Pink Floyd and Slash

I wandered into Amazon Prime video on Friday night. I ended up watching a documentary The Making of Dark Side of The Moon. They explicitly made an observation that I have told people myself — you can definitively bisect Pink Floyd’s discography at the Meddle album. Specifically right before the last song, Echoes, a 20 minute opus that would set the stage for the most epic run of album per unit of time in history:

1973: Dark Side
1975: Wish You Were Here
1977: Animals
1979: The Wall

Echoes was a preview of Dark Side and really dialed in so much of what they hinted at in their prior albums and especially in the movie scores and soundscapes they crafted.

They are such a compelling band not just for what they created but the arc of their career and how it lined up with the music they created. You can practically feel the band’s mindset as you travel through the discography and hear them evolve. I’ve toyed with doing a write-up based on the various docs I’ve watched and my own joy of the music but I can see it just being a long Twitter thread if the inspiration holds long enough above my personal activation threshold.

If you are a fan then this doc, Momentary Lapses, is worth your time.


Friday, I also watched the Amazon original Slash: Raised On The Sunset StripI’ve read plenty of books about GnR including Slash’s biography. He was raised in Laurel Canyon in the 1960s and his parents were both creative designers. The young Saul Hudson was regularly in the company of folks like David Bowie, David Geffen, and many music artists you’d all recognize. I’ve previously mentioned the Echo In The Canyon doc which accompanies this Slash one well, as it is set in the 60s and 70s while the Slash doc takes the baton into the 80s and beyond. The cameos in the Slash doc are fun with the Dave Grohl one being especially interesting for anyone familiar with Axl Rose’s run-in with Kurt Cobain at the 1992 VMAs.

If you have any interest in this stuff you can get some leads in some of my prior posts:

The Sunset Strip Pilgrimage (Link)

Movies For Your 60s Nostalgia Fix (Link)

Making Property Taxes Apples to Apples

You will be working from home more often. Not all of you but many of you. That means browser tabs devoted to Zillow searches in Austin, Nashville, Vegas, Denver, and Miami. Geo-arbitrage won’t be as dramatic as software devs had hoped since the big companies will cut your pay when you leave, but in some of these places you could sustain a 20% pay cut and still be better off (at least if you’re leaving SF).

One of the biggest inputs into cost-of-living comparisons are so-called SALT (state and local) taxes. Since 2018, SALT deductions are limited to $10,000. They were previously uncapped. This has created even larger disparities in cost-of-living between states. CA, IL, NJ, and NY have income taxes that get a bit handsy with their residents.

Beyond state income taxes, one needs to consider property taxes for a more complete picture. Texans enjoy zero state income tax but hefty property taxes. NJ residents are assaulted from both ends — above average state income taxes and punitive property taxes. How about CA? The state income tax, gas tax and the cost of renewing a vehicle registration are nothing short of sunny weather ransoms.

But what about CA property taxes? The answer to this is sneaky and can be used to understand the impact of property taxes in general. But I’d go further and say that if you have not walked through the math the way we are about to, then you may be walking around with some very mistaken impressions about the cost of housing.

Property Taxes: Apples to Apples

The effect of property taxes depends on 2 core variables. The property tax rate and the assessed value. If you are weighing a house in CA to a house in NJ you want to make an apples-to-apples comparison. How do you do that when the rates are different and the methods of assessing value are different?

Let’s isolate each effect.

[Obviously the cost to buy a home has many factors that can mostly be tucked under the headings of supply and demand. Yet the effect of property taxes is significant so it’s worth isolating. It’s also worth noting that since a primary residence is most people’s largest asset, a property tax is a defacto, albeit incomplete, wealth tax. Economically it’s passed-thru to renters so it hits everyone]

Assessed Value Effect

Property taxes are waged on assessed value. In NJ, assessed value resets whenever a home trades. So if you buy a $1,000,000 home and the property tax rate is 1% you owe $10,000 per year in property tax. As the estimated market value of your home changes, your assessed value changes. So if your market value jumps 15% in one year you can expect a big increase in your tax bill. It may lag the full market return but the idea is the assessed value tracks the value of the home. Downturns in prices require homeowners to plead their case that the home’s value has declined if they want relief on their taxes.

Like NJ, CA assessed value resets to the purchase price after a transaction. But then CA diverges from other states. A month before I was born, in June 1978, CA passed Prop 13, a ballot proposition that has created distortions in wealth that few could have foreseen. Prop 13 froze assessed values at 1976 levels for homes which have not since traded. It also limits increases in assessed value to a cap of 2% per year.

Combined with a NIMBY attitude to permitting new construction, CA features a lopsided sight to behold — multi-million dollar homes with single-digit thousand tax bills. Nice for those owners but not socially desirable.

Consider:

  • The flipside of having seniors be able to stay in their homes is that it limits worker mobility by poorly allocating big homes to people who don’t need them. It basically keeps rooms off the market. If you are a senior citizen on a fixed income you are not going to sell the home you’ve outgrown to buy a condo with much higher property tax than the big house you leave behind. And that’s after you pay a huge cap gains bill.
  • Prop 13 starves the state of tax revenue that needs to come from somewhere. So the state income tax can be seen as a wealth transfer from young, working Californians to older, entrenched Californians.

In a state that has seen generational wealth built on a loop of buying real estate, and cash-out refis it’s easy to see how Prop 13 has contributed to the party. Let’s pretend you buy a home in CA and NJ.

Assume:

  • Each home costs $1,000,000
  • Each has a property tax of 2.5%. We are isolating the assessed value effect so need to hold the tax rate constant.
  • Each home has a real (inflation-adjusted) return of 2% per year.
  • The only difference is the CA home is assessed only when you buy it, but the NJ home is assessed each year.

The CA home’s IRR will be .14% after-tax while the NJ home’s IRR is -.52%. The CA home outperformed the NJ home by .66% per year over 30 years. On a $1mm home that’s over $275,000 simply because the NJ home is re-assessed every year.

It gets crazier. The effect actually explodes with higher appreciation rates. If we double the appreciation rate to 4% per year, the CA homes nets you $700,000 more than the NJ home. Remember that the tax rates are the same! We are just isolating the impact of fixing the assessed value at the purchase price.

The main takeaway is Prop 13 is a call option on inflation. Your home is much less of an inflation hedge than you think if its assessed value increases in-step with the market value.

[This year Prop 15 is on the CA ballot. Prop 15 would repeal Prop 13 for commercial properties only. Based on the examples above, it’s obviously something RE investors are highly concerned about.]

Rate Effect

What if you wanted to compare the price of homes in 2 places with different property tax rates? Let’s pretend CA no longer had Prop 13. Like NJ, it’s property taxes were re-assessed annually. This allows us to simply isolate the impact of differing tax rates.

Let’s assume:

  • Each home costs $1,000,000
  • CA tax rate is 1%
  • NJ tax rate is 2.5%.
  • The homes do not appreciate over 30 years (just to keep it simple)

Let’s explore 2 methods of comparison:

The Mortgage Method

If the homes do not appreciate then their assessed value remains fixed at $1mm. This makes it easy — the CA home owes $10,000/yr in taxes and the NJ home owes $25,000. On a monthly basis, the NJ home costs an extra $1,250. If mortgage rates are 3% we can find that a $300,000 30-year mortgage corresponds to a $1,250 monthly payment. So we can say that a $1mm house in CA costs the same as a $700,000 house in NJ since the $700,000 plus an additional $300,000 mortgage would equate to the cost of the CA home.

The IRR Method

The IRR on your home’s value will approximately differ by the spread in the tax rates. In the table below, we see that the CA home returns 1.44% more (close to 1.50%) over 30 years. If we use an inflation rate of 3% to keep consistent with what I chose as a mortgage rate, we find that the NJ home costs you $300,000 more over the 30 year holding period than the CA home, matching the result from the mortgage method.

Combining Effects

To compare the price of a home in CA to a home in NJ you need to account for both the difference in property taxes and how assessed values are treated. Let’s combine the results in one model with more realistic numbers:

  • A 4% annual home appreciation in both markets
  • A 2% inflation rate
  • CA tax rate is 1%
  • NJ tax rate is 2.5%
  • CA assessed values do not increase, NJ is re-assessed annually

CA, due to Prop 13 and a lower property tax rate, has an almost 2% edge in annual return (3.29% vs 1.34%). Since these are nominal returns and inflation is 2% per year we see that the NJ home end up actually losing value in real terms. The fact that the home is re-assessed every year means that even though the home’s value is growing faster than inflation the taxes are also growing very quickly.

I don’t want to have you miss the point — these CA and NJ homes were assumed to grow at the same rate of 4% per year and yet the CA home earned you an extra $900k in present value vs the NJ home. This is strictly due to lower property taxes and Prop 13.

We know that home appreciation in CA has been faster than NJ (my family considered moving to CA in late 70s, early 80s so we are very sensitive to the comparison). The difference in property tax policies has a staggering delta in terminal wealth when applied to CA real estate boom over the past 50 years.

Wrapping Up

Having grown up in NJ and now lived in CA, I have noticed a massive divide in how people have earned their money and wealth. You cannot live here and not notice the wealth built in real estate and not think about how policy has enabled it. When you start comparing apples-to-apples, the headline prices of CA homes are not as relatively expensive as they appear. Don’t hate on Californians though. Those SALT taxes are still burying all of us who still work for a living.

In sum:

  • Prop 13 allows homes to be a call option on home appreciation/inflation
  • High property taxes on homes that are re-assessed require rapid appreciation to not render the home ‘dead money’
  • Compare homes with different property taxes by amortizing the difference in monthly payments into a mortgage

Sending a thanks to @econompic who I discussed these topics with. As another NJ to East Bay transplant he has given these ideas plenty of thought as well. And on the math side, he gave me the idea to use IRRs instead of CAGRs. CAGRs are simpler because they are compounded returns which require no more than a start value, ending value, and time period. They are commonly used when calculating a return for a stock or fund that you buy and hold.

In this case, IRRs or NPVs are preferable since there are many cashflows.

Resisting Arguments and Magical Thinking

Last week we explored how we form beliefs. The main takeaways were:

  • we adopt ideas before we reason about them
  • most of our beliefs are derived from others

There is nothing inherently wrong with these mechanisms. They are adaptive. The problem arises when our standards for adopting a belief are poorly matched to how we apply a belief. If that sounds abstract, don’t worry, I am going to tackle it in an upcoming letter. For now, just realize that we form beliefs the way we do for economical reasons, but that efficiency can mask deep pitfalls.

This week we will see how beliefs stay so firmly lodged. I have bad news. This also happens for sound reasons which is unfortunate when the beliefs are wrong and counterproductive (some wrong beliefs are totally benign…like thinking seahorses are mythical).

Let’s explore 2 ways in which we adhere to false beliefs, why they should be forgiven, and what the remedy is.
Failure mode #1: Not Letting New Information In

We all know about confirmation bias. It is our nature to reject contrary evidence. We prefer to protect our egos. We are “cognitive misers” so we like to avoid inconvenient information because thinking hard consumes calories. News flash: humans are insecure and lazy.

  • Why should we forgive this failure?

    Here’s a more charitable reason for why we shoot down foreign concepts. Scott Alexander calls it “epistemic learned helplessness”.

    He writes:

    A friend recently complained about how many people lack the basic skill of believing arguments. That is, if you have a valid argument for something, then you should accept the conclusion…And I nodded my head, because it sounded reasonable enough, and it wasn’t until a few hours later that I thought about it again and went “Wait, no, that would be a terrible idea.”

    He goes on to explain that people’s dominant strategy is to ignore many smart-sounding arguments. You will recognize his hair-pulling examples of nodding along with clever reasoning, be swayed 180 degrees by equally clever rebuttals, only to come back to agreeing with the original argument ashamed to have doubted it in the first place (Link with my highlights)

    Without this helplessness, most people’s lives would turn into a silver pinball ricocheting at the flippers of copywriters and TED talk sophists.

  • The remedy

    Get smarter. That’s kind of it. Hopefully reading Moontower helps, I don’t know what else to say.

    Slatestar continues:

    I’m also glad epistemic learned helplessness exists. It seems like a pretty useful social safety valve most of the time…you have to be really smart in order for taking ideas seriously not to be immediately disastrous. You have to be really smart not to have been talked into enough terrible arguments to develop epistemic learned helplessness.

Failure mode #2. Doubling Down On Wrong Beliefs

This is what is journalistically referred to as “mental gymnastics”. Look around and you will see people so limber they are suspended in a floating Siddhasana pose channeling Dhalsim. Which is convenient, since this is the best posture for indulging “magical thinking”. This failure mode is embodied by a runaway uncritical acceptance of confirming information.

This video is about 45 minutes but it’s a wild trip into who, why and how of magical thinking in the US today. It’s well-edited, moves fast, and leaves quite an impression. (Link)

 

  • Why should we forgive this failure?

    Magical thinking is double-edged. It is only through the power of beliefs, often false beliefs, that we can fight through utter despair and hopelessness. “There’s no atheists in foxholes”. Or if you prefer the more secular Lucasfilms interpretation, “Never tell me the odds”.

    My favorite example of this is what Tali Sharot calls optimism bias. It’s an adaptive use of magical thinking that seems integral to our collective progress. It’s not possible or desirable to wish magical thinking away altogether.

  • The remedy

    I’m not going to make any friends saying this but here it goes. Logic and rationality are reasonable antidotes to magical thinking — but only if the subject is relatively young. I need to believe teens can be saved and hopefully people in their 20s, maybe even 30s. But, if epistemic learned helplessness is so cemented in a subject that has went down the QAnon rabbit hole, then logic is not going to cut it. Just remember this Jordan Ellenburg quote:

    “If you do happen to find yourself partially believing a crazy theory, don’t worry — probably the evidence you encounter will be inconsistent with it, driving down your degree of belief in the craziness until your beliefs come in line with everyone else’s. Unless that is, the crazy theory is designed to survive the winnowing process. That’s how conspiracy theories work.”

    Look, a person inoculated against sound reasoning is a tough customer for conversion. Some people will believe reason never did them any good, and trying to convince them otherwise without invoking logic is like trying to describe “green” to a blind person.

    So if logic is futile, how do we combat magical thinking?

    We recognize that magical thinking is a natural response to desperation. The prevalence of magical thinking is an irregular pulse of a patient’s vitals. If it’s quickening, the patient is scared. The answer is to address the underlying causes of the fear.

    It’s a cop-out answer to say fix the world and magical thinking will decline. But if you think magical thinkers are ready to hear why they’re wrong then you never tried to reason with a hungry bear. Your choices are to either stop hunting the bear’s food or adopt the prepper’s mindset — you don’t need to outrun the bear, just someone else.

Recap

We cling to false beliefs by:

  • resisting arguments. This is often a valid defense. But even white blood cells make mistakes.
  • diving into comforting or confirming fantasies. Pressure thins the line between being stupid and coping. Address the source of distress not the fantasy.

If interested in more on beliefs and illusion see my post Illusions, Empathy, and The Hackability of Perception (Link)


Here are a few Twitter threads pointing to signs and causes of desperation:

  • Let’s play a game. in one tweet only (no threading or linking!) how would you describe the crux of the problem of American society in 2020? (thread by @danlistensto)
  • Here’s a sign of the state of the US that doesn’t seem to be getting covered much: The country is sold out of handgun ammo. Every website is sold out, the ranges in Austin are sold out, a guy at Cabela’s said each restocking shipment sells out in < 1 hour. Absolutely wild. (thread by @nateliason)
  • Majority (now 52%) of 18-29 year olds living with their parent(s). (chart via @ROIChristie)
  • Interesting and somewhat disturbing. The % of people earning more than their parents has collapsed. (chart via @jsblokland)

Adopting Beliefs

If Trump was gung-ho about masks would masks have been politicized?

The more you think about that question the more uncomfortable you become.

I have questions.

  • Would liberals have been the mask-deniers?
  • Would pro-mask research from the science community be suppressed from the left?
  • Would pro-mask research from the generally left-leaning science community actually be boosted from the right?
  • What arguments in favor of masks would a Trump base promote if they were not rooted in science?

These questions are unsettling because one wouldn’t think masks would become political. Do you think it’s possible that the red and blue positions could have been exactly flipped based on Trump’s mood towards masks (I know it’s hard to imagine him embracing masks but what if he saw them as the key to business as usual, or if you are more cynical, if he happened to have a stake in the world’s largest N95 manufacturer)?

Is there a limit to “my enemy’s enemy is my friend” logic?

I hate to be a pessimist, but the answer is no. The mind can rationalize anything. Every historical human atrocity had a wave of support. Support from ordinary people who were once innocent children. Blank slates.

Let’s see how. I have broken this into 2 parts as I’m trying to keep these letters compact.

Part I: How We Adopt Beliefs

1. Belief precedes reasoning

The mind doesn’t see facts then build beliefs on top of them. It starts with beliefs then finds facts to support them. This is hard-wired. Kids believe in Santa based on trust. Then around age 7 their ability to reason takes a big leap forward and the fantasy melts away from the heat of logic. The Santa story has too many holes in it to believe.

Yet, we have flat-earthers.

This is instructive. Survival doesn’t depend on accurate abstract logic (although luxuries like circumnavigating the world does). Survival just depends on accurate beliefs about sensory perception. Fire burns. Falling hurts. These beliefs don’t rely on knowing the reasons. This is merciful. Reasons are not our strong suit.

Annie Duke on the dangers of holding beliefs before we vet them:

  1. We often fail to later vet the ideas we are wandering around with in our heads.
  2. If we do vet, we are biased. This leads to what Kahneman called “motivated reasoning”. Examples:
    • Confirmation bias. You know, ignoring evidence that doesn’t fit. Finding patterns in randomness. Ouija.
    • Blindspots. Often willful.
    • Smart people being often more extreme in their biases because they rationalize with greater repertoire.

So the main takeaway:

Out of the box, we really have no trouble believing things without logic. If someone tells us it’s important to have reasons to support our opinions, we come fully-equipped to mine for them after the fact. Or simply make them up.

2. We outsource opinions

We start our lives by downloading our parents’ beliefs. They are the tribe we are dealt. As we get older, we make friends. They are the tribe we choose. They are like us and make us feel good. If we are so alike, then it follows that what’s good for them is good for us. What a great shortcut. Instead of researching every opinion or decision a citizen needs to make, we can just let the “you might also like” recommendation algo choose for us.

I sound sarcastic but it is reasonable to outsource decisions to your tribe. You cannot be an expert in everything. Modernity is too specialized and complex. I’ve written in Build Your Own Cabinet about how you need to do this thoughtfully.

Whether or not we do it competently, we cannot help but borrow views from others. But if we cling to those views strongly it’s not because we expended great effort to acquire them. The stickiness of a view is more correlated with the order in which it arrived than the rigor it endured on its way over.

In sum:

Beliefs are either birthed by perception or we adopt them from others. They originate from impressions. They are far more spontaneous than deduced. Your beliefs won’t tell you what to do. They’ll make you feel good about what you do. They are chosen for comfort not speed. They are here to protect more than to serve. They are only invited in if they play well with your other beliefs. You don’t have time nor energy to listen to them quarrel in your head. And lastly, they use the first-in-last-out accounting method.

For all these reasons, it is obvious that once beliefs become tenants they will soon become squatters. You’ll let them live rent-free in your mind. The buyout price doesn’t seem visibly worth it. Once a belief takes up residency it is very difficult to evict.

Next week, in part II, we will see how beliefs become so firmly lodged and how we might loosen the grip on them in ourselves or others.

Literary Version Of A Chart Crime

Last week, we talked about “chart crimes“. Often these are charts that poorly constructed because the authors have been fooled by correlations or invalid comparisons. These are naive but honest. Then there are charts that use sleight of hand to nudge a conclusion. This author has an axe to grind. 

This week, we will discover the literary version of chart crimes. It’s what Cedric Chin simply calls “sounding insightful”. It’s an approach honed in the internet tournament for attention. Since desire is the only barrier to publishing online we are witnessing “an arms race in writing. The best online writers are able to make something sound insightful — regardless of whether it’s true, or whether it’s useful.”

Ced continues:

This isn’t some evil conspiracy. ‘Writers optimizing to produce insight porn to grab attention’ sounds nefarious, but it’s really more like ‘writers responding to the incentives of the social internet’ — a simple side effect of the attention economy.

My own feeling is that the overlap between universally “good writing” and “optimizing for attention” is much higher than “good writing” and “being right about what you are writing about”. I’m sure there’s some mix of practice, talent, and writing ed that can make you a good writer. But I’m not sure how correlated any of that is with having accurate or well-reasoned thoughts.

A bad writer with bad takes is harmless. Nobody finds them. A bad writer with good takes needs an agent. A good writer with bad takes is hard to detect for 2 reasons:

1. Part of good writing is being effectively persuasive. A good writer has you in a spell. 
2. There are elements common to all good writing so you cannot distinguish good takes from bad takes based on style.

Ced refers to some of these common elements as “tricks”. 

Here’s 2 familiar ones:

  1. Use a story.

    I started this piece with a story. Preferably from a historical period that the reader isn’t familiar with.

     
  2. Repackage obvious truths and sprinkle them over the course of an essay

    Clichés can thus be repackaged to sound insightful. This is a useful trick because a) clichés are often truths the reader already agrees with, and b) whatever sounds insightful will keep the reader going.

     

Usefulness Separates Infotainment From Scholarship 

Ced warns that what sounds insightful isn’t always true or useful. Some excerpts:

  • [Venkat] Rao’s piece is not ok if your goal is to read for career reasons. But it’s ok if your goal is to read for entertainment. It’s ok because Rao’s goal is to attract eyeballs, not create better business leaders. And his writing is so good most people will forgive him for it.
     
  • As a writer, I admire what he’s done. But as a business person, nearly everything that [Dave] Perell says in the piece about business is subtly wrong — enough to make me treat his essay as entertainment, not education.
     
  • Writers are often seen as smarter because good writers today are trained to optimize for sounding insightful. This bleeds over into reader perception. I think that whether a writer sounds smart or a piece sounds sophisticated shouldn’t affect you if your goal is to put things you read to practice. The questions remain the same: “Is this person believable? How likely is this going to be useful? And what’s the cheapest way to find out?”
     

Clear Thoughts Do Not Equal Correct Thoughts

Ced concludes his post:

A year ago I wrote Writing Doesn’t Make You a Genius. I noticed that people tend to assume good writers are smarter than they actually are. I argued that this was mistaken — that writers sound smarter on paper because the act of writing forces them to clarify their ideas.

But now I have another reason. Writers are often seen as smarter because good writers today are trained to optimize for sounding insightful. This bleeds over into reader perception.


My Own Reconciliation My feeling is the usefulness of writing comes in 2 forms:

  • Form 1: The writing helps you make better decisions or predictions.
     
  • Form 2: The writing is useful for entertaining or provoking you. If a writer is wrong in interesting ways their work is still useful.

The most common failure is to incorrectly label a Form 2 piece as Form 1. If all you ever read is Malcolm Gladwell or self-help you might never know the difference. 


For a fuller discussion, please check out Ced’s Beware What Sounds Insightful (Link)

T’Challa Is A Real Leader

We all know a story of some actor whose real life personality is nothing like the role they play on TV. We are 2 degrees separated from the actress who plays “Darlene” on Ozarks. We hear she’s the sweetest lady ever in real life. On the show, she’d shoot your balls off. I remember once reading about the actress who plays “Suzy” on Curb Your Enthusiasm. She lives in Brooklyn and apparently whenever she gets recognized in public, fans just ask her to curse. Just say “Larry, you four-eyed f_ck!”. In reality, she couldn’t be any further from Jeff Garlin’s caustic wife on the show.

Well this weekend, we were pretty bummed about Chadwick Boseman’s passing. Covid season has meant a lot of Marvel movies on loop. Max was in a phase for awhile where he’d declare “Wakanda forever” before leaving the room. I’m not familiar with Boseman’s body of work other than Black Panther but his portrayal of T’Challa stands so tall. He’s magnetic, charming and inspiring. You cannot help but feel that Boseman’s real life character is bleeding through. You wouldn’t want to discover the negative version of the “Darlene” or “Suzy” surprises.

Fortunately, the man, Chadwick Boseman, would make T’Challa proud. Some of my favorite discoveries:

  • The “Black” Jeopardy SNL skit (Link)
  • Boseman talking about his relationship to kids with terminal cancer. He was quietly battling Stage 4 colon cancer during this interview. I’m not crying, you’re crying. (Link)
  • A 90 second clip from a commencement speech he gave. I’m sure you don’t need to be religious to hear the message. Last 30 seconds were especially resonant. (Link)

Public discourse, by its nature, promotes glory and underappreciates silent heroism. It’s why the Humans of New York project you see on social media is so special. It’s about the unheralded. Appreciating the day-to-day struggle that people privately deal with makes the world feel more relatable. It connects us in ways that we need more of. I’ve mentioned this in various ways in Antidote to Abstraction and my eyerolly take Avoid Boring People?.

Boseman was a celeb who provided a rare example of silent leadership.

Chart Crimes

A good friend shared this in one of our Whatsapp chats.

Tsk, tsk.

Classic #chartcrime. I don’t want to be too hard on my friend, after all, Bay Area real estate has certainly co-moved with the stock market. But this chart is intentionally heavy-handed. The axes don’t start at zero which should immediately cause you to wonder “what’s that smell?”

Look a little closer and you see the dual vertical axes are out of proportion. The blue axis goes from $400 to $1,100 while the red makes a much larger percent jump from $7,000 to $29,000.

Getting fooled by a chart is a forgivable offense. The friend who shared that chart has a grad degree in physics and extensive business and tech experience. It’s tiring and impractical to slow down at every chart we see. Fortunately, spotting chart crimes is just a matter of practice.

For financial #chartcrimes I recommend this thread by my buddy Jake who ruthlessly collects them.

Every chart you see was created by someone who was framing a story. Every chart has intent. Design choices are never accidental. This doesn’t mean every chart crime is nefarious. Often they just reveal how people have fooled themselves.

Here are 2 common failure modes:

  • Spurious Correlations

    These are best explained by simply looking at ridiculous examples. Call it lazy pattern-matching or uncritical data-mining. Correlation/causation errors are in our DNA. I’m convinced there’s no solution to this. And even when we think we isolate causation we are prone to being exactly wrong. A recurring theme in Moontower is we often say “because of” when we mean “in spite of”.

  • Invalid Comparisons

    What can cause 2 quantities to be non-comparable? One series might be “stationary” and the other “non-stationary”. These are technical words so I feel like an imposter even writing them. The ELI5 gist of a non-stationary series is one that does not have a stable mean. For example a stock price index or your age. These are quantities that trend (we can debate the stock one, but if you believe in inflation at the very least the price is subject to the trend of the denomination. All prices are relative to a denomination. I can compute the price of oil in USD but I could also compute in terms of eggs per barrel, diplomas per barrel, or Pokemon per barrel).

    Examples of stationary or stable quantities would be how many hours you sleep, how many times you go to the bathroom, or returns. So it would not make sense to compare the price level of the SP500 which has a mean which changes over time with the level of the VIX which is mean-reverting.

    So when making comparisons it’s important to consider what drives the measurables. If the drivers do not come from the same distribution or behavioral class you might be fooling yourself.


Just before I was set to blast out the newsletter I learned this is the “most liked” tweet of all-time. That’s informative but it does make you wonder what the most liked tweets of all time are normalized by number of active Twitter accounts. And even then you’d like to further account for Russian bot accounts. A common way to normalize a non-stationary series to a more stationary one is to normalize it with a ratio. GDP vs GDP per capita. Inventories vs Inventory/use.

Straddles, Volatility, and Win Rates

One of my favorite follows on #voltwit is @SqueezeMetrics. The account more colloquially known as “the Lemon” has a personal crusade against using implied vol to refer to option prices. Recall, volatility is just the asset’s standard deviation of returns. It’s usually an annualized number. So if the SPX has a 15% volatility that just means you expect the SPX to return +/- 15% about 68% of the time1

“Lemon” prefers using the average expected move, more commonly known as the straddle.

Thus tweeted the Lemon:

I think the convention of turning the straddle price into an annualized standard deviation is obfuscatory. Straddle gives you the average move that’s priced in. Why complicate that?

I can see how the distinction between average move (aka the “straddle”) and standard deviation (aka the “vol”) is “obfuscatory”.

So let’s clear it up.

Expect to learn:

  • The math relationship between the straddle and the volatility
  • How the distinction relates to win rates and expectancy
  • Why the spread between the straddle and volatility can vary in turn altering win rates
  • My own humble opinion on the matter

Turning Volatility Into A Straddle and Vice Versa

A handy formula every novice trader learns is the at-the-money straddle approximation2:

Straddle = .8Sσ√T

where S = stock price
σ = implied volatility
T = time to expiry (in years)

Ok, let’s pretend the SPX is $100, there’s 1 year to expiry, and implied volatility is 15%. Plug and chug and we get a straddle value of $12 or 12%. Pretty straightforward.

Straddle/S = .8σ√T

If we want to simply speak in annualized terms then we can assume T = 1 and can simplify:

Straddle as % of Spot = .8 x σ

Which of course means if you know the annualized straddle price as a percent of spot you can go in reverse to get the volatility:

σ = Straddle as % of Spot x 1.25

When is this useful?

Let’s say based on a stock’s past earnings move you see that it usually moves 5% per day. In other words, the earnings day straddle should be 5%. Then, you can find the standard deviation:

5% x 1.25 or 6.25%

The standard deviation is a volatility which you can annualize to plug into an options model which will spit out a 5% straddle price.

6.25% x 252 = 99.2% vol

Knowing the 1-day implied volatility is useful when you are trying to estimate a term volatility for a longer period that includes the earnings day (topic for another time).

What’s the practical difference between straddles and volatility?

Volatility is a number you stick into a model to generate a price for an instrument you actually trade. In this case, a straddle. If you input 15% vol into our above example, you will find that a 1-year straddle will cost you 12% of spot.

If you buy this straddle your return is equal to:

Absolute value of SPX return – 12%

Your worst case scenario is the SPX is unchanged and you lose your entire 12% premium. You are “long volatility” in that you want the SPX to move big one way or another.

So let’s talk about what we really care about — expectancy and win rates.

Expectancy

The point of the model is to generate a price that is fair for a given volatility. 12% was the fair theoretical value for a 15% vol asset.

If you pay 12% for the straddle on a 15% vol asset you have zero expectancy.

But that’s not the whole story.

Win Rates

Expectancy and win rate are not the same. Remember that the most you can lose is 12% but since there is no upper bound on the stock, your win is theoretically infinite. So the expectancy of the straddle is balanced by the odds of it paying off. You should expect to lose more often than you win for your expectancy to be zero since your wins are larger than your losses.

So how often do you theoretically win?

A fairly priced straddle quoted as percent of spot costs 80% of the volatility. We know that a 1- standard deviation range encompasses about 68% of a distribution. How about a .8 standard deviation range?

Fire up excel. NORMDIST(.8,0,1,True) for a cumulative distribution function. You get 78.8% which means 21.2% of the time the SPX goes up more than .8 standard deviations. Double that because there are 2 tails and voila…you win about 42% of the time.

So in Black-Scholes world, if you buy a straddle for correctly priced vol your expectancy is zero, but you expect to lose 58% of the time!

Outside Of Black-Scholes World

The Black Scholes model assumes asset prices follow a lognormal distribution. This leads to compounded or logreturns that are normally distributed. This is the world in which the straddle as percentage of spot is 80% of the annualized volatility.

In that world, you lose when you buy a fairly priced straddle 58% of the time. Of course fairly priced means your expectancy is zero. What happens if we change the distribution?

I’m going to borrow an example of a binary distribution from my election straddle post:

  • 90% of the time the SPX goes up 5.55%
  • 10% of the time the SPX goes down 50%

    Expected move size = 90% x 5.55% + 10% x 50% = 10%

Expected move is the same as a straddle. The straddle is worth 10% of spot. Your expectancy from owning it is 0.

If this was Black-Scholes world, we would say the volatility is 1.25 x 10% = 12.5% (not annualized). But this is not Black Scholes world. This is a binary distribution not a lognormal one. What is the standard deviation of this binary asset?

We can compute the standard deviation just as we do it for coin tosses or dice throwing.

σ= √(.9 x .05552 + .1 x .502)

σ = 16.7% (again, not annualized so we can compare)

Note that your straddle is 10% but your volatility is 16.7%. That ratio is not the 80% we saw in the lognormal world, but instead it is 60%.

Note you cannot repeat the earlier process to find the win rate. You can’t just NORMDIST(.6,0,1,True) because the distribution of returns is not normal. Luckily, with a binary distribution our win rate is easy to see. In this example, if you pay 10% for the straddle you lose 90% of the time.

Even if you paid 6% for the straddle you still lose 90% of the time. However if you bought the straddle that ‘cheap’, your expectancy will be massively positive!

My Own Humble Opinion

When there is a short time to expiration, arbitrarily let’s say a few weeks, my mind’s intuition might latch on to a straddle price. I might think in terms of expected move as one does for earnings in getting a feel for what is the right price. But on longer time frames I prefer to think of implied vol because I am going to be dynamically hedging. Measures of realized vol can be readily compared with implied vol.

If I look at a straddle price for a long period of time, say 1 year, I might fall into a trap thinking “20%? That just sounds high.” I’d rather just compare the implied vol which would be 25% (remember 1.25 x straddle), to realized vol since I am interested in the expectancy of the trades, not the win-rate.

There are all kinds of house of mirrors when looking at vols and straddles and thinking about winning percentages. As Lemon says, it’s “obfuscatory”. Everyone should do what works for them.

If you tend to be long vol, be aware having more losing months than winning months might be completely normal. It’s baked into the math. And the more skewed the distribution, the worse your batting average will be.

But in the long run it’s your slugging percentage that matters.

Recap

  • Straddles as a percent of spot are 80% of the volatility (all annualized)
  • Straddles tell you the average move.
  • Fair straddles have zero expectancy.
  • You lose more often when you win when you are long a straddle.
  • Your win sizes are larger than your losses.
  • Skewed distributions change the relationship between win rates and expectancy. They also change the relationship between straddle prices and standard deviations.

The Curse of the Reserve Currency

I’m familiar with the US dollar as the world’s reserve currency through a conventional lens. As a deliberate bargain between the US and the rest of the world.

It goes something like this:

The US enjoys a stable currency effectively lowering her cost of capital. In exchange, US Naval might enforces order on maritime trade routes. The safety of shipping lanes is a global good lifting all economies through the efficiencies of comparative advantage and arbitrage. This global good would be difficult to coordinate without a single cop like the US so the world accepts this bargain as reasonably fair even if it might nitpick aspects of it.

If you are a just being introduced to this idea you can see my notes on:

I recently read a different perspective on this global arrangement. In this alternative view, the status quo was not an explicit or even implicit deal between the US and the rest of the world but an emergent phenomenon. The distinction is important because the force that maintains it is not international diplomacy shaped by national interests. Instead, it is simply the position at which the equilibrium is at rest according to economic gravity. The invisible hand working bottom-up not authority working top-down.

Yakov Feygin and Dominik Leusder explain:

The dollar system evolved not as a tool of imperial statecraft, but as the project of a transnational elite that has effectively usurped control of an international public good.

Frameworks for understanding the persistence of the dollar system tend to vary from from reductionist to outdated, often examining international politics with discrete nation states as the main unit of analysis. In this view, the dollar is a product of hegemonic US interests, wielded as a tool of statecraft. But global financialization has upended this framework: elite interests are not aggregated domestically but internationally, and are transmitted via the balance-of-payments mechanism and the financial system…Herman Mark Schwartz, one of the foremost experts on the dollar and American hegemony, offers a better way to think about the dollar—namely, as the state money of a quasi-imperial global system, in which the different economic regions are tied together by a shared reserve currency. This ‘imperial currency’ is more of a by-product, and less of an enabler of (or even an enabling constraint on) American expansionism and military adventurism, both of which preceded the reserve currency status of the dollar.

In this version of world order, the status quo is not actually to any nation’s benefit but to a political and economic class whose interests transcend sovereign borders. This leads to a counterintuitive conclusion:

to the extent that the world has prospered since Bretton Woods, it is in spite of, not due to, the USD being the reserve currency.

The full case is laid out in The Class Politics Of The Dollar System (Link)


My Selected Excerpts And Notes

The Soft Power Of Issuing The Reserve Currency

Two clear geopolitical advantages accrue to the US because of its reserve currency status:

  • Sanctions

  • Dollar liquidity swap lines

The source of the Federal Reserve’s power over the eurodollar system—and the vulnerability of emerging markets within it—is the global reliance on central bank backstopping. In the 2008-9 crisis, the Fed deployed so-called central bank liquidity swap lines to backstop the global system. These took the form of reciprocal currency arrangements between central banks: The Fed replenished the dollar reserves of other central banks in exchange for local currency. The real power of the swap lines is not who gets them but rather who doesn’t. In a recent piece for the Nation, Andres Arauz and David Adler highlight how these swap lines can be used for a form of monetary triage, in which the United States decides which countries have better prospects for weathering economic storms.

Questioning the Narrative

Despite the advantages, dollar eminence should not be a goal. The long-run cost outweighs the near-term benefit.

Dollar primacy feeds a growing American trade deficit that shifts the country’s economy toward the accumulation of rents rather than the growth of productivity. This has contributed to a falling labor and capital share of income, and to the ballooning cost of services such as education, medical care, and rental housing. With sicknesses like these, can we say for certain that the reserve currency confers substantial benefits to the country that provides liquidity and benchmark assets denominated in that currency?

How The Plumbing Works

Offshore dollar pools depend on the liquidity of treasuries and near substitutes as collateral to raise cash in the event of a margin call.

The reason for these dollar pools is twofold. First is the need to fund trade. The Eurodollar system facilitates trading relationships between countries with different currencies by giving them access to a common stable currency in which to denominate trade—the dollar. Dollar credit allows the execution of contracts without actual, US-issued currency being exchanged. Instead, the system functions as an exchange of IOUs to deliver receipts at various periods of time.

Because 80% of trade in emerging market economies is denominated in dollars, firms with receipts in a domestic currency acquire unsustainable debt in dollars if the domestic currency falls. For this reason, central banks attempt to stockpile dollar assets, most commonly US debt. To acquire them, they usually run a persistent trade surplus by repressing the real wages of their workers. (I need more clarification on this point)

This might be sustainable in the short run, but in the long run, it leads to periods of economic stagnation, or international trade and currency wars.

The second driver of these offshore dollar pools is wealth inequality and outsized corporate returns. Large corporations, pension funds, and extremely wealthy individuals cannot bank their money in the retail banking system. Instead, they hold them in pools of dollar liquid denominated assets that can be converted into dollars quickly. While this ‘shadow banking’ system has legitimate uses, it also facilitates tax evasion and kleptocratic corruption.

The dollar system thus facilitates and fuels the power of elites who have an interest in maintaining the status quo. A globalized system with a dominant key currency aids the accumulation of rents at the expense of higher consumption from workers in exporter countries and the hoarding of those rents in the legal black hole of offshore finance.

Zooming In: How It Hurts The US

  • Financial “Dutch Disease”

    Talent or ample resources have a downside. Some might even say a curse. It can make you lazy or overly reliant on your intrinsic advantage. Here’s the idea applied to USD dominance.

    Demand for high quality dollar-denominated assets saddles the United States with a financial ‘Dutch Disease’; a situation in which the reliance on exporting a single commodity raises the exchange rate and thus squeezes out the production of tradeable, value-added goods in favor of services and financial rents….Dutch diseased economies often result in a shrinking, narrow elite whose power rests on income from sales of the single commodity, or the services and management that bloom around the cash flows generated by this commodity. For the United States, this single commodity just happens to be the dollar.

  • The evidence

    The most visible cost of the disease is the steady appreciation of the dollar since the 1980s, despite a falling US share of global gross domestic product. The main domestic symptom has been the rising costs of non-tradable goods—such as medicine, real estate rents, and education—over tradable goods. This disconnect is at least in part responsible for the country’s low rate of inflation, falling wage share, and increased economic insecurity despite access to a wider range of consumer goods. While the American consumer can now purchase an ever-expanding set of appliances, electronics, and small luxuries, services that are necessary for economic mobility and household sustainability are increasingly out of reach.

  • MMT as full blown financial Dutch disease

    Justin Czyzsczewski writes:

    In the MMT view, there is no recourse against a government going off the rails. Some developing countries are said to suffer from a “resource curse“, when an abundance of natural resources means the government doesn’t rely on taxes, and so becomes unresponsive to the wants and needs of the populace. In the past, kings with powerful armies ruled in the same way. There is a very real risk of the same phenomenon when government spending becomes untethered from taxation.

Zooming In: How It Hurts Developing Nations

  • The need to hoard dollars crowds out productive domestic investment

    For the rest of the world, the ills are clear enough. In developing countries, the need to insure their economies against currency crises and debt deflation has meant the accumulation of dollars at the expense of necessary domestic investment. These policies are usually accompanied by a suppression of consumption and incomes to establish a permanent trade surplus vis-à-vis the dollar system.

  • Dollar liquidity lowers the cost of corruption

    The dollar system allows corrupt elites to safely transport their ill-gotten earnings to global banking centers located in jurisdictions with opaque ownership laws.

While the dollar system has undoubtedly had a disproportionately negative effect on developing countries, the main fault lines that emerge from the dollar system are along class, rather than national lines.

In other words, a rich Chinese national has more in common with the US elite than their fellow citizens.

Obstacles and Remedy

  • Elites’ preference for status quo

    Developed world exporters like Japan and Germany also maintain a growth model based on cost competitiveness and wage suppression. An increased role for the Euro or the Yen would undercut these models. For resource exporters, it facilitates corruption and tax evasion through simple capital flows. In the United States, it benefits financial industry elites, who can reap the rewards from intermediating capital inflows into US markets, while the cost of non-tradable services like tuition, healthcare and real estate rises for everyone else. Across all countries, elites win.
  • Reducing Inequality

    Too great a share of the national income is in the hands of high-saving entities with dollar liquidity preferences, such as high net worth individuals and large corporations. To reverse this imbalance, income would have to be transferred from these powerful interests to China’s workers—a dynamic described by Albert Hirschman as early as 1958.

The fact that the dollar system is primarily based on social, rather than geopolitical conflict means that the best solutions suggest at a reform of the system in a manner that empowers people at the bottom of the global social hierarchy.

Channeling Greg Giraldo

When I moved to CA in 2012, I thought earthquakes were the greatest natural disaster risk.

The forests of CA: “Hold my beer”

CA is on fire again. People are being displaced in what is now a late-summer tradition. We have been very lucky so far since our only inconvenience is needing to wear a mask inside our smoky house. At least we have a house.

Afternoon activities this week have included staying indoors and watching Floor is Lava on Netflix. This is not a twisted programming choice given the circumstances just the whim of the kids. If you must know, it’s like American Ninja Warrior except nobody is a ninja. Or a warrior. Or coordinated even. But at least we had power. We didn’t experience any of the rolling blackouts this week when it hit 105 degrees. Lucky.

Other activities included calling my insurance company to review my fire coverage. I’ve started to hear stories about friends unable to even find companies to underwrite or renew policies My company, Farmers, does provide insurance. It’s expensive but at least available. Lucky again.

I’m gonna stop now because I feel like I might be channeling too much of the first 90 seconds this bit by the late Greg Giraldo. Just replace “in this economy…” with “during Covid…”. (Link)

A warning: you probably shouldn’t listen past the first 90 seconds.

Giraldo is one of my favorite comics and I got to see him live a few times. He’s vulgar as hell. He lived fast and died young. He also had a JD from Harvard and Wikipedia says he had a near-perfect LSAT. He reminds me of a mix of Carlin and 1980s Denis Leary. I never listened to Kinnison but I wonder if he fit that mold. Check him out at your own risk.