Recorded January 4th, 2021
You can also watch a video of the conversation here.
Read the full transcript
TYLER COWEN: Hello, everyone. Welcome back to Conversations with Tyler. Today, I’m here with John Cochrane. I refer to John as a voice of sanity, but to the world as a whole, he’s known as a senior fellow at the Hoover Institution, and he also blogs at Grumpy Economist. John, good morning.
JOHN COCHRANE: Good morning. How are you, Tyler?
COWEN: These are the questions I want to ask you. First, why aren’t real interest rates equalized across countries? That’s always bothered me.
COCHRANE: You started right in easy. I don’t know. [laughs]
COWEN: Brazil has very high real interest rates for decades, right? Arbitrage doesn’t seem to work.
COCHRANE: Well, that’s not an arbitrage. An arbitrage is the opportunity to make a sure profit, no risk. You got to invest in Brazil, and you got to take the risks of investing in Brazil, which include, usually, currency risk. The real interest rate is the interest that you get after the expected appreciation or depreciation of the currency. Then there’s the legal risk that they might expropriate your stuff.
It looks like there’s a profitable opportunity to invest in Brazil. Put that way, now it starts to look like everything else in finance. There’s what looks like a profitable opportunity. There’s risk. Are people properly balancing the profitable opportunity and the risks? Why is Tesla stock so high? Why are value stocks so low? There’re opportunities that you and I, as an economist, can’t quite suss out what the risks are, keeping other people from investing in. But if you’d like to buy a Brazilian gold mine, I can arrange it for you, Tyler.
COWEN: Well, but look, we know currencies are very close to a random walk, correct? You’ve seen the countries that have higher real rates of return, higher discount rates. They should have higher expected returns on their market. Brazil is small relative to the world as a whole. There’s a lot of capital that could invest more in Brazil without being systemically much riskier. You would think that simply pursuing higher expected returns — that ought to go away, and real interest rates across the world should equalize, but they don’t seem to.
COCHRANE: Well, all sorts of apparent opportunities should equalize. I urge you to start a hedge fund. [laughs]
Let’s talk about what’s documented here. There’s the puzzle of uncovered interest parity — you do seem to be able to make more money investing in countries that have high interest rates now. As you’ve mentioned, a high interest rate should go along with an expected depreciation of the currency, and that pattern doesn’t seem to be very strong. On the other hand, when it goes wrong, it goes wrong big time and all at the same time.
Our friends who have started hedge funds that do this sort of stuff make money for a little while, and then they lose it all. There hasn’t been a gold mine in people trying to exploit this thing. It’s one more hedge fund strategy that you’re welcome to invest in, like all the other hedge fund strategies.
There’s a larger question — why is China exporting capital and not importing capital cross-border flows? It’s one of those things that sort of bedevils us free marketers. We look at something that ought to happen more of.
For years people said, “Why isn’t there more cross-border investment?” Then there started being huge cross-border investment that has to go on container ships. Money doesn’t just flow. Investment means you put stuff on container ships and send it around the world. Now, all of a sudden, “No, there’re too many trade flows and too much hot money, and we can’t have all this cross-border investment.” [laughs]
There is more and more cross-border investment happening, now to the extent that many of our colleagues call it a puzzle and a savings glut, sudden stops, and so forth. I don’t think judging the right price or the right market is what free-market libertarians ought to be doing. That’s why I’m a little uncomfortable with your question.
COWEN: Say you take the major forecasters, who are not at all stupid, right? It seems their real interest rate forecasts have been very wrong now, actually, literally for decades. What theoretical mistake are they making, in your opinion?
COCHRANE: Let’s talk about this. There’re nominal interest rate forecasts, where people, for example, for the last entire 10 years, everyone said, “Well, we’re going to exit quickly.” And we didn’t. I don’t think there’s forecasts at the real rate, but there’s this long trend since 1980 of real rates going down.
Again, we’re playing the game that Hayek told us not to play, of sitting around a coffee table and say what forces are moving prices around. There’s all sorts of speculation about it. We can have fun. I can give you the five theories. I don’t believe in any of them. There are fundamentals here. We have moved to a much lower growth economy.
Let me back up. Everyone jumps to the savings gluts in the Federal Reserve and the this and the that. There’re fundamentals that say low interest rates make sense. The first one is, we are moving to a lower-growth economy, to stagnation. You and I are technical optimists. We think this is temporary and will reverse.
But the fact is, productivity growth has been slowing down. We’re now a low-growth economy. Well, a low-growth economy has lower real interest rates. That’s just the first principle of macroeconomics — a low-growth economy has less opportunities for investment. Therefore, lower interest rates, lower returns on capital.
COWEN: It’s weird that that’s the first principle of macro, and all these smart people get it wrong, right? What’s their defect?
COCHRANE: Well, I have a hard time figuring out what I think is right, let alone why other people get things wrong. And looking into people’s heads is another bad intellectual habit.
There’re basic principles that say low interest makes sense. Low growth, and for the moment, low inflation. I’m not quite sure why we have low inflation, but low and anchored inflation means there’s much less inflation risk.
Furthermore, especially for the dollar, bonds are very good. They’re very safe investments because every time there’s a recession, bonds go up. So there’s every reason to hold bonds, in particular, for those lower than stocks. On top of that, you can put on your frictions and your demographics and so forth. I think it sort of makes sense, but also, I don’t like armchair theorizing about things like this.
COWEN: Well, we’re in armchairs.
COCHRANE: Yes, well, that’s our job.
COWEN: Why is there so much active funds management? We all know, for risk rebalancing, it makes sense. For liquidity, it makes sense, but it seems there’s much more trading than can be accounted for, for those motives. Doesn’t this mean markets are, in some sense, highly inefficient, if everyone’s paying all those fees?
COCHRANE: You ask two questions here. One is active management, and the other is trading. I’d like to distinguish them. It’s a puzzle in the Chicago free market sense.
Let me ask your question even more pointedly. If you believe in efficient markets, and you believe in competition, and things work out right, we’ve scientifically proven since the 1960s, that high-fee active managers don’t earn any more than a proverbial monkey throwing darts in a well-managed slow index. So why do people keep paying for high-fee active management?
Chicago free market — we’re not supposed to say, “Oh, people are dumb for 40 years — 50 years now,” [laughs] but there’s a lot of it. It’s one of those things. Active management is slowly falling away. The move towards passive index investment is getting stronger and stronger.
There’s a strong new literature, which I’ll point to. My colleague here, Jonathan Berk, has written some good articles on it. This is the puzzle of efficient markets. If everybody indexed, markets couldn’t be efficient because no one’s out there getting the information that makes markets efficient. Markets have to be a little inefficient, and somebody has to do the trading.
Your second question is about trading. Why is there this immense volume of trading? When was the last time you bought or sold a stock? You don’t do it every 20 milliseconds, do you? [laughs]
I’ll highlight this. If I get my list of the 10 great unsolved puzzles that I hope our grandchildren will have figured out, why does getting the information into asset prices require that the stock be turned over a hundred times? That’s clearly what’s going on. There’s this vast amount of trading, which is based on information or opinion and so forth. I hate to discount it at all just as human folly, but that’s clearly what’s going on, but we don’t have a good model.
COWEN: By the way, the only stock I ever sold was Brazil Fund.
COCHRANE: You sold it, and you’re telling me what a great opportunity Brazil is.
On financial models
COWEN: There are habit formation theories of equity returns, right? As you well know. The notion that the return on equity is so much higher than the return on bonds because if you suffered losses on equity, it would disrupt your habits. In a way, there’s a form of risk aversion that doesn’t exactly translate into the inverse of the discount rate. You know all that. Now, having observed almost a year of pandemic behavior, do you now find habit formation theories more or less convincing?
COCHRANE: Let me clarify. The essence of the habit — and this is a paper that John Campbell and I wrote in the 1990s — what we were trying to get at was not so much the level of the equity premium — why do stocks seem to pay reliably more than bonds, so much for so long? It doesn’t do a great job of that. What it does a great job of is capturing what the essence of recessions is, and that’s a time when people get scared. It’s a variation in risk aversion.
When you think about what happens in a recession, what happened last March, what happened in 2008, what happens in every recession — it’s not so much that people want to consume less today and consume more of tomorrow’s savings. It’s people get scared. They don’t want to hold risky assets. They want to hold safe assets. They act as if their risk aversion has gotten higher, and that’s what habits capture.
As consumption goes down relative to what you’re used to, people get more risk-averse, unwilling to take risks on stocks going forward. So the stock market goes down much more than the economy goes down because recessions are mild, and that’s really puzzling.
People keep saying, “Oh, this is the worst economy.” No, the economy — we’re back down to the level of 2017. Why do these temporary fluctuations make asset prices go so crazy? I think there’s something deep in that, and when stocks went down in March, I think people were scared as heck.
Whether the mechanism is habits or whether the mechanism is something involving leverage and risk-bearing capacity in financial markets is less important. That was the deep point of the paper, which, of course, I’m going to keep saying I think is right. I’m prejudiced in favor of it.
People do, but I think it’s a deep feature. I think there’s something deep to it that when you are forced . . . Even a middle-income person in America is vastly better off than the average person in India. Yet, if you take somebody who’s earning $200,000 a year and make them earn $50,000 a year, this feels like a disaster to them.
As opposed to, you take an average person in a village in India, and they get to earn $50,000 a year — they feel wonderful. The fact that people’s feelings about their consumption level and their actions, which is what counts in economics — their wanting to avoid a disaster depends on their experience of their recent past. I still like that idea.
COWEN: Here’s a question from a reader. To paraphrase, “Finance was really exciting in the ’70s and ’80s. There was CAPM, Black–Scholes, prospect theory, et cetera, but what big exciting things have happened since? Where should we be looking for the next great innovation in finance?”
COCHRANE: I love this. You and I are now old enough to remember that every age thinks of the previous age as the great golden era. I have a story. Bob Lucas told the story that in the late ’60s and ’70s, when he and his buddies were developing rational expectations and getting all the stuff that got the Nobel prizes at Chicago, they felt awful because all the hot attention was going to MIT and Harvard and what people were doing there.
They felt like they were out in the wilderness, and they were, of course, looking back at — this was in the ’80s — they were looking back. “That is a great golden age.” And now the ’80s, “Oh, it’s so boring here now.” Of course, now we look back at the ’80s as a great golden age. There’s always this golden age of the past.
What’s going on now in finance, I find fascinating. I’m the kid of a historian, so I have always a broad aspect. I think of what our children will understand that we don’t understand yet and all the puzzles out there to be learned about them. It fills me both with excitement and dread that I don’t have enough hours in the day to work on them.
I mentioned one. Why is there so much trading? Here’s a fundamental question we don’t know about asset markets. What happened in the last 10 years has been, I think, really deep. The field of finance turned from what I was doing — macro-finance versus the behavioralists who want to put psychological imperfections at the heart of everything. That faded, and an immense amount of effort went into the plumbing of finance. They call it institutional finance.
The plumbing failed in 2008, so we learned a tremendous amount about the plumbing and about liquidity and about all the ways in which asset markets don’t look like the simple models, as you mentioned. What’s wrong with interest rates in Brazil? Well, rather than look to habits of everybody or to psychological imperfections of everybody, what people are looking to now is, who’s active in currency markets, and how our banks are active, and how do their balance sheets look?
And the facts are just astounding. It does look like when there’s a lot of demand, prices go up. That shouldn’t be in financial markets. People putting in a bunch of orders shouldn’t drive the prices up. There’re these facts about trading and volume and the prices and flows. The institutional finance — that’s the exciting thing that just happened, and now we have a great new data point in front of us. Any scientific field feels chaotic in the moment, but I still think it’s an exciting place to be.
On the fiscal theory of price level and inflation
COWEN: This is the hardcore podcast, so we’re going to plunge right into the fiscal theory of price level and inflation. In your forthcoming manuscript, you summarized it as follows in one sentence: “The fiscal theory says that the price level adjusts so that the real value of a nominal debt is equal to the present value of primary surpluses.” Is that still true? If on average, g is greater than r, namely, the growth rate of the economy is higher than real interest rates, the government has to pay on its debt?
COCHRANE: Yes. [laughs]
COWEN: Easy questions.
COCHRANE: I wish I could say the manuscript’s forthcoming. It’s turning into the key to all mythologies, but there is a draft. This is a big book project I’m working on. I put the drafts up on my website as it goes along. I just wrote a “g greater than r” section last week. I knew this was coming.
Let me just back up. The fiscal theory — for those of you who haven’t heard of it — this is an attempt at the basic plumbing of where inflation comes from. It’s not about the Fed printing up too much money. It’s not about the magic of controlling interest rates. But fundamentally, money gains its value because the government can soak it up by charging taxes at the end of the day. That seems perfectly obvious, but it actually changes a lot about how all of the monetary theory we do works.
Among other things — I’m just backing up here for a second for our listeners — it says that the distinction between money and government bonds isn’t that important. What matters is overall government debt and the government’s ability to pay that debt back. And inflation comes when people lose faith in the government’s ability to pay back its debt. They try to get rid of the debt because they know it’s not going to get paid back. What do you do with it? You buy stuff, and that drives up the price of goods and services. That’s your quick background.
What is the fiscal theory at the price level? Now, r less than g stuff — it’s a broader issue than fiscal theory. It’s the question of debt sustainability, and it’s a big deal right now. Does our government have to pay back debt or can it borrow? Here’s the strategy: borrow money and never pay it back. In other words, just roll over the debt. Let it grow at the interest rate.
For you and me, that doesn’t work because the repo man comes calling. But for the government, if the economy grows faster than this rate of interest, then the ratio of debt to GDP will come back all on its own without the government having to do a lot to pay back that debt.
So this is the shining promise. If that’s true, and if it scales — this is the crucial thing — if you can borrow more, and the interest rates don’t go up, then government debt is a money machine. Nobody needs to work anymore. No one needs to pay taxes anymore. You can tell that’s not the case. [laughs] The question’s why is that not the case? When you look at the strategy, that’s not about . . . I’m going to route that back to answering your question.
Today’s fiscal question has really nothing to do with the r greater or less than g, even though it’s been a technical issue that makes economists just love writing papers about it because you get to do all sorts of limits and transfer salary conditions and interesting models about it. The reason is, what’s in prospect for the US is not borrowing once and then running no surplus or deficit for 40 years while we slowly grow out of the debt. What’s in prospect for the US is borrowing forever and ever.
If the interest rate is 1 percent less than the growth rate, that gives you 1 percent of GDP for free, but the US is borrowing 5 percent of GDP forever. That doesn’t compute even if r is less than g. If r is less than g — finally in answer to your question — big fiscal borrowing must be repaid by taxes. Anything over 1 percent of GDP has to be repaid by taxes. If it isn’t going to be repaid by taxes, people are still going to try to get rid of that government debt and they’ll cause inflation.
COWEN: Now, during the pandemic, government debt is way up. Production is not up. What’s the prediction of the fiscal theory about price inflation?
COCHRANE: Economists should never make predictions.
COWEN: But theories make predictions.
COCHRANE: Theories make conditional predictions. Theories make if x happens and you hold everything else constant, then y ought to happen. Economics is awfully bad at making unconditional predictions. “Here’s what’s going to happen.” Period. I think it’s a mistake to get into that game, but let me tell you what fiscal theory says.
I’ve been worried about inflation for 10 years, and critics say, “Look, it still hasn’t happened. So, dot, dot, dot, what a dummy you were.” Fiscal theory is not particularly special here. It just opens the possibility that if you have too much debt, and you can’t pay it back, and bond markets get tired of you, that there will be sharp inflation to get rid of that debt rather than a default. That’s all the fiscal theory offers, which is, in some sense, pretty obvious. Well, it could happen.
Having built up a lot of debt, are we in danger of some sort of run — sovereign financial crisis? I think the answer is yes. Ken Rogoff is out there. He’s even more of a hawk than I am on these issues most of the time. Now, it’s a danger. Greek debt was great — 2005, 2006 — low interest rates. Why hasn’t Greek debt exploded? I don’t know. Well, until all of a sudden, it didn’t. The mechanism’s like a run. It’s like an earthquake. We’re in danger of a roll-over crisis.
Bond markets look at $25 trillion of US debt and then in the next crisis, we want to borrow another $10 trillion. They say, “Sorry, guys, we’re done.” And now, everything that looked sustainable is all of a sudden not sustainable, and the r’s that were less than g are suddenly a lot bigger than g. You’re sitting on a powder keg, and a powder keg, a run, a crisis — if you could predict it happening, it would already have happened. It’s one of those unstable situations. Fiscal theory —
COWEN: But interest rate futures are inefficient in this explanation, right?
COCHRANE: Not inefficient, no, because —
COWEN: Go long on volatility of interest rates.
COCHRANE: [laughs] It’s inherently unpredictable. Efficient or inefficient, now we’re down to arguing about information versus risk premiums, which I don’t want to argue about. Even in an efficient market, there’s such a thing as a bank run. Everything looks fine until all of a sudden, the bank run, the black swan. That’s the mechanism of the inflation. It can look fine. Interest rates never forecast inflation. We can get religious about efficient markets or not.
In the 1970s, interest rates were not high ahead of inflation. In the 1980s, interest rates were not low ahead of disinflation. Interest rates are kind of a random walk, just like exchange rates. This is a deep fact of empirical finance. Asset prices don’t seem to move on information about fundamentals — if you want to call them that — like cash flows; they move on discount rate news. Another way of saying there’s money to be made by buying when prices are low and selling when prices are high if you can wait a long time.
We’re sitting on a powder keg. We’re sitting on the possibility of a run, a crisis, which would be a sharp unforecast inflation, which the Fed gets to . . . So yes, it’s about risk. It’s not about the forecast. That’s a good way of putting it.
On the value of crypto
COWEN: Originally, I thought the value of crypto assets would fall to zero due to an arbitrage condition. I now think I’m wrong. What’s your theory of the value of crypto?
COCHRANE: I think you’re still right.
COWEN: So that market is also inefficient.
COCHRANE: No, it’s not inefficient.
COWEN: We need a way to short Bitcoin in your view. That’s probably hard to do right now, but if we had one —
COCHRANE: Well, you short bitcoin . . . Here’s why I think Bitcoin eventually will die — because it is a pure fiat-unbacked money. It doesn’t have a government that can raise taxes to soak up the extra money if needed. It’s not a promise of anything real. It’s just a thing that’s in limited supply because in order to short it, you have to use up a lot of computer power, but you can create substitutes.
It’s classic. I’m very interested to watch the crypto community re-learn centuries of monetary economics. It’s classic MV = PY fiat money. It has value because it has a liquidity use. It’s useful for anonymous transactions, to put it politely, and it’s in limited supply because it takes money to make it.
But there’s nothing that stops you from making substitutes, and nothing that stops you from making derivative claims on Bitcoin that trade just like Bitcoin. So, if there’s nothing that stops you from making substitutes or derivative claims, eventually that value has to go to zero. That can take a long time.
So this is it. I’ve written about this too. A market can be very slightly inefficient in rate of return and very highly inefficient in terms of prices. Shorting Bitcoin wouldn’t work because it can go up for a long time before it goes back down again. If it costs you even a 10th of a percent per year to short the Bitcoin, and if you don’t have the money to stand the mark-to-market losses on the way, that price can be very far out of line. So, 1 percent inefficiency in rate of return can be a factor of two or three in efficiency in terms of prices, and I think we see that all over the place.
COWEN: Well, let me tell you why I’m maybe not yet converted to the fiscal theory and see if you could change my mind. It’s the same issue with crypto assets as with dollars and T-bills. They’re pretty close substitutes, but they’re not perfect substitutes. If they’re perfect substitutes, we’re in the world of finance. All the curves are perfectly horizontal. Arbitrage determines everything, and there’s one blade of the scissors.
But if they’re even somewhat imperfect substitutes, and I think they are — Ether and Bitcoin, dollars and T-bills — then you’re in the Donald Patinkin world with a downward sloping demand curve based on something — it could be liquidity, could be risks, could be whatever — there’s a downward sloping demand curve, upward-sloping supply curve.
It’s the world of Milton Friedman, Irving Fisher, something like the old-fashioned quantity theory. The fiscal theory is a special case of that when only one blade of the scissors cuts, but then in a lot of settings, I think both blades of the scissors matter. Now, what am I getting wrong there?
COCHRANE: The fiscal theory does not require that money in treasuries are perfect substitutes. It allows that, which is the lovely fact, given the greater and greater substitutability of all financial assets.
But you can add liquidity demands for all sorts of stuff very easily in the fiscal theory. Liquid treasuries traded — and this is on the run, off the spread, that liquid treasuries have slightly different interest rates than unliquid treasuries. Money can trade at a different interest rate than treasuries. No problem whatsoever to have a variety of assets that have a variety of liquid discounts in the fiscal theory.
The question is, do these liquidity spreads — do they determine the price level? The dog and the tail don’t have to be in exactly the same place. The question is, if you hold the tail, does the dog wag? And the central problem with the view you mentioned — the classic monetary problem — there are these spreads, but the government does not control the quantity of money. Doesn’t even pretend to control the quantity of money anymore.
You need a liquidity demand for some special asset money, and you need the government to control its supply if you want that to determine the price level. Instead, the price level is determined by fiscal theory, and then the quantities of money versus other assets are determined by people’s desire for various liquidity things.
All the liquidity ends up doing is, it ends up driving slight interest rate spreads. If the government doesn’t give you enough money, then you have a little bit higher interest rates spread on one asset versus another, but that’s not the key for determining the price level when the government doesn’t control the supply of money.
On reforming health insurance
COWEN: Healthcare — I’m a big fan of your proposals for what I think you called time-consistent health insurance. You buy health insurance and you buy insurance against your premium going up. If later on, you develop a serious condition, you’re insured against the fact that your insurance costs more, right? Now, why has no one done this? Because it does make sense.
COCHRANE: People did it [laughs] until it was made illegal.
COWEN: Who did it? When? Where?
COCHRANE: God, it was in the 1990s. Which insurance company? A better word for it that Mike Cannon at Cato came up with is health-status insurance, that you can insure yourself against the risk of getting sick in the future. One insurance company started offering the right to buy health insurance in the future if you’re sick now, which essentially, that’s the beginning of the idea.
Also, the good old-fashioned health insurance, starting in the 1990s, was guaranteed renewable, meaning if you bought the health insurance now, you had the right to continue buying that health insurance without your premiums going up if you got sick. That’s essentially the same thing as health-status insurance. So private insurance was working its way in this direction.
COWEN: But why did it take so long? It wasn’t dominant back then, right? This is another example of market inefficiency?
COCHRANE: Come on.
Technical innovation takes a remarkably long time to spread, and this is a technical innovation. One thing is, it takes time for institutional — especially an incredibly regulated industry where you have 50 state regulators who have to bless every single contract — it takes a long time. Then it was made illegal under Obamacare, which is why it wasn’t happening. United Airlines still hasn’t figured out that Southwest knows how to get people on planes faster. [laughs] That service stuff takes time.
Why wasn’t this in health insurance to start with? When health insurance first started up, there wasn’t this thing of a pre-existing condition, of something that we get news that’s going to make you really expensive. You either died or you didn’t die, and that was the end of that. A very expensive health that is very persistent, and where you need insurance against ongoing future expenses — that can’t be done in a one-year contract. That’s also something that we didn’t have until the 1960s or ’70s.
Institutions take a while to adapt. You got to take a longer-run view here, Tyler. But I do want to advertise it for listeners who haven’t heard about it. We’re still in the pre-existing conditions as the original sin of markets, whereby the government must completely screw up your and my healthcare. That is not true. Free markets can handle the question of pre-existing conditions, your need for long-term insurance.
Term life insurance has had it forever. If you buy term life insurance when you’re young and healthy, you get to keep that insurance, no matter how sick you get as time goes on. There’s no failure of insurance markets that means we can’t have it.
COWEN: How much do you worry about superior genetic information making it hard for insurance to actually serve insurance purposes? It would be fairly priced if you could buy it, but you’re just paying the value of your treatment plus a small fixed cost.
COCHRANE: You’ve spent too much time teaching Econ 101 where we’re worth 5 percent. We figure out that markets can handle 95 percent, and then you’re going to focus on the last 5 percent and tell me, “No, the government’s got to run everything.” Like any insurance, health-status insurance — you have to buy it before information is revealed that you’re sick. That’s fairly reasonable.
Now, one answer to that is — let’s do this at the family level — I can buy health-status insurance before I conceive a child, for that child, and then if there’s a genetic problem that’s knowable, then the kid is covered. The other answer is, I will have a perfectly reasonable . . . Unless you’re at two o’clock in the morning, drinking stuff with libertarians, it is allowable for the government to step in when there’s a very clear market failure.
I would be fine with — when we start this up, and you, Tyler, have some known genetic quantity that means you’re going to be more expensive, the government gives you a lump sum. “Here’s 50 grand, and we’ll put that in your health-status insurance account, and that will fund your higher insurance payments for the rest of your life. See you later.”
There’s a clear argument for lump-sum transfers to the ex post insurance, mediated by the government. If that’s all the government did, and then left the rest of the healthcare and insurance industry free to cutthroat, free market, innovative competition, drive out the incumbents, serve you and me better, I’d be fine with it.
COWEN: Here’s a quotation from you online, which I didn’t follow. I’d like for you to explain. I think you’re talking about second- or third-best here. You wrote, “It has made me a tentative supporter of Medicare for any.” What did you mean?
COCHRANE: I mean, the biggest original sin I see now in our healthcare system is cross-subsidies. The government wants to provide for poor people and other people. It doesn’t want to make them pay — or old people — they don’t want to pay, but the government doesn’t want to raise taxes and provide their healthcare.
So, what the government does is, it tells hospitals, for example, “You must treat everybody who walks in the emergency room.” The hospital says, “That’s nice, where do we get money from?” Then the government says, “You can overcharge private employer-provided insurance, which will force employers to give, and you can overcharge the few cash-paying customers who come in.”
The problem with that is you can’t allow competition. If you’re overcharging people, then you can’t allow hospital B to come in and say, “We’re going to offer less price, and we won’t even have an emergency room.” So you’ve killed competition. That I think is the original sin, the deepest problem in our healthcare system.
They just recently said hospitals have to disclose prices. Heavens, disclose prices! Well, that’s a sign this is a horribly uncompetitive business. An airline that tried to not disclose prices until you get off the plane would be bankrupt because no one would go there. There’s competition in the airlines.
How do we solve this problem? Just forcing hospitals to post prices — they have to cross-subsidize the Medicare or Medicaid that doesn’t pay anything like what it costs from something else because the government’s not paying. You and me don’t need health insurance. We have enough money. We need maybe something catastrophic if we get something that costs $10 million, which is, you have to get some really rare form of cancer for that. You and me could afford to pay for this like we pay for our vet bills.
Why can’t we be in the total free market? Well, because there’s this cross-subsidy rig going on. Here’s the deal. I said “tentatively.” Let the government just forthrightly raise taxes, pay for health insurance for poor people, indigent people. We could do a lot better job for the schizophrenics on the streets and for whoever the government wants to pay their healthcare. Do that on budget. Allocate it, so we can all see what the government’s paying for. Then you and me can be freed to the mercies of an unbridled competitive free market.
If somebody wants to come in and offer us care cheaper and set up a new hospital, they don’t need a certificate of need. They don’t need all the other stuff. They can come in and offer us whatever we’re willing to pay for. We would get far better care, far cheaper, much more medical innovation than we do now. You and me could be free to the wonders of a free market if we would pay taxes to support whatever the government wants to support. Then we can look at the budgets and see what that is.
We’re at the worst of all systems right now. This system of cross-subsidies is just atrociously wasteful and inefficient. It does provide reasonably good care, but at just hugely more expense than it should. That’s a second best.
On flying gliders
COWEN: In the year 2004, you were national gliding champion. Tell us what you achieved.
COCHRANE: I fly gliders, which are beautiful-looking airplanes without engines. The way they work . . . I was only a champion in one class, which wasn’t the very high-profile class, I have to admit.
COWEN: You competed in the world championship in Hungary, correct?
COCHRANE: Yes, I did. I didn’t do that great, but I had a wonderful time in Hungary. This is a serious sport. What you do is, it’s about speed, and you try to find these rising currents of air called thermals, and you glide to the next one. Our typical races around here in California will be 200 to 300 miles or more. I did one at 90 miles an hour last year. I’ve done them over 100 miles an hour. This is average over 300 miles of flying without an engine at attitudes up to 18,000 feet around here. Not so high on the East Coast.
You’re racing these guys. It’s like a sailboat race in three dimensions at 100 miles an hour, flying out over the deserts in Nevada. It’s just absolutely wonderful. The game is speed. Can you go to airport A, airport B — and your GPS shows you where you’ve been — and come back, and do it two minutes faster than the other guy?
COWEN: How good or bad is the government’s regulation of gliding?
COCHRANE: [laughs] An uneasy truce. Pretty bad, but just enough to let it survive. The government regulates —
COWEN: What’s the main inefficiency?
COCHRANE: The FAA.
COWEN: What should they do that they don’t? What should they allow?
COCHRANE: They have killed the domestic industry that makes gliders. There’re only a couple left in Europe. Certification of aircraft under the FAA is a disaster. This is more visible in general aviation power. Go down to your local airport, and you will see what looks like a Cuban car lot full of designs from the 1950s.
It’s just incredibly difficult to certify a general aviation airplane. Their standards for pilots’ licenses are ridiculously too high. America is one of the best places in the world. When you go around the world, you will notice — if you’re a pilot — how empty the skies are because everywhere else has regulated general aviation completely to death.
COWEN: The private rules associated with gliding — are they Coasian and wealth maximizing? Or are they all screwed up?
COCHRANE: [laughs] I served for a while on the rules committee that sets the rules for gliding competitions, which was a wonderful experience as far as me understanding political economy and just what’s wrong with Congress. I had all sorts of wonderful ideas on the scale of health-status insurance and my proposal to reform the issuance of treasury bonds that went exactly as far in the rules committee as my proposals have gone in Washington. It’s interesting. Eventually, reason prevails.
Many of the psychological biases you see in many sports are there — the denial. I was a safety advocate, so I had some rules in mind that wouldn’t hurt the competition, but would do a lot to increase the safety of this thing. All the same things that . . . Bicycle racers said, “Oh, we can’t have helmets. We won’t be able to see.” Glider pilots have the same response to any rules that make things a little bit safer. It was a great education.
COWEN: There’s finance economist John Cochrane, policy economist and blogger and reformer John Cochrane, and glider and gliding reformer John Cochrane. How do they all fit together? How many dimensions are needed to explain the whole John Cochrane here?
COCHRANE: Well, I think it’s all totally consistent, part of one piece.
COWEN: What’s the consistent theme that one sees in the gliding as well as the thinking about gliding?
COCHRANE: We’re all bad at reflecting what our own mental strengths and weaknesses are. I try to reduce things down to a very few fundamental principles and a logical structure. When I was in college, I was a physics major. I was great at physics, and I nearly flunked chemistry because physics . . . My peak intellectually was electricity magnetism, where there’re three equations, and everything follows from that.
My book on asset pricing — we start with one equation, and it has three sides, and everything follows from that. Similarly, I did some work in gliding, trying to apply optimal portfolio theory to the theory of optimal gliding. I’ve tried to put things together in a logical structure. Fiscal Theory of the Price Level — the damn book’s up to 600 pages, and I’m trying to think about all of monetary policy in the structure of one simple present value equation. That’s my habit of mind.
I really admire people with different habits of mind. My historian friends who can keep unbelievable numbers of facts and their citations in their head at one time — I just can’t do that. Mathematician friends who are great at seeing logical structure of things without the vision — I admire that. But that’s my one uniting theme.
On what Cochrane learned from family
COWEN: Now, I knew your father’s work before I ever had heard of you, in particular, his book on historians and historiography of the Italian Renaissance. That’s Eric Cochrane, for those of you who don’t know. What is it intellectually that you learned from your father?
COCHRANE: Oh my God, so much. This tells you something about —
COWEN: It’s a great book, by the way.
COCHRANE: Everybody else who’s ever heard of my father, heard of Florence in the Forgotten Centuries, which is the one I’ll recommend online. If you’ve read the historiography book, it says . . . I don’t know how you do it — you’ve read everything that there is, which is a big thing. He was a major influence in my life. One, the historical perspective — I think that a lot.
The writing in Forgotten Centuries was wonderful. My best-read paper of any is “Writing Tips for PhD Students,” which passes along a lot of Eric Cochrane’s writing tips for his history graduate students. He’s an unusual man. He took us to Florence, where I spent a lot of time as a kid, and forced us into the local culture. He was also very connected to the community of the Southside of Chicago, sent me to public schools there, which was another culture, so I certainly learned to navigate other cultures.
We had a fantastic dinner table where I cut my teeth on many things intellectually. I don’t agree with everything he did. He was a converted Catholic who was also a historian and read the minutes of the Council of Trent in the original Latin. That was a challenge [laughs] for a 16-year-old atheist, but there’s a lot of that left in me.
COWEN: Now, I also knew your mother’s work before I knew your work, in particular, her translations of Paolo Rossi, especially Rossi on Vico. What is it intellectually that you learned from your mother? I didn’t know any of this about you until preparing for this podcast I might add.
COCHRANE: I’m just amazed at the range. Yes, my mother — she taught French at the Lab Schools while I was growing up — a remarkable woman. After my father died, sadly, just as I got back to the University of Chicago, she took on this career of translating and translated many, many books for the University of Chicago Press. I would occasionally read what she translated — academic books from French and Italian into English. Have you ever tried to read academic history French? Oh, my God. She managed to make sense of that stuff as well.
Yes, she was the other part of that dinner table where I both learned a lot and I learned to think. Then they listened to kids. Even when they had academic friends around, they listened to kids. I was expected to show up and play my part. Except for the one time when I was 12 years old, and we had a bunch of historians over, and I piped up and said to my dad, “Dad, what’s the Council of Trent anyway?” He said, “Oh my God.” I could see the look on his face, “Oh, I haven’t told my kid anything.”
But on the other hand, my wife, Beth Fama, did the same thing at age 12. Looked up at that dinner table full of finance people and said, “Dad, what’s arbitrage?”
COWEN: Now, your wife is also a well-known author. She has a well-received book about mermaids, right? It’s fiction. It’s called Monstrous Beauty. How has having a wife who writes fiction influenced you intellectually?
COCHRANE: Yes, she’s really smart. She’s not only a fiction writer. She has a PhD in economics from the University of Chicago and a smart person in all sorts of ways. We don’t really do economics at the dinner table together, but we certainly learn a lot about politics and current events.
I don’t delve too deep in her fiction, but it’s a very intellectual pursuit for her, and she’s really committed to writing great young adult literature, not just stuff that sells. Yes, Monstrous Beauty is wonderful. Plus One is her book after that, which I recommend. It’s a secretly libertarian young-adult romance set in a world that comes after a pandemic. Ought to have lots of good book sales now.
COWEN: You think Tuscan cuisine is underrated or overrated?
COCHRANE: Tuscan cuisine is wonderful [laughs].
COWEN: What’s your favorite in Tuscan cuisine?
COCHRANE: Oh my God, where do you start? The simple. There’s nothing like a ribollita on a cold winter day. Tuscan cuisine is supposed to be simple, not fancy.
On culture changes
COWEN: Conquest’s Second Law, sometimes called O’Sullivan’s Law — it says that organizations not explicitly set up as right wing tend to evolve to become left wing. Why is this true? Organizationally, what happens?
COCHRANE: That certainly is a trenchant observation of the current time. I pause to think whether that’s true of all places and times. We live in a time when this cultural elite is moving sharply left in a sort of religious revival, a great awokening. The Ford Foundation now is sharply left — hilarious when you consider who Henry Ford was. That’s a great example.
All of our universities. Noncompetitive institutions are moving sharply left. The institutions of civil society are moving sharply left, but that’s not always the case. There was a Reagan-Thatcher counterrevolution in the 1970s. There’s the natural tendency — people in a comfortable society start feeling guilty and telling other people what to do and how the government should spend other people’s money.
COWEN: Why are economists right now moving so much to the left? What’s the most structural explanation for the mistake they’re making, the highest-order account of what’s going on?
COCHRANE: Well, economists have always been left, right? The American economists —
COWEN: But they’re much more left than 20 years ago.
COCHRANE: Yes, and passing that on. I think the single greatest . . . No, you’re right. Well, economists — the question is, why has the left current within economics become more powerful? It always was — not left–right — a free market versus interventionist debate. That is the debate of all time. Free market versus interventionist.
Left ideology gives you a moral basis on which to go out and try to run things. Lots of people go into economics because they want to save the world. Then you take some classes that say the best way to save the world is to stay the heck out of the way, and that’s discouraging if you’re a young millennial who wants to go and save the world, so we go find —
COWEN: But that’s a levels explanation, right? Not a change explanation.
COCHRANE: I don’t know. You got to give me three. I’ll choose a, b, or c.
COWEN: Well, some of it could be the demographic composition of who becomes an economist has changed, I believe. There’re many more foreigners. I’m not sure of the net effect there. It could also mean you just have more political spectra floating around, but I think non-Americans, on average, are more interventionist than Americans.
At least in terms of the flow of younger people, I believe there are more women. Women, on average, are further to the left than are men, especially educated women who are probably not yet married. I’m not sure those are the reasons. That’s what pops into my mind.
COCHRANE: Okay, good. Now we can have a debate. I don’t think that’s true. Many of the foreigners I know come from socialist-y or much more interventionist countries, saying, “Oh my God, I love this free place.” Talk to an Argentinian about government. I know a lot of libertarian foreigners. Economics is a classic case of the wonders of free immigration because — listeners may not know — many economics departments — there’s few native-born Americans left. We have scooped up the talent from around the world, and they bring with them some political inclinations.
So you’re right. Some of them tend to be more lefty. Some of them tend to look at where they come from. The people pushing back against Princeton’s latest woke outbursts are Eastern Europeans who say, “Hey, guys, socialism — we were there. You don’t want it.”
Foreigners, I do think, are driving the other unfortunate feature of contemporary economics — its increasing careerism. People don’t go to a university . . . When I first got my job and the dean started telling me about the retirement program, I was just glazing over. “What are you talking about? I’m not going to be here then.” Now, people seem to regard their progression in a company the way the labor markets work in Italy. That’s an unfortunate feature of ours.
There’s not that many in economics. What’s driving the woke-y leftyism in economics is the millennials, the American-born millennials who’ve been through our school systems and our colleges, which teach this kind of stuff.
If there’s anything different about the demographic composition, it’s that people like me can’t be in economics anymore. People like Gene Fama can’t be in economics anymore. Gene Fama — he did his internship when he was an undergrad; he worked in the steel mills. I applied to be an economics graduate student on a lark one month before classes start.
You can’t do that anymore. You have to be deeply ingrained in the system, starting as an undergraduate. Maybe there’s a self-perpetuation in that sense that wasn’t there in the much more freewheeling earlier era.
COWEN: How would you reform the economics profession to make it better along these dimensions? You’re in charge. You pick the reforms as if you would run the whole gliding committee. What would you do?
COCHRANE: Well, that’s a hard question for a libertarian because — [laughs]
COWEN: No, it is voluntary. Voluntary rules, but you set them. People can secede if they don’t like it. You can make a tenure clock. Ten years everywhere. You could make it two years. You could abolish tenure. A lot of different things you could do.
COCHRANE: I’d have to obey some much harder rules here, that I’m not allowed to put myself in charge. We have to somehow obey competition. There’s a remarkable lack of competition among universities. Let’s get rid of the entire legal structure of the nonprofit organization to start with. I think that’ll lead to getting rid of tenure.
Tenure is useful for one thing. It forces people to make a decision. Tenure is not about the permanent employment. It’s about, when do you get to have a vote on who else gets to be in this place? It forces people to sit down and read the damn papers and say, “Should we keep Tyler on or not?” That’s kind of a useful thing, but you can have those without tenure. I have to go back to my libertarian instincts and say what we need is a healthy dose of competition in this business and —
COWEN: But why is for-profit education done so poorly? We’ve had a lot of it. We’ve had it in other countries like the Philippines. Turkey in earlier decades, had a lot of for-profits. They seem to disappear largely for market-based reasons.
COCHRANE: Oh, no, they’re in a competition with a heavily government-subsidized sector. Some of the for-profit charter schools, I gather, are doing a bang-up job. The big problem with being a nonprofit . . . A nonprofit is protected from the market for corporate control. If Stanford is screwing up, you can’t just buy up all the shares, kick out the management, and improve it. That’s also part of the secret of why hospitals are so screwed up — because they are also protected from that market.
The whole nonprofit business — this is a side issue which we should talk about some time — the nonprofit status in the US has been, like everything else, horribly misused. Now it’s a cover. A lot of it is a cover for getting out of the estate tax and for subsidizing political activity at taxpayer expense.
I was trying to think of things that open it up to competition better. If we have to think about routes, ways to change things . . . You make me benevolent dictator. Yes, I think there’s a lot of different ways we could run journals. I think putting things to the market test of ideas would be a lot more helpful.
But we’ve got to face the fact that a lot of the market is, who wants economists? The Federal Reserve wants economists to justify what the Federal Reserve is doing. The regulatory agencies want economists to justify what the regulators are doing. A lot of the market for economists is government intervention, so they’re going to turn out a product that justifies government intervention when faced with the market.
On Cochrane’s intellectual development
COWEN: How did you become a libertarian?
COCHRANE: Long period of reflection, and it was. I grew up in kind of a liberal community and was unthinkingly that. You just start reading, and you read classic things. I told you, my habit of mind is to put things in logical structure. If you start thinking cause and effect in logical structure, and not just my feelings about things and the government has to jump, then you are drawn to the classic reading list I had as well as you had.
I had some conversion moments. So this is how I became an economist, really. It’s the same thing, which is understanding social problems as dispassionate cause-and-effect things and recognizing how they didn’t work otherwise. I’ll tell you two.
One was I was a kid reading the newspaper, actually, in Italy — there was a plan. The government of Tuscany — there’s a problem with vipers. These are little poisonous snakes, and the government of Tuscany said, “We’ll get rid of the vipers. We’ll give a bounty of 1,000 lire per viper, and that’ll clean up the viper problem.”
Well, these dirty farmers of the Casentino found out that they could raise vipers. At 1,000 lire per viper, they could raise a lot of vipers fast, and the supply would overwhelm the demand. Stories of well-intentioned ideas that have unintended consequences that rank this. There’s cause and effect. That fits in lovely.
The other one — my big conversion moment — I remember it. It’s the 1970s. I was taking a class in microeconomics, and this was a time when welfare was a big problem. On one hand with the destruction of the black family was in the air. You could see the dysfunction in the south side of Chicago where I lived — lots of moralizing about it.
And I saw the budget constraint facing a teenage woman of not many means. It said if you have a kid and don’t work, we’ll give you an apartment and some money, and then there’s that kink in the budget constraint. What I saw was eye-opening to someone attuned to many different cultures. It was, “There, but for the grace of God, go I.” We’re all the same. We just face different budget constraints.
Here’s an analysis of a social problem, a deep social problem, that’s just completely cause and effect, and we know how to fix this, and you don’t have to get into morals and psychology and religion and all the rest of it. That was my conversion point as an economist. Once you start thinking that way, you end up as a libertarian. Now I’m a libertarian with many adjectives in front of it: conservative, rule of law, Pax Americana. There’re many different brands of libertarian.
COWEN: Should more economists blog? You’re doing it, right? We were all surprised when we saw you doing it.
COCHRANE: Well, I don’t like the competition, so no, stay out of it, guys. [laughs] Everybody else in any business — the first thing any businessman does is try to get rid of the competition.
The blog is an interesting art form. I don’t know how long it will last. It allows me to write short essays quickly that seem to have some following, even though I should edit each of them for a week and make them better. I found that a useful way to get ideas out and to hear from other people. I think that forum is good. Our academic journals are a disaster, and blogs seem to be an interesting way to get ideas back and forth in economics.
They merge economics and politics. I don’t know if that’s a good or a bad idea. The problem with all of us doing it is, I think what we’re seeing in the market is less blog, which is a personal brand name, and more of the Vox, Quillette, and so forth — curated things that are not publications.
It’s really a question about what’s the right format for getting essay-length things into the debate more quickly, both on actual economics and economics and politics.
COWEN: Last question: after you finish your 600-page book on The Fiscal Theory of the Price Level, what is it you think you will do next?
COCHRANE: [laughs] My problem in life is that my list of great projects, earthshaking projects, is growing as I get older and try to bite them off, so I have to pick one or the other. Which one do I want to pick?
Of course, one should finish what one has started. The Fiscal Theory of the Price Level was going to be something that included the theory and how it explains all of historical experience with inflation, money, and so forth. I’m at 600 pages. I haven’t finished the theory part, so one should do that. One needs to understand. I still don’t know that I have a good story for the inflation of ’70s and ’80s, which is a gaping hole. So I should finish that, but I probably won’t.
I did mention, I think, that why that takes so much trading to get information into prices — that’s a big unknown thing about asset markets, so I’m tempted to go back to that. Part of me wants to go into political philosophy. The danger of libertarians is . . . Oh, what was the question you asked me? Make me king for a day. Well, make us king for a day, and we could solve most of the problems of the American economy in about 10 minutes flat, yet our Congress doesn’t do it. What is there about our political system that is unable to come to these sensible cause-and-effect, obvious solutions to obvious problems?
Interesting — America had this amazing flowering of political engineering in 1790, and we seem to have just lived in the building ever since and not really done a great job of thinking about it.
In any scientific pursuit, you need to start with answers, not with questions. If you start with big questions, you’re never going to get anywhere. I think I have some answers, but that certainly strikes me as a question. How can we better engineer our political organization — kind of a constitutional moment — to produce the better economic outcomes that you and I know are there and just sitting —
You and I are techno-optimists, where I think we think that the US, the world could be vastly wealthier, healthier, and cleaner if just the regulatory state would get out of the way. And that’s a political question — a political economy, political structure, constitutional question, I think, so I’m tempted to turn my attention to that.
COWEN: John Cochrane, thank you very much.
COCHRANE: Thank you.