer than very short run) the number of firms is fixed but firms can adjust the amount they are producing.
Theoretically, marginal and average costs ought to increase in response to increases in output but most studies fail to show increasing average or marginal costs but rather find that marginal and average costs are constant over large ranges of output.
Long Run
In the long run all productive inputs are variable. Nicholson makes the point that some factors may be difficult to alter even in the long run. The rate of technical substitution must equal the ratio of the input prices.
The long run total cost curve is found by considering all short run total cost curves and choosing the lowest one for each possible output level. "The locus of all these cost minimizing choices is called the long-run total cost curve..."
Under the assumption of constant returns to scale, the long term total cost curve is a straight line and average and marginal costs are constant and equal (equal because of the assumption of constant returns to scale which means that the marginal cost equals the average cost).
If there is a fixed input, average costs fall as variable inputs are added, but then rise again as the fixed input causes diminishing marginal productivity.
At the minimum piont of the Long Run Average Total Cost Curve the Long Run Marginal Cost Curve = Long Run Average Total Cost Curve = Short Run Average Total Cost Curve = Short Run Marginal Cost Curve
In reality, many empirical studies find declining long run average costs for smaller size with a flattening minimum average cost beyond a threshhold.
Changes in input prices will tilt the total cost lines. Changing input prices will change the isoquants on which the total cost curves are based and change the ratios of inputs.
I have decided to treat myself to review some basic economics this evening. It's been 20 years since I looked at my last economics textbook. What better way to brush up than my 1983 copy of Walter Nicholson's Intermediate Microeconomics and Its Application textbook? In this blog I will briefly review his thoughts on costs.
Costs (chapter 9)
Economists view historical costs as sunk costs. The implicit cost of a machine is what someone else would pay for it, i.e., its "rental rate". To minimize production costs firms choose inputs such that the rate of technical substitution is equal to the ratio of input costs. Thus if wages are w and machinery rental rates are v then:
Rate of Technical Substitution = wage rate/rental rate = w / v
That is, the rate of technical substitution is the rate at which one input may be traded off against another in the production process while holding output constant and that rate is the same rate at which they are traded in the open market.
In other words, the rate of technical substitution of labor for capital is the ratio of the
marginal product (labor)/ marginal product (capital)
so that each input should provide the same additional output per dollar spent and if they don't, firms will trade some of the less productive input for the more productive.
Short versus Long Run
In the short run production capacity is fixed. In the long run production can be curtailed. Fixed costs are fixed in the short run.
Short run average total costs = (total costs) / (total output)
while
Short run marginal costs = (change in total costs) / (change in output)
In the very short run price purely rations demand. This is because supply cannot be increased. But generally in the longer run there is a supply response to changing demand. In the short run (longer than very short run) the number of firms is fixed but firms can adjust the amount they are producing.
Theoretically, marginal and average costs ought to increase in response to increases in output but most studies fail to show increasing average or marginal costs but rather find that marginal and average costs are constant over large ranges of output.
Long Run
In the long run all productive inputs are variable. Nicholson makes the point that some factors may be difficult to alter even in the long run. The rate of technical substitution must equal the ratio of the input prices.
The long run total cost curve is found by considering all short run total cost curves and choosing the lowest one for each possible output level. "The locus of all these cost minimizing choices is called the long-run total cost curve..."
Under the assumption of constant returns to scale, the long term total cost curve is a straight line and average and marginal costs are constant and equal (equal because of the assumption of constant returns to scale which means that the marginal cost equals the average cost).
If there is a fixed input, average costs fall as variable inputs are added, but then rise again as the fixed input causes diminishing marginal productivity.
At the minimum piont of the Long Run Average Total Cost Curve the Long Run Marginal Cost Curve = Long Run Average Total Cost Curve = Short Run Average Total Cost Curve = Short Run Marginal Cost Curve
In reality, many empirical studies find declining long run average costs for smaller size with a flattening minimum average cost beyond a threshhold.
Changes in input prices will tilt the total cost lines. Changing input prices will change the isoquants on which the total cost curves are based and change the ratios of inputs.
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