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Black swans and dark matter

December 22nd, 2008

There’s been a lot of talk about the idea that the GFC (the in-group shorthand for ‘global financial crisis’) is an example of a ‘black swan’, that is, an event that would be treated as impossible on the basis of induction from past experience, and hence that could not be encompassed by formal models of the kind used by risk managers. All this talk has of course been great for Nicholas Taleb who has a book with this title. It’s good in a lot of ways, but I found it ultimately insufferable in the continuous repetition of the message that only Taleb was smart enough to see all this. ( To be fair, Taleb predicted a global financial crisis, and didn’t simply claim it in retrospect as an unpredictable Black Swan).

I spend a lot of my time working on how to think about unforeseen contingencies and I’m not at all convinced that the GFC should be described in this way. Of course, the models used by the risk managers in investment banks didn’t include this as a possibility; if they had, the implication would have been that all sorts of much-desired deals should not go ahead. But as I pointed out a while ago, very simple models based on well-established principles predicted that the bubble economy would end badly.

The crisis then, involved something more like dark matter, the ‘missing’ matter in the universe that must exist if it is to work as it does, but can’t at presented be detected. Given that risk can’t easily be made to disappear*, it was obvious that the risk associated with lending of all kinds (most obviously, mortages offered to people with no capacity to repay) was being borne by someone, and probably someone who was unaware of it.

The big problem for the Cassandras (and we were certainly both correct and disregarded) was that it was easy to see that the bubble could not continue and much harder to foresee how it would end – it’s one thing to say that dark matter must exist and another to work out what it is really like. Like Brad and Brad, I expected that the problems would emerge first in the form of a run on the US dollar, given that holders of US dollar assets were receiving very little compensation for the obvious risk of large capital losses. In fact, the US dollar actually rose in the early stages of the meltdown, though it has been falling more recently.

One ‘black swan’ explanation of the mortgage crisis was that the mortgage derivatives created by Wall Street couldn’t fail except in the event of a simultaneous downturn in all major housing markets in the US, something that had never been observed, and therefore could not be included in the models. But of course the reason such a thing had never occurred was that local housing markets had been separate from each other, with their own sets of banks, S&Ls and other financial institutions. The very banks that were doing the modelling were creating the conditions under which a national bubble and bust could take place. This was both foreseeable and foreseen.

*Unlike matter, risk can be created with ease. Reducing it is more difficult, though pooling and sharing of uncorrelated risks works in many cases.

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  1. CuH
    December 22nd, 2008 at 16:27 | #1

    to be fair to taleb, he says the financial crisis was not a black swan – he agrees with you that it was predictable, and like you, he predicted it.

  2. December 22nd, 2008 at 17:13 | #2

    Another Cassandra is The Economist, which said that it is in the nature of capitalism to invent new instruments (it was an article on CDS) and use them to destruction… (or something along those lines)

    If we trust the insight of The Economist (which I do pretty much even tho I’m a leftie and The Economist is very pro free trade), then this sort of thing is unavoidable, and no black swan.

    It seems that while The Economist is still pro free trade as a means to addressing the problems of society, it is becoming increasingly “lefty” in its view of financial engineering.

    (btw, check out “Credit Crunch” game at http://economist.com/boardgame … brilliant!)

  3. smiths
    December 22nd, 2008 at 18:16 | #3

    i agree with your sentiments on taleb, clearly right in a lot of ways but talking like a tosser all the time, (is there some way of making it a wayne swan)

    i find the same with roubini, he spends half his time making predictions and the other half talking about stuff he has already written and said and going on about it, again a bit of a tosser i think

  4. Ikonoclast
    December 22nd, 2008 at 19:24 | #4

    How could a bad recession or depression be treated as impossible on the basis of induction from past experience? Have we not had recessions and depressions before? Such assertions are only made those who know no history ,repress their knowledge of it or imagine that “we know too much now” to fall into such errors again.

    What disturbs me in all this is that most of the people who predicted this are almost “fringe” economists who are respected in academia but generally ignored by business, governments and their apparatus.

    Those who failed to predict this and who pretty much belong to the “we know too much to have a disaster now” school are still in charge of all the levers as the disaster unfolds. If the US economy was a patient, Greenspan and Bernanke would be up on malpractice suits now.

  5. Salient Green
    December 22nd, 2008 at 19:30 | #5

    I think the Dark Matter is high oil prices and if they (neo-liberal world governments) succeed in pumping up the bubble again, it will surely be quickly pricked by another rise in oil prices.

    Thankyou John Quiggin for this blog. It has become my first port of call of all the blogs I frequent and allthough some of the discussion is over my head, thanks to your rules I am still treated with respect even when showing my ignorance.

    We’ve all lost wealth this year, retirement funds and house prices, but it’s not real wealth.

    The real wealth is family, friends, safety, the comfort and convenience of homes and transport whatever their market value, safety nets, health care, good food and water. And the opportunity to share.

    We in Australia are so very, very fortunate. Christmas cheers to all.

  6. Elwood Anderson
    December 22nd, 2008 at 20:54 | #6

    When an imbalance in income and wealth develops between the capital investing sector and the consuming sector of the economy, funds for investment far exceed the available opportunities for productive investment, and investment returns fall unless capitalists resort to riskier investments. To sustain their high returns, the finance industry resorts to leverage and risk hiding schemes. Every derivative they come up with expands the money supply and increases the debt overhang they have on their investments, and securitization of debt clouds real risk. These gimmicks are what got our banking system and the shadow banking system in trouble. This led to expansion of credit and careless lending, while consumers used the easy credit and housing appreciation to sustain consumption and demand.

    Governments are responsible for promoting the general welfare and should step in to rebalance income and wealth in the capital and consumption sectors of the economy through taxation adjustments, when they see bubbles developing. Many people saw the housing bubble developing as early as 2005 by observing the widening discrepancy between costs to own and rent, but everyone was enjoying the fruits of the bubble too much to do anythings about it. Now we are suffering the consequences. If you look at history you will see that instability in the financial system occurs when income and wealth inequality becomes too great. It’s happened many time before and it is happening now. But, economic models don’t address this, so it continues to be ignored by both economists and politicians.

  7. December 22nd, 2008 at 21:22 | #7

    If a Black Swan is taken to mean a relatively infrequent event, then this generational event might be appropriately so classified. This ongoing nonlinear devolution was predicted:


  8. December 23rd, 2008 at 03:02 | #8

    I was another of the Cassandras, although I thought that the collapse of the housing bubble would trigger the run on the dollar. As it was, when the full-scale collapse of all the interconnected derivatives markets hit on Sept. 17, there was this run to the dollar as the “safe haven,” with negative interest yields on Treasuries briefly appearing (and reappearing more recently again). But now the dollar seems to be a lot more down.

    I agree that Taleb’s book is great fun and stimulating, but also very frustrating, given all his egomaniacal self-promotion. The real contradiction is that on the one hand he goes on and on about how to deal with true Keynesian-Knightian uncertainty (aka “black swan” events), while on the other claiming that he has the way to deal with them (barbell strategies of various sorts). In his book he identifies the large literature on fat tails and non-Gaussian distributions as “grey swans,” but that is what his approach is, ultimately pulling off the multi-fractal distributions of Mandelbrot.

    BTW, for calling him out on the fact that in more years than not the barbell strategy described in his book lost money, I am probably his least favorite economists, as one can find by digging around on his website, although Tyler Cowen is a close second, and for the same thing. The guy is thin-skinned, but reports have it that he and his firm have made lots of money this year.

  9. calmo
    December 23rd, 2008 at 03:02 | #9

    thanks smiths for “tosser”, not a common expression here in the Pacific North West, but oddly enough connected to a small town in Oregon, Wanker’s Corner.
    And to JQ for punchin it home with “Dark Matter” which, although crafted by more capable hands in Ricardo Hausmann and Federico Sturzenegger, is safely back in the astrophysics tent, right? Right?

    What Elwood said…we can’t all B filthy rich…not for long…but there is no shortage of tryin…and no shortage of tossers willin to try us.

  10. plaasmatron
    December 23rd, 2008 at 04:02 | #10

    As a physicist I would be careful with the dark matter analogy. Dark matter is an idea proposed to account for an observation that cannot be explained by present theory (essentially the galaxies are rotating too fast for the otherwise conceivable mass, which is inconsistent with current graviational theory). The GFC is easily explained by present economic theory; the theory of bubbles.

  11. jquiggin
    December 23rd, 2008 at 06:03 | #11

    I think the analogy is closer than you suppose. There is no “theory of bubbles”, at least none that is generally accepted. Rather there are observations of actual bubbles that seem to require a theoretical explanation – something that has proved very hard to produce.

  12. carbonsink
    December 23rd, 2008 at 07:15 | #12

    There is no “theory of bubbles”, at least none that is generally accepted

    Er, Minsky?

    Dr. Minsky proposed theories linking financial market fragility, in the normal life cycle of an economy, with speculative investment bubbles endogenous to financial markets. Minsky claimed that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what borrowers can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to companies that can afford loans, and the economy subsequently contracts.

    The fact that Minsky is not generally accepted is probably due to the length of time since the last (serious) recession. The economic orthodoxy that developed during this period — price inflation targeting while ignoring asset bubbles, the belief that markets are self-regulating and tend towards equilibrium — will be seriously challenged over next few years.

    Economics seems to follow fashions driven by what’s happening at the time. We were all monetarists in the 1980s. Today we’re all Keynesians (apparently). Tomorrow we may all be devotees of Minsky.

  13. Sean Morris
    December 23rd, 2008 at 07:23 | #13

    Credit crunch, a brief history.

    A, Economic
    B, Financial
    C, Political

    A, Economic

    * What we experiencing at the moment is an asset bubble that has popped and gone nuclear.

    * Ever wonder where all that cash came from that the banks were throwing around not too long ago?

    * Did you notice all that stuff we seem to be importing from the far east?

    * Well, they sold us stuff, made a lot of money, and saved it.

    * When they saved it, it found its way back to our shores, which filled the bond and money markets full of cash. (this is your dark matter Mr Q, except most of us see it plain as day, always follow the money)

    * To protect their industries, the Chinese Govt. bought a lot of US Dollars (a real lot ) This had the effect of keeping interest rates artificially low, which kept us borrowing, mainly from them.

    B, Financial

    * We used to pay a deposit on a home loan, this acted as a sort of additional insurance to the creditor (the Banks)

    * They came up with a method they thought could minimise risk, by spreading the risk between banks, they believed they could lend money to more risky customers (and they had a lot of money to lend, See A)

    * Some decided as a result of the money in the markets, and this new full proof lending system they would lend 100%, 110%, 125% loans to value of the property something they have never done before and 4, 5, 6 times earnings. The thought they were clever.

    * The effect of this system was to create in effect one great big bank, all sharing each others risk, so when the sub prime crisis took off in the USA, it spread like wild fire all through the worlds banking system.

    * By creating a virtual giant bank, they suppressed competition, markets do not operate properly without competition.

    * Banks borrow money in the main against the value of the property, but by borrowing ever increasing amounts (which they were keen to do) they created a feedback loop, their lending itself created every increasing property values which in turn lead to more lending.

    * Our own banking and mortgage system which mirrored the US Banking system caught fire almost at the same time, as our banks (not all) where doing the same kinds of things.

    C. Political

    * So why did not anyone notice all this going on? After all its the governments job to look out for us.

    * Simple answer is they were in on the mess. Banks paid a lot of wages, and bonuses add to that profits which ran into the billions, these incurred a lot of nice big taxes for the government to spend.

    * Our own government not content with the taxes it was getting through a healthy economy decided to borrow quite a lot more from the money markets itself, so when the crunch came it did not have any money saved for a rainy day to help people out, so they borrowed again, or are trying to borrow as they price has gone up as the money has dried up.

    * They also decided in 2004 it would be a good idea to take house price inflation out of headline inflation figure, the IMF said this was a mistake. This had the effect of keeping interest rates low, which encouraged people to borrow and not save, thus creating an even bigger bubble.

    * The could have looked at the amount of credit growth in the economy and noticed that it was way above the general economic growth rate, they might have asked where was the money coming from, but they did not, the housing market too provided billions in tax revenues., once again the situation was to there advantage, happy people make happy voters, even better the banks where lending money and lots of it to people who previously would not have qualified for credit, they saw a social good.

    * Our governments did not see the problem caused by our trade imbalance, did not act to maintain a orderly property market, believed everything the banks were telling them and ontop of that many borrowed themselves, when it should have been building up its reserves for unexpected things that happen in life

    And finally under both the financial and political category we must not forget to mention “Enron off book Accounting”

    Now in 2003 I wrote to my UK MP about the housing market, I was upset at the higher multiples and self certification mortgages, she wrote back, Govt wonderful, new economic age, a new order, dont worry about the gap between average wages and average house prices blah. AND what do we have now from the same bunch of PHD fools who did not see the iceberg? a new problem, epic in scale, spending lots will see us through.

    Disasters in history are just enough apart for most people never to learn the lessons, instead of learning the trial and error lessons of life, the PHDs believe in thy myth of the framework.

    The frameworks and patterns that justify their existence, whatever those ideas maybe., i suppose they too have mortgages to pay.

  14. December 23rd, 2008 at 07:50 | #14


    What do you mean that “there is no theory of bubbles”? If anything, the problem is that there are too many such theories. Now, many do not count as theories to folks in Chicago because they involve models of heterogeneous agents, with some of them behaving “irrationally” or with imperfect information, or something like that. It is also true that Tirole proved a theorem involving backward induction that in a world of homogeneous, infinitely lived, perfect foresight individuals, bubbles cannot happen.

    However, there are theories of rational bubbles. Probably the most famous is that due to Blanchard and Watson dating back to 1982. It is the model of stochastically crashing rational bubbles. They must accelerate upward at an ever-increasing rate to provide for the rising risk premium for the rational investors as the probability of a crash increases.

    See Chap. 5 of my _From Catastrophe to Chaos: A General Theory of Economic Discontinuities: Vol. I, 2nd edition, 2000, Kluwer, for more detailed discussion of this and various other kinds of bubbles.

  15. jquiggin
    December 23rd, 2008 at 08:03 | #15

    We seem to be in furious agreement here
    “There is no “theory of bubbles”, at least none that is generally accepted.’
    “If anything, the problem is that there are too many such theories.”

    These are different ways of saying the same thing, aren’t they?

  16. December 23rd, 2008 at 09:02 | #16


    Lots of people accept that the stochastically crashing rational bubble theory is a reasonable theory, and there have been many who have engaged in econometric estimations of some events using this model, including even myself with some coauthors in one paper. It is also the case that some people, particularly certain well-known econphysicists, have made themselves look foolish holding press conferences to predict crashes of bubbles at particular times based on such models, something that most economists know enough not to do.

  17. smiths
    December 23rd, 2008 at 09:14 | #17

    people in my field of nanofibonnarphasal econopeptics saw this one coming a mile away

  18. smiths
    December 23rd, 2008 at 09:23 | #18

    and also well said sg,

    The real wealth is family, friends … And the opportunity to share.

    Christmas cheers to all.

  19. John Foster
    December 23rd, 2008 at 10:02 | #19

    Following on from John and Barkley’s discussion, why has it been the case that perfectly sensible bubble theories, such as that of Minsky have remained on the fringe while theories with unrealistic assumptions have held centre stage? Robert Schiller has also puzzled over this because it seems to be inconsistent with progressive science. Science is not just about prediction, it is also about explanation – conventional theories generally fall down when exposed to the historical facts. We get too distracted by the Cassandra’s at times like this. Forget prediction, we need to know how the economic system works as it evolves. If economists continue to make simplistic assumptions at the core of their theoretical models they will never be able to understand the consequences of economic evolution (see Foster, J. “From simplistic to complex adaptive systems in economics.” Cambridge Journal of Economics, 2005, vol. 29, pp. 873-892. Reprinted (in Spanish) in J.J. Urrieta, Evolucionismo Economico, Instituctions y Sistemas Complejos Adaptativos, Editorial Porrua, Mexico, 2007, pp. 127-54).

  20. Jim Birch
    December 23rd, 2008 at 11:11 | #20

    Wouldn’t a real scientific theory of bubbles actually come up with some solid testable predictions, like when they will pop?

    There’s a lot of well-know elements, economic “fundamentals” even, that can be rolled into a believable narrative but this is an entirely different thing to a theory of bubbles. You’d expect that a theory of bubbles would distinguish what to measure, what doesn’t need to be measured, and come up with some definite predictions. AFAICS the type of predictions that have been made have been more along the lines of “this can’t go on forever.”

    Predicting catastrophic events is difficult but can be done in some areas, eg, materials science can predict reasonably well the load under which a standard material will fail. It seems to me that at the base of the bubble problem, there are key “aggregate psychological” coefficients (like elasticity of demand or risk averseness) that vary over time in ways that we can’t predict very well at all.

  21. John Foster
    December 23rd, 2008 at 11:44 | #21

    When we are dealing with systems that are adaptive and reflexive then we can only rely to a limited extent upon what we learn from physical or chemical models concerning abrupt transitions. In the changed conditions that arise as the economy evolves, human agents will adapt their behaviour as they learn. Therefore, the past is not necessarily a good guide to the future. However, if we do the hard work of understanding how the system is changing and responding to institutional and technological rules that may have become inappropriate of inadequate, our capacity to predict can be improved. What I mean by ‘predict’ is to come up with a predition with an approximate time attached. The trouble with the Cassandras is that they keep predicting a crisis for years on end and, of course, they are eventually be ‘right’ but what use is that to anyone? Some years ago I wrote an article on the possibility of applying synergetics in economics to capture structural transition events. Most of the problems are discussed there (Foster, J. and Wild, P. “Economic evolution and the science of synergetics” Journal of Evolutionary Economics, 1996, Vol.6: pp.239-260). In relation to this, it is worth pointing out that Steve Keen’s dynamic Minsky model that has driven most of his predictions since the early 2000s lacks an evolutionary dimension and, thus, his timing has been very inaccurate – the bubble went on much longer than he expected and, because of adaptive behaviour and learning, it is likely that his gloomy predictions of a second Great Depression will also be off the mark.

  22. smiths
    December 23rd, 2008 at 11:48 | #22

    in terms of shape and action its surely more volcanic

    supertoxic magma building up pressure inside a bell curve and at the top the lid blows off,
    raining the toxic magma down onto just about everybody below,
    grinding down slowly to the bottom and solidyfing into a flat lifeless blob

  23. December 23rd, 2008 at 15:10 | #23

    Part of the problem here is what counts as a “theory”? So, John Quiggin’s rank-dependent utility theory is fairly “high level,” along the lines of the additivity failure model of Schmeidler. Perhaps John does not accept as “theory” anything that does not involve sufficiently rational agents, which is the view one finds in Chicago, where theory must involve full rationality and equilibrium.

    So, as John Foster notes, Minsky had his theory some time ago, but it was verbal and not mathematical. Back in the 1950s, Baumol and Telser and some others had models of bubbles, but they involved heterogeneous agents, as did Zeeman’s catastrophe theory model of bubbles in 1974 in the Journal of Mathematical Economics. But these theories were dismissed because some of the agents, those destabilizing trend chasers, aka “chartists,” were supposedly not rational. But then Fischer Black told us of the unavoidable nature of “noise traders,” and then in 1990 DeLong, Shleifer, Summers, and Waldmann showed us that sometimes the noise traders can not only survive, in contrast to Milton Friedman’s prediction from the early 1950s that was used to drive Baumol and Telser and others out of town, that the noise traders may even do better than anybody else. In a bubbly market, the person making the most money is not the “rational fundamentalist,” but the “noise trader” who bought at the bottom and sold at the top.

  24. Michael of Summer Hill
    December 23rd, 2008 at 15:23 | #24

    John, if I may reply to John Foster by saying whilst no one economic theory and/or school of thought can explain every problem, one must not under-estimate the historic importance and significance of ‘seminal works’ in explaining past events relative to current circumstances.

  25. Pani Pani
    December 23rd, 2008 at 17:11 | #25

    I find it odd you say Nassim Taleb said the GFC was a black swan. He said no such thing.

    “Taleb said the current crisis is a “White Swan”, not a Black Swan, because it was something bound to happen.” (reference: http://www.bloomberg.com/apps/news?pid=20601087&sid=aDVgqxiT9RSg&refer=home)

    Are you misrepresenting his ideas, like these academics?:

    Are you committing a ludic fallacy?:

  26. Alanna
    December 23rd, 2008 at 17:27 | #26

    In a very simple way I think crashing bubbles are like marble games or pokemon card swapping games that get out of hand in the school playground – the adult version. Its nonsense to say people didnt see it coming – lots did and if we are really honest probably most of us knew the sort of asset price growth we were seeing was unsustainable eg between 10 and 20% capital gains on shares or real estate year after year. Perhaps we are genetically hardwired to get drawn in and gamble (part of it is fun?)

    Someone did a study on Amsterdam house prices over 400 years. Average growth – less than one percent a year. Some centuries the prices rose for 30 years and others they fell for 50 years.

    I dont believe its a shock – I thought it would crash in about 2000 actually (but I am higher than usually risk averse – I hate both banks and debt) but it didnt – it just kept rolling along. They should have put interest rates up sooner but I suspect they were doing a gently gently approach after 1987 because the 1987 policy was crticised for being a foot slammed too hard on the brakes.

    There really wasnt any attempt to slow down the building bubble when perhaps there should have been.

  27. GreekAmongRomans
    December 23rd, 2008 at 19:28 | #27

    To continue on with the vernacular of astrophysics, a Black Swan event is not absolute in nature, but rather, relativistic.

    Taleb references his example of the turkey and the butcher when referring to the GFC.

    Within the turkeys frame of reference the event, which was soon to afflict it, is certainly a Black Swan for the turkey, whilst within the butchers frame of reference the event is certainly not.

    The economic agents that inhabited the universe of the turkey (Alan Greenspan, Ben Bernanke, Glen Stevens et al., government, bankers, real estate agents, the majority of the general public) certainly did not see this event at all, as most of them have already readily publicly proclaimed.

    Whilst the economic agents in the butchers universe (of which there were many) had identified the symptoms of the underlying problem, which was excess liquidity. Although most in the butchers universe found it difficult to identify the precise time of reckoning.

    A Black Swan event does not exhibit the absolute nature of the constant c, but rather, the relativistic nature of space and time.

  28. jquiggin
    December 23rd, 2008 at 20:45 | #28

    “I find it odd you say Nassim Taleb said the GFC was a black swan. He said no such thing.”

    And I find it odd you say I said Nassim Taleb said the GFC was a black swan. I said no such thing. In fact, clarifying in response to an earlier comment, I said “Taleb predicted a global financial crisis, and didn’t simply claim it in retrospect as an unpredictable Black Swan”

    This post and associated links seem to have elicited some interesting reactions from Taleb fans, which, have, on the whole, confirmed my initial impressions.

  29. December 23rd, 2008 at 22:28 | #29

    Pani Pani’s linking to Taleb’s website with his denunciation of “phonies,” including me at length, is rather amusing. I will simply note that Taleb grossly misrepresents his and my interaction. I read his book and initially liked it and had heard he was having trouble publishing his papers, which looked interesting to me (I am a fan of Mandelbrot). I sent him an email, which he quotes snearingly from, inviting him to submit some papers to JEBO, the journal I edit that John Quiggin once served on the ed board of. In his link, Taleb claims that he is not into “resume polishing” as I supposedly am, although he has published some of his papers in places like American Statistician and the International Journal of Forecasting, acts which are clearly not “resume polishing,” I guess.

    Taleb’s response to my invitation was to send me a form email about how he was too busy to respond to me. OK.

    Some time later I became aware of a study done in 2003 by Oleg Bondarenko that showed how the simple barbell strategy pushed by Taleb in several of his books was a money loser in most years, although I am sure it would have made money this year. I posted on the now-defunct maxspeak about The Black Swan, mostly praising it, but noting this study by Bondarenko, and wisecracking that Taleb would not be able to make money using it, rather he would have to sell his books to do so.

    Within 20 minutes, this guy who was too busy to respond to my polite invitation, sent me an email telling me how I should be careful what I said and that I did not know how he makes money. I then changed the wording in my posting, although I noted that the Bondarenko study would suggest that his firm could have made money by selling the strategy he was pumping to clients, being on the opposite side of the transaction, implying that he was “pumping and dumping” in his books. Taleb then sent me another email threatening to sue me. I posted this in the comments section of my post on maxspeak and accused him of being thin-skinned and hypocritical, which still pretty much looks like the case. I have never heard from him directly since, however he has put up this seriously misleading piece about our interactions on his blog.

    He also dumps on Tyler Cowen. Cowen’s sin? Same as mine, pointing out that the literature showed that the financial strategy hawked by Taleb publicly was a loser, although he may well have made money privately doing other things or fancier versions of it (he hinted at the latter in his second email to me, “I am not so stupid as to buy naked puts,” although he appeared to advise just that to readers).

    Others taken to task in his goofy link include Ken Rogoff for saying he had forecast the recession. His sin? Wearing a bowtie while doing so, I kid you not. Taleb also challenged him on whether he held bank stocks in his portfolio or had shorted any stocks recently. I have no idea whether he did or not, but who cares? Such a phoney that Ken. Can’t trust those chess grandmasters, especially after they start wearing bowties while blathering in public.

    Alan Greenspan and Robert Merton are listed, but no specifics are provided. I might be more inclined to agree with him on them as having some problems.

    Robin Hanson is also dissed for supposedly making fun of a friend of Taleb’s who supposedly showed that economists have a lousy econometric record. I do not know anything about that one, although I know that this friend and Taleb are polishing their resumes by supposedly coediting a special issue on forecasting rare events in the International Journal of Forecasting. I actually wish them good luck on that project.

    Again, as far as I am concerned, the bottom line is that Taleb plays a double game. To the traders he is the philosopher, telling people to accept the black swans and learn to suck it up. To the philosophers, he is the trader who has his own grey swan answer, the barbell strategy or some variation on it, for how to deal with black swans, or at least the darker of the grey swans.

    Oh yes, and I agree with JQ that Taleb did say that the GFC was coming. A lot of us did, even if we did not all have all the details right. Bu then, I don’t think Taleb did either. I do not think anybody did, economist or philosopher or trader or whatever.

  30. radish
    December 24th, 2008 at 07:28 | #30

    Interesting. The “dark matter” analogy is more or less how I learned to love econ, so it’s a little weird to see it out in the wild like this.

    Having gotten all my earlier exposure to complex systems in the biology context, getting interested in econ (especially macro) was like being drugged and dropped into a hall of mirrors. It only really started to make sense when I figured out where the ethological glue — the “dark matter” holding economies together more tightly than what makes ecological (or microeconomic) sense — comes from. Economies are clearly a special case of sociability, where the expectation of reciprocity is nearly universal, but why? The closest non-human equivalent is eusociality, where intraspecific cooperation and reciprocity are categorical (i.e. not based on individual recognition), based on association with the same superorganism and mediated by chemical signals, but circumscribed by instinct.

    Humans have always been social, engaging in individual and categorical reciprocity based on cultural or family ties, mediated by recognition of identity, behavioral cues and so forth. However we’ve also adopted a mechanism (money) which allows reciprocal transactions without any need for either a pre-existing individual relationship, or a categorical (ethnic, genetic, cultural) similarity. We’ve got “trust” signals which are both fungible and reliably transmissible. That realization was the “dark matter” moment for me.

    This single behavioral adaptation — a way to mediate anonymous cooperation — can provide a population with most of the systemic advantages of a superorganism. It displaces the usual requirement that same-species individuals contemplating a cooperative or reciprocal activity exchange categorical signals, or recognize each other individually, or even negotiate a terminal outcome, prior to proceeding directly to the business at hand (whatever that happens to be). The signals required to mediate cooperative activity are profoundly simplified, and — most importantly — do not require any past or future relations. Frighteningly efficient, ecologically speaking. There are other positive side effects too, as well as plenty that are not so hot.

    I keep meaning to write an essay about how swiping more ideas from ecologists (and entomologists) might help with some of the ugly gaps between micro and macro, but haven’t been ambitious enough to actually do it, what with not doing this stuff for a living.

  31. Socrates
    December 24th, 2008 at 07:52 | #31

    Thanks JQ for an excellent post. I confess bias as a modeller of another kind, but hardly think it fair for all those shysters making these deals to blame the modellers, who usually operate under their instructions anyway. They made the deals and took the fees; they should take the blame when it goes bad.

    I think there is some Dark matter too. The market has invented all sorts of instruments designed to avoid normal reporting mechanisms in the past few years. Disssolving reliable and unreliable mortgages into one big pot effectively hid risk. No wonder modellers couldn’t predict a crash exactly. The information on CDOs and CDSs isn’t all reported either as I understand it.

  32. radish
    December 24th, 2008 at 07:53 | #32

    Wouldn’t a real scientific theory of bubbles actually come up with some solid testable predictions, like when they will pop?

    Not really. These are open, stochastic systems — you can “predict” them only in the same sense that you can “predict” the weather. Tomorrow’s weather, yeah, more or less, but you’re guaranteed to be wrong some of the time even with the best models. Next week’s weather, kinda sorta, but you’ll be even wronger even oftener. The limits on the accuracy of your prediction go beyond the quality of your model or the amount of processing power you throw at it.

    Of course you can also focus on statistical inferences from past observations, and only work with events that have some sort of periodicity. But “winter will be colder than summer” is a safe bet only because the “temperature” variable happens to be tightly coupled to a linear, non-chaotic system. Once you start using periodicity your insight into aperiodic events effectively disappears, and you’re stuck playing the turkeys vs butchers game.

  33. Ikonoclast
    December 24th, 2008 at 08:07 | #33

    Radish, your praise of money (as being a “single behavioral adaptation — a way to mediate anonymous cooperation”) is clever but misplaced. Language got there before money.

    Money is a subset of language. Everything money does, language did before money arrived and still does after the advent of money (which is a truism as money is a subset of language). Promises were made and obligations incurred for goods and favours and for these “promissory words” were issued, witnessed by other tribal memebers. Thence followed counting and inscribed records on bark or stone; mathematics also being a subset of language.

    But then maybe the notion that money is a subset of language is intentionally implicit in your exposition, in which case I have only “discovered” what you actually said.

  34. smiths
    December 24th, 2008 at 11:00 | #34

    before even language was trust,

    it is the true lubricant that makes everything, even capitalism possible

  35. MH
    December 24th, 2008 at 11:25 | #35

    JQ I am not convinced the so-called financial risk models actually capture risk except in a narrow fashion by factoring interest rate spreads, stock and asset valuations and currency movements. I am unconvinced that dark matter is adequate when by any reading the same systemic failures present in 1929 have again paradoxically presented themselves, namely:

    (1) The bad distribution of income.
    (2) The bad corporate structure.
    (3) The bad banking structure.
    (4) The dubious state of the foreign balance.
    (5) The poor state of economic intelligence.

    The data shows that income distribution has become increasingly skewed over the past decade in the US and elsewhere (Krugman et al have commented repeatedly), that the Bush administration has effectively opted out of regulatory governance and oversight (anyone care to remember Enron, and there is no other explanation for the Maddoff debacle), the US abandoned effective banking regulation and diluted the regulations allowing the non bank financial institutions to expand exponentially, the US foreign debt and BOP has been getting steadily worse and as Shiller’s long term research shows, rational informed economic or financial decision making is as elusive as ever. Nere was there a better example of poor market intelligence than the glib assurances of the rating agencies collectively.

    I would prefer Prof James Reason’s model to understand the systemic and management failures that led to the GFC and like Reason’s analogy of the holes in the swiss cheese through which undetected or unrecognised failures travel resulting in a ‘crash’ or ‘accident’ so the five criteria outlined by Galbraith, all lined up again to create the GFC. All these factors were within the control of the body politic but the many many failures to achieve international governance mechanisms as globalisation ripped, convieniantly hid this from view. The first and foremost failure though was cognitive, neo-conservatism and its collectivised fantasies of laissez faire, in the end the failure has been moral as well as political, we have allowed a well serving view of discernible truths in the conduct of our affairs to be subverted by the intellectual charade of post-modernism or modern nihilism, which lays the ground work by which we deceive ourselves personally and collectively through the acceptance of spin (Believable Lies or My reality is as acceptable as yours).

    I appreciate Taleb’s popular contribution to probability outliers, or unknown unknown’s, via the Black Swan analogy (his critique of Gaussian Bell Curves is not without merit)but a prescient savant he is not. There is something to Mandlebrot’s fractals (Please no Gary Lammert ravings) just as there is to the laws of thermodynamics, which would suggest we are not in a place of dark matter but simply in where we were bound to end up in any closed system, a place of entropic disorder.

    Merry Xmas to you all.

  36. Jim Birch
    December 24th, 2008 at 12:23 | #36

    radish @33

    There are limits to the predictability of the weather but weather forecasts have been getting progressively better and can be expected to continue to do so for some time yet. More computing power, better numerical methods and better data have to resulted in demonstrably improved forecasts despite theoretical limits. These advances are based on modelling weather as predictable physical process. Small scale randomness takes a fair time to significantly alter the macro scale; better initial data and better models is more of a practical concern for getting a good result.

    It’s possible that randomness may prevent bubble theory from ever working but this is an open question at this stage. Some good models might help.

  37. smiths
    December 24th, 2008 at 13:24 | #37

    some of you lot just cant see the wood for the trees,

    this so called profession of economics kicked itself loose of reality a long time ago and wherever the map didnt seem to describe the terrain the terrain was discarded,

    it came to resemble a fairy tale more and more which is plain;y demonstrated by the fact that everyone described financial wizards and goldilocks economies without a hint of laughter …

    and now a large section of the poster here are talking about more sophisticated models of bubbles,

    sheesh, you’ll all be staring into the glow of the last bubble whilst the next one is forming,

    remember geeks, while your out there studying the last reality, they are out there creating the next one, and they all end the same,

    it may be a lack of some things, and an excess of others, but do not kid yourselves that iit was incompetence or accidental,

    not saving lehman was the foot to throat, and it was calculated and deliberate

  38. Alanna
    December 24th, 2008 at 15:31 | #38


    Politicians are always responsible for the good times and economists are only responsible for the bad times.


  39. Alanna
    December 24th, 2008 at 16:02 | #39

    As a Xmas present? 11 lessons from Samuelson (1974)
    1. Economists cannot forecast the future with any precision.
    2. Neither can anyone else.
    3.Economists succeed in forecasting like each other.
    4. Some economists manage to forecast worse than others.
    5. An automatic computer can forecast better than an official government agency.
    6. Judgmental analysts cannot do without the computer.
    7. Economists can forecast (well almost forecast) everything but prices.
    8. In recent years the US economy has been remarkably unprone to swings of inventory accummulation.
    8. A microeconomic event such as an arab oil boycott can loom large as a macreoconomic depressant.
    9. The conventional wisdom that currency depreciation will improve the balance of payments seems in 1973, at long last, to receive some support from the factual evidence.
    11. Events of at least half a dozen years have shown us how much economics remains an art rather than a science.

    Some things never change?

  40. radish
    December 24th, 2008 at 16:19 | #40

    Money is a subset of language.

    Not sure how many linguists would agree with that, but yeah, okay, works for me. 🙂

    Promises were made and obligations incurred for goods and favours and for these “promissory words” were issued, witnessed by other tribal memebers.

    Ah, but those people already know — and trust — each other. They’ve already done all the economically inefficient signaling and negotiating necessary to build trust and stabilize relationships. That trust is what lets Alice march into her friend Bob’s store and promise him that if he gives her a rib roast and a gallon of milk, their mutual friend Charlie will at some point give him a pack of cigarettes and her sister Dora will fix him up with 5 gallons of gas.

    But that doesn’t work between parties who don’t trust each other, and anyway all that promissory bookkeeping gets out of hand long before any serious industry can get going, which means it doesn’t scale.

    There are plenty of ways humans (and other animals) confirm and expand and consolidate trust circles, but what’s different about money is that it short-circuits the need for pre-existing relationships altogether. Alice and Bob and Charlie and Dora don’t even have to have met before, let alone trust each other. They just have to agree on currency.

    We tend to overlook how adaptive and efficient and unusual this is because we’re so used to it. But without this substitute for trust, the kind of anonymous markets and large industrial societies we take for granted couldn’t exist.

  41. radish
    December 24th, 2008 at 16:26 | #41

    better initial data and better models is more of a practical concern for getting a good result.

    I wouldn’t dispute this as such, but as long as we’re analogizing to physics I would argue that the “better initial data” problem is a little bit like the “accelerating mass to the speed of light” problem. Not a big deal in theory, but awfully energy intensive once you actually try it. You can get close, for some definitions of close, but the closer you get the harder it gets to get any closer.

  42. nanks
    December 24th, 2008 at 16:57 | #42

    @ radish et al – aside from prediction it might be of value to understand the current system dynamics and how to push them somewhere more desirable. That’s a different approach, but perhaps not so useful to people wanting to exploit markets for personal gain.

  43. GreekAmongRomans
    December 24th, 2008 at 17:35 | #43

    [email protected]
    “Alice and Bob and Charlie and Dora don’t even have to have met before, let alone trust each other. They just have to agree on currency.”

    Ah.., but they have merely replaced one trust framework for another. That is, a trust network has been replaced by a trust hierarchy. The root of the trust hierarchy becomes the authority of the state, to which Alice, Bob, Charlie and Dora have accepted as the established and trusted authority. The other actor, save Alice, Bob, Charlie and Dora is the state.

  44. Russell
    December 25th, 2008 at 00:28 | #44

    Barkley Rosser, wrote (of Taleb):

    “…in more years than not the barbell strategy described in his book lost money…”

    That’s dumb – so what if the barbell strategy loses money more years than not? If I lose £5 every year for 10 years, and then in the eleventh year (using the same strategy) make £5000000 – is it a bad strategy?

  45. December 25th, 2008 at 01:06 | #45

    All depends on how deep your pockets are, how long you can play the game, and exactly how you do it, as Taleb himself notes, there all sorts of variations on it besides “being so stupid as to buy naked puts.”

  46. radish
    December 25th, 2008 at 05:15 | #46

    Ah.., but they have merely replaced one trust framework for another.

    Exactly. And it turns out to be a big win, corresponding to the difference in efficiency between barter/gift economies and money-based economies. In this new framework people can cooperate today without having to calculate the present value of future reciprocity from the particular individual with whom they are cooperating. They don’t have to calculate the value of each promissory note separately.

    There’s a minimum amount of friction that can never go away, but “do I trust Alice to fork over the cash when I hand her the groceries” causes a lot less friction than “do I trust Alice to speak for Charlie and Dora without consulting them, and do I also trust Charlie to fork over the smokes in a couple of weeks, and do I also trust Dora to fork over the gas tomorrow, and… hey wait a minute, I don’t even smoke!”

    That is, a trust network has been replaced by a trust hierarchy.

    Hmmm. For purposes of this particular theory having a mappable hierarchy negates the “Big Win” mentioned above. What you need is a complete abstraction. The trust that we care about is the trust each agent has for “any other user of any of the same currencies that I use.” It has to be vague, otherwise it wouldn’t apply to spontaneous currencies, or parallel currencies, or deflation, or any of a half dozen other things that happen in real life. The only thing the theory tries to explain is how it’s possible, in modern economies, for such an enormous amount of trust to exist in the absence of any prior relations.

    Again, this is the trust that would ordinarily be required in order for Bob to believe Alice’s promise that Charlie and Dora will indirectly reciprocate his generosity toward Alice. Only multiplied by hundreds, then thousands, then millions. To a biologist all this spontaneous indirect forward reciprocity — between unrelated same-species entities no less! — is absolutely infuriating and inexplicable. Ants and bees do it, sure. They’re wired to do it. But humans? There has to be some explanation.

    The theory is ultimately a theory about reliable signaling, so it’s definitely sensitive to problems like counterfeiting and Gresham’s law and commodity backing and so forth. But it does not require a single locus of trust, and it definitely doesn’t require that locus of trust to have a monopoly on the use of force.

  47. December 26th, 2008 at 00:30 | #47

    Something else to keep in mind is that we are dealing with markets. One of the reasons the barbell strategy did so poorly for so many years was that so many people were trying to do it. Lots of people wanted “tail insurance,” so its price was too high. Those selling it were the ones making the money. A world in which everybody tries to follow Taleb’s supposed strategy becomes absurd. For one thing, economic growth will halt because no one will invest in all those intermediate risk activities between government securities and puts on major crashes. Making money is always a minority game, being one step ahead of the herd, or in the terminology of Keynes’s beauty contest, operating at one level higher than the others (guessing the average guess about the average guess of the others, at whatever level).

  48. GreekAmongRomans
    December 26th, 2008 at 19:21 | #48

    “Exactly. And it turns out to be a big win, corresponding to the difference in efficiency between barter/gift economies and money-based economies.”

    I don’t think anyone disagrees with the premise that by replacing a barter/gift system with a monetary system engenders a far more efficient system of commerce. That, in it’s self, is self evident.

    “Hmmm. For purposes of this particular theory having a mappable hierarchy negates the “Big Win” mentioned above.”

    Whether it negates the “Big Win” or not that is what has occurred. The introduction of a monetary system, which you refer to as currency, has only ever been established under an organised society, in which dynamics of a societal structure begin to exhibit themselves. One such dynamic is the establishment of an entity being the state. The state establishes numerous organs, the purpose of which are to ensure the stability and continued existence of the state.

    “But it does not require a single locus of trust, and it definitely doesn’t require that locus of trust to have a monopoly on the use of force.”

    Of course it does, the single locus of trust is the state. The fiat monetary system, which most developed societies utilise, does exactly that. A fiat monetary system is by state decree, and through the states legal organ, it enforces this decree.

    With a fiat monetary system, peer-to-peer trust no longer needs to exist, save the doctrine caveat emptor, which still applies, irrespective of the trading system, be it a barter or monetary system. Rather, trust has been handed over to the state, which performs a silent role of intermediation, via it’s fiat monetary system, in which both peers trust. Thus, the framework has been transferred from peer-to-peer to peer-to-state-to-peer.

  49. radish
    December 27th, 2008 at 17:12 | #49

    Of course it does, the single locus of trust is the state.

    Nuh-uh. Although that’s obviously what agents of the state would have you believe. 😉 It’s certainly possible for all the agents using a monetary system to share a single locus of trust, and even for that locus of trust to be the state. But the whole point is that it can’t be necessary, because people are constantly using money that wasn’t issued by a state they personally trust.

    I think you’re interpreting what I’m saying as being way broader than it really is. All I’m really offering is a theory to explain an awkward discrepancy between economics — especially macroeconomics — and behavioral ecology. The discrepancy becomes visible when a large and heterogenous population of agents behave as if a particular kind of signal (money) is orders of magnitude more reliable (aka trustworthy) than what makes any sense for them as individuals.

    These populations can cooperate with an efficiency and consistency that’s practically unheard of outside of the very homogenous populations in order hymenoptera. They engage in this categorical reciprocity even when they can barely speak to each other, or are citizens or subjects of different states, and even when they are otherwise hostile. Thus the “dark matter” analogy.

    If you knew about markets where everybody agreed to ignore obvious opportunities for a certain kind of arbitrage, for an extended period of time, you’d be puzzled, right? You’d want an explanation. Anonymous reciprocity is like that. It looks like it violates the rules, ecologically speaking (even though it doesn’t, really), so it demands explanation.

  50. GreekAmongRomans
    December 28th, 2008 at 11:47 | #50

    I don’t think so.

    “Although that’s obviously what agents of the state would have you believe.”

    If you are inferring to illegal or black market activities, I doubt that constitutes the majority of economic activity within an established society.

    “But the whole point is that it can’t be necessary, because people are constantly using money that wasn’t issued by a state they personally trust. ”

    Which money is that, which “people are constantly using that wasn’t issued by a state they personally trust”? Please elucidate your position.

    “Anonymous reciprocity is like that.”

    Ah…, but it is anonymous reciprocity within the context of the legal framework established by the state. Further, I don’t really see the connection between market arbitrage and anonymous reciprocity, please elucidate.

    In times where a society morphs into a dysfunctional state or completely collapses, the economic agents revert to a barter system or to a commodity that exhibits the fungible properties of money, for instance gold.

    radish, I actually welcome this discussion :-), although I do wonder, whether we in science often attempt to explain observations in one area of human endeavor with observations in an other that might not be all that relevant. That is not to say, one should not explore such possibilities, but rather be aware of the limitations of such a pursuit. I think the following passage by Taleb might be really worth some consideration– “I urge all you scientists to go take your “science” where it may work—and leave us in the real world without more problems. Please, please, enough of this “science”. We have enough problems without you.”

  51. radish
    December 28th, 2008 at 18:53 | #51

    Well I guess since our host hasn’t yet kicked us out for abusing his comment section…

    Which money is that, which “people are constantly using that wasn’t issued by a state they personally trust”?

    How about US dollars. My position is that an agent’s confidence in the negotiability of dollars does not necessarily depend on the US enforcing legal tender laws, nor did it depend on the agent associating any material utility with the commodity which backed dollars back when dollars were backed by metals. Rather, it has, in general, mostly to do with the agent’s observations about how many other agents are willing to accept dollars today.

    Other than mentioning that I personally don’t trust the US to have a sane monetary policy, I’m not sure how to support this position without doing some rather labor intensive research, the marginal utility of which would be low for me personally. And since nobody has offered to pay me for it, I hereby decline to do it.

    Further, I don’t really see the connection between market arbitrage and anonymous reciprocity, please elucidate.

    It’s not that anonymous reciprocity creates opportunities for arbitrage, it’s that anonymous reciprocity is an unexpected behavior, just as failure to exploit arbitrage is an unexpected behavior. Why that particular behavior is unexpected is a bit complicated, so again, apologies for length.

    Money is a form of information, fundamentally a signaling medium. But agents who use money have a pronounced tendancy to treat these signals as reliable, sort of as though they had inherent material utility, or could only be sent at high cost. I believe this is one of the things that’s made economics into a somewhat schizophrenic discipline. 😉 Anyway, it’s puzzling, because it’s extremely rare elsewhere in nature, and occurs only under very specific circumstances.

    One way explain this is essentially what Ikonoclast suggested. That money is simply a special case of language. We can coordinate reciprocity because we can talk about the future. We can make promises. While this is true as far as it goes, it doesn’t explain why we believe the promises of strangers when they speak with money but not when they speak in other languages.

    More technically, it doesn’t explain how reciprocity signals can be homogenous and universal when identity signals are heterogenous and highly differentiated. For trivial cases, or if you just don’t look too closely, this might not seem like a deal-killer, because there are indeed some “universal” signals associated with reciprocity and trust among humans. Smiling, frex, can trigger forward reciprocity. What it can’t do get you to work umpty hours a week for years on end for someone whom you hate with a passion.

    Ants and bees are also creatures using intraspecific signals which are strong reciprocity triggers, but those are associated with very strong, very homogenous, identity signals. At the end of the day, forward reciprocity ordinarily requires a lot of very strong identity signaling to be in place, in humans, and in all the other creatures which engage in it. The exception being the use of money, which seems to fuction as an identity signal in and of itself. That’s the puzzle. If you really want a decent model this discrepancy has to be dealt with.

    So. Humans have acquired this strictly behavioral adaptation which enables them to engage in lots of forward reciprocity without the perceived risk of having it turn into altruism. They have, somehow, done away with the otherwise consistent requirement for a reliable identity signal, and replaced it with… what?

    You say trust in the state. I say that doesn’t explain the edge cases, and it wouldn’t be strong enough even if it did. The state can coerce people to cooperate with it. It can even discourage them from certain behaviors. What it cannot do is coerce them into cooperating with each other.

    I urge all you scientists to go take your “science” where it may work—and leave us in the real world without more problems.

    It’s funny you should mention that because I just saw that a few days ago, and found it very amusing to see a mathematician/philosopher and sometime quant guy rant about science being detached from the “real” world. I respect Taleb’s opinions a great deal in general, but I have to agree with the folks who say that he doesn’t seem particularly interested in anybody else’s opinions, or in phase changes that aren’t abrupt and dramatic. There are quite a lot of interesting things that Taleb doesn’t seem to like talking about.

    Doug Rushkoff’s comment however, is one that I can endorse wholeheartedly and without reservation, and which I bookmarked when I saw it.

  52. December 29th, 2008 at 07:49 | #52

    For the record, since posting here my long comment about my history with Taleb, I went back and looked at TBS and found that I had misrepresented his barbell strategy, which calls for more generalized “speculative bets” rather than just puts on major crashes. I have posted on econospeak a public apology to him, with a more extended discussion “under the fold.”

  53. GreekAmongRomans
    December 29th, 2008 at 22:49 | #53


    “Well I guess since our host hasn’t yet kicked us out for abusing his comment section…”

    This will be my final post on this matter. I will respectfully agree to disagree with you on some of your analysis. 😛

    “How about US dollars. My position is that an agent’s confidence in the negotiability of dollars does not necessarily depend on the US enforcing legal tender laws, nor did it depend on the agent associating any material utility with the commodity which backed dollars back when dollars were backed by metals.”

    The US dollar is a fiat currency. It obtains it’s unique perceived value from the US govt. decree, declaring it as the legal tender of the state of the US. Moreover, the state has the ability to pronounce this decree through it’s unique position and the power of authority bestowed on it by, either the majority of the citizenry of the state, or by force.

    The economic agents of the state have faith in the US govt. to ensure that the US dollar or US dollar denominated financial instruments are accepted as legal tender in commerce.

    The states function is to establish and maintain an environment that ensures the above, and that intrinsic properties of money [1] are established and maintained. If the state fails in it’s essential role to achieve this, then the economic agents will eventually cease to consider this as a form of money, but rather just a piece of printed art work, and nothing more. If the fiat money ceases to serve it’s role in effectively providing the essential characteristics of a efficient mechanism of exchange, then the economic agent will seek substitutes.

    This circumstance may precipitate for many reasons, a few being, if the economic agents loose faith in the US govt. due to it’s poor economic management, or the continued debasement of the currency by the state, or the loss of authority of the state over it’s citizens.

    In any case, the state is an essential actor in the establishment and maintenance of stability in all its forms. From this stability further dynamics manifest themselves that facilitate sophisticated economic pursuits.

    “You say trust in the state. I say that doesn’t explain the edge cases, and it wouldn’t be strong enough even if it did. The state can coerce people to cooperate with it. It can even discourage them from certain behaviors. What it cannot do is coerce them into cooperating with each other.”

    It doesn’t need to coerce them to cooperate. The economic agents will on their own recognise the benefits and accept to use this form of money as a efficient means to facilitate the activity of commerce, with the premise that the this form of money truly does serve that role.

    What I am suggesting is the immensely import property, called trust, and all that which precipitates from it, such as, confidence, integrity, faith et cetera. These properties precipitate further derivatives, such as future reciprocity. The framework which allows for these properties to establish themselves in a sophisticated society is through the essential role that the state plays in establishing a society that has stability and longevity. Without the state, it is difficult to perceive that such sophistication could ever be achieved.

    [1] – These intrinsic properties that any form of money is required to fulfill are:

    1. a store of value.
    2. a unit of account.
    3. a medium of exchange.

  54. Alanna
    December 30th, 2008 at 10:44 | #54

    According to Galbraith, Veblen and others there is an additional function of money
    “an enormous number of people want money for its own sake, for the self gratification and self assurance its successful pursuit and possession give them”

  55. Nick K
    December 30th, 2008 at 22:14 | #55

    When it comes to making predictions, there are a few points to keep in mind. One is that if people make enough predictions, it is almost certain that some of them will turn out to be correct. The other is that if one predicts doom frequently enough, it is likely that eventually one will be proved correct. I have spoken to people who have been confidently predicting the imminent collapse of the Aus housing market since the late 1990s. I guess they had to be correct sooner or later.

    Even dart-throwing monkeys are right a significant proportion of the time.

    Therefore, all that really counts is whether an individual has a relatively high average success rate of predicting events. Not whether an individual is right on one prediction.

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