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Detail specificity depends on context: exs – arithmetic & GDP vs GNP September 12, 2011

Posted by larry (Hobbes) in economics, Logic.
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When it comes to applied contexts in some sciences such as economics, there is sometimes a feeling that a discussion is overly detailed.  This is sometimes true. But I would like to use an example from arithmetic to show that this is ultimately the case.  The principle I am working with is the one that stipulates that one should be as simple as one can be but no simpler, a principle that dates at least back to Ockham.

When one sets out the fundamental principles of arithmetic, say those of addition and multiplication, you find statements like these:

x + y = y + x

and

x + 0 = x.

The first says that addition is commutative, that is, that it doesn’t matter in what order you add two numbers together. The second principle says that zero is the identity element for addition – any number added to zero equals itself.

Now, it may be thought that these are obvious and therefore need no explicit representation.  But this would be a misunderstanding of the context these principles operate in.  For example, multiplication is commutative, that is, x * y = y * x.  But division is not commutative, that is, x ÷ y does not equal y ÷ x.  Neither is subtraction commutative.

And zero is not an identity element for multiplication, for x * 0 ≠ x.  The identity element for multiplication is 1.

The reason such strict distinctions must be made is that it is easy to extrapolate incorrectly from one arithmetic operation to another where it won’t work correctly.

Something similar could be said about certain distinctions between certain chemical elements, say U235 and U238. While the difference could be said to be small, it is nevertheless a momentous one. You can make a bomb with one but not the other.

The same goes for a theoretical and applied social science* like economics.  Take the distinction between GDP, Gross Domestic Product, and GNP, Gross National Product, which are two distinct measures of a nation’s economic productivity.  States used to use GNP but changed over time to GDP.

These measures are very similar but in certain contexts one may be preferable to the other.  GNP measures productivity in terms of ownership regardless of where the ownership lies.  For instance, it counts income made overseas as part of the nation’s income.  GDP, on the other hand, measures a nation’s productivity that takes place within its territorial border whether produced by a foreign firm or not.  These two measures can produce different accountings of total output.

The reason given by the Bureau of Economic Analysis for making the change from GNP to GDP, which took place in the early 1990s, was that it made international comparisons more direct and facilitated comparisons among different kinds of economic activities.  Some economists deplore the change from GNP to GDP, contending that the latter is a misleading indicator of actual productivity.  Whether it is or not depends on the context, even if the measures do not differ much in value. US GDP in 2009 was estimated by the BEA at $14.119 trillion and its GNP at $14.265 trillion.  Whether the value itself or the method by which it was obtained is considered significant/meaningful will be largely determined by the context, including the theoretical framework where the interpretation of these and related measures are embedded.

As William James once wrote: in order for a difference to be a difference, it must make a difference. Sometimes the context is all.

For a detailed discussion of various alternatives from one economic perspective, see ALTERNATIVES TO GROSS NATIONAL PRODUCT: A Critical Survey (1998) by Richard England & Jonathan Harris. Whether GDP or GNP are adequate measures of a nation’s economic well-being is another matter.

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* The social sciences are sciences although they are not identical to physics, nor should physics be pursued as an ideal, as happens in the pseudo-field of econophysics.

Parody of Greg Mankiw’s economics text by Yoram Bauman July 1, 2010

Posted by larry (Hobbes) in economics, humor.
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This is a hilarious parody.  Brilliant.  I laughed out loud.  A lot.

Response to Ann Pettifor’s ‘Recession is not over’ blog June 12, 2009

Posted by larry (Hobbes) in economics.
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[Do read Ann’s new blog –   http://debtonation.org/2009/06/no-the-recession-is-not-over/. She is right; green shoots in the financial sector, if there even are any, do not mean a lot.]

I couldn’t agree with Ann Pettifor more. The entire thing is disgusting. Although some of the regular and financial economists, like Nassim Taleb and Vince Cable, spoke up, they were studiously ignored. And the rest never seemed to notice. Like her, I don’t think there is any reason at all for trusting the bankers. The data compiled by Eichengreen and O’Rourke show that this depression and the one in 1929 are not too dissimilar (http://www.voxeu.org/index.php?q=node/3421).

Nothing has been done about job creation, mortgage foreclosures, or business survival. Nor has anyone been indicted for the massive fraud that has gone on. The case of Deepak Moorjani provides good reasons for us to be enraged – cf. http://thedukeofurl.wordpress.com/2009/05/28/deepak-moorjani-deutsche-bank-the-nyt/. The claim that Brown is the only one to get the country through the recession is a joke.

In 1929 in the US, while the feds did nothing about mortgage foreclosures, many states individually initiated moratoria. I think there may be a good reason, from the point of view of the bankers and some politicians, that nothing be done; because they hope to recreate the bubble, thinking that this will end the recession and thereby render structural reform of the financial sector irrelevant. Even should some recovery take place, this will only postpone the inevitable reckoning that must occur. Besides, it is dangerous. Even now, some of the banks are back to their nefarious practices.

As she points out, such a “solution” is only applicable to the financial sector, and it is a short-term fix in any case. The real economy is being squeezed. As Moggridge argues for the Depression, structural reform and putting a substantial number of people to work, however artificially, is what is required. The notion that we “can’t afford it” is absurd, as anyone familiar with the arguments of Keynes, Minsky, Moggridge, and a few others should be able to see. What we can’t afford is to pretend that the debt can be paid down; it is too large – more money than the world possesses.

What will it take for there to be an uprising? My take on the rage at MP’s expenses is that it is partly displacement activity due to the bankers not being punished by the politicians who soon after the financial debacle were discovered lining their own pockets. People can’t get at the bankers, so they are getting at the politicians who haven’t gone after the bankers.

I see no reason to think that Brown either will, or even can, change. And Cameron has returned the Tories to Thatcherism, a disaster in every possible way – political, economic, psychological, social, cultural – in the making. As one flawed 20th century innovator once wrote, what is to be done?

Taleb’s 10 step solution to a Black Swan-proof world June 5, 2009

Posted by larry (Hobbes) in economics.
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On the 7th of April, Nassim Taleb issued his 10 step program for protecting the financial sector from black swans in the future. Of course, by his own reckoing, this proposal can offer no guarantee that black swans will not reoccur, only that their likelihood would thereby be significantly reduced. I would like to quote his short piece from the Financial Times in full.

Ten principles for a Black Swan-proof world

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

Unfortunately, the suggestion that banks be turned into utilities has no legs, that is, there is not the remotest chance that this suggestion will be implemented, even in a minor way.  Nor is it likely that his other suggestion, to take away the toys from the boys who broke them, has any chance of seeing the light of day in the political chambers. No one, either in the US or the UK, has made any moves to assist mortgage holders or do enough to create jobs. What a mess.

Check the Financial Times for related articles.

Deepak Moorjani, Deutsche Bank, & the NYT May 28, 2009

Posted by larry (Hobbes) in economics.
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On 10 May 2009, Zero Hedge published a story about an employee of Deutsche Bank Japan, Deepak Moorjani, who had been trying to get the bank to reform its risk practices and management. In a letter sent to the New York Times and published in their Dealbook section on 16 April 2009, Moorjani sets out his case against Deutsche Bank’s risk culture. Zero Hedge tired to link to the letter but found a 404 error instead – the Times had removed the piece, presumably on advice of legal counsel after being contacted by Deutsche Bank or its lawyers.  Moorjani was involved in litigation with a unit of Deutsche Bank at the time and, presumably, still is. Fortunately, you can find the letter in its entirety here: http://www.scribd.com/doc/14757881/Another-View-Deutsche-Banks-Culture-of-Risk. This document is a damning indictment of Deutsche Bank’s practices.

The removal of this entry by the New York Times is not quite the same action as that taken by the Daily Telegraph in regard to their Patterson report. In the case of the Telegraph, no legal case was being brought by any of the parties involved, although the Telegraph might have had concerns that one might suddenly materialize. It is unfortunate that Zero Hedge did not obtain any legal opinion concerning whether the Times may have had to remove the Dealbook entry for legal reasons.

Moorjani is a rather courageous individual and Deutsche Bank have acted like bullies, employing legal means to attempt to silence him. Fortunately, new Japanese labor law* protects Moorjani from arbitrary dismissal, which is what such dismissal would have amounted to in his case, although DB would no doubt differ with me on this.

* For a summary of Japanese labor protection, see http://www.scribd.com/doc/13453568/DLA-Piper-Legal-Background (provided by Moorjani at Scribd).

Update: There have been reports that Deutsche Bank has been engaged in “naked short selling”, a dubious activity at best, which the SEC has only recently, and reluctantly, decided to address – http://www.deepcapture.com/deutsche-bank-sold-massive-amounts-of-phantom-stock/.  DB have also been accused of fraud – http://www.dbankfraudinfocenter.com/information.php, and the list of bank fraud news sites is uncomfortably long.

Daily Telegraph news story suppressed May 27, 2009

Posted by larry (Hobbes) in economics.
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Naked Capitalism, Zero Hedge, and The Analytic are all engaged in trying to discover the truth of a report by Evans-Pritchard that appeared in the Daily Telegraph and which was suddenly removed from the paper’s web site following a complaint.  According to the report, Mark Patterson, chairman of MatlinPatterson Global Advisors, a private equity firm and recipient of initial TARP funding, said in a meeting in Qatar that the Geithner bailout was a sham and that the banks were insolvent.

You can find the report here – http://zerohedge.blogspot.com/2009/05/mark-patterson-its-sham-banks-are.html .

A number of disturbing inferences arise from this case.  One is that web content is inherently fragile and can disappear overnight. Were the paper deposited in a library, some record of it will have been kept (as has luckily happened electronically in this case, but you can’t count on it). An argument for a publically accessible digital archive available into the indefinite future as “hard copy” in principle is?

Another is that a media organization, presumably after consultation with its lawyers, removed a news report simply upon receipt of a complaint, which may never be recoverable from the original source.  There does not appear to be anything to stop the newspaper from digitally shredding the report thereby having it “go missing”.

Should Mr Patterson’s comments be viewed as a matter of private concern although made in a public arena? If what the paper initially published was factually incorrect, as MatlinPatterson claim, then surely the paper should have left the story as is, as it has had to do with the hard copy version, and issued a public apology to Mr Patterson in a subsequent issue of the paper. This would seem to be the most appropriate way of dealing with such conflicts.

The thing is, if Patterson did say what he is reported as saying, he is right.  “Geithner’s put” is rubbish.

It will be interesting to see whether Naked Capitalism, http://www.nakedcapitalism.com/ , The Analytic, http://theanalytic.com/ , and Zero Hedge, http://zerohedge.blogspot.com/ , will be able to get to the bottom of this affair.

The Velocity of Money, a thriller May 27, 2009

Posted by larry (Hobbes) in economics.
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“Velocity of money” is a term referring to the number of financial transactions in a given moment of time.  For a stock exchange, the time might be measured in minutes, but for the average consumer, it might be a day or a week. The more financial transactions there are per unit of time, the greater the velocity.

However, the title of this post refers only incidentally to financial transactions. It is the title of a thriller by Stephen Rhodes (aka Keith Styrcula) published in 1997. The plot concerns a conspiracy to bring about a crash of the financial markets using a computerized trading program based on the derivatives market, and begins, as thrillers do, with a body dropping out of a window of a skyscraper onto and into the roof of a NY cab, in this case the body of a banker.

What might come to the reader’s mind is an image of the suicides that took place in 1929, the time of the stock market Crash, sometimes referred to as the Great Contraction to distinguish it from the Great Depression. This, of course, is no suicide, but murder.  And the life of our hero, a securities lawyer at a Wall Street firm, is naturally eventually in danger, and his wife is newly pregnant.

The relevance of the novel for our purposes, however, is not its aspects as a thriller, but its prescience in suggesting that the ongoing 1990s bubble could burst, something denied by many at the time, though there was a bit more than a hiccup in this period.  Rhodes worked for an off-shore financial firm and influences for the thesis of collapse are some of the usual suspects, such as John Kenneth Galbraith and Hyman Minsky, but also Alan Greenspan, C. P. Kindleberger (an expert on the Depression), and the computer hacking magazine, Phrack (a recent article is Hacking your Brain: Artificial Consciousness).

The stock market crashed dramatically in October 1929, not as a consequence of some shadowy conspiracy, but through independently converging causal chains, though the precise character of this causal network and it’s role in the disaster is still a matter of hot dispute. Is a conspiracy to bring down an entire financial system plausible, even if it were possible?

It is difficult to see how it would work. Small-scale conspiracies carried out on individual currencies and sets of institutions have taken place historically.  The primary problem of a conspiracy on this scale would seem to be the difficulty of getting everyone, who normally are in competition with one another, to cooperate to bring down a system from which they are gaining enormous benefits. It is difficult to see how any of these individual players could see such an action as being in either their personal or collective interests.

I was happy to suspend disbelief for the enjoyment of the read and, although Rhodes makes the events seem somehow plausible, I thought then and I think now that such a conspiracy is unlikely. Neither the Great Crash of 1929 nor the Credit Crunch of 2007-08 were the consequences of conspiracies to bring the events about, but rather the inevitable consequences of the way business was being carried out in what had become the normal way every day.  While it might be more satisfying to blame a few conspirators for the “interesting” times we are currently living in, it seems that greed, ego, ambition, collusion, incompetence, and even more than a little fraud, according to some accounts (and not just by the Bernie Madoffs), are the primary engines of our current catastrophe.

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For an extensive list of such novels, arranged by genre and then by author, see http://projects.exeter.ac.uk/RDavies/bankfiction/bigbang.html by Roy Davies. You may be surprised, as I was, to discover that one of the great expositors of poltical economy, John Kenneth Galbraith, wrote two novels.

Sal Khan of Khan Academy May 26, 2009

Posted by larry (Hobbes) in economics.
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I recently came across a variant of the good bank-bad bank proposals that have been made recently over the past few months by Salman Khan and David Leinweber that they published online on 11 November 2008 – “New American Bank Initiative” – http://cift.haas.berkeley.edu/docs/nabi/nabi-Nov11.pdf.  You can also watch Khan explain this plan to a CNN reporter on video using his own educational ‘tool’ – (http://www.youtube.com/watch?v=_ZAlj2gu0eM). In both the paper and in the CNN interview, Khan gives credit for this particular version of the good bank-bad bank solution of the crisis to a univeristy friend, Todd Plutsky.

Khan has set up a youtube affiliated educational web site devoted to explaining visually and in terms that are easily understood concepts in mathematics, physics, finance and banking, and the current credit crisis – http://khanacademy.org.  In Bailout 14: Possible Solution, Khan shows the viewer the letter he received from Plutsky. He is a brilliant expositor of ideas most people find difficult, and he does it in such a way that you will wish you had come across him before. His explanation of his friend, Plutsky’s, solution to the financial crisis is a model of clarity.

If this is such a good idea, why isn’t it being implemented? You may well ask.  The answer is simple.  The bankers don’t like it (although Citigroup has expressed an interest). And they don’t like it for a very good reason from their point of view.

The toxic assets they possess will be eliminated by being passed onto the ‘bad bank’, which will then be allowed to fail, which means that they will receive no remuneration for these toxic assets for which they overpaid.  It also means that the extent of the toxicity due to their poor management of other people’s money will be publically revealed for the scandal it is.

The toxic waste created by these institutions is estimated by some to be over a quadrillion dollars, which is more money than the world has. It can never be paid off, only written off.  Bankers would rather that no one became aware of this for a certainty, if they even know themselves, and some politicians agree with them, especially those who have “palled around” with bankers in the recent past.

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Other more technical discussion of the good bank-bad bank solution are: 1) Reorganizing the Banks by Bulow & Klemperer – http://www.voxeu.org/index.php?q=node/3320 ; 2) Willem Buiter’s How to Set Up a New ‘Good Bank’ – http://blogs.ft.com/maverecon/2009/02/how-to-set-up-a-new-good-bank/ which has links to other discussions of this, including his own development; 3) Buiter’s good bank-bad bank illustration – http://blogs.ft.com/maverecon/2009/03/dont-touch-the-unsecured-creditors-clobber-the-tax-payer-instead ; 4) The Right Way to Create a Good Bank and a Bad Bank by Hall and Woodward – http://www.voxeu.org/index.php?q=node/3132.

Why no one is agreeing with Brown’s additional ‘plan’ March 26, 2009

Posted by larry (Hobbes) in economics.
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Brown’s desire to pump more money into the banking sector is either being received unenthusiastically or rejected. There will be a number of reasons for individual responses. But one will be that it will be folly to put any additional funds into a set of institutions that are insolvent, can be shown to be insolvent, and whose directors (who have mostly not been replaced) brought their banks to ruin. It would be not unlike shipping your money to a black hole from which it will never return nor could any return be generated.

In 2007, Fitch Ratings sat down with a sample of 45 loan documents and discovered that fraud was involved in the majority of these loans. Some of them were tagged as questionable but the loans were granted nevertheless. Some of these were structured investment vehicles, many of which were devised to avoid regulation or to commit outright fraud.

What Fitch found is only the tip of the iceberg. The derivatives market debt, which is predominantly responsible for the current financial crisis, not subprime loans though they were the trigger for the collapse, in estimated to be massively in excess of world GDP. And this was in 2007, before the collapse.

The gross world product (GWP) for 2008 is estimated to be $70.65tn (purchasing power parity) or $78.36tn (official exchange rate) (CIA World Factbook). The derivatives debt is estimated by some to be as high as $1.5 quadrillion. This is obviously much greater than the world GDP. There is obviously no way that this can be paid down. It must in some way be written off.

Krugman has objected to Geithner’s plan, which he contends is nothing more than the Paulson plan redesigned. And to show how serious the current situation is, he has calculated a significant comparison of 1930 with now (from his blog, The Conscience of a Liberal).

“the change in industrial production, measured in logs, from the previous peak in 1929-30 and 2007-9.

[I am not allowed to post an image here so I will just have to provide you with the URL. Apologies. http://krugman.blogs.nytimes.com/.]

At first, the current recession didn’t hit industrial production all that hard. But the pace accelerated dramatically last fall, so that at this point we’re sort of experiencing half a Great Depression. That’s pretty bad.”

James K. Galbraith, in a piece in the Washington Monthly issue for March-April 2009 and in interviews, has suggested ways of dealing with what are irreparably insolvent banks, as has Willem Buiter, in his Mavercon blog for the Financial Times. Both advocate at the very least a radical restructuring of the banking system. *

It is clear that neither Brown’s not Geithner’s plans will work. Galbraith contends that this may well be because Geithner and his colleagues are trapped in old ways of thinking – this may leave them unable to think themselves out of the real box in which they find themselves. If they are trapped in old ways of thinking, then they have to be let go and others found who can think “outside the box”.

The Governor of the Bank of England recently made a public statement that no more money was available for fiscal stimulation. This statement is not quite as pellucid as it might appear to be. There certainly is no more money to plough into insolvent banks. But it may be possible to do a Roosevelt and provide money for projects that will generate tax revenue which will fund further projects utilizing a kind of multiplier effect. For this to work, it must me the major part of any financial package, not a subsidiary part. So far, it hasn’t been.

The rejection of Brown’s stimulus package by others can not be taken at face value. It is not enough to know that they reject it; one must also know why they reject it. Only then can one know how they are viewing the recession and how they view dealing with it. This is important because this recession, being global in scope, requires a coordinated global response. On that, Brown is undoubtedly right. This is because the banking institutions and hedge funds that created this problem in the first place are global institutions whose effects, including their indebtedness, are global in reach.

* Donald Moggridge argues that something akin to the Marshall Plan was needed to get the US out of the Great Depression – what Roosevelt did was good but not enough. (Donald E. Moggridge, “Policy in the Crises of 1920 and 1929”. In Financial Crises: Theory, History and Policy, C. P. Kindleberger and J. P. Laffargue, eds. (1982))

Problem analysis vs. Problem solutions January 26, 2009

Posted by larry (Hobbes) in economics, Logic.
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Unfortunately, there is no necessary logical connection between the analysis of a problem and its solution. The two are essentially independent. So, someone could analyze a problem correctly but provide incorrect proposals for solving said problem. In accepting Roubini’s assessment of the problem, we do not need to accept his ideas on how it can be solved or what he thinks might be poor solutions, as his philosophical/theoretical stance will largely determine what he believes to be viable.

This is a problem with a lot of discussions in economics. Lots of assumptions not made either explicit enough or at all. Others introduce ideas that they think are new but have actually been around for years. For example, Soros’s introduction of the notion of reflexivity (a kind of feedback loop in economic behavior) has been a known problem in philosophy and parts of social science for over 50 years. Yet most economists fail to acknowledge this except for Soros and a few others. Neoclassical economists like Stigler and Friedman ignored it completely and possibly weren’t even aware of the issue. Keynes was aware of this problem though he didn’t discuss it in these terms.

Since a solution of a serious economic problem invariably involves a political (policy) dimension, economists aren’t very good at incorporating socio-political policy considerations into their analyses, hence their solutions should be inspected closely.

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