Where economic theories take the wrong turn. (Long read)

[TygrBright]

Disclaimer: My opinion, based on a good deal of topic-specific reading and research I have been doing lately (as well as studies some decades ago at University), plus more than six decades of living in an increasingly unregulated capitalist economy. Your mileage WILL vary... that's part of what I'm getting at, here.

Economic theories are less like bungholes (everyone has one, and occasionally trumpets smelly and noisy stuff from it) and more like sex toys: People may try several, but they generally end up relying on the one that gets them off the most reliably.

As with a lot of other human nature-based phenomenological patterns, we've been trying to make economics into a "science" for ages. Proponents of this instance as evidence the elaborate mathematically-based models that occasionally coincide with observed phenomena, the demonstrable reliability of large-number prediction algorithms, and various other facty and numbery aspects of the discipline.

The addition of artificial intelligence, supermassive data sets, and high-speed processing gives these folks hope that someday we'll be able to feed in numbers and get out a precise explanation for why there's hyperinflation in Venezuela, and, even more hopeful, how exactly we can avoid the next bubble-related economic contraction. But economics, as a thought discipline (or even a worldly philosophy) doesn't work at those levels.

Granted, some things are fairly predictable - most of the time. When interest rates go up, usually bond prices drop and yields go up. When stock values go down, bonds become more desirable.

Of course, when interests rates go up AND stock values tank, where does that leave bonds?

You can tie yourself in knots trying to get every detail right in a prediction algorithm, because the suite of phenomena that make up "the economy" in the "finance and money policy" sense of the term (as opposed to whether you'll be able to get a job, afford your mortgage payments, or get the car fixed sense of the term) is getting steadily more complicated. Our understanding of "money" - what it is, how it functions, how to set policy involving it that won't fuck up the rest of the economy - has never been less of a consensus. And money is where it all started.

There are endless tomes on this, some more readable, some less. Having studied a good few, what I came up with boils down to this:

Money functions in a narrow channel that has greed (or 'incentive' if you like) on one side, and trust (or 'security') on the other side.

If you try to make the system absolutely secure, confining every kind of transaction with regulations, certainties, rules, and guarantees, money (and the economy) languishes. Growth fails, it may not even keep up with expanding populations. Stagnation is the best you can hope for, dearth is more likely, and Malthusian outcomes are not impossible to contemplate.

If you try to make the system absolutely free to grow and innovate and offer endless risks that incentivize growth and expansion, money (and the economy) spirals into an increasing concentration, producing a casino that rewards a miniscule few and impoverishes a multitude. Oligarchy is the best you can hope for, dearth is more likely, and bloody revolution is not at all impossible to prognosticate.

Any economic theory that ignores the reality of that narrow channel is someone's fantasy. Or perhaps, political agenda. Any economic theory that attempts to define that channel and explain how to keep it open in terms of measurements like interest rates, bond yields, commodity prices, trading practices, hedging tools, etc. is playing darts blindfolded.

The channel between greed and trust can easily be mismanaged in two ways: First, micromanagement that is like stretching temporary barriers along the sides of a river's path to try and keep it in bounds or nudge it a little this way or that. Such strategies may produce evanescent local effects, but they won't stop the river from eating out its channel as dictated by flow and climate conditions and random boulders crashing down here and there.

The channel between greed and trust can also be mismanaged by using Corps of Engineers tactics and building heavy-duty dams, levees, etcetera. They may last longer but when the inevitable comes the catastrophes are all the greater, even if you thought you got it right. (And how often do you? Look at the track records on America's major floodplains and coastal areas...)

So what does help?

A better understanding that economics is a dynamic discipline that is constantly changing, but it DOES exist in the context of human behavior. So aim at balancing the influences of human excess: Set up a system that provides modest incentives for those who seek security above all, to try a little risk. Add guardrails that prevent those who hit big at the greed casino from having access to the power structure, so they cannot bring others down with their risk taking, or consolidate their wealth into a twenty-ton weight damming the flow.

Tax progressively, but modestly, including all forms of wealth in the mix - asset holdings, value growth, and revenue.

Use the powers of government, through taxation, insurance, targeted credit guarantees, and the provision of base-level savings/investment tools, to provide access to minimum financial health for citizens. Post-office savings and loans rather than payday usurers. Reinsurance programs to assist the insurance industry in spreading risk and keeping prices low and accessible to homeowners. 'Untaxable' maximums for retirement and educational savings, based on mandatory and frequent reassessments of value. There are a hundred creative ways - of course, they all depend on having adequate tax revenue from those who benefit most from the economy.

Allow risk, and reward levels of successful risk taking that don't incentivize playing with other peoples money unbeknownst to them. "Windfall" tax exemptions, income averaging, deferred interest credits and other tools can encourage the creative to innovate, reward innovation, and still keep the games honest. Stepped 'elevators' to asset and growth tax exemptions that can be adjusted to somewhat offset marginal tax rates on income.

We are now suffering from decades of progressively unregulated capitalism and laissez-faire market practices. (One phrase: "Collateralized Debt Obligations" ) We've let the whales into the casino management, and they've rigged every game. So yes, recovery will have to start with restoring trust, in a big way. Reining in the excesses of "corporate personhood". Tying off the conduit between massive wealth and political control. Re-regulating the basics more stringently and capping the worst excesses of the baroque 'innovations' in hedging, arbitrage, venture capital, merger and acquisition rules, monopolization, etc.

Until then, all the formulae for interest rate management, credit and commodity pricing, bond offering, exchange and currency management, are just so many darts flung at the board. Some will make a difference for a while, maybe.

What we need to aim for, long term, is a realistic outlook that sees the economy as a platter balanced on a stick, with a bunch of marbles rolling around on it. Equilibrium becomes defined not as "no lateral motion" but as an acceptable level of lateral motion that always moderates in the other direction to a near-equal degree. "Acceptable" being perceptible but never at risk of wobbling out of control to the extent of the marbles falling off, or worse, the plate dropping off the stick.

It will always be a game of whack-a-mole with innovators trying to subvert or use each new rule to their own advantage. Therefore, having a robust and skilled corps of "hackers" to test each rule in advance, and reverse-engineer solutions to emerging problems, is also essential.

But first, we need to turf the whales out of the casino management.

thoughtfully,
Bright

[The Magistrate]

1. Excellent Commentary, Ma'am

[Warpy]

2. Long Term Capital Management

Used a Nobel prize winning formula that allowed them to invest, hedge their bets, to spot bubbles early and exit them before they burst, earning phenomenal amounts of money for its investors...until it didn't. There is always something out there that people forget to plug into the system, some obscure variable that one day will bring the whole thing crashing down. AI isn't magic, it still relies on mere human beings to tell it what is worthy of specific notice.

The problem is that everything is focused on fattening the owning class. Clearly this is no way to run an economy, unless mass starvation and civil unrest are what you are looking for. All the schemes have absolutely no mechanism for scraping profiteering off the top and circulating it back at the bottom as a way of supercharging an economy. Instead, our present system encourages stratification with entrepreneurship and innovation largely crushed while public works are undone, the tax burden shifted from the rich to the rest.

We know exactly what o do about all of this with no AI program needed. What we lack is a sufficient crisis to break the system down so that we can implement it. Overreliance on an AI program might just provide the crash.

[Farmer-Rick]

3. Well said

Capitalism concentrates wealth in a few hands.A few people with most of all the nation's wealth passing it on to their off spring when they die. And those off spring gathering in more wealth with their inherited capital. Capital making capital. Eventually most all the capital is owned by one or two people. It is the ultimate outcome of capitalism.

In the mean time, everyone else gets poorer. Markets are monopolized by the wealth extraction tools of the capitalist. The richer get richer. The planet is destroyed and polluted and human habitation on this planet becomes impossible. All so we could keep playing around with money and capital.