Saturday, June 13, 2009

Making Excuses for Economists

Economics has never been a science - and it is even less now than a few years ago. ~Paul A. Samuelson

Any article that starts out with the sentence, "According to classical models of economics, financial crises don't happen," is bound to be a knee-slapper. Back in the Neolithic, after flopping at physics, I moved into Management Sciences, a very impressive-sounding way of saying "Business Major." Along the way, I managed to pick up a minor in economics, so I have actually studied the subject. And I can tell you, my professors could define any number of ways financial crises would happen.

The article goes to say that the study of economics could benefit from methods developed in other sciences. Presumably, they're thinking of string theory, which also has no ability to predict anything.

They're missing the point. It's not that classical economics can't function as a guide and make general predictions. It's not even that the assumptions of classical economics are all goofy. It's that the actual economic systems in existence today have nothing to do with real market principles. And until the economists and the policy-makers get that through their thick heads (or stop accepting bribes from the market-wreckers), economic predictors will make the weather forecasters look like psychics by comparison.

For example, one assumption of classical economics is "perfect knowledge." That is, investors know everything there is to know about the supply and demand of a product. In the olden days, someone could create a market panic just by falsifying a report of floods in Paraguay destroying some crop or another. If anything, the knowledge level today should be better than it's ever been. However, when markets are controlled by a few large players, like, say, oil, then all bets are off.

The funny thing is that people all blame OPEC for their control of the oil supply. At one time, their control was probably impressive. When one looks at the profits now generated by Exxon, BP, and Dutch Shell, it should be clear that OPEC is just along for the ride. In fact, if anyone ever decides to actual investigate the books of those giants, I suspect they'll find that they were the big players in oil future speculation.

In case anyone wasn't paying attention, it was overpriced fuel that began the so-called financial crash. After all, someone had to be buying those futures that someone (most likely the oil companies) was selling. When fuel prices got out of hand, consumers had to start cutting back on purchases and began defaulting on credit and mortgages. Meanwhile, the financial folks who had bet wrong on oil futures going up indefinitely, which would be most of them, suddenly got cash strapped when oil began to fall, and they found themselves on the wrong end of the oil companies short-selling.

Then there's the general business of monopolistic markets. Everyone recognized for years that, if you didn't regulate monoplies, they would put the screws to everyone. Now regulated utilities worked fine for years. The "breaking up" of AT&T into little unregulated regional monopolies was the biggest absurdity of modern economic times. Most of those pieces are back together, and rates are going up while service goes down. Almost anywhere in the civilized world you can get better internet service than you can in the United States. With AT&T pretty much allowed to do what they want, it's not hard to understand.

Note: AT&T recently shed the last bit of regulatory control Alabama had imposed on them. They celebrated by raising dial-up internet access by 50%. Meanwhile, they do nothing to improve the availability of ADSL, meaning that they have a captive market. Doesn't exactly sound like a free market to me.

Another assumption of classical economics is that investors will act rationally. I'll wait while you stop laughing.

There's two things wrong with that. First of all, a huge amount of investing is actually being done by computer models that don't do anything rationally. The programs just follow rules. In many cases, those rules allow for a market to enter a death-spiral because, for instance, a drop in price can trigger sales, which trigger lower prices, which trigger more sales and so on.

There are so-called "witching days" where all the financial computer models trigger an activity based on whatever conditions are programmed into them. There are times that several of these witching days coincide, with all sorts of volatile results, almost none of which ever favor an individual investor.

Back in the 1920's, everybody was speculating in the market. Worse, they weren't investing for the long term; they were looking for the quick kill. The result was margin-buying and hot-tip buying, both of which are recipes for disaster. Now, we have endless ads from online investing outfits that purport to give you sophisticated tools to do quick-kill investing. If there's anything that a rudementary study of economics reveals it's that constantly going for short-term gain is a recipe for disaster, whether for individuals or for businesses.

The other thing economics teaches us is that the small investor is not a rational investor. They got into trouble in 1929, which is why the SEC came about and financial institutions got heavily regulated. The idea was to keep the small investor from betting the farm based on whatever any huckster tells them. Then the de-regulators started having their way. The banks could be stockbrokers, the stockbrokers could be banks, and small investors could go nuts once again on their own. Which is another reason 2008 looked a lot like 1929.

We don't need more science in economics because we haven't paid attention to what it already has taught us. If we won't learn from economic history, applying some theory from physics to economics won't help.

Dark matter is bad enough; can you imagine "Dark Money"? It positively makes the blood run cold.

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