The state of the economy

We’ve heard all the politicians bulls**tting about the US economy. I believe little of what they say. After all, isn’t the litmus test for whether a politician is lying to see whether his or her lips are moving?

I’ve been struck by four fairly powerful analyses in recent days, all received through various e-mails. I thought you might be interested. I recommend all of them very highly. I don’t agree with everything they say, but they certainly made me think!

First, a tip o’ the hat to the Mad Rocket Scientist, who drew my attention to an excellent article in Wired entitled ‘Recipe For Disaster: The Formula That Killed Wall Street‘. It’s staggering in its implications – not least of which is the crass stupidity of the economists and bankers who relied on such a faulty model! An excerpt:

A year ago, it was hardly unthinkable that a math wizard like David X. Li might someday earn a Nobel Prize. After all, financial economists—even Wall Street quants—have received the Nobel in economics before, and Li’s work on measuring risk has had more impact, more quickly, than previous Nobel Prize-winning contributions to the field. Today, though, as dazed bankers, politicians, regulators, and investors survey the wreckage of the biggest financial meltdown since the Great Depression, Li is probably thankful he still has a job in finance at all. Not that his achievement should be dismissed. He took a notoriously tough nut—determining correlation, or how seemingly disparate events are related—and cracked it wide open with a simple and elegant mathematical formula, one that would become ubiquitous in finance worldwide.

For five years, Li’s formula, known as a Gaussian copula function, looked like an unambiguously positive breakthrough, a piece of financial technology that allowed hugely complex risks to be modeled with more ease and accuracy than ever before. With his brilliant spark of mathematical legerdemain, Li made it possible for traders to sell vast quantities of new securities, expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond investors and Wall Street banks to ratings agencies and regulators. And it became so deeply entrenched—and was making people so much money—that warnings about its limitations were largely ignored.

Then the model fell apart. Cracks started appearing early on, when financial markets began behaving in ways that users of Li’s formula hadn’t expected. The cracks became full-fledged canyons in 2008—when ruptures in the financial system’s foundation swallowed up trillions of dollars and put the survival of the global banking system in serious peril.

David X. Li, it’s safe to say, won’t be getting that Nobel anytime soon. One result of the collapse has been the end of financial economics as something to be celebrated rather than feared. And Li’s Gaussian copula formula will go down in history as instrumental in causing the unfathomable losses that brought the world financial system to its knees.

Very thought-provoking indeed. Go read the whole thing.

The second analysis is a video posted on Snotr, which makes a pretty good effort at explaining the ‘credit crunch’ in layman’s terms – and in only 11 minutes. I found it very informative. Here it is.

The third source is an article in Information Clearing House entitled ‘How The US Economy Was Lost‘. I must state up front that I don’t agree with all the author’s premises. For example, he’s very strongly anti-free-trade, whereas I can see the sense in it to at least some extent. Protectionism has ruined just as many economies as has free trade. Nevertheless, his perspective on the loss of US jobs and what it’s done to our economy overall is very telling. An excerpt:

The proverbial hit the fan when Soviet, Chinese, and Indian socialism collapsed around 1990, to be followed shortly thereafter by the rise of the high speed Internet. Suddenly, American and other first world corporations discovered that a massive supply of foreign labor was available at practically free wages.

To get Wall Street analysts and shareholder advocacy groups off their backs, and to boost shareholder returns and management bonuses, American corporations began moving their production for American markets offshore. Products that were made in Peoria are now made in China.

As offshoring spread, American cities and states lost tax base, and families and communities lost jobs. The replacement jobs, such as selling the offshored products at Wal-Mart, brought home less pay.

“Free market economists” covered up the damage done to the US economy by preaching a New Economy based on services and innovation. But it wasn’t long before corporations discovered that the high speed Internet let them offshore a wide range of professional service jobs. In America, the hardest hit have been software engineers and information technology (IT) workers.

The American corporations quickly learned that by declaring “shortages” of skilled Americans, they could get from Congress H-1b work visas for lower paid foreigners with whom to replace their American work force. Many US corporations are known for forcing their US employees to train their foreign replacements in exchange for severance pay.

Chasing after shareholder return and “performance bonuses,” US corporations deserted their American workforce. The consequences can be seen everywhere. The loss of tax base has threatened the municipal bonds of cities and states and reduced the wealth of individuals who purchased the bonds. The lost jobs with good pay resulted in the expansion of consumer debt in order to maintain consumption. As the offshored goods and services are brought back to America to sell, the US trade deficit has exploded to unimaginable heights, calling into question the US dollar as reserve currency and America’s ability to finance its trade deficit.

. . .

The pressure of jobs offshoring, together with massive imports, has destroyed the economic prospects for all Americans, except the CEOs who receive “performance” bonuses for moving American jobs offshore or giving them to H-1b work visa holders. Lowly paid offshored employees, together with H-1b visas, have curtailed employment for older and more experienced American workers. Older workers traditionally receive higher pay. However, when the determining factor is minimizing labor costs for the sake of shareholder returns and management bonuses, older workers are unaffordable. Doing a good job, providing a good service, is no longer the corporation’s function. Instead, the goal is to minimize labor costs at all cost.

Thus, “free trade” has also destroyed the employment prospects of older workers. Forced out of their careers, they seek employment as shelf stockers for Wal-Mart.

Again, thought-provoking stuff. Go RTWT.

Finally, at this year’s TED (Technology, Entertainment, Design) Conference, Juan Enriquez delivered an 18-minute talk that really blew my mind. I most strongly recommend that you make time to view the whole thing. When you look at his take on where we’ve come from, and where we’re going to, you’ll question most aspects of your future. Very, very powerful stuff.

I hope you’ve found these four insights useful. They’ve certainly opened my eyes.

Peter