Tim Lund

I’m currently reading Simon Schama’s “Citizens: A Chronicle of the French Revolution”. It would be superfluous to add to general praise it has won since publication nearly 30 years ago, but for what it’s worth, here’s the NYT review of it.

This blog is merely triggered by his account of Turgot’s 1776 economic policy disaster.  Constraints on trade and prices were suddenly removed, people rioted, Turgot was dismissed, and Simon Schama’s writing conveys a knowing roll of the eyes.  To my modern mind, familiar with cases of countries not responding as hoped to the shock imposition of neo-liberal policy prescriptions, the story seems rather familiar. Continue reading Adam Smith on neo-liberals

Having already expressed my doubts about Mervyn King’s ideas on credit in his recent book, “The End of Alchemy”, I’m moved to comment on John Kay’s very positive review of it yesterday for the FT,

The enduring certainty of radical uncertainty

where for him the most important message was the stress on radical uncertainty. He describes his and Mervyn King’s parallel intellectual careers where they were together at the start, receiving and passing on what now seems an absurd idea of Milton Friedman’s – that there is no “sharp distinction between risk, as referring to events subject to a known or knowable probability distribution, and uncertainty, as referring to events for which it was not possible to specify numerical probabilities.”

Up to a point, I don’t think Friedman is being absurd, although that point is reached only a few lines further on in the text John Kay refers to (Price Theory, p. 282), of which more later. Of course there is a distinction to be drawn between these types of risk, but I don’t think it’s that sharp, because almost all financial risks have a degree of uncertainty in the sense of the distribution not being known. But now, conjuring up the idea of radical uncertainty, it suggests a qualitative boundary beyond which quantification is pointless, and that given the pervasiveness of uncertainty, this applies to most financial risk.  Perhaps mundanely, I’d suggest

• there is no such boundary,
• that pretty well all financial risks have a degree of uncertainty in this sense, but
• that in general this can be reduced with some risk analysis (preferable not just collecting data about past performance), and
• a subjective estimate of the remaining uncertainty is useful for a financial risk taker.

Where I’d say Friedman crosses the border to absurdity is when he writes

Sometimes people will agree – we then may designate the probabilities as “objective”; sometimes they will not – we may then designate the probabilities as “subjective”.

In this, I think Friedman is claiming that by observing how such risk takers act on their subjective estimates, and generate a market price for the risk if there are enough of them, then it will be possible to calculate the probability implied by that price, and that this probability is “objective”.  The scare quotes are still there, but so are they round “subjective”, for no reason I can see.  Combine with this dogma that markets are the best possible calculating device – rather than just a signal worth having on the radar – and the intellectual path is open to the justly derided excesses of financial quantdom.

The example of Gillian Tett’s insights into CDO traders from her studies as a social anthropologist is now well known, and in retrospect we can see that this would have kept our estimates of the uncertainty – and expected value – of such products more objective – no scare quotes needed here.  But so would insights from other disciplines – understanding of IT systems security, for example, and  maybe even some of what still seems like financial quantdom will have a role in understanding uncertainty and reducing it.

John Plender gives a warm review to Mervyn King’s recent book, The End of Alchemy: Money, Banking and the Future of the Global Economy

Uncertainty principles: ‘The End of Alchemy’, by Mervyn King

concluding

It is rare to encounter a book on economics quite as intellectually exhilarating as The End of Alchemy

I’m not convinced, at least by the review.

The aim of the book is said to be to “put an end to the alchemy that has made financial crises a permanent feature of the landscape and allowed money — a public good — to become the by product of credit creation by private-sector banks”.

This is odd, because there are numerous public goods which are created to a significant extent as by products of private-sector activities.  A typical pattern is that private sector agents engage in transactions where both parties benefit – which, if you insist, can be expressed as both seeing an increase in their utility – and that by such transactions becoming routine, helped by the emergence of institutions to support them, a public good is created.  Very often a public sector agency is needed to support such goods – so judges to support a system for enforcing and interpreting contracts, paid as indirectly as possible – by general taxation – by the parties to the transactions.

It’s how money and banking systems developed, and while in a sense they are inherently unstable, being based on a degree of trust which may suddenly evaporate, on balance I would expect a Central banker to see private-sector credit creation as a strength of a banking system, to be helped impartially in supporting the public good it creates, but not something to be eliminated.

The starting point for the argument is that we live in what economists now call “radical uncertainty”, where it is not always possible to compute the expected utility of any action, and the probabilities of all future events cannot be identified, so no set of economist’s equations that describe people’s attempts to cope with that uncertainty.

I wonder if it was ever possible to calculate the probabilities of all future events, so raising some doubts about any such set of equations.  So what have bankers and monetary economists being doing all along?  Doing the best they can, and if we accept that banking systems have on balance been beneficial, then the policy focus should be on helping them do better in serving the public. This would suggest greater transparency, more public provision of data which will help bankers and their customers identify individual risk, and the prevention of structure which divorce individual risk from public risk (the problem of too big to fail.)

Instead, the concept of radical, or Knightian uncertainty, asserts that some risks can never be calculated, so is qualitatively different from the sorts of risk which it might be possible to understand better.  I can accept that a theoretical distinction can be made between some risks which is it possible to quantify – the result of tossing a coin, for example – and others, which are not, such as whether a potential client is actually an extraordinarily accomplished conman, or whether a technology which depends on cutting edge science – quantum computing, anyone? – is actually going to deliver. Put like that, I’d suggest bankers have always dealt with radical uncertainty, an impression supported when I google to look for examples of such uncertainty.

Explained: Knightian uncertainty

Mervyn King’s response to accepting the world as it is, with such uncomfortable uncertainty to be found not only in businesses as modelled by central banks, but the financial sector itself, is to give Central banks the authority to perform various calculations

he offers an elegant refinement of the concept of “narrow banking”, which seeks to ensure that all deposits are covered by safe, liquid assets. In his system, banks would decide how much of their asset base to lodge in advance at the central bank to be available for use as collateral. For each asset, the central bank would calculate a haircut to decide how much to lend against it.

What is more, it would not just apply to the current financial system, but to any other business which emerged performing an equivalent role

The system would apply to all financial intermediaries, including those now outside full banking regulation, to avoid the “boundary” problem whereby depositors evacuate in search of higher yielding outlets.

I struggle to see how this is elegant – unless the word carries with it the suggestion of intensely learned or technical discussion, with subtleties beyond the appreciation of those not trained as economists.  It doesn’t look that different, to me, to the system of risk weighting for bank capital.

What is rather clearer, however, is that somehow, in a world just admitted to be characterised by radical uncertainly, the central banks will someone be in a class apart from everyone else in the economy, and able to get their calculations right.

It is fairly clear this is nonsense.

Alternatively, how much inequality would there be if all human lives were played out on an economically levelled playing field?

I know it’s never going to happen, not least because economic winners, whether thanks to luck or talent, like to tilt the odds for the next generation by giving their children the benefit of their experience while alive, and their money when they die.  In earlier ages they have also constructed ideological systems requiring access to certain roles – being High Priest of the Temple, Caliph, or allowed to vote in elections – to those with some arbitrary genetic inheritance, or born or living within some administrative region.

But there is a more modern ideology out there in favour of equal opportunities, which has had some success in getting measures implemented in public policy.

Chart of the Week: How two decades of globalization have changed the world

This chart derives from the work of Branko Milanovic – no fan of inequality, or neo-liberal cheer leader – but the implication is that globally inequality has declined thanks to globalisation, and inequality only appears to increase if seen through a nationalist prism.  The big picture, I’d say, is that on balance globalisation has levelled the economic playing field, and the developed world middle classes are now obliged to compete with equally talented people from emerging economies such as India and China.  Meanwhile members of elites, individually benefiting most from globalisation, very often buy assets in safer developed economies, and go to live there for at least some of the time, so boosting inequality as perceived in these countries.

That chart was just for the period up to 2008, so what happens now, post-crash, will be interesting. From a simple Marxist point of view, one would expect the development among the middle classes of the developed world of ideologies opposing globalisation.