19 November 2014

A Dirty Little Secret [update]

The quants operate, oft times unknown to themselves, based on a dirty little secret. "What might that be", called from the Peanut Gallery?? The notion that the risk-free, inflation-free interest rate is equal to homo economicus' "rate of time preference", i.e. homo econ will lend you one unit of fiduciary capital (dollar, bolivar, ruble, whatever) for one unit of time (day, month, year, decade, whatever) on condition that homo econ gets one unit plus some vig. And that such rate is completely independent of everything in the real world but homo econ's demand for the vig.

All those wonderously complex financial engineering models, the quant ones not the reg fiddlers of course, depend on this notion of some exogenous interest rate. Taint so, alas.

The secret, of course, is that this assumption of control, or even choice, is false. The risk-free, inflation-free rate of interest is determined by technological improvement. This risk-free, inflation-free rate is the last chance opportunity cost faced by capitalists. But, here's the thing: if they're unable to conjure productive uses of physical capital, there's no other demand that homo econ can bring to bear on borrowers. Homo econ may want 10% for the use of his moolah, but no one can earn that, so his demand is ignored. And so on down the number line, to 0% where there is no productive use and time preference is irrelevant. No one wants your damn moolah!! In times, such as now, when capitalist overlords can find no way to turn fiduciary capital into physical capital, i.e. (again) they cannot conceive of new plant and equipment improvements which are more productive than existing, it matters not how much holders of units of value wish to be paid. There's no growth in the system to pay them. Full stop. Period.

Unlike usual trade with a supply and demand which are independent and infinite (that last bit is vital), capital return isn't. While a capitalist can make an infinite number of widgets, simply given a high enough price (or consumers take an infinite number given a low enough price), an infinite return on physical investment has to be the result of infinite ingenuity in technology. You have to be organically smarter, you have to know that which is better and was not known before; it's not sufficient to, somehow, "work harder" or have access to more abundant, cheaper inputs. Ah? You need a bigger brain which can divine more about the real world than is universally known, already. Ah? What happens when all that's left to discover is trivial? Cold fusion? Mr. Fusion? Ford Fusion? Movies on a portable phone?

Thus, in this state of the world, we get stories with titles thus, U.S. stocks are soaring, global economy in a ditch: Now what?. Even the business press is befuddled. They really ought to know better. It's just simple arithmetic.
And what's great for American corporations isn't always great for most Americans. Merger activity has picked up to new highs this year, and U.S. profit margins continue to hit record levels, defying forecasts that they are going to come back down to earth. [Yahoo Finance Editor-in-Chief, Aaron] Task says, "The problem for the rest of us is that these corporations... are not spending a lot of money on new development... and they aren't doing a lot of hiring or when they do hiring they are not paying people big wages."

There's a reason that Big Gummint debt, which is auctioned (not set by fiat) just to remind, is going for so little. The alternative is to sit on your moolah when you can't figure out a way to allocate to growing (organically, not just by buying your competitor) your business. Which Big Corps are doing, to a faretheewell. The opportunity cost is, basically, 0.0 (props to Bourdain). They're sitting on trillions of dollars, with nothing to spark their interest. So to speak. Well, they've invented securitized, sub-prime used car loans. Deja vu all over again.

The Wiki article is pretty much what is written in Econ 101 (and subsequent) texts. Quite obviously, it ignores the source of the vig. That source is technology, nothing more. The Dark Ages were a time of stasis because knowledge was so, not the other way 'round. Now that we know pretty much everything about how the real world works, we're near a permanent Dark Age; this isn't 1800 with the periodic table to be filled in. We're in a period, likely infinite, of ignorance, no longer a world of discovery. Most everything that marks us as modern was discovered in the first half of the 20th century or earlier (the understanding of semiconductors began in the 19th century). The technology discovery curve has flattened out; the big deal is whether a 4" smartphone is worse than a 5" smartphone. The population curve hasn't. There is no New World to pillage. And so on. Have a nice day. And, abandon the hope that compound interest will make you, or your spawn, rich just because it worked for your grandpappy. Those days are past.

To demonstrate how meager "innovation" is these days, we now know that the iWatch is just visual Bluetooth!! Some fool recently compared present day innovation to the steam engine. Gad.

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