Charlie Munger on hedging your bets

More from Charlie Munger:

One of the greatest economists of the world is a substantial shareholder in Berkshire Hathaway and has been for a long time. His textbook always taught that the stock market was perfectly efficient and that nobody could beat it. But his own money went into Berkshire and made him wealthy. So, like Pascal in his famous wager, he hedged his bet.

For those of you who like me don't remember Pascal's Wager, it's this:

If you erroneously believe in God, you lose nothing (assuming that death is the absolute end), whereas if you correctly believe in God, you gain everything (eternal bliss). But if you correctly disbelieve in God, you gain nothing (death ends all), whereas if you erroneously disbelieve in God, you lose everything (eternal damnation).

But of course Munger's famous economist won't lose nothing if his hedge doesn't pay off.

Charlie Munger on the great lessons of microeconomics

From Elementary, Worldly Wisdom by Warren Buffett's partner Charlie Munger:

The great lesson in microeconomics is to discriminate between when technology is going to help you and when it's going to kill you. And most people do not get this straight in their heads.

He goes on to explain:

For example, when we were in the textile business, which is a terrible commodity business, we were making low-end textiles—which are a real commodity product. And one day, the people came to Warren and said, "They've invented a new loom that we think will do twice as much work as our old ones."

And Warren said, "Gee, I hope this doesn't work because if it does, I'm going to close the mill." And he meant it.

What was he thinking? He was thinking, "It's a lousy business. We're earning substandard returns and keeping it open just to be nice to the elderly workers. But we're not going to put huge amounts of new capital into a lousy business."

And he knew that the huge productivity increases that would come from a better machine introduced into the production of a commodity product would all go to the benefit of the buyers of the textiles. Nothing was going to stick to our ribs as owners.

That's such an obvious concept—that there are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that's still going to be lousy. The money still won't come to you. All of the advantages from great improvements are going to flow through to the customers.

Conversely, if you own the only newspaper in Oshkosh and they were to invent more efficient ways of composing the whole newspaper, then when you got rid of the old technology and got new fancy computers and so forth, all of the savings would come right through to the bottom line.

In all cases, the people who sell the machinery—and, by and large, even the internal bureaucrats urging you to buy the equipment—show you projections with the amount you'll save at current prices with the new technology. However, they don't do the second step of the analysis which is to determine how much is going stay home and how much is just going to flow through to the customer. I've never seen a single projection incorporating that second step in my life. And I see them all the time. Rather, they always read: "This capital outlay will save you so much money that it will pay for itself in three years."

So you keep buying things that will pay for themselves in three years. And after 20 years of doing it, somehow you've earned a return of only about 4% per annum. That's the textile business.

And it isn't that the machines weren't better. It's just that the savings didn't go to you. The cost reductions came through all right. But the benefit of the cost reductions didn't go to the guy who bought the equipment. It's such a simple idea. It's so basic. And yet it's so often forgotten.

Munger sees another lesson from micro, one which should be familiar ato anyone reading this, uh, blog:

Then there's another model from microeconomics which I find very interesting. When technology moves as fast as it does in a civilization like ours, you get a phenomenon which I call competitive destruction. You know, you have the finest buggy whip factory and all of a sudden in comes this little horseless carriage. And before too many years go by, your buggy whip business is dead. You either get into a different business or you're dead—you're destroyed. It happens again and again and again.

And when these new businesses come in, there are huge advantages for the early birds. And when you're an early bird, there's a model that I call "surfing"—when a surfer gets up and catches the wave and just stays there, he can go a long, long time. But if he gets off the wave, he becomes mired in shallows....

But people get long runs when they're right on the edge of the wave—whether it's Microsoft or Intel or all kinds of people, including National Cash Register in the early days.

The cash register was one of the great contributions to civilization. It's a wonderful story. Patterson was a small retail merchant who didn't make any money. One day, somebody sold him a crude cash register which he put into his retail operation. And it instantly changed from losing money to earning a profit because it made it so much harder for the employees to steal....

But Patterson, having the kind of mind that he did, didn't think, "Oh, good for my retail business." He thought, "I'm going into the cash register business." And, of course, he created National Cash Register.

And he "surfed". He got the best distribution system, the biggest collection of patents and the best of everything. He was a fanatic about everything important as the technology developed. I have in my files an early National Cash Register Company report in which Patterson described his methods and objectives. And a well-educated orangutan could see that buying into partnership with Patterson in those early days, given his notions about the cash register business, was a total 100% cinch.

And, of course, that's exactly what an investor should be looking for. In a long life, you can expect to profit heavily from at least a few of those opportunities if you develop the wisdom and will to seize them. At any rate, "surfing" is a very powerful model.

Indeed.

"Economists" on Jeopardy! [sic]

HT: Tyler Cowan

Registered for Slesnick's micro theory class

ECO 420K (33545) MW 9:30-11:00, F 9:00-10:00

Picking a prof for ECO 420K

Since there will be no honors section of Micro Theory taught in the Spring semester, I have a choice of four professors for the non-honors version: Slesnick, Watson, Hayashi, and Dusansky.

The Course-Instructor Survey results and the ClassPoint reviews put Selsnick at the top of my list and Hayashi at the bottom. I'm going to check around, see what the kids think, and report back here. As if you care.

Update: Wrong choice.

More grades

100's on both my macro quiz and my health econ exam. Boom.

Samuel Johnson meets Adam Smith

From The Worldly Philosophers, which I'm already enjoying a great deal:

Sir Walter Scott tells us that Johnson, on first seeing Smith, attacked him for some statement he had made. Smith vindicated the truth of his contention. "What did Johnson say?" was the universal inquiry. "Why, he said," said Smith, with the deepest impression of resentment, "he said, 'You lie!'" "And what did you reply?" "I said, 'You are a son of a bitch!'" On such terms, says Scott, did these two great moralists first meet and part and such was the classical dialogue between two great teachers of philosophy.

Too bad President Obama didn't take the opportunity to replay this exchange.

The waiting is the hardest part

Apologies to Tom Petty, but waiting to find out how I did on my health econ exam yesterday is killing me.

I wonder if I could pay the TA to grade my exam sooner. Seriously. People respond to incentives, and I don't see how there would be any academic dishonesty involved. Am I right?

I actually drafted an email to the TA offering her such a deal but thought better of it. I guess I'll have to wait until Wednesday to find out. Ugh.

Update: As Chris Selland pointed out, even the losers get lucky sometimes. :-)

Integrating the news into the classroom

Well this is cool. Greg Mankiw publishes a blog map which lists his recent blog posts and links them to the chapters in his economics textbook(s).

In my intro macro class, we're currently studying Chapter 16: The Monetary System in the macro principles version of his text. This corresponds to Chapter 29 in the combined micro/macro version, so the blog map is here.

This is a hugely valuable resource. Other textbook authors, teachers, and journalists should take note.

They have these things called books

After plowing through a small stack of economics-related books last summer, I got a bit burned out and turned to a few novels. But I find myself once again ready for some book learnin', and happen to be sitting in a big-ass library. So, what's next?

I'm interested by the fact that the same names keep coming up in both my classes and the news, e.g., Akerlof, Stiglitz, and Shiller. Greg Mankiw's freshman seminar reading list seems like as good a place as any to start:

• The Worldly Philosophers, by Robert Heilbroner
  
• Spin-Free Economics, by Nariman Behravesh
  
• Capitalism and Freedom, by Milton Friedman
  
• Equality and Efficiency: The Big Tradeoff, by Arthur Okun
  
• Nudge, by Richard Thaler and Cass Sunstein read it, should have been an article instead of a book
  
• The Return of Depression Economics, by Paul Krugman
  
• Animal Spirits, by George Akerlof and Robert Shiller
  
• The Myth of the Rational Voter, by Bryan Caplan
  
• Economic Gangsters, by Raymond Fisman and Edward Miguel
  
• The Price of Everything, by Russell Roberts

It looks like UT has two copies of Animal Spirits by Akerloff and Shiller, one at the Law Library and one on the "hold shelf", which doesn't sound promising. But there are twelve copies of The Worldly Philosophers in various states of availability. Boom.

The Skyrocketing Costs of Attending College

From The Skyrocketing Costs of Attending College on the NYT Economix Blog:



Yikes.

Frontline: The Warning

Last night I watched this Frontline episode on Brooksley Born's warnings about the systemic risk created by the unregulated market for over-the-counter derivatives. We all know what happened when those warnings went unheeded.

Fascinating look into how Alan Greenspan, Robert Rubin, and Larry Summers absolutely blew it.

No honors micro theory next semester

Well that's a bummer. I just learned that there will be no honors section for ECO 420K in the Spring.

A different way of discussing global imbalances

My favorite paragraph so far this morning comes from A different way of discussing global imbalances by Tyler Cowan:

The two prices contradict each other and they continue to do so because explicit arbitrage is not possible.  (Ideally, at least in neoclassical fantasy land, the U.S. government should be borrowing money from the Chinese and selling them back insurance at a higher price.)

I think I'll start abbreviating "neoclassical fantasy land" as "NFL".

Great Moments as a 40YOF #2

Today in my macro class the professor started off with, "Most of you were pretty young when we went through something called the dot-com boom."

Speak up, sonny!

Google Billionaires Say Happy Days Are Here Again

Gawker:

Alan Greenspan, an actual economist and former Federal Reserve Board chair, predicts the economy will just get worse and then stagnate for a good long while. But he cited absolutely zero Google statistics for his prediction, nor does he get free food and laundry and transportation and snacks and internet access and literally actual trips to Disneyland provided for him free at work, so can you really trust it?

But seriously, this goes to my earlier question: if the overall economy is bad, does that necessarily mean I'm worse off?

A Question for Dr. Krugman

Paul Krugman is soliciting questions. Here's mine, #453 of the 915 accepted (!) before the editors shut it down:

Dr. Krugman-

It’s commonly assumed that growth is good, unemployment is bad, and deficits are… well, at least unpopular. But I’m left wondering what it all means to me personally.

For instance, unemployment may be nearing a post-Depression high, but I’m self-employed and run a small business. If I needed to shut down my company and get a job the u-rate would worry me greatly. But as it is, what I see are more highly-skilled potential employees demanding lower wages. (That being said, I’m certainly not unsympathetic to those out of work. I have friends and family members who are unemployed. It’s a stress I wouldn’t wish on anyone.)

Similarly, manufacturing output is growing more slowly than manufacturers (and macroeconomists) would like, but I don’t produce those goods; I consume them. If their business is hurting, shouldn’t that lead to lower prices for me?

Economists are well-known for being two-handed, but when they talk about the gloom and doom in the economy these days I don’t hear much “on the other hand”. I’m hoping you can help with that.

Thanks,
Charlie

If he answers my question (as did Buzz Aldrin—thanks, Buzz!) I'll post his reply here.

Great Moments as a 40YOF #1

A guy in my class complains to me about his hangover. I complain to him about my hip. I am not joking.

January 2009 Jobs Forecast with Updated Results

In January I wrote a post titled Predicting the Recovery about the Obama administration's report a out the job impact of the stimulus package.

For reference, here's the chart from that post showing predictions about unemployment both with and without the plan:



Here, thanks to Greg Mankiw, is the same chart updated with some actual numbers from the period since January:



Mankiw's analysis:

What does this mean? One interpretation is that the fiscal stimulus has failed to achieve what Team Obama thought it would. Another interpretation is that the baseline was worse than they believed at the time. I am confident the report authors would adopt the second interpretation. If so, that fact is consistent with what I said in a previous post: In light of the shifting baseline, it is impossible to hold the administration accountable for whether its policies are achieving their intended effects.

My analysis:

We're only now understanding the scope and depth of this recession.

Mandelbrot on Risk

In-depth (48 minute) interview from the Financial Times with Benoit Mandelbrot on why efficient markets collapse:



Also, a fan-made video for Jonathan Coulton's "Mandelbrot Set":



Don't forget to buy the MP3.

Common Sense in Economics

From Seduced by a Model on the New York Times Economix Blog:

David Colander made this point about economic models: The sociology of the economics profession gave preference to elegant mathematical models that could describe the world using the smallest number of parameters. “Common sense does not advance one very far within the economics profession,” he says.