Monday, September 30, 2013

Some conspiracies are real...

I wrote a while back in Bloomberg about the mystery of how so little has changed in economics and finance, despite the crisis. I mentioned there the great new book, “Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown,” by economic historian Philip Mirowski. It reads a little like a conspiracy theory, as he argues that defense of the academic status quo in economics and finance also serves an array of interests in business and finance for whom the “markets always work best” mantra paves the way to profit. Hence, the profession’s claim that nothing is seriously wrong with economic thinking has found ready allies, especially in conservative and libertarian-leaning think tanks and foundations.

 The picture above is of Polish economist Michael Kalecki, who died in 1970. Lars Syll points out that Kalecki had some very wise things to say -- and not all that different from Mirowski -- about the convenience of many "principles" of economics for industrial interests:
Every widening of state activity is looked upon by business with suspicion, but the creation of employment by government spending has a special aspect which makes the opposition particularly intense. Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.

Thursday, September 26, 2013

What do we know about climate?

Sad to say this is only my second post of September. I have been busy with other things... extensive travel.... re-roofing a barn... the usual. Anyway, just a couple of links I'd like to mention in connection to my most recent Bloomberg column, which appeared yesterday.

The point of my column was to emphasize just how complex the science of the Earth's climate really is. I was struck by two recent articles in Nature, both of which are worth reading. One, an excellent feature by Nicola Jones, describes a few of the counter-intuitive effects of climate, for example, how the sea can rise (or fall) in different ways in different places. Water doesn't just spread out, as you might intuitively think. It has mass, and inertia, gets blown by winds, etc., and can pile up. A short taste:
When Jeff Freymueller, a geophysicist at the University of Alaska Fairbanks, visited Alaska's Graves Harbor more than a decade ago, his marine charts showed three isolated little islands; what he saw, instead, were three grassy peninsulas connected to the mainland. That was because water levels in some parts of Alaska are dropping — by up to 3 centimetres per year.

The ground there is lifting upwards, in a slow-motion rebound that has been going on for 10,000 years, since the glacial ice sheet that once weighed down the continent receded at the end of the last ice age. Gravitational influences on the oceans are also at work: as local glaciers recede and the Greenland ice sheet melts, their gravitational pull is subtly reduced, allowing more ocean water to slop southwards.

Trends in local sea level can differ strongly from the global average, which is increasing by around 3.2 millimetres per year. “Some places, sea-level rise is ten times faster than the average,” says Jerry Mitrovica, a geophysicist at Harvard University in Cambridge, Massachusetts.

One side of this equation is the movement of the land. Canada's Hudson Bay, for example, was once buried under more than 3 kilometres of ice, and the release from that load is now causing the land to rise at about 1 centimetre per year. As that part of North America moves upwards, land to the south is being levered down: the US east coast is dropping by millimetres per year.

Subsidence can cause some areas to sink much faster. Compaction of river sediments and hollowing out of the earth by groundwater extraction, for example, are causing parts of China's Yellow River delta to sink at up to 25 centimetres per year4.

Adding to the complexity, the oceans do not rise evenly all over the world as water is poured in. Air pressure, winds and currents can shove water in a given ocean to one side: since 1950, for example, a 1,000-kilometre stretch of the US Atlantic coast north of Cape Hatteras in North Carolina has seen the sea rise at 3–4 times the global average rate5. In large part, this is because the Gulf Stream and the North Atlantic current, which normally push waters away from that coast, have been weakening, allowing water to slop back onto US shores.

Finally, waters near big chunks of land and ice are literally pulled up onto shores by gravity. As ice sheets melt, the gravitational field weakens and alters the sea level. If Greenland melted enough to raise global seas by an average of 1 metre, for example, the gravitational effect would lower water levels near Greenland by 2.5 metres and raise them by as much as 1.3 metres far away.
Scientists and engineers are only just starting to wrangle all these effects into local projections. In June, the New York City Panel on Climate Change updated its estimates of sea-level rise by including the local effects of gravitational shifts6. Panel members concluded that they expect to see 30–60 centimetres of rise by 2050. Finding and combining the right data sets took about six months; the exercise should pave the way for other cities to do the same, says Cynthia Rosenzweig, a climate-impact researcher at NASA's Goddard Institute for Space Studies in New York City. “We really are working to get the best science.”

Equally interesting and informative, in a very different way, is a commentary piece in the same issue by K. John Holmes. This looks at the history of the use and management of the arid lands in the central and western US. Sounds a little boring, but Holmes argues that the process then was just as messy, just as fraught with hysteria and massive disinformation, as is the current debate over climate change and what to do about it:
When nineteenth-century explorer William Gilpin travelled across the Great Plains, the expanse that covers much of the central and western United States, he marvelled at the “great pastoral region”, the dry climate of which was “favorable to health, longevity, intellectual and physical development”1. Great cities could be built there, he imagined, taking advantage of the wealth of local resources — rivers, forests and even gold.

Geologist John Wesley Powell saw things differently. Moving from the humid east to the arid west would affect agricultural practices, occupations, social interactions and political customs, he contended2, 3. Dry-land agriculture could not support a large population; any towns built in the west would need appropriate designs, irrigation and resource management. A controversy erupted.

The ensuing debates about how the arid lands should be settled hold lessons for us today on adapting to a changing climate. At their heart was a development plan for the region that Powell published in 1878 (ref. 2). It called for detailed scientific and engineering surveys, and analysis to inform land-use plans and laws. Although it addressed a spatial change in conditions caused by westward population expansion, Powell's coupling of physical and human dimensions was a forerunner to the assessment approach used today by the Intergovernmental Panel on Climate Change (IPCC).

Powell's plan was never implemented in its entirety, but it began an era in which large-scale environmental and natural-resources assessments became central to the policy process in the United States4. Stalled by misinformation, political controversy and recessions, legislation for allocating resources in the arid lands took decades to enact. Then, as now, the assessments and their validity became part of the debate. Eventually, extreme weather, including long droughts, pushed policy-makers to act.
Read the whole thing here

Sunday, September 8, 2013

Undoing the pretzel logic of finance

My latest column in Bloomberg came out a few days ago. The article looks at some recent work of young MIT economist Alp Simsek that considers how new derivative instruments influence market stability. He comes to a conclusion that most ordinary people would find utterly unsurprising:
Financial markets in recent years have seen a proliferation of new …financial assets such as different types of futures, swaps, options, and more exotic derivatives. According to the traditional view of …nancial innovation, these assets facilitate the diversi…cation and the sharing of risks. However, this view does not take into account that market participants might naturally disagree about how to value …financial assets. The thesis of this paper is that belief disagreements change the implications of …nancial innovation for portfolio risks. In particular, market participants’' disagreements naturally lead to speculation, which represents a powerful economic force by which fi…nancial innovation increases portfolio risks.
There you go. Because not all people have the same views on the future, derivatives can be used to speculate and gamble. This increases risks in the market. More derivatives and more complete markets is not always a good thing, as standard financial theory would have it.

To be clear, I'm not poking fun at Simsek's work. Not at all. I think this work should be spread far and wide. That this idea comes as news to the academic finance community shows how deeply confused they have become by the received wisdom of market completeness as an ideal. They (at least many) do believe that UP = DOWN, and so news to the contrary sounds radical. In the article I've mentioned several other earlier studies (I've written about them here before, just search on "derivatives") that point to the same conclusion: more derivatives in general leads to more market instability (again, as most people already believe).

It's nice to see some influential young economists picking up and exploring this idea.