Is the World Split into Alpha Math Masters, Other Economists and Those Outside the Ivory Tower?

Friday, July 03, 2009

This blogger is proud to have become part of a webring of select and motivated economists initiated by blogger pal Edward Hugh. Ed applies Facebook's advantages so one can read all realtime arguments or comments on macroeconomic issues on one page instead of having to open n emails (yesterday 400+.)
Although I am a bit wary of social networks due to concerns Cryptohippie has perfectly summarized in this brilliant article on privacy in cyber age (PDF), I like the limit of 50 words as this forces one to be concise to the max.
We have blogs to dive deeper into issues, always knowing that billions of eye pairs will correct any mistake at lightning speed in comments.
Suffering from a blind spot for mathematics that cannot be done on my iPhone (i.e. electronic tag) and - god beware - contain other Greek letters than alpha, beta and delta, Deepak Jois from India has started a clever discussion on the issue of math proficiency in the macroeconomist world and its mostly incomprehensive results for those outside the ivory tower, like in markets or commerce.
I replicate first Deepak's wise words which combine thoughts on math and the Austrian school of economics and are seriously alpha:
What frustrates me as somebody who has a strong interest in Economics and has at times thought about taking it up seriously. Some of the core textbooks and papers I have read (are) such stylized models that I learn practically nothing from them because they have no real world applicability. This coming from somebody who actually has a background in computer science/math.
That is one of the reasons I am attracted to the Austrian School which emphasizes the importance of studying history and philosophy as well. My ideal economics curriculum would be something that would combine the principles of the Austrian school along with the things that Taleb talks about in the Black Swan regarding the 'science' of rare events and the cognitive biases that we as homo sapiens exhibit.
Here comes my beta-reply:
I am happy to see others share the problem that formulas with Greek letters may be of interest and useful only when one can make sense of it.
Honestly, everything exceeding merchant's mathematics, yield calculations and moving averages will forever be my blind spot and I will have to be reborn to mentally understand the deeper meaning/use of algorithms (if they are not done automatically in the few Excel sheets I use) but then again all my math skills come from financial analysis, whereas macroeconomics were rushed through in my diploma course. Especially the part on fractional reserve banking was given not much more than 2 minutes in a grad programme with lecturers from commercial banks.
I can follow the arguments of Benoit Mandelbrot with his fractal geometry model to better assess market risk than with the Gaussian bell curve, also thanks to reading Nassim Taleb.

Scholes Does Not Want to Discuss His Option Formula Anymore
Myron Scholes fled me at recent panel discussion in Vienna when I wanted to interview him on whether the Black-Scholes options formula is still valid in the time of frequent occurrences of black swan events.
And, interestingly, has anybody heard anything about Harry Markowitz' model of risk free portfolio diversification recently?
I hope not to offend any economist when stating that the financial sector is only interested in all calculations where there is a currency sign in front of numbers. No bond salesman understands convexity but only knows that it's a good sales pitch (this wisdom taken from Michael Lewis' "Liars Poker".)
As I am most interested in everything that helps me sharpen my forecasting potential and especially keeping it in a style so the interested layman/investor does not fall asleep while reading it I'd like to point out that there were no complex formulas needed to see the USA's change from biggest creditor to biggest debtor in the world.
It is trends I am keen to recognize as early as possible and so far I have a fairly good track record from what I can read from yield curves in connection with industrial production figures, current accounts, unemployment and other key macro indicators. I cannot see how a formula could have helped me better to see changes in banks' lending than a few calls to bankers (the Fed calls this anecdotal information), but then again I am maybe ignorant due to my failure to understand anything that has 2 Greek letters in it.

Read Schumpeter: No Formulas Or Fancy Charts Make It Actually Entertaining
Coming to the Austrian school, where I got erased from the mailing list of Austrias Friedrich von Hayek foundation after I enraged bankers with my libertarian view that we should shut down the rating agencies and send bankers back to do their homework, i.e. assessing risk. Bankers alphabet only included AAA to C and now they are in the costly process of learning that the alphabet continues to D(efault).

Irving Fisher: The Economist Gone Broke Weeks After His Infamous Remarks on Wall Street
Irving Fisher's infamous statement from Sep 1929 that stocks will remain forever on an elevated plateau is as much a joke as was Abby Cohen's 2000 "new paradigm" that internet stocks were to dominate stock exchange listings and would outperform in the long run. Fisher lost all his money in the crash and spent the rest of his lonely life in a condo paid for by others.
In this context I also have my problems with Josef Schumpeter and his euphemism of "creative destruction" i.e. recession, a process where over capacity in some sectors gets wiped out again.
In Austrian history Schumpeter's name will forever be associated with the fact that he was the first finance minister of the young Austrian republic who acquainted us with an acceleration of inflation into the triple-digit area.
Schumpeter resigned from this post after only a few months and later founded his own bank which went belly up in the early 1920's. After retreating into the academic world later on Schumpeter also started to rethink whether his libertarian approach does actually work in a real-life economy.

While Greenspan favored abstaining from any protectionist measures (and is best forgotten by now after publishing his coffee table memoirs), Schumpeter had gone the other way at the beginning of the 1930's.
Although an advocate of a free market economy, Schumpeter turned to protective ideas.
Had he first noted on the US depression 1839-1843 that the economic devastation caused by recessionary periods is essentially a process of "creative destruction" and such periods are essential to the advance of capitalism, his views changed with his personal fate, a situation remarkably similar to the change of attitude towards free trade of US policymakers nowadays.

Schumpeter: From Libertarian to Protectionist in 2 Decades
To quote Schumpeter (from a lecture held in Tokyo in 1931):
"I need only quote the wide spread belief, that every export means a gain and every import means a loss to the nation; or that it is always an advantage to produce at home, instead of importing, a commodity which a nation is able to produce, and that we ought to rejoice in every national industry created by a protective duty; or that tariffs remedy unemployment; or safeguard the national currency; or that they are necessary to keep up a high standard of wages; or that it is their function to equalize cost of production at home and abroad and to enable the home industry to compete with foreign products on what has been called ‘fair’ terms.
All this is wrong.
The last argument for instance, which is so popular in the United States runs directly against the very meaning of international trade.
What other reason can there be for importing a commodity from abroad, and why is international trade advantageous if not for the reason that a nation may, importing, get a commodity with less effort that is to say, at less cost, than if it produced it at home?
Hence, equalizing costs at home and abroad would, if carried out to its logical consequences, put a stop to importation and exportation and amount to prohibition of international trade.
And if we want this, it is much more logical and much simpler to say so and to prohibit imports entirely, instead of creating in the public mind a vague impression that equalizing costs of production at home and abroad only eliminates some 'unfairness' from international trade but is not really meant to prevent imports.
Yet, although protectionist arguments can often be proved to be nothing else but errors, it does not follow that protection itself is always wrong.
Indeed, few modern economists will hold the free-trade argument so absolutely as the classics did.
They will hold rather that every case has to be dealt with individually and that it is impossible to recommend free trade on general grounds, and for all times and places."
Not from Schumpeter, but nevertheless valid is my view that the US depressions of 1839-1843 and that of 1929-1934 acted as a catalyst for economic and political reform in the US. Still valid is also the view that there is no stronger catalyst for a political changes than a declining economy. Take your own clues (and be long gold.)
I nevertheless consider his late (last?) book "Capitalism, Socialism and Democracy" one of the best pieces of economic literature I have read so far.
I also see a tendency to equate Austrians with unfettererd free market liberal policies.
This is simply not true.
Schumpeter and his liberal predecessors David Ricardo (no formulas, no tables, no charts) and Adam Smith (no formulas either) nowhere said that the process has to go so far to as being to the disadvantage of workers.
They all considered social peace by a more balanced distribution of profits as a necessity to avoid social unrest, which may be the last event in the current death of capitalism, initiated by US president Barack Obushama who should better lend both his ears to his economic adviser Paul Volcker instead of sending more troops to Afghanistan in the name of petro-theism.
As a last note I need to react to one economist chiding me yesterday in one of those 400+ emails for my view that much of the macro outlook can be done on the back of an envelope. Check out the baffling simplicity of big government (Treasury) documents found at such fine blogs like Zerohedge and remember that people look to quick solutions when in panic mode, instead of doing due diligence before they go on air.


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