A Crisis of Numbers

Here is a silly problem for which no simple solution exists, as far as I know. My inability to make sense of it makes me question my own judgment so much that I'm less sure than usual that I even exist.

Suppose two envelopes are placed in front of you, and you are truthfully told that one of the envelopes has twice as much money in it as the other one, but you don't know which one is which. One of the envelopes is randomly assigned to you. You look in the envelope and discover that it contains X dollars. You are given the opportunity to trade in this envelope for the other one before you walk off with your money.

Suppose you are given an envelope in this manner every day. On average, do you earn more money by switching or by sticking with the envelope originally assigned to you?

Conventional wisdom says that it is pointless to swap envelopes as long as you have no idea which one contains more money. But then explain what is wrong with the following logical illogic: You know that there is a 50% chance that the other envelope contains 1/2 of X dollars, and there is a 50% chance that the other envelope contains 2X dollars. Therefore, if you swap envelopes, you're "average expected outcome," or "expected value," is equal to 50% of 2X plus 50% of 1/2 of X, for a total of X and 1/4 of X, which is more than X.

This is known on wikipedia as "the two envelope problem."

People = Numbers

As an economist and a mathematician, one of my favorite things to do in life is to obliterate culture in favor of uniformity, replace emotions with equations, substitute markets for morals, and represent people with numbers.

The process of representing people with numbers has come such a long way since the beginning, when everyone was just a person. There was a time when people did the work of God, looked after their everlasting souls, and lived as one with nature. How far we have advanced since that time!

We've got numbers to represent all the physical characteristics of a person: height, weight, BMI, cholesterol, age, strength, top speed on bike and foot, metabolism, and hotness coefficient.

We've got numbers to summarize the usefulness of a person: GPA, SAT score, years in the workforce, salary, wage-per-hour, hours-worked-per-week, and job-performance rating.

And we've got numbers to measure the social and intellectual import a person brings to society: number of friends on facebook, frequency of comments on your wall, portion of your friends that befriended you before you befriended them, the number of numbers in your phone, portion of those number that call you as often as you call them, the number of readers on your blog, how long each reader spends there, and how many kids you have.

"a stainless steel canteen"!

The Freakwenter got mail!

Hi Freakwenter,

Thanks for your blog post on the opportunity cost of philanthropy. You made some excellent points! I was just wondering if you ever considered the merits of doing both- investing money in a profitable and environmentally and socially responsible cause? I'm working with a progressive bank that has recently been endorsed by Van Jones (author of the bestseller The Green Collar Economy) because of their 35 year commitment to environmental responsibility and community development. Because of your blog's focus on the economy, I thought this might be of interest to you.

We would like to send you a complimentary copy of Van Jones' book and a stainless steel canteen. Please let me know if you are interested.

Thanks.

[name withheld]

Dear Green Collar,

Thanks for your interest in promoting your stuff on my blog. I'm impressed that you care enough to write to a blog whose readers probably spend less time reading the content than the author spends writing it. You must be very grass roots!

And thank you for the very generous offer of a free tree-hugger book and a stainless steel canteen! I've always wanted a stainless steel canteen! My plastic one keeps leaching dangerous chemicals into my blood and will lead to my early death. Just kidding. I don't have any use for a stainless steel canteen because I live in cyberspace. Moreover, I don't have a physical address, so it would be difficult for you to deliver it. But if you can figure out a way to email me the book, I just might review it for you.

Yours,
The Freakwenter

A Reason to like the Electoral College

In it's current form the electoral college functions as a winner-take all system. That is, in most states, candidate that gets the most votes gets ALL of the votes of that state. The most recent disaster associated with the electoral college was the election of W, when he beat Mr. Stop Global Warming without winning the popular vote.

Disasters aside, I argue that the electoral college serves an important purpose by encouraging cultural homogeneity. Cultural homogeneity is good because it marks the absence of extreme political polarization and the domestic strive and civil wars associated with heterogeneity.

The electoral college supports cultural homogeneity in two ways. First, it encourages us to talk to our neighbors. Knowing that your state's votes go all-or-nothing toward the candidate that you like helps to reduce campaigns to a local level. Especially if you live in a swing state, it makes more sense to campaign at home instead of going to California to preach to the choir.

Second, the college helps to prevent major divisions between states by encouraging migration from homogeneous pockets into pockets of the opposite orientation. For example, if you care about politics and you live in super-liberal land where your vote doesn't make a difference, you might decide to move to Alaska so that you can help to dilute the bad political sensibilities of that state, and possibly make some conservative friends in the process.

Greenspan's libertarian lousiness: no longer the purest purist

Greenspan recently admitted that he maybe should have imposed a couple of regulations on the financial sector during his time as Fed chairman to help prevent the financial crisis. This admission is a partial abdication of his previously purist libertarian position.

Slate's Jacob Weisberg wrecently wrote that the financial crisis takes the financial crisis to be final and crushing evidence against libertarianism, and calls out libertarians like me for blaming the market failures on excess government involvement, such as Congress pressuring Fannie Mae and Freddie Mac to invest in over a trillion dollars of subprime mortgages. He says that this is not enough to fully explain the market failures, and I accept this as a likely possibility.

And yet I still call myself a libertarian. Not a purist, for sure -- purity in nearly any ideology seems to prioritize principle over practicality. But aside from purism, there is a grain of truth in most ideologies, and I think that the grain of truth in libertarinism is still strong enough to be useful even in the market of the future.

The grain of truth is that every governmental action has economic costs as well as benefits, and that much governance does more harm than good. There is no reason why the current crisis should be taken as a referendum on this simple principle. Some politicians talk as if "deregulation" is to blame. In hindsight it is clear that a different mix of regulation was needed. A failure in our old set of regulations is no excuse for mindlessly slapping on a bunch of new regulations. Each new regulation must be carefully examined so that we can understand its potential unintended consequences. This is the kind of caution that I think libertarians have to offer.

I'm pretty sure that Greenspan understands this now.

Good luck peeling back the layers on this metaphor!

The Freakwenter
Shtatement of Purpose
Application to the Ph.D. program in applied freakonomics

I am a helper in the International Crap-Throwing Section of the Prosperity Assurance Ministry. I regularly collaborate with freakonomists to process Shtinky International Crapital data to monitor the international flows of crapital, and I assist freakonomists with a variety of incomprehensible shtudies. It has been a privilege to serve at the Ministry during a major re-evaluation of market regulation and ministerial policy. I get to be present for discussions on the freakonomic crisis, and I attend talks by leading freakonomists.

My interests are so wide that I don't care what I get to shtudy as long as you pay me to do it. To show you that I don't just sit in my office all of the time and do nothing, I will briefly describe two of the topics that have caught my attention as a result of my participation at the Prosperity Assurance Ministry.

The unsushtainability of the crap account deficiency is an issue that my section shtudies because we handle the data which records inflows of crap into to the U.S. The ability of the U.S. to consume more crap than it produces is largely a result of our ability to import more crap than we export, which in turn depends on our ability to secure crap-on-loan from foreigners. This dependence on crap-loan inflows exposes the U.S. to sudden shifts in the crappy preferences of foreigners, which translates into uncertainty for exchange rates and for long-term interest rates on crap. I would like to investigate the level of pungency associated with our dependence on foreign crap to help clarify whether the U.S. government budget deficits are contributing to a larger shtench.

One of the incomprehensible shtudies that I am working on with freakonomists in my section concerns the International Crapital Ass Pricing Model (ICAPM). The weighted average return on international crap portfolios of the U.S. from 1994 through 2006 exceeds the return of a portfolio based on the ICAPM. This suggests that there should exist an alternative to the ICAPM exist which gets crappier returns in the real world, where markets are not efficient. To that end, we are evaluating an empirically-based mean-variance efficient ass allocation strategy. Preliminary results suggest that the new strategy substantially outcraps the portfolio prescribed by the ICAPM.

I want to obtain a Ph.D. in freakonomics to improve my ability to make money off of the public sector. Your freakonomics program interests me because of its excellent academic reputation, its emphasis on incomprehensible shtudies, and the wide range of professor's interests. Your program is also ideal for me in terms of geographic location. Many of my friends and family are within a reasonable biking distance. Having this social support will contribute to my determination to shtick with the program through the completion of a Ph.D. After graduate school I plan to pursue a career working on incomprehensible shtudies at a government agency such as the Prosperity Assurance Ministry

My personal background is somewhat unique among Americans pursuing a Ph.D. in freakonomics. I grew up in rural shtate as one of thirty children. The only subshtantial source of income for my family was my father's salary as a public high school janitor. We foraged for much of our own food and split wood by hand to heat the house. My family may have been poor by the shtandards of my peers, but much of our decrepit lifeshtyle was a matter of choice. My parents never seriously considered getting a dishwasher, clothes dryer, microwave, cell phone, or TV. While some of their ambivalence toward modern crap may have shtemmed from their Gothic heritage, I think that it would be more accurate to say that my parents simply had an unusual set of preferences. They believed that they were leading the good life.

Coming from a countercultural background gives me a special awareness for the range of ways in which one can measure progress. For my parents, progress had little to do with money in the bank and much more to do with good relationships, good weather, and finding good ways to compost crap. My exposure to these values will always affect my concept of utility, and contributes to my interest in the field of behavioral freakonomics.

My interest in freakonomics grew out of an interest in making more money. In early childhood, I thought about problems relating to freakonomic development. I occasionally made small donations to charity, and I wondered how to tell which organizations would do the most with my money to help the poorer. My questions grew more nuanced as I became aware of how some poor people don't like to work, how some people are poor because they are in jail, and the importance of nongovernance. During college I realized that shtudying freakonomics could improve my undershtanding of the roles of both public policy and private charity in freakonomic development, so I took several freakonomics courses in my senior year.

I temporarily put aside my shtudy of freakonomics to pursue a Ph.D. in math for dummies at the University of the Second Rate, at the urging of one of my worst undergraduate mathematics professors. I completed an M.S. in Approximately Nothing in 2007. Although I had passed the necessary exams to continue on towards a Ph.D., I decided to accept a position at the Prosperity Assurance Ministry as a helper to make a career transition into public-sector freakonomics research. The opportunity at the Prosperity Assurance Ministry to work on several incomprehensible shtudies in freakonomics sparked my interest in pursuing a career in incomprehensible shtudies.

The Bank Bailout

The latest twist in the bailout is Henry Paulson's plan to buy an ownership stake in banks to help banks raise capital. How is it possible that banks need more money, given that banking reserves are exploding?

Evidently, a bank is more than the sum of its deposits. A bank holds the deposits of its customers without owning these deposits. To pay its employees, a bank draws out of its own, separate corporate account. This corporate account is normally filled by interest that the bank earns when it loans out the deposits of its customers. But when the business is bad, the bank doesn't earn much interest, or lots of loans fail and the corporate account runs low. This is when the bank needs to raise money by taking loans from other banks or selling more stock in the bank.

In theory, it might be possible for a bank to take a loan for itself from out of its customer deposits. But auditing rules prevent banks from doing this secretly. What would you do if you found out that your local bank is spending your checking account to pay it's employees? You would quickly go get all your money out of the bank, putting the bank out of business.

Therefore, having a high level of reserves is basically useless for a bank on the brink of failure.

Signs of the End Times

Dear Freakwenter,

It has been reported that U.S. Adjusted Reserves are up 768.1% compounded annually since July 30. Is this a good or a bad thing for me?

Dear Astute Observer,

Banks usually lend out most of their deposits to make money. The reserves are the part of deposits that are not out on loan. The data you found shows that the amount of money in banks that is not out on loan nearly doubled in the last few days for which we have data, in mid-September.

This means that either someone suddenly put about $70 billion in the banks (perhaps by selling stocks), and the banks have not had time to lend it out, or it means that banks aren't making loans anymore, or both.

Is this a good thing for you? I'd say it depends on whether you are the person who put $70 billion in the bank or the person who is trying to get a loan.

-The Freakwenter