So, let's get in Mr. Peabody's Wayback Machine, and visit econ near its beginning, 1776. The field was then known as 'political economics', reflecting that Damn Gummint policy has both direct and indirect effects on the nation's economy. And, if your economy is big enough (the United States of Alabama, fur instance) or deeply embedded enough (OPEC, et al) in the global system, then all nations.
And so it was, until
Samuelson screwed things up by plastering political economics with a slathering of mathematical lipstick. Then his colleague, Solow, went ahead and did much the same with math stats.
Unlike natural phenomena, which play by God's rules (more or less immutable; until we find we've deduced one or so incorrectly, see Einstein), humans write the rules of economies. And, of course, in most cases the stronger players write the rules on their behalf. And, so economics lost its way. They/we might bigly benefit from a text by a couple of real maths, von Neumann and Morgenstern on
Game Theory:
Richard Stone (1948) Asserts that Unquestionably, for economists this book is the most important contribution that has appeared since J. M. Keynes's General Theory was published in 1936. It is concerned with the behaviour of individuals, and the coalitions which they may form in attempting to better themselves. It is directed therefore to the kinds of problem that are met with in the theory of value, and especially those that arise under conditions of duopoly, imperfect competition and the like.
[my emphasis]
As most know, econ is divided into at least two distinct types: micro and macro. The former generally deals with problems of The Firm, and the latter with problems of The Whole Damn Economy, and by default, what the Damn Gummint does, or doesn't do, to affect the nation's economy as a whole. Our Dear Friend Krugman is of the latter tribe. As am I.
The overriding problem for the macro tribe is data. Most of it is shaky, at best. Manipulated at worst. And, not always by malfeasance. As mentioned in these missives from before they existed, much of the macro data is samples. And, of course, sampling always has error; there's a good bit of theory about that in any math stats sampling text. And, of course, it's been widely documented that much sample data at the national level has been falling in response rate. On the whole, one might surmise that a data-driven macro policy agenda is on thinning ice. (
Ayatollah 49% Don© is licking his chops.) Take the recent oddity with
the inflation number: our friends in the Damn Gummint put a foot on the scale. I guess they figured no one would notice.
Deep inside its monthly inflation report on Friday, the Bureau of Economic Analysis said that the cost of legal services rose 1.8 percent in January. That was an unusually large increase, but not nearly as big as the double-digit gain that some forecasters were expecting.
The reason for the divergence: The agency, which is part of the Commerce Department, had changed the source of its data on legal prices, relying on wholesale prices from the Bureau of Labor Statistics rather than the consumer price data it usually uses.
[T]he adjustment was enough to shave roughly a tenth of a percentage point off the monthly change in the core Personal Consumption Expenditures price index.
Which brings us to the obit of an unknown, to me anyway, economist,
Christopher A. Sims. Who the hell cares about an obscure econ? Because he was emblematic of the curse of macro data in economic analysis.
Though statistical models of the economy improved, they still couldn't always provide reliable forecasts or guidance for policymakers. A notable failure was the 2008-9 financial crisis, which few economists saw coming.
Ahhh. The ones who did, and often not 'economists', knew that macro results are always, within non-primitive societies, driven by the Damn Gummint's laws and regulations. Some times by intention, and some times by inattention. What those who figured out where the USofA's economy was headed knew what
Blythe Masters had unleashed. With no guardrails or barriers or laws or regulations to stop the tsunami from killing the global economy.
She is widely credited with creating the modern credit default swap, a derivative used to manage credit exposure to underlying reference entities.
Here's
the CDS:
Some general criticism of financial derivatives is also relevant to credit derivatives. Warren Buffett famously described derivatives bought speculatively as "financial weapons of mass destruction." In Berkshire Hathaway's annual report to shareholders in 2002, he said, "Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses—often huge in amount—in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen)."
In essence, CDS et al, are just gambling vehicles which allow unconnected parties to bet on the health, or lack thereof, of companies. As the Great Recession proved, at values far in excess of the companies targeted. One might call the CDS as short-selling on one part LSD and two parts steroids.
So, was Dr. Sims an evil genius? Not entirely sure. He did get the nearly-Nobel in econ, though.
