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We are humans, and we should figure something out

April 12, 2011

A Man walks on the Moon, but we cannot improve the perfect market

Again, Perry Mehrling:

“But Greenspan also thinks that, even if we do manage to get a glimpse, it would not help us much, because the system is “more complex” than we contemplate, on account of “the degree of global interconnectedness of recent decades.” Why collect data, if you will never be able to understand it?

To which I, and again pretty much every economist I know, would answer, What else is science but the possibly quixotic belief that application of effort and reason will eventually be sufficient to unlock the mysteries of the universe? Even if some mysteries remain beyond our ken, we can never know that in advance. If it looks like a big job, then best to get started, and if it is too daunting for you, then please step aside and give others a chance”

I have a small nuance to add to Mr. Merhling’s statement.  I don’t think most economists are creating useful work, because much of their assumptions are based on the non-trivial assumption that deviations from an unfettered market must result in less optimal results. It’s a bad assumption because the version of optimal results ignores risk.  And I hate to remind him, but Greenspan is an economist.

Why in the world does the economics profession spend so much time on creating elaborate proofs of our helpless situation, instead of working on things we can solve and make slightly better.  Its as though engineers and spent all their time proving Fire is really complex and burns best if left alone under ideal conditions, so we shouldn’t bother with trying to improve Internal Combustion engines, because those aren’t ideal conditions for Fire.

Most economists had never heard the term “Risk adjusted returns”  and therefore assume that high returns are always better than low returns.

This is from an article I wrote about Tyler Cowen’s near complete blindness a while back.

I find it odd that humans can: Put people on the moon; design, build, and program computers; improve traffic patterns; run profitable businesses; create and run the internet; raise ever more intelligent kids.  But for many economists, their most sacred principle is that even the smallest deviation from unfettered natural systems reduces economic performance.

The idea of maximizing economic performance instead of maximizing the risk adjusted returns of our economy is probably flawed.   Brad Delong points to an interesting chart that shows how much volatility we have taken out of our economy with active management.   But the long term growth rate has remained largely the same – we’ve just cut off the lower tail.

This is similar to the return curve that most Long Term Trend Followers have, and why they insist on using theSortino Ratio, instead of the Sharpe Ratio. Downside return volatility is far more devastating than upside volatility, even though you need to monitor both.

It does not make coherent sense, on some basic level.  Either humans can figure stuff out to make it better, or they cannot.   There isn’t some vast, cosmic, “un-figure-out-able” off-limits sign on economic activity, just the ones we put their ourselves.  I am not claiming it is easy, only that the natural order isn’t likely to deliver what we want.

Tyler Cowen gets a huge salary from the Koch brothers through the Mercantus foundation.   He’s paid to not just ignore any useful information, but rather help to build an edifice of knowledge that shows humans are helpless to improve their lot any better than the awesome complexity of markets would. To remind the world of his goofy-ass statements:

“Oddly, Taleb’s argument is weakest in the area he knows best, namely finance. Only on Wall Street do people seem to give proper credence—not too much, not too little—to very unlikely events.”

Thats from June of 2007.  Smart guy, eh?

Perry Mehrling is being paid to figure out useful stuff.  Note that both Perry and Tyler are huge “fans” of Fischer Black.  Only one of them learned anything useful from Mr. Black.

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