“I have a working knowledge of the entire universe and everything it contains”

As Sheldon Cooper would have it, physics explains everything. All the workings of the universe, from black holes and dark energy to the financial markets down to the inner workings of our brains and the atoms and molecules that comprise them are assumed to be controlled by the same set of fundamental physical laws. That goes a long way towards explaining why the finance industry hires so many physics Ph.Ds. Anyway, or so the thinking goes, the only people who are studying anything really interesting are – like Sheldon – theoretical physicists.

The misplaced triumphalist arrogance of certain physicists (and many alleged experts) is nothing new, of course.  For example, the discoverer of the positron proclaimed that, thenceforth, “the rest is chemistry.”

PuritySource: xkcd

Unfortunately for Sheldon, the ability to reduce everything to physics does not mean that we can start with physics and reconstruct – or even model meaningfully – the universe. In fact, the more we learn about fundamental physics, the less relevance it seems to have to our everyday world, largely on account of scale and complexity. Continue reading

“Assume a Spherical Cow”

Anyone who has managed money for more than about a nanosecond recognizes that the idea that the markets are efficient is a myth, especially in times of crisis, real or perceived. Despite claims of scientific objectivity, economics is as prone to human frailty as anything else. As Seth Godin wrote this week: “Your first mistake might be assuming that people are rational.” For example, on my birthday in 2008, the S&P 500 lost over 9 percent, over a trillion dollars in value, on account of (per CNN) nothing more definitive than “recession talk.” That’s hardly evidence of rationality.

The consistently engaging 3 Quarks Daily has a new piece up this week on economics as religion rather than science. It’s hardly a novel concept, but the argument is an interesting one.  However, author Ben Schreckinger missed or ignored some of the best available evidence, which I’ll get to in a bit of a roundabout way.

Spherical Cow2The above cartoon (from Abstruse Goose) riffs on a classic physics joke that goes something like this:

Milk production at a dairy farm was low, so a farmer wrote to the local university to ask for help. A multidisciplinary team of professors was assembled, headed by a theoretical physicist, and two weeks of intensive on-site investigation took place. The scholars then returned to the university, notebooks crammed with data, where the task of writing the report was left to the team leader. Shortly thereafter the physicist returned to the farm, and advised the farmer, “I have the solution, but it only works in the case of spherical cows in a vacuum.”

Thus “spherical cow” has become a metaphor for highly (overly!) simplified scientific models of complex real life phenomena. Economists may be even worse offenders than theoretical physicists. As Hale Stewart wrote yesterday, “complex models that claim to model the entire US economy just aren’t worth the time of day no matter how good the algorithms backing it up. “That economists so frequently suffer from “physics envy” makes for a delightful bit of irony. Yet an even worse offense by economists is their all-too-frequent willingness to elevate a favored ideology ahead of the actual facts. People are routinely driven by their ideologies and their behavioral biases rather than facts and data, of course, but economists claim to be acting as scientists, with a delineated method designed to root out such things. If only. Continue reading

Dread, Foreboding and Fear

My late mother always used to say that the anticipation of Christmas was a major part of its allure.  C.S. Lewis capitalized on that truth in The Lion, the Witch and the Wardrobe by making the White Witch’s evil spell on Narnia mean that it was “always winter, but never Christmas.”  Heinz used the power of our anticipatory feelings to its advantage in the following commercial (using Carly Simon’s classic song – you can view a rare Simon live performance of it here).  Even though it’s just ketchup, albeit very s-l-o-w ketchup, it works.

Anticipation has a negative counterpart, of course.  It’s dread – the feeling that you know something isn’t quite right, you fear it’s bad (and maybe really bad), but you still aren’t quite sure what will happen or how it will happen.  Terror seems on the way.  Horror is possible, even likely.  But, for now, all we have is a foreboding dread.

Does that feel familiar? Continue reading

Bernanke Speaks

Fed Chairman Ben Bernanke gave a speech on the economy yesterday. He was clear in outlining his employment objectives and in his commitment to keeping interest rates low even after the economy begins to improve (at least through mid-2015).  In general, Wall Street loved itMatt Yglesias loved itJoe Weisenthal loved it.  Of course, it makes sense that Wall Street would generally be supportive.  Bernanke’s policy tract is designed to support asset prices and keep the cost of capital low.  Win-win.

In the speech Bernanke made the case that the Fed is not enabling fiscal profligacy (despite all evidence to the contrary), is not monetizing the debt (really?), is capable of handling inflation when the time comes (we’ll see), and is highly transparent and open (that’s why he doesn’t want to be audited). He also asked Congress to address the “fiscal cliff,” just not yet.  Jon Stewart dealt with an earlier version of claims of this sort here.

Bernanke also tried to debunk the idea that the Fed’s interest rate policy is not screwing savers.  In this regard he focused on the need to deal with the financial crisis and the ongoing economic weakness.  He then went on to argue that because savers “wear many economic hats,” low rates need to be viewed in context.  In Bernanke’s view, policies leading to a stronger economy trump all other concerns.

The best and most comprehensive solution is to find ways to a stronger economy. Only a strong economy can create higher asset values and sustainably good returns for savers. And only a strong economy will allow people who need jobs to find them. Without a job, it is difficult to save for retirement or to buy a home or to pay for an education, irrespective of the current level of interest rates.

This viewpoint carefully ignores the basic economic principle that incentives work.  When savings returns are less than zero (after inflation) and close to zero nominally, we can’t expect people to save.  Indeed, the personal-saving rate stood at just 3.7% in August 2012. That’s up from the 1.5% low of 2005, but half the 7.5% average recorded in the last three decades of the twentieth century. As my friend Joe Calhoun points out, Bernanke wants us to spend today — and not on stuff with guarantees attached. Meanwhile “[w]e’re running out of future from which to borrow” in order to pay for what we buy.  

What’s worse, even if we conceded that it’s okay to screw savers and mortgage the future to get the economy moving, we simply can’t expect the economic recovery Bernanke’s policies are supposed to achieve unless and until the economic benefits the Fed doles out to major banks and major corporations via lower interest rates and bond purchases and to banks and the well-to-do via frothy markets trickle-down to the masses. Do we have good reason to expect that to happen?  For example, the S&P has risen roughly 80 percent since the lows of 2009 with only meager economic improvement and dreadful ongoing unemployment.

The overall idea behind all this is obviously to “stimulate demand.” Only once demand is restored will companies begin hiring again, or so this thinking goes. Yet despite the Fed’s best efforts, from the first quarter of 2008 through the second quarter of 2012, annualized growth in real consumption spending has averaged a mere 0.7% — all the more extraordinary when compared with the pre-crisis trend of 3.6% in the decade ending in 2007. Recent data have been terrible too.

Following a decade of profligate spending fueled by debt and credit bubbles, American households (fearful for their jobs and nervous about the future) are simply trying to repair the damage to their household balance sheets.  The overall level of household indebtedness is at 113% of disposable personal income as of mid-2012.  That’s down from its pre-crisis peak of 134% in 2007, but still well above the 1970-1999 norm of around 75%.

Even so, the Fed still tries to get demand going by – you guessed it – offering lower interest rates and supporting asset prices.  Déjà vu all over again.

Savers will continue to get screwed.  Bernanke essentially admits it.  Meanwhile, those with first access to money (think banks, Fortune 500s and the wealthy) are the primary beneficiaries of the Fed’s largesse.  Earlier rounds of quantitative easing haven’t helped much (if at all).  Bernanke pleaded his case, but is there any reason to think that the benefits of the Fed’s free-money policies will trickle-down to the general population?

Just askin’.

What Bernanke Really Said

As I noted a week ago, the Fed has effectively conceded that it is out of bullets.  Via a speech yesterday afternoon in Cleveland and the Q&A session that followed, Fed Chairman Ben Bernanke reiterated the point more directly.  Bernanke acknowledged that long-term unemployment is a “national crisis” and suggested that Congress should take further action to combat it.  He argued that Congress could be especially helpful in the areas of long-term unemployment, budgetary discipline and housing policy. Bernanke then went on to offer both a sort of justification for what the Fed has done (or not done) to this point along with an admission that he’s out of ideas. 

“The Federal Reserve has made enormous efforts to try to help this economy recover and stabilize” though its control of interest rates, or monetary policy, he said. “Monetary policy can do a lot, but monetary policy is not a panacea,” Bernanke said.