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February 09, 2005

The Minuteman Asks: Who Would Like To Bet On Paul Krugman?

Tom Maguire asks:

JustOneMinute: Who Would Like To Bet On Paul Krugman?: However, my point stands in direct contradiction of a column written by Paul Krugman.... So, my proposition - I will pick out a couple of key phrases that summarize the Krugman argument, and put my money where my mouth is. If a consensus emerges that I am correct, you pay; if, OTOH, I am wrong, I pay.  The technical term for this is "wager".... Now, frankly, I ought to be the underdog here - we are talking about macroeconomic forecasts, and Paul Krugman is who he is (I am who I am, too, but what is that?) And, as regular readers know, there is a certain "stopped clock" quality to my criticism of Paul Krugman.  Oh, I may think I score the odd success, but frankly, if Krugman said "Good morning", I would probably put up a post saying it's nighttime in Tokyo, and wondering how a guy with a reputation as an international economist could possibly overlook that trivial and obvious fact.

Well.  The wagers.  Despite my heavy underdog status, I will put these up at even money.  $100 on this one: "the numbers the privatizers use just don't add up."

Let me take the bet--or, rather, propose my version of the bet. I will give Tom Maguire 4-1 odds. I will bet that twenty years from now--February 9, 2025--it will be the case that at least one of:

will turn out to be true. (I think all three of them will turn out to be true; but I like to make bets that I think I have a very good chance of winning.)

I will bet a case of the products of the Bonny Doon winery against three bottles.

And I would caution Tom (or anyone) against accepting bets specified by others. As the old story goes, "Someday, someone is going to come up to you with an unopened deck of cards, and bet that he can tap the deck and the jack of spades will jump out and squirt cider in your ear. Son, do not accept this bet."

Posted by DeLong at February 9, 2005 10:18 AM

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And that old story about taking a bet is from a Damon Runyan story, by the way.

Posted by: Donald A. Coffin at February 9, 2005 10:26 AM

It's in Guys and Dolls. Sky Masterson.

Posted by: buce at February 9, 2005 10:37 AM

Boony Doon is a good choice. But do you really want to bet that they'll still be here in 20 years?

Posted by: Jennifer at February 9, 2005 10:38 AM

Oh good, a wine bet.

You buy the case now, have him buy the three bottles. When the time comes, whoever wins has to pay the loser the current market value on the others holdings.

On a side note...this reminds me of a bet my father made with his friend and fellow wine collector. Over dinner, and probably too much wine, they bet a case of '68 BV Private Reserve on whether or not wine would be available in a can by x year. I can't remember when the bet was made or what year Dad speculated on wine-in-a-can, but needless to say my folks wine cellar increased by 12 rather tasty bottles of Cabernet that year.

Posted by: Stuart at February 9, 2005 10:47 AM

Bonny Doon will be on the S&P 500 in 25 years.

Not sure if that's a good thing.

Posted by: ogmb at February 9, 2005 11:02 AM

Well, thanks very much for the link.

As to your proposal:

1. An average dividend yield of 2% - I have no opinion, nor any likelihood of forming one. I am firmly in the camp of Nobel Laureate Franco Modigliani who observed, among other things, thatthe dividend decision is strictly a financing decision independent of the value of the firm. The many subtle variations struck on that theme (taxes, investor preference, agency issues, and signaling spring to mind) have not changed the underlying truth. Dividends don't matter... much.

2. Real GDP growth has exceeded 2.4% per year: First, I surely hope so. Second, in my "full disclisure" atthe bottom, I allowed that the Soc Sec trustees seem to have an institutional bias towards low-ball forecasts.

3. Real returns will be less than 6% over 20 years: elsewhere in my fill disclosure, I gave my reasons for thinking that the past observed equity premium was too high an estimate for future returns - survivor bias is the theme.

In fact, if "6" is the over/under, I would bet "under" - I picked 5% a few days ago (and now I am stuck with it, I guess...).

All somewhat beside the point - can we find someone to defend Krugman's assertions, please? My money is waiting.

[Why don't I make a reservation at a restaurant in San Francisco to drink the wine I will win on February 10, 2025? You're welcome to join me.]

Posted by: Tom Maguire at February 9, 2005 11:13 AM


Paul Krugman

Paul Krugman's first analysis suggests earnings growth at 1.9% and stock dividends and buybacks at 3%. So, we can project real returns to be 4.9%. [Nominal returns of 7.9%].

The 1.9% economic growth or earnings growth estimate is taken from the actuaries for Social Security.

Paul Krugman's second analysis suggests earnings growth at 3.4% and stock dividends and buybacks at 3%. So, we can project real returns to be 6.4%. [Nominal returns of 9.4%].

The 3.4% economic growth or earnings growth estimate is the rate for the last 75 years.

Posted by: anne at February 9, 2005 11:53 AM

But, Tom, that is Krugman's assertion: you can't come up with 6.5% stock market returns in both (1) a 1.9% real-growth environment and (2) the current P/E ratio.

I'll concede the Samwick/CEA point immediately: get the market to a current P/E in the 12-16x range and I probably won't be the only one moving money out of T-bills and into HPQ (especially after Carleton the Doormat succeeds Snow in a month or two).

But since you're not adopting that caveat, the terms presented above appear to reflect your underlying assumption.

Posted by: Ken Houghton at February 9, 2005 11:55 AM

Economists love models and graphs. Krugman makes some obvious points that if the macro ecomony improves investments in private accounts, then SS fortunes also improve.

Where are the models with interactive graphs that allow us to plug in the assumptions for the next 75 years and see how a change in n impacts both the Bushco 'plan' and the current system, and some reasonable alternative like raising the maximum income level for contributions.

No doubt one of deLong's grad assistant could have this up on the internet by this weekend, get an A and help save civilization all for good measure

Posted by: Desert Donkey at February 9, 2005 11:56 AM


You left off the best part:

"...for as sure as you do, you are going to get an ear full of cider."

From "The Idyll of Miss Sarah Brown," on which "Guys and Dolls" is based.

The musical is of some pedagogic interest because it contains an excellent example of the concept of Net Present Value:

"If we only had a grand we would be a millionaire."

Posted by: Bernard Yomtov at February 9, 2005 12:11 PM

Paul Krugman's first analysis suggests earnings growth at 1.9% and stock dividends and buybacks at 3%. So, we can project real returns to be 4.9%. [Nominal returns of 7.9%].

The 1.9% economic growth or earnings growth estimate is taken from the actuaries for Social Security.

Krugman's 4.9% projection will be too low only if economic growth is higher than the 1.9% assumed by the actuaries or the price earning ratio for the S&P rises from its current 19.6.

Should we grow at the 3.4% rate of the last 75 years, then Krugman's projection will be 6.4% with a constant price earning ratio. With a 3.4% growth rate Social Security will be fine for the century, and we can look forward to promising stock market investment returns.

Posted by: anne at February 9, 2005 12:22 PM


Paul Krugman:

The price-earnings ratio - the value of a company's stock, divided by its profits - is widely used to assess whether a stock is overvalued or undervalued. Historically, that ratio averaged about 14. Today it's about 20. Where would it have to go to yield a 6.5 percent rate of return?

I asked Dean Baker, of the Center for Economic and Policy Research, to help me out with that calculation (there are some technical details I won't get into). Here's what we found: by 2050, the price-earnings ratio would have to rise to about 70. By 2060, it would have to be more than 100.

In other words, to believe in a privatization-friendly rate of return, you have to believe that half a century from now, the average stock will be priced like technology stocks at the height of the Internet bubble - and that stock prices will nonetheless keep on rising.

Posted by: anne at February 9, 2005 01:03 PM

Two quotes from "The Flim Flam Man" starring George C. Scott.

1) "Never let the other fella call the toss"

2) "You can't cheat a 'honest' man."

Posted by: pragmatic_realist at February 9, 2005 01:30 PM

tom falls down when he pulls out the equations. His Algebra is wrong.

There are not two instances of the variable "Workers" in his equation but three. You can't cancel just two of them and have the other one disapear on its own. He noted this one sentence before he tried to do it:

Capital = Workers x (Capital/Worker) or C=W(C/W)

Then he gives us his return on Capital

SO: Return on Capital =

[Workers x Productivity x Inc Sh to Cap] / Workers x (Capital/Worker)

or Return on Capital = WPI/(W(C/W))

He has just noted that the denominator simplifies to C, giving you Return on Capital = WPI/C. Which leaves you with no W in the denominator. As any basic Algebra student can tell you, one can cancel the two Ws but that will also leave you with Return on Capital = PI/(C/W). When you multiply by the inverse you get right back to WPI/C. Multiplying C by W/W can have no lasting effect on the W in the numerator.

Maybe we should think twice before daring equations.

Posted by: Retief at February 9, 2005 02:06 PM

Not sure if Bonny Doon is really made for long bottle-aging, so hold off from buying any Cigare Volant for now...

Posted by: nick at February 9, 2005 02:17 PM

Ken Houghton wrote, "I'll concede the Samwick/CEA point immediately: get the market to a current P/E in the 12-16x range and I probably won't be the only one moving money out of T-bills and into HPQ (especially after Carleton the Doormat succeeds Snow in a month or two)."

Right. Peter Diamond has looked into these issues (there are PDFs at his webpage, I believe), and IIRC there are ways to make the return pretty decent, if the stock market crashes first.

I think Dean Baker conceded this in a reply to Samnick he penned on Max Sawicky's website.

Posted by: liberal at February 9, 2005 02:26 PM


In Mississippi, Setting the Pace for a New Generation of Republican Governors

JACKSON, Miss. - Inside the domed State Capitol here, the gold-framed portraits lining the Hall of Governors testify to one party's centurylong grip on Mississippi politics. Since 1876, all but one of them is of a Democrat.

Haley Barbour, the former chairman of the Republican National Committee who is now the second Republican governor of Mississippi since Reconstruction, is in a rush to try to end that tradition once and for all.

After ousting the Democratic incumbent, Ronnie Musgrove, in 2003, Mr. Barbour, who came back home after being a political adviser to presidents, a party chairman and a high-paid Washington lobbyist, pushed sweeping restrictions on civil liability lawsuits through the Democratic-controlled Legislature, presaging similar efforts by President Bush and other Republican governors.

But he has not only taken on the Republicans' bĂȘte noire, trial lawyers, in the battle over civil liability. He has also fought taxes, spending, growing Medicaid costs and the state's public employee union, setting a pace for a new generation of Republican governors who, like Mr. Barbour, embraced the ideas of Ronald Reagan in the 1980's but honed their sharp-elbowed political styles during the Republican revolution of the 1990's....

To help control spiraling Medicaid costs, he won the authority to eliminate state health care benefits for 48,000 low-income elderly and disabled people, resisting efforts to increase taxes to bail out the program. Mr. Barbour has warned that he will make other deep cuts to Medicaid if the Legislature does not come up with its own cost-savings plan....

Posted by: anne at February 9, 2005 02:36 PM

OT---just checked Yahoo! finance. 10-year T-note yield is now 3.977%.

Posted by: liberal at February 9, 2005 02:38 PM

Yes. Who is Maugire anyway? Really? Indeed, even a broken clock is right twice a day. So what? That does not make Krugman's caution or his projections any less valid. Krugman is one of the few voices that is both rational and honest. I'll put my money on Krugman any day.

Posted by: Scott at February 9, 2005 02:47 PM

Paul Krugman's projections of stock returns under administration assumptions are not important to conservatives. What they wish is not to preserve Social Security or Medicare or Medicaid or social benefit programs extending from Theodore Roosevelt to Franklin Roosevelt and on. The wish is to set aside these programs, but Paul Krugman constantly shows just this in a major forum and as such must be attacked relentlessly. Paul Krugman is no more a concern for these folks than Buster Rabbit, but Buster Rabbit too represents America as having a wonderful legacy an increasingly caring society and therein is the problem.

Posted by: lise at February 9, 2005 03:21 PM

"I'll put my money on Krugman any day." - Scott

Where does one trade Krugman futures?

Posted by: Fred Boness at February 9, 2005 10:01 PM

I assure you I won't be taking investment advice from Tom Maquire, pretend economist pretend investment analyst.

Posted by: lise at February 10, 2005 06:47 AM

Well - semi-relatedly, there is one such website where one can publicly place a long-term wager - www.longbets.org. Founded by Kevin Kelly with the intent of improving long-term thinking (not for profit or off-track type betting) - this might just be of interest. NFI, etc, etc.

As an aside: Always an enjoyable read. Many thanks for your postings.

Posted by: Zach at February 10, 2005 08:54 AM

I'm with Fred Boness, we need a futures market. Plus, having a market aggregate our predictions for another market would be cool.

Failing that, maybe DeLong and Maguire need to head over to http://www.longbets.org

Posted by: Eshan at February 10, 2005 01:30 PM

[comment spam]

Posted by: at February 24, 2005 06:32 PM

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