Awasu » Connecting the dots
Friday 6th October 2006 5:32 PM [General]

I saw An Inconvenient Truth last night which was an interesting combination of footage from Al Gore's presentations on global warming with snippets from his personal life. Other than the main topic of the film, two things really made an impression on me. Firstly, watching him making his well-reasoned, scientifically-backed arguments, I couldn't help but wonder what kind of a world we would be living in today had he have been awarded Florida way back when [1] and secondly, a commment he made in reference to how difficult it can be to get people to recognize that they are in a crisis and respond to it: "People will eventually connect the dots but when they do, they will often wish that they had connected them earlier."

My local bookstore runs themed promotions each month which definitely work because last month, when I saw a pile of books on economics on display, I realized that it was a subject I don't know an awful lot about and so decided to pick up a few. Oddly enough, quite a lot of them looked interesting but I eventually chose two: Hidden Order by David Friedman and The Armchair Economist by Steven Landsburg. Now, while I like to think of myself as a reasonably intelligent sort of a guy, I have to confess that I have never read so many articles where the author explains something in a series of steps, each of which make perfect sense, but the final conclusion seems completely, intuitively wrong. Maybe I'm just not as smart as I think I am [2]. Or maybe nobody understands this stuff, not really.

I wanted to reference an article I came across a few weeks ago that linked to "the ten most important articles about economics you won't understand" (or something like that) but I'll be buggered if I can find it again :-(. And while yes, I didn't understand the economics behind most of them, the feeling I definitely got was that neither did the experts. If you consider the massive losses that Amaranth recently sustained (along with the many other high-profile crash-and-burns before them), while some of it may well be explained by greed and incompetence, when words like "gamble" and "risky" (which is really a convenient euphamism for "gamble" :roll:) keep coming up, you kinda get the feeling that they weren't really sure what was going on either :unsure:

Clearly IANAE but my understanding is that when the US dollar became a fiat currency in 1975, for the first time a dollar note was no longer backed by something tangible (e.g. gold) but instead, only had value because the government said it did. I wrote recently about peoples' tendency to confuse things that appear to be the same but are in fact very different (doing something for love or for money) and I think the same thing happens here. When we open our wallets to check how much is inside, we think of those notes and coins as themselves having value, the same as we do when we look at the numbers on our monthly bank statements that represent blips in a computer [3]. But they don't, they only have value because someone else is prepared to accept those coloured bits of paper or electronic blips in return for real, tangible goods. As soon as that network of trust is gone, the whole system collapses and your "wealth" vanishes into the ether. And this confusion between real wealth and the proxy we use to represent it is a recipe for disaster.

I've been listening (several times) to a recording of a fascinating presentation by Dr. David E. Martin where he talks about the house of cards the global economy is built on. One of his claims was that 90% of GDP growth in the US in 2001-2 came from housing [4] which suffers from exactly the same problem: the value of your house is exactly what someone else is prepared to pay for it. If no-one wants to buy it, it ain't worth jack.

Now, it's a truism in stock trading that it's time to cash in your chips when your mom and taxi drivers start getting into the market and it looks like we may be seeing something like that here. Ordinary folks are starting to play a game that previously only professional players used to indulge in, leveraging huge amounts of debt, but instead of using it to build value, it's often used instead to fund a life of consumerism. And it's a game that many don't understand. I have a house in Australia that has seen a pretty big increase in it's nominal sale price and it's certainly easy to see why people would be tempted to borrow against that to buy a plasma TV or second car but honestly, it's not real wealth! People have been predicting an end to the housing bubble for ages now and when it comes (and come it will), even in just a limited way, it's going to be utterly brutal when folks have to start paying off their purchases with real money. This article says that "[c]onsumer spending is currently responsible for 70% of US GDP growth" which is worrying because it means that when the politicians proudly proclaim that GDP growth is going through the roof and everything is hunky-dory, it really is all built on a house of cards.

Scary stuff (and you know it's scary stuff when Earl Mardle takes a break from worrying about peak oil and global pandemics to start freaking out about it as well :-)).

Connect the dots, indeed, but what if I don't like the picture that starts to appear? How do I get off this ride...?

[1] If you read the blogs of other feed readers, you will know what can happen when they start talking about politics so I'll just leave it at that :roll:
[2] I'm going to have another crack at these books while I'm away and might post something if I can get my head around them a bit better. But don't hold your breath...
[3] I once had a friend who used to work in the forex trading division of a large multinational bank and I asked him if what he did was anything more than a bunch of guys playing with numbers on a computer, if there was any real value being created. He was rather embarrassed to not be able to answer that question.
[4] I didn't find anything to corroborate this but I did come across this which says that housing accounted for 50% of GDP growth in the first half of 2005.

2 Responses to this post

"I have to confess that I have never read so many articles where the author explains something in a series of steps, each of which make perfect sense, but the final conclusion seems completely, intuitively wrong."

I can't speak for Steve Landsburg, but I sometimes deliberately reach a conclusion that I expect readers to react that way to. After all, if the reader's reaction is "of course that's true," he is unlikely to pay careful attention to the steps and so unlikely to learn anything. If the conclusion seems obviously wrong to him, that gives him a good reason to try to actually follow the argument--either to find the mistake or to discover that there is no mistake and his initial view was wrong.

Hey, thanks for the comment. I'm still scratching my head a bit but now I've got a better handle on the basics, I'm going to go back and try again :-)

>>> If the conclusion seems obviously wrong to him, that gives him a good reason to try to actually follow the argument

Of course, the problem with this is that the reader is probably more likely to just ignore the argument because it seems either intuitively wrong and/or just too hard to understand :roll:

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