One of the things I run into with great consistency when I try to talk to people about alternate conceptions of social organization (besides the currently prevalent "nation-state") is their unbalanced accounting: they will dig hard and deep to find the most perplexing edge-case for the alternate system (examples include tragedy-of-the-commons type problems, "freeloader" problems, etc., problems that of course exist and are not nicely solved by the current system either) and when the answer isn't a slamdunk proclaim "aha! Your system is broken, conversation ended!", while seemingly not seeing the gargantuan mass of problems that the *current* system already has in widely demonstrable form. I wish I had documented *all* of them, just so I could return their remark with a list of thousands and thousands of not imagined problems or anticipated problems but *existing* problems, but I guess there's no time like the present to start.
To wit: what a surprise, an audit has found that police regularly misues police databases to look up data about celebrities. And yet, the same people that tell me how good the current system is and how bad an alternative would be will just go on assuming that somehow the people who work for government are "different" than eveyrone else, that government is "benevolent" and works "for the people", rather than seeing that there is no such as "government" as an entity, there are only people, the only agents in our society that take action are people, and whether or not people work for the government or not, they still have the same strengths, weaknesses, desires, self-interests, etc., as everyone else. Which is to say: any system designed with the notion that there will exist one "super class" of people that is above human nature and can be trusted to act benevolently even if they do not have sufficient incentives to do is designed from false assumptions and likely to be very dissappointing.
It is likely to end up, say, trusting that "super class" of people with more information and power than normal people and then expecting them not to use that information or power for their own uses.
And that's not theory: it is demonstrable fact. Read the article.
Friday, August 7, 2009
Wednesday, July 1, 2009
On why we can't overinterpret history
One of the places where I often run into fundamental blocks when discussions subjects of interest to this blog with others is in the interpretation of history.
Some people will look at a historical event and draw definitive conclusions from it. Irrespective of whether they are correct or not in their conclusion, the methodology is broken.
Compare and contrast a scientific experiment with a historical event. If you've ever taken a class with a laboratory component, you know how much effort and precision goes into the design of experiments: they must be carefully controlled so that you can be sure that the effect you are seeing has the cause that you are hypothesizing. Famous examples of mistaken experiments abound, and these are mistakes that are very subtle and yet completely alter the conclusion that can be drawn from the experiment.
Now contrast this with the process of reading about a historical event and attempting to draw a definitive conclusion about cause and effect from it: nothing is controlled, there is only one data point. Could you imagine trying to submit a paper proving Newton's law of gravity not by actually running experiments in which you drop things (carefully!) and measuring them (carefully!), but instead by reading about someone dropping something in a history book??
History is great for two things: for hypothesis creation, and for negative proof via counter-examples. It is terrible for hypothesis *proving*, however.
The frustrating result is that 99% of what is said by many reasonably smart people is just wasted oxygen/pen/electrons. It's not that it's wrong, but that because its methodology is wrong, it adds nothing to the information about the subject.
Just one of the many things that frustrates me about the world I live in.
Some people will look at a historical event and draw definitive conclusions from it. Irrespective of whether they are correct or not in their conclusion, the methodology is broken.
Compare and contrast a scientific experiment with a historical event. If you've ever taken a class with a laboratory component, you know how much effort and precision goes into the design of experiments: they must be carefully controlled so that you can be sure that the effect you are seeing has the cause that you are hypothesizing. Famous examples of mistaken experiments abound, and these are mistakes that are very subtle and yet completely alter the conclusion that can be drawn from the experiment.
Now contrast this with the process of reading about a historical event and attempting to draw a definitive conclusion about cause and effect from it: nothing is controlled, there is only one data point. Could you imagine trying to submit a paper proving Newton's law of gravity not by actually running experiments in which you drop things (carefully!) and measuring them (carefully!), but instead by reading about someone dropping something in a history book??
History is great for two things: for hypothesis creation, and for negative proof via counter-examples. It is terrible for hypothesis *proving*, however.
Statistician Paul Holland (1986) cautions that there can be “no causation without manipulation,” a maxim that would seem to rule out causal inference from nonexperimental data.This is a perfect example: if you don't get to manipulate an experiment to try to tease out the causal factors, you really can't make causal inferences. And yet, this is bread and butter in 99% of common discourse! Every talk radio, newspaper editorial, television advocacy program, politician, and blog lives on this. Just look, for example, at the number of definitive statements that have been made about the recent economic situation. Sure, there is interesting stuff to see here to try to formulate hypotheses that we can then go and analyze and experiment with in much more detail, but we cannot draw conclusions from this set of history, there are way too many uncontrolled variables.
The frustrating result is that 99% of what is said by many reasonably smart people is just wasted oxygen/pen/electrons. It's not that it's wrong, but that because its methodology is wrong, it adds nothing to the information about the subject.
Just one of the many things that frustrates me about the world I live in.
Monday, June 22, 2009
Debate on the Great Depression and current crisis comes from within Federal Reserve system itself
I have had at least one professional economist declare to me that certain things in economics are known as facts, and that anyone who disputes them is "discredited" and full of "nonsense". To him, this includes all Austrian economists and the entire school of Austrian economics, as well as many closely related thought leaders, e.g. Robert Higgs and his alternative analysis of the Depression in terms of "regime uncertainty". He has insisted that no one who counts amongst "mainstream economics" even thinks there is a "debate" any longer on these issues.
I wonder if economists in the Federal Reserve system itself count? Members of the Richmond Federal Reserve bank Steelman and Weinberg, in the lead article of the 2008 Annual Report of the Federal Reserve bank of Richmond, make heavy reference to Higgs' regime uncertainty concept:
More broadly, they criticize the Fed (their own employers):
The authors certainly do not buy Higgs' thesis hook, line and sinker, but that's not the point: the point is that it is part of the debate, and not just within masturbatory austrian circles, but in the much wider economics community.
HT: I lifted these quotes from The Beacon, which is a very interesting Blog by members of the Independent Institute (which includes Higgs, though he didn't write the post from which I am cribbing).
I wonder if economists in the Federal Reserve system itself count? Members of the Richmond Federal Reserve bank Steelman and Weinberg, in the lead article of the 2008 Annual Report of the Federal Reserve bank of Richmond, make heavy reference to Higgs' regime uncertainty concept:
Through the [current] crisis, the Fed’s approach has evolved and changed in numerous directions, including the direction of credit to particular market segments and institutions. Beyond winding down its many new lending vehicles, the Fed will need to make it clear to all market participants which principles it will follow during future crises…. Public policies by all agencies must be well articulated and time consistent so that market actors can make rational plans regarding their financial and other business affairs. Arguably, such policy uncertainty did much to prolong the Great Depression in the United States (pp. 16-17) [footnote to Higgs (1997)].
Third, there is policy uncertainty. After the onset of the crisis, the Federal Reserve and the Treasury took several actions to help stabilize the financial sector. However, these actions appeared to evolve on a case-by-case basis. Some institutions received support, while others did not, making it more difficult for market participants to discern the governing principles and to make predictions about future policy moves. These institutions were already facing an uncertain economic environment, which contributed to relatively sparse lending opportunities. Coupled with an uncertain public policy environment, it is not surprising that many have been hesitant to lend and that many have had trouble raising private capital.
[T]here is also a strong case to be made that the function of market discipline can be improved by constraining some forms of government intervention, especially those that dampen incentives by protecting private creditors from losses (p.5)…. However, additional regulation of financial markets would likely hamper innovation in that industry. An alternative approach is to seek to reduce the scope of explicit safety net protection—as well as creditors’ expectations of implicit protection of firms deemed too big to fail (p.11).
More broadly, they criticize the Fed (their own employers):
The Fed could benefit from heeding the advice of two classical economists, Henry Thornton and Walter Bagehot, who considered how the Bank of England could act effectively as the lender of last resort. The Thornton-Bagehot framework stress six key points:
• Protecting the aggregate money stock, not individual institutions
• Letting insolvent institutions fail
• Accommodating only sound institutions
• Charging penalty rates
• Requiring good collateral
• Preannouncing these conditions well in advance of any crisis so that the market would know what to expect.Current Federal Reserve credit policy has deviated from most if not all of these principles.
The authors certainly do not buy Higgs' thesis hook, line and sinker, but that's not the point: the point is that it is part of the debate, and not just within masturbatory austrian circles, but in the much wider economics community.
HT: I lifted these quotes from The Beacon, which is a very interesting Blog by members of the Independent Institute (which includes Higgs, though he didn't write the post from which I am cribbing).
Saturday, June 20, 2009
Paul Krugman wanted the government to cause a housing bubble
Here's some of Paul Krugman's "best": (from August 2002)
"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
That's right: Paul Krugman *wanted* the government to create a housing bubble.
But somehow this is *not* an example of government intervention just putting off until later a needed correction? Much like the current government is attempting to do *again*? We're supposed to listen to this clown despite his complete and total miss on this?
"To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble."
That's right: Paul Krugman *wanted* the government to create a housing bubble.
But somehow this is *not* an example of government intervention just putting off until later a needed correction? Much like the current government is attempting to do *again*? We're supposed to listen to this clown despite his complete and total miss on this?
Saturday, February 14, 2009
On banking
Like many people, I have found myself unusually interested in topics like economics and banking lately. I've watched much of my net worth go up in smoke as housing and stock prices have plummeted, I've watched friends and family struggle through lost jobs, and I realized that I really had little idea of what is causing all of this.
So I've been on a crash-course lately. One of the first things I've read on the subject still remains perhaps my major candidate: our "financial system", by which I mean our currency system, our banking system, and the federal reserve system that is the engine for both of of those.
Let me be clear: I'm not *just* talking about the current economic crisis. I'm talking about the repeated *pattern* of such crises, from the dotcom bubble, back to the recession of the late 80s/early 90s, and going back further to the economic problems of the late 70s and early 80s (i remember mortgage rates in the high teens, though I was too young to have one myself).
And I'm really not talking just about the US: it's clear that many if not most other countries are experiencing similar boom and bust cycles.
So why currency and banking? For one, it is my understanding that most countries now have the same basic system as the US, more or less the "federal reserve system". In particular, the bugaboos that I see are A) fiat currency, that is, currency not backed by something of intrinsic value (like gold), and B) fractional reserve banking, that is, the policy by which a bank can accept money from depositors based on the promise that *at any time, that depositor can have his money back*, and then they promptly turn around and loan the vast majority of it out (the exact amount that they have to keep is the "fraction" that they have to keep in "reserve").
This post in the NYTimes freakonomics blog is pretty typical of the reasoned, relatively politically impartial explanations and discussions I have seen about the economic crisis:
http://freakonomics.blogs.nytimes.com/2008/10/15/everything-you-need-to-know-about-the-financial-crisis-a-guest-post-by-diamond-and-kashyap/
Take a step back: does it sound like a good idea to build the entire concept of a nation's prosperity and longevity on something as ephemeral as "confidence"?
Isn't there a small voice in the back of your mind that says "perhaps it should be based on solid principles that *can't* fail instead of 'confidence'"?
And to be really cynical: don't we have a special, pejorative term for businessman that rely on "confidence", that is, "confidence man"? And isn't that term reserved for a con-artist who only gets away with his cons because of the confidence his marks have in him?
Shouldn't, in other words, our *legitimate* banking system be based on something other than what con-artists based their success on? Or, put another way: if both con-artists and bankers depend on "confidence" for their success, are they really *different*?
These questions aren't just rhetorical when you dig into the details: there's a disturbing similarity between fractional reserve banking as it is practiced today and so-called "Ponzi schemes" as practiced by con-artists (such as the currently infamous Bernard Madoff).
Let's review Ponzi schemes (or more generally pyramid schemes): the con-artist hangs out a shingle advertising himself as a place for investors to invest their money at good rates of return. Investors originally come to him because of some sort of confidence in the con-artist: he has a good story to sell, he's a good salesman, he prints up glossy brochures, whatever. He tells the investors that they will get a good rate of return, and that they can take their money out of the scheme at any time. Original investors give him money, and he duly reports that they have made additional money. If the investors are convinced that their money is safe and growing in the scheme, generally they do not make withdrawals. For the few investors that do make withdrawals, the con-artist simply gives them back money he has taken from them and other investors. Often, the con-artist uses those withdrawers as "proof" to other current and potential investors that the scheme is legitimate, because look, that person got his money back and then some! Do you see the pattern? As long as enough investors have "confidence" in the scheme so that they leave the money in the scheme and don't withdraw it, the con-artist can continue taking money and spending it on himself without ever actually investing the money. The scheme can continue for as long as the confidence is sufficient to bring in more money than is being withdrawn, and in the meantime, the perception on the part of the investors is that things are going great, because on paper, they appear to be getting wealthy fast.
Of course, eventually what happens is that something happens and people start to lose confidence and withdraw their money, and the deception and con are laid bare, and many people lose a *lot* of money.
But wait! What if there were a *network* of con-artists, each running their own Ponzi schemes, that cooperated to cover each other's "runs"? In other words, if one scheme gets a "run", the other schemes step in and temporarily loan him the money to cover his run - in a short-term, for-interest loan naturally - until his investors get their confidence back? Once his scheme is flowing again, he can pay back those loans, and the crisis is averted for the whole collective of ponzi-schemers.
Except: can't that also fail if there is a *massive* loss of confidence in *all* ponzi schemes? At this point, the schemers can't borrow from anyone because they are all in trouble, short-term loans from other schemers dry up because none of them has the extra cash to spare, and what can happen is a domino effect as one after another scheme is laid bare and goes insolvent.
Unless, of course, there's a "lender of last resort": an entity that can print infinte money and that can step into the void and prop up the entire Ponzi-scheme industry when there is a massive, industry-wide "lack of confidence".
I admit that similarity is not "proof", but it's at least a warning flag: doesn't the above sound a *lot* like our current banking system, with "ponzi scheme" replaced by "bank", "con-artist" replaced by "banker", and "lender of last resort" being played by the Federal Reserve?
I am not at all convinced that that parallel is not accurate.
I suppose one legitimate question that I don't think I'll attempt to answer in this post is "well, so what? *If* it's the case that the banking scheme as currently constructed is at its roots a ponzi scheme *but it still provides great value to society* because, say, it "greases economic wheels" in a way that a less ephemeral system might not, then merely noting that our system *is* a ponzi system may not be enough to justify changing that. I'm skeptical that I could be convinced of that - again, look at the freakanomics blog and look how much it talks about the need to mitigate *exactly* the kinds of problems a network of ponzi schemes would have to mitigate to conclude (at least tentatively) that if we didn't have that scheme, we wouldn't have those problems to mitigate in the first place, and thus arguably wouldn't be having these periods of booms and busts - but I'll leave that on the table for some later day.
Meanwhile, let me return to this issue of banking. From the day I was a kid, I've been told and "understood" that when I made a deposit in a bank, it didn't actually *stay* in the bank, it was lent out to someone else. And I bought that (I believe I've blogged about the scene in "It's a Wonderful Life" where Jimmy Stewart sells this idea lock stock and barrel).
But the more I think about it, the more something doesn't smell right. For one, symmetry is usually a good sign. When I take out a loan from a bank - that is, when they give me money on the promise that they'll get their money back later - I do not take it on the basis that the bank can come and get their money any time they want. In fact, I have a very measure timeline over which they will get their money back: they get a certain amount once a month, for a fixed period of time. Because I know exactly what that schedule of repayment is, I can safely manage spending that money in a way in which I will never be "surprised" by a "run" on the money I've borrowed from the bank. The bank does not need to have "confidence" that I have the money: they have a schedule saying exactly when they will get the money paid back, and in the event that I fail to keep to that schedule, they have the collateral that I've put up against that loan, e.g. my house in a mortgage loan.
But the lack of symmetry is startling. In terms of first principles, there is no difference between a bank giving me money for me to eventually give back, and me giving the bank money for them to eventually give back to me. And yet, the terms are completely different. When I give the bank money - at least in a standard deposit - the bank does not have a schedule on which to give it bank to me. Instead, it is as if they took a loan from me that I can insist at any time I want the entire balance back, instantly. Who would take a loan like that? It seems clear to me that the same reasons an individual doesn't take a loan like that - basically, because it makes the money unusable - are the same reasons such a loan would have no value to a bank. And yet, they take it... just like the con-artist takes the money into his Ponzi scheme on the false promise that all of his investors can have their money back in total any time they want. The second that bank actually *does* something with that money, they've made it so that they cannot keep their promise to all of the people they have taken a loan from.
Doesn't that sound like it could be a root cause of a lot of ills? We have people signing contracts that they know they cannot keep, and this is the fundamental basis of the federal reserve system. It *is* a ponzi scheme, and it is therefore no wonder that the scheme depends on the "confidence" of the people who have given their money into the scheme in the mistaken belief that the schemers can actually keep the contract they made with them.
And all seems great while confidence is high, as in all Ponzi schemes: the depositors leave their money in the scheme and see great numbers on paper and feel wealthy and may even go out and spend more on consumer items and other immediate consumption than they normally would, and that money goes into the hands of the people who sold those products and they feel confident and continue to spend the money, all because on *paper*, they have a lot of wealth stored in the ponzi scheme.
That spending/consumption has a reverberation in the system, though: it represents withdrawals from the ponzi schemes. Ponzi schemes can survive a certain amount of withdrawal - as noted, they pay withdrawals from others' deposits - but they can be a victim of their own success: as people see a *lot* of wealth on paper, they feel more comfortable withdrawing that money *for the consumption we just mentioned*. As that spending continues, the Ponzi schemes start to get closer and closer to the breaking point. They are of course still exuding confidence: they have to, that's what their scheme is based on. But ironically, too much exuded confidence continues to prompt depositors to take their paper wealth and spend it, bring the schemes to the popoint of ruin. The first schemes to hit this point will survive by the trick of borrowing from other schemes, but if the depositor's behavior is widespread, eventually they are all going to hit the edge, and the whole system is going to come crashing down.
Note that this crash can also be exacerbated or caused by externalities that cause a lack of confidence, e.g. 9/11, but the dynamics here seem to indicate that even without the externality, the system is bound to run into boom/bust cycles.
I'm not in any way saying that this is a thoroughly educated economics proof, but it sure does pass at least the "laugh test" for me. It is plausible, it is explanatory, it is predictive, and those predictions match the general pattern of what we've seen historically, as well as even the descriptions of what we are seeing in the responses to the current crisis: it sounds like a group of ponzi schemers trying to figure out how to keep their scheme afloat. Look at the specifics: the banks are "trying to get credit flowing again", or in ponzi-speak, the ponzi schemers are trying to get enough above water that they can start covering each other's "runs" again. In fact, the term "run" is explicitly used in the discussions of the banking industry's problems!
So if this is true, then how to fix it? I think it starts right at the bottom, in the relationship that banks have with depositors: no one should ever agree to a contract that they can't keep. Just as a person taking a loan from a bank does not falsely promise to pay back that loan whenever the bank wants it and backs up their loan with something tangible that will go to the bank if they can't otherwise pay the bank, a bank should only make contracts with its depositors that it can keep. If it takes in a depositor's money based on the notion "you get your money whenever you want", then it needs to *keep that money*. No fractional reserve banking *on that kind of a deposit*. True, the banking industry would need to change a little, but that's kind of the whole point here, right, if it's the banking system that's at the heart of the boom/bust cycles, then we *want* to change the banking system. If a bank is just going to keep your money in a vault - literally just be a safe place to store your money, the way it is adverstised - they inevitably you are going to have to pay them for that, just as you pay the UStorage place to keep your stuff in storage. The free market will eventually work out good compromises and rates here.
Where will banks get money to loan out, if not from deposits? Basically, they need to "borrow" money from individuals in the symmetric way that individuals borrow money from banks. One way in which this concept exists today is in the form of "certificates of deposity". A CD is analagous to a loan: the bank does *not* promise that the money can be had at any time in its entirety, but instead agrees to a fixed schedule for repayment, with some extra interest on top. Because the bank knows that this money can't be "run", it can figure out how to loan that money out *and still pay the money back on the schedule that it agreed to*. Think about it: when you get a loan, say, it is not uncommon to think "I'll need to pay back this loan starting next month, so I'll put a bit of the loan aside to make the first few payments; I'll then use the rest to buy the car I wanted, and I know from my analysis of my cashflow situation that I'll be able to start making the payments from my salary starting in a couple of months." That is, you can spend the money from the loan while still carefully planning on how to pay back the loan. With a CD or other "loan" like instrument, a bank can do exactly the same thing. They will know their payback schedule and the payback schedules of the loans *they* have made, and it's an easy accounting exercise to make sure that they can meet their obligations. Note that the bank is not in danger even if their outstanding loans go belly up, as long as they did their homework in evaluting the collateral: if the loan defauls, they take the collateral and convert it into the cash they need to pay back their CD holders. To be sure, such a bank can *purchase* insurance to cover the very small chance that they lose money on a loan and cannot quite cover a CD obligation, but as that should be very rare and a very small amount of money, such insurace such be inexpensive relatively speaking, and of course the bank should account for that cost in the interest it charges on its outgoing loans.
No "confidence" is needed in such a system. There is no "ponzi scheme" element to such a scheme. It works because it is a series of contracts that are actually intended and guaranteed. There cannont be a "run" on such banks.
It's pretty clear that individuals would participate. How many would choose to just keep their money in a bank for a fee? Probably not too many: they know that they can make interest on that money in a CD, so they'd probably choose to put most of their excess into CDs, leaving enough in the bank to cover immediate cashflow. Thus, most of the money would still be available to the banks for loaning. But that money would not require *confidence* to loan back out, it would simply require *accounting*: there's no risk that the holders of CDs can "run the bank", and so banks can lend it out with clarity about their obligations and determinism about what they do and will hold and when.
So in my naive, non trained-economists view, this appears to solve the problems with "runs" on banks and "confidence" while still allowing capital to flow throughout the economy. It allows banks to make money, but arguably less money than they currently make, for the benefit of reducing the "boom/bust" cycles that seem to naturally flow from the ponzi-scheme setup that most of all current nations currently have. And it eliminates the need for a "lender of last resort" and thus the currency manipulation on the part of the Federal Reserve or its equivalent in other countries that seems to contribute to many woes (admittedly, I haven't gone into that much here, but this post is long enough).
So I've been on a crash-course lately. One of the first things I've read on the subject still remains perhaps my major candidate: our "financial system", by which I mean our currency system, our banking system, and the federal reserve system that is the engine for both of of those.
Let me be clear: I'm not *just* talking about the current economic crisis. I'm talking about the repeated *pattern* of such crises, from the dotcom bubble, back to the recession of the late 80s/early 90s, and going back further to the economic problems of the late 70s and early 80s (i remember mortgage rates in the high teens, though I was too young to have one myself).
And I'm really not talking just about the US: it's clear that many if not most other countries are experiencing similar boom and bust cycles.
So why currency and banking? For one, it is my understanding that most countries now have the same basic system as the US, more or less the "federal reserve system". In particular, the bugaboos that I see are A) fiat currency, that is, currency not backed by something of intrinsic value (like gold), and B) fractional reserve banking, that is, the policy by which a bank can accept money from depositors based on the promise that *at any time, that depositor can have his money back*, and then they promptly turn around and loan the vast majority of it out (the exact amount that they have to keep is the "fraction" that they have to keep in "reserve").
This post in the NYTimes freakonomics blog is pretty typical of the reasoned, relatively politically impartial explanations and discussions I have seen about the economic crisis:
http://freakonomics.blogs.nytimes.com/2008/10/15/everything-you-need-to-know-about-the-financial-crisis-a-guest-post-by-diamond-and-kashyap/
Of course there's a lot more in the post, but I'm struck time and again by this same sort of message: the underlying problem seems to be that banks could fail, and the driving of that possible failure is "loss of confidence".Until this week, it appeared to be increasingly possible that there could be widespread bank failures that would impair the lending capacity of the banking system for a long time. We agree with the words of Ben Bernanke this week: “As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets …”
Banks are vulnerable to loss of confidence because they rely on short-term funding.
Take a step back: does it sound like a good idea to build the entire concept of a nation's prosperity and longevity on something as ephemeral as "confidence"?
Isn't there a small voice in the back of your mind that says "perhaps it should be based on solid principles that *can't* fail instead of 'confidence'"?
And to be really cynical: don't we have a special, pejorative term for businessman that rely on "confidence", that is, "confidence man"? And isn't that term reserved for a con-artist who only gets away with his cons because of the confidence his marks have in him?
Shouldn't, in other words, our *legitimate* banking system be based on something other than what con-artists based their success on? Or, put another way: if both con-artists and bankers depend on "confidence" for their success, are they really *different*?
These questions aren't just rhetorical when you dig into the details: there's a disturbing similarity between fractional reserve banking as it is practiced today and so-called "Ponzi schemes" as practiced by con-artists (such as the currently infamous Bernard Madoff).
Let's review Ponzi schemes (or more generally pyramid schemes): the con-artist hangs out a shingle advertising himself as a place for investors to invest their money at good rates of return. Investors originally come to him because of some sort of confidence in the con-artist: he has a good story to sell, he's a good salesman, he prints up glossy brochures, whatever. He tells the investors that they will get a good rate of return, and that they can take their money out of the scheme at any time. Original investors give him money, and he duly reports that they have made additional money. If the investors are convinced that their money is safe and growing in the scheme, generally they do not make withdrawals. For the few investors that do make withdrawals, the con-artist simply gives them back money he has taken from them and other investors. Often, the con-artist uses those withdrawers as "proof" to other current and potential investors that the scheme is legitimate, because look, that person got his money back and then some! Do you see the pattern? As long as enough investors have "confidence" in the scheme so that they leave the money in the scheme and don't withdraw it, the con-artist can continue taking money and spending it on himself without ever actually investing the money. The scheme can continue for as long as the confidence is sufficient to bring in more money than is being withdrawn, and in the meantime, the perception on the part of the investors is that things are going great, because on paper, they appear to be getting wealthy fast.
Of course, eventually what happens is that something happens and people start to lose confidence and withdraw their money, and the deception and con are laid bare, and many people lose a *lot* of money.
But wait! What if there were a *network* of con-artists, each running their own Ponzi schemes, that cooperated to cover each other's "runs"? In other words, if one scheme gets a "run", the other schemes step in and temporarily loan him the money to cover his run - in a short-term, for-interest loan naturally - until his investors get their confidence back? Once his scheme is flowing again, he can pay back those loans, and the crisis is averted for the whole collective of ponzi-schemers.
Except: can't that also fail if there is a *massive* loss of confidence in *all* ponzi schemes? At this point, the schemers can't borrow from anyone because they are all in trouble, short-term loans from other schemers dry up because none of them has the extra cash to spare, and what can happen is a domino effect as one after another scheme is laid bare and goes insolvent.
Unless, of course, there's a "lender of last resort": an entity that can print infinte money and that can step into the void and prop up the entire Ponzi-scheme industry when there is a massive, industry-wide "lack of confidence".
I admit that similarity is not "proof", but it's at least a warning flag: doesn't the above sound a *lot* like our current banking system, with "ponzi scheme" replaced by "bank", "con-artist" replaced by "banker", and "lender of last resort" being played by the Federal Reserve?
I am not at all convinced that that parallel is not accurate.
I suppose one legitimate question that I don't think I'll attempt to answer in this post is "well, so what? *If* it's the case that the banking scheme as currently constructed is at its roots a ponzi scheme *but it still provides great value to society* because, say, it "greases economic wheels" in a way that a less ephemeral system might not, then merely noting that our system *is* a ponzi system may not be enough to justify changing that. I'm skeptical that I could be convinced of that - again, look at the freakanomics blog and look how much it talks about the need to mitigate *exactly* the kinds of problems a network of ponzi schemes would have to mitigate to conclude (at least tentatively) that if we didn't have that scheme, we wouldn't have those problems to mitigate in the first place, and thus arguably wouldn't be having these periods of booms and busts - but I'll leave that on the table for some later day.
Meanwhile, let me return to this issue of banking. From the day I was a kid, I've been told and "understood" that when I made a deposit in a bank, it didn't actually *stay* in the bank, it was lent out to someone else. And I bought that (I believe I've blogged about the scene in "It's a Wonderful Life" where Jimmy Stewart sells this idea lock stock and barrel).
But the more I think about it, the more something doesn't smell right. For one, symmetry is usually a good sign. When I take out a loan from a bank - that is, when they give me money on the promise that they'll get their money back later - I do not take it on the basis that the bank can come and get their money any time they want. In fact, I have a very measure timeline over which they will get their money back: they get a certain amount once a month, for a fixed period of time. Because I know exactly what that schedule of repayment is, I can safely manage spending that money in a way in which I will never be "surprised" by a "run" on the money I've borrowed from the bank. The bank does not need to have "confidence" that I have the money: they have a schedule saying exactly when they will get the money paid back, and in the event that I fail to keep to that schedule, they have the collateral that I've put up against that loan, e.g. my house in a mortgage loan.
But the lack of symmetry is startling. In terms of first principles, there is no difference between a bank giving me money for me to eventually give back, and me giving the bank money for them to eventually give back to me. And yet, the terms are completely different. When I give the bank money - at least in a standard deposit - the bank does not have a schedule on which to give it bank to me. Instead, it is as if they took a loan from me that I can insist at any time I want the entire balance back, instantly. Who would take a loan like that? It seems clear to me that the same reasons an individual doesn't take a loan like that - basically, because it makes the money unusable - are the same reasons such a loan would have no value to a bank. And yet, they take it... just like the con-artist takes the money into his Ponzi scheme on the false promise that all of his investors can have their money back in total any time they want. The second that bank actually *does* something with that money, they've made it so that they cannot keep their promise to all of the people they have taken a loan from.
Doesn't that sound like it could be a root cause of a lot of ills? We have people signing contracts that they know they cannot keep, and this is the fundamental basis of the federal reserve system. It *is* a ponzi scheme, and it is therefore no wonder that the scheme depends on the "confidence" of the people who have given their money into the scheme in the mistaken belief that the schemers can actually keep the contract they made with them.
And all seems great while confidence is high, as in all Ponzi schemes: the depositors leave their money in the scheme and see great numbers on paper and feel wealthy and may even go out and spend more on consumer items and other immediate consumption than they normally would, and that money goes into the hands of the people who sold those products and they feel confident and continue to spend the money, all because on *paper*, they have a lot of wealth stored in the ponzi scheme.
That spending/consumption has a reverberation in the system, though: it represents withdrawals from the ponzi schemes. Ponzi schemes can survive a certain amount of withdrawal - as noted, they pay withdrawals from others' deposits - but they can be a victim of their own success: as people see a *lot* of wealth on paper, they feel more comfortable withdrawing that money *for the consumption we just mentioned*. As that spending continues, the Ponzi schemes start to get closer and closer to the breaking point. They are of course still exuding confidence: they have to, that's what their scheme is based on. But ironically, too much exuded confidence continues to prompt depositors to take their paper wealth and spend it, bring the schemes to the popoint of ruin. The first schemes to hit this point will survive by the trick of borrowing from other schemes, but if the depositor's behavior is widespread, eventually they are all going to hit the edge, and the whole system is going to come crashing down.
Note that this crash can also be exacerbated or caused by externalities that cause a lack of confidence, e.g. 9/11, but the dynamics here seem to indicate that even without the externality, the system is bound to run into boom/bust cycles.
I'm not in any way saying that this is a thoroughly educated economics proof, but it sure does pass at least the "laugh test" for me. It is plausible, it is explanatory, it is predictive, and those predictions match the general pattern of what we've seen historically, as well as even the descriptions of what we are seeing in the responses to the current crisis: it sounds like a group of ponzi schemers trying to figure out how to keep their scheme afloat. Look at the specifics: the banks are "trying to get credit flowing again", or in ponzi-speak, the ponzi schemers are trying to get enough above water that they can start covering each other's "runs" again. In fact, the term "run" is explicitly used in the discussions of the banking industry's problems!
So if this is true, then how to fix it? I think it starts right at the bottom, in the relationship that banks have with depositors: no one should ever agree to a contract that they can't keep. Just as a person taking a loan from a bank does not falsely promise to pay back that loan whenever the bank wants it and backs up their loan with something tangible that will go to the bank if they can't otherwise pay the bank, a bank should only make contracts with its depositors that it can keep. If it takes in a depositor's money based on the notion "you get your money whenever you want", then it needs to *keep that money*. No fractional reserve banking *on that kind of a deposit*. True, the banking industry would need to change a little, but that's kind of the whole point here, right, if it's the banking system that's at the heart of the boom/bust cycles, then we *want* to change the banking system. If a bank is just going to keep your money in a vault - literally just be a safe place to store your money, the way it is adverstised - they inevitably you are going to have to pay them for that, just as you pay the UStorage place to keep your stuff in storage. The free market will eventually work out good compromises and rates here.
Where will banks get money to loan out, if not from deposits? Basically, they need to "borrow" money from individuals in the symmetric way that individuals borrow money from banks. One way in which this concept exists today is in the form of "certificates of deposity". A CD is analagous to a loan: the bank does *not* promise that the money can be had at any time in its entirety, but instead agrees to a fixed schedule for repayment, with some extra interest on top. Because the bank knows that this money can't be "run", it can figure out how to loan that money out *and still pay the money back on the schedule that it agreed to*. Think about it: when you get a loan, say, it is not uncommon to think "I'll need to pay back this loan starting next month, so I'll put a bit of the loan aside to make the first few payments; I'll then use the rest to buy the car I wanted, and I know from my analysis of my cashflow situation that I'll be able to start making the payments from my salary starting in a couple of months." That is, you can spend the money from the loan while still carefully planning on how to pay back the loan. With a CD or other "loan" like instrument, a bank can do exactly the same thing. They will know their payback schedule and the payback schedules of the loans *they* have made, and it's an easy accounting exercise to make sure that they can meet their obligations. Note that the bank is not in danger even if their outstanding loans go belly up, as long as they did their homework in evaluting the collateral: if the loan defauls, they take the collateral and convert it into the cash they need to pay back their CD holders. To be sure, such a bank can *purchase* insurance to cover the very small chance that they lose money on a loan and cannot quite cover a CD obligation, but as that should be very rare and a very small amount of money, such insurace such be inexpensive relatively speaking, and of course the bank should account for that cost in the interest it charges on its outgoing loans.
No "confidence" is needed in such a system. There is no "ponzi scheme" element to such a scheme. It works because it is a series of contracts that are actually intended and guaranteed. There cannont be a "run" on such banks.
It's pretty clear that individuals would participate. How many would choose to just keep their money in a bank for a fee? Probably not too many: they know that they can make interest on that money in a CD, so they'd probably choose to put most of their excess into CDs, leaving enough in the bank to cover immediate cashflow. Thus, most of the money would still be available to the banks for loaning. But that money would not require *confidence* to loan back out, it would simply require *accounting*: there's no risk that the holders of CDs can "run the bank", and so banks can lend it out with clarity about their obligations and determinism about what they do and will hold and when.
So in my naive, non trained-economists view, this appears to solve the problems with "runs" on banks and "confidence" while still allowing capital to flow throughout the economy. It allows banks to make money, but arguably less money than they currently make, for the benefit of reducing the "boom/bust" cycles that seem to naturally flow from the ponzi-scheme setup that most of all current nations currently have. And it eliminates the need for a "lender of last resort" and thus the currency manipulation on the part of the Federal Reserve or its equivalent in other countries that seems to contribute to many woes (admittedly, I haven't gone into that much here, but this post is long enough).
Friday, December 19, 2008
So much for "democracy"
When I was younger, I went through a phase in which I read a lot of espionage/conspiracy fiction (Ludlum, Follet, etc). One of the reasons that phase ended rather abruptly was that I got frustrated with what I deemed at the time an overly used lack of realism: time after time in these books, things happened that the characters got away with some major, obvious lie/conspiracy that I thought they would *never* get away with in the real world. "As soon as any inclination of that got out, those people would be toast" thought I, "the people would not stand for that."
I'm considering going back to the genre: I'm coming to see, over and over, that that scenario is not unrealistic, because I'm watching it play out over and over. The first example where this really hit me was the Iraq war based first on the claims that Iraq had WMD - something I knew was *not* true from information I gleaned while working at the time at a major government facility from whose population some of the inspector teams in Iraq were drawn, and watched in horror as our government baldfacedly lied to our population *and the swallowed it, burped, and asked for more* - and then the so-blatant-even-Joe-the-plumber-could-figure-it-out bait-and-switch that no, it wasn't WMD, it was that Iraq was involved with Al Quaeda and 9-11, yeah, that's the ticket (with a nod to Jon Lovitz' compulsive-liar SNL sketches) (or do I have the sequence of these lies reversed?).
Well, that's old news, but we sure have a whopper staring at us today: President Bush is going to end-around the democratic process and give the automakers the bailout that Congress denied them:
I just can't see how everyone isn't either going apoplectic or hanging their heads in shame for their own complicity and stupidity. A few short months ago, our populace sat quietly by as our government instrumented an extraordinary power grab, authorizing the staggering sum of 700Billion dollars (estimated by most to really be several times that figure by the time we are done) based on weak and hurried arguments about the eminent collapse of our economy and passed only on the promises to "trust them": that the use of these funds would be specific to the "saving" of the financial industry.
And yet
How the *fuck* do you take extraordinary measures to authorize the partial nationalization of an industry and a huge hidden tax on everyone (that 700 BN dollars is essentially newly minted money, meaning it comes from every one of us by devaluing the money we already have) based only on our trust that you'll do what you said you were going to do with that money and then mere *weeks* later use that money to run roughshod over the democratic process by having the executive branch essentially make the "laws" that congress voted down, and have no one go ape-shit about it??
This isn't theory, this is in-your-face reality, and yet I *still* don't see the outrage that even the most stringent defender of our system should be expressing at this violation of that very system. I don't see how these thing fail to shake the religious belief in "government" or "the state" as our omnipotent, omniscient God. Where is the *thinking*, people?
I'm considering going back to the genre: I'm coming to see, over and over, that that scenario is not unrealistic, because I'm watching it play out over and over. The first example where this really hit me was the Iraq war based first on the claims that Iraq had WMD - something I knew was *not* true from information I gleaned while working at the time at a major government facility from whose population some of the inspector teams in Iraq were drawn, and watched in horror as our government baldfacedly lied to our population *and the swallowed it, burped, and asked for more* - and then the so-blatant-even-Joe-the-plumber-could-figure-it-out bait-and-switch that no, it wasn't WMD, it was that Iraq was involved with Al Quaeda and 9-11, yeah, that's the ticket (with a nod to Jon Lovitz' compulsive-liar SNL sketches) (or do I have the sequence of these lies reversed?).
Well, that's old news, but we sure have a whopper staring at us today: President Bush is going to end-around the democratic process and give the automakers the bailout that Congress denied them:
Mr. Bush made his announcement a week after Senate Republicans blocked an automaker bailout that had been negotiated by the White House and Congressional Democrats. The loan package announced by the president includes requirements that are roughly identical to those in that bill, which was approved by the House.I have my complaints about government even when it is an actual democracy, but ours is not even that any longer: in what kind of "separation of powers" is it possible for more than one branch to do exactly the same thing? That's not "separation of powers", that's "or'd" powers: this thing gets done if branch A wants it done or branch B wants it done...
I just can't see how everyone isn't either going apoplectic or hanging their heads in shame for their own complicity and stupidity. A few short months ago, our populace sat quietly by as our government instrumented an extraordinary power grab, authorizing the staggering sum of 700Billion dollars (estimated by most to really be several times that figure by the time we are done) based on weak and hurried arguments about the eminent collapse of our economy and passed only on the promises to "trust them": that the use of these funds would be specific to the "saving" of the financial industry.
And yet
The money to aid the automakers will come from the Treasury’s $700 billion financial stabilization fund.Wwwwwwwhat?? That wasn't what we signed on for (to the extent that we signed on at all)! Where is the outrage? How far away are we from just having a system in which Congress just authorizes a huge sum of money for the government to spend on whatever they want, without any debate, due process, accountability, etc?
How the *fuck* do you take extraordinary measures to authorize the partial nationalization of an industry and a huge hidden tax on everyone (that 700 BN dollars is essentially newly minted money, meaning it comes from every one of us by devaluing the money we already have) based only on our trust that you'll do what you said you were going to do with that money and then mere *weeks* later use that money to run roughshod over the democratic process by having the executive branch essentially make the "laws" that congress voted down, and have no one go ape-shit about it??
This isn't theory, this is in-your-face reality, and yet I *still* don't see the outrage that even the most stringent defender of our system should be expressing at this violation of that very system. I don't see how these thing fail to shake the religious belief in "government" or "the state" as our omnipotent, omniscient God. Where is the *thinking*, people?
Sunday, November 23, 2008
Doesn't just wanting "change" mean something was seriously wrong?
Much of the rhetoric around Obama's successful election campaign, as well as the economic problems that are facing the country and world, can be summarized in one word: change. To take a representative quote:
Something really bothers me about this line of "thinking", and I think I can explain it with a little mental exercise.
Imagine a game in which the object is to get the highest score on a scale of 1-100. The game allows you to make "moves" when it is your turn; for simplicity, let's just say it's some set of moves numbered from 1 to n. What the moves actually *are* isn't important for this thought exercise. In fact, the moves are completely meaningless to the players: the game does not tell you ahead of time what the relationship between the moves and scores is. The game also does not tell you ahead of time how many moves you will get to make. All you know ahead of time is that each move gives you some score between 1-100, and to simplify the thought process a little, let's assume that the game also tells you that if you just randomly pick rules, your average score will be 50, that is, the distribution of scores is some symmetric curve around 50 (it's probably best to just think of a constant distribution, that is, every score from 1-100 is equally likely).
So, basically, it's a guessing game: you make a random move, you get a score. The game might end at that point; you don't know. Your score in the game is the score of your last move.
Note, however, that you don't *have* to make a different move. If you're happy with the score you have, you can keep choosing the same move and getting the same score.
So, let's consider playing this game. You must start by making some random guess, and you get back a score. When and why would you choose to make *another* guess? Clearly, if your score is less than 50, it is *always* a good idea to make another guess, because the expected value of your new move is higher than your old one, and you'd rather end up on a better score. If your score is already over 50, it only makes sense to guess again if you have some way of predicting how many moves the game might go on; otherwise, if you guess again and get a lower score, you run the risk of the game ending and thus ending up with a worse score. Since the rules of the game dictate that you *don't* have any way to predict how many moves the game will last, guessing when you are over 50 is at best risky, and perhaps suboptimal.
In either case, it's important to note the following conclusion: the *only* time when it makes sense to randomly guess a new move is when you are already below the halfway mark.
Now let's pull this back to "change": according to Bloomberg and the apparent social, government, and MSM consensus, *any* change right now is better than none at all. Any *random* change; IOW, they are advocating that in our game, we definitely should take another move and randomly get a new score. In the context of our game, this implies that the current "score" must be less than 50, must be less than "halfway".
Do you see the dilemma? Assuming of course that our game is a decent analogy for the "economy" and generally for "society" - and it's clear enough from centuries of failures, mistakes, tragedies, rise and fall of ideologies, etc, that the relationship between the "moves" that government can make and their "economic score" is nearly random (this follows mathematically from the highly nonlinear and thus chaotic nature of economic and social systems) - this means that either A) after 232 years of being "in charge", our government is still scoring less than halfway in this game, or B) random change is *not* the optimal move.
In either case, our government is failing us: either they have failed to achieve the halfway score that a monkey throwing darts at a dartboard to run the economy would achieve (the median of our distribution), or they are now embarking on a venture that is going to make things worse on average.
The point really is: change for change's sake is never a good idea unless you are in the total crapper.
I realize that Democrats will be happy to conclude that the economy *is* in the crapper and that it's the republican's fault, and thus random change *does* make sense. Sorry, you don't get a pass: economic momentum spans far more than the term of one president or congress, and includes the consequences (usually unintended: politicians don't have much incentive to think longer-term than the duration of their terms, unlike private parties who have incentives to think in terms of spans of time that are at least their lifetime long and oftentimes the lifetime of their children and children's children) of decisions made many decades ago. The current economy cannot be laid at the feet of Republicans or the Bush administration; it's a bipartisan failure, tracing some of its origins to events such as the imposition of the individual income tax and the creation of the fraudulent Federal Reserve system that go back almost a decade and which had the complicity of every congress and president since, Republocrat and Demopublican.
If I had hired "government" to run my economy and the solution they gave me after 232 years was "random change", well, they'd be fired.
And isn't that what the government is? People that work for us? Doesn't the preamble say "for the people"?
I say we fire 'em, and look for a group of people who has something better to sell us then "change". How about, you know, an actual *plan*?
Nobody knows exactly what they should, but anything is better than nothing.This from New York City mayor Bloomberg, discussing government bailout of companies in the wake of the stock market crash, on the September 21 edition of Meet the Press.
Something really bothers me about this line of "thinking", and I think I can explain it with a little mental exercise.
Imagine a game in which the object is to get the highest score on a scale of 1-100. The game allows you to make "moves" when it is your turn; for simplicity, let's just say it's some set of moves numbered from 1 to n. What the moves actually *are* isn't important for this thought exercise. In fact, the moves are completely meaningless to the players: the game does not tell you ahead of time what the relationship between the moves and scores is. The game also does not tell you ahead of time how many moves you will get to make. All you know ahead of time is that each move gives you some score between 1-100, and to simplify the thought process a little, let's assume that the game also tells you that if you just randomly pick rules, your average score will be 50, that is, the distribution of scores is some symmetric curve around 50 (it's probably best to just think of a constant distribution, that is, every score from 1-100 is equally likely).
So, basically, it's a guessing game: you make a random move, you get a score. The game might end at that point; you don't know. Your score in the game is the score of your last move.
Note, however, that you don't *have* to make a different move. If you're happy with the score you have, you can keep choosing the same move and getting the same score.
So, let's consider playing this game. You must start by making some random guess, and you get back a score. When and why would you choose to make *another* guess? Clearly, if your score is less than 50, it is *always* a good idea to make another guess, because the expected value of your new move is higher than your old one, and you'd rather end up on a better score. If your score is already over 50, it only makes sense to guess again if you have some way of predicting how many moves the game might go on; otherwise, if you guess again and get a lower score, you run the risk of the game ending and thus ending up with a worse score. Since the rules of the game dictate that you *don't* have any way to predict how many moves the game will last, guessing when you are over 50 is at best risky, and perhaps suboptimal.
In either case, it's important to note the following conclusion: the *only* time when it makes sense to randomly guess a new move is when you are already below the halfway mark.
Now let's pull this back to "change": according to Bloomberg and the apparent social, government, and MSM consensus, *any* change right now is better than none at all. Any *random* change; IOW, they are advocating that in our game, we definitely should take another move and randomly get a new score. In the context of our game, this implies that the current "score" must be less than 50, must be less than "halfway".
Do you see the dilemma? Assuming of course that our game is a decent analogy for the "economy" and generally for "society" - and it's clear enough from centuries of failures, mistakes, tragedies, rise and fall of ideologies, etc, that the relationship between the "moves" that government can make and their "economic score" is nearly random (this follows mathematically from the highly nonlinear and thus chaotic nature of economic and social systems) - this means that either A) after 232 years of being "in charge", our government is still scoring less than halfway in this game, or B) random change is *not* the optimal move.
In either case, our government is failing us: either they have failed to achieve the halfway score that a monkey throwing darts at a dartboard to run the economy would achieve (the median of our distribution), or they are now embarking on a venture that is going to make things worse on average.
The point really is: change for change's sake is never a good idea unless you are in the total crapper.
I realize that Democrats will be happy to conclude that the economy *is* in the crapper and that it's the republican's fault, and thus random change *does* make sense. Sorry, you don't get a pass: economic momentum spans far more than the term of one president or congress, and includes the consequences (usually unintended: politicians don't have much incentive to think longer-term than the duration of their terms, unlike private parties who have incentives to think in terms of spans of time that are at least their lifetime long and oftentimes the lifetime of their children and children's children) of decisions made many decades ago. The current economy cannot be laid at the feet of Republicans or the Bush administration; it's a bipartisan failure, tracing some of its origins to events such as the imposition of the individual income tax and the creation of the fraudulent Federal Reserve system that go back almost a decade and which had the complicity of every congress and president since, Republocrat and Demopublican.
If I had hired "government" to run my economy and the solution they gave me after 232 years was "random change", well, they'd be fired.
And isn't that what the government is? People that work for us? Doesn't the preamble say "for the people"?
I say we fire 'em, and look for a group of people who has something better to sell us then "change". How about, you know, an actual *plan*?
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