That’s not actually wrong, but I think it’s highly misleading.
The failure mode in the long case that corresponds to “stock price suddenly skyrockets” in the short case is that the value of whatever currency you bought the stock with suddenly skyrockets relative to other assets. This (1) is extremely rare, corresponding to a very large negative inflation rate, and (2) is generally something you would be happy about overall because you surely have a lot more dollars (or whatever) than you are spending on the stock.
On the other hand, it’s not nearly so unusual for the price of a stock to increase abruptly, and if you’re shorting it you probably don’t have a lot more of it to be happy about the increasing value of. (If you did, you’d just be selling rather than shorting.)
The failure mode in the long case that corresponds to “stock price suddenly skyrockets” in the short case is that the value of whatever currency you bought the stock with suddenly skyrockets relative to other assets.
Um, does this ever happen? Ever? It looks like an imaginary situation.
Besides, your description implies that you don’t want to measure your wealth in money. What do you want to measure it in?
Don’t privilege any given currency—you don’t buy or sell things, you trade commodities. Sometimes that commodity is a currency, sometimes it’s a stock, sometimes it’s an actual thing.
For the trade that is currency exchange, one currency’s hyperinflation is the other’s hyperdeflation. If you traded away USD for Zw$, your loss (as measured by the amount of Zw$ you could have had later for that USD) was near-infinite.
(note: I honestly believe this, but I am presenting it more forcefully than I believe for socratic and exploration reasons).
Interesting. What other approach makes sense? When you stop treating currency as special, all costs are opportunity costs. The only actual loss you experience from spending now is that you can’t spend it later.
your loss (as measured by the amount of Zw$ you could have had later for that USD) was near-infinite
but if everything is just a tradeable good, why do you choose to measure your loss in Z$? Your loss in McDonald’s hamburgers is zero, your loss in some now-out-of-fashion accessory is actually a gain, etc. etc. If you don’t have money, you have no baseline but just a huge matrix of barter ratios. Whether you have a gain or loss (and its magnitude) solely depends on which pair you pick and there is no pair that’s privileged, is there?
Speaking more generally, not all costs are opportunity costs, some are just actual losses. If you want to think of spending your resources (=money=commodities) in terms of consumption and investment then sure, any consumption incurs opportunity costs because it’s not investment and investment can be seen as risky delayed consumption. But that’s just Econ 101 and it works perfectly well with money as well.
Within the investment world yes, cash is just another asset. But you still need a baseline way to measure things and measuring investment returns in bananas or Swiss watches is kinda inconvenient and an excellent way to screw yourself up. What’s the point?
I see. I think you’re treating your varied anticipated future consumption as your “base currency”, which adds a fair bit of complexity over the simpler two-commodity model. (but it matches common intuitions better, I’ll admit).
I’ve never heard of its doing so. That was approximately half of my point (#1 in the above). If you think I was suggesting it’s a thing anyone should be worrying about, then I respectfully advise you to read what I wrote again. If you merely think I should have been more forceful about how unlikely such an event is, you may be right.
that you don’t want to measure your wealth in money. What do you want to measure it in?
Ability to procure things I value. If my bank account stays exactly as it is and prices of food and books and computers and other things I spend money on halves, then the portion of my wealth embodied in my bank account has effectively doubled. If the prices of those other things double instead, then the portion of my wealth embodied in my bank account has effectively halved.
Of course in practice different things’ prices change in different ways. And in practice the relationship between money and those other things I care about stays pretty stable, which is one reason why Thomas’s analysis is highly misleading. And in practice I care about future prices at least as much as about present prices (but present prices are pretty much our best estimates of future prices, at least for well traded assets). So measuring wealth in money works very well in principle. But Thomas was (in effect) envisaging a weird situation in which the value of money relative to everything else increases abruptly, and although it’s very unlikely ever to happen it seemed worth pointing out some actual likely consequences.
[EDITED to add: This is currently at −1. I honestly have no idea why that might be. Anyone—preferably whoever actually downvoted me—want to explain?]
Um, does this ever happen? Ever? It looks like an imaginary situation.
The closest direct analog is a crash—if I go from being able to buy one share for one dollar to being able to sell my one share for one penny, one can see this as the value of cash going up 100X.
(This is somewhat contrived when dealing with cash, but it does seem that the foundational level of wealth is food and ammunition. It could happen that the exchange rate between those and cash and stocks skyrockets, and that would be Bad News for a lot of reasons.)
Indirect analogs rely on opportunity cost—because you invested in A and got a 2X return, you missed out on investing in B, where you would have gotten a 2000X return. This is a profoundly unhealthy way to view markets.
The closest direct analog is a crash—if I go from being able to buy one share for one dollar to being able to sell my one share for one penny, one can see this as the value of cash going up 100X.
For this to work you need for basically all financial assets to crash, not just some particular stocks. Besides, we still have the problem of the unit of measurement. If you want to measure your wealth in consumables (say, cans of beans) then for “unlimited” losses from long positions you need not only a financial crash, but also cans of beans becoming really really cheap. This is.. unlikely.
All in all, there is a real asymmetry between going long and shorting. Trying to construct imaginary situations in which you could lose a lot from being long isn’t terribly helpful.
because you invested in A and got a 2X return, you missed out on investing in B, where you would have gotten a 2000X return. This is a profoundly unhealthy way to view markets.
I think it is the correct way to view the markets once you add risk management. If the probabilities of getting those returns for A and B were the same (and the distributions were shaped the same), you indeed missed out greatly.
Yeah, basically the only scenario I see is cans of beans becoming very cheap in terms of ammunition for unethical reasons.
I think it is the correct way to view the markets once you add risk management. If the probabilities of getting those returns for A and B were the same (and the distributions were shaped the same), you indeed missed out greatly.
Agreed—I’m making the assumption that such comparisons are made retrospectively instead of prospectively, and thus are implicitly ignoring risk.
the only scenario I see is cans of beans becoming very cheap in terms of ammunition for unethical reasons.
Unethical even in the Zombie Apocalypse scenario? X-)
But sure, if the entire financial system {im|ex}plodes, your shorts aren’t going to do you any good and so we finally achieve symmetry—everyone is fucked.
I’m making the assumption that such comparisons are made retrospectively instead of prospectively
It is still the right way even retrospectively if you think in probability distributions. And, of course, anything “ignoring risk” is automatically the wrong way to think about the markets :-)
That’s not actually wrong, but I think it’s highly misleading.
The failure mode in the long case that corresponds to “stock price suddenly skyrockets” in the short case is that the value of whatever currency you bought the stock with suddenly skyrockets relative to other assets. This (1) is extremely rare, corresponding to a very large negative inflation rate, and (2) is generally something you would be happy about overall because you surely have a lot more dollars (or whatever) than you are spending on the stock.
On the other hand, it’s not nearly so unusual for the price of a stock to increase abruptly, and if you’re shorting it you probably don’t have a lot more of it to be happy about the increasing value of. (If you did, you’d just be selling rather than shorting.)
Um, does this ever happen? Ever? It looks like an imaginary situation.
Besides, your description implies that you don’t want to measure your wealth in money. What do you want to measure it in?
Value of USD (and many other currencies) against Zimbabwe Dollar skyrocketed pretty spectacularly in July 2008. I have a Z$10^12 note at home.
This is a rare, but absolutely possible, outcome.
I don’t see how it fits the case.
If your domestic currency is USD, you bought an asset (foreign currency) and that asset dropped in price to near zero.
If your domestic currency is Zimbabwe dollar ZB, then you had to *short the USD to suffer huge losses.
As gjm notes, you need a huge negative inflation rate (aka deflation) and I don’t think that ever happened, at least during the fiat money era.
Don’t privilege any given currency—you don’t buy or sell things, you trade commodities. Sometimes that commodity is a currency, sometimes it’s a stock, sometimes it’s an actual thing.
For the trade that is currency exchange, one currency’s hyperinflation is the other’s hyperdeflation. If you traded away USD for Zw$, your loss (as measured by the amount of Zw$ you could have had later for that USD) was near-infinite.
You are now talking, basically, opportunity costs. I don’t think your approach makes sense.
(note: I honestly believe this, but I am presenting it more forcefully than I believe for socratic and exploration reasons).
Interesting. What other approach makes sense? When you stop treating currency as special, all costs are opportunity costs. The only actual loss you experience from spending now is that you can’t spend it later.
Well, to start with the Z$ example, you say
but if everything is just a tradeable good, why do you choose to measure your loss in Z$? Your loss in McDonald’s hamburgers is zero, your loss in some now-out-of-fashion accessory is actually a gain, etc. etc. If you don’t have money, you have no baseline but just a huge matrix of barter ratios. Whether you have a gain or loss (and its magnitude) solely depends on which pair you pick and there is no pair that’s privileged, is there?
Speaking more generally, not all costs are opportunity costs, some are just actual losses. If you want to think of spending your resources (=money=commodities) in terms of consumption and investment then sure, any consumption incurs opportunity costs because it’s not investment and investment can be seen as risky delayed consumption. But that’s just Econ 101 and it works perfectly well with money as well.
Within the investment world yes, cash is just another asset. But you still need a baseline way to measure things and measuring investment returns in bananas or Swiss watches is kinda inconvenient and an excellent way to screw yourself up. What’s the point?
I see. I think you’re treating your varied anticipated future consumption as your “base currency”, which adds a fair bit of complexity over the simpler two-commodity model. (but it matches common intuitions better, I’ll admit).
I’ve never heard of its doing so. That was approximately half of my point (#1 in the above). If you think I was suggesting it’s a thing anyone should be worrying about, then I respectfully advise you to read what I wrote again. If you merely think I should have been more forceful about how unlikely such an event is, you may be right.
Ability to procure things I value. If my bank account stays exactly as it is and prices of food and books and computers and other things I spend money on halves, then the portion of my wealth embodied in my bank account has effectively doubled. If the prices of those other things double instead, then the portion of my wealth embodied in my bank account has effectively halved.
Of course in practice different things’ prices change in different ways. And in practice the relationship between money and those other things I care about stays pretty stable, which is one reason why Thomas’s analysis is highly misleading. And in practice I care about future prices at least as much as about present prices (but present prices are pretty much our best estimates of future prices, at least for well traded assets). So measuring wealth in money works very well in principle. But Thomas was (in effect) envisaging a weird situation in which the value of money relative to everything else increases abruptly, and although it’s very unlikely ever to happen it seemed worth pointing out some actual likely consequences.
[EDITED to add: This is currently at −1. I honestly have no idea why that might be. Anyone—preferably whoever actually downvoted me—want to explain?]
The closest direct analog is a crash—if I go from being able to buy one share for one dollar to being able to sell my one share for one penny, one can see this as the value of cash going up 100X.
(This is somewhat contrived when dealing with cash, but it does seem that the foundational level of wealth is food and ammunition. It could happen that the exchange rate between those and cash and stocks skyrockets, and that would be Bad News for a lot of reasons.)
Indirect analogs rely on opportunity cost—because you invested in A and got a 2X return, you missed out on investing in B, where you would have gotten a 2000X return. This is a profoundly unhealthy way to view markets.
For this to work you need for basically all financial assets to crash, not just some particular stocks. Besides, we still have the problem of the unit of measurement. If you want to measure your wealth in consumables (say, cans of beans) then for “unlimited” losses from long positions you need not only a financial crash, but also cans of beans becoming really really cheap. This is.. unlikely.
All in all, there is a real asymmetry between going long and shorting. Trying to construct imaginary situations in which you could lose a lot from being long isn’t terribly helpful.
I think it is the correct way to view the markets once you add risk management. If the probabilities of getting those returns for A and B were the same (and the distributions were shaped the same), you indeed missed out greatly.
Yeah, basically the only scenario I see is cans of beans becoming very cheap in terms of ammunition for unethical reasons.
Agreed—I’m making the assumption that such comparisons are made retrospectively instead of prospectively, and thus are implicitly ignoring risk.
Unethical even in the Zombie Apocalypse scenario? X-)
But sure, if the entire financial system {im|ex}plodes, your shorts aren’t going to do you any good and so we finally achieve symmetry—everyone is fucked.
It is still the right way even retrospectively if you think in probability distributions. And, of course, anything “ignoring risk” is automatically the wrong way to think about the markets :-)