And so it goes

The spreadsheet error heard 'round the world has spawned a cottage industry in hand-wringing. Not that any of this would actually, you know, change anyone's policies. But it is fun to mock the more-ignorant-than-you, as Ireland, Greece, et al. will be under death-spiral austerity for some time to come. The premise is wrong, but the debate seems to be between which conclusion from the incorrect premise is better. Is 90% debt-to-GDP sustainable, or is it 110%? How many angels can dance on the head of that pin?

If people were honest, they'd note the obvious. Debt-to-GDP is relevant when a country becomes reliant on the confidence of external creditors to sustain borrowing. This instance, from historical observation, is only applicable to developing nations. If the external creditors find reason to believe that existing loans might not be repaid, interest rates rise and new loans prove difficult to acquire. This causes the country's economy to stagger and fall, and due to the vicious cycle of recession leads to unemployment which leads to lower income tax revenue which leads to bigger budget problems which leads to less confidence in the ability to repay which... lather, rinse, repeat.

Debt-to-GDP is also an issue with those on fixed exchange rate regimes (gold standard, circa 1920) or common currency areas, where monetary and fiscal policy autonomy has been ceded to the central, external monetary authority. In this case, the country is physically restrained from borrowing by the central authority, which causes the same vicious cycle outlined above.

And then there are countries like the U.S. and Japan, which are not reliant on external financing and can for the time being monetize any realistic amount of debt. In this case, the percentage becomes meaningless. Does it matter that Japan owes 220% of GDP when 95% is owed to itself? Or that the U.S. biggest creditors are the Federal Reserve and Social Security? This sorta blows out of the water this presumed linear relationship between GDP and debt. Maybe the problem wasn't that the parameters weren't right but someone forgot to run a freaking Chow test? How many structural breaks can fit on the head of a pin, or a data series with so many quarterly, serial-correlated observations?

So the hand-wringers will wring their hands, and the Fed will be criticized for "not doing more" with an unemployment rate still in the 1991 recession range, and the central banks will continue to dictate the same policies because the alternative is Financial Armageddon, or something. Economics is the story rich people want to hear. And the rich run things. So nobody really listens.

The Hypothesis

The Behavioral Model Hypothesis is a quite simple one. People can’t predict the future, so they project the current situation ahead as far as necessary when making economic decisions. This general decision making rule, when executed by everyone in the economy, creates the necessary dynamics for a cyclical economy. When enough people make bad predictions, the economy reaches a turning point. Too optimistic? That’s a recession Too pessimistic? That’s a recovery.

Structural factors are what keep the economy from experiencing a never-ending boom or death spiral. On the upside, there are increasing economic costs that create a natural speed limit on how fast the economy, or even sectors of the economy can grow. On the downside, businesses can operate profitably at low income levels, consumers have a significant amount of non-discretionary spending, monetary authorities can prevent an implosion of fractional reserve lending, and the same lumpy economy creates investment opportunities even in the deepest recession.

Structural factors also can act as an impediment to recovery. Broken consumers, lenders, creditors, or governments can reduce the quality of a recovery, even if the recovery is still guaranteed to occur. Likewise, fiscal and monetary policies that can reduce the structural impediments to the next recovery are desirable, even though they are unable to prevent or end a recession.

Keynes was the original proponent of the Behavioral Hypothesis in his General Theory, published in 1936. The problem Economics had is that if Keynes’ ideas on uncertainty were implemented into conventional economic theory, most of it would have had to be thrown out. Therefore, the most important feature of Keynesian Economics was thrown out, so that the rest could be seamlessly incorporated into the Classical Model.

Very many economists, most frequently those with Keynesian leanings, complain bitterly about this omission of uncertainty. Very few actually have the ability to complain effectively. One of those that could was Hyman Minsky.

Minsky developed the Financial Instability Hypothesis (officially in 1992, though he had published many papers on this subject prior) based on the application of uncertainty to financial markets. Decision makers in finance are particularly likely to project the current situation out indefinitely, since departures from herd behavior are very costly to them. Bubbles become endogenous to financial markets through this behavior, and always end up with the proverbial bust.

The problem with Minsky’s FIH is it only relates to a relatively modern financial system, and does not explain how the economic cycle is a feature of economies at all times and in any level of development. Clearly, Minsky’s idea should be applied much more broadly than just the modern U.S. financial economy.

The goal of this blog is to flesh out the Behavioral Model Hypothesis and then apply it to financial markets. Ultimately, my goal is to get a book out of this solely for my own edification. However, I think it this type of analysis is both potentially profitable and woefully lacking today. The only way to find this out is to launch it and see what happens.

My first goal is to post basic but useful commentary on the weekdays. On the weekends I’ll post a longer research-oriented thing on Sunday that I’ve worked on during the week. Once I can do this for a month, I’ll start trying to cross-pollinate with other business blogs. Baby steps first. Here we go.

Who is defending austerity now?

Nobody...and everybody.

Austerity is strictly a policy of the creditor caste. It has never worked, but it is always the first policy implemented. "For their own good", it is always said. But the premise is always wrong. These countries are rarely, if ever, spending out of control. Like this cycle, it is always an income shortfall. Austerity throws people out of work and amplifies the shortfall in income. Meanwhile, asset prices plummet and the only people with money, strangely the same creditor caste forcing the austerity programs, snaps them up for a song. Lather, rinse, repeat. It doesn't matter whether its the Third World Debt Crisis, due to plummeting raw materials prices...or Russia, with state assets sold for pennies on the dollar, or East Asia. The only winners are those that refuse to play the game. The losers are multitudes. Heck, they lost Stiglitz over a decade ago, but it doesn't matter. When the chips are down again, it's always the Jeffrey Sachs of the world calling the shots. So we can't defend austerity...because of an Excel spreadsheet error? Are you kidding me? Adolf Eichmann is kicking himself in hell. I should haff zed it vas a circular referenz! So this means we're gonna tell Ireland, Greece, Cyprus, Italy, Portugal and so on all is forgiven? Oh, its okay now! You can go to 110% not 90%. Here's some money for those social programs we made you cut to get loans. Uh...probably not. Greece is at 27% unemployment and children are starving across the country. Reinhart and Rogoff get scolded for not updating their formulas.

RIP Ritchie Havens

I was born less than a year before Woodstock. My parents, middle-of-the-road Republicans from Southern California, were too far geographically and politically to think about attending. As a history buff, though, U.S. history 1950-1970 is my favorite period. I first saw the Woodstock concert on Night Flight in 1987 as a high school senior. Havens' performance immediately stands out, though a lot of fantastic artists followed. An obscure "folk poet", called to open the concert when the intended act's gear had not arrived, performs a fantastic 45-minute set, then another, then another, then another, until he had sung every song he knew. The energy moves into the crowd. They stand up. They clap. They dance. From that point forward, it's no longer a concert. It's a happening. You can see where a recently burnt-out H.S. Thompson could write half a decade later.

And that, I think, was the handle—that sense of inevitable victory over the forces of Old and Evil. Not in any mean or military sense; we didn't need that. Our energy would simply prevail. There was no point in fighting—on our side or theirs. We had all the momentum; we were riding the crest of a high and beautiful wave.… So now, less than five years later, you can go up on a steep hill in Las Vegas and look West, and with the right kind of eyes you can almost see the high-water mark—that place where the wave finally broke and rolled back.

For Ritchie Havens, the wave never broke. He noted soon after his 70th birthday, "I don't feel any different from when I walked into Greenwich Village 50 years ago...Everything I hoped for has happened. In 1969, he opened Woodstock with a message of energy and hope. He leaves us in body, but his energy remains for those who can still feel it.

Reboot

Will try to do better this time.

Shorter The Stone

Is American nonviolence possible?

A-ha-ha-ha-ha-ha-ha-ha-ha-ha-ha-ha-ha! No.