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Dinner with the Econ

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Late this afternoon (Friday), the picture below appeared on my Google Reader screen with the caption Six kinds of recycling at the University of Oregon,

compliments of the feed from Brad DeLong’s blog. I immediately thought, is Brad DeLong (with iPhone camera) on campus? and checked the seminar page in the economics department. Yes, he was scheduled for a 3:30 pm seminar, with Economist’s View blogger Mark Thoma as host!

Given current events, I thought this would have to be an especially interesting talk, so I walked across campus for the chance to be a fly on the wall during a meeting of the Econ tribe. I was treated to a wonderful 90 minute talk which started from the general question of whether central banks should fight asset bubbles, but soon dove into the intricate details of the credit crisis. Mark recognized me and was kind enough to invite me to dinner, along with the speaker and professors Tim Duy and Nick Magud. It was quite an interesting discussion as we had among us a former member of Treasury (Brad), of the Fed (Tim) and an expert on Latin American financial crises (Nick). At one point Brad asked me about spontaneous symmetry breaking and the Higgs. I noted that physics is much easier than figuring out how Treasury is going to handle the bailout!

Quant trivia: at one point in the talk Brad mentions all the physicists modeling mortgage backed securities. The economists laugh, but Brad protests that his Harvard roommate Paul Mende (who did a string theory PhD under David Gross at Princeton) is now working for a hedge fund modeling volatility!

Written by infoproc

October 4, 2008 at 4:14 am

Posted in academia, economics

Meltdown links

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1) Leonard Lopate interview with Economist editor Greg Ip, formerly of the WSJ. (Scroll down the page to Financial Crisis: What Happens Next?). This is the best 12 minute summary of the current situation I have yet heard. Ip is consistently good at explaining this complicated subject in an accessible manner. If you have a friend who is confused about the credit crisis, have them listen to this interview. (Avoid Terri Gross and pals on this one… 😉

I have been listening to Leonard Lopate’s show for some time and I can tell his grasp of finance has increased dramatically in the last year or so (his strength is interviewing artists, writers, etc.). It’s yet another example of high-g at work. He knew almost nothing a year ago but now asks occasional perceptive questions. (But of course it doesn’t matter how smart our next President is!)

2) Mark Thoma discusses the pros and cons of mark to market accounting. To me it’s rather obvious that M2M accounting is exacerbating this crisis. It has introduced a very significant nonlinearity, both on the upside (bubble), and now in the collapse. If the market for mortgage assets has failed it is crazy to use it as a barometer for value. More discussion at WSJ.

3) This NYTimes Op-Ed written by a former theoretical physicist discusses agent-based simulation, behavioral economics and phase transitions — yes, in an Op-Ed! (Thanks again to reader STS for the pointer.)

Written by infoproc

October 1, 2008 at 7:43 pm

Babbage on economics and innovation

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Hmm… might be worth a look sometime, if I can find it in the library. From this talk.

Google books link.

Babbage, who, like Isaac Newton, was Lucasian professor of mathematics at Cambridge, attempted to construct the first computer in the early nineteenth century, more than a century before the first working computer was produced. Of course, Babbage’s computer was based on mechanical power rather than electronics, but it still required parts with very precise specifications. In carrying out this project, Babbage had to work with many workshops. In the process Babbage learnt a great deal about modern manufacturing.

Based on his experience, Babbage published an extraordinary book, The Economy of Machinery and Manufactures, which well beyond any contemporary work of political economy in creating a realistic analysis of modern production. The significance of rapid technical change struck Babbage, who claimed, “… the improvements succeeded each other so rapidly that machines which had never been finished were abandoned in the hands of their makers, because new improvements had superseded their utility” (Babbage 1835, p. 286). Babbage’s rule of thumb was that the cost of an original machine was roughly five times the cost of a duplicate (Babbage 1835, p. 266).

More from Wikipedia, on comparative advantage:

In On the Economy of Machine and Manufacture, Babbage described what is now called the Babbage principle, which describes certain advantages with division of labour. Babbage noted that highly skilled – and thus generally highly paid – workers spend parts of their job performing tasks that are ‘below’ their skill level. If the labour process can be divided among several workers, it is possible to assign only high-skill tasks to high-skill and -cost workers and leave other working tasks to less-skilled and paid workers, thereby cutting labour costs. This principle was criticised by Karl Marx who argued that it caused labour segregation and contributed to alienation. The Babbage principle is an inherent assumption in Frederick Winslow Taylor’s scientific management.

My favorite Babbage quote:

On two occasions I have been asked, – “Pray, Mr. Babbage, if you put into the machine wrong figures, will the right answers come out?” In one case a member of the Upper, and in the other a member of the Lower, House put this question. I am not able rightly to apprehend the kind of confusion of ideas that could provoke such a question.

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September 13, 2008 at 3:39 pm

Confessions of an economist

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A revealing dialog from Brad DeLong, in which he questions the choice of topics in his spring semester macro course. A must read for all social scientists who have faced math intimidation tactics from economists 🙂

[… Previous discussion: the Solow model tells us nothing useful about the real world. But Brad spent 5 weeks last semester covering it in his macro class… ]

Glaukon: But the bottom line is that we don’t have good explanations at any deep level for why the U.S. today is and stays 30 times richer than Kenya.

Akhilleus: Or, rather, that we have good explanations but they are historians’, political scientists’, and sociologists’ explanations–not explanations in which a facility with the differential calculus is terribly helpful and thus not explanations instrumentally useful to a sect of academics who want to use their facility with the differential calculus to impose a form of hegemonic domination over social science in general.

Akhilleus: But surely there is value in being confused about the issue at a higher and more sophisticated level…

See also this Larry Summers anecdote (Ellison, an anthropologist, was Dean of the Graduate School under Summers):

Over lunch not long after Summers took over the presidency in 2001, Ellison said, Summers suggested that some funds should be moved from a sociology program to the Kennedy School, home to many economists and political scientists. ”President Summers asked me, didn’t I agree that, in general, economists are smarter than political scientists, and political scientists are smarter than sociologists?” Ellison said. ”To which I laughed nervously and didn’t reply.”

Most amusingly, see Life among the Econ by Axel Leijonhufvud. Discussed previously on Economist’s View. Twilight of the modls!

Life among the Econ

The Econ tribe occupies a vast territory in the far North. Their land appears bleak and dismal to the outsider, and travelling through it makes for rough sledding; but the Econ, through a long period of adaptation, have learned to wrest a living of sorts from it. They are not without some genuine and sometimes even fierce attachment to their ancestral grounds, and their young are brought up to feel contempt for the softer living in the warmer lands of their neighbours. such as the Polscis and the Sociogs. Despite a common genetical heritage, relations with these tribes are strained-the distrust and contempt that the average Econ feels for these neighbours being heartily reciprocated by the latter-and social intercourse with them is inhibited by numerous taboos. The extreme clannishness, not to say xenophobia, of the Econ makes life among them difficult and perhaps even somewhat dangerous for the outsider. This probably accounts for the fact that the Econ have so far-not been systematically studied. Information about their social structure and ways of life is fragmentary and not well validated. More research on this interesting tribe is badly needed.

Caste and Status

The information that we do have indicates that, for such a primitive people, the social structure is quite complex. The two main dimensions of their social structure are those of caste and status. The basic division of the tribe is seemingly into castes; within each caste, one finds an elaborate network of status relationships.

An extremely interesting aspect of status among the Econ, if it can be verified, is that status relationships do not seem to form a simple hierarchical “pecking-order,” as one is used to expect. Thus, for example, one may find that A pecks B, B pecks C, and then C pecks A ! This nontransitivity of status may account for the continual strife among the Econ which makes their social life seem so singularly insufferable to the visitor.

Almost all of the travellers’ reports that we have comment on the Econ as a “quarrelsome race” who “talk ill of their fellow behind his back,” and so forth. Social cohesion is apparently maintained chiefly through shared distrust of outsiders. In societies with a transitive pecking-order, on the other hand, we find as a rule that an equilibrium develops in which little actual pecking ever takes place. The uncivilized anomaly that we find among the Econ poses a riddle the resolution of which must be given high priority in Econological research at this time.

What seems at first to be a further complication obstructing our understanding of the situation in the Econ tribe may, in the last analysis, contain the vital clue to this theoretical problem. Pecking between castes is traditionally not supposed to take place, but this rule is not without exceptions either. Members of high castes are not infrequently found to peck those of lower castes. While such behavior is regarded as in questionable taste, it carries no formal sanctions. A member of a low caste who attempts to peck someone in a higher caste runs more concrete risks-at the extreme, he may be ostracized and lose the privilege of being heard at the tribal midwinter councils.

A comparison of status relationships in the different “fields” shows a definite common pattern. The dominant feature, which makes status relations among the Econ of unique interest to the serious student, is the way that status is tied to the manufacture of certain types of implements, called “modls.” The status of the adult male is determined by his skill at making the “modl” of his “field.” The facts (a) that the Econ are highly status-motivated, (b) that status is only to be achieved by making ”modls,” and (c) that most of these “modls” seem to be of little or no practical use, probably accounts for the backwardness and abject cultural poverty of the tribe. Both the tight linkage between status in the tribe and modl-making and the trend toward making modls more for ceremonial than for practical purposes appear, moreover, to be fairly recent developments, something which has led many observers to express pessimism for the viability of the Econ culture. …

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May 20, 2008 at 3:43 pm

The big dog

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This picture (via Barry Ritholtz) illustrates that the US is still the dominant economy in the world.

Note, though, that the growth rate differential between the US and China is currently around 7 percent per year (e.g., 10 vs 3). If that persists for another decade, China’s PPP GDP will exceed that of the US.

See here for a list of PPP adjusted GDPs by country.

70% of US GDP is consumer-related. One can expect significant consequences abroad from any slowdown here — for example due to freezing of home equity lines of credit 😉

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May 16, 2008 at 3:22 pm

Inflation, deconstructed

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This NYTimes illustration of the various components of the CPI (inflation index) is one of the most impressive web graphics I’ve seen in a while. I suggest you click through and look at the original — it allows you to zoom in and see the contribution from individual components (gasoline, computers, college tuition, eyeglasses, etc.) to the overall index. Blue regions represent deflation (reduction in prices); reddish regions are strong inflation (the big red blob is gasoline).

One interesting point is that the CPI uses “owner’s equivalent rent” to calculate the housing part of the index. This missed the run up in house prices (rents were pretty flat over the last few years, meaning price to rent ratios were very high, a strong signal of a bubble). Had the cost of ownership, as opposed to renting, been factored in, inflation would have been significantly higher in recent years. Of course, most of that will go away now that the housing bubble has popped 🙂

See previous discussion here.

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May 5, 2008 at 3:12 pm

Soros tells it like it is

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The Financial Crisis: An Interview with George Soros with Judy Woodruff on Bloomberg TV.

According to his estimates (see below), housing starts would have to go to zero (he gives a normal value of 600k per annum, but I think the correct number is about twice that) for several years to compensate for the inventory that will flood the market due to foreclosures. So, no recovery in the near future, and continued pressure on the dollar. He also has some nice things to say about academic economics 🙂

Judy Woodruff: You write in your new book, The New Paradigm for Financial Markets,[1] that “we are in the midst of a financial crisis the likes of which we haven’t seen since the Great Depression.” Was this crisis avoidable?

George Soros: I think it was, but it would have required recognition that the system, as it currently operates, is built on false premises. Unfortunately, we have an idea of market fundamentalism, which is now the dominant ideology, holding that markets are self-correcting; and this is false because it’s generally the intervention of the authorities that saves the markets when they get into trouble. Since 1980, we have had about five or six crises: the international banking crisis in 1982, the bankruptcy of Continental Illinois in 1984, and the failure of Long-Term Capital Management in 1998, to name only three.

Each time, it’s the authorities that bail out the market, or organize companies to do so. So the regulators have precedents they should be aware of. But somehow this idea that markets tend to equilibrium and that deviations are random has gained acceptance and all of these fancy instruments for investment have been built on them.

There are now, for example, complex forms of investment such as credit-default swaps that make it possible for investors to bet on the possibility that companies will default on repaying loans. Such bets on credit defaults now make up a $45 trillion market that is entirely unregulated. It amounts to more than five times the total of the US government bond market. The large potential risks of such investments are not being acknowledged.

Woodruff: How can so many smart people not realize this?

Soros: In my new book I put forward a general theory of reflexivity, emphasizing how important misconceptions are in shaping history. So it’s not really unusual; it’s just that we don’t recognize the misconceptions.

Woodruff: Who could have? You said it would have been avoidable if people had understood what’s wrong with the current system. Who should have recognized that?

Soros: The authorities, the regulators—the Federal Reserve and the Treasury—really failed to see what was happening. One Fed governor, Edward Gramlich, warned of a coming crisis in subprime mortgages in a speech published in 2004 and a book published in 2007, among other statements. So a number of people could see it coming. And somehow, the authorities didn’t want to see it coming. So it came as a surprise.

Woodruff: The chairman of the Fed, Mr. Bernanke? His predecessor, Mr. Greenspan?

Soros: All of the above. But I don’t hold them personally responsible because you have a whole establishment involved. The economics profession has developed theories of “random walks” and “rational expectations” that are supposed to account for market movements. That’s what you learn in college. Now, when you come into the market, you tend to forget it because you realize that that’s not how the markets work. But nevertheless, it’s in some way the basis of your thinking.

Woodruff: How much worse do you anticipate things will get?

Soros: Well, you see, as my theory argues, you can’t make any unconditional predictions because it very much depends on how the authorities are going to respond now to the situation. But the situation is definitely much worse than is currently recognized. You have had a general disruption of the financial markets, much more pervasive than any we have had so far. And on top of it, you have the housing crisis, which is likely to get a lot worse than currently anticipated because markets do overshoot. They overshot on the upside and now they are going to overshoot on the downside.

Woodruff: You say the housing crisis is going to get much worse. Do you anticipate something like the government setting up an agency or a trust corporation to buy these mortgages?

Soros: I’m sure that it will be necessary to arrest the decline because the decline, I think, will be much faster and much deeper than currently anticipated. In February, the rate of decline in housing prices was 25 percent per annum, so it’s accelerating. Now, foreclosures are going to add to the supply of housing a very large number of properties because the annual rate of new houses built is about 600,000. There are about six million subprime mortgages outstanding, 40 percent of which will likely go into default in the next two years. And then you have the adjustable-rate mortgages and other flexible loans.

Problems with such adjustable-rate mortgages are going to be of about the same magnitude as with subprime mortgages. So you’ll have maybe five million more defaults facing you over the next several years. Now, it takes time before a foreclosure actually is completed. So right now you have perhaps no more than 10,000 to 20,000 houses coming into the supply on the market. But that’s going to build up. So the idea that somehow in the second half of this year the economy is going to improve I find totally unbelievable.

Woodruff: When you talk about currency you have more than a little expertise. You were described as the man who broke the Bank of England back in the 1990s. But what is your sense of where the dollar is going? We’ve seen it declining. Do you think the central banks are going to have to step in?

Soros: Well, we are close to a tipping point where, in my view, the willingness of banks and countries to hold dollars is definitely impaired. But there is no suitable alternative so central banks are diversifying into other currencies; but there is a general flight from these currencies. So the countries with big surpluses—Abu Dhabi, China, Norway, and Saudi Arabia, for example—have all set up sovereign wealth funds, state-owned investment funds held by central banks that aim to diversify their assets from monetary assets to real assets. That’s one of the major developments currently and those sovereign wealth funds are growing. They’re already equal in size to all of the hedge funds in the world combined. Of course, they don’t use their capital as intensively as hedge funds, but they are going to grow to about five times the size of hedge funds in the next twenty years.

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April 28, 2008 at 3:14 am