Reader Comments, Discussion on ECONNED

Reader Sundog suggested I gather reader comments on ECONNED and update them weekly, particularly since I am answering questions. In the future, I’ll do this on slower news days (probably Saturday AM into Sunday), but figured I should start now.

Also, radio/TV bookings are just starting, will also keep you updated. I was just on WLW, the Bill Chapman show, out of Cincinnati (3/7, 11:30 PM EST); will be on WBAI with Doug Henwood at 3:00 PM EST on 3/8. Some TV bookings circled for this week, not yet confirmed.

We also got a very nice review from Joe Costello at Archein, which he starts with the closing paragraph of the book:

The result has been a massive transfer of wealth, with its centerpiece the greatest theft from the public purse in history. This campaign has been far too consistent and calculated to brand it with the traditional label, “spin”. This manipulation of public perception can only be called propaganda. Only when we, the public, are able to call the underlying realities by their proper names—extortion, capture, looting, propaganda—can we begin to root them out.

The review continues here.

Here is one conversation in comments:

EmilianoZ says:
March 7, 2010 at 3:32 pm (Edit)
2 questions about “Econned”. At the beginning of chapter 2, Krugman is savaged for saying in 2008 that skyrocketing oil prices were not driven by speculation.

1) I don’t understand what argument Krugman was making about futures price and spot price. What should be the relation between futures and spot prices in presence and absence of significant speculation?

2) The other argument by Krugman is illustrated by Figure 2.1. On the horizontal axis is Quantity and on the vertical one is Price. You have two lines representing Supply and Demand. The Supply line goes up, which seems to mean that as producers make more of the same stuff they’re asking higher prices for it. Does that make sense? Are we talking price per item?

Yves Smith says:
March 7, 2010 at 6:45 pm (Edit)
One of the arguments made (Mike Masters in particular was big on this) was that investors using futures contracts as an inflation hedge was distorting prices. The data did clearly show a big increase in “non commercial” purchases of commodities futures of all sorts, generally via index funds (personally, I don’t think this was likely the main distortion mechanism; the oil market has a proud history of traders, as opposed to passive investors, pushing prices around).

Krugman basically said those futures purchases were irrelevant, since futures all converge to the spot price.

Re his chart, that depicts a general argument often made. He’s basically saying, “OK, let’s say, despite my belief otherwise, that somehow these speculators pushed prices higher than the level that would be due to fundamental forces.” In that argument, the “higher price” is the horizontal line, the price you’d get from fundamental forces is where the supply and demand lines intersect. The shaded triangle is excess inventories. If you have a higher price than dictated by the “fundamental” price, you’d expect to see inventory accumulation. He said there was no evidence of inventory accumulation, ergo the price must be right (as in the result of fundamental forces).

EmilianoZ says:
March 7, 2010 at 9:48 pm (Edit)
Thanks for the reply. So, Krugman’s argument was that futures and spot prices were converging.

But, can it happen that all the available oil is bought in the form of futures (by real users and speculators) and there aint any left to be bought on the spot?

charles says:
March 7, 2010 at 10:08 pm (Edit)
The problem lies with the definition of what is an inventory for oil. If one adopts a narrow definition (tanks in cushing, floating storage in supertankers), inventories have not raised by much and the argument by Krugman is valid. However, spare capacity in oil wells that can be tapped quickly represent a “shadow” storage capacity that can be mobilised through the intertemporal oil market (futures and OTC instruments). In normal times, this shadow storagehas no value, but when investors want to get long oil without the capacity to store it, holders of storage capacity(shadow or narrow) can ride the contango by selling the short end futures (no risk to them as they have the capacity to deliver), but knowing very well that these futures are in fact going to be rolled thus extracting a big benefit every time there is a roll, by putting themselves on the other side of the roll trade.
If one counted these “shadow” inventories that were mobilized, Krugman assertion may not be that valid…

The final problem is to find out if this mecanism is “evil” speculation, or “legitimate” market behaviour driven by an adjustement of expectations of future oil availability and demand on one side, and the real value of the dollar on the other.

Yves Smith says:
March 7, 2010 at 10:17 pm (Edit)
You need to be a professional (have access to storage) to use futures as a way to “buy” oil. In fact, only people who can take delivery are allowed to enter into contracts where they might have to take delivery.

Krugman’s point on spot v. futures would be correct if people bought oil based on spot prices (or in relationship to spot prices) which is the way it works in most commodity markets. But precisely because oil had had a history of price manipulation, prices were set for many buyers and sellers not via spot prices, but via the BWAVE, which is formula which averages futures prices.

Another question:

I’m intrigued by the 3-body problem expounded in Chapter 2 of Econned as an example of non-ergodicity in real-life. Samuelson’s ergodic assumption states that there must exist a “unique, long-run equilibrium independent of initial conditions”. On the other hand Poincare showed that solutions to the 3-body problem were so sensitive to initial conditions that infinitesimal variations in them lead to totally different outcomes.

1) It seems to me that Poincare’s findings only partially negate ergodicity. Let’s say for argument’s sake that there are 2 solutions to the 3-body problem. In the 1st we have a system like sun+earth+mars, body 2 and 3 orbiting body 1. In the second we have sun+earth+moon, body 3 orbiting body 2 that orbits body 1. Those two solutions are different but they’re still stable. What’s most important for economists? The existence of an equilibrium or the uniqueness of that equilibrium? Maybe they can work with ergodicity-lite: “there exist different long-run equilibrium states that depend on initial conditions”.

2) Extreme sensitivity to initial conditions reminds me of climate modeling. We’ve all heard of the “butterfly effect”. You launch a simulation you obtain sunny sky. You change an input variable just a wee tiny bit (like the flap of a butterfly’s wing) you obtain a hurricane. I’m not a climate scientist but my understanding is that they overcome this problem by performing a lot of simulations with a lot of different input parameters. Apparently the average of all the different results is to be trusted. This might be similar to the Monte-Carlo method where you randomly sample the space of all possible configurations. If climate scientists do it and physicists do it, why can’t economists do it too?

Yves Smith says:
March 8, 2010 at 12:23 am (Edit)
I had an elite mathematician (Harvard PhD in theoretical math, which if you know math programs, makes him one of the very top mathematicians in the US) editing the book. This isn’t a matter of two solutions to the three body problem. The number of solutions, for practical purposes, are so large as to be incomputable (or more accurately, if I recall the later Karl Sundman solution correctly, this is the problem with not being a Serious Mathematician, is that while it was in theory solvable, the proof demonstrated that any solution would require so many terms as to make it unsolvable for practical purposes).

From March 4:

liberal says:
March 4, 2010 at 7:34 am (Edit)
I’m having a Dean Baker moment.

Only thing I see missing from ECONned’s index: Dean Baker!(*)

He got the housing bubble right, for the right reasons, earlier than almost anyone.

Not to mention calling the dot com bubble, which saved me quite a bit of money.


(*) Well, not entirely. No reference to Henry George or e.g. Michael Hudson either. If we taxed the cr*p out of land, credit markets would be much much smaller, and bubbles would be far fewer. Otherwise book seems really good.

Yves Smith says:
March 4, 2010 at 7:45 am (Edit)

Just so you know, Palgrave fought me on book length (look at teeny type of endnotes and the treatment of the dedication…). Given that that the book covers over 60 years of territory, that forced some choices.

And from March 3:

Michaelc says:
March 4, 2010 at 1:40 am (Edit)
Yves, I have to commend you on Heart of Darkness. It’s an excellent piece. ‘trading sardines’, very droll

I was dismayed after reading chapter nine, to read Michael Greenberger’s presentation at the Roosevelt Institute which leaves little hope that his sensible (and revoltionary) suggestion will make it into the legislation as long as Geithner’s in charge.

Perhaps you can deliver an autogrphed pamplet containing Chapter 9 to every senator/congressman who has a hand in crafting the bill, with copies for Timmy and Summers for good measure. II’ll contrast nicely with the ISDA papers they’re more familiar with.

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  1. Swedish Lex


    These and other comments make me think of the Sweden’s particular responsibility with regard to the global financial crisis. Assar Lindbeck was nominated for the Dynamite award for these reasons:

    “Assar Lindbeck is a Swedish neoliberal, right-wing economist, relatively unknown internationally. He is however the head schemer behind the so called Nobel prize in economics. The Nobel prize in economics is one of the main factors behind the almost total conversion of the economics profession (and in fact of world public opinion) to market fundamentalism. Assar Lindbeck therefore deserves a place beside better known economists such as Lawrence Summers and Robert Lucas.”

    (I have met Lindbeck once at a seminar when we debated the pros and cons of a constitution for the EU, but that is another, very marginal, story).

    Alfred Nobel did not include economics in his 1895 list of prices to be awarded. The “Nobel Price in Economics” is a recent invention that many believe infringes on Nobel’s “IP rights”. For a critical view on the price in economics and arguments why it should be abandoned:

    So, to the extent that “belief” in economics as a pure, stand alone, discipline of science has been reinforced with the promotion of its disciples by bestowing them with Nobel prizes, Sweden has a special part of the blame. It is ironic that this should be the case since Sweden is the country where politics and economics are widely regarded as the two sides of the same coin.

    1. Yves Smith Post author

      Hah, I must confess to not knowing about Lindbeck’s special role as “head schemer,” that is useful intelligence. I do have a dry remark in the (sadly rendered in itty bitty font) endnotes re the fact that the “Nobel Prize for Economics” as it is commonly described is most decidedly not one of the prized funded by the estate of Alfred Nobel.

  2. charles

    “You need to be a professional (have access to storage) to use futures as a way to “buy” oil. In fact, only people who can take delivery are allowed to enter into contracts where they might have to take delivery.”

    This is not the case. What happens when you are a financial investor is that you have to close your contract a few days before maturity. Do you really think locals in Chicago that trade pork bellies all have a big refrigerator in their backyard ? If you want to hold on to your exposure, you have to roll to the next future. Here is an example of policy for Interactive Brokers, but I guess all brokers are the same.

  3. Christian


    I have enjoyed your book. It strikes me as a return to “political economy” with its twin concerns of (economic) efficiency and power. It reminded me of Veblen’s work on the Business Enterprise and the distinction between “business” and “industry” He had similar problems with the marginalists / lassez-faire of his time including J.B. Clark, etc. It seems that you are channeling this through the likes of Thomas Ferguson and James Galbraith, modern day Veblenites.

    However, I think that you are off the mark in the emphasis on instrumental rationality and its generality in the social sciences. I think it is a helpful assumption in setting a null hypothesis to examine seeming departures from rationality and as a narrative device in explaining the logic (a word I much prefer to rationality) behind the choices of individuals, institutions, etc. It works poorly as an assumption to build a model if that model is the end product.

    I also think that many who study international and comparative political economy in political science and comparative sociology have been making this case for decades. I think there is something to be said that spending time studying the institutions of foreign countries or an international perspective makes it easier to come to certain conclusions instead of regressing variables on postwar US economic data or building models of an idealized American economy and judging institutions only by how close they come to that ideal or not.

    1. Yves Smith Post author


      I’m not sure re channeling Ferguson and Galbraith as much as finding each other because we are like-minded. My stance on these matters on the blog predated my knowing either of them.

      As someone who is big on the cognitive bias literature and the operation of cults (which demonstrate how far people can be pushed beyond what their former boundaries are) I not a believe in rationality even as a null hypothesis. Dunno if you have gotten to Ch. 4, but look at the contortions that neoclassical economist have to go through when presented with altruism, problems with conflicting desires, lack of self discipline, etc. Our limited cognitive capacity also makes rationality a questionable benchmark.

      And Ferguson would disagree with your characterization of political science (and as someone over 60 who got his PhD in economics and migrated to political science, he is in a good position to opine). He sees the adoption of econ-type methodologies by political scientists as a combination of colonization (much like law and econ) and econ pay envy (as in driven by the premia over other social scientists that economist get in earnings). He also pegs the change as much more recent than you do.

  4. purple

    Nice to see you’re doing D Henwood’s show. He’s one of the more under-appreciated political economists out there.

  5. Semiclassicist

    As a dynamical system the economy is orders of magnitude more complex than the solar system. However, the number of possible solutions to the three body problem is irrelevant, the point is there is no “long run equilibrium solution”. They simply do not exist, unless you assume all the complexity away.

    The strongest statement you can make about the solar system is that it is currently in a “local equilibrium”. See this paper from 2008:

    They tested long run simulations of the solar system. Essentially they found it was stable for 20 bn yrs (current aged guesstimated at 14 bn years). However, shifting the initial position of Mercury by 2cm produced scenarios in which Mercury falls into the Sun or Mars is ejected from the solar system. What do you suppose is the measurement error in locating a planet for such a model? And the uncertainty in economic observables like non-farm payrolls?

    Monte Carlo works by taking a weighted average of the simulated outcomes. For example, if you wanted to calculate the “expected outcome” of all the solar system scenarios, you would weight the results according to how often they occurred. And you would nodoubt find that with 99% confidence, the solar system is stable for the next several billion years. And you would be in no position to say whether our “realised trajectory”, ie what is actually happening, is stable or not.

    Given economics papers don’t even use error bars it feels we are a long way from having an informed discussion.

    1. marc fleury

      Clearly economics is not a 3 body problem, but rather a 6Bn body problem :) 3 body is a drastic assumption. We should question that model right there and right now. Who gave that schmarvard professor his license to teach?

      As you point out it is the number of variables, and they dynamic coupling that creates unstable systems. 3 bodies and their positions as variables is unstable (aka infinitely sensitive to initial conditions).

      As for monte-carlo simulations, they are used every day in finance. The technique first developed within quantum mechanics frameworks, is useful any time a current state is the sum of future possibles. Discounted cash flow analysis is such as beast as it sums the present value of discounted future cash flows. The discount is the weight. Weighted average of possible futures is something every financial analyst does every day, intuitively, without being scared by complicated theories.

      Oil, can be such an example. Any time you compute futures, you make assumptions. You speculate. The price can be then manipulated. But Krugman is right, spot = futures (0). The price of spot is the price of spot by demand and if there is no surplus then the market cleared. Ergo, there was no market manipulation it was supply and demand. I think it is simply that the market has to clear in the case of oil, it is not like you do without oil on such short notice.

  6. LAS

    Yves, I really love the survey of financial models you have in your first few chapters (where I’m still reading). Your references to Benoit Mandelbrot were pleasant. Years ago Dr. Mandelbrot came to speak to our physics club when I was a student. Mandelbrot said that he might be able to do it, depending on how things floating around in his schedule settle down around about that time and to recontact him about 2 days before the event we had in mind and he’d let us know for sure (really, that’s how he stated it). In other words, he asked us to tolerate suspense and chance before he would agree. However, when the time arrived, he did come and he behaved so gentlemanly, that he really made a nice event for us.
    At that time we were studying qualitative solutions to ordinary differential equations. Even without solving these equations in the complete sense, one could see that small changes in determinstic equations lead to instability and chaos; that with perfect knowledge of a closed system, nevertheless chaos and/or a blow-up to infinity can result.

    I agree with your basic premise (as I understand it) that much financial modeling and economic arguement has been used to deprive average citizens of influence on social goals and policy. The charm of advanced degrees and higher math are often used by operators to overcome the natural moral repugnance of society toward egregious selfishness. I’m quite fed up with hearing arguements that average people are “stupid” in how they manage their finances, and they deserve what they get, etc. when all the while financial products have been deliberately crafted to be complicated sufficient enough to persuade the reluctant and cautious.

    It surprised me that you gave Prof. Krugman such a hard time since he seems cognizant of his own (he calls them “silly”) assumptions more than many in his profession, but your choice to do so serves to remind that, regardless of academic or pure motives, it all becomes material for a sales pitch by the big operators, and we’re all so easily misled.

  7. Attitude_Check

    I will have to buy the book. I’ve had the complexity discussion on other blog forums. As a physicist by education and a engineer by vocation, I am quire familiar with the 3-body problem, and have had an interest in complex systems and chaos. It may help the non-specialist to know that non-linear systems, complex systems and chaos are very close cousins. It has been shown that a non-linear system (the variables cannot be solved for separately) that has tight coupling between variables, will result in a chaotic system. Additionally a system that exhibits a hierarchical structure with tight coupling between levels of the hierarchy will also exhibit complex “emergent” behavior.

    None of these are REMOTELY consistent with any equilibrium mathematical formation. I think this is a case of folks “dumbing down” the math sufficiently to enable them to understand and use it to make predictions. Sadly the math no-longer has any relation to the real-world they are trying to analyze. This is a logical failure of massive proportions, and a result of a serious lack of rigor in thought by economics in general. The more I learn of economics and the horrendously bad math behind it, the more I have a hard time believing any trained economist (with a few exceptions). There are ways to deal with non-linear analysis and system design, that have been successfully used in engineering for many years. Sadly the hubris and arrogance of mainstream economists (Krugman et al) needs to be solved before any real progress it made it appears.

    1. Jim in MN

      What do you think of Ilya Prigogene, for instance From Being to Becoming and The Arrow of Time? I’ve always thought these to be very important books for those who want to ‘translate’ between the hard sciences and other aspects of life.

      I also wonder about your statement that these types of systems are not “REMOTELY consistent with any equilibrium mathematical formation.” I thought the point was that such systems can enter and leave equilibrium, for instance an eddy or a convection cell in a fluid…but you get the Nobel Prize as Prigogene did for even beginning to probe at the mathematics of how such phase transitions work.

      I have also been somewhat convinced by the argument that many systems, including ecological ones, tend to evolve towards the boundary between equilibrium and chaos. There is a reason: an equilibrium system cannot evolve to meet changing conditions and thus will not survive, while a chaotic system cannot reproduce itself and thus cannot survive. So selection drives ‘edge’ systems that balance between the two, with complex tendencies to form and break equilibrium. Genetic mutations and human psychology show at least superficial resemblances to this general pattern.

      But overall we lack the ability to encapsulate such realities in our models.

      Just food for thought. I am glad Yves is bringing critical thinking into important topics….

      1. Attitude_Check


        It is true that these systems can exhibit meta-stable solutions, sometimes called “strange-attractors” in chaos theory, where they exhibit what “appears” to be equilibrium behavior, then will suddenly change without warning. On a short-enough timescale equilibrium assumptions can be valid. But I stand by my statement that this is not REMOTELY consistent with equilibrium assumptions and models. the math is completely different, and the timescale matters.

  8. Jim in MN

    It’s also interestng that the problem of first movers (or initial conditions) dictating outcomes is typical in Nash and Cournot equilibria and related game theory. In fact, this is an important problem in dispatching electric power supplies onto a grid. There are often numerous solutions to the optimization problem, but the fact that it matters which plants ‘go first’ is something many in the regulatory field don’t want to talk about. Why? Because it proves that you cannot remove equity considerations from the efficiency problem. In other words someone must judge, using random draws, human judgement or the dreaded small-p ‘politics’, which plant wins (runs and makes money) and which does not.

    So an ‘objective’ system operator is actually choosing which of many equilibria will apply on a given day, and it matters!


    “State of the art scheduling and optimal
    dispatch algorithms contain inherent indeterminacies which provide broad latitude to the operator with
    potentially severe distributional implications.”

  9. Matt

    This is a brilliant idea! I can’t even imagine how many times I’ve finished a great book and wanted to clear up some of the points I didn’t quite get with the author or hear them expand on a point they had to condense for the sake of the single book.

  10. C

    These reader comments/discussions should have a hyperlink below the book with a “last updated” date, instead of in the general posting area. This would make it easier for people to comment and post directly on the book, and would be ‘automatically organized’ so that you don’t have to look through posts to reply to later.

    Just my two cents, anyway.

  11. Sundog

    What I have in mind is a post called “Econned book talk X” where Yves just says here’s a place to discuss the book, carry on folks, I might chime in if I feel like it but don’t count on it.

    If there get to be too many comments, or just automatically the next day or week or whatever, start a new one called “Econned book talk X+1” and let the chatter carry on from there. Instead of the most recent post at the top of the site, install the current book talk thread there.

    I have no idea how practical or not this idea is, just what seems ideal to me. Cheers Yves!

  12. Calpurnia

    I’m reading chapter 6 of Econned (“How deregulation led to predation”) and have a few questions. You start with describing how old style banking (prior to the 70ies) worked.

    1) You explain the “underwriting” done by investment bankers. From what I’m able to understand underwriters are the middle men between the “issuers” who need money and the investors. But what exactly are the essential services performed by the underwriters? Why can’t “issuers” and investors deal directly?

    2) On p. 138, in the paragraph that ends the discussion about underwriting, you write “Credit was mainly provided to companies by commercial banks”. But I thought Glass-Steagall separated commercial banks from investment banks. So, how come commercial banks are providing credit in the underwriting business?

    3) On p. 139 you explain that bonds are traded OTC while stocks are traded on exchanges. Can you explain the main differences between OTC and exchange trading? Also, why are bonds not traded on exchanges? My guess is that bonds are more expensive. One bond might be worth $100,000 so not many people might be able to buy one singlehandedly. But why don’t they do bonds in smaller denominations? With everything now being done electronically servicing one hundred $1000 bonds should cost the same as servicing one $100,000 bond.

    Thank you! The book is great for laypeople like me.

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