Lars P. Syll — a question of economic methodology

Radical uncertainty is feature of a complex adaptive system a chief characteristic of which is emergence. Emergence is at the heart of evolution theory. Emergence in this context means that there is no way to predict what will emerge from a complex adaptive system based on investigation of the past and present state of the system. This implies that surprise is a characteristic of such systems.

This also implies that complex adaptive systems are like open systems rather than closed, receiving input exogenously, although in reality the additional input arises endogenously through the system dynamics, e.g., through reflexivity that engenders feedback and learning, but it a way that cannot be foreseen based on the present and past system states and operations.

Treating social systems as if they conformed to the structure and dynamics described theoretical in natural science, e.g., based on endogeneity, involves oversimplification. There is a strong tendency among rationalists that prefer formal solutions to adopt methodological assumptions based on mathematical tractability and convenience instead of accepting the empirical limitations of complex adaptive systems like human societies.

This has resulted in what Michael Hudson has dubbed "junk economics." Elegant but wrong.

It's long past time to admit that Keynes and Knight were correct and that Ramsey and Savage were wrong.

Lars P. Syll’s Blog
Radical uncertainty — a question of economic methodology
Lars P. Syll | Professor, Malmo University

Tyler Durden — BIS Issues Alert: Tightening “Paradoxically” Leading To Excessive Risk Taking; Reminds What Happened Last Time

What’s really puzzling Claudio Borio, however, is that the market euphoria, or “ebullience” as he terms it, has continued as the Federal Reserve has proceeded with its tightening. While Borio acknowledges the BoJ has left its accommodative policy unchanged and the ECB may have “at least relative to expectations”, he notes that the Fed is the “issuer of the dominant international currency and its sway on markets remains unparalleled”. In Borio’s view this has led to a paradox, as he explained.

Hence a paradox. Even as the Fed has proceeded with its tightening, overall financial conditions have eased. For instance, a standard indicator of such conditions, which combines information from various asset classes, points to an overall easing regardless of the precise date at which the tightening is assumed to have started. Indeed, that indicator touched a 24-year low. If financial conditions are the main transmission channel for tighter policy, has policy, in effect, been tightened at all?

If you think you have it figured out, give Claudio Borio a call. 😃

Zero Hedge
BIS Issues Alert: Tightening “Paradoxically” Leading To Excessive Risk Taking; Reminds What Happened Last Time
Tyler Durden

See also

The New Arthurian Economics
24 years, Borio says. It's not a coincidence.

The Arthurian

William Nelson — Setting the record straight on why leverage ratio must change

A recent op-ed on this blog by Paul Kupiec misstates the Clearing House’s criticism of the supplementary leverage ratio. Kupiec’s article indicates that the Clearing House’s position is contained in a recent article by Darrell Duffie, a professor at Stanford University. Although Professor Duffie’s article appeared in the Clearing House’s quarterly journal “Banking Perspectives”, his views were his own, and he received no compensation from the Clearing House.

We will let Mr. Kupiec debate Dr. Duffie’s views with Dr. Duffie. As for us, the Clearing House’s arguments against the leverage ratio are explained in a Clearing House Research note, “Shortcomings of Leverage Ratio Requirements,” which has been available on our website for over a year. The leverage ratio’s core intractable problem is that it treats all bank assets as having the same level of risk, from deposits at the central bank and Treasury securities to leveraged loans, loans to small businesses and credit card loans. If the leverage ratio were simply a backstop that didn’t influence bank behavior, its poor design would be irrelevant for banks’ capital planning decisions. But as I explain below, it clearly is influencing banks’ behavior, and its flaws therefore have dangerous implications....

American Banker
Setting the record straight on why leverage ratio must change

William Nelson | head of research and chief economist for The Clearing House, and formerly a deputy director of the Division of Monetary Affairs at the Federal Reserve Board

Noah Smith — Want More Startups? Build a Better Safety Net

Good one. Another myth debunked.

It's about creating space and the right conditions for things to happen rather than relying on incentive.

This goes along with Mariana Mazzucato's entrepreneurial state. A safety net creates space and an entrepreneurial state creates the right conditions.

Bloomberg View
Want More Startups? Build a Better Safety Net

Noah Smith, contributor

Eric Falkenstein — Finding Alpha pdf

My book The Missing Risk Premium is a steal at only $15, but my first book, Finding Alpha, is a $65, which is a bit much for anyone not expensing their books. Finding Alpha goes over why the current asset pricing model fails, with lots of evidence, explains why economists still like it, and then in chapters 10-13 shows concrete examples of how investors have actually found alpha.…

You can download the individual chapters in pdf form here...

Thanks.

Falkenblog
Finding Alpha pdf
Eric Falkenstein

HBR — You Can’t Make Good Predictions Without Embracing Uncertainty

But the uncertainty of the future is no excuse for less rigor or clarity. A consistent, quantitative perspective on uncertainty not only builds the best foundation for making good management decisions but also provides a platform for developing a shared understanding of trade-offs, bridging disagreement and establishing accountability.…

Uncertainty cannot be pretended away.

Harvard Business Review
You Can’t Make Good Predictions Without Embracing Uncertainty
Peter Hopper, partner and managing director of the Hong Kong office of the Strategic Decisions Group, and Carl Spetzler, chairman and CEO of SDG and coauthor

Brad DeLong — When and why might a “confidence” shock be contractionary? Karl Smith’s approach can bring insights

Sectoral balances.

WCEG — The Equitablog

When and why might a “confidence” shock be contractionary? Karl Smith’s approach can bring insights

Brad DeLong

What Can We Really Know About the Future of Stock Prices? — Lynn Parramore interviews Roman Frydman

Lynn Parramore interviews Roman Frydman.

The Huffington Post
What Can We Really Know About the Future of Stock Prices?
Lynn Parramore
ht Neil Wilson

BBC — News Bank of England's Carney warns of climate change risk

The Bank of England governor has given a stark warning that climate change poses a huge risk to global stability.

At a gathering of leading insurers at Lloyd's of London, Mark Carney pointed out the rapid increase in weather-related catastrophes and the jump in both the physical and financial costs.

He said the challenges currently posed by climate change "pale in significance compared with what might come".

He said this generation had little incentive to avert future problems.

He avoided spelling out what was causing this apparent change, but said evidence was mounting of man's role in climate change.…

Currency irresponsibility may lead to financial instability in the future.

"The far-sighted amongst you are anticipating broader global impacts on property, migration and political stability, as well as food and water security."

But he said because the cost would fall on future generations there was little impetus on the current one to fix it: "In other words, once climate change becomes a defining issue for financial stability, it may already be too late."

And social, political and economic stability as well.

For example, while not related directly to solely to climate change, Europe was unprepared for the influx of refugees from MENA.

BBC News
Bank of England's Carney warns of climate change risk

Jeff Cox — Markets are still addicted to money printing

Rational expectations?

Friday's stock surge provides yet another reminder that when it comes to moving the market, there's nothing like a little old-fashioned money printing. 

What waits on the other side—asset bubbles, inflation, the prospects for still greater wealth disparity—remains, of course, an issue for another day. 

The important thing is that the market wants what the market wants…

CNBC NetNet
Markets are still addicted to money printing
Jeff Cox | Finance Editor

Justin Fox — Instinct Can Beat Analytical Thinking

Absolute must-read. 

I had realized this forty years ago when invited to teach decision theory in a military setting characterized by complexity and radical uncertainty in contexts where speed of response is crucial.

Harvard Business Review — HBR Blog Network
Instinct Can Beat Analytical Thinking

Justin Fox

Noah Smith — "Land of the brave" no more?

Noah Smith speculates on reasons for the decline in entrepreneurship in the US implying an increase in risk aversion. They are all correct in my view. 

What he leaves out is the tightening of bankruptcy law, the purpose of which is to offset consequences of failure in addition to providing recourse for creditors. Now it is skewed toward creditors thanks to creditors' lobbying efforts.

Another reason may be concentration of capital in dominant players, leaving only relatively minor niche markets available for modest startups. Before Walmart and the big box stores, and now Amazon and the Internet, it used to be less difficult to carve out a niche in retail, for instance.

Noahpinion

"Land of the brave" no more?
Noah Smith | Assistant Professor of Finance, Stony Brook University

Steven Perlberg — 12 Major Global Risks That Seem Like Something Out Of A Movie

Investors can envision a stock market correction this year even if they think it ultimately won't happen.

Then there's income disparity, unemployment, liquidity issues — these are the risks we anticipate, if not expect.

But what about the other risks out there? The lesser-known unknowns?

The World Economic Forum is out with their list of global risks for 2014, and it of course includes the usual suspects of familiar problems. But the WEF also highlights a few global risks that sound like the very stuff of science fiction or action/adventure.

Business Insider
12 Major Global Risks That Seem Like Something Out Of A Movie
Steven Perlberg

Not concerned yet?

See also Mamta Badkar, Here's All The Stuff That Could Ruin The World This Year 






Read more: http://www.businessinsider.com/ultimate-2014-global-risk-guide-charts-2014-1#ixzz2qcVaCufF

Nassim Taleb — Skin in the game – how to make economic models contact reality

Why businesses don't employ econometricians, how Wall Street was taken in by the quants, and why you shouldn't listen to them either.

Lars Syll's Blog
Skin in the game — how to make economic models contact reality
Nassim Taleb

Jan Kregel: The Continuing Risk of Derivatives - Interview with Marshall Auerback [Video]

INET

Jan Kregel: The Continuing Risk of Derivatives

Don't Tell Me ... They're Worried Canada Might Run Out Of Loonies? :(

(commentary posted by Roger Erickson)

The daily news only gets more bizarre.

IMF recommends Canada scale back CMHC

The International Monetary Fund says Canada is exposing itself to risk by insuring mortgages through the Canada Mortgage and Housing Corporation and recommends scaling back the federal housing agency.

Don't tell me ... they're worried Canada might run out of loonies? :(

This is the International Monetary Fund that we're talking about here?

What's that saying about SETI? That the best proof that extraterrestrial intelligence exists is that it HASN'T tried to contact us yet?

Can you imagine if some ETI did actually visit Earth, and met the IMF first of all? 

They'd probably gracefully wipe all Lagard's memories of the mtg, exit quietly, and bookmark us with a note to check back for signs of TI after another 1000 years.

ps:  Any one see any Public Purpose in the IMF's advice to Canada?

Now We've Heard Everything - Some Think That The Fed Needs A Bailout

   (Commentary posted by Roger Erickson.)



OMG! Yes, Maude, it's true. This raises the most dire spectre of all!!! The USA itself could run out of fiat! If that were to happen, who would be left to bail us out? Who and what would they have to defraud next, to make it look real? The US Constitution? Please, let's not take the idiocy that far.

As stimulus tab rises for Fed, worries grow it may require a bailout

Just when you thought the level of discussion could not sink further.

LA Times: "The Fed's bond-buying binge could put the central bank's finances at risk if interest rates were to rise sharply, critics warn."

Seriously? In a prominent US newspaper? With a straight face?

You couldn't make this stuff up! What's next? Bail needs an out? In case systemic fraud were to rise sharply? Coupled with an increase in ignorance about fiat currency operations? It could happen, you know.

So who are the geniuses espousing this view?

James D. Hamilton, an economics professor at UC San Diego."It's really pretty cut-and-dried as far as the arithmetic goes: If you buy bonds and interest rates go up, you're going to take a capital loss on those bonds. The more they buy, the bigger their balance sheet, the bigger the loss they're going to face."

Sounds like the organ responsible for generating his logic DID dry up! No intellectual capital left.

Rep. Mick Mulvaney, R-SC. "The Fed stands to lose a lot of money, and by a lot of money, I mean hundreds of billions of dollars. It is not hyperbole to suggest the next big bailout could be of the Federal Reserve."

Ooh! He means it. There's a lot of fiat involved in denominating Public Initiative. Somebody get his train of thought a track to run on. It's chugging, but obviously derailed.

Et tu, Ben Bernanke? "The bottom line is that for any reasonable interest rate path, this is going to end up being a profitable policy for the taxpayer" says spineless, pandering Ben, as he sinks further into the political quicksand.

Sounds like Ben Bernanke is the one bailing out! Seems he pines for his cushy job at Princeton, where he can just go back to writing his little papers, not responsible for even pretending to counter the Erble Logic that is leading his nation astray. Ben prefers to sit in a comfortable deck chair and play his violin, as the ship goes down? With a stiff drink? Anyone noticed if he's been drinking more lately? Maybe he's planning to move to Switzerland too, or the Cayman Islands.

Marvin Goodfriend, an economics professor at Carnegie Mellon University's Tepper School of Business. [Finally! Surely we can expect a bit more from people grounded in business, not just nominal economics?]

"In the short term, it's a money-maker. The borrowing cost is cheap right now. Those borrowing costs are going to rise."

Ok, guess not. Another hope dashed. Move along folks, no situational awareness to see here.

The last word goes to the venerable LA Times. "When interest rates begin rising, the Fed will have to pay a higher rate on bank excess reserves. That will eat into the Fed's bottom line."

Let me get this straight. The Federal Reserve, accountant to the Treasury of the USA, denominator of a growing nation's purely nominal records of Public Initiative ... has a bottom line of nominal? Perhaps in nom only? Where'd this come from? How do we turn out citizens like this with no remaining connection to reality? Is our education system now completely nominal as well? Real situational awareness is considered purely nominal?

The article goes on to quote the least authority of recent times, Peter Schiff. I won't bother dipping into his meandering path, as his skiff sails further beyond the bounds of reason. Maybe he'll drop off his imagined horizon someday.

Too bad the US electorate doesn't set a bottom line in situational awareness. We could use a threshold defining a minimal, survivable level for an informed electorate right about now. Our economists are advising us to tighten the nominal noose we've placed around our own economy's real neck. Even if this is just some eco-erotic game for economists, please stop now, before it's too late for everyone?

Since assisted suicide is illegal, surely citizens could plausibly arrest all orthodox economists, for promoting and abetting economist_assisted_national_suicide?

Izabella Kaminska — Property bubbles and ghost cities

I have a working theory about the premium property bubble in capital cities like London. There’ll be a post about it on AV soon. (Have been a little under the weather so it’s taken a while.)
In a nutshell, the idea is that the economy is plagued by a glut of misvalued capital — which is seeking preservation for as long as possible and at all costs. The preservation is not really about the dollar sum of that capital, but about preserving the position on the social hierarchy ladder that it provides for....


But, as per my German sun lounger analogy, owners of abstracted financial capital have lost perspective on what their capital rights represents. They wish to preserve not the wealth provided for by the means of production, but the superior social position that this used to entitle them to.
The truth, however, is that they are no longer entitled to that. Also, what they misunderstand is that they are no less well off as a result of losing that claim. It’s everyone else who is elevating to their wealth.
Nevertheless the search for the preservation of their past superiority continues — the days when they were adding social value — continues.
Consequently this capital flitters from one idle asset class to the next, avoiding at any cost an opportunity to invest in something productive — out of fear this might expose them to the sort of risk that might lose them their superiority claims forever. It’s worth noting that the constant speculative flittering is damaging in its own right.

Dizzynomics
Property bubbles and ghost cities
Izabella Kaminska

In a healthy capitalism, the purpose of real capital is production for consumption and financial capital is for further capital formation from gains from production, that is, for productive investment. When financial capital is accumulated as financial wealth for it own sake, neither for consumption not productive investment, rentierism and power, then capitalism becomes dysfunctional.

Tim Johnson — Lady Credit

Economics is can be seen as being primarily concerned with managing resources when faced with scarcity; the maximisation of expected utility. An alternative view is that aspects of economics, particularly finance, are concerned with managing resources when faced with uncertainty. This distinction is not new, Moses ben Maimon, Maimonides, argued that the suffering of mankind is not because they were expelled from the Garden of Eden into a world of scarcity but because they were expelled into a world of uncertainty. In the Garden of Eden humans had perfect knowledge, which was lost with the Fall, and it is the loss of this knowledge which is at the root of suffering: If we know what will happen we can manage scarcity

Magic, Maths, and Money
Lady Credit
Tim Johnson | Academic Fellow, Department of Actuarial Mathematics and Statistics and the Maxwell Institute for Mathematical Sciences, Heriot-Watt University

(h/t geerussell via email)

This post is really about the philosophy of economics set forth in terms of the history of economic thinking. Really insightful and lots of good info. It's not perfect, but very good. You will want to read this one.Yes, MMT and Chartalism make an appearance. 

Steve Keen — Instability may not be optional (1)

If instability is a feature of capitalism rather than a bug, the question becomes how much instability should be risked institutionally in order to unleash individual incentive to risk without excessively putting social stability at extreme risk.

Or should we be asking whether "capitalism" is worth the human cost.

Steve Keen's Debtwatch
Instability may not be optional (1)
Steve Keen