Archive for the ‘Finance, Economics, Money’ Category

Below, I’ve embedded a talk given by Tomas Sedlacek at the RSA in London.  Sedlacek is a young, Czech economist/historian/philosopher who has written and spoken about the problems of economics in both it’s current & historical context.

Something that is noticeable in Sedlacek’s economic thinking is the moral philosophy aspect.  Most economists often speak with a lot of “shoulds”, but very few have any real background in the history or moral philosophy behind economics.  In this regard, Sedlacek is a refreshing break from a lot of the economic thinkers who focus too narrowly, or don’t incorporate historical thinking.

In any case, it’s worth checking out.

A few take-aways from Sedlacek’s talk:

  • Economics is now a religion – we ask it today, the same questions that we asked Gods in earlier days.
  • Compares the dicey relationship of monetary policy & fiscal policy to JRR Tolkien’s Ring in Lord of the Rings.  A force that is too powerful to be allowed to exist.
  • How interest is analogous to alcohol.  Interest & alcohol are similar in that that they allow us to make energy time-travel from the future to the present for the purposes of current consumption (and leverage).
  • Talks about the wisdom of Aristotle, the Islamic tradition & the Pharaohs with respect to interest rates & business cycles.

Additional Resources:

Does Economics Trump Ethics? Does it Pay to Be Good? (link)

Thomas Sedlacek’s site

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Chris Martenson just released a podcast where he interviews the popular behavioural economist, Dan Ariely.

As you may have noticed from some of my previous posts, I’ve taken a keen interest in this issue of “human nature” and topics such as psychology, cognitive bias, behavioural economics, and so on.  It seems only prudent that if you want to know what might happen in the future – you really have to (try to) understand human beings in all of their magnificent glory & tragic stupidity.

I’m glad to hear that Chris Martenson will be drawing upon the insights of behavioural economics in his future writings.

To quote Martenson:

The resulting interview is full of fresh, non-intuitive insights and shines light on how the human brain is often hard-wired for irrational action when it comes to money

…If you’re not acquainted with it already, the perspective offered by behavioral economics is a valuable addition to add to your world view. We’re definitely planning to look through its lens more often going forward.

And here’s the podcast – “Dan Ariely Decodes Why Humans Are Hard-Wired to Inflate

Cheers,

– a.j.m.

Additional Resources:

Back in September, I embedded a series of videos of Nate Hagens giving a lecture on the demand/behavioural aspects of the energy issue – “Energy Resources & Human Demand on a Full Planet” – start watching Part 2 around 8:30 (link)

Gregor MacDonald, once again does a great job illuminating the centrality of energy in the global economic situation.   In this post, he focuses on a chart snagged from The Oil Drum’s 2010 Chart of the Year post.  The chart provides a clear perspective on the total energy expenditures of the US.  Because data on the energy costs of energy extraction are slim-to-none, it’s easier to estimate this cost using inflation-adjusted dollars.  Having done this, it is clear to see that energy costs during the 2000-2008 period were much higher than those in the decade preceding it.  Even with rising energy prices, total energy supply (in Quads) wasn’t able to increase – a clear indication of an energy limit of some kind.

(via Gregor.us)

The Decline of Available Energy to Society

Over the New Year’s Day weekend The Oil Drum put out a call to its community of analysts for chart submissions. What’s been created there over the past 72 hours is a kind of museum of data covering population, energy, growth, and the economy. Do check out the post, Chart of the Year, which is still expanding. Amongst all the various entries, I found this following nugget from a paper by Alan Dechert:

Quantification of the decline of available energy, which results from the increased cost of energy extraction, is difficult. Instead of trying to quantify EROEI (energy return on energy invested) Dechert uses the proxy of inflation-adjusted dollars to obtain his result. I think the answer is valuable, and his graphic here is a more complete look at energy expenditures in the US than my own chart from late last year. What I like about the Dechert chart is that he tracks BTU consumption and shows that this levels off as the cost of that consumption soars. This may appear obvious, but the decline of energy available to society–the energy available after one has spent energy to obtain it–has a forceful and direct impact on the economy. What’s anomalous is that in our age of trailing fossil fuel wealth, we simply don’t recognize the transition. In Dechert’s chart, however, you can very clearly see that we have crossed a threshold.

-Gregor

Graphic: Safe Energy Association: from What’s It Going to Be Like on the Downside of the Curve?, page 21, Dechert.

I forgot to publish this post when I first came across it back in August.  In any case, it’s still relevant to the current environment and is reflective of thinking being done by groups like the Institute for Integrated Economic Research, people like Charlie Hall and his students at SUNY-ESF, and countless others mapping the energy-economy-nexus.

Excerpt Below

via iTulip

originally posted @ Gregor.us by Gregor Macdonald on August 16th, 2010.

The Federal Reserve Enters Decline

The Federal Reserve is an artifact of the Abundance Economics that have governed Western economies over the past 250 years. For nearly 250 years exactly we have climbed the ladder of ever increasing energy density, and ever increasing energy supply. That era has now come to an end. You can see that view, the end of the abundance era, expressed by a number of different writers, whether it’s today’s longish piece from Matterhorn Management, last year’s piece by Richard Heinberg on the End of Growth, or some of the shorter (free) posts I write here at Gregor.us. To keep things simple, oil is no longer available to fund world growth. Oil is certainly available to fund existing systems as they are currently set up, but not new growth. You can only fund new growth with an energy supply that is growing. That’s why the developing world has turned to coal, not oil, to fund its growth. Based on the most recent data, let’s update the chart of global crude oil production:

The credibility of the United States Federal Reserve is closely aligned with its ability to induce economic activity, by the provision of money and credit. But you can see the problem: if there is not an expanding supply of energy, credit is less useful as credit cannot be paid back very easily in a future of either flat, or declining growth. Now that the return on the Fed’s credit provision has gone into decline, then its incumbent on the Federal Reserve to rethink its approach. But the Fed, governed by post-war economists, is apparently unable to learn from new information.

There is another limit to the Fed’s provision of money and credit: and that is the quantity of debt already being carried in the economy.  As debt levels rose in the US economy over past decades, the Federal Reserve simply kept repeating itself in a kind of argumentum ad infinitum, providing ever more money and credit as though completely unaware of the levels to which debt was rising. Now, presently, the Fed has declared a war on debt-deflation. But, the Fed indicates no understanding of the core thrust of debt-deflation. I’ll help out: there can be no kick-starting of economic activity, until debt levels are reduced significantly. What the Fed is looking for is not the effects of more credit provision, but instead, debt jubilee.

The Federal Reserve is now in permanent, irreversible decline because it has no tools to fight both the limits placed on the economy by oil, and, current debt levels. Were the Fed to conduct debt jubilee on a scale sufficient to restart demand, that would vaporize the currency. But even if it were possible to manage a workable debt jubilee, then the economy would come more squarely back into confrontation with the energy limit. And there too the Fed would discover that its role as provider of money and credit was reduced, as credit itself relies on future growth.

The Federal Reserve came into existence during the fattest part of the abundance curve, made possible by the extraction of energy-dense fossil fuels. The early part of the last century was the moment when the world started to transition from Coal to Oil, with the fullness of oil’s resource spread out before the industrial economy like a broad forest. As an artifact, not a creator, of this abundance the Fed was merely a mediator of wealth and performed (at best) a smoothing operation as the economy traded credits on future labor and future growth. Like most institutions in decline, the Fed can either reform itself now and embark on a substantially new mission, or, it can decay into irrelevance as it attracts lower quality intellects, and is dismembered of its power. Indeed, if you look around the edges, that process of decay in the Federal Reserve has already begun.

-Gregor


A year or two ago, I came across a Wikipedia entry of all the known cognitive biases that human beings are subject to (link).  Rather quickly, I concluded that these were all ways that our brains played tricks on us, and that in order to avoid making poor decisions, understanding this list would be crucial.  Which brings me to the topic of this post.

In the TED talk embedded below, Yale primate psychologist and behavioural economic researcher Laurie Santos discusses her research with Capuchin monkeys who have been trained to use a currency in exchange for food.  The fascinating thing about the experiments is that these monkeys (who split off from the human ancestral line ~35 million years ago), make many of the same mistakes that humans do when it comes to making decisions in the realm of economic calculation.  This suggests that we could very-well be evolutionarily unsuited to make sound financial and economic decisions.

It may come as a surprise to those haven’t studied some economics, but one of the core tenets of this faux-science, is that human beings are “rational, utility-maximizers.”  Findings such as those discussed by Santos (and there are many others) pose a fundamental challenge to this underlying premise, as they show just how irrational we can be, not to mention that this behaviour is evolutionarily ingrained (and hence not easily “fixed”).

Although we are highly intelligent in certain domains (i.e. mathematics, physics, engineering, etc.) and in certain environments, in other domains & environments, we are prone to many psychological biases which cause us to make poor decisions (i.e. socio-economic & political realms, interpersonal relationships, etc.).

It seems as though the domains which we champion as proof our intelligence are those that require the use of abstract concepts & symbolic logic which allow for quantification, whereas the domains that we often accuse of being the source of our irrationality are closely connected to limbic-system functions such as memory, fear, aggression, etc. which do not lend themselves to simple quantification.  Santos work shows that, although we may like to think we use reason & logic to solve economic problems, in reality, our behaviour is influenced far more by our evolutionary biology.

The behaviour that Santos observed in the Capuchin monkeys suggests that there are at least two underlying drivers of poor decision-making in the realm of economics.

The first is that we have a very hard time seeing things in absolute terms.  We constantly put things in relative terms.  We don’t evaluate things in rational terms when it comes to risks & rewards.  As Santos says “we think ‘oh, I’m gonna get more’ or ‘oh, I’m gonna get less” rather than (in my words) – “okay…I have X% chance of outcome A if I chose Option 1 and Y% chance of outcome B if I chose option 2, and if I calculate a probability-weighted outcome, then the rational choice would be to chose Option 1 (or 2).”  Simply put, the idea that we are rational and always seek to maximize our utility in our economic decisions is a myth unsupported by the facts (we seek utility of course; but not rationally as is so often assumed).

The second underlying driver of poor decision making is what is called “loss aversion bias.” Wikipedia describes loss aversion bias as follows: “the disutility of giving up an object is greater than the utility associated with acquiring it.”  Basically, this means that we hate losing more than we love winning.  We hate losing so much that we will actually engage in riskier behaviour just to avoid losses.  The paradox of course is that by trying to avoid losses, people often engage in behaviour which actually increases their chances of loss.

I’m certainly not the first blogger to find this gem of a video.  Barry Ritholtz of the always interesting finance & economics blog “The Big Picture” wrote about it back in June:

Excerpt: “Over the past few years, I have increasingly taken to referring us humans as “Slightly smarter, pants wearing primates.” (here, here and here). When I discussed it in a Forbes interview (Ritholtz’s Monkey Theory)  it generated a ton of email:

What is the greatest financial lesson you’ve ever learned?

You’re a monkey. It all comes down to that. You are a slightly clever, pants-wearing primate. If you forget that you’re nothing more than a monkey who has been fashioned by eons on the plains, being chased by tigers, you shouldn’t invest. You have to be aware of how your own psychology effects what you do. This is why we as investors sell at the bottom, get panicked. All the other lessons I’ve learned have come out of that. As has the field of behavioral economics.

Wall Street clichés, like “cut your losses and let your winners run” come back to prevent the monkey part of your brain from doing what it does. There’s a banana–I want it. That’s how chimps behave. Us humans react to greed and fear in predictable ways. We are predictably irrational. If you understand that you can take steps to prevent that–we don’t own anything in the office that doesn’t have a stop-loss on it. In 2008, we watched the market go down 40%. We figured out we’re chimps, and don’t let the chimp inside us make those chimp-like decisions.

Every good financial decision I’ve made comes from, “Wait a second, monkey boy, step back, don’t do that.” Once you realize how your own brain chemistry works against you, it gives you a chance to not panic at the bottom.

It was (mostly) a glib comment to show how irrational and biased us monkeys can be. (I even made reference to it in Bailout Nation.) It turns out that joke was closer to the truth than anyone believed. Laurie Santos gives a talk at TED that looks at how shockingly similar our biases are to those of monkeys when it comes to hardwired foolishness. The good news, for investors as well as monkeys, is that recognizing our limitations — acknowledging, learning the details of, and contextualizing them — allows us to rise above them . . .

So, is it true? Can we actually become conscious of our own limitations in order to make better investment decisions and, by extension, life or perhaps even societal decisions?  Are we capable of coming to terms with the preponderance of evidence of our irrationality when almost all “progressive” intellectual thought from at least the Enlightenment onwards has been about the the faculties of reason & systems of logic?  Can the ego deal with the notion that “I’m not as smart as I think I am”?  Will we stop turning to “experts” & “specialists” to solve massively complex & wide-boundary predicaments and instead approach these problems with a systems perspective in mind?

It seems to me at least, that it’s going to take a major paradigm shift before we realize that our rational faculties – though absolutely instrumental in our heroic rise to glory, and definitely essential for our continued survival into the future – are also screwing us over in many ways.

Many of the dominant theories upon which our institutions are built, seem to rest upon simplistic or linear assumptions derived from reductionist, rational & utilitarian schools of thought.  These schools of thought are, if not wrong, then at the very least no longer true or woefully incomplete for those of us who wish to comprehend, cope with, and adapt to the bewilderingly complex world in which we now find ourselves.

The findings of researchers like Santos challenges us to fundamentally re-think our underlying economic assumptions – particularly the notion that we are rational, utility maximizers.  It’s a tough pill for our ego’s to swallow, but more and more, it seems like it’s a necessary action if we are to cure ourselves of poor economic decision making.

To close, I wanted to pull a quote from Ronald Wright’s excellent book A Short History of Progress which I thought was relevant to the above discussion:

Homo sapiens has the information to know itself for what it is: an Ice Age hunter only half-evolved towards intelligence; clever but seldom wise.

Let’s hope we slightly clever, pants-wearing (and gun-toting) primates find wisdom soon.

Cheers,

– a.j.m.

Additional Resources: http://www.philosophytalk.org/pastShows/IrrationalAnimal.htm

Another fascinating talk by David Korowicz of the Foundation for the Economics of Sustainability (FEASTA):

Embedded below is a great video by David Korowicz of the Foundation for the Economics of Sustainability (FEASTA).

As with many of the resources I share on this blog, the following video explores the pressing concerns of today from the perspective of complex-adaptive systems theory.

Complexity is one of those things that most people “get” (at least intuitively) but about which very few people think systematically.  Instead of trying to comprehend, cope with & adapt to complexity, many people’s response to it is just simply to ignore it or to minimize it.  But, the law of requisite variety says that “if a system is to be stable the number of states of its control mechanism must be greater than or equal to the number of states in the system being controlled (wiki link).” So, for us to properly understand and control our responses to complexity, our mental control systems must be broad enough to be able to handle the massive range of inputs.  In a world of hyper-specialization with subject matter experts, pundits & guru’s, very few of us have a perspective that is transdisciplinary enough to actually understand what’s really going on in the world.

People like David Korowicz of FEASTA, Stoneleigh of The Automatic Earth, Nate Hagens of TheOilDrum & The Institute for Integrated Economic Research, Buzz Holling – the father of resilience theory, or the noted trans-disciplinary thinker Thomas Homer-Dixon – these guys & gals are among a select group of individuals with enough understanding of enough different fields of study to actually have something useful to say about how the future might unfold.  Although the subject matter experts have their purpose, I am of the opinion that in the current environment, anyone who fails to understand complexity and the role that energy plays in sustaining it is not worth listening to for very long.

We live in a complex world.  To deny or ignore this is to severely limits one’s ability to understand and consequently, to make wise decisions.  So, I try to focus on the trans-disciplinary thinkers who make complex-adaptive systems an explicit part of their perspective.

Korowicz is one such thinker.


Additional Resources:

http://www.feasta.org/

https://catagenesis.wordpress.com/2010/07/13/tipping-point-near-term-systemic-implications-of-a-peak-in-global-oil-production/