Re: Edward Prescott, Idiot
From: Igor (jjweatherby_at_houston.rr.com)
Date: 10/31/04
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Date: Sun, 31 Oct 2004 01:43:44 GMT
royls@telus.net wrote:
> On Sat, 30 Oct 2004 07:32:29 GMT, Igor <jjweatherby@houston.rr.com>
> wrote:
>
>
>>royls@telus.net wrote:
>>
>>
>>>On Fri, 29 Oct 2004 01:49:18 GMT, Igor <jjweatherby@houston.rr.com>
>>>wrote:
>>>
>>>
>>>>In the first section
>>>>the equations you do not understand and think are stupid ARE NOT USED.
>>>
>>>Then why did you say they were?
>>
>>I did not say there were used in the first cut of estimation. There are
>>two approaches to estimation used and reported. Again this is explained
>>IN THE PAPER. You have to read past the abstract. The equations are used
>>in the second estimation. Presscot uses data similar to Fisher for the
>>first section. I may be wrong but I think he uses values generated from
>>stock market data in the first section. I do not remember how exactly he
>>did it but he followed Fisher's method.
>>
>>The second section takes into intangibles. The equations are way to find
>>out how much the intangibles are worth.
>
>
> No, they aren't. They are a way to find out the value the intangibles
> were expected to have in 1929, at the time they were bought.
>
running in circles again. I have explained this at least twice now I
will not explain it again. It is simple profit = return on tangible
capital plus return on intangibles. If you know profit and you know the
return on real capital then return on intangibles is profit - return on
tangible capital. It is a simple statement. What you argue is if the
psychical capital was MEASURED correctly. So far you have presented
absolutely no tractable alternative to measuring capital. I am not going
to run around in circles with you.
>>So if you subtract capital returns from profits what is left is returns
>
>>from intangibles. In that section, the model is used as a way to
>
>>estimate the value of the unobserved intangible capital assets.
>
>
> Which don't remotely follow P = MC.
>
Of course it does. Returns are equal to the interest rate * K. You use
the interest rate because in competitive markets returns on assets will
be equal therefore no one has incentive to switch assets unless
conditions change.
Now how do you measure capital at market value? The Price of one unit is
EQUAL TO ITS MARGINAL COST if the market is competitive. So the market
value is a measure of the cost of the good. You deflate these prices to
remove pure inflationary increases. Yes there are problems with
deflators and sometimes they take out quality increases instead of pure
inflation. After you do that you add us the values to get the value of
the stock. The problem is some of the stock has devalued due to wear and
tear. So you deprecate the capital at a fixed rate to take care of this.
In other words Change in K = Investment(deflated) - (deprecation
rate)K(t-1) . That is how you build a stock using the perpetual
inventory method. This is what Presscot shows in equation 3.
The stock is resource cost - minus deprecation because the price goods
were bought for reflect the marginal cost of the good.
>
>>>>What facts are those that the stock market crashed due to excessive
>>>>margin calls not bad news about profits?
>>>
>>>It crashed because the profits weren't going to be there to support
>>>the prices, because the money the corporations had spent on their
>>>capital (resource cost) was not all spent wisely, given changing
>>>market conditions. Margin calls were just the trigger, not the cause.
>>
>>Wrong. There was no reason to believe that.
>
>
> Wrong. The Fed had already slammed on the brakes.
>
I do not think that was until after the market crash. I think a few days
after. I would have to look up a time line to make sure but I do not
think the Fed. actions were before the crash.
>>At the moment of the crash stocks were
>>undervalued.
>
>
> Nope. They were _about_ to become _over_valued. That is very much
> the point. Stock value is based on _future_expectations_of_profit_,
> not past expenditures on asset acquisition.
>
Exactly. WHAT IS THE DEFINITION OF UNDERVALUED. The definition says that
expectations of future profits ARE BELOW CURRENT PROFITS. A low P/E
ratio means that stocks are undervalued because certain expectations
said this corporation was expected to make less than it is making now.
To say a stock is undervalued DOES NOT MEAN THAT THE PRICE WILL RISE. It
says people's expectations about future profits are less than current
profits. This can be a good sign for buying a stock but not always.
Somethings expectations about future profits are correct and investing
in an "undervalued" stock will cause you to lose money because future
profits really do fall. Some times they are wrong and you gain money as
the market adjusts it is expectations and send prices up. To Say a stock
is undervalued is not to say that PRICE WILL RISE. It is no guarantee of
a good buy. It says current expectations are that the corporation will
make less money than it is making now. It could because investors are
correct. It could also be because investors were surprised and the
corporation MADE MUCH MORE THAN EXPECTED.
To say stocks were undervalued in this case makes a strong case for
rational expectations. It says that people set expectations and they set
them correctly. The crash was an immediate adjustment of expectations.
If you want to say it was because of Fed policy then you have proved the
point was true. People adjusted expectations quickly causing low P/E
ratios. Undervalued IS NOT a 100% prediction of stocks rising. It says
that if people are wrong there is a potential to make money once
expectations adjust upward. An overvalued stock does not mean that price
will rise. It says that it has a low potential to make money because
people are already pricing the stock at expectations of higher profits.
So if profits rise meeting that expectation there is little gain to be
made. It is much riskier to invest because if expectations are wrong you
lose big time. You bought a stock at high and when profits are shown low
expectations will cause prices to drop.
Undervalued means a POTENTIAL to make big money. It means expectations
say low profits. While current profits are high profits. If you invest
and expectations are WRONG they you make a lot of money because price
will rise if expectations were wrong. If expectations were right you
don't lose much because you bought the stock at sometime close to the
future price.
The misunderstanding is what undervalued means. Undervalued means
expectations say that profits will be lower in the future. It DOES NOT
say that prices will rise. A stock is not necessiarly overvalued if the
price drops in three months. It is overvalued if PEOPLE EXPECTED PROFITS
to be much higher than they actually were.
>
>>Where they undervalued 2 days later maybe not. Where they
>>undervalued a year later? Most likely not. The captial stocks may have
>>dropped or by the formulation intangibles may have dropped.
>
>
> Stocks are value on expected returns, not returns hoped for when
> assets were acquired.
>
That is the price. Under and Over valued are determined by comparing
STOCK PRICES TO CURRENT PROFITS. It says does the market expect this
firm to have lower or higher profits.
>
>>You arguing that because you know from hindsight a recession was coming
>>that at THAT moment stocks were undervalued. This is in correct. They
>>were not Over valued until later.
>
>
> Wrong. They were overvalued the moment Fed policy became more
> restrictive.
>
No because PROFITS WERE STILL HIGH and PEOPLE EXPECTED PROFITS TO BE
LOWER LATER. That means it was UNDERVALUED. The P/E ratio was low.
Prescott calculates these P/E ratios. I do not remember what exactly
they were.
>
>>>>>>The statement surprised me but the
>>>>>>data supported it when Fisher did his analysis and Prescott's analysis
>>>>>>supported the statement as well.
>>>>>
>>>>>Except that history proved them both laughably wrong.
>>>>
>>>>How?
>>>
>>>By seeing stock prices collapse.
>>
>>Stock prices can collaspe while the market is undervalued. Look at 1986.
>>Undervalued does not mean that the market will immediately jump or that
>>they are permenantly undervalued. The standard terms means a lower P/E
>>ratio. Prices are low compared to profits (earnings).
>
>
> But stock prices are not based only on current earnings, but mainly on
> expected earnings.
>
Yes but UNDER AND OVER VALUED JUDGMENTS ARE BASED ON EXPECTED EARNINGS
COMPARED TO ACTUAL CURRENT EARNINGS. If the economy is headed for
recession and people know it then stocks will be undervalued. You will
have a low price while profits are still high. This is EXACTLY THE
SITUATION AT THE TIME OF THE 1929 CRASH.
>
>>At the time of the
>>crash data shows prices were still low related to the value of the firm.
>
>
> Data shows no such thing. It shows only that investments had been
> made in expectation of returns that the Fed was then in the process of
> evaporating.
>
Current profits were still high. Prices had already begun to drop or the
market had not expected the profits to be as high at that point. The
data show this.
>>They are not a
>>produced good. Expected profits of the firm drives prices.
>
>
> The prices of its assets are likewise driven by what the market thinks
> they will return, not by what they cost to acquire.
>
Exactly and when expectations of future profits lead to lower prices and
at that moment firms are making high profits what do you call that?
UNDERVALUED STOCKS.
>
>>P=MC does not make sense for
>>stocks because there are no marginal cost. They are an investment that
>>expect to gain returns.
>
>
> Like corporate assets. Right. So contrary to Prescott, _neither_ of
> them can be valued based on cost.
>
Corporate assets are produced and bought on the market. A machine has a
market value that reflects cost. A building has a market value that
reflects cost of production, and so on.
>
>>Capital goods are produced products so if the market is competitive
>>supply represents MC.
>
>
> Only to acquire them new.
Right WHICH IS WHY DEPRECIATION IS TAKEN OUT OF THE VALUE>
>And not all the "capital" Prescott makes up
> values for is capital goods. Land is not a product, and thus cannot
> be valued by marginal cost.
>
Land is not capital Roy. I hate to break it to you but is considered an
entire different resource. Resources are land, labor, capital, raw
materials, and energy. LAND IS NOT CAPITAL.
>
>>Demand represents value to the buyer. P wil equal MC.
>
>
> No, it won't, especially for intangibles.
>
That is why intangibles are a residual. We can not observe them. They
often have 0 MC but have a price above zero. This is why you have to
subtract the returns on tangible capital from Profits to estimate the
amount of return on intangibles. YOU CAN NOT OBSERVE THEM THAT IS WHY
THEY ARE INTANGIBLES. No cost measure is used to construct intangibles
THEY ARE A RESIDUAL.
>
>>>>Profits were high at that period of time.
>>>
>>>
>>>They weren't going to stay high.
>>
>>This does not mean at that one point in time that stocks were
>>undervalued. Even after the crash profits were high for some period.
>
>
> Irrelevant. So were Enron's.
>
It is releveant because UNDERVALUED MEANS EXPECTED PROFITS ARE BELOW
ACTUAL PROFITS. So at that moment the stock is undervalue. As I
explained that does not preclude future expectations are wrong and the
PROFITS COULD DROP causing the stock to be overvalued at a later time.
>
>>>>On the day the market crashed conditions were good. Labor
>>>>disputes had been settled. It was subsequent events that caused the
>>>>economy to tank.
>>>
>>>Nope. Money supply growth was already being reversed.
>>
>>Yes but it had not taken effect yet.
>
>
> ROTFL!! What do you think caused the crash??
>
Expectations of future profits could have caused this. You even admitted
this that is expectations of FUTURE PROFITS that drive prices not
CURRENT PROFITS. Over or under value refers to if profits are higher or
lower then people expect them to be.
A good portion of the crash had nothing to do with though. It was the
fact that people borrowed way too much to buy stocks. As EXPECTED
profits began to decrease they could not meet the margin calls. The
market open with tons of stocks needing to be dumped to meet margin. At
that point expectations did not matter. Supply was increasing not
because expectations of future profits were dropping but because people
had to liquidate to meet margins. As the sellers flooded in prices
dropped causing more stocks to be sold to meet the margin. It started a
deadly spiral.
>
>>A reversal in policy does not fully
>>take effect over night.
>
>
> Stock speculators are not as stupid as you and Prescott.
>
Exactly that is why expected profits were dropping causing the stock
prices to be UNDERVALUED. I do not think they are stupid nor does
Presscot. The misconception is that you do not understand what
UNDERVALUED means.
>
>>It takes time for the policy to "move through"
>>the system and have full effect.
>
>
> And meanwhile, everyone just pretends they don't see it coming?
> ROTFL!!
>
No as expectations drop stock prices drop but PROFITS ARE STILL HIGH
BECAUSE THE POLICY HAS NOT EFFECTED REAL VARIABLES YET. Therefore Stocks
are undervalued. Prices are very low while profits are very high. As I
said before this is NO guarantee stock prices will rise or the market is
wrong. When you invest in an undervalued stock you are betting the
market's expectations are off.
>
>>Freidman estimated at least 9 months
>>before monetary policy affects aggregate variables. In the 1920's it
>>actually took a little longer.
>
>
> It very obviously didn't take longer to hit the stock market.
>
No because those are expectations but CURRENT profits would not be
affected for some time. That sets the stock in an undervalued state.
AGAIN RTFM. This is explained. The P/E ratios are calculated. I am not
sure Presscot gives the definition of undervalued but the definition I
give is what he is referring to.
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