Merton H. Miller, one of the most prominent Chicago School economists, was honored for his fundamental advancements in the field of finance and economic regulatory problems, with a particular focus on the financial service industry. His partnership with Franco Modigliani sparked not only a dear friendship, but also generated a theorem which upended all previous work and beliefs on the relationship between the value of a company and its debt-equity structure. Beyond this, Miller’s career path also led to prestigious positions as an economist for the federal government and public director of the Chicago Board of Trade.
Merton H. Miller
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, 1990 (shared)
Where do brilliant ideas come from?
Around the time the gangsters fled from Chicago for prospects in Miami, Miller started to celebrate his last years in the Windy City, as he recalled back in 1992. Despite a dark sense of humor, the Laureate was well aware that his life had always been extraordinarily enjoyable.
After his own upbringing in the midst of the Great Depression, which awoke his interest in economics, key influences in Miller’s professional life were figures like Nobel Laureate George Stigler, who mentored and supported the young economist. “I learned more economics from two or three months’ worth of lunches with George Stigler than I learned in four years of college,” he recalled. “He had expensive taste, so my miserable pittance of a salary from my research assistant job was spent on lunches with him.” In Miller’s view, such interactions and dialogues were the basis of successful economic science.
You don’t just go away and have a brilliant thought. You talk, you discuss, you argue. Every rewarded paper, in fact, emerges from a successful collaboration.
Understanding the stock market
Ironically, his famous advice for making money on the market was to write about it, and not to participate in it. “The stock market doesn’t have people rushing around throwing papers on the floor – that’s only for the people in front of the television. What we do at the end of the day is, we collect the prices and the volumes gathered and we study them. We try to understand the movements. Why do things go this way and not that way? It’s very important.”
Does it matter how you cut a pizza?
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To help people understand one of his most important contributions, the Modigliani-Miller Theorem, Miller uses the example of pizza. “The pizza-delivery man comes to the customer and he says: How do you want me to cut this pizza? Do you want me to cut it in quarters? And the customer says: no, cut it into eight pieces. I’m feeling hungry tonight. If you know why that’s a joke, you understand what the Modigliani-Miller Theorem is.” Miller explained that it doesn’t matter how you cut the pizza, it’s going to be the same pizza. It was an easy example to emphasize that in financial markets, it doesn’t matter how many different kinds of securities you issue, the total value stays the same. “Don’t keep searching for the ideal combination,” Miller said.
But it’s not all that simple (which is why their idea would lead to the Nobel Prize eventually): one mustn’t forget that proving such a theory mathematically is not as delicious as the pizza itself. “We used a special kind of a proof called an arbitrage proof. That was quite novel and has turned out to be very influential in other kinds of problems and proofs.”
But why are people spending so much time deciding how to divide up their securities if Miller and Modigliani proved it senseless? “Well, we didn’t say it doesn’t matter. What we said is, under these conditions it wouldn’t matter and there’s a long list of them. People have been studying these conditions, and the assumptions underlying the Modigliani-Miller Theorem have become the organizing principle for research in the field, and that’s why it’s had such a major impact.”
What effect has the US government had on the finance industry?
You might ask why we see so many new financial products on the market. What’s the reason behind so much innovation and rapid change in these products? Curiously, Miller attributed part of the answer to the government. “Most of these advanced products were created as a response to bad regulatory steps taken by the US Government. For instance, it made it difficult for American firms to sell bonds in Europe, and as a result the market moved offshore.”
How will the financial market change?
Miller explained that whenever economic failures appear, people tend to look for villains, for a particular component to blame. He cautioned that economics are broad-titled forces and are not bound to particular individuals. He reminded us that institutions are far more powerful than we believe, and stressed the fact that people should turn to the government for change. He characterized his work as an unbiased outside critic towards the governments of the world, saying: “It doesn’t matter whether the Democrats or the Republicans are in Washington, I would criticize them both.” Miller didn’t see any change coming in the foreseeable future.
“The money markets of the world are now very closely linked, and risk management devices have greatly reduced the riskiness of the international currency movements for funds,” he said. “The banking industry is shrinking, it’s changing its role, but it’s gonna be a very slow evolution.”
I see the two great economic growths of the future not in Europe at all, but in China and India.
Can tax authorities work perfectly?
What is the true power of free markets?
“Some things in life,” says Miller, “like really good economics, are counterintuitive.” For the individual standing outside the economic spectrum, it’s hard to understand the mechanisms of a free market. “The market is not like quantum physics. It goes against the ordinary way of thinking.”
Miller promoted the free market, even in the face of recessions or an unstable environment. And he was quick to point out the frictions that occurred when the government intervened, for example with monetary policies.
People often say to me: what is the cause of this recent recession? And the answer is: the last boom. And what was the cause of the boom? Well, the previous recession. Active monetary policies have not had a very good record, and they do lead to this stop-go-stop-go-stop-go thing.
With regards to the environment, Miller was certain that through the free-market approach, it was possible to achieve the greatest amount of improvement with the least collateral cost.
What did the big giants not understand about the free market?
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What didn’t the big giants understand about the free market?
Miller recalled that when he was studying economics, it was considered an important part of the subject to know how to draw graphs. So Miller put great efforts into drawing, and in fact became very good at it. Apart from economics and liberal arts, Miller also found another passion in history. With numerous anecdotes and stories, he easily placed any dull, dry economic theories into entertaining historical flashbacks.
To explain the effects of a free market better, Miller looks to the story of Mikhail Gorbachev. “I think he did some very important things, but he made two fatal mistakes,” he said. “One, he stayed too long. Two, he thought you could gradually transform communism into a free market. He could have transformed the communist system into a free-market, but the gradualism was the problem.” Miller elaborated further.
If you have an economy that is basically free, you can have some little islands of socialism in it – the German train system and the post office, for example. But you can’t do it the other way around. If you have an economy that’s basically socialist and then you allow some parts of it to act under the free market, it will just eat away at the rest of the structure.
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When will there be another crash?
Miller’s colleague and close friend Franco Modigliani correctly predicted the stock market crash in 1987. But whenever Miller was asked about the next crash, he laughed and shook his head. “Modigliani told you about the one time he was right. Did he tell you about all the times he was wrong?"