Asian decoupling?

Not yet, but coming soon. More cars, computers and cellphones sold in emerging markets than in the US. The current US recession will still have a big impact in Asia, but much less so than in 2001.

BusinessWeek: Are Asian Economies Decoupling from U.S.?

Morgan Stanley emerging markets guru Jonathan Garner says the days of a U.S.-centric world are fading fast


The debate over whether emerging markets are decoupling from the US continues to rumble on. With the US economy slowing and probably heading into recession, the debate is of particular interest at this time. Here Jonathan Garner, managing director and head of global emerging markets equity strategy with Morgan Stanley, explains why he thinks that emerging markets will weather this slowdown far better than in previous US slowdowns.

What are your main reasons for arguing that decoupling is under way?

The emerging markets are now 30% of the global economy at current exchange rates. They are even larger now than developed Europe and their share of global GDP is steadily rising and will continue to rise, I suspect, for the foreseeable future.

Also emerging markets have demography on their side. The emerging world's working age population will increase by another one billion people between now and 2050. The developed world's working age population will shrink by about 120 million—or about one eighth, whereas emerging markets will rise by about 25% from the current level. This and the adoption of the market economy, urbanisation and other profoundly positive trends will keep emerging markets moving forward.

How rapidly is this process moving?

I would say we are exiting the US-centric world pretty quickly. And if we are right about this, emerging markets will contribute over 60% of global growth this year. Last year they contributed about 48%. China alone is contributing more to global growth than the US now and will do so for the foreseeable future. China contributed about 11% last year and will contribute 12% this year. This process is slowly bringing down the global share of US GDP while the share of emerging markets is steadily rising.

The decoupling argument seems to have plenty of sceptics

Decoupling runs against the consensus view. Some people simply don't buy it and don't understand the profound change that is underway. And most people still have this view of the US as the core and emerging markets as the periphery. If you go back to the 1990s that was true to some extent—the core drove the periphery—but that was when you had small emerging countries like Hong Kong, Singapore and Thailand that were exporting to the US. It's very different when you have got really large population emerging market countries adopting a market economy. When that happens their growth really starts to kick in.

How is it different this time?

Some things are happening that don't usually happen in a US recession. Export growth in emerging market countries is still running at 19.9% year-on-year. Look at the last US recession, which began in Jan 2001: Then Emerging Markets export growth plummeted. The reason for this difference is that the US is gradually becoming less and less important. Since 2001 there has been a huge gain in intra-emerging market trade and a huge decline in the share of exports from the emerging markets to the US. As an end-user market the US now takes less than a fifth of emerging market exports. And the biggest growing element is trade with the emerging markets and after that trade with the EU.

How is this reflected in product categories?

If you look at auto sales for example, in China alone they have grown from two million units in March 2002 to 7.5 million December 2007. Auto sales in the Bric countries (Brazil, Russia, India, China) totalled 14 million units in 2007. That's 88% the size of the US market and they are growing at 20% year-on-year which means that within a year the Bric counties will have larger auto sales than the US. If you go back to the last US recession in 2001-02, the Bric countries had auto sales that were less than one-third the size of the US. If you look at the auto sales to population densities—this trend definitely won't stop here.

Are the any other areas where growth has been strong?

It's also true in areas such as personal computers—not an area where you tend to think about decoupling. Back in 2001 the US was twice the size of the Asian market ex-Japan, while in 1998 it was three times the size. Today it is scarcely larger.

It is happening in even smaller ticket items such as mobile phone handsets. The US and Europe together take less than one-third of global handsets. In the last US recession it was more than a half. The vast majority of handsets these days are sold into the emerging markets.

What about spending on infrastructure development?

Infrastructure is very important. We have tried to estimate infrastructure spend and gross fixed capital formation and then looked at the proportion of that that which goes to infrastructure. We reckon that the 29 emerging markets countries that we have modelled will have about $22 trillion over the next 10 years. So rising from about 2% of global GDP in 2008 to about 3.5% of global GDP in 2017. That's a very major improvement and it's a structural driver of global GDP growth as we expect it to be growing faster than overall GDP growth.

How is this spending going to be financed?

It can be funded because the emerging markets countries have got their house in order economically. They are running surpluses and their public sectors are external creditors not debtors. The big debtor is the US. The public sector even in places like Brazil and Mexico is now a creditor. Its gives them huge scope to engage in infrastructure building and at the governmental level almost every emerging markets country has drastic infrastructure spending plans across a whole range of sectors. These include airports, power stations, power stations, property, and railways. It really is a far bigger and probably far longer investment theme than the housing problems in the US right now. People find it hard to get their mind around it right now because it crosses many countries and involves a lot of different sectors.

So do you think a slowdown in the US is going to have much impact on Asia?

Well it will have some—we are expecting a growth deceleration. It would be foolish to argue there would be no effect. But we think it will be quite limited. Much more so than in previous US recessions. Because emerging market countries are no longer just exporting to the US. They are exporting to the EU and to each other to feed their own end-use consumers.

So long, Bear: fear crushes greed

Bear Stearns evaporated over the weekend. Its market cap plummeted from $20B a year ago to $3.5B on Friday to essentially zero this weekend, when JP Morgan acquired them for less than the real estate value of their building in Manhattan. Due to Fed guarantees made to JP Morgan, US taxpayers are on the hook for $30B of the most illiquid mortgage backed securities on Bear's books. The Fed intervened because had Bear been allowed to melt down there would have been chaos in and systemic risk to the financial markets ("too big and interconnected to fail"). The current crisis is much more serious than either the Long Term Capital collapse of 1998 or even the savings and loan crisis of the 1980s.

How do illiquid securities get priced? Ultimately, it's competition between FEAR and GREED. At the moment FEAR is winning -- there are serious mispricings in corporate and municipal bond markets due to gigantic risk premia and a flight to security. Mortgage securities won't bottom out until GREEDY capital (controlled by investors willing to take a risk today in hopes of future profits) is sufficient. The problem is that price recovery can't take place until market confidence returns and, additionally, the ultimate value of mortgage securities depends on future projections about the bursting housing bubble, default rates, overall macro trends, etc. It could take a long time for markets to clear, with the Fed (taxpayers!) acting as the buyer of last resort in the interim.

WSJ: ..."At the end of the day, what Bear Stearns was looking at was either taking $2 a share or going bust," said one person involved in the negotiations. "Those were the only options."

To help facilitate the deal, the Federal Reserve is taking the extraordinary step of providing as much as $30 billion in financing for Bear Stearns's less-liquid assets, such as mortgage securities that the firm has been unable to sell, in what is believed to be the largest Fed advance on record to a single company. Fed officials wouldn't describe the exact financing terms or assets involved. But if those assets decline in value, the Fed would bear any loss, not J.P. Morgan.

The sale of Bear Stearns and Sunday night's move by the Fed to offer loans to other securities dealers mark the latest historic turns in what has become the most pervasive financial crisis in a generation. The issue is no longer whether it will yield a recession -- that seems almost certain -- but whether the concerted efforts of Wall Street and Washington can head off a recession much deeper and more prolonged than the past two, relatively mild ones.

'Uncharted Waters'

Former Treasury Secretary Robert Rubin last week described the situation as "uncharted waters," a view echoed privately by top government officials. Those officials have been scrambling to come up with new tools because the old ones aren't suited for this 21st-century crisis, in which financial innovation has rendered many institutions not "too big too fail," but "too interconnected to be allowed to fail suddenly."

Bear Stearns's sudden meltdown forced the federal government to come to grips with the potential collapse of a major Wall Street institution for the first time in a decade. In 1998, about a dozen firms, with encouragement from the Federal Reserve Bank of New York, provided a $3.6 billion bailout of Long-Term Capital Management that kept the big hedge fund alive long enough to liquidate its positions. Bear Stearns famously refused to participate in that rescue.

The scale of the financial system's troubles are even bigger this time around. Since last summer, the Fed has lowered its target for the federal-funds rate, charged on low-risk overnight loans between banks, to 3% from 5.25%, and it is expected to cut the rate again this week. Last week, the Fed said it would lend Wall Street as much as $200 billion in exchange for a roughly equivalent amount of mortgage-backed securities.

But those moves have failed to soothe investors and lenders, who are worried about the true value and default risk of many debt securities or are hoarding cash to meet their own needs. As worries grew that failing to find a buyer for the beleaguered investment bank could cause the crisis of confidence gripping Wall Street to worsen across the financial system, federal regulators pushed Bear Stearns's board to sell the firm.

Who can forecast or model the future value of a complicated CDO tranche? Only a quant with a PhD. Are the real decision makers and risk takers on Wall Street in the mood to trust those calculations? Certainly not at the moment. Therefore, I predict, for now, very limited bargain hunting by just a few bold investors, and no end to illiquidity.

From a recent Fortune interview with Paul Krugman; he seems to be saying subprime is oversold and there's money to be made for the steely eyed:

Fortune: ...do you think the sense of crisis is turning into a crisis of confidence more than anything else?

I fluctuate on that. I look at the prices on subprime-backed securities. Even the AAA-rated tranche is selling for barely over 50 cents on the dollar, and the rest is essentially worthless, which amounts to a prediction that you're going to get really very little on this stuff. Even if every subprime borrower walks away from his house and a lot of money is lost in foreclosure, it's hard to get numbers that bad. So there might be some overselling in these markets. But on the other hand, a lot of the financial system looks like it's going to shrivel up and have to be rebuilt. And that's not too good.

The other risk is, of course, a dollar meltdown. As the Fed lowers interest rates and (effectively) prints money to stimulate the economy and prop up banks and securities firms, foreign investors must begin to question the future of the dollar as a store of wealth. The same crisis of confidence that brought down Bear could eventually bring down the US dollar.

Weighted US dollar index (NYBOT:DX):

Happiness: all in da gene?

shared environment = no effect
monozygotic twins = big effect

An overview of recent books on happiness, in the New York Review of Books.

...Beginning in the 1980s, Lykken and his colleagues surveyed 2,310 pairs of identical and fraternal twins, some reared together, others brought up apart, looking to see how closely mood, affect, temperament, and other traits tracked with shared genes and/or a shared environment.

What they found (from a smaller subset of the original group) was that the "reported well-being of one's identical twin, either now or 10 years earlier, is a far better predictor of one's self-rated happiness than one's own educational achievement, income, or status." This held not only for identical twins raised together but for those brought up apart, while for fraternal twins raised in the same household, the likelihood that one's sense of well-being matched one's twin's was, statistically speaking, not much greater than chance.

Original research by the Lykken group.

Happiness Is a Stochastic Phenomenon

David Lykken and Auke Tellegen
University of Minnesota
Psychological Science Vol.7, No. 3, May 1996

Happiness or subjective wellbeing was measured on a birth-record based sample of several thousand middle-aged twins using the Well Being (WB) scale of the Multidimensional Personality Questionnaire (MPQ). Neither socioeconomic status (SES), educational attainment, family income, marital status, nor an indicant of religious commitment could account for more than about 3% of the variance in WB. From 44% to 53% of the variance in WB, however, is associated with genetic variation. Based on the retest of smaller samples of twins after intervals of 4.5 and 10 years, we estimate that the heritability of the stable component of subjective wellbeing approaches 80%.

Lykken's book.

The renormalization of G

New paper! Can the scale of quantum gravity be deduced from simple dimensional analysis using low-energy inputs like Newton's constant (G), Planck's constant (hbar) and the speed of light (c)? This leads to the usual estimate of 10^19 GeV for the Planck scale. But it's also possible that renormalization effects (i.e., significant renormalization group evolution of Newton's constant at short distances) cause the true energy at which quantum gravity becomes strong to differ substantially from the naive estimate of 10^19 GeV. We analyze this possibility in the paper. There is an interesting connection to Dvali's work on solving the hierarchy problem by introducing a large number of new particles with conserved charges. He argues that unitarity of black hole evaporation would then require a drastically reduced Planck scale, and our results agree.

arXiv:0803.1836 (hep-th)


Quantum gravity at a TeV and the renormalization of Newton's constant

Xavier Calmet, Stephen D. H. Hsu, David Reeb

We examine whether renormalization effects can cause Newton's constant to change dramatically with energy, perhaps even reducing the scale of quantum gravity to the TeV region without the introduction of extra dimensions. We examine a model which realizes this possibility, and describe experimental signatures from production of small black holes.

A fighter's heart

I recommend Sam Sheridan's book A Fighter's Heart: One Man's Journey Through the World of Fighting to anyone who is interested in the fight game (ultimate fighting, martial arts, boxing).



When I started on Sheridan's path 15 years ago, I thought I'd write about it someday, but I never got past a single short essay I posted on my web page.

Sheridan studies muay thai (kickboxing) in Thailand, boxing at Harvard and later in Oakland (with Andre Ward), MMA in Iowa with the Miletich camp, and jiujitsu in Brazil (with BTT). He also travels to Tokyo with Antonio Rodrigo Nogueria ("minotauro" -- former Pride and current UFC heavyweight champion) for his decisive encounter with Fedor Emelianenko.

Sheridan's insights and writing are good. The only problem is the guy has no ground game, so he writes about grappling -- the real heart of fighting -- like a mere journalist :-)

Wanted: a beautiful mind

Nice work if you can get it! (I mean Brian Grazer's gig, not the "cultural attaché" cum intellectual lackey...)

New Yorker: ...The rumor, according to one (unofficial) e-mail: “Oscar-winning producer Brian Grazer (Da Vinci Code, A Beautiful Mind, American Gangster) is looking for a new cultural attaché.” The e-mail explained:

This person would be responsible for keeping Brian abreast of everything that’s going on in the world; politically, culturally, musically. . . . They’re also responsible for finding an interesting person for Brian to meet with every week . . . an astronaut, a journalist, a philosopher, a buddhist monk. . . . There is LOTS of reading for this position! Grazer may ask you to read any book he’s interested in. You’ll probably get to read about 4 or 5 books a week and you may be required to travel with him on his private plane to Hawaii, New York, Europe—teaching him anything he asks you about along the way. . . . You will also be provided with an assistant. . . . Salary is around $150,000 a year. . . . You will be to Grazer what Karl Rove was to Bush.

...Michael Rosenberg, the president of Imagine, the production company Grazer owns with Ron Howard, said that about a hundred would-be attachés have e-mailed résumés since word of the job got out. One was Ed Cooke, twenty-six, a British writer and education consultant. His résumé: philosophy-and-psych degree from Oxford, three languages, a demonstrated interest in “the philosophy of cricket.” “This seemed like a job that would suit me,” Cooke said. He’d sent in a list of interesting people: the medieval scholar Mary Carruthers; the cricket star Shane Warne; Dmitri Nabokov.

But Cooke didn’t make the final cut. By last week, Grazer’s staff had already narrowed the potential attachés down to four finalists, who would interview with the boss. “I’ve met a lot of good candidates,” Grazer said, reached on his cell phone en route to a meeting with the screenwriter for “Angels and Demons.” He said that he’d been hiring cultural attachés for twenty years, ever since he asked Jonas Salk’s assistant to help him track down interesting people in science. Fifteen or twenty people have held the job since then. (The “attaché” title started out as a joke.) “They have to be really resourceful,” Grazer said. “I like to meet people in dangerous organizations, and my cultural attaché finds out who that person is—who runs the Yakuza, or the Masons, or MI5.” The best attaché so far, Grazer said, has been Brad Grossman, the current one, who is leaving the post, after four years. Grossman is thirty-two; he owned a tutoring business before taking the job, and Grazer said that he is especially good at explaining the things he’s asked to learn about—bacteria or makeup or superdelegates. “I’m looking for a person who has that teacherlike quality,” Grazer said. “Also, it’s good to have a person who is a connector, who is liked by people.”

Grazer has had one bad attaché experience. “A few years ago, I hired this really smarty-pants Harvard guy,” he said. “He was just remarkably lazy. If he didn’t get the Wall Street Journal on his desk, it was like it didn’t exist.” Still, he said, the experience came with a lesson: “Under no condition can you teach curiosity.”

Before Grazer became a successful producer, he was—like most people— his own cultural attaché. Two weeks ago, he found a letter he’d written to the physicist Edward Teller during that period. “It made me remember how much work it was,” Grazer said. “I had to do the begging and grovelling and ass-kissing myself. I had to find the newspapers and magazines. Even then, I put so much thought and effort into trying to meet and learn from the people who mattered to me.”

2 million minutes: US vs China and India education

Have a look at this documentary film (trailer below) about global education and competitiveness. The producer is a US venture capitalist who has spent time abroad in China and India.





WSJ: ...Bob Compton, a Memphis-based venture capitalist, ran into many kids like Jack when he was traveling in China and India. They were two and three years ahead of his two teenage daughters -- not just in math and science, but in almost every other subject, too. That discovery prompted him to make a documentary called "2 Million Minutes," which followed students in the U.S., India and China to show how they spent their four years of high school -- which works out to about two million minutes.

The film's conclusion: Chinese high-school students spend almost twice as much time on schoolwork as their American peers. (Indian kids spend half again as much time as Americans.)

In Beijing, Jack used to average three or four hours of homework a day. In his Peoria high school, he spent less than an hour a day. At IMSA, homework demands around two hours a day, and Jack still has two hours to play basketball. He told me he's learning and happy.

Indian takover?

Times of India: ...as many as 12% [of] scientists and 38% [of] doctors in the US are Indians, and in NASA, 36% or almost 4 out of 10 scientists are Indians.

If that's not proof enough of Indian scientific and corporate prowess, digest this: 34% employees at Microsoft, 28% at IBM, 17% at Intel and 13% at Xerox are Indians.

Nevertheless, having a professor of Indian or Chinese extraction in our department is not considered as adding to our "diversity" -- presumably because it doesn't help Oregon students prepare for the multicultural "workforce of the 21st century" :-/

Note: A commenter suggests the numbers are a bit high; perhaps the real percentages are about half what the Times of India estimates?

Spitzer, escorts and the new rich

Although I admired some of Eliot Spitzer's efforts as DA, I can't believe he was stupid or arrogant enough to think that he, a prominent public figure, could get away with using high priced prostitutes ("escorts"). Apparently some of the girls at Emperors Club (his service of choice) had already recognized him as the NY governor, so it was only a matter of time before the whole thing blew up. (Times profile of the escort named in the FBI complaint in which Spitzer is "client 9"; photo below. $1k per hour? You be the judge :-)



Current press reports about how the investigation was initiated are implausible -- the claim is that the IRS was tipped off by Spitzer's banks about some suspicious money transfers (Spitzer was careful not to use his credit card, though it was common practice for other customers of the club) that ultimately led to the prostitution ring. Sounds fishy -- we're talking about no more than tens of thousands of dollars in the accounts of a very rich individual. Why would the banks not contact Spitzer first about the transfers? Don't tell me the IRS is checking out every unexplained transfer of a few thousand dollars from a public figure's accounts. Spitzer had powerful enemies on Wall Street and among the Republican party. Combine that with his holier than thou public persona and it is no surprise that he was a target for this kind of investigation. I hope the guy resigns immediately and disappears from public life.

(The prices quoted below should be enough to convince you that this kind of prostitution is as close to victimless crime as you can get. Nevertheless, Spitzer has been shown to be a liar, hypocrite and violator of the law, so good riddance. Why does politics these days only attract pathological types?)

The WSJ has a nice piece on how the new rich are affecting the escort business.

...the wealth boom — and the explosion in the number of multi-millionaires — has created entirely new pricing levels for escorts. According to the complaint, the Emperors Club escorts charged between $1,000 and $5,000 an hour, depending on their “rankings.” Clients could also pay between $25,000 and $50,000 for a three-day visit. It may be the world’s oldest profession: but the prices reflect the new realities of wealth.

The escorts were well-versed in the lucrative potential of this new market. In the complaint, a prospective escort in London turns down the job based on price, saying that £500 an hour for starting escorts — close to $1,000 an hour — was chump change, especially since it didn’t incldue dinner.

“This is the kind of money I make very easily on photoshoots,” the woman said.

...According to a survey by Russ Alan Prince, president of Connecticut-based wealth-research firm Prince & Associates, in his book “The Sky’s The Limit,” a sizable percentage of the super wealthy use escorts. He surveyed 661 people who owned private jets. It found that 34% of males and 20% of females had paid for sex.

The most popular reason was “unique experiences” (71%), followed by “higher quality experiences” (57%). Conventional wisdom says that the rich visit escorts to avoid messy break-ups or extra demands for cash. But the study shows otherwise: “No strings attached,” ranked last as a reason.

“With the wealthy,” Mr. Prince says “it’s all about power and control and new experiences.”

Mining your data at NSA

Let me get this straight. Because there are a lot of Arab-Americans in Detroit, a routine search by an NSA employee could dredge up some communication or transaction of mine with an entity in Detroit, even if it has no connection to a suspected terrorist? Whatever happened to my privacy rights?

Oh, I forgot, they went away thanks to the never ending "war" on terror, which is, apparently, more of a threat to our way of life than facing down a technologically advanced nuclear adversary with thousands of warheads and delivery systems. I had more legal protections of my privacy during the cold war than I do now. See earlier comments here, here and here.

Posted in 2005: ...You might argue that Al Qaeda is more dangerous than the USSR and eastern bloc, with their hundreds of ICBMs and thousands of nuclear warheads, but you'd be crazy. Let me offer the following analogy. While walking home you are confronted by a man with a loaded shotgun. By staring him down and pointing out that you yourself are armed, you avoid having your head blown off. Continuing on your way home, a small dog bites your ankle. Is the dog really a greater threat, just because it bit you, than the guy with the shotgun? If not, why should we allow Bush to unilaterally claim greater security powers than Reagan or Carter had? (Indeed, contravening the existing FISA law of 1978.)

The fact that the NSA has the capability to, e.g., pull up my past internet searches and email traffic, means that the telcos are turning over gigantic amounts of data on each of us to NSA for storage and indexing. The article below states that they don't generally have access to the content of email messages. However, this does not imply that they don't store the content (the text part of the message is a trivial amount of data, not much larger on average than the header information), just that they need a higher level of (FISA?) approval before looking more deeply at the communications. So, if you ever need to recover some lost email that you sent, you could always check with the NSA as a last resort!

WSJ: ...According to current and former intelligence officials, the spy agency now monitors huge volumes of records of domestic emails and Internet searches as well as bank transfers, credit-card transactions, travel and telephone records. The NSA receives this so-called "transactional" data from other agencies or private companies, and its sophisticated software programs analyze the various transactions for suspicious patterns. Then they spit out leads to be explored by counterterrorism programs across the U.S. government, such as the NSA's own Terrorist Surveillance Program, formed to intercept phone calls and emails between the U.S. and overseas without a judge's approval when a link to al Qaeda is suspected.

The NSA's enterprise involves a cluster of powerful intelligence-gathering programs, all of which sparked civil-liberties complaints when they came to light. They include a Federal Bureau of Investigation program to track telecommunications data once known as Carnivore, now called the Digital Collection System, and a U.S. arrangement with the world's main international banking clearinghouse to track money movements.

The effort also ties into data from an ad-hoc collection of so-called "black programs" whose existence is undisclosed, the current and former officials say. Many of the programs in various agencies began years before the 9/11 attacks but have since been given greater reach. Among them, current and former intelligence officials say, is a longstanding Treasury Department program to collect individual financial data including wire transfers and credit-card transactions.

It isn't clear how many of the different kinds of data are combined and analyzed together in one database by the NSA. An intelligence official said the agency's work links to about a dozen antiterror programs in all.

...the systems then can track all domestic and foreign transactions of people associated with that item -- and then the people who associated with them, and so on, casting a gradually wider net. An intelligence official described more of a rapid-response effect: If a person suspected of terrorist connections is believed to be in a U.S. city -- for instance, Detroit, a community with a high concentration of Muslim Americans -- the government's spy systems may be directed to collect and analyze all electronic communications into and out of the city.

The haul can include records of phone calls, email headers and destinations, data on financial transactions and records of Internet browsing. The system also would collect information about other people, including those in the U.S., who communicated with people in Detroit.

The information doesn't generally include the contents of conversations or emails. But it can give such transactional information as a cellphone's location, whom a person is calling, and what Web sites he or she is visiting. For an email, the data haul can include the identities of the sender and recipient and the subject line, but not the content of the message.

Founders' stories

If you want to know what it's like to found a technology startup, read Founders at Work: Stories of Startups' Early Days by Jessica Livingston (Web page, Google books, Amazon). She interviews 32 founders of companies such as Apple (Steve Wozniak), Hotmail (Sabeer Bhatia), RIM (Mike Lazaridis) and ViaWeb (Paul Graham). I haven't finished it yet, but so far the stories ring very true.

One complaint I might have is that all these startups succeeded. It would be good to hear from a few founders who crashed and burned! You do get a bit of exposure to failure in this collection, because in almost every story there are close brushes with defeat -- founders running out of cash, having to radically change business models, lay off employees, etc. -- but ultimately there's a happy ending.

I guess I'm an old Silicon Valley hand, because I knew the broad outlines of the stories of almost all the companies in the book, but each interview so far has revealed fascinating details I'd never heard before.

Another nitpick about the interviews, which I think kind of reveals that the author Livingston is not herself an entrepreneur, is that they don't go into very much detail about the financials of the company -- the real nitty gritty of valuations, equity stakes, acquisition prices, how key negotiations (like exits) went. I guarantee you that almost any startup guy (emphasis, perhaps, on "guy"), when hearing the story of another startup, is doing a running calculation in his head of the founders' equity stake and how much they ended up making. It may sound crass but it's absolutely true and I've experienced it many times in conversations ("Hmm, what was the price? What was his stake?").

The best in-depth account of a startup I've read is High Stakes, No Prisoners by Charles Ferguson, who doesn't leave out any of the key details. I read it before I started my first company, and I'm very glad I did. Ferguson is a very interesting character (Times profile); I can't wait to see his new movie on Iraq.

A note to scientists, academics and economists: even if you have no plans to ever start your own company, I recommend this book for the insight it gives into the workings of technological innovation -- Schumpeter's all important process of creative destruction, as wrought by individual entrepreneurs.

Econlib.org on Schumpeter:

Capitalism, Socialism, and Democracy was much more than a prognosis of capitalism's future. It was also a sparkling defense of capitalism on the grounds that capitalism sparked entrepreneurship. Indeed, Schumpeter was among the first to lay out a clear concept of entrepreneurship. He distinguished inventions from the entrepreneur's innovations. Schumpeter pointed out that entrepreneurs innovate, not just by figuring out how to use inventions, but also by introducing new means of production, new products, and new forms of organization. These innovations, he argued, take just as much skill and daring as does the process of invention.

Innovation by the entrepreneur, argued Schumpeter, led to gales of "creative destruction" as innovations caused old inventories, ideas, technologies, skills, and equipment to become obsolete. The question, as Schumpeter saw it, was not "how capitalism administers existing structures,... [but] how it creates and destroys them." This creative destruction, he believed, caused continuous progress and improved standards of living for everyone.

Bell and GHZ: spooky action at a distance

I think it is safe to say that no one understands quantum mechanics. -- Richard Feynman

Recently I've been lecturing on quantum weirdness (in Einstein's terminology, "spooky action at a distance") in my graduate quantum mechanics class. The main result is Bell's theorem:

No physical theory of local hidden variables can ever reproduce all of the predictions of quantum mechanics.

Usually this result is proved using the Bell inequalities, which have been tested experimentally. The problem with the Bell inequalities is that they are statistical in nature. I prefer to discuss the so-called GHZ states:

| GHZ > = | 000 > - | 111 >

(after Greenberger, Horne and Zeilinger), with which one can demonstrate a much sharper disagreement between local reality and quantum mechanics.

It's interesting that so much time elapsed between Einstein's 1935 paper with Podolsky and Rosen (EPR) that first discussed spooky action at a distance, and Bell's theorem in 1964. Bell was a particle theorist working at CERN who only did foundations of quantum mechanics on the side (he's also the Bell in the Adler-Bell-Jackiw anomaly in quantum field theory). The GHZ paper didn't appear until 1989. For a long time foundations of quantum mechanics was dismissed by physicists as a fringe activity, suitable only for fuzzy headed philosophers. It's only recently, with the explosion of work in quantum information, that there has been renewed interest in the subject.

I find that the hardest thing about teaching this material in class is that, after half a year of training students' brains to think quantum mechanically, it is extremely difficult to get them to feel the weirdness of Bell's theorem and spooky action. It all seems quite normal to them in the context of the course -- they know how to calculate, and that's just how quantum mechanics works!

For my limited thoughts on quantum foundations (mostly about many worlds or "no collapse" formulations), see this talk (PDF) I gave at the Institute for Quantum Information at Caltech, and these blog posts.

Amazingly, I found almost all the reference links above (to GHZ, Bell's theorem, Bell inequality, EPR) on Wikipedia!

Note added: See Dave Bacon on ScienceBlogs for more discussion and some comments. It appears many younger physicists claim to not find QM weird. However, there may be some selection bias towards researchers in quantum information, who generally work in a non-relativistic setting, and may not have thought as much about causality, the light cone, the intricate spacetime structure of quantum field theory, etc. (i.e., unlike Einstein). Or, it could really be a generational change :-)

Taleb or not Taleb?

Nassim Taleb, love him or hate him, has appeared quite a few times on this blog. Personally I find him quite amusing. I like his irreverence for "expert" opinion (especially that of economists) and his skepticism toward finance theory (in particular, towards Black Scholes and assumptions about perfect hedging and normally distributed risks). His earlier book Fooled By Randomness is largely devoted to making the simple point (amazingly, not appreciated by many otherwise very smart people) that it is quite difficult to tell whether success is due to ability or plain luck. In Wall Street terms, when is there enough data to be confident about someone's alpha?

I recently found this interesting essay by Eric Falkenstein, which is quite critical of Taleb and his book The Black Swan. Many of Falkenstein's points are well taken, although one should evaluate his arguments carefully -- his background (worked on VAR, an economics PhD) might predispose him to dislike Taleb. He criticises Taleb's hero Mandelbrot and the use of fractal ideas in finance, but these criticisms point to the fact that the ideas do not lead to easily implementable models, not that they are wrong as a fundamental description of the underlying phenomena. See, e.g., here and here for more discussion. Eventually, he cuts to the chase and notes that Taleb's earlier hedge fund was probably a loser, and that if he had had any success as a trader he wouldn't be out there hawking books and giving lectures on the rubber chicken circuit :-)

Taleb's trading strategy, based on the idea that others in the market are insufficiently aware of fat tailed distributions, was to buy out of the money puts in hopes of a profiting from a catastrophe. Under this strategy his fund constantly lost small amounts of money in hopes of making a big killing. Sadly for Taleb, he never hit the jackpot, although (see the Fooled By Randomness comment above) that doesn't necessarily undermine the validity of the strategy. More damaging, however, is the fact that insurance companies are basically on the other side of Taleb's trade all the time, and they seem capable of generating steady profits for long periods of time. My guess is that any trader who sold a put to Taleb's fund would pad out the price so much that even if their probability distribution were off at the tails, they would still exact a premium over the real value of the option. The deeper out of the money you go, the more careful and suspicious your counterparty is likely to be.

Finally, here's a recent paper by Taleb which is harshly critical of Black-Scholes-Merton.

Falkenstein: ...Taleb argues that the unpredictability of important events implies we should basically forget about all that is predictable, because that’s not where the real money or importance is. So from a risk management perspective, we should ignore Value at Risk, which measures anticipated fluctuations. Further, we should ‘go long’ on these unanticipated events by engaging in quirky activities on the off-chance that we randomly find something, or someone, really valuable.

Success in markets, like life, is a combination of ability, effort, and chance. Much of intelligent thought is distinguishing between what is predictable v. what is unpredictable; it is to any organism's advantage to find out what we can figure out and change, and what is forever mysterious and unalterable (eg, the Serenity Prayer). The brain is constantly predicting the environment, trying to figure out cause and effect so it can better understand the world. Most of what humans process is predictable, but because we take predictable things for granted, they are uninteresting. We can't predict some things, but instead of resorting to nihilism, we merely buy insurance or manage our portfolios--in the broad sense of the term--to have an appropriate robustness. Discovering certain things are basically unpredictable does not diminish our constant focus on trying to predict more and more things. People will disagree on which risks at the margin are predictable, but that's to be expected, and we all hope to be making the right choices that optimize our serenity at the margin of our predictable prowess.

Of course, in the face of being totally wrong in his evaluation of the usefulness of VAR as a tool — it’s ubiquitous in practical management of diverse trading books — Taleb now says he merely warned against naive usage of VAR. However, it was only his absurdly strong statement that VAR was for charlatans that got him mentioned in the Derivatives Strategy article that propelled him into public discourse (conveniently removed from his website, but you can read it online here). Then, as now, he points to anecdotes of imperfection to "prove" his points.

From Taleb's Wikipedia entry circa July 2006, we see where Black Swan thinking goes when applied to an investment strategy:
When he was primarily a trader, he developed an investment method which sought to profit from unusual and unpredictable random events, which he called "black swans." His reasoning was that traders lose much more money from a market crash than they gain from even years of steady gains, and so he did not worry if his portfolio lost money steadily, as long as that portfolio positioned him to profit greatly from an extremely large deviation (either a crash or an unexpected jump upwards).

In fact, Mandelbrot also argues for this strategy. Taleb co-authored a paper arguing that most people systematically underestimate volatility. Furthermore, he argues there exists not only a lack of appreciation of fat tails, but a preference for positive skew, in that people prefer assets that jump up, not down, which would imply the superiority of buying out-of-the-money puts as opposed to calls because those negative tails that increase the price of puts are unappreciated.

These assertions present some straightforward tests, which a Popperian like Taleb should embrace. Specifically, buying out-of-the-money options, especially puts (because of negative skew), should, on average, make money. But insurance companies, which basically are selling out-of-the-money options, tend to do as well as any industry (Warren Buffet has always favored insurance companies, especially re-insurers, as equity investments). Studies by Shumway and Coval (2001) and Bondarenko (2003) have documented that selling puts is where all the extranormal profit seems to be. Of all the option strategies, selling, not buying, out-of-the-money puts has been the best performer historically.

Famed New Yorker writer Malcom Gladwell in a 2002 New Yorker article contrasts the thoughtful, pensive Taleb versus the brash cowboy Victor Neiderhoffer: Taleb buys out-of-the-money puts, Neiderhoffer sells them. Taleb is betting on the big blow up, Niederhoffer on the idea that people overpay for insurance. Who was right? Well, Neiderhoffer still ran his flagship fund until September 2007 from a chalet-style mansion in Weston Connecticut . Taleb shut down his Empirica Kurtosis fund at the end of 2004, and the only public data on it suggest a rather anemic Sharpe ratio, below that of the S&P500 (60% in 2000, about zero for the next 4 years, see here), which is consistent with shutting it down, and trying to redescribe it as a hedge or laboratory, and then move into the more profitable business of teaching how to invest. While neither strategy was great, Niederhoffer's was better, if you just look at their lifetimes (management, in this case Taleb, always likes to say that people left positions of power due to desires to be with family or other opportunities, but the bottom line is, selling puts remained immune to family considerations longer than buying puts).

Taleb's big problem is that he misinterprets the mode-mean trade. A mode-mean trade is where a trader finds a strategy with a positive mode, but zero or negative mean. He then uses someone else’s capital to make money off several years of good returns, making good money for creating or managing the strategy, then, when the strategy gives it all back, the investor bears all the loss. That’s a bad strategy for the investor, and the trader who manages it is either naïve or duplicitous. That is, selling extreme options or writing insurance on extreme events at any prices generates a good mode return, but if it underestimates the probability or severity of the bad times, it may generate a zero or negative average return. Buying High Yield debt is a good example. However, just because selling puts is a bad strategy, it doesn't mean buying puts is a good strategy. A Sharpe of 0.2 is a bad long position, but a worse short (because a - 0.2 Sharpe is worse than a 0.2).

Dick Cavett on Bobby Fischer

Dick Cavett, blogging in the Times, treats us to some recollections of and reflections on Bobby Fischer. Although I've read several biographies of Fischer, I doubt I've seen much live footage of him. The clip below is wonderful and a bit surprising -- it captures a moment, one we'll never see again.

Cavett's focus on Fischer's physical appearance (his height, eyes, even shoulders) is interesting, perhaps odd, but understandable given that celebrity itself is his (Cavett's) main expertise. Sylvia Nasar devoted an equivalent amount of attention to John Nash's appearance in A Beautiful Mind.

The comments on the original post are well worth reading -- many are from the generation that experienced Fischer's meteoric ascent firsthand. See here for a followup.

NYTimes: It must seem strange to people too young to remember that there was once a chess champion — of all things — who became arguably the most famous celebrity on earth. And that his long-anticipated match against the reigning Russian champion, Boris Spassky, was broadcast and watched worldwide as if it were the Super Bowl, except that chess drew a much bigger audience.

There was another element that added to the drama. With Fischer the American and Spassky the Russkie, the monumental match was seen as a Cold War battle.

The Russian chess champions considered themselves the undoubted best. Time out of mind the Soviet chess dynasty had reigned supreme, viewing themselves as a rightful symbol of Soviet superiority in all fields.

PBS broadcast the drama in sports fashion, complete with play-by-play commentary by Shelby Lyman, who himself became a household name. People stayed home from work, glued to their sets, and PBS got its highest ratings ever. The country and the world became chess-crazy. And Fischer-crazy. Chess sets, dusty on the shelves, suddenly sold in the millions.

We ordinary mortals can only try to imagine what it might feel like to be both young and so greatly gifted at a complex art. And to be better at it than any other living being, past or present. There are plenty of geniuses and lots of famous people, but few are both. Is anyone really capable of surviving such a double burden?

We assume that geniuses are blessed creatures who don’t have to work hard to achieve their goals. Hard for us, easy for them. But Bobby as a kid — IQ pushing 200 — put in 10 to 15 hours a day of brain power and heavy concentration that would kill an ordinary person. (Or at least me.)

The chess world was already well aware of this kid prodigy. But they were unprepared for him to suddenly go up against the acknowledged top player of the day in the United States Chess Championship. And win — at the age of thirteen. When asked what happened, he said, “I got better.”

What does such dedication to seemingly unreachable goals — until he reached them — do to the rest of you, the over-achiever? Touchingly, when he returned to my show after having disposed of Spassky, triumphant in the eyes of the world, he opined that he might be wise to try developing some of the rest of himself. He had begun to see that a life of nothing but chess was “kind of limited.” (He went to dinner in Reykjavik with friends. “Bobby couldn’t follow the conversation,” one said. “He sort of backed into the corner, got out his little pocket chess set and played with himself.”) He announced on my show that he was now “reading a lot of magazines, trying to keep up with what’s going on in the world.” He was still in his twenties.

Until the advent of Bobby Fischer, my image of a young chess genius was not flattering. I pictured a sort of wizened and unpopular youth, small of frame, reclusive, short, with messy hair, untended acne, thick glasses and shirt sticking out in back. And also perhaps, as the great V. Nabokov wrote in describing somewhat genderless piano prodigies with eye trouble, obscure ailments, “and something vaguely misshapen about their eunuchoid hindquarters.”

**********

Getting Fischer on my show that first time, before the big match, was considered a major catch at the time. If anyone in the audience shared my image of what a chess genius probably looked like, Bobby’s entrance erased it.

Here was no Nabokovian homunculus. There appeared, somewhat disconcerted, a tall and handsome lad with football-player shoulders, impeccably suited, a little awkward of carriage and unsure how to negotiate the unfamiliarity of the set, the bright lights, the wearing of make-up, the band music, the hand-shaking and the thundering ovation — all at the same time. I had hoped to avoid the cliché “gangling,” but Bobby gangled. He sort of lurched into his chair.

Once seated, he was something to behold. Six foot two (tall in those days), athletic in build, perfect in grooming, and with striking features. The face radiated intelligence. You couldn’t confuse him with anyone you’d ever seen.

And there were the eyes.

Cameras fail to convey the effect of his eyes when they were looking at you. A bit of Svengali perhaps, but vulnerable. And only the slightest hint of a sort of theatrical menace, the menace that so disconcerted his opponents.

Looking out over the audience, I could clearly see entranced women gazing at him as if willing to offer their hearts — and perhaps more — to the hunky chess master.

When I asked him about such matters, he said that the awful demands of his life — the global travel; the constant study, sometimes until dawn, followed by play; the punishing five-hour sessions at full concentration, day after day — all this made it “pretty hard to . . . [hesitates] . . . build up a relationship.” He seemed quite surprised with himself, as did friends watching, that he had allowed so revealing a moment. (That old Cavett magic, no doubt.)

One thing he said in that first appearance became famous. At one point I asked him what, in terms of thrills, the chess equivalent might be of, say, hitting a home run. His answer: “I like the moment when I break a man’s ego.” There was a trace of a chill in his laughter.

... I’ve sat for a while trying to figure out how to close. A faint glimmer of a bit of poetry had been swimming elusively in my head, just out of reach. And then it emerged.

It’s from E.E.Cummings’ famous poem about another lionized and legendary figure who, after triumph and glamour, also did not have “a good death”: Buffalo Bill.

With Cummings’ quirky punctuation, it’s a short poem, with no title but referred to by its first three words: “Buffalo Bill’s / defunct.”

Its closing lines somehow seem appropriate here. They are:

Jesus
he was a handsome man
and what I want to know is
how do you like your blue-eyed boy
Mister Death

From the comments:

... The finest thing about Bobby ...is that he made being smart, that is intellectualism, a cool thing. He was brilliant, knew it, was outwardly proud of it and not only could perform great feats with it but he said that he would and then did and did so far beyond the wildest dreams of anyone. So thank you Bobby and thank you Dick.

The truly great thing about Bobby Fischer was an audacious courage that for lack of a better comparison I mention Muhamid Ali and even though Bobby’s courage was on its own level there were similarities in the “not afraid of nothin” certainty with which they went about their business. Fischer’s march through the qualifying rounds of the world championship are simply unfathomable. Bobby the destroyer of ego was in full bloom and the completeness and ruthlessness was scary to watch even though I could not look away.

Even to people who play high level chess, the things he lay before the world were unbelieveable to see. It was watching that runup to the world championship that confirmed my inklings that a man could become mad in chess and accept it fully as more than reality and that here was such a man who not only possessed a fine and strong intellect but also the courage to throw it against or into the madness, the howling inferno that chess on that level can become. I was witnessing my own personal dark fear displayed on the largest stage and at a scale bigger than life in a man with one of the finest minds and the profound courage to risk it entirely. The outcome of the championship was certain to everyone by quarter finals.

Thank you so much Bobby and to borrow a few words to help express my love from Don McClane:

“but I could have told you Bobby, this world was never meant for one as beautiful as you”

Conrad Elledge

Humans bad at violence?

The Chronicle of Higher Ed interviews sociologist Randall Collins on his new book Violence: A Micro-Sociological Theory (Princeton University Press). I haven't read the book yet, but I find many of his points quite plausible. I always found the S.L.A. Marshall statistics (see below) that only about 25% of soldiers fire their guns in combat quite interesting -- believable, particularly for conscripts, but presumably correctable with training.

Collins notes that most people are generally quite reluctant to initiate violence. It's also true that very few people are competent (in a technical sense) at inflicting injury on others.

Violence, Up Close and Personal: A sociologist challenges prevailing theories of when, and why, people lash out

Randall Collins, a sociologist at the University of Pennsylvania, thinks human beings are bad at violence. Is the man mad? Any newspaper would seem to falsify his claim, offering up a bestiary of child killers, cross-tribal ethnic cleansers, and suicide bombers, not to mention military attacks sanctioned by law but still brutally sanguinary.

Collins, author of the new book Violence: A Micro-Sociological Theory (Princeton University Press), is not so naïve as to deny that the globe is drenched in blood. But he argues that to confront another human being and do him harm is far more psychologically difficult than most social scientists appreciate. "There is," he writes, "a palpable barrier to getting into a violent confrontation." And the resulting anxiety makes people lash out incompetently. Most people back down from fistfights after a bit of trash talking. And in war, more soldiers cower than attack the enemy effectively.

To make his case that we have no talent for violence, Collins adduces evidence ranging from the low casualty rates in most Greek and Roman battles to photographs documenting how few people in "violent" crowds on the West Bank are actually wreaking havoc. (Modern photojournalism has opened doors for this subfield of sociology, he argues.) He also includes his own voyeuristic accounts of confrontations on the streets of Philadelphia and other American cities, which tend to confirm that most showdowns peter out at the bluster stage.

In a discursive, 550-page book, Collins manages to fold into his theory such topics as domestic violence, British sports hooliganism, and the history of duels (a method of cabining violence to a scale where humans can stomach it). Along the way, he rips into some prevailing sociological theories, including the idea that much violence among disadvantaged groups amounts to a form of political "resistance." That theory, he suggests, has a "twisted quality," lauding thugs who are the violent exception and who prey mostly on members of their own low socioeconomic groups.

He also has few kind words for the reigning evolutionary-psychological interpretation of violence, which sees it as a holdover from a long prehistory in which men competed ruthlessly for status and mates. Collins does not reject biology but cites a different Darwinian drive: the human desire to form social bonds. A visceral aversion to throwing a punch, even if the recipient richly deserves it, he writes, "is the evolutionary price we pay for civilization."

The seed of the book, Collins says, lay in his 1975 book, Conflict Sociology, which examined the competition among various economic, ethnic, and cultural groups. "After having written that, I realized it was about conflict, all right, but nobody ever did anything to each other," he says. "There was no real fighting in it."

He's remedied the omission — and then some. Now he is so immersed in real violence that it will spill over into a sequel, which will encompass topics given short shrift in Violence: A Micro-Sociological Theory, including rape and decisions by states to go to war.

[Interview follows] ...

A lot of people would say that nature is red in tooth and claw and all that — that modern violence is a carry-over from the evolutionary past. What's wrong with that picture?

If you look at the history of fighting, you find that primitive people are actually not very good at fighting. We do have some anthropological films of tribes in wars, and it looks almost like a dance routine. You'll get 100 or so men of the tribe shouting and chanting and waving their spears and bows and arrows, and out of that group a few — six or eight — will run up toward the front line. One or two will dash across the line, throw a spear, then turn around and run and come back in. This may go on for a while until someone gets a spear — usually in the back — when they run away. Then they decide to stop.

Early in the book you put a lot of weight on the finding of the military historian S.L.A. Marshall that only something like 15 percent to 25 percent of American infantrymen fired their weapons in combat. Have his figures held up? And is that figure still true in current conflicts?

There's been controversy about that. At the time of the Second World War and the Korean War, some officers, typically higher officers, said they didn't believe [that figure] — it was just an insult to the troops. Other officers said they thought it was approximately right. It's generally thought now that Marshall was sort of giving a ballpark figure. Surveys from the Vietnam War show generally much higher figures if you ask them whether they ever fired their guns. If you ask them if they are doing a lot of firing, it starts looking more like Marshall's figures: Twenty to 25 percent are really gung ho and do lot of firing, and most of the others fire some of the time, but they aren't very enthusiastic about it.

You talk about panic firing during military combat, and firing among troops. And in an analogy you draw, you also find a lot of panicked firing and incompetent shooting among gang members, and only a few people taking part.

We've got sort of a sieve that goes down by two levels. The first level is whether people are actually engaged in the violence, whether it's shooting guns or throwing punches. Then there's the second level of how competent they are at it: whether they actually hit what they intended, whether they hit anything. … That's true in the case of cops and robbers — both sides — as well as in the Army. U.S. forces have been trained to try to overcome this nonfiring problem [by doing] a huge amount of firing, and so it's not too surprising that in that situation bystanders get hit.

... How is it ugly in one-on-one situations?

In one-to-one situations, it's usually not ugly so much as it is boring. There's a really strong tendency for people to jaw at each other, and then eventually the fight winds down because it becomes so repetitive. It's not difficult to keep fights from escalating as long as it's one on one. All you have to do is be really boring. They will keep on trying to escalate the fight, but you just stay at the same level.

Bore your opponent into submission. I think I could handle that.

You can actually see in videotapes people say the same thing over and over and over again, 10, 20 times. That's actually quite distinctive of conflict talk.

What if people are violent and want to be violent, but they also don't want to be hurt, so they need to get themselves pumped up or otherwise push themselves forward into violence? Couldn't that be another explanation for what you've observed?

We can actually take a fair amount of pain if it's not in a conflictual type of situation. People in disasters tend to behave quite heroically; people in medical situations who are under a lot of pain tend to behave surprisingly well. Soldiers are put through painful body-stressing exercises. But the same people seem to have trouble with the notion of actually hitting somebody else in a combat situation or even in a fistfight. It looks as though people have more trouble inflicting violence on other people than taking it.

New Yorker on behavioral economics

Elizabeth Kolbert reviews two recent books on behavioral economics. She even notes the negative consequences of "irrationality" for democracy.

NewYorker: ...Over the years, Tversky and Kahneman’s initial discoveries have been confirmed and extended in dozens of experiments. In one example, Ariely and a colleague asked students at M.I.T.’s Sloan School of Management to write the last two digits of their Social Security number at the top of a piece of paper. They then told the students to record, on the same paper, whether they would be willing to pay that many dollars for a fancy bottle of wine, a not-so-fancy bottle of wine, a book, or a box of chocolates. Finally, the students were told to write down the maximum figure they would be willing to spend for each item. Once they had finished, Ariely asked them whether they thought that their Social Security numbers had had any influence on their bids. The students dismissed this idea, but when Ariely tabulated the results he found that they were kidding themselves. The students whose Social Security number ended with the lowest figures—00 to 19—were the lowest bidders. For all the items combined, they were willing to offer, on average, sixty-seven dollars. The students in the second-lowest group—20 to 39—were somewhat more free-spending, offering, on average, a hundred and two dollars. The pattern continued up to the highest group—80 to 99—whose members were willing to spend an average of a hundred and ninety-eight dollars, or three times as much as those in the lowest group, for the same items.

This effect is called “anchoring,” and, as Ariely points out, it punches a pretty big hole in microeconomics. When you walk into Starbucks, the prices on the board are supposed to have been determined by the supply of, say, Double Chocolaty Frappuccinos, on the one hand, and the demand for them, on the other. But what if the numbers on the board are influencing your sense of what a Double Chocolaty Frappuccino is worth? In that case, price is not being determined by the interplay of supply and demand; price is, in a sense, determining itself.

...A few weeks ago, the Bureau of Economic Analysis released its figures for 2007. They showed that Americans had collectively amassed ten trillion one hundred and eighty-four billion dollars in disposable income and spent very nearly all of it—ten trillion one hundred and thirty-two billion dollars. This rate of spending was somewhat lower than the rate in 2006, when Americans spent all but thirty-nine billion dollars of their total disposable income.

According to standard economic theory, the U.S. savings rate also represents rational choice: Americans, having reviewed their options, have collectively resolved to spend virtually all the money that they have. According to behavioral economists, the low savings rate has a more immediate explanation: it proves—yet again—that people have trouble acting in their own best interests. It’s worth noting that Americans, even as they continue to spend, say that they should be putting more money away; one study of participants in 401(k) plans found that more than two-thirds believed their savings rate to be “too low.”

...Like neoclassical economics, much democratic theory rests on the assumption that people are rational. Here, too, empirical evidence suggests otherwise. Voters, it has been demonstrated, are influenced by factors ranging from how names are placed on a ballot to the jut of a politician’s jaw. A 2004 study of New York City primary-election results put the advantage of being listed first on the ballot for a local office at more than three per cent—enough of a boost to turn many races. (For statewide office, the advantage was around two per cent.) A 2005 study, conducted by psychologists at Princeton, showed that it was possible to predict the results of congressional contests by using photographs. Researchers presented subjects with fleeting images of candidates’ faces. Those candidates who, in the subjects’ opinion, looked more “competent” won about seventy per cent of the time.

When it comes to public-policy decisions, people exhibit curious—but, once again, predictable—biases. They value a service (say, upgrading fire equipment) more when it is described in isolation than when it is presented as part of a larger good (say, improving disaster preparedness). They are keen on tax “bonuses” but dislike tax “penalties,” even though the two are functionally equivalent. They are more inclined to favor a public policy when it is labelled the status quo. In assessing a policy’s benefits, they tend to ignore whole orders of magnitude. In an experiment demonstrating this last effect, sometimes called “scope insensitivity,” subjects were told that migrating birds were drowning in ponds of oil. They were then asked how much they would pay to prevent the deaths by erecting nets. To save two thousand birds, the subjects were willing to pay, on average, eighty dollars. To save twenty thousand birds, they were willing to pay only seventy-eight dollars, and to save two hundred thousand birds they were willing to pay eighty-eight dollars.

What is to be done with information like this? We can try to become more aware of the patterns governing our blunders, as “Predictably Irrational” urges. Or we can try to prod people toward more rational choices, as “Nudge” suggests. But if we really are wired to make certain kinds of mistakes, as Thaler and Sunstein and Ariely all argue, we will, it seems safe to predict, keep finding new ways to make them. (Ariely confesses that he recently bought a thirty-thousand-dollar car after reading an ad offering FREE oil changes for the next three years.)

Les Grandes Ecoles

This Times article on the elite world of French business has some interesting facts about Ecole Polytechnique and Ecole Nationale d'Administration (ENA). In physics, we typically encounter graduates of Ecole Normale Superieure ("normaliens"), which boasts 9 Fields Medalists and at least 8 Nobel Laureates in physics. 15 years ago a normalien friend complained to me that the ENArques were getting the upper hand, but it appears from the article the polytechniciens are hanging tough! The greatest polytechnicien of all time might be Poincare, but then again there are also Cauchy and Ampere and Poisson and Navier...

An earlier post on Les Grandes Ecoles. I must say, these schools, with their strictly meritocratic admissions policies, sound a lot more like Caltech than like Harvard.

NYTimes: ...AT least half of France’s 40 largest companies are run by graduates of just two schools, the École Polytechnique, which trains the country’s top engineers, and ENA, the national school of administration. That’s especially remarkable given that the two schools together produce only about 600 graduates a year, compared with a graduating class of 1,700 at Harvard.

...Rather than a rigid class system, it was Mr. Fourtou’s and Mr. Bébéar’s admission into the École Polytechnique that assured their place in the elite. And that is one of the great ironies of the French establishment: while it enjoys the privileges associated with the elites of the United States, entry is, if anything, much more rigorously meritocratic, based on exams and ever-narrowing selection from an early age.

Indeed, getting into Harvard, which accepted 9 percent of its applicants last year, is a breeze compared with getting into the École Polytechnique.

Out of 130,000 students who focus on math and science in French high schools each year, roughly 15 percent do well enough on their exams to qualify for the two- to three-year preparation course required by the elite universities. Of those who make it through that, 5,000 apply to École Polytechnique, which is commonly called simply “X,” and just 400 are admitted from France.

Admission is based strictly on exam grades; there isn’t even an essay requirement or interview. And there are no legacy admissions, sports scholarships or other American-style shortcuts for getting into X.

“You can be the president’s nephew and it won’t help you get in,” says Bernard Oppetit, a 1978 graduate of X who later worked for BNP Paribas before starting Centaurus Capital, a London investment fund with $4 billion under management.

The École Polytechnique was founded in 1794, during the French Revolution, to train the country’s military engineers, and it officially remains under the umbrella of the French ministry of defense. Not only is the school free, but students also receive a stipend from the government to cover their expenses.

“We call it l’élitisme démocratique,” says Pierre Tapie, dean of Essec, a leading French business school. “These are places where you meet extraordinary people who are there because they worked hard and are among the most brilliant of a generation.”

Although the school teaches high-end fare like physics, engineering, and computer sciences, its broader goal is to create a leadership cadre that shares an ordered, prioritized view of the world, says Xavier Michel, the president of the École Polytechnique and an active-duty general in the French armed forces.

In France, this is known as the Cartesian system, after the mathematician and philosopher René Descartes, and Mr. Michel says the school encourages its students “to modelize” the world. And when they eventually become chief executives, he says, “they understand what are the capabilities of their companies. They understand what they can do and what they can’t do.”

Until, of course, models run off the rails — as they so often do in the business and financial worlds, regardless of what country devises them.

Housing bubble: dynamics of a bust

The first figure is from today's WSJ and incorporates data from Q4 2007. The second figure appeared in the Economist some time ago and was discussed previously on this blog. Does anyone care to predict the future for bubble states like California, Florida and Arizona using the Japanese data as a guide?

Lower interest rates will not re-inflate the housing bubble (although they may affect the rate at which it deflates; note the BOJ dropped real interest rates below zero in the wake of their bust). People understand now, as they did not just a few years ago, that home prices can go down. This change in ape psychology (try putting that in your macro model!) makes all the difference.

Below is historical data compiled by Yale economist Robert Shiller showing that home prices have not on average provided attractive real returns (right hand axis is inflation adjusted returns for same house sales over time; previously discussed here -- the real rate of return was 0.4% between 1890 and 2004). This is yet another example in which market participants (home buyers) made decisions based on faulty assumptions that might have been easily corrected by a modest amount of research. So much for efficient markets!



Here's some detailed data from Case-Shiller and OFHEO indices (also from WSJ; note OFHEO only tracks conforming mortgages so has less sensitivity to the high end of the market):



Finally, it is worth noting that the subprime mortgage meltdown is merely a symptom of the real estate bubble. If home prices continue to fall we will see (as we are already beginning to) higher default rates in so-called "prime" as well as subprime mortgages.

WSJ: ...I assumed, for the sake of calculations, that California prices fell 8% last quarter from the third quarter, a huge number by historic measures but not out of line with Zillow's data. For Florida and Arizona I assumed declines of 5% and 5.5%. You could use other, more modest estimates for the recent declines: They won't change the outcomes much. I also assumed personal incomes in these states rose in line with recent and historic averages."

The results? In all three markets, the prices are well off their peaks when compared to incomes. But they remain far above historic averages.

Median prices in California peaked in 2006 at 13.3 times per capita incomes. Hard to believe, but true. They may be down now to about 11.1 times.

But that's still way above the ground. Throughout most of the 80s and 90s they ranged between six and seven times incomes.

Just to get down to seven times incomes, prices would have to fall 37% tomorrow.

Those who bought at the peak of the cycle may be pinning their hopes instead on "incomes catching up" instead. But they had better be patient. Even if house prices stayed exactly where they are, it would take around 10 years for rising incomes to bring the ratios back into any sort of alignment.

The exponential curve for genome sequencing

Below is an update on progress towards less expensive gene sequencing. At the moment you can have your genome sequenced for $350k, but we might hit the $1k mark within just a few years. This progress is funded by a combination of taxpayer and venture capital dollars. The rate of technological advance would slow to a snail's pace without sophisticated capital markets, intellectual property rights and plain old human greed and ambition.

For a cost per base pair curve extending up to 2005, see here. As the cost nears $1k per genome we will see a tremendous explosion in detailed genetic data across all major population groups.

NYTimes: A person wanting to know his or her complete genetic blueprint can already have it done — for $350,000.

But whether a personal genome readout becomes affordable to the rest of us could depend on efforts like the one taking place secretly in a nondescript Silicon Valley industrial park. There, Pacific Biosciences has been developing a DNA sequencing machine that within a few years might be able to unravel an individual’s entire genome in minutes, for less than $1,000. The company plans to make its first public presentation about the technology on Saturday.

Pacific Biosciences, or PacBio, is just one entrant in a heated race for the “$1,000 genome” — a gold rush of activity whose various contestants threaten to shake up the current $1-billion-a-year market for machines that sequence, or read, genomes. But the company has attracted some influential investors. And some outside experts say that if the technology works — still a big if — it would represent a significant advance.

“They’re the technology that’s going to really rip things apart in being that much better than anyone else,” predicted Elaine R. Mardis, the co-director of the genome center at Washington University in St. Louis.

If the cost of sequencing a human genome can drop to $1,000 or below, experts say it would start to become feasible to document people’s DNA makeup to tell what diseases they might be at risk for, or what medicines would work best for them. A DNA genome sequence might become part of each newborn’s medical work-up, while sequencing of cancer patients’ tumors might help doctors look for ways to attack them.

To spur such advances, the federal government has awarded about 35 grants totaling $56 million to companies and universities for development of technology that could put the $1,000 genome sequence within reach. PacBio has received $6.6 million from that program.

The nonprofit X Prize Foundation, meanwhile, is offering $10 million to the first group that can sequence 100 human genomes in 10 days, for $10,000 or less per genome. Six companies or academic groups — although not PacBio — have signed up for the competition so far.

Computerized sequencing machines use various techniques to determine the order of the chemical units in DNA, which are usually represented by the letters A, C, G and T. Humans have three billion such units, or six billion if one counts the second copy of each chromosome pair.

The industry has long been dominated by Applied Biosystems, which sold hundreds of its $300,000 sequencers to the publicly financed Human Genome Project and to Celera Genomics for their sequencing of the first two human genomes, which were announced in 2000. But two newcomers — Solexa and 454 Life Sciences — have already started to cut into Applied Biosystems’ sales with machines that are faster and less costly per unit of DNA sequenced. Solexa is now owned by Illumina and 454 Life Sciences by Roche.

Applied Biosystems, which is a unit of Applera, recently started selling its own new type of sequencer, which it obtained by buying Agencourt Personal Genomics for $120 million in 2006. Helicos BioSciences, a newly public company, announced its first order on Friday. It has said its machine might be able to sequence a human genome for $72,000, with further improvements to come.

“We can look somebody in the eye and say, ‘This instrument is going to get you to the $1,000 genome,’ ” said Steve Lombardi, the president of Helicos, which is based in Cambridge, Mass.

Intelligent Bio-Systems, a privately held company in Waltham, Mass., says it will introduce a machine by the end of the year that might reduce the cost of a genome to $10,000. Other contenders include the privately held companies NABsys of Providence, R.I., VisiGen Biotechnologies of Houston and Complete Genomics of Mountain View, Calif.

Some contestants say that they might try for the X Prize as early as next year and that the $1,000 genome is as little as three years away. But other experts are more conservative. ...

Money:Tech

O'Reilly Media, Feb. 6-7, NYC

So far I've met several participants who read this blog!

schedule

Books and IQ

Here's some research which correlates books with the IQs of their readers :-) Now you can check quantitatively whether you have highbrow or lowbrow taste! The method attempts to estimate the midpoint IQ of people who list a particular book as their favorite, using Facebook and university SAT data. It craps out at the really highbrow end, due to low statistics; see below.

Many of the books appearing at the center of the distribution are typically assigned as required reading (A Farewell to Arms, On the Road, A Tale of Two Cities, etc.), hence are likely to be mentioned by low-scoring students who don't read very many books. Their ranking here is probably deceptively low.

List of schools ranked by SAT (Caltech #1, of course), with links to 10 most frequent Facebook "favorite books" at that university. Click the image below for a bigger one.

Some notable results:

Harry Potter is the most popular book. The Bible is the second most popular book. At least among college students, Harry Potter is, like the Beatles, indeed bigger than Jesus. Harry Potter still wins even if you add "The Bible" and "The Holy Bible" together.

Although I had no idea at the beginning of this project, I was ever so pleased to discover that Caltech is the smartest school in the country (on average).

The smartest religious book is "The Book of Mormon". The dumbest religious book is "The Holy Bible". I'm sure this pleases the Mormons immensely.

The dumbest philosophy book is "The Five People You Meet In Heaven" and the smartest philosophy book is "Atlas Shrugged".

"Lolita" is the smartest book.

The top/bottom 20 books are remarkably stable. I tried 5 different weighting algorithms and their only variation was in the middle. The dumbest books were always at the bottom, and the smartest books were always on top. This is even further corroborated by the fact that the extremes change remarkably little with increasing m.

Do people with SAT >= 1400 just not read books? Yes, they do read books. Just look at those schools' facebook profiles! However, there often aren't enough schools with high SATs to have reliable statistics for these high-ringing books. So it goes.

Methodology:

Get a friend of yours to download, using Facebook, the ten most frequent "favorite books" at every college (manually -- as not to violate Facebook's ToS).

These ten books are indicative of the overall intellectual milieu of that college.

Download the average SAT/ACT score for students attending every college.

Presto! We have a correlation between books and dumbitude (smartitude too)!

Books <=> Colleges <=> Average SAT Scores

Plot the average SAT of each book, discarding books with too few samples to have a reliable average.

Post the results on your website, pondering what the Internet will think of it.

Yes, I'm aware correlation ≠ causation. The results are hilarity incarnate regardless of causality. You can stop sending me email about this distinction. Thanks.

The soldier-monks of Societe Generale

Vive les moines-soldats!

NYTimes: ...The derivatives group started in the 1980s as a small team of highly trained and highly regarded engineers and mathematicians from the best schools. They quickly became known as “les moines-soldats,” the soldier-monks. And as their importance inside the bank grew, their confidence, even arrogance, grew with it.

Like the devout and disciplined fighters they were named for — the monks who fought in the Crusades — the soldier-monks of Société Générale prided themselves on rising above the passions that moved the masses.

Similarly, Société Générale’s soldier-monks believed that they could manage both the risk inherent in betting on the markets — through complex computer models — and the ardor of their regular traders, through controls.

Their hubris was having too much faith in their power to do either.

But they were dedicated to making Société Générale a world-class power in derivatives and, like the knights of old, they were fiercely competitive, both on and off the trading floor.

“We considered it a mission,” recalled Antoine Paille, who recruited Jean-Pierre Mustier, now the head of Société Générale’s corporate and investment bank. It was Mr. Mustier who ultimately confronted Mr. Kerviel after his fraud was discovered on Jan. 18. ...


A Red Flag Cited

Mr. Kerviel was never viewed as soldier-monk material. He was a provincial from decidedly middle-class stock — the son of a hairdresser and a metal- shop teacher — but he possessed an advantage that his better-bred superiors did not.

In his five years toiling in the back office before being promoted to Delta One in 2005, he had become expertly familiar with the proprietary system Société Générale used to book trades, known as Eliot inside the bank. While the risk-control department did monitor the bank’s overall positions very closely, it did not verify the data Mr. Kerviel entered into Eliot. And Mr. Kerviel knew the timing of the nightly reconciliation of the day’s trades by Eliot, so he was able to expertly delete and then re-enter his unauthorized transactions without being caught.

Mr. Kerviel’s method of entering trades was one red flag cited by Eurex in its initial warning, along with questions about two “large” positions — one net short position in DAX futures and one net long position in Euro Stoxx 50 futures. In the same letter, they asked what his investment strategy was and why these transactions were often entered through a London-based Société Générale subsidiary called FIMAT Futures Limited. Eurex even inquired whether Mr. Kerviel had entered the transaction automatically or manually.

“Please explain the background for this procedure,” two Eurex officials wrote to Xavier de la Maisonneuve, a compliance officer at Société Générale who has been questioned by investigators.

Vincent Duclos, another compliance officer in the equity derivatives division, not yet questioned by the police, provided the Nov. 20 and Dec. 10 responses to Eurex. His replies in part were based on accounts provided by Mr. Kerviel and his supervisor, as well as a compliance officer at FIMAT, said Jean Veil, a lawyer for Société Générale. Mr. Kerviel’s “supervisor had signaled that there was no anomaly whatsoever,” Mr. Veil said.

Mr. De la Maisonneuve, who received the initial query on Nov. 7, said the bank gets 15 to 20 queries from different exchanges each year, many of them from Eurex.

In a telephone interview Monday night, he insisted his team had been in telephone contact with Eurex after their two letters in November to ensure it would fully answer their queries.

“Their questions were based purely on strategy and procedure,” he said. “At no moment of these conversations was there any mention of abnormal volumes. They considered our second written response adequate and satisfying.”

He added that Eurex did not take up Société Générale’s offer of a conference call to further discuss the matter after the Dec. 10 letter.

A top official at Société Générale, who insisted on anonymity because of the sensitivity of the matter, said that in the weeks after the Eurex warning, Mr. Kerviel was shaken, and took additional steps to cover his tracks. He tried to manipulate areas of the internal risk-control system he was unfamiliar with, which ultimately led to the discovery of his suspected fraud in mid-January.

In his testimony to the police, however, Mr. Kerviel identified two members of the Delta One team he said were familiar with his activities going back to last April. These colleagues, according to lawyers familiar with the case, were Martial Rouyère, head of the Delta One trading desk, and his deputy, Eric Cordelle. Mr. Rouyère has since been questioned by the French authorities. Mr. Veil said he expected Mr. Kerviel’s “entire hierarchy,” including Mr. Mustier, to eventually be questioned by the police. ...

Dating by algorithm

In this post NYTimes science reporter John Tierney, who writes the blog Tierny Lab, does a little experiment on the dating site eHarmony. eHarmony uses a complicated algorithm to match couples based on a lengthy personality questionnaire. Tierney seems surprised that the algorithm doesn't match him up with his wife, even when restricted geographically to his NYC zip code and even after further tweaking of their survey responses and consultation with eHarmony's chief scientist.

What Tierney doesn't seem to understand is that, under almost any algorithm for matching (including the "correct" algorithm that would predict happiness in his case), it is highly unlikely that the wife he found is actually optimal :-) Within a 10 mile radius (in NYC) there are dozens (hundreds? thousands?) of better matches he unfortunately never met. It's unromantic but true that chance played a bigger role in his marriage choice than optimality.

On a related note, I wonder whether social networking and online dating are gradually increasing the overall quality of marriages. It seems much easier to meet compatible partners than it was in the pre-Internet dark ages.