New blog -- The Social Atom goes to Wall Street

I haven't posted here for quite some time now and I presume everyone has gone away to browse in more frequently updated pastures. But I wanted to alert everyone to a new blog I've just started: The Physics of Finance. I touched on the self-organizing dynamics of financial markets a little in The Social Atom -- and had an Op-Ed on the topic in the New York Times a couple years ago -- but this is a enormous topic deserving a large space of its own. The new blog explores a growing revolution in the science of markets based on ideas and concepts from physics. This kind of work has really been exploding in the past few years. If traditional economics has emphasized self-regulating processes and the concept of market equilibrium, the new perspective emphasizes the myriad positive feed backs which often drive markets away from equilibrium and cause tumultuous crashes and other crises.

 If anyone comes back to this blog or still gets updates from it, I hope you'll visit me at The Physics of Finance. I'm only just getting this going so the blog is a little sparse now. But I'll be working on it regularly from now on. Economics is too important to be left to the economists!

Mixed metaphors and messages...

An article in the NYT describes the growing concern over economic conditions, and all of the candidates' immediate desire to assign blame on you-know-who and to proclaim how they'd do better. It's obviously an irresistible way, I suppose, to score points. Much as I think the Bush administration has acted childishly and incompetently in almost every area, however, I find it awfully hard to give them any responsibility for the property market, or the irresponsible lending practices that pumped the bubble for so long. That's happened before and it will happen again. (They can be attacked much more reasonably on their policies that have led to exploding inequality.)

But I'm still not convinced that anyone can really predict and manage an economy on the basis of anything more scientific than the reading of tea leaves. As far as I can tell, economics, especially the "macroeconomics" of entire economies, is still very far from being a real science. (I wonder if any readers out there -- perhaps, some economist -- can point me to any data showing that economists can predict the movements of economies with anything like the accuracy one routinely finds in the rest of science? I'd be very interested to see such evidence.) This post from the Leiter Reports, although three years old, gives an interesting (legal philosopher's) perspective on economics as a science, and it's one I find myself largely agreeing with. Economics has been so committed to rational behavior, to proving mathematical theorems (which makes it look scientific), and even worse, perhaps, to the notion that all systems can be understood by supposing they are in some equilibrium, that it's tied one or both arms behind its back in its efforts really to understand economic phenomena.

Remarkably, these theoretical addictions still persist. An economist told me that it's still very hard to publish in some of the "best" economics journals if one does not assume that economic agents are fully rational. This is a problem in the sociology of the economics discipline. But it's changing, of course, as it would have to if economics is going to grow into something more intellectually sound. One promising development, for example, is a great body of work in computational economics, in which researchers aim to make plausible assumptions about human behavior -- based hopefully on empirical evidence -- and then use computational models to explore outcomes in large systems of interacting agents.

For now, we're still largely stuck with metaphors, and mixed ones at that. Take this gem from the NYT article on how the Fed manages the money supply:

Typically, the Fed raises interest rates to ward off inflation when the economy is growing fast and in danger of overheating, and lowers rates when the economy is slackening.

Apparently, the economy is sometimes an automobile at risk of overheating, and at other times, a sailing vessel stranded as its sails slacken in weak winds. Take two metaphors and call me in the morning. But can macroeconomics go much beyond such metaphors? I'd like to be convinced, but I'm not yet.

Conservative greed, liberal... ?

It's pretty clear that convinced belief in the self-serving and greedy nature of humanity can induce that very behavior, not only in those who believe it, but in others as well. I've written before about the rather alarming study that looked at how graduate students in various disciplines play cooperative games, such as the Ultimatum game, in which participants do better in so far as they manage to temper narrow self-interest and cooperate. Except for graduate students in economics, students in all fields played just about as cooperatively as the public at large. But the economics students were much more greedy. The explanation, as the economists who conducted the research suggested, isn't that these students were born that way, but that they had learned the self-interest model of human behavior in their economic studies, and assumed that others had too; they expected to find nothing but self-interest in others, and so acted accordingly. Not surprisingly, those others, encountering clearly selfish partners, soon responded in kind.

I was reminded of this by a comment that Zak left on my earlier post Who's the real enemy? As he wrote:

I consider myself a political conservative. The notion that politicians usually act in their own political best interest rather than in the best interest of the nation is close to being a conservative axiom. The resulting conclusion is that the electorate should be extremely stingy in how much wealth and power is ceded to the government.

I am continually amazed at the glaring inconsistency of well meaning liberals who think giving more wealth and power to the government is the best way to solve many problems, but are simultaneously horified at how elections actually turn out, and how the political process incentivises politicians to actually behave. Hope springs eternal that if only MY guys (gals) would win the elections, then things would be different. But history has shown repeatedly that people making this bet have been sorely disappointed.

I'm not sure that liberals really think that "giving more wealth and power to the government is the best way to solve many problems"; I would classify myself as liberal, and I certainly don't think that. But there's a deeper point here, which relates to the self-fulfilling behavior of economics students described above.

If it really is "close to a conservative axiom" that politicians always pursue their own political self-interest, this is a fairly demoralizing and, I think, ultimately damaging view of human affairs. Indeed, this is the "economic way of thinking" applied to government, as captured in so-called Public Choice theory; it's the rationalist view of how government works when everyone is thoroughly greedy and self-interested. It suggests, in particular, that anything and everything we've heard from the Bush Administration, or indeed, from anyone else, about the dangers of terrorism, the need to be vigilant so as to protect freedom and democracy, etc., has been nothing more than strategic noise by those in power as they go about seeking their personal interests. If it's a conservative axiom that this is business as usual, then I guess that's okay.

But I think this view contains within it the same danger as the economists' (traditional) view that people are only motivated by greed. If we only expect people to be greedy, and we're satisfied with such behavior, then that's what we'll get. Indeed, in a world of greedy people, acting in your own narrow self-interest at all times really is the only sensible strategy. But most of us, I think, aren't satisfied with that; we want more from government, just as we want more from our friends and colleagues. Even conservatives want more.

Consider a snippet from an article in the NYT about Jack Goldsmith, former head of the Office of Legal Counsel in the Bush White House. Goldsmith was there in the hospital on that fateful night when Alberto Gonzales and Andrew Card went the hospital bed of the very ill Attorney General Ashcroft to get him to sign off on measures in the "terrorist surveillance program" over which a number of Justice Department officials had already threatened to resign. Goldmith's recollections of what happened in that room:

Suddenly, Gonzales and Card came in the room and announced that they were there in connection with the classified program. "Ashcroft, who looked like he was near death, sort of puffed up his chest," Goldsmith recalls. "All of a sudden, energy and color came into his face, and he said that he didn’t appreciate them coming to visit him under those circumstances, that he had concerns about the matter they were asking about and that, in any event, he wasn’t the attorney general at the moment; Jim Comey was. He actually gave a two-minute speech, and I was sure at the end of it he was going to die. It was the most amazing scene I’ve ever witnessed."

That's a man acting on more than self-interest. It's a man who believed in something about government, and about the way it should be run.

If it really is "close to a conservative axiom" that everyone in government (and perhaps elsewhere?) is driven solely by greed, that may well be "hard-headed." But in the effort to recognize and take note of the baser nature of much human motivation, it risks throwing out, and indeed actually eliminating from public life, human motivation that goes beyond naked self interest. I'd say that it's close to a liberal axiom that people, however much they are motivated by self interest, also have other motivations. Most people care about fairness and justice. Most people (if it hasn't been trained out of them) have a spontaneous willingness to cooperate. Most people, or at least many people, will help their neighbors, and not merely because they expect something in return.

I don't think it's naive to want some of those kinds of motivations to play a role in government, be it large or small.

Liberalism and its enemies...

Stanley Fish has written an interesting essay in today's New York Times. As he points out, alongside a spate of recent books attacking religion and its growing influence, publishing houses seem to be issuing defenses of liberal political organization, such as Paul Starr's Freedom's Power: The True Force of Liberalism. I think I could count my Social Atom as taking a similar position, arguing for government based on the maximum use of science, knowledge and open discussion based on real understanding, rather than ideology. But as Fish argues, and I think he is right, there is no way to defend the supremacy of that kind of "liberal" government over illiberal government (theocracy, dictatorship, or anything else) on purely logical grounds. Commenting on Starr, he writes that

...in the invocation of "free development" and "mutual forbearance," Starr gives the lie to liberal neutrality. Free development (the right of individuals to frame and follow their own life plans) and mutual forbearance (a live-and-let-live attitude toward the beliefs of others as long as they do you no harm) are not values everyone endorses.

And neither are the other values Starr identifies as distinctively liberal – individualism, egalitarianism, self-realization, free expression, modernity, innovation. These values, as many have pointed out, are part and parcel of an ideology, one that rejects a form of government organized around a single compelling principle or faith and insists instead on a form of government that is, in legal philosopher Ronald Dworkin’s words, "independent of any particular conception of the good life." Individual citizens are free to have their own conception of what the good life is, but the state, liberal orthodoxy insists, should neither endorse nor condemn any one of them (unless of course its adherents would seek to impose their vision on others).

Can one defend this liberal view on logical grounds? No. That's the way it is with values. They're assertions, not derived facts, although our language induces us to treat them as facts.

For example, I don't support the torture of animals. Or anything else. I find the idea completely reprehensible. But I won't claim that torturing animals is "wrong" in some absolute moral sense. There is, as far as I can tell, no source of absolute and final moral values, there to be read in the very fabric of the universe, a source from which we could take unquestionable values about how life "ought" to be led. That may be disappointing, but it seems to be the case, and I'd prefer to live with honesty rather than self-deception. [I say "prefer"; I cannot prove that one should do that either.] So in honesty, and clarity I think, my position on torture is that I do not do it, I don't think others should do it, and I am willing to work actively to stop them. But the point is: I am the source that value. My willing self. Not some book of eternal values.

Of course, this is rarely the way moral values get put forth. People use the terminology of "right" and "wrong" (usually unconsciously) because it is a powerful technique of persuasion, perhaps the most powerful. You're not going to follow my prescription for life, but you may that of an all powerful and invisible god who is watching your every move.

Today we have a battle of increasing animosity, and employing all the best techniques of moral persuasion, between those who would like to enforce their arbitrary values on the rest of us, and those -- supporters of the "liberal" philosophy -- who wish to recognize and remain aware of our inability to find absolutely true values, and to try without self-deception to live as best we can without them. In that sense, I don't think the liberal and illiberal positions are equivalent; the one aims to keep its eyes open and to live with knowledge and light, while the other aims to close down the mind and live in illusion.

You cannot prove that one is better than the other. I know which I prefer.

But Fish is also right that the battle between these two mindsets is real, it involves a real struggle for power, and it is practically of utmost importance. What should we do? He suggests, linking to an essay by Mark Lilla, trying to "cope":

One thing we can’t do is appeal to some common ground that might form the basis of dialogue and possible rapprochement. There is no common ground, and... "agreement on basic principles won’t be possible." After all, it is a disagreement over basic principles that divides us from those who have been called "God’s warriors." The principles that will naturally occur to us – tolerance, mutual respect, diversity – are ones they have already rejected ; invoking them will do no real work except the dubious work of confirming us in our feelings of superiority. (We’re tolerant, they’re not.)

So again, what to do? Lilla’s answer is pragmatic rather than philosophical (and all the better for that). All we can do, he says, is "cope"; that is, employ a succession of ad hoc, provisional strategies that take advantage of, and try to extend, moments of perceived mutual self-interest and practical accommodation. "We need to recognize that coping is the order of the day, not defending high principles." Now there’s a principle we can live with, maybe.

Perhaps, this is indeed true. For all the sense I find in the essays against religion of Richard Dawkins, Sam Miller or Christopher Hitchens, I can't imagine they're going to change anyone's mind. However, that may not be their real value. If we (meaning those who prefer "liberal" government in the sense used above) wish to defend our values, we need to recognize the energy and determination of those acting against us, who would very much like to stamp their values on our foreheads. Dawkins, Miller and the like have at the very least sounded an important warning. Lilla put the matter quite well:

Today, we have progressed to the point where our problems again resemble those of the 16th century, as we find ourselves entangled in conflicts over competing revelations, dogmatic purity and divine duty. We in the West are disturbed and confused. Though we have our own fundamentalists, we find it incomprehensible that theological ideas still stir up messianic passions, leaving societies in ruin. We had assumed this was no longer possible, that human beings had learned to separate religious questions from political ones, that fanaticism was dead. We were wrong.

This is important...

I'm totally bogged down in an article in quantum non-locality, which is one of my most long-standing pet interests. I'll say more next week, after finishing the article, but I'm beginning to believe that social dynamics have actually had quite a lot to do with this area of physics over the past 50 years. For many years, in effect, people were unable to get jobs at good institutions if they wished to work in unorthodox areas, especially if they questioned the prevailing orthodoxy on the interpretation of quantum theory.

Scientists are people too, and all the usual dynamics and pressures of fashion and group influence work there too. Anyway, in the past few days, I learned of some new work that, if it turns out to be free of holes and as important as it seems to me, may be the most profound development in quantum theory (and therefore basic physics) in maybe 40 years. In essence, it suggests that the widespread belief that quantum theory demands a break with ordinary thinking and with a belief in a reality that exists separate from our observation of it may be very much incorrect.

But more on that later. Here's a link to something much more down-to-earth, and important, in a very practical sense. Our government, it is clear, will get away with whatever we let them get away with.

Who's the real enemy?

In an Op-Ed last weekend, the New York Times' Thomas Friedman asked some curious questions, questions with answers that I think ought to be all-too-obvious. He wrote:

One thing that has always baffled me about the Bush team’s war effort in Iraq and against Al Qaeda is this: How could an administration that was so good at Swift-boating its political opponents at home be so inept at Swift-boating its geopolitical opponents abroad?

How could the Bush team Swift-boat John Kerry and Max Cleland — authentic Vietnam war heroes, whom the White House turned into surrendering pacifists in the war on terror — but never manage to Swift-boat Osama bin Laden, a genocidal monster, who today is still regarded in many quarters as the vanguard of anti-American “resistance.”

Is it really too much to comprehend that perhaps, in a White House in which "everything is driven by the political arm," the likes of John Kerry and Max Cleland were seen as greater threats than Osama bin Laden, or any other terrorist for that matter, and so smearing domestic opponents took (and still probably takes) priority over anything having to do with the "reality based" world?

I don't find anything puzzling here at all. This administration invented the "War on Terror," and induced every major news organization to go along with the phrase, making it seem almost like an element of objective reality, rather than the very effective demonstration of framing that it is. Terrorism may be real, but the "War on Terror" is a psychological tool of US politics.

I haven't seen any evidence to dissuade me from the belief that this administration is far more interested in appearing to face up to the threat, than in actually doing so.

Property values NEVER go down...

Apparently some people, even many people, really believe this. Indeed, a friend of mine said as much to me a couple years ago. "House prices always goes up." He meant even more than that, believing that house prices always rise faster than inflation. Which may be true if you take only the past ten years as evidence. Go a little further back, of course, and you see that house prices flop up and down just like anything else, sometimes very rapidly, often driven by collective waves of behavior that look decidedly like the consequence of imitation. Stalwart economists may still harbor doubts, but property markets herd just like equity markets; only the time scales are different.

House prices are now set to fall, as the New York Times reports. That's not really so interesting; more interesting is the human dynamics behind the story. "Many government officials and housing-industry executives,"the article reports, "had said that a nationwide decline would never happen." On what possible grounds? If you suspect some conflicts of interest, I think you wouldn't be too far wrong.

As just one example, the article quotes Ben Bernancke:

In 2005, Ben S. Bernanke, then an adviser to President Bush and now the Fed chairman, said “strong fundamentals” were the main force behind the rise in prices. “We’ve never had a decline in housing prices on a nationwide basis,” he added.

That, pure and simple, was a form of cheerleading.

We're not so good at predicting the future when the past is given to us as statistics about "fundamentals," or sold to us in glowing terms by those with vested interests in keeping the bubble going. But one thing people are really good at is detecting patterns. We can recognize a person we know, even someone we haven't seen in a couple years, after a glimpse of the back of their head at 50 yards.

For a bit of fun, check out this video that puts you on a rollercoaster ride through housing prices, adjusted for inflation, over the past 120 years. After a century of riding, I think you'll have a good feel for the typical ups and downs of the market; and, I suspect, an accurate expectation of what might come next.