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Friday, January 15, 2010

The New Year question (and the answer)

Last updated: January 15, 2010

January 10, 2010

Edward Hugh: In your NYT article “How Did Economists Get It All So Wrong”, you state what I imagine for many is the obvious, that few economists saw our current crisis coming. The Spanish economist Luis Garicano even made himself famous for a day because he was asked by the Queen of England the very question I would now like to put to you: could you briefly explain to a Spanish public why you think this was?

Paul Krugman: I think that what happened was a combination of two things. First, the academic side of economics fell too much in love with beautiful mathematical models, which created a bias toward assuming perfect markets. (Perfect markets lead to nice math; imperfect markets are a lot messier). Second, the same forces that lead to financial bubbles – prolonged good news tends to silence the skeptics – also applied to economists. Those who rationalized the way things were going gained credibility until the day things fell apart.

Source: Ten New Year Questions For Paul Krugman

I would say that the first thing is actually very characteristic of too much of what passes for social sciences these days, see the comments section of this post where I make a very similar point about demography. As to the second one, I would expand it all the way to the global scale and for a start I would point out that the anti cyclical policies are very much responsible for the current crisis, maybe even more than the lack of regulation and failure of the fed to tighten monetary policy. It does look that prolonged periods of uninterrupted economic growth breed carelessness and encourage risky behavior on the part of institutions and people. In this sense the Wall Street was only part of the problem as it's impossible to say that the fed itself, the regulators and ordinary Americans were conducting themselves any better.

Downturns play a vital role in the economic life of nations as they deflate bubbles and bring people back to their senses and smoothing the cycles out may be laying ground for major disruptions in the future. Economic models may fail to account for such a possibility, but from the purely psychological point of view, it's as clear as daylight. Had the dot com crisis been allowed to play itself out, the resultant crisis may well have cooled down the economy and nipped the residential estate bubble in the bud. Instead the markets have been allowed to escape the consequences of the dot com bubble with relative impunity and so they proceeded to inflate one of the biggest bubbles in the post WWII history.

But even larger implications of this rule are relevant for the whole post WWII history. An unparalleled period of impressive economic growth and stability has convinced the Western society that these can be taken for granted now and was followed by no less impressive explosion of utopian lunacies and ideologies that are so out of touch with the reality that it's astonishing. It's here that the bubble of all bubbles has been steadily building itself up. Across the West the nations continued to ignore gradually mounting problems while Europe was busy packing its cities with unintegratable immigrations that eventually spawned massive no-go areas and ghettos that sometimes look like mini-copies of Saudi Arabia herself.

So what the new year and the next years are going to be about? I would bet on a lost decade the Japan style with some nations slipping again back into recession and others struggling to generate sufficient economic growth. The slog accompanied by accumulation of massive deficits and debts across large chunks of the West will be followed almost without a break by another lost decade brought upon by severe demographic crisis in Southern Europe, East Europe and Japan. Throw in a looming trade war between China and the US, never mind some people insisting that China's impressive economic recovery is just another bubble waiting to explode, and we may be up for big troubles.

In many ways Japan should be a good example of what is waiting for the West, if it does not regain sanity. One of the most indebted nations in the West, Japan's whole system, from top to bottom, from the government to the banks and insurance sector, is ridden with trillions worth liabilities, non performing loans, underreported debts and all sorts of pretty toxic stuff. The country's workforce has been shrinking for more than a decade now increasing the total debt per capita ratio, or better per working capita ratio, and the last stimulus package unveiled by the new government is promising to escalate the already weird situation to new heights. When you look at the graph below, you know that this nation has turned the corner, and as the country's indebtedness keeps growing and its population keeps shrinking at an accelerating rate (and aging even faster), the happy end looks increasingly unlikely.

Over the last decades the West, followed by the rest of the world, has accumulated an absolutely incredible ideological ballast starting from this weird PC culture all the way through to even more radical and toxic movements and schools of thought. Not that it was much better on the other side of the political divide where the concept of free markets has been increasingly transformed into one of free lunches crowned by the messianic lunacy of the previous administration that was trying to spread its democracy message by sword to the most unlikely corners of the world.

However, while a couple of lost decades seem inevitable now, it's never too late to adopt a pragmatic and reasonable approach, to let the technocrats come up with plausible solutions, in short, to start making sense. It's really about time for the West to start ridding itself of its intellectual toxic assets. It's about time to understand that no things can be taken for granted and past successes are no guarantees for the future. And for the future to have a chance for something better, the ideology should be put to death.

January 15, 2010

The law of good news and the Middle East

Another example of how prolonged "good" news are breeding expectations of more good news in the future. Over the last decades the world witnessed Islamic fundamentalism in the Middle East and elsewhere surging relentlessly until it eventually unleashed not a wave, but a tsunami of suicide attacks (remarkably recently most of them were directed against Muslims). The common man law of good news postulates that if something is experiencing a prolonged positive trend, it can only grow more in the future. The law of bubbles, however, reasons that the fundamentalist surge is already over precisely for the same reason. Is the cycle really about to reverse itself?

It's not clear whether the Green Revolution in Iran signals the death of the political Islam. The enthusiasm for movements such as Muslim Brothers is still there and may survive the concept of modern Sharia state by a good few years. But behind the scene there is a whole host of indications that the fundamentalist surge is running out of steam. What some very aptly call anti-culture of the West has been repackaged by Haifa Wehbe and her doubles and smuggled into the Arab and Muslim world with all the regular paraphernalia of belly dancing and incessant "ya habibi" evocations. As this storm of silicon enhanced plastic surgery and belly dancing is sweeping regional TV channels, the Arab birth rates crashed and, if just Haifa Wehbe's cleavage can produce such demographic devastation, one can only be wondering as to what will happen when some real stuff starts happening in the Middle East.

The demographers were recently having all their models and graphs massively sabotaged in the Middle East with the Arab/Persian collapsing fertility showing no or very limited correlation with urbanization, education levels and prosperity. But as this hapless science is trying to pick up pieces of what was left of once formidable theories, it's obvious that a massive cultural shift is unfolding and transforming the Middle East, defying on its way GDP per capita, infant mortality and other stuff with which demographers and others are usually feeding their models.

The key to the recent developments seems to be a certain uncanny ability of the TV with its reality shows and soap operas to spread and hook people on certain lifestyles and attitudes without the audience being able economically to experience them. It's a kind of the tail wigging the dog scenario, in which the lifestyle is preceding the level of socio economic development normally associated with it. It's the inability of social sciences to properly measure and quantify such stuff as contents and impact of entertainment programs that's behind their failure to detect such tectonic shifts on time and even recognize them postfactum (they do however can measure such trends as the spread of satellite TV. IMHO should be one of the most predictive indicators).

Anyway, sexualization of the Arab mass culture, its growing consumerist and individualist orientation are obvious and however impressive the fundamentalist blah blah blah may look from outside, from inside the fundamentalist bubble may be already hollow enough to collapse on itself. This is at least what the law of bubbles says: they had it too good and way too long.

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Proclaimed un monstruooo muy monstruoso at 1:04 AM