Did Capitalism Cause the Irish Famine?

Nathan Cedric Tankus ran a piece yesterday on Naked Capitalism about Karl Marx’s interpretation of the Irish famine in his Das Kapital. The theory that Tankus is referring to is laid out in Chapter 25 of the book.

The whole discussion is shot through with Marx’s dubious method which is basically to take a bunch of statistics, lay them out to give his analysis an air of objectivity and then immediately turn around and engage in rhetoric that borders on conspiracy theory. What Marx notices is that the economy of Ireland ticks over fairly well despite the massive depopulation. He says that, by contrast, England “would have bled to death with such a drain of population as Ireland has suffered”. He attributes this to the fact that Ireland is simply an “agricultural district” of England.

Marx goes on to argue that Irish agriculture in the 19th century became more concentrated and capital intensive — which is true — and that this created a “surplus population” that was then wiped out, in what appears as some sort of Malthusian conspiracy (“nothing more excellent could be wished for by orthodox economy for the support of its dogma”), by the potato blight. The idea lying behind this is that the landlords actually need the blight in order to clear the land for livestock and so, while Marx never actually goes into conspiracy territory and claims that the landlords instigated the blight, he paints it as a seemingly inevitable outcome of the capitalist transformation of Irish farming. And in order to “prove” this he uses the rhetoric of the most extreme of the property-owning class.

As Tankus says:

From this perspective, the potato blight was socially produced since small farmers were pushed into monocropping as the only crop that a family could survive farming on such small plots.

Yes, it’s a nice story. It means that the blight was not just a fact of nature but instead the fault of capitalism — which, of course, if understood correctly then makes the case for socialism. None of this is remotely true, of course. The facts are, as they so often are, much simpler. What’s more, this is a history that is not just already written but fairly widely accepted.

In actual fact, the potato was in large part responsible for allowing the population boom of the 19th century across much of the world. The potato was a very cheap source of certain nutrients that were not available from other foods and this allowed the population to grow at a previously unprecedented rate. Ireland was no exception to this, seeing a massive population boom from around 1800 up until the famine.

As we can see the level of population increase in Ireland was enormous. It went from about 4.5m in 1800 to just over 8m at its peak before the famine set it back on a trend back to around 4.5m where it stabilised by about 1900. Clearly then, Ireland accumulated a massive population on the back of the potato crop. This leads to a situation in which the failure of this crop would then lead to massive amounts of the population being wiped out — which is precisely what happened in the famine.

Am I then claiming that the famine was, in fact, a wholly “natural” event? No, absolutely not. It is well recognised that English free-trade laws prevented food produced in Ireland from being given to the starving population. This food was instead sold abroad as exports. But this was not so much the fault of capitalism, as Marx claims, as it was the cruelty with which the English clung to their free-trade laws. They could have easily imposed protectionist measures that would have channeled resources toward the domestic population during the famine. But they chose not to. This is the history taught to every Irish student in secondary school (that is, “high school”) history class.

The reasons that they chose not to do so are complicated and still in dispute. But the existence of an absentee class of landlords — who were both English and Anglo-Irish — was probably a major factor when considering the coldness of the English response. This was an issue intimately tied up, not so much with the development of English capitalism, but rather with the relationship between England and Ireland in this period. It is for this reason that the famine did not produce a major socialist movement in Ireland but instead strengthened and, in some ways radicalised, the nationalist movement who recognised that at the root of the problem was self-governance.

Tankus tries to draw parallels between Ireland’s current migration problems and those during the famine. Well, there are parallels but not the ones he thinks. Because he uses the old Marxian framework he concludes this has something to do with contemporary policy producing some sort of “surplus population”. But this is not at all what the parallel is (after all, famine caused by reliance on the potato and unemployment due to lack of effective demand are two rather different creatures). No, the parallel is that Ireland today, as in the 19th century, has a crisis of governance. This has nothing to do with capitalism as such let alone something called “surplus population” which is a bizarre concept, but rather to do with who pulls the levers of power and whether they have Ireland’s interests at heart.

More on Oil Market Speculation: Correction and Clarification

The other day Dean Baker ran a piece on the aluminium market scam that some of the major banks are currently involved in (more info here). I got onto Dean with regards to what he wrote on oil market speculation. He had written that speculation was probably only adding about 10% or less to the price. I think that this is far too low an estimate.

So, I showed Dean the supply and demand graph that I put up here in my piece about oil market speculation. I pulled the graph from a report given to the US Senate. Here it is again:

I regret to say that I never really looked into what this figure represented. I assumed that the EIA had figured out a way to estimate the supply-side and the demand-side of the market with which they could figure out if supply was keeping pace with demand. I thought this to be the case because the supply and demand diverged from each other — which would not, presumably, be the case if this were a simple identity (i.e. if supply always equaled demand given market clearing).

Dean pointed out that this was, in fact, just that identity. The divergence between the supply and demand lines are due to the EIA not counting inventory accumulation as demand. Thus supply and demand are always equal in the above graph provided inventory accumulation is taken into account. I now believe that Dean is correct and that means that the Senate report, in this regard at least, was somewhat misleading.

There is, however, another way of looking at the oil market which might tell us if speculation is adding substantially to price. We can look at the amount of excess capacity in that markets. In theory, price should rise significantly only when excess capacity is tight — otherwise producers could just increase production to dampen the price increases. If excess capacity is tight when price is rising we should look elsewhere to explain the price increases. Here is the relevant graph taken directly from the EIA website:

As you can see I’ve also left in the gloss that the EIA has included with the graph in which they say quite clearly that high excess capacity indicates that OPEC are managing prices.

Okay, so the run-up in prices makes some sense between 2003 and 2008, as the gloss says, because excess capacity was quite low (I am not saying that speculation was not playing a role here, but let’s just keep with the EIA’s own argument). However, from 2009 onwards the price makes no sense. It is quite clear that there is far more excess capacity than there was in, say, 2004-2006.

Another period that doesn’t appear to make sense is the massive run-up in prices at the end of 2007 and the beginning of 2008. The excess capacity was nowhere near historic lows and yet prices rose faster than at any other time in the series.

I’ll end this piece by reminding people that while I have no basis to give an estimate on how much speculation is driving price in these markets, using figures from one of Goldman Sachs’ own internal memos Bart Chilton of the CFTC estimated that there was a ‘speculative premium’ of $23.39 on each barrel of oil at the beginning of 2012; that accounts for almost 25% of price at that time. Chilton also strongly hinted that this might be underestimating the amount because it didn’t include the speculative activities of commercials.

These markets are damn near impenetrable. But the more you pour over the data — and the more you hear about extremely dodgy practices by big banks — the more you come to think that the problem is far bigger than people like Baker are portraying.

Kaldor’s Theory of Speculation: An Overview

I’ve been reading up a lot on economic theories of speculation as this is precisely what my dissertation is on and so far as I can tell the only real attempt to deal with speculative dynamics from a properly macroeconomic point-of-view is Nicholas Kaldor’s 1939 paper Speculation and Economic Stability. Sure, people will point to Minsky’s theories but they do not really contain a theory of speculation. The closest is really Keynes’ own A Treatise on Money but the discussion there is rather primitive. In what follows I will lay out a critical overview of Kaldor’s paper.

Kaldor sees the functioning of markets for financial assets and other things that resemble financial assets (such as commodities) as Keynes does in the General Theory; that is, he sees them as being subject to the famous ‘beauty contest‘ dynamic. This means that for Kaldor, as for Keynes, financial asset markets are based mainly on expectations and to some degree these expectations are not dependent on fundamentals and are instead subject to self-reinforcing dynamics of their own.

I totally agree with this view and for those who don’t I would suggest reading some of the latest literature being read by financial market participants which clearly states that the best way to profit is to follow (and thus help generate) trends.  For example, in Kirkpatrick and Dahlquist’s Technical Analysis: The Complete Resource for Financial Market Technicians they write:

Technical analysis is based on one major assumption — trend. Markets trend. Traders and investors hope to buy a security at the beginning of an uptrend at a low price, ride the trend, and sell the security when the trend ends at a high price. (Pp9)

If that doesn’t sound like a recipe for speculation, I don’t know what does. And this view will be confirmed by speaking with market participants or watching their television programs. These people simply do not care about fundamentals in the manner which would lead them to make so-called ‘rational’ decisions in the market. (It seems to me that any trader with a Porsche and a mansion who follows trends is not engaged in any ‘irrational’ activity at all; indeed, if their goal is to be rich and their means of successfully achieving that the following of market trends then to call them ‘irrational’ is simply a perversion of the English language).

But back to Kaldor. There are many points that I agree with Kaldor on. He measures the degree to which speculation may affect a market in two ways. First of all, there is what he calls the ‘elasticity of speculative stocks’; that is, the amount of potential purchasing power there is to absorb an asset. Secondly there is the ‘elasticity of expectations’; that is, the amount to which prices will change purely in response to expectations. (He borrows this concept from John Hicks and as we shall see in a moment, this is very important). As the elasticity of speculative stocks reaches infinity the amount to which the price will rely on expectations becomes absolute, while as it reaches 0 the amount to which the prices will rely on expectations becomes nil. This is simply because the amount of speculative stocks in existence will determine the ability of speculators to speculate. Once we have a given amount for the elasticity of speculative stocks we then just have to turn to the elasticity of expectations to understand how speculation will affect the price. Again, a higher degree of elasticity of expectations will mean that excited speculators will move their money into the market in great degrees — expanding and contracting the speculative stocks — while a lower degree of elasticity of expectations will mean that timid speculators will be less inclined to move their money into the market.

In my dissertation I will be approaching the problem using a similar framework. However, I disagree with Kaldor on distinguishing between so-called fundamentals and speculation in these markets. If we are talking purely about price formation I do not think that we need to distinguish between the two sources of demand. It seems to me to just lead to messiness and confusion in what follows. The question of fundamentals only really comes in when we are concerned what might happen when speculation leaves a market — i.e. when a bubble bursts. Also the question of fundamentals is largely meaningless in actual asset markets like the stock market. It seems to me, in contrast to what Kaldor thought at the time (which we shall discuss momentarily), that “fundamentals” in markets like the stock market are entirely open to interpretation and rely heavily on investor expectations. To believe otherwise is to believe some sort of watered down version of the EMH, such as that expounded by Fischer Black in his awful paper Noise.

This is, in my estimation, a central problem of Kaldor’s paper: it’s a bit of a mess. In the later sections of the paper Kaldor tries to tie speculation into the fluctuation in output and employment. He essentially tries to rewrite Keynes’ theory of the liquidity trap. I will come back to this in a moment but first just let me point out something that I think important. Kaldor had the opportunity to overturn the neoclassical theory of price in this paper. And he could well have succeeded. But instead the paper was ignored and I think this was because it was not laying emphasis on what Kaldor’s theories meant for the neoclassical theory of price formation. Instead Kaldor focused on the annoying and banal liquidity trap argument that makes up a paragraph or two in the General Theory.

This brings us back to Hicks. In the paper, Hicks’ shadow looms large. He is referenced numerous times and it is well-known that he and Kaldor were good friends at the time. After the paper was published Hicks sent Kaldor a letter telling him that his paper had “completed the Keynesian revolution”. Actually what Kaldor was really doing was attempting to complete the Hicksian revolution. Because it was Hicks’ ISLM model that relied so heavily on the liquidity trap argument, not Keynes’ General Theory.

The liquidity trap argument in the General Theory was a simple curiosity for Keynes thrown out as a sort of supplement to the actual critique of neoclassical theory that he was putting forward. But, as is well-known, Hicks picked up on it and since then it is argued in textbooks that depressions that require fiscal policy only occur when the central bank can no longer reduce interest rates. Because Kaldor’s focus was essentially Hicksian I believe this accounts for why Keynes, after he read Kaldor’s paper, basically shrugged his shoulders and said that Kaldor might be correct that it was the speculative impulse that was behind any tendency toward a liquidity trap. Kaldor’s paper was not particularly interesting from a true Keynesian perspective, as from this perspective interest rates have uncertain effects on the level of economic activity at all times.

In joining forces with Hicks Kaldor lost a golden opportunity: namely, to shift his focus onto what his theory meant for financial asset pricing and pricing more generally. It is this matter that I hope to tackle in my dissertation.

One or two more points before I end this overview. On page 3 Kaldor seems to eliminate certain markets from being subject to speculative dynamics. In particular he takes aim at markets for goods that are bulky and thus have high carrying costs. Kaldor is just flat wrong here. With the development of contracts that can be used to speculate on these goods before they are even produced — that is, futures contracts — anything can be subject to speculation. Anything. Just look at oil which should have massive carrying costs. I’ve come to think that the only reason we cannot speculate on the price of, for example, refrigerators using a futures market is simply because no one has bothered trying. This is actually a rather profound, not to mention disturbing, thought if understood correctly and lucidly.

On page 16 Kaldor also makes the assertion that Price-Earnings ratios in stock markets are relatively stable. This is a bizarre statement with no basis in fact and seems to hint that stock markets are not subject to speculative excesses. Writing ten years after the Great Crash of 1929 one wonders what on earth Kaldor was talking about.

Finally, some claim that this paper contains the germ of what would become Kaldor’s theory of endogenous money. This is just flat wrong. The relevant graph is on page 14 of the paper and it clearly has an upward-sloping supply curve for money. It is not very steep, indicating that Kaldor was not in any way a ‘verticalist’, but it is unquestionably upward-sloping.

We can also take a biographical lesson from all this about Kaldor himself. Namely that at this stage of his life — for he was still young, had grown up under the wing of Hayek and was at this time heavily influenced by Hicks — Kaldor was only beginning to become a Keynesian. There is no question in my mind that he was not there yet. Had he followed this trajectory he would have ended up a Neo-Keynesian in the style of Hicks. But, as we all know, he did not follow this trajectory. And the world of economics is a better place for it.

Clement Atlee: Full Employment Austerian?

The following is an article that I wrote for a newspaper and was never published:

 

In a recent interview with The Guardian Ed Miliband summoned up the ghost of the post-war prime minister and Labour Party icon Clement Atlee to support his recent austerity push within the party. Miliband pointed to the fact that Atlee’s government achieved many progressive goals, such as the establishment of the NHS, while at the same time running a balanced budget. While it is certainly true that the Atlee government did run a balanced budget in the immediate aftermath of World War Two this should not be understood without considering the broader context.

According to the Institute for Fiscal Studies the Atlee government achieved a gradual closure of the massive wartime deficits in 1946 and 1947 and eventually ran a budget surplus for a couple of years before military commitments in Korea led to a resurgence in the deficit in 1950. Meanwhile the unemployment rate remained at historic lows, averaging about 2.1% over the five year period from 1946 to 1950. So, how do we account for this?

First of all it should be understood what happened to the economy during this period of post-war demobilisation. During the war years huge amounts of savings were built up by private sector households and businesses. These savings came directly from the spending by the government. If a person was paid wages to build machine guns and tanks and could not spend substantial amounts of these wages because of the rationing of consumer goods they would then necessarily accrue as savings. As demobilisation kicked in and the rationing began to be gradually lifted these savings began to flow out into the economy thus generating demand and supporting employment.

Then there was the fact that the Britain managed to push its current account back into surplus by 1948. By selling more exports than it was buying imports the country as a whole could ensure that additional demand was flowing from abroad which provided further gains in employment. Part of the reason for this was due to import restrictions – as Mr. Miliband himself said in the recent interview: “This was a government that banned the import of sardines because they were worried about the balance of payments.”

Compare this with the situation of Britain today. While it is true that over the past few years the government has run substantial government deficits these were nowhere near the levels of those seen in the Second World War. This can be seen by the fact that the national debt went from around 125% as a percentage of GDP in 1941 to around 220% in 1946. Contrast this with the increase in the national debt between 2008 and 2013 from around 45% of GDP to around 90% of GDP. In addition to this Britain today runs rather large current account deficits that act as a drain on demand and employment.

This explains quite well why Britain today faces an unemployment crisis while in the immediate post-war years it was experiencing record levels of employment. Comparing an economy with a trade surplus that has massive amounts of cash accrued through forced saving and rationing with an economy crawling out of the largest recession experienced in decades is extremely misleading. While it remains to be seen whether Miliband can make good on his promise of a “society-changing government” it seems highly unlikely that anything like the full employment society that emerged after Atlee and lasted over 25 years will come out of Labour’s misguided aspirations toward austerity.

The Dreaded Specter of Nihilism in Economic Theory

There’s a funny point on which almost all economists that I’ve come across agree upon — from neoclassical to Marxian to Post-Keynesian. And that is that something which they call “nihilism” must be avoided at all costs. Let us first try to pinpoint what exactly this so-called nihilism is. A good starting point is Marc Lavoie’s seminal Foundations of Post-Keynesian Economics (a book which, incidentally, I hear is under substantial revision as we speak).

The second chapter of the book is entitled ‘Theory of Choice’ and deals with how Post-Keynesian economists should understand decision-making by economic agents. Lavoie is categorical in that marginal utility theory should be rejected and on that we fully agree. Tied to this Lavoie tells us that we should also reject the assumption of absolute rationality on the part of economic agents — again, I agree with this.

Next, however, Lavoie claims that we need to put forward what he calls a theory of procedural or bounded rationality. He quotes Cyert and Simon who define bounded rationality as such:

The rationality of the business firm is a rationality that takes accounts of the limits on its knowledge, on its information, on its capacity for computation, and on its understanding of theory. It is a rationality that makes extensive use of rules of thumb where a more exact application of theory is impossible whether because this theory is not understood, because the data needed for estimating its parameters is not available, or because the decision must be made under conditions of uncertainty. (Pp. 51-52)

I in no way disagree with this characterisation of how real world business firms make their decisions. I also think that this “rule of thumb” approach is applicable to some extent to individual agents — at least when it comes to activity such as meeting absolute living requirements (heating bills etc.); less necessary consumption and savings allocation/speculation have a completely different dynamic. I do, however, object to the use of the word “rationality”. We will come back to this in a moment but let us first turn to the question of nihilism.

Lavoie discusses what he calls “nihilism” on page 59 of the book. He does not provide a definition of the term, but I think we can derive one from what he has written. It seems that what worries Lavoie is that if we push the Post-Keynesian of uncertainty too far we have to then admit that there are no laws and regularities underlying economic activity — and thus that economics is largely a crock. Tied to this Lavoie is concerned that if we push the uncertainty concept too far we will find ourselves in a world characterised by total and utter chaos with no order whatsoever. What Lavoie calls “nihilism” then is more accurately called “epistemological nihilism” — that is a denial that we can have any knowledge of anything whatsoever.

He goes on to say that neither of these things follow because people follow rules of thumb in line with bounded rationality. Again, I agree with this. But the term “rationality” seems to me misleading and leads to the wrong conclusions.

The term “rationality”, as Joan Robinson once pointed out, is a circular concept. It assumes that agents act in line with some sort of theory — usually marginal utility theory — but the theory, in turn, is always grounded in the fact that agents are rational. Thus the theory really says nothing beyond “agents act as the theory says they act”. It is, in essence, a tautological argument.

The same holds for Lavoie’s use of the term. It doesn’t really tell us anything beyond the fact that agents act in line with how Lavoie thinks that they act. Thus when he uses the term “irrational” to describe the supposedly nihilistic universe of lawless chaos, all he is really saying is that in such a case the agents don’t act as he thinks that they act. In a very real sense then the term “rationality” is a moral argument in that peoples’ actions are judged purely on how well they conform to a given theory — neoclassical or otherwise.

This brings us to the next point: do economic laws really exist “out there”? I have argued before that they do not; that economics is simply one system among others which we use to organise our lives. In this conception it is true that some systems of action are better at achieving set goals than others. But the goals themselves need not be characterised as “rational” or “irrational” or anything else. They are simply seen as arbitrary and, ultimately, subject to our own moral judgement which precludes any application of economic theory.

I would argue that the “rules of thumb” that Lavoie discusses in his theory of bounded rationality are also arbitrary. Whether a firm or an individual has this or that goal in mind is basically arbitrary, although again there are better and worse ways of achieving this goal. This does not mean that these arbitrary rules of thumb lead to nihilistic chaos. They still produce regularities — although they certainly do not produce Laws, which in science must be timeless — and so we do not need to give up on economic theory altogether.

Still though, the specter of nihilism looms large and it is, so far as I can see, exaggerated. It is the yawning abyss that has people continuing to build bridges out of tautologies. Better, in my opinion, to just ignore it and get on with things. The day that economists stop using the term “rationality” is the day that they finally move away from becoming a modern day Church of Reason and become rather more humble in their role.

Gold Fails to React… Again

Just a quick follow up to my post on gold the other day. In that post I wrote that:

In plain English: the chances of the gold price falling substantially is far, far higher than the chances of the gold price rising substantially — the latter of which to me seems almost non-existent outside of some completely unforeseeable event.

Yesterday we got yet more evidence of this. Bernanke’s Humphrey-Hawkins speech was pre-released and analysts are already noting its dovish tone — most notably the return of talk about deflation. This indicates that, should economic conditions worsen, the Fed might not reduce its QE program; indeed, if they worsened enough they might even increase the so-called money printing.

Now, presumably the gold price should react to this, right? Nope. A tiny little bump yesterday which then self-corrected almost instantly.

This is actually to be expected.  When QE3 was announced back in September of 2012 the gold price failed to react in any meaningful way, as can be seen from the chart below.

This was the first signal I picked up on that the gold market had succumbed to a sort of chronic fatigue. After all, if the reason that the price of gold is supposed to rise is because of so-called money printing and the fear of inflation then why on earth wouldn’t it rise on the back of an announcement of QE by the Federal Reserve?

The answer to that question is simple, and it is precisely the one I gave in my February piece on the matter: the gold market is completely saturated. All the true believers already own their gold and those that lack the faith aren’t interested. That also explains the extremely low price elasticity discussed in my earlier post. When investors do dump gold onto the market no one wants it because the hoarders already have their hoards and no one else believes the hype. This really is a classic end-of-bubble scenario.

A Challenge to Michael Emmet Brady

Who is Michael Emmet Brady? Well, he appears to be a man with a PhD in economics who claims to have unearthed what he considers to be the “true” interpretation of the work of John Maynard Keynes — one which, he claims, has been missed by almost everyone else who claims to follow in the tradition of Keynes.  He publicises his views in a few academic papers but most people come across him through his reviews of Post-Keynesian books on Amazon.

The Radical Subjectivist did a nice post on Brady that seems to me generally correct. Basically Brady appears to be making the claim that buried within Keynes’ Treatise on Probability is some sort of theory of microeconomic behavior. This has always seemed to me a bizarre assertion.

Surely for someone to make decisions in line with Keynes’ work on probability they would have to have first read and understood this work. Given that such an argument is coming from a scholar that complains that not enough people read the Treatise the irony is, of course, enormous. Indeed, in many ways Brady’s argument is structured in the same way as a rational expectations argument in that the economist assumes that people act in line with his model of them — so, it implicitly assumes that such a model exists “in their heads”, which seems unlikely unless they have deeply studied and adopted said model.

I’ve had debates with Brady’s followers before — yes, he has some rather vocal followers. My experience has been that they focus on minutiae and cannot really answer more fundamental criticisms like the one above. I have also pointed out where he was factually wrong in one of his reviews and never got a reply. All that considered, here I am going to take a different tack.

Okay, Brady is claiming that he has a mathematical model to get a grip on uncertainty. Fantastic. Then I think that it is time to apply it and display the results. He can do this in the financial markets. These markets, as Keynes and the Post-Keynesians know well, are characterised by substantial degrees of uncertainty (and no, that does not mean that you cannot make educated guesses to try to predict the movements of these markets as Brady seems to think). So, what Brady should do is apply his mathematical understanding of uncertainty to these markets to make predictions.

And that is where my challenge comes in. I follow the markets regularly. I think I know them pretty well at this stage. I also find them to be characterised by enormous amounts of uncertainty. So, if Brady takes up my challenge, I will continue to watch these markets and any time I come across what I consider to be a completely uncertain forecast — and there are many of these every week — I will lay out both the data and why I find it uncertain on this blog. Brady can then apply his technique and we can see if it works. If it does, we can then talk to some of the people I know in the hedge fund industry and we can set up a fund the money from which we can use to spread Brady’s ideas.

If Brady does not want to take up this challenge or his technique fails — let’s say that it gets things wrong more than 80% of the time — then we will know that he has not made the discovery he claims to have made. If he does take up this challenge and his technique succeeds, then we should all prepare for the coming revolution in not just finance and economics, but in science generally.

LOL GOLD!

Hyperinflation is coming! No, seriously! Yes, I know that I’ve been saying that since 2008 and that I’ve also said that it would be due to QE and low interest rates and now the Fed has signaled that these might come to a slow soon, but still it’s totally coming! What should you do? Buy gold, of course. Oh, and my website just so happens to sell gold — and tinned food; make sure to buy lots of tinned food.

Seriously though, the gold bugs are getting burned like there is no tomorrow these days. Check out this entertaining clip of an economist who studied the long-run trend of gold prices:

Of course, such studies should be looked upon with some skepticism. The future, after all, is not a perfect mirror of the past. Still, as I divined back in February using some rather unusual, erm, data-points, gold is likely to continue it’s fall in the coming year and I’ve heard crazier estimates than $800 as the price it will revert to. Oh, and for all you folks interested in the underlying dynamics of the gold market I cannot recommend this absolutely fantastic analysis by hedge fund manager Mark Dow enough.

Although I was aware of most of this analysis myself Dow points to something I had missed: the extremely low price elasticity of gold. For all those of you who have not been indoctrinated in the jargon of the dismal science in practical terms that means that when even a small amount of gold is dumped on the market its price must fall substantially before a buyer is found. What this tells us is two things. (1) That gold is less a hot commodity than a hot potato commodity — outside of a select group of cultists no one wants the stuff. (2) Any time an “event” happens in the gold market that signals a sell opportunity — as, for example when Bernanke announced the QE taper — the price effects are going to be substantial.

While I’m not in the business of giving investment advice (right now, anyway…), that makes it a very attractive short for gold bears because in the medium to long-run there is substantially more downside risk than upside risk. In plain English: the chances of the gold price falling substantially is far, far higher than the chances of the gold price rising substantially — the latter of which to me seems almost non-existent outside of some completely unforeseeable event.

Recollection and Repetition: Ergodic and Non-Ergodic Processes in the Sciences

Say what you will, this problem is going to play an important role in modern philosophy because repetition is a decisive expression for what ‘recollection’ was for the Greeks. Just as they taught that all knowledge is recollection, thus will modern philosophy teach that life itself is a repetition.

— Soren Kierkegaard, ‘Repetition‘

Just a bit of a follow-up here to my last post on the limits of probability theory. I got two fantastic responses that I think require me to clarify things somewhat. One was from Lord Keynes in the comments of his blog, the other was from Tom Hickey of Mike Norman Economics in the comments of mine.

First off, I should lay out the reason it seems clarification is necessary. In the last post I was largely concerned with laying out the properly relevant philosophical questions underlying probability theory. I think I succeeded in doing that but I only really hinted at what my own opinions on the matter were. So, let’s go into that a bit.

Lord Keynes’ response was basically that in the social sciences the future mirrors the past only in a very limited sense and that in the natural sciences there are many processes in which the future fully mirrors the past — he gives examples of cycles of seasons and so on. Cast in different terminology what Lord Keynes is saying is that determinism is very limited in social science if it indeed exists at all, but that it does exist to a large extent in the natural sciences. Or, one more time to ensure that we all know what the words we are using mean, that social science is based on material that is largely non-ergodic while the natural sciences are based on material that is ergodic.

I largely agree with this assessment although I think I’d go one further. In my response to Lord Keynes I brought up a metaphysical distinction that I think useful in discussing these issues. The metaphysical  distinction is the question of whether we view reality as being based on deterministic constants — Infinite Laws — or simply on repetitions — Finite Regularities. Actually, this metaphysical distinction is the same one as Kierkegaard laid out in the opening quote: that between recollection and repetition.

Think about this for a moment. What does it mean to say that the universe is deterministic? Well, we’ve already phrased this in a different and useful way: it means that the future mirrors the past in some sense or other. Let’s cast this in Kierkegaard’s language to see how it fits: a deterministic universe is characterised by the future ‘recollecting’ the past. The idea here is that the future is determined fully by the ‘memory’ of the past. Everything that is in the future is always already contained in the past. The future is thus a sort of congealed memory of the past.

Okay, that’s a good description of a deterministic universe, one which is just the infinite unfolding of any number of abstract Laws. But what about a non-deterministic universe? Well, this I would argue, is a universe of repetition. In such a universe the future does contain the past — it can never truly break free — but it nevertheless adds something new that was not there before. Kierkegaard sums up the two metaphysical positions nicely:

Repetition and recollection are the same movement, just in opposite directions, because what is recollected has already been and is thus repeated backwards, whereas genuine repetition is recollected forwards. (‘Repetition and Philosophical Crumbs‘, Pp3)

Kierkegaard was, of course, interested in the meaning these two different metaphysical views had for ethics; he claimed that recollection makes a man unhappy and repetition makes him happy. However, as we have just seen, they also have a lot to say about how we understand more practical matters; like economics and science.

Back to Lord Keynes’ examples. In the social sciences — and I shall prove this logically in a moment — the universe we deal with is no doubt the non-deterministic, non-ergodic universe of repetition. Thus it is pointless trying to discover fixed, timeless Laws as, for example, the neoclassicals try to do. Instead we must seek out the repetitions themselves. What I mean by this is that we need to try to find regularities. So, we might look at spending multipliers; at propensities to save in different income groups; basically: macroeconomic trends. Using these trends — but understanding always that as they repeat through time they change — we can make judgements about what might happen or what policies might be appropriate.

What about the natural sciences then? What about the changes in seasons or the movement of the celestial bodies? Lord Keynes says that these are ergodic processes. I’m not sure that they are. Obviously for all intents and purposes we can act ‘as if’ they are ergodic processes; as if they are subject to recollection rather than repetition. We can do this just as we can use Newton’s laws of gravitation for most engineering problems even though we know these laws to be overturned by Einstein’s relativity theory. But I don’t think that these are truly ergodic processes. I think they are just repetitions with a far longer time horizon to those that we deal with in the social sciences. Eventually the cycle of the seasons will change, as will the movement of the celestial bodies. We won’t be around to see this, as we are quite literally a product of and contained within this particular repetition, but we should recognise that it is nevertheless a repetition.

Like all metaphysical judgements we can agree to disagree on this point. To each his own. But back to more pressing matters for a moment. I said that I would prove logically that in the social sciences we deal with repetitions — that is, with non-ergodic, non-deterministic processes — so allow me to do that. I will repeat here what I said to Tom Hickey in my response to his comment.

Imagine for a moment that it were possible to discover certain Laws dictating my behavior. Now imagine that you discovered these. In order for them to continue to be valid you would have to keep them secret from me otherwise, using this knowledge, I could reflexively change my behavior and invalidate these Laws. The same is true if we determine Laws for large groups of people. Once they became commonly known people would change their behavior. This reflexivity suggests that there is a non-deterministic process at work — a repetition rather than a recollection.

In human affairs there is a degree of freedom that negates any notion that we can come up with deterministic Laws that dictate behavior. The very process of trying to discover such Laws is in itself an act of creative repetition. Think, for instance, of a neoclassical policymaker trying to impose so-called ‘market forces’ on a public sector institution. He acts as if he is just renaturalising this institution in some way — as if he is bringing it back in line with the Laws of the market after it has been made impure through regulation. But what he is really doing is creating a new institutional framework through an act of creative repetition.

This is the nature of all human endeavor and it is this that the neoclassicals ignore. Such ignorance not only generates bad theory but it also gives them an authority they would not otherwise have; it naturalises their decisions and their ideas — their repetitions — in a way that lends them power. Like the organised religions of the past, this is what neoclassical economics is all about.

Addendum

The above discussion takes its leave from Kierkegaard’s ethical considerations of repetition. His book is brilliant but very obscure and, for those interested in the topic, I do not recommend it. From a social sciences perspective the definitive work on repetition is that of the French sociologist Gabriel Tarde. A good outline is his Social Laws: An Outline of Sociology which is available online. From a metaphysical perspective the definitive, if difficult work is that of Gilles Deleuze — most notably his Difference and Repetition. Finally, although many evolutionary economists are doing work similar to what I just discussed, the most interesting work that I ever came across in economics that uses the framework I am talking about — albeit not using the terminology I have laid out above — is Joan Robinson’s forgotten classic Freedom and Necessity: An Introduction to the Study of Society.

Infinite Monkeys: The Limits of Probability Theory

No one could be more frank, more painstaking, more free from
subjective bias or parti pris than Professor Tinbergen. There is
no one, therefore, so far as human qualities go, whom it would be
safer to trust with black magic. That there is anyone I would
trust with it at the present stage or that this brand of statistical
alchemy is ripe to become a branch of science, I am not yet
persuaded. But Newton, Boyle and Locke all played with
alchemy. So let him continue.

— John Maynard Keynes speaking of one of the pioneers of econometrics

Recently the blogger Lord Keynes over at the always excellent Social Democracy for the 21st Century blog has been doing some posts about probability theory (examples here, here and here). There is a famous theorem in statistics called the ‘Infinite Monkey Theorem’ which states that as n approaches infinity the probability Xn approaches zero. We’ll get back to this theorem later but let me lay down a theorem of my own — one which I hope that Lord Keynes and others interested in this topic pay attention to: as a person’s wonderment at probability theory approaches infinity the probability that they will get anything of worth done approaches zero.

I say this because the issues surrounding probability theory and economic theory, while they are so profound as to be possibly the most important part of economic theory, are nevertheless a rather basic and simple metaphysical puzzle that can be laid out in clear terms and thus answered in clear terms. Once you understand this puzzle you “get it” and the deeper you dig into probability theory, the more this puzzle will repeat itself. Indeed, this puzzle has already been laid out and answered by the Post-Keynesian economist Paul Davidson in his writings on ergodicity in the social sciences.

Everything comes down to this: do you believe that the future mirrors the past? Or, put another way: do you believe in deterministic laws that govern the universe and can be understood by human beings? Everyone can answer that question themselves. It is a metaphysical question that borders on the theological — and it really goes all the way back to the debate between Erasmus and More on the existence of free will. Again, everything comes down to this. No matter how deep you dig into probability theory you will not find any other question and so you can save yourself a great deal of time by pondering this question in pure form rather than getting caught up in the nuances of probability theory.

(Okay, I’m not saying just avoid the whole of probability theory. It is indeed interesting. But I would advise against becoming obsessed, as I know how obsessive the structure of theory is. It could potentially — and I mean this literally — drive a person mad because it takes the form of an infinite series of questions which never provide any answers, simply because the meta-question is the one I just laid out above.)

But back to the monkey theorem for a moment. The theorem states that if a monkey sits at a typewriter hitting random keys it will eventually come up with the collected works of Shakespeare. When expressed in mathematical form the theorem makes sense, but when stated anecdotally and “brought back down to earth”, as in the monkey example, it makes no sense at all. First of all, a monkey’s behavior does not generate random walks. What the anecdote does is replace a truly random-generating machine with a monkey, but the analogy is incorrect because a monkey would not behave in a properly random manner. Secondly, infinity does not exist in our oh-so finite reality. It is either a figment of our imagination or it is some divine space inhabited by a higher power.

This is important because we should remember what we are really dealing with when we are dealing with such theorems. People often mistake these theorems as saying something tangible about our lived reality. But often this is simply not the case. What these theorems do is absorb and disguise debates that used to take place among metaphysicians and theologians and then pretend as if certain questions which philosophers have been tackling since time immemorial have been answered. One is tempted to put this down to the hubristic tendencies in the scientific method itself.

Whatever the reason, however, the lesson for the Sciences of Man should be clear: these questions have not been answered; methods derived from disciplines like probability theory (for example: econometrics) probably have a very limited reach; and you’re not going discover the secrets of the universe by becoming an expert in these disciplines, although society may bestow you with a role similar to that occupied by a priest or a haruspex in times past. If this is indeed your goal well, as Keynes said all those years ago, Newton, Locke and Boyle played at alchemy, so by all means continue.