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Colossal_octopus_by_Pierre_Denys_de_MontfortProPublica and This American Life have broken an expose of sorts about the spinelessness of the New York Fed in relation to the Wall Street banks which it is enjoined to supervise, specifically Goldman Sachs (which is basically the apotheosis of a Wall Street bank). But this is really all style and no substance: as Daniel Gross points out the New York Fed has always been a creature of Wall Street, there to do its bidding. The reason that this story is worth reporting on is that a whistle-blower recorded some of the meetings between Fed officials and Goldman Sachs, and therefore highlighted just how clear it is that the latter calls the shots for all practical purposes. But we all knew that after 2008. Wall Street socialized its losses, and came roaring back, privatizing the gains which accrued from the easy money doled out by the Fed, as well as the now explicit back-stop of the American government. They know we know, and they know we won’t do a thing about it. Basically it’s like Wall Street punched us in the face, and then sent us a bill for the injury. Also, they demand an apology whenever we besmirch their honor.

There will always be winners and losers, the high and mighty and the low. The key is that it is optimal for the many when the great gain honor through actions which spill over into the public good. The ‘innovations’ of the financial sector, and the bloat that has occurred in ‘inter-mediation’, do not fall into that category. There are only so many gains on the margin of improved allocation of capital. At some point the proliferation of professions meant to smooth the institutions of an advanced society end up devolving into a zero-sum game for finite resources. This is true with bankers and lawyers. Both these are honorable and necessary professions, but when there is a surfeit of both you know that society has gone sclerotic.

downloadThis is why I put my hope in Silicon Valley, and in particular men such as Elon Musk. Musk is as much a megalomaniac as a Wall Street “master of the universe,” but his ambitions and greed for glory drive him to found firms which aim to change the fundamental rules of our civilization. And for the better. It’s not a zero-sum game he is playing; he wants to explode the pie and grab a huge chunk of it. A high-risk high-reward endeavor.

Ultimately to fend off sharks you need killer whales. Our civilization is premised on capitalism, and growth. Without growth elite over-production leads to the rise of zero-sum competition for resources, and the brutal games of greed which led in part to the financial crisis of 2008. The hope is that Silicon Valley and other genuinely innovation sectors of society can hoover in enough talent, creativity, and ego, to change the rules so that the crass an Byzantine machinations that are on display in the activities of the New York Fed become blips upon our near term historical trajectory. In contrast, if we stagnate, except the games to get bloodier and more desperate.

• Category: Economics • Tags: Finance 
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This article in The New York Times focuses on cash in terms of paper currency, but the lessons are generalizable to coinage as well, which pre-dates paper currency by 1,500 years. Some fascinating numbers:

…In 1970, at the dawn of plastic payment, the value of United States currency in domestic circulation equaled about 5 percent of the nation’s economic activity. Last year, the value of currency in domestic circulation equaled about 2.5 percent of economic activity.

…Indeed, cash remains so pervasive, and the pace of change so slow, that Ron Shevlin, an analyst with the Boston research firm Aite Group, recently calculated that Americans would still be using paper currency in 200 years….

… Thanks to technological advances, the average dollar bill now circulates for 40 months, up from 18 months two decades ago, according to Federal Reserve estimates….

…. In 1989, the Fed replaced 46 percent of returned dollar bills. Last year it replaced 21 percent….

We don’t know if the United States of America will be around 200 years from now, so the question about the persistence of cash is rather moot in my opinion. But in any case, the marginalization of (relatively) untraceable cash for abstract monetary units of value is going to entail some changes. Not only are financial institutions going to track and analyze your purchasing habits in fine-grained detail, but governments will able to get their hands on that information if they have a will to do so. Additionally, that information and the meta-data will be stored somewhere, so there are going to be solutions which emerge to resolve the problem of information getting stolen by pirates. Finally, at some point within the next generation or two I suspect that utilization of paper currency might suggest that something is off in your circumstance or intent. That is, people may wonder why exactly you are using an antiquated currency medium whose primary benefit is that it renders your transactions invisible. It will be an order of magnitude worse than the cases we encounter now with people who write checks in retail lines. They are sources of hapless inconvenience, not targets of suspicion.

• Category: Economics, Science • Tags: Finance 
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Steve Hsu points me to this essay which discusses ‘high-frequency trading’, How to Make Money in Microseconds. This might elicit a takfir from my friends at the Singularity Institute, but that piece makes me less ill-disposed to a Butlerian Jihad. A lot of this stuff on the margins and frontiers of finance reminds me of intragenomic conflict or cancer; entities and phenomena which are generally proposed to serve as means toward particular ends develop their own internal logic and ends through a co-evolutionary “arms race” in their own domains.

• Category: Economics, Science • Tags: Finance 
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Yesterday I made an admission of my lack of trust after the 2008 financial crisis. I should have been more precise and clarified that my collapse in trust has been particularly aimed at elites and “experts.” In any case, I realized that the General Social Survey has 2010 results available. This means that I could check any changes in public trust and confidence from 2008 to 2010! Below in the set of charts there is one that assesses trust in banks and financial institutions. The direction of change validates my specific implication. But it seems that my intuition was wrong in that American society had slouched toward more general distrust. This makes me less pessimistic about the direction of our culture and the future rationally (I can’t say that my visceral emotional cynicism has been abolished).

As you can see there wasn’t much change between 2008 and 2010. For the broad question of “can you trust people” I also decided to break it down by political ideology, education, and intelligence in two year rages, 1972-1991 and 1992-2010. There are noticeable differences in intelligence and education (less intelligent and less educated people are more distrustful), but not in terms of ideology.

After the bar plots there are another range of line graphs by year showing confidence in a range of institutions (including finance) from 1972 to 2010. It is interesting how much you can see short term volatility due to world events, which quickly recedes back toward the trend line.

• Category: Science • Tags: Data, Data Analysis, Finance, General Social Survey, GSS, Trust 
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The nature and character of your financial decisions is shaped by your genes. That shouldn’t be too horrible. Many decisions are the outcome of a combination of heritable and non-heritable predispositions. But I have to honestly express a bit of alarm at this segment I just heard on Marketplace, There’s only so much you can teach your kids. Here’s the subhead:

For better or for worse, kids take after their parents — but studies show parental influence only goes so far when it comes to how your children will handle money.

I’m not one to be worried about “genetic determinism” (usually just an insult which describes very few scholars), but this is a bit ridiculous. First, the primary research, of which you can find a pre-print online, seems to indicate that around ~30% of the outcome of financial decisions are heritable. That is, that ~30% of the variation in financial decisions within the population can be accounted for by variation in genes within the population. Additionally, there’s some context missing. The researcher expresses surprise that monozygotic twins converge in behavior as they age, and that parental influence tends to wear off as people leave the home. I don’t know if the researcher was taken out of context, but this is a totally unsurprising result. Over time shared home environment, what your parents model and teach you, tends to wear off, and gene-environment correlation increases the correspondences between particular genetic makeups and behaviors (i.e., identical twins resemble each other more at maturity than in their youth). For most behavioral traits heritability increases with age.

But the problem that microeconomic analyses like this create is that they confuse the public as to the relevance of charts such as this:


That’s the median savings rate in the USA.

There’s not enough time to explain this sort of volatility as the result of changes in gene frequencies. Some of the trends, as the recent increase in savings, have easy contextual explanations. The point is that individual dispositions express themselves within an environmental context, and culture is such an environment. This is why we have to be careful about the high heritabilities of obesity. Your genes may indicate how high your masts are going to be in the flotilla, but the rising and falling of the tide are going to have a huge absolute impact on the position of the whole constellation of ships.

Image Credit: Wikimedia

• Category: Science • Tags: Behavior Genetics, Finance 
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I’ve been hearing about structural adjustment due to technology and gains to productivity from people since the early 1990s. The sort of dynamic which motivated the original Luddites. But this chart from Calculated Risk makes me lean toward the proposition that the time is nigh. In relation to previous post-World War II recessions the big difference in unemployment seems to be in the area of the long term; these are those whose skills will degrade, and are probably least likely to reenter the labor force at an equivalent position.


• Category: Economics, Science • Tags: Finance, Sociology 
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For the past year I’ve been having periodic discussions with a friend who has a nice amount of money which he invests (he’s a single male cresting up to his peak earning years after receiving an advanced science degree from an elite institution). He is pessimistic about the long term prospects for the American economy, and believes that the current run of stock market gains are simply a bear market rally. Even when he made his assertion last year I pointed out that if it was a bear market rally it was unprecedented in its magnitude. Of course I wasn’t too confident about appealing to historical precedents after what’s happened in the past few years. Look at the comments I elicited after mooting fears of a recession in May 2007. I know some of the commenters are regular readers to this day, so I hope everyone enjoys watching the frankly moronic confidence. I use the term not as an aspersion but as an accurate description of the hubris and complacency on display. I myself told a friend that the credit crisis was overblown in the summer of 2008, relying on moronic conventional wisdom from overeducated morons that the Great Moderation was in effect. I was wrong, and I don’t have a word to capture the contempt which I have for the likes of me, a fool who relied naively on the foolish. I am reckoned a young man by some, so that’s the excuse I’ll give.

With all that stated then as to my profound uncertainty I have to say I’m a bit perplexed by green shoots of economic optimism which seem to be sprouting here and there. Ultimately I would dismiss this, but the stock market performance is mystifying to me. We know from historical precedent that market run ups presage economic growth in the future. This is presumably because investors are pricing information which they receive before the rest of us, and the NBER, and so give us a more accurate crowd-sourced preview of the future. But like my friend I have a hard time understanding where the fundamentals are which could give rise to a robust cycle of growth. We are, thankfully in my mind, being weaned off of consumer credit. So we can’t fake the growth through debt fueled consumption, we have to produce. But what new technologies are causing structural changes in the economy? I don’t see it.

But it is important to remember that most people didn’t see the internet being of economic relevance in 1994. Deep into 1995 Microsoft was “all in” on the next big technological breakthrough…interactive television! And while the .com bubble was blowing up no one had any idea of the awesome investing potential represented by the revolutionary economics of 21st century homebuilding…oh, oops! But let’s just assume that the stock market is telling us something real, that growth which is not fueled by consumers or the state taking on more debt is in the offing. Where does that growth come from?

I have no idea, so I’ll offer a speculative theory: in the next few years we’ll see the rise of magic, which will revolutionize modern economies with supernatural green forms of transport. Screw the Segway, imagine how efficient magic carpets will be as personal vehicles! Not only do they run on supernatural fuel which has no carbon footprint (all the waste is emitted in magicland, which is parallel to the real world), but they take up very little space, and are multipurpose as well as aesthetically customizable. The main downside is you’re exposed to the elements, and velocity has to be modest so you don’t fall off the carpet.

You might think this is a silly prediction to offer. So what’s your theory? Peter Thiel has billions, invested in PayPal and Facebook, and claimed that the markets are not so retarded that they’ll invest irrationally in a new bubble for a generation after being burned twice in the past 10 years. Is Thiel wrong? Are the markets not-so-efficient. Or are we going to have to get ready for some magic?

I seek a true guide to the perplexed, not platitudes from latter day kleptocrapts.

• Category: Economics, Science • Tags: Finance 
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greenyEzra Klein references the old Shaggy hit “It wasn’t me” to characterize Alan Greenspan’s testimony yesterday. It’s not just Greenspan, Robert Rubin is pulling it too. The point isn’t that these people have plausible deniability, they don’t, the issue is that there’s no real recourse anyone has to hold them accountable. They can lie to your face because there’s no consequence. I noted below that institutional investors demand risk so that they can have an opportunity for high returns. This isn’t necessarily just from on high, pension funds need the high returns to fulfill their obligations, and those obligations were entered into by labor and management. The fact is that we don’t have the economic growth to come through over the long term through a conservative investing strategy, so the managers start rolling the dice. If they fail and it blows up, they’re fired, and if they luck out, they’re heroes for the day.

It wasn’t just the big shots. Unless you’re a prodigy (i.e., you’re a 2 year old reading this weblog) and you’re an American you lived through the real estate bubble of the mid-aughts, and you know people who treated their homes like ATMs. People who bet on a “sure thing” future which never came about. Yes, there were greedy mortgage brokers and shady speculators, but if it wasn’t for the avarice of the average man and woman it wouldn’t have been so widespread. But here’s the difference: the average American has experienced a lot of economic distress or insecurity. There have been real consequences for their bad calls. The unemployment rate is high enough that anyone who isn’t a shut-in knows someone who’s been negatively impacted. Not so for Sirs Greenspan and Rubin. The high & mighty are too big to fail, they may have their reputations tarnished but ultimately their lot is one of comfort and ease. This is of course not atypical, it’s most of human history.

I think the ultimate long term problem for American society is that many Americans now perceive the elites as rent seekers and not engines of productivity. The vision of the expanding pie is starting to recede, and once the spell is broken I fear for the well being of the “virtuous circles” which economists praise.

Anyway, I was referencing Shaggy long before Mr. Klein.

• Category: Economics, Science • Tags: Culture, Finance 
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Daniel Gross has a piece out on the rise of the cash economy, Cash Is King I found this section interesting, though not surprising:

…During the go-go years, it was common to hear theorists talk about the “discipline of debt.” On paper, high debt loads force managers (and homeowners) to make tough, swift decisions to stay solvent. Default, and you lose the company (or the house). But in reality, rather than scrimp, overextended borrowers are more likely to walk away from mortgages, or push companies into Chapter 11 bankruptcy protection. Americans are now discovering that cash exerts a superior discipline. The real discipline of cash may be that it causes executives, consumers, and investors to think twice—and to think about the long-term consequences—before spending. The need for instant gratification is part of what created the current mess.

There’s theory, and then there’s reality. I really don’t know if cash is so much better at enforcing discipline, but I’m sure theorists can invent a new rationale for why it is superior to debt financing in maximizing economic utility. Economic behavior is the most amenable in the social domain to theorizing, but too often it seems to fall prey to false certainty and after the fact rationalization of the status quote as the timeless equilibrium. This of course does not mean that we should not think logically, or deduce inferences from what we know a priori. Rather, in the social domain we should be extremely self-aware of our uncertainty as to the validity of our inferences based on the lessons of history. For example, there’s an obvious straightforward possible social consequence in regards to the spread of cash envelope usage, more break-ins. The greater utilization of relatively concrete paper currency* and its consequent drawbacks will probably make us more cognizant of the benefits of more abstract financial tools such as revolving credit card accounts (e.g., you lose cash, you’re screwed, you lose your credit card, you’re insured).

* Paper currency is itself a relatively new invention over the scope of human history

• Category: Economics, Science • Tags: Finance 
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I’m going to leave this without comment, The Crash-Test Solution. Subhead: “we now know that few people saw the downturn coming. Scientists are working to make sure that never happens again.”

• Category: Science • Tags: Finance 
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From Toward Rational Exuberance: The Evolution of the Modern Stock Market:

What must have been most galling was a simple point Cowels often made that was never answered effectively by the investment advice practioners. As Cowels put it, “Market advice for a fee is a paradox. Anyone who really knew just wouldn’t share his knowledge. Why should he? In five years, he could be the richest man in the world. Why pass the word on?”

In spite of the conclusions he reached, Cowels never doubted that investors would keep buying newsletters. As he put it, “Even if I did my negative surveys every five years, or others continued them when I’m gone, it wouldn’t matter. People are still going to subscribe to these services. They want to believe that somebody really knows. A world in which nobody really knows can be frightening.

The quote is from Alfred Cowles, the early patron of econometrics. It’s kind of like The Bachelor, people know it’s not really going to work out, but they keep watching just in case there’s a repeat of Trista & Ryan. This book was written in 2001, but a great deal of it will be of interest to those of us who live in 2009 (see this review).

• Category: Science • Tags: Finance 
Razib Khan
About Razib Khan

"I have degrees in biology and biochemistry, a passion for genetics, history, and philosophy, and shrimp is my favorite food. If you want to know more, see the links at"