Keynes on GameStop

I could not resist another Keynes quote in light of recent events

The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment today is ‘to beat the gun’, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow…


…professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitors has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgement, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.

The FOMC meets and, among other things, we discover Jerome Powell has been vaccinated

The FOMC met for the first time in 2021 yesterday. The committee has maintained its accommodating policy stance as the economic recovery slows in the US.

Chair Powell hanging on for dear life like the rest of us

As at the last meeting, the Fed expects to keep this in place for some time:

With regard to interest rates, we continue to expect it will be appropriate to maintain the current 0 to ¼ percent target range for the federal funds rate until labor market conditions have reached levels consistent with the Committee’s assessment of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.

The Q&A session with Chair Powell had a few interesting nuggets:

  • He addressed the ‘burst of inflation’ hypothesis (discussed by me here), arguing that any inflation this year is likely to transient and minor“we think its very unlikely that anything we see now results in troubling inflation.” And, even if it did appear, “we’re going to be patient. Expect us to wait and see, and not react.”
  • With the ongoing Gamestop frenzy (expect a write up soon…), there were lots of questions about markets, macro-prudential regulation, and ultra low-interest rates. He reminded everyone that with 9%-10% unemployment, the Fed will continue to prioritise jobs over hedge fund tears.
  • One of the striking parts of the Fed’s language in recent years has been the recurring emphasis on employment, jobs, and minorities. Inflation increasingly feels like a side-show. This conference was no different, Chair Powell discussed joblessness in almost emotive terms.

We’re not just going to look at the headline numbers. We’re going to look at different demographic groups, including women, minorities, and others. We’re not going to say we’ve reached full employment, which is our statutory goal, until we have reached maximum employment. Which you haven’t if there are lots of pockets of people not participating or not employed in the labour market.

We want an economy where everyone can take part, can put their labour in, and share in the prosperity of our great economy.

I’m much more worried about falling short of a complete recovery and losing people’s careers and lives that they’ve built because they don’t get back to work in time. I’m more concerned about that, not just to their lives, but to the US economy. I’m more concerned about that than about the possibility – which exists – of higher inflation. Frankly we’d welcome slightly higher, somewhat higher, inflation. The kind of inflation that people like me grew up with seems far away, unlikely, in the domestic and international context we’ve been in for some time.

This shift in emphasis was partly forced on the Fed. Persistently low inflation despite falling unemployment shone a spotlight on the full employment side of the Fed’s mandate. Its similar elsewhere; as central banks took on on ever larger roles in economic management following the GFC, they needed to maintain legitimacy with a public concerned about joblessness and inequality, not inflation.

From my own analysis of language in all central banking speeches between 01/2007-01/2020

This language creates precedent which could constrain, or influence future Fed decisions, or at the very least, how they are presented and framed. This could have long-term consequences. It is said that the experience of inflation in the 1970s/80s shaped the minds of a generation of economists and policy makers. The Fed’s new attitude and language may have a similar effect on its institutional culture. Might there be a dovish, employment bias, for years to come?

GameStop, Can’t stop, Won’t stop

There are a few GameStop stories: a story about hedge funds fleeing before a subreddit on a warpath; a story about how commission-free trading on apps like Robinhood is transforming retail investing; a story about a guy who turned $50,000 into $13.9 million (and counting) and then dunked a chicken tender in champagne.

If you’ve got no idea what I am talking about – read this (and get out [on Twitter] more).

A stock that was trading at $4 last August is now trading at ~$350. The company sells video games in malls.

No matter how this story is told, it involves a cacophony of jargon: puts, shorts, longs, calls, squeezes, brokers, and margin calls. If you are like me, you have followed the story with a tab open to Investopedia, double, then triple checking what a ‘bear put spread‘ is.

One of the fun things about this blog is I get to spend hours learning complicated things that pique my interest, and then explain it to people. What follows is a simplified overview of the financial dynamics behind this vertiginous price rise.

The scene

Our players:

  • The shorts. People who believe the price of an asset will fall in the future (Hedge funds)
  • The longs. People who believe the price of an asset will rise in the future (Reddit)
  • The brokers in between them. People who make money off them being wrong

Now, it is one thing to believe in the future price of a stock, it is another to put your money where your mouth is. How do our shorts and longs actually make money?

  • Buy or sell the stock now.
  • Buy the right to buy or sell the stock later. This is called options trading, and we are going to come back to it

Stock trading is easy for a long. You buy the stock, check your portfolio every time you go to the toilet, pray, chicken out at the first sign of trouble, sell, then get called a cuck on Wall St Bets when the stock triples a day later – more on them in a minute.

Things are more difficult for a short, how do you sell what you don’t have? Enter the first part of our story – short selling.

When short sellers get caught out

How does short-selling work?

  • You borrow a share of Apple worth $10 from your broker. They charge you a fee and ask for some collateral (collateral could be money or another asset)
  • You immediately sell it to someone else for $10
  • The price goes to $5
  • You buy Apple again at $5, return it to your broker, and walk away with $5 in profit minus the broker’s fee

This is the best case scenario for a short, but a lot can go wrong, as we are about to see:

  • You borrow Apple worth $10 from your broker. They charge you a fee and ask for some collateral.
  • You immediately sell it to someone else for $10
  • The price goes to $20
  • Your broker calls you: “hey, that collateral was based on an asset worth $10, its now worth $20. I want some more collateral” (This is called a margin call)
  • You tell yourself this is temporary, and that the price is about to fall
  • Elon Musk tweets that he loves apples
  • The price goes to $40
  • Your broker calls you – less friendly – “It’s me again, I want some more collateral” (Remember, collateral = money or another asset)
  • Apple goes to $60
  • You broker has graduated to angry voice mails. You’ve disconnected your phone (for some reason you still have a land line)
  • You decide to exit the short. You buy Apple for $60 and return it to your broker. You’ve lost $50, the fee, and any interest on the collateral.

When a short exits, they need to buy Apple, sending the price still higher, and putting pressure on those who remain. This feedback dynamic means concentrated short-sellers are vulnerable to a sudden surge in price. like if, for example, an internet forum organised thousands of retail investors to buy in unison.

Change Apple to Gamestop and your Twitter feed should make sense to you now.

Smaller investors face down hedge funds, as GameStop soars | CTV News

Hedge funds borrowed GameStop shares (lots of them), and sold them, planning to buy the shares back after a fall in price. Instead, Wall St Bets – a Reddit investing forum – organised retail investors into sending the share price soaring. The hedge funds have had to pay margin calls to their increasingly concerned brokers, or exit with a loss – further driving up the price. Attacking an exposed short position with concentrated buying is not a new strategy, it even has a name, a short squeeze. What is new is to see it organised by retail investors with such relish.

The initial case on Wall St Bets was driven partly by the belief that GameStop was undervalued, partly by squeeze exposed short-sellers – GameStop was one the most shorted stocks in the world. It has now taken on a delirious, intoxicating, and quite likely insane momentum of its own.

When brokers hedge

There is another technical dynamic driving this price increase, and it involves our stressed broker and options trading.

Options let you purchase the right to buy or sell a stock for a specific price (called a strike price) by a certain future date. Think of an option like a bet, or an insurance policy – depending which way you think the price will go.

Take the example of Gamestop shares at $40.

  • If I buy a call option on a Gamestop share with a strike price of $50, I am purchasing the right to buy a Gamestop share at $50 by a certain date. This could be very profitable if Gamestop shares rose to $100 before then. I could exercise my option, buy a share for $50, then turn around and sell it for $100 in the market. It’s a bet on the price going up. If it goes the other way, I never exercise my option, and simply lose the price of the option.

The important thing to remember is who is on the other side of the trade. For every Redditor buying a $50 call option because they think Gamestop is going to $100, there is a broker selling it to them, in effect committing to the possibility of selling a $100 share for $50 in the future.

Imagine our stressed broker. She’s recording another angry voice message to her hedge fund manager, but her phone is ringing off the hook (lots of people in this story have landlines). People want call options. She gets concerned: if she sold calls at $50, and the price goes to $1000, she is on the hook for a lot of money. To hedge the risk, the broker decides to buy some Gamestop; better to buy it now than at $1000.

And the price goes up.

The price began rising because a motley crew of investors, organised through Reddit. hatched a bold plan. It has kept rising thanks to feedback dynamics from a short squeeze, broker hedging, and hysterical levels of hype. As I write this the New York Stock Exchange opens in 50 minutes. Who knows what happens then.

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I highly recommend reading the articles linked in the first paragraph, or subscribing to Matt Levin’s Money Stuff if you enjoy finance more generally.

Porque no los dos? Dual interest rates and monetary policy

When we talk about monetary policy, we tend to think of the interest rate, singular and all-powerful. I used to imagine a giant lever in the basement of the Reserve Bank of Australia that the Governor would adjust while the rest of the Bank watched in silence.

Colors Live - Homer pulling a lever by jenthegelfling
Philip Lowe about to lower interest rates

Like many things we tend to think, this is not quite right.

Eric Lonergan and Megan Greene have been advocating for dual interest rates for a few years now. This overview in VoxEU was illuminating. Put simply, by offering one rate for lending, and another for deposits, central banks can engage in near limitless stimulus.

What are dual interest rates?

All banks have accounts at their respective central banks, where they keep reserves. Like your and I’s deposit accounts, banks in many countries are now paid interest on the balances in these accounts. By lowering or raising that rate of interest, the central bank can indirectly shift other interest rates (like what you pay your bank for a mortgage). The lower the rate, the cheaper the lending, the more stimulus – simple.

The world today needs lots of stimulus, but with interest rates already at zero, central banks are struggling to keep stimulus going. The limbo bar cannot go below the floor. Once banks are paying money to hold reserves (thats what negative interest rates do – you pay to save), it makes them less profitable and less likely to lend, choking off growth. It also pisses the hell out of savers. The opposite of what you want in a recession.

Quantitative Easing – my favorite two letter acronym – was one way around this problem. Dual interest rates is another.

Basically, the central bank keeps the deposit rate steady, but introduces a new, lower rate: the lending rate or, the rate it lends banks money. Banks have always been able to borrow from their central bank in an emergency, but usually for short periods of time, and at a penalty. Dual interest rates inverts this. In this hypothetical world, banks could be paid 0.1% interest on any reserves they hold, but could borrow new reserves from the central bank at -1%, effectively being paid to take a loan (presumably the term-length is adjusted depending on the stimulus required). Central banks can then keep savers and banks happy with positive deposit rates, while also offering money at negative rates to keep stimulus going.

Liquidity: Definition, Ratios, How It's Managed

Where I say “printing press” thrice in four paragraphs

The sharp-eyed observer will see what is happening here: subsided loans, powered by central bank money creation, mediated through the financial system.* The central banks are making losses on these loans, but that doesn’t matter since they can print money.

The policy is sort of in place already. The EU’s TLTRO program (I’ve spoken about it before) lends money long-term to banks at special interest rates below the deposit rate, on the condition they lend to non-financial corporations and households (except loans for home purchases).

The proposal is valuable for acknowledging the power society possesses in the printing press, while offering a sensible proposal for using it wisely.

What’s missing for me is a discussion about coordinating this program with the government. Arguably it should not be left solely to the technocrats to decide how the state’s printing press is used to provide cheap loans for banks to distribute. Similar to the ECB’s TLTRO program, dual-interest rate lending should come with special conditions, which could be determined alongside the Treasury or equivalent.

More broadly, where dual interest rate policy is used to provide long-term loans, it begins to intersect with tricky questions of climate change, and industrial policy. Should environmental conditions be attached to TLTRO-esque programs? Should dual-interest rate policy be mobilized to support strategic state initiatives like decarbonisation?

I suspect the authors omit this out of a concern for politicizing the initiative. They are confident that dual-interest rates, as an extension of interest rate policy, could be “the least unsettling politically.” I am less convinced, especially in today’s environment where central banks are under a much greater spotlight (and scrutiny). With a powerful new tool in our hands, we should consider all its possibilities.

In sum, lots of interesting food for thought. Please do read the full thing.

*They are only likely to be subsidized during a recession when there is a demand deficit. The reverse can happen during a boom.

Keynes on what makes ideas attractive

Keynes on why classical economics exerted the influence it did, from Chapter III of the General Theory:

That it reached conclusions quite different from what the ordinary uninstructed person would expect, added, i suppose, to its intellectual prestige. That its teaching, translated into practice, was austere and often unpalatable, lent it virtue. That it was adapted to carry a vast and consistent logical superstructure, gave it beauty. That it could explain must social injustice and apparent cruelty as an inevitable incident in the scheme of progress, and the attempt to change such things as likely on the whole to do more harm than good, commended it to authority. That it afforded a measure of justification to the free activities of the individual capitalist, attracted to it the support of the dominant social force behind authority.

Keynes combined a recognition that the success or failure of an idea could not be divorced from questions of power, with an optimism that good ideas, in the end, win out. I do not share the full measure of his optimism.