FDL Book Salon Welcomes Yves Smith, ECONned:

[Joanne98]

Welcome Yves Smith and Host, masaccio.]

Yves Smith brings the same clear and concise writing to ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism, her explanation of the Great Crash of 2008, that she shows every day at her website Naked Capitalism. Smith points to the abject failure of neoclassical economics as the beginning point for this disaster. The unproven assumptions of this theory were converted into Indubitable Truth by academic economists. Their careers were based on their ability to combine those Indubitable Truths with other unproven assumptions and turn them into mathematical formulas which, they said, explained the way the economy works. These ideas were widely accepted by corporate interests and their shills and think tanks, media elites and politicians, and turned into statutes and regulatory policy. Immediately the vipers on Wall Street exploited every one of the new weaknesses for personal profit, first at the expense of other traders, then at the expense of their own clients, and finally at the expense of taxpayers.
Today’s neoclassical economics started with Paul Samuelson, who realized that if he made certain assumptions, he could turn big chunks of economics into mathematical equations, and explain the US economy in a few formulas. One of his simplifying assumptions is that economy is like a pendulum. No matter where it starts, it swings towards a position of equilibrium, a place where no further motion occurs. Fortunately, and amazingly, that equilibrium is at the point of full employment.

Smith explains that this assumption has no basis in reality. Any moderately complex system has feedback loops. Some are negative, that is self-damping, like pendulums. Others are positive. They generate wilder and wilder swings until they disintegrate. It is easy to think of positive feedback loops in the economy. Smith points to the tragedy of the commons, with a real world example of the over fishing of the Great Banks. Throughout the book she describes feedback loops that contradict the equilibrium hypothesis.

She takes up several of the other mainstays of neoclassical economics, including the efficient market hypothesis and rational expectations theory, and their theoretical children, which formed the basis of financial economics. These ideas led to the complex models used by the geniuses on Wall Street. In order to make the math easier, they all assume that randomness in the economy has a Gaussian or normal distribution. The evidence shows that randomness in financial markets is much more complex, and very difficult to compute. She points to a significant economic theorem that mainstream economists had to ignore, the Lipsey-Lancaster theorem. But those annoying reality thingies didn’t stop them. Any theory is better than none, said Milton Friedman, and the equations flowed.

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http://firedoglake.com/2010/03/13/fdl-book-salon-welcomes-yves-smith-econned/