Deming Down Analysis

W. Edwards Deming is reputed to have said:

In God we trust; all others bring data.

The latest place I've seen it is in the preface to The Elements of Statistical Learning, with the caveat that there's no proof Deming actually said it. The problem with Deming is that he was grounded in manufacturing quality control, Shewart control charts and such, where processes obey God's laws. In the human world, data isn't really the issue. Changing behavioral incentives are the issue. We humans, some of us, change the rules/incentives as suit some of us.

If we consider what caused The Great Recession, it's easy to blame The Quants. I've sipped that Flavor Aid some times, alas. Still, one cannot forget The London Whale and his mess. That, beyond question, was a quant going off the reservation. But, what exactly, motivated The Great Recession?

First, and mostly, was the massive increase in availability of funds into US, and Europe lesserly, housing. It's reasonable to ask, why? Did the quants, somehow, fiddle it. The answer is no. After the bursting of the DotCom Bubble, moolah began to pile up, yet again. Corporations' real investment demands just couldn't keep up, at a level of risk holders of the moolah were willing to accept. As usual, they wanted money for nothing (and chicks for free).

The subprime to liar loan spectrum was created by mortgage companies, not commercial banks, built into mortgage backed securities for the purpose of sopping up a tsunami of risk-averse holders of moolah. We see exactly the same motivation with the "Greek Crisis" (Spain is similar): holders of moolah want above market rate of interest at lesser risk. Housing, up until then, had been largely risk free; same with sovereign debt. But, because all the lemmings were headed in the same direction, they all went off a cliff. If they hadn't dragged the rest of the global economy with them, it would have been a minor event. The instruments came not from quants, per se, but from bankers, loosely defined.

Once the instruments came to exist in quantity, then the quants started to move the levers of arbitrage to make their money. Anticipating when the money flows are zigging before anyone else is lucrative. Such an exercise is closer to God's laws, in that the lemmings are blindly following the butt in front of them. With sufficient, accurate, data the quants could see where the plot was going.

Not to mention that folks like Paulson made smart bets, so it seemed, by putting a heavy thumb on the scale.

As some say, you can only sell a bad instrument to someone who is looking the other way. That happened in Florida, the Spanish coast, Ireland, and Greece. There remains trillions of dollars of "savings" looking for a place to sit. A lot of it sits on corporate balance sheets. Ever more of it moved to buy back stock, thus moving moolah from the pockets of 1%ers to pockets of other 1%ers. The right wing bleating about inflation is misdirection. Not all of them are idiots, and know full well that inflation, caused by too much moolah floating around rather than output shortage, happens only when Joe Sixpack has the moolah to spend on stuff. The QE monies, ours and Europe and Japan, have been wholly sent to the financial sector; thus the stock markets have shown impressive capital gain. D'oh!!! But this also means that the following must be true: corporations have about run out of productive ways to turn fiduciary capital into physical capital, at least relative to the supply of fiduciary capital. In other words, there is, by definition, a savings glut. Which deadly sin is gluttony?

Shiller, in a recent piece, had the advice that if one continued to live as a student, then the moolah would pile up and a better life to follow. He ought to know better. We already have, globally, more savings than can be productively used; that's why so much went into non-productive housing. Adding billions or trillions more from whatever letter generation is au courant will only drive down the interest rate more. So, yes by not consuming, your money will pile up. (And by not consuming en masse, we get a Depression, by definition. The 1%, with their hoard of moolah, will be very happy.) But it is only your deferred consumption, not growing by some fat rate of compound interest. That latter is among the ripest chestnuts in the econ/finance lexicon. Up through the beginning of the 20^th century, when new bits of science were discovered daily and thus new forms of physical investment could be made to exploit such, the permanency of compound interest in the economy was obvious. But, as we've filled out our knowledge of math and physics and chemistry and biology, we're like that old paradox: "how long does it take to get to that wall if you step half-way each step?" The answer, of course, is forever. But the paradox also means that each step of progress is of diminishing size. Don't assume that the second, or millionth, step is as great as the first.