Thursday, 26 March 2009

Pictures and Expectations

Fascinating how politicians, commentators, and the markets alike are in constant search for the turnaround. It seems that even after almost two years of slide, it is still difficult to take in the magnitude, depth, and length of the crisis.

Amidst all the talk of optimism and rebounding markets, consider this picture of the Japanese export dynamics from today's FT. Remember those times a year - year and a half ago when we were still debating whether the East Asian region will 'decouple'?

Of course, one could argue that Japan is different, the ultimate trump card in any macro conversation. If so, what about the German business confidence? Spooky how the two are almost identical.


Tuesday, 24 March 2009

The Stone Axe of Economic Policy

Now there it is. We have kept trading down the policy tools. By now, only the stone axe is left. Just as the super-sophisticated inflation targeting (or almost that, in the case of the Fed) has by now been replaced by the 1 trillion intervention (a.k.a. The Round Large Red Panic Button), the fiscal intervention has reached a new peak (or low - depending on your point of view) with the Geithner-plan.

Most commentators failed to notice that the markets rallied due to the expected relief of the banks, rather than a positive systemic impact. And, in this case, the two are not the exactly the same. From the troubled banks’ point of view, this is great, for they will get to rid themselves of the burden their ‘expected-not-to-perform’ assets pose. (Although, the usual devil will be in the exact definition of these.) But, from the systems point of view, only a small step forward.

The state provides almost all the funds, takes most of the risk (and most importantly, the entire bad side of the tail of the distribution), in a move which cannot be seen anything else than outsourcing an auction operation to a bunch of investment management firms. At rather high fees, one might add. This is not private-public-partnership, this is a public-hires-private game.

The funniest thing is that the structure of the Geithner-plan is the same as the investment banking bonus system, the subject of that ludicrous ‘debate’ of the past weeks. Think about it: an investment manager (a) plays with others’ money, (b) has only very limited pain if the portfolio goes sour, (c) has a very high payoff if he gets lucky -- a large part of which is being paid in the form of a ‘bonus’, and (d) in return he is expected to structure and manage risk in the best interest of his employer. The Geithner-plan is exactly the same.

To be fair, this plan, if seen through, will indeed serve as a small step from the system’s point of view. Perhaps even two small steps. First, it could reduce the uncertainty about what is on the balance sheet of the US banks. The ‘toxic assets’ will come out onto the daylight, and will be assessed by the financial market. If economic theory is still to be trusted, this will be the best assessment one might ever achieve. Second, the relieved banks could stop being completely paralysed and start operating as banks should.

The trouble is that although transparency will increase, we will still not know what to do with it. The risk valuation problem, the phenomenon that lies at the origin of the rise of toxic assets, will be still here. And they will be until we move economic modelling from national to global level, and thus allow ourselves to describe the economic processes encompassing all the factors that affect our financial assets. (With the added trouble - as this blog pointed out before - that we do not have the theory that could provide such a truly global framework.)

Furthermore the trouble with the banks getting rid of their shackles is that this in itself will not make them return to the market, and behave just as before. The less-troubled, and the non-so-troubled didn’t do it, why would the newly-relieved do it? Same song: until effective policy emerges, there will be little economic incentive to do so. Effective policy in a global economy means global policy. Unpopular as it may be.

Wednesday, 18 March 2009

The Future of Economics

Economics is a prostitute, really. After having managed to turn itself into the most science-like of all those groups thinking about the ways and whys of societal behaviour, a feat done mostly via the application of mathematics as language, it has sold itself, body and soul to, well, whoever pays.

The people who try to figure out how economies behave tend to be preoccupied with the question of how to make money (how many investment bank ‘research’ analysts are really interested in the way the society works?), or with how to keep the economy going so that the next election can be won (or retrospectively, which of those populist promises must be delivered on if the election was won), or how to keep the bankers and politicians from ruining the economy for good (enters the central bank).

The people left in ‘academia’ either tend to do a lot of consultancy for the corporate/policy researchers, and thus are steered towards answering the same questions but do it using slightly different frameworks (and earn less money for it), or choose to remain on the fringe of the debate.

Thus, economics has become more of an engineering discipline than a science. If its subject matter were houses, for instance, it would be concerned with how to build, or maintain houses, rather than what houses are, or where they come from. Maybe think of it as the relationship between physics and engineering; only with the physics bit mostly missing…

As a consequence, economics is the most coherent, but also the most backward social science. Its usage of mathematics ensures rigour, but the prostitution of the questions asked disrupts any real scientific endeavour. Incidentally, the parts where the applications are the least profitable tend to be the most innovative (game theory, networks).

The failure of the discipline is most evident in the current crisis. Analysts in investment banks keep giving in to the latest fads, seeing no point in making calculations any more. Policy economists appear to have decided - for some very odd reasons - that the old models must have been fine, it was just the implementation of the consequent policies that landed us where we are (a bit of self flagellation is always fun, but that is no guarantee for being right). Academic economists are mostly left baffled, living off their reputation, taking any opportunity to pretend that they know something of an Answer.

I challenge all academic economists to recognise the need for a new theory. In particular, a model describing how the global economy behaves is needed. It is increasingly evident that the world economy is as much not a macro economy, as a national economy is not a large market. We will need to depart from the macroeconomic theories, just as macro had to depart from micro some eighty years ago.

The future is global economics.

Friday, 6 March 2009

Read Excerpts And Wait For Their Next One

(A review of the book ‘Economics 2.0’ by Norbert Häring and Olaf Storbeck)

I set out reading this book (I was asked to do so by the publisher) with great expectations. The blurb and the reviews that the publisher provided suggested that although this will probably be no economics revelation, a lot of fun was guaranteed. Well, the first part was definitely true. But fun?

This book is economics 2.0 in its title only. The book has a very limited offering regarding the frontiers of economics. It assumes that game theory and experimental economics are the main drives. Where is the great merger of the three schools of macroeconomics? Where is the rise of mathematical finance? Where is the completely new economics of transition? And most of all, where is the emerging global economics?

As for new, dare we say, economics 2.0 methods: where is high computing in finance? The role of simulations in macro? Or, the use of networks? 

Furthermore, the text flows as well as a compilation of 150 abstracts would. The fact that the papers behind the abstracts are really interesting makes it even more annoying. You would actually want to read this book, but it is just so unfriendly. For instance, it is peppered with names (and often titles) of economists. A randomly selected 15-page sample included 61 mentions of economists’ names. Very tiresome.  

The book sees the discipline of economics through German lenses. In particular the ‘frontier’ is noticed in areas where German economists are strong. (This is probably no surprise as the two authors are well established names in German financial journalism.) This makes me want to be nice to them: it is great when there is a local economics culture which is actually good at something. Unfortunately, there seems to be no self awareness about this feature of the book. The discussion of the problems to be solved, and the solutions, are all from the perspective of that particular Frankfurt-Zurich-Bonn-Munich based economist subculture. The fact that they quote the work of non-Germans, in other academic centres of the world, comes across as mere decoration. 

And in any case, unlike the behavioural economics bit, which is fairly up to date, most of the macro could have been written fifteen years ago. The chapter on globalisation is especially annoying,suggesting that “Vasco da Gama was probably the first global player”, and offering such insights as “No doubt, globalisation has changed the world we live in at breakneck speed.” Grrrrrr.  

In conclusion, this book is a lost opportunity. The subject is great, the work the authors have put in is substantial, and it is clear from the occasional shine-throughs, that they have a really good sense of humour. They could have written a brilliant book, the one that was promised. Sadly, they didn’t. My suggestion is that you leave this book aside, and wait for their next one.