Dr. Keynes Was Right

It's the Distribution, Stupid
MAY 22, 2012 10:48AM

Triple Crown

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"A horse!  A horse!  My kingdom for a horse!"  Market quants are always seeking a better horse, never quite getting there.  And occasionally falling off onto their ass; and the rest of the world's while they're at it.  The debacle at JP Morgan, and the obfuscation attendant thereto is just the latest installment.

Quant methods (one position I had early on was in the Office of Analytic Methods, so I've been there) can be quite useful.  The issue, and for market quants a major one, is that quant methods assume, and that's something they have to do, that whatever human behaviour is being investigated responds just like a natural system.  Engineering of human behaviour.  For the very short term, say the trading day, one can measure money flows among some set of instruments, and with sufficiently detailed data and sufficiently powerful computers, anticipate where the money is going to be before it gets there.  But that's just the USofA/Russia MAD paradigm.  No economic good comes of it, of course.  It's casino activity.  It's a zero sum game.

In the long term (a decade or longer), macroeconomic forces take over.  Or, as Galbraith said:  "financial genius is a rising market".  Japan is the explanatory counter example.  To the extent that an economy (speaking of nationally bounded entities) moves from real investment to fiduciary investment (the term still hurts my teeth, but it's common), real growth dissipates.  The reason is clear:  economic growth is driven only by technological increase, and that means physical investment.

It is not a good thing that Facebook would be valued at $100 billion.  Nor is it a good thing that Young People seek to make fortunes building Farmvilles.  I'm not, I'll suppose, the first to point out that shifting smart people into zero-sum software gaming (stock market or otherwise) from physical sciences (assuming they are really smart enough to do EE, for example; I've never been convinced that they are, by the way) is also not a good thing.  It is said of Texas and Saudi Arabia:  you can't eat oil.  In Texas, these days, you can't even raise cattle.  They're being shipped north (not, alas, to Blue States) where there's some water and grass.  You can't eat virtual food, either.

Uruguay, in the 1960's, did the segue from real economy to fiduciary economy.  It ended up with severe income inequality and civil war.  That lesson has been ignored.  Well, a tiny country south of the equator; out of sight, out of mind.  

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