The credit crunch was, it has been said, the most severe economic crisis since the Great Depression. Well, for the severest economic crisis since records began, it certainly didn't feel like it. But then I might feel differently if I had lost my job. In January 2001, I left Ericsson and within a month, the company share price had fallen by 75%. I like to think the markets had heard word that I had left. The Ericsson share price ultimately fell 98% from its peak and alhough it eventually recovered somewhat, my Ericsson shares (Buy One Get One Free, 7.5% of my salary for about a year) are still worth about two-thirds of bugger all. And had I stayed at Ericsson I would almost certainly have been redundant. Was it Harold Wilson who said that "a recession is when your neighbour loses his job; a depression is when you lose yours." If you were a banker who was given hundreds of billions of dollars by the central banks to give yourself a bonus with, the credit crunch might feel different too. Some of us have already been through a downturn and the FTSE100 is still more than 20% below the peak it reached on 30 December 1999.
But perhaps contemporary neoliberal capitalism is just better at getotting itself out of a crisis than the old system was (whatever we might choose to call it) - Russian crisis, Asian crisis, dotcom crash, 911, Enron, the credit crunch. Maybe, a few little local difficulties aside (how much for Dubai, anybody?), it is more or less back to full steam ahead, at least until the Chinese decide to cash their chips (US Treasuries) in.
Then again perhaps n. The banking system came close to failing. Hell, the banking system
did fail by all reasonable criteria, even if the cash machines never flashed up the message "Funds Not Withdrawable" (apparently we were within hours of that in 2008). As the Weasel has pointed out, it is astonishing that there isn't a banker swinging from every lamppost in the City, Canary Wharf, Wall Street, Frankfurt, Zurich and
King Abdullah Economic City pour encourger les autres. If not what has happened, what will it take?
The problem with the business as usual model is that it is likely to get us back into the same mess. And next time we might be able to pull ourselves out - we still don't know that we
have pulled ourselves out. What caused the credit crunch? The inability to price complex financial instruments. The thing is that it is difficult enough to price simple financial instruments. Consider the Net Present Value of a company (from which one can calculate the share price). Nobody really has an idea what the income of a company might be in ten years' time or what an appropriate discount rate might be: there are only more or less well-informed guesses. And unless you use an unrealistically high discount rate, a large fraction of the NPV is from beyond the ten year horizon. Now you might think a fair price for Vodafone is 180p. But if the consensus value is 300p, you might feel, or your managers might feel, more comfortable if you tweaked the parameters of your model a little and came out with a value of, say, 240p - low, but closer to the mode of the price in the research notes of other analysts. Of course, if you think that a fair price for Vodafone is more like 30p, because you think that disruptive 5G technologies (
cognitive radio,
ultra wideband spread spectrum) are going to destroy Vodafone's business model, you might prefer to say nothing. The market is not very good at handling (pricing in) black swans. There is an asymmetry in the movement of the value of stock markets. Markets random walk towards higher values, but a market can lose 10-20% in a day, whereas they never gain that much (certainly not a major market). The same applies to the share price of an individual company, although these are more volatile as there is the chance of a positive black swan for a company (for instance, winning a large order), which isn't the case for a whole stock market.
It is difficult enough to price Vodafone shares. It is even more difficult to price leverage instruments based on the price of Vodafone shares (because there of the additional risks associated with the nature of the leveraging that must be taken into account). Replace the price of Vodafone shares with, say, the price of (portfolios of domestic or commercial) property, as the basis of the instrument. "I paid £65k for this flat; now, six years later, it is on the market at £165k." "Yes, but what is the
value of the flat?" Now, if you have financial instruments that are based on the price of other financial instruments based on the price of the price of some (volatile, speculative) asset, it is only a matter of time before someone
(in this case, BNP Baribas) decides that they no longer want to play the game because, in effect, they can no longer go along with the crowd and pretend the price of Vodafone ought to be 300p rather than 30p.
One thing about the global financial system is that it is very large.
There are more Vodafone shares traded on a slow Friday than the total number of shares traded on
Black Tuesday. Comparisons between the the global financial systems of the 2000s and that of the 1920s are effectively category errors. The other thing about global financial systems is that it is global. Cameron's Red Tories might fancy a bit of
distributism and might feel that the banks play a role as important as the Post Office and railways did in the Edwardian imagination. But, of course, it would have to be applied on a global scale, and maybe if there is a double dip for the credit crunch or some other bank-related economic crisis in the next ten years, the
Gnomes of Zürich might say enough is enough and scrap the existing edifice it with something radically simplified. Or, more likely radically complexified.
Economics is the study of the allocation of resources under scarcity. Leaving aside the issue of what post-scarcity economics might look like, we know that, under certain assumptions, a market will allocate resources in the optimum manner. Hence "
market socialism". Whatever economic system there is on the first working day after the Revolution, it will certainly have to have markets. The question is what kinds of markets - the important point being that markets are effective "under certain assumptions" that are not always in the real world, either actually or potentially (we are all all too familiar with market failures of many different kinds).
If you can price assets more accurately than the next man then that gives you a definite edge in playing the markets (whether going long or short). If you could you surely would, although people mostly seem not to. We can understand those reasons, so economic models (
evolutionary economic/
behavioural economic ones) that take into account the fact that people are people and behave like people and are mostly not really rational utility maximisers are necessary. And, of course, related to that fact is the fact that people tend to underestimate the impact of non-systemtic risks (i.e. black swans). One mechanism is
predictive markets. Another would be large scale simulations using autonomous agents with multi-vectorial representations of the motivations of people, including
reputational factors, embedded in rich environments of the kind found in MMORGs and virtual worlds.
Increasingly powerful computers will allow a wide range of scenarios to be explored using these kinds of mechanism for the purposes of price discovery.
Apparently, Soviet central planners used the Sears, Roebuck catalogue to obtain pricing cues for their linear programming and operational research efforts. We could imagine a situation in which the retailer (whether the vegetable seller in the street market or the local building society) decides the retail price while the wholesale price is determined by global Cybersyn-type system that would do this
ab initio using the kinds of ++Economics mechanisms I have outlined. In a situation where the map is the territory, issues of gaming the system could, to a degree, be avoided. The question though of ultimate calibration with reality would, of course, remain.
We may have arrived at a neo-Keynesian moment. Sarah Palin is twitting against Obama's deficit spending: "Baffling/nonsensical: Obama's talk of yet another debt-ridden 'stimulus' pkg. Fight this 1, America, bc after last 1 unemployment rose, debt grew." We might yet get a New Economics and a New Politics in the Tens, but neither of them might be the ones we want or need.
Tags: TensfortheTens
Thursday, January 14, 2010 at 5:52PM 