Looking for Laffer-Likes
December 31, 2018·4 comments·Money
We anchor ourselves to the few things we know for certain, the extremes, and extrapolate backward to explain the messy middle. It feels like rational thinking. It has destroyed better arguments than this one. The question isn't whether passive investing or algorithms will break markets at the margins. It's whether we're asking the right question about why they might change how prices get set.
• The Laffer Curve wasn't absurd because it was wrong about extremes. A 0% tax rate yields no revenue and a 100% rate yields none either. The problem was treating those certainties as proof of what happens in between.
• We do this whenever systems grow too complex to predict. When we lack a good model, we grab the few bits we understand and build everything else from there. It feels reasonable. It's how we fool ourselves.
• The current versions of this mistake are passive investing and algorithmic trading. Investors worry these will break price discovery. The worry rests on extrapolating from extremes without asking what's actually changing at the margins.
• The real shift isn't that information stops moving prices. It's that the composition of people responding to information has changed, and so has which information matters.
• The cost of this kind of thinking is subtle but serious. We replace complex questions with simple stories that feel grounded in fact. We become confident in narratives that are mostly convenient and only partially true.
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Comments
Great perspective, we get caught up in the minutia too much sometime…made me think of another recent good read!
Of Dollars and Data Blog…
"In Everybody Lies, Seth Stephens-Davidowitz illustrates how the news media doesn’t influence peoples’ beliefs, but rather, the audience determines what kinds of stories news agencies cover and publish. He states:
Many people, particularly Marxists, have viewed American journalism as controlled by rich people or corporations with the goal of influencing the masses, perhaps to push people toward their political views. Gentzkow and Shapiro’s paper suggests, however, that this is not the predominant motivation owners. The owners of the American press, instead, are primarily giving the masses what they want so that the owners can become even richer…There is no grand conspiracy. There is just capitalism.
Stephens-Davidowitz’s conclusion suggests that you are the gatekeeper to your own mind. You decide what comes in. You decide what sticks. So whether you see the universe as kind or hostile, this belief will flow through your entire belief system and affect all the others. When you choose between kindness and hostility, choose wisely."
Situational Awareness! Reset, look again, look at what’s not said, move upstream, get to high ground! Get a different look! High Risk Decisions for Low Risk Outcomes or vice versa…
Yes, I agree that at times it can be difficult to differentiate between giving people “what they want” and exploiting the vulnerability we have to narratives that seem convenient to our own perspective!
This is kind of a reverse reductio-ad-absurdum argument where the premise is true at the extremes, but is not a continuum in the middle. That said, IMHO, it probably is a continuum, i.e., tax rates and revenues are inversely related, although with varying first derivative rates along its continuum. However, in a real economy, the impact of small changes to tax rates on government revenue can easily be overwhelmed by all the other variables at play.
An example that fits Rusty’s point even better might be government debt and interest rates - away from the extremes, there appears to be no consistent correlation. And Japan is, at minimum, proving that the extreme of one end of the relationship is farther out than previously believed.
My take is that it is the simplicity of the two-variables model that is core to the flaw in “laffer-like” beliefs. Rarely in any system are two and only two variables the factors which determine outcomes. We live in a complex inter-related world and do ourselves a disservice believing we can distill the complexities into a 2-dimensional model. This flaw is repeated in every aspect of our lives. Here are two examples outside of Politics and markets: physical fitness: how much you workout vs what you eat = weight gain/loss or school: how much you study vs raw intellect = academic success. each of these are equally flawed as the laffer-likes…
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