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NEW ENGLAND COMPLEX SYSTEMS
INSTITUTE presented by |
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| Video Commentary | The links in the left column will bring up a relevant video from Dean LeBaron's daily video commentary. The complete archives are available at his website: http://www.deanlebaron.com. |
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| FORECASTING 4/21/98 |
We are puzzled by global economics. Forecasts are universally disparaged for this most dismal of sciences, so much so that many refuse to call it a science and, instead, attach the black art label, with heavy reliance on promotion. Yet we are accustomed to aggregate growth achievements, around the world, on the order of 2% or so. So something must be happening right…or so we thought until a few years ago. |
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| EMERGING
MARKETS 8/28/98 |
Things started to unravel and unravel big time. The precepts which lead the Asian tigers to prominence selected them to have the first troubles, first with their financial structures and then with their economies. And there was no warning. Even now most of us still don't know what happened. | |
| RUSSIA
EVENTS 3/26/98 JAPAN BASHING 7/14/98 |
And it spread to Russia, threatened Latin America. Meanwhile Japan, the number two economy in the world, slid into a recession/depression from which it seems powerless to recover. | |
| BIG
ISSUES 4/29/98 |
The US remained almost immune…until April when its 16-year equity bull market gave its most vigorous signal yet that all was not well, with the average stock declining since then by about 50%. And the US seemed to recognize, slowly, that it could not be "an island of prosperity in a sea of depression." | |
| FORECASTING
GOOFS 5/4/98 |
Old ideas are only abandoned when they have been proven faulty, and surely the old economic premises have given a resounding signal that they are no good. We can do no harm by accepting the challenge to use complexity to find new ones. | |
| And so I propose to select the ten principal issues I believe
will help us understand the global economic environment. For each of these, there will be
the conventional, structural, linear analysis leading us to prescriptions for solutions.
And I shall propose, for each, a complexity-grounded suggestion, often with a model,
leading us to quite another choice. And leave it to you to determine, in the end, if complexity has anything to offer in building models of this economy and policy proposals which can be studied in detail and, if convincing, be implemented. |
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| IMF
BASHING 10/8/98 |
1. Issue: Can the institutions established by
the 1944 Bretton Woods convention, IMF and World Bank, determine who gets assistance or
not? Conventional: Tight monetary policy, balanced budgets, low inflation will attract capital and build up supply, often export goods. Seven volumes essentially the same. Sound financial policy will lead to economic growth. |
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| CHINA 2/24/98 |
Complex: Growth can come in many forms. Internal demand (China and Eastern Europe). Export (Japan and Tigers). Economies are not necessarily homogeneous. They can shift from one state to another as in a social system for agrarian (like the US adopting emergency agricultural subsidies this year) to ignoring Glass-Steagall. There is an idea on the part of developing countries that prescribed behavior—democracy, human rights (what is that?), environmental concerns—will lead to cheap, long-term money. | |
| FREE TRADE 4/17/98 CUBA 4/23/98 |
It is quite possible that the advice of the postwar period for development of war-ravaged areas was good for the early days of developing markets, coupled with large amounts of money when none other was available. But it may be that growth, at whatever cost, is more necessary. And postwar Japan, under General MacArthur, and Chile were hardly paragons of democratic virtue. The advice prescription from complexity is to adapt to the times and not have a rigid set of rules in seven notebooks. | |
| 2. Issue: Is long term less risky than short
term? Conventional: Regression to the mean. Wait long enough and economic balance returns. Economics of equilibrium. Long-term capital credit. Look for small historic anomalies, with confidence add leverage, and wait for market to rebalance itself. (OK with infinite amount of money, not with loans.) These were common tenets of today's modern capital theory and application. |
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| TIME 6/9/98 |
Complexity: Time is discreet, not continuous (as in Bob Merton's book). Information comes in bursts to the market and all time is not equal on the x-axis of a two-axis plot. Backtesting tells you little if you are careful. Most financial people follow the dictum of statistics "if you torture the data long enough, it will confess to anything." Economics of increasing or decreasing returns. Momentum and expectations may create their own trends (Soros' reflexivity). | |
| PERSPECTIVE 6/22/98 |
3. Diversification is a good… Conventional: If risk (volatility) is equivalent to return and we know how to increase risk, all we have to do is mix assets that are uncorrelated to increase aggregate (portfolio) return and reduce risk. Alphas, betas and R-squared are part of the friendly analyst lexicon. Close to the means, these measures seem to be quite stationary over the time periods we have studied them. |
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| CAUSALITY 6/2/98 |
Complexity: Past correlation tells us little about "stress" times. The factors that determine values are non-stationary and combine in different ways. Evolutionary history of markets is unlikely to combine in the same way each time. And when they part, the results may appear chaotic. | |
| CONNECTIVITY 5/22/98 |
4. Globalization is a benefit to all
participants Conventional: Free economics lets each specialize in their best skills to the combined benefit of all. Money will flow to the highest and best return per unit of risk and continuously stay close to balance. Without barriers there are no massive dislocations except in the most exceptional exogenous events. |
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| MONEY
TECHNOLOGY 4/16/98 |
But if globalization, free flow of goods and money do not work, bring institutions to work for stimulus, bailouts usually at the financial sectors of the affected economy because that is where the trouble started. RTC, international currency agreements, Japanese banks. | |
| YEAR
2K 3/11/98 |
Complexity: Doubtful policy makers can determine when to flow and when to curb. But it may be necessary to put barriers around a system in trouble to see it does not contaminate. (We may be this with Y2K systems next year…only hook to those that are Y2K compliant.) | |
| SAFETY
VALVES 6/29/98 |
Have to have the system "punish" itself by selecting its own victims. | |
| 5. Economic model construction Conventional: Conventional: Most models are simple, historic, static and have two variables. Most have face validity with end period dominance. Most consensus models are proven useless or wrong. Models are developed by history and may be quite sophisticated but depend upon the assumption that the past is the prolog of the future and all info is captured by the model period and no simplifying assumptions are predetermining the outcomes. These models are generally static, contain few variables selected by face validity and are often unstable in different market environments. Investment stat is rather crude. |
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| SIMULATIONS 3/3/98 |
Complexity: Forward testing. Simulations (…Bob Monks on Russian corporate governance…Brightline). Understand how the assumptions selected by the modeler will determine outcomes…Heisenberg. | |
| FOREIGN
EXCHANGE MARKETS 4/14/98 |
6. Central banks can regulate capital flows Conventional: Belief in the US that Fed sets interest rates and, through monetary policy, can influence level of business and interest rates. Fed is all knowing. Fed chairman is most powerful person in US. Forex trading is about 1.5 trillion. Fed might trade 10-20 billion a day, hardly significant. A kiddy car on the Mercedes autobahn. Complexity: Capital flows are so large they have to be set by the markets. Markets act best when they have good info…purpose of the Fed is disclosure to the agents not secrecy. |
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| INTERVENTION 6/18/98 |
7. Bailouts Conventional: Leave system alone until it is in trouble. Then rescue…Mexico, hedge funds, RTC. Complexity: We tinker with the system to our peril. The system needs to have an automatic destructive cleansing. And the bailout gives markets a message of tempered risk. Attempts to have a positively skewed payoff pattern often results in unintended consequences. |
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| MARKET STRUCTURE 5/1/98 | 8. Insider info Conventional: Keep market fair by preventing insiders from trading during corporate blackout periods and make government officials use blind trusts. Complexity: Encourage insiders to get their info priced into the market by trading…perhaps revealing their insider status but not the insider identity. Companies could use posted FAQ's for continuous offerings. |
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| DEFLATION 2/18/98 THE BULL CASE 6/4/98 |
9. Importance of level of inflation Conventional: Low single digit inflation is a good even though it may be a path on the way to deflation. Figures are believed although revisions are the norm. Complexity: Adaptable to a range of alternatives, not a single point. And expect that a number reflects some plus and minus. Prepared for leaps and surprises as the norm. Measurement lags…hindsight based. |
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| MICROSOFT
& THE US 5/7/98 |
10. Risk free Conventional: Interest on US treasuries is the risk-free rate in all calculations. It is easily measured and usually reported to four decimal places. At the moment its real rate seems rather high. Quality preference is highest per unit of government yield and has been increasing for four years. Complexity: Perhaps risk-free is the riskiest. US is the biggest borrower in the world and is only perceived as credit worthy because others give us their money to hold. How stable is this perception? |
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| MEASUREMENT 6/8/98 |
(and for a "Baker's Ten") 11. Performance measurement…globally, of companies and managers Conventional: All historical and all short-term. If you improve the quality of the numbers you improve the quality of the results. Complexity: Of historic interest only. Forms a basis of discussion. |
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| PROBLEMS 5/18/98 |
Despite the work and the money spent in studying global economics, we know very little. Largely we are studying old, outmoded precepts. When we incorporate the principles of complexity we have a chance, just a chance, to understand this adaptive world better. | |
| We know that systems often adapt best at the edge of chaos
but to do so they need better disclosure to the agents and minimal barriers to
propagation. It is our job to encourage policy makers to risk new approaches in improving fitness to the landscapes surrounding us…and of which we are essential and active agents. We can be applying our complexity work in biology, physics and other fields to policy prescriptions. |
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