jim.shamlin.com

9: Saving Capitalism from Itself

The author is "amused" that economic doctrines find their strongest supporters in academia, which his by definition a nonprofit enterprise in which professors protected by tenured appointments argue the merits of systems in which they have no participation. "They would not last five minutes on a trading floor."

(EN: this is an ad-hominem attack based on generalizations, but not without some merit. While the counterpoint is that many college professors in business departments are retired professionals, experienced consultants, or adjunct faculty who teach part-time while continuing to work full time, there are distressingly many career academics who have either failed or simply not tried to hold a real job. But this criticism applies equally to those whose theories the author accepts.)

The author concedes that capitalism and the market economy are "far better than any other economic system ever invented" insofar as the production, distribution, and trade of goods - but when it comes to financial markets, it has been deemed necessary to impose restraints on free exchange. And in that regard, the author feels that it is necessary to take care in the reconstruction of markets such that the benefits of capitalism are not lost, but its risks are mitigated.

As such, the author intends to use the present chapter to discuss some of the central ideas and general principles he feels will be critical to reforming the world economy.

Internal checks, balances, and watchdogs

Free markets work as they are alleged, though over a very long period of time. During the short term, there can be considerable variances that do grievous harm - and the goal of regulation should be geared toward mitigating this short-term effect without restricting its long-term growth.

This regulation cannot come from within the industry. Left to their own devices, the managers of the banking industry would have been skittish of the risk of excessive lending and put the brakes on, or their shareholders would have required them to do so. But this failed to happen. (EN: This seems to assume, or pointedly ignore, that the problem began when government felt banks were being too tight with credit and put in place legislation to encourage, and sometimes force, them to do so.)

Had they reacted on their own, the author speculates that they would have done so "with a vengeance," restricting credit to the point where the economy would be paralyzed, and putting in place procedural measures that would make the market sluggish and illiquid.

Given that the financial institutions are prone to overacting - not to mention that the financial press upon which citizens and shareholders rely for insight was asleep at the wheel (or worse, cheering on the villains) - it seems unlikely that the system of the private watchdogs can be counted upon to perform their proper functions.

The do-nothing option

There is a good argument for leaving the market alone and allowing it to return to equilibrium on its own. Given that the next few years hold significant danger of overregulation, as politicians beset by their supporters to do something often leads them to do something awful.

Moreover, what we presently see in the US and UK is regulators clamping down on firms and institutions that were bystanders to the crisis. Governments are broadening their reach into hedge funds and private equity businesses, rather than addressing the principle agents of the crisis: banks, which were already "thoroughly but incompetently regulated."

Even so, extra restrictions on financial markets seem necessary for two reasons:

First, while they may have been bystanders to the crisis, all firms are affected by it. The idea that they can carry on as before while the rest of the industry is being regulated is unthinkable. The solution to the problem must be undertaken by administering to the system as a whole, not merely the afflicted organs.

Second, it's likely that there will be aftershocks during the period of reform - and while certain institutions were able to weather the initial round, many are left in a weakened state and are vulnerable should there be a second collapse.

As such, action by government regulators is necessary throughout the system - in may focus on regulation of banks and financial institutions, but it must consider the economy as a whole in order to effect a lasting resolution.

The shape of banking regulation

The banking system was only part of what caused the Great Implosion: another significant factor was a failure of regulation. And in the wake of the crisis, more regulation is applied. The aim of regulation should not merely be more control, but more intelligent control, which may require less rather than more.

But before getting to specific suggestions for regulation, the author wishes to explore four areas where regulation is necessary because the market, even if it works efficiently, will not produce an outcome that will generate stability.

Reforming capital requirements

The free-market approach leaves banks to decide what is in the best interests of the firm and its shareholders, but the author suggests it should not be so. Banks are important to the entire system, such that the failure of a bank does not merely impact its shareholders, but its depositors, and the failure of multiple banks causes an illiquidity that is detrimental to the entire market.

Primarily, there is the problem of myopia: bank executives tend to underestimate the amount of capital they need to maintain - left to its own devices, a bank will hold as little capital as possible. When a bank fails, the state must ultimately provide protection, and as such it seems reasonable for the state to exercise some control to protect the public interest.

The main method for the state to control banks is to set a minimum capital requirement that is more cautious than a bank might choose for itself. Further, this requirement will vary over time according to the need for capital in the market. The goal should be that the bank should maintain sufficient capital reserves to withstand a "a normal recession" without the need for an injection of capital.

Imposing liquidity requirements

The situation with liquidity is similar. Under their own governance, banks will tend to hold fewer liquid assets because they generate a lower return, and can even generate a loss for their failure to produce revenue. Not only will a bank seek to have as much capital "working" as possible, seeking the greatest return on its investments lead it to less liquid options.

The interbank market was the mechanism that would enable banks to lend among themselves, such that a bank with frozen assets could obtain a temporary reserve of liquid assets from another bank: but in the present crisis, the interbank market failed.

One suggested defense against the unreliability of interbank funding is to compel banks to rely on their own deposits. Taken to the extreme, this would utterly end interbank loans. This is not desirable, as there would be a considerable loss of efficiency.

A better defense is for banks to attract long-term money, which also seems reasonable but puts banks at considerable risk when they have contracted to pay a higher rate for long-term deposits than they can demand for short-term loans. It is opposite to the operational strategy of most banks, which is to borrow short-term and loan for long-term.

The solution that most banks use, and should likely continue to use, is to hold a significant amount of liquid assets, or assets that can be liquefied very quickly, in the form of marketable government debt.

Public regulation of remuneration structures

The idea of the state dictating compensation in private industry is utterly ridiculous. The supply and demand of labor sets its price in the market, and while there are variances and deviations, "capitalism's natural recuperative process" will ensure that these variances will not be long-lived.

Nevertheless, because of the recent crisis (particularly in banking executives receiving enormous bonuses as their firms were failing) has led to a public outcry for justice against the executives of the banking industry.

(EN: Pause here to consider this is more in the nature of vengeance than justice, and moreover it is visited upon a class of people - executives in general - rather than those specific individuals whose misconduct elicited the outrage. That is, compensation restrictions are inflicted on the next generation of leaders who are replacing those who were unjustly rewarded in the past.)

Even though government interference in matters of pay cannot be advocated, there is nonetheless need for greater scrutiny of pay structures, such that depositors and shareholders, at the very least, are aware not only of the salary and bonuses, but of the conditions under which pay incentives are granted, to consider what sort of behavior is being encouraged.

For institutions that accept government support in times of trouble, it is neither unreasonable nor unjust to require that they also accept government conditions in regard to remuneration, as well as other practices.

Controlling remuneration does not necessarily require salary caps, but might require that bonuses be paid in stock rather than cash; that bonuses are tied to performance measures; and that they are accessible to beneficiaries only after a considerable amount of time has passed. Such measures not only reward past performance, but provide incentive to maintain a high level of performance over a longer period of time.

Restrictions on some financial instruments

The author presents the perspective of two celebrated investors: Warren Buffet declared derivatives to be "financial instruments of mass destruction" and George Soros called for a ban on credit defaults swaps as being "like buying insurance on someone else's life and owning a license to kill them."

During the heyday of investment activity before the bubble burst, there were numerous new vehicles for investment which provided excellent returns while the market was running at a fever pitch, and which proved disastrous when the market took a downturn.

As such, the author subscribes to the view that greater scrutiny of investment vehicles is necessary, and there is a strong case for placing restrictions, if not bans, on such instruments.

Eligibility for public support

One of the more distressing events of the recent crisis involved arbitrary decisions made in governments around the world as to which firms would receive government support. Politicians, caught between the consequences of collapse and the public's hatred of corporate welfare, made a number of hasty and poorly considered decisions.

The main problem is than banking, which has long functioned as a utility that provides capital where it is needed for production, had taken on the character of a casino, facilitating gambling and wild speculation. Ideally, decisions should have been made to preserve the essential functions of banking while discouraging the "racier bits," though there is little evidence that this was considered.

One problem was the repeal of the Glass-Steagall Act in 1999, which had previously mandated a clear separation between commercial banking and investment banking. This act enabled the government to be heavily involved in the utility functions of banking, heavily regulating it to ensure stability, while leaving the speculative business of investment banking untethered to move at will. The separation of the two meant that the risk of investment banking was borne by the speculators, who should well understand the risks of the investment market, rather than visiting the risk upon banking customers, who had a false sense of security, unaware that their deposits were being played in the casino.

The author suggests that there should be a three-tiered system of banking, in which banks would fall into one of three categories:

Under such a structure the depositors would have a clear understanding of the way in which their funds would be utilized and the degree of risk they would accept in pursuit of higher returns.

No complete solution

Even though the structure just described provides some firebreaks in the financial system, the author does not believe that governments could simply set up this infrastructure and walk away. The financial system remains interdependent, even when subdivided thus, and a collapse of one class of banks would have some impact outside of its borders.

Consider that the financial crisis in 2008 was something of a domino effect, in which the collapse of an investment bank (Lehman) began a chain reaction that toppled other large financial institutions. A similar effect was seen in the dot-con crash in which hedge fund LTCM began a systemic crisis.

(EN: I'm not convinced of this argument, as blaming the first firm to fail for the collapse of others seems much like blaming the first person to feel a raindrop for causing the storm that got everyone else wet. There are interdependencies among firms, certainly, but a convincing chain of causation has not yet been presented.)

Accordingly, the banking system will likely need close supervision to ensure that the firebreaks are sufficient to prevent disaster from spreading - though having ultra-safe consumer banks should at least minimize the panic that might otherwise be caused by the failure of an investment bank.

Moreover, regulators can work toward a diversity of risk among investment banks - such that they are subjected to different risks. The recent catastrophe occurred because many of the banks were vulnerable to the very same risks, such that they all fell as a result of the same factors. More diversity in the overall system is a fail-safe that ensures that a change in conditions may harm a few banks, but not a critical mass of banks.

There is also some argument over matters of scope: that "bigness" is intrinsically bad, and that the size of banks should be restricted. This seems absurd, as size is of little consequence: if there were no large banks, and their operations existed in "umpteen small pieces" the crisis could still have happened. Given that there was a lack of diversity of portfolios, that banks engaged in the same practices and followed the same strategies, it matters not if it is ten big banks or a thousand small ones - they would all have collapsed. Moreover, it may have been harder to detect and intercede since many small pieces are more difficult to monitor and manage than a few large ones.

The argument against bigness is based on the assumption that each bank pursues a single strategy and that different banks pursue different strategies. This seems reasonable at first blush, but given that all banks pursue the same goal (maximizing profit), it is highly probable that they will identify a similar, if not identical, strategy for achieving that goal.

In that regard, it makes no sense to split large firms into smaller ones unless you also split up their functions and restrict their activities such that they are not all following the same playbook.

It's also worth remembering that the collapse of savings and loans in the 1980s preceded deregulation of the banking industry - at a time when there were no gargantuan banking institutions, yet a greater number of smaller ones failed all the same. As such, smallness in itself is not a guarantee of diversity and risk mitigation.

Wider financial reform

The reforms the author has prescribed should make a significant difference, but are likely not enough to reform the financial markets, given that the human urge to get riches quickly with minimal effort will likely lead the markets to become bloated beyond their usefulness.

One possible strategy would be to eliminate privately funded pensions, as they represent an enormous amount of investment activity, and return to pay-as-you-go pension systems such as Social Security. However, such systems have greater problems, and the author would not advocate such a measure.

Another option would be to impose prohibitive taxation on financial transactions. The author refers to Tobin's advocacy of a tax on foreign exchange activity to discourage people from selling dollars. The notion of taxing financial transactions has been explored, and has always been vehemently attached by the financial markets. However, the author is very much in favor of it.

The level of actual investment activity in markets is relatively low and is characterized by few and infrequent transactions, whereas speculative behavior (such as day trading) is characterized by frequent and frantic trading. There is considerable cost in supporting this activity, in terms of processing a large number of transactions, monitoring and policing them, and the volatility that is created.

Moreover, speculative investment adds nothing to human welfare: it does not provide funds to productive enterprises, but merely seeks to generate profit by fluctuations in value. While it can create wealth for some (in equal to the measure lost by others), it ultimately does not create or finance the creation of any product or service that contribute to prosperity.

Apart from the objection to interfering with free enterprise, the main argument against such a tax is that financial markets would find ways around it by finding venues (such as overseas brokerages) where the tax would not apply. Yet, this can be avoided if the rate of the tax were set sufficiently low that it would be easier to pay than avoid.

Even though it seems a good theory, the author expects that such a measure would do "next to nothing" to affect speculators and the buildup of bubbles, any more than charging slightly higher commissions on trading.

Another radical suggestion the author proffers is to restrict payment of dividends such that they could only be received by those who have held their shares for at least two years. The author feels that such a measure would be "a much reduced level of trading activity." (EN: I disagree, given that dividends are generally sought by investors who are already conservative and speculators are more interested in share price alone.)

Along the same lines, the author suggests that restrictions could be placed on executives and employees to prevent them from being awarded stock options or similar events for at least ten years, which is mean to ensure that they consider the long-term welfare of their firms.

(EN: The author fires a volley of other ideas, single sentences without detailed explanations, but generally geared toward discouraging individuals from holding short-term investments. This is followed by four or five bullets addressing specific items: banning trailing commissions, compelling pension funds to enable clients to move their funds without penalty, separating financial advice from brokerage services, and establishing professional guilds.)

Government debt

One of the main causes of concern over government debt is that there are no policies regarding how deeply the government will allow itself to become indebted. A complete ban on public borrowing is inadvisable, as governments must deploy "massive fiscal expansion" in reaction to a recession, but without any statement of policy, the public is prone to overreact to the prospect of any public debt.

As such, politicians are inhibited from taking swift and decisive action: consider that the governments of the US, UK, and Eurozone were hesitant to take action at all - realizing that if they ran at an annual deficit of even 10%, they would over a period of years find themselves in dangerous territory with investors concerned about default.

Opinions vary as to what level of debt is acceptable and appropriate, but the author feels 20% to be a reasonable number, which would enable governments to take fairly dramatic action without concern for upsetting the public. However, it must be stressed that this reserve should only be tapped in times of fiscal crisis ... running at a deficit as a matter of course, during times of peace and prosperity is unforgiveable.

Inflation targeting and asset prices

The author expresses doubt about some of the reforms that have been undertaken to control bubbles - sensing that the regulations put in place to ensure overall stability entail substantial inefficiency on the level of the individual bank.

In particular, restricting a bank's ability to borrow based on income sounds like good business, as it does seem a method of assessing whether the bank can service the debt - but he feels a better approach would be to limit mortgages based on variable capital ratios (EN: by which I believe he means measures such as the capital adequacy ratio).

A policy of this nature has enabled Spanish banks to withstand the currency crisis pretty well = but at the same time, it did not prevent the people of Span from suffering a "poverty boom." This is likely because the restraint of these arrangements was "swamped" by the low interest rates imposed by the European Central Bank. Accordingly, the author doesn't believe that such instruments, on their own, are adequate.

Instead, he believes that the objectives of monetary policy should be reformed to consider the growth of asset prices, such that when there is rampant growth, interest rates rise accordingly to prevent or at least mitigate bubbles from occurring. Ignoring asset prices in setting interest rates was seen when the recent market bubble inflated: consumer inflation remained low while asset prices, particularly for residential property, rose dramatically.

Rampant asset price inflation is not consistent with monetary stability, and it is pointless for a central bank to argue that "all is well" because interest rates are being kept down in spite of dramatic inflation in consumer prices.

His argument is not to replace inflation targets with asset prices, but rather to modify the way in which they operate, such that the ultimate goal is to control the rampant increase in certain sectors of the market, rather than providing cheap capital that will fuel even more rampant growth.

Forecasting misleads

The author feels that the present policy regime places too much emphasis on forecasting, especially in the UK. The bank of England forecasts inflation two years out, considering a range of indicators, in setting interest rates. The problem is that consumer prices behave erratically, such that the predictions are very seldom accurate - such that a great deal of effort is placed into developing a forecast that is almost certainly wrong.

If central banks have only one instrument, namely short-term interest rates, then they are blinded to any other factor that might influence the economy. And since bankers in each market follow a general consensus, they feel they are absolved from the responsibility to do their own thinking.

Considering interest rates isn't a bad practice, but it should not be the exclusive practice. The author suggests considering asset price levels, and even giving it a key role, as they are a key driver of the demand for capital and the willingness to pay a given interest rate.

More specifically, central banks should gauge the level of capital needed in the market according to the prices of the goods that the capital will be used to purchase. To set an interest rate for capital by any other factor is simply arbitrary and insufficient to maintain stability in the market.

In the UK, there is a declared target of 2% for the CPI. While the US does not declare a target, it is believed that they tacitly set the same goal. A 2% rate should cause prices to double every 35 years and is sufficient under normal circumstances to discourage deflation. However, as was shown in the deflation scare of 2007-2009, it is clearly not sufficient to discourage deflation under abnormal circumstances. This may be inevitable, because it would likely be unwise to give up a practice that offers price stability in reaction to temporary exigency.

Even so, the author feels that giving central banks the ability to have complete control over the money supply gives them "far too much rope" and suggests that central bankers should be beholden to a parliamentary committee to whom they must justify their decisions regarding inflation and interest. Of course, he imagines that asset prices will have some prominence in those discussions.

The gold standard

There is great support to the notion of returning to a gold standard for currency, especially given that the volatility in the global economy has been considerably worse since Nixon broke from the Bretton Woods system some forty years ago (while the gold standard proper broke down in the 1930s, it was replaced by a system that still had gold at its heart).

At first blush, it is easy to see that a system based on gold would be less subject to inflation over the long term, given that currency could only be issued in a finite amount, not subject to government control or manipulation, and as gold as a commodity it holds its exchange value against other commodities very well over the long run. For those who wish to banish inflation entirely, the gold standard is "immensely seductive."

However, this would not make currency stable, as it would vary according to the supply and demand of gold itself. Much as the value of goods increases or decreases from one year to the next, so would the value of any currency based on commodities. While the gold standard did remain reasonable stable for nearly a century, until 1910, there were also enormous fluctuations during this period - from a 13% inflation rate in 1835 to a 15% deflation rate in 1840.

However, there is a more profound difficulty in remaining on a gold standard - namely on the part of governments who wish to use currency to control the economy. That is, the gold standard can only be maintained "through an act of political will," specifically the willingness of government to refrain from interfering in economic matters. Having witnessed the abandonment of gold in the 1930s and 1970s, it is clear that government is unwilling to restrain itself in this manner.

(EN: I've paraphrased here - the author suggests that "man" or "society" rather than government rejected the gold standard, but given that in both instances physical gold had to be wrested from citizens at gunpoint and private ownership of gold was likewise made punishable by law, it cannot justly be said that people have little faith in the value of the metal. Even during the present economic crisis, people turn to gold in such numbers that its price nearly quadrupled between 200 and 2012.)

The author suggests that the belief that returning to a gold standard would end financial instability "is a delusion." The real estate bubble would have inflated regardless of the standard on which currency was based, as properties were sold on credit rather than purchased with cash. If anything, the inability to create more currency by fiat would have exacerbated rather than prevented the bubble. There is historical precedent for this: consider the economic inflation of the early twentieth century, before the Great Depression, happened in a gold-standard economy.

Ultimately, the instability of financial markets in the modern world is not an effect of currency, but because financial markets are larger and more fragile than ever before, regardless of whether currency is based on commodity or fiat. As such, the recurrence of the debate over a gold standard is simply a red herring.

A global money

Another proposal for effecting global economic stability is the establishment of a global currency, the absurdity of which is clear considering that it already has one, in the US dollar. Many currencies are pegged to the dollar, and even those that are not directly pegged are heavily influenced by international exchange rates that defer to the dollar as the standard unit against which all currencies are measured.

Given the present situation with the dollar and with the rise of China, it seems likely that there will be a change in the next century - not to the adoption of the Renminbi, but toward a global money and global financial governance.

The idea of a global currency was proposed by Keynes and Schumacher after the second world war, but the "bancor" was unable to prevail against the interest of the US in making its own dollar the key global currency. The author remarks that some of the ideas expressed by the director of the Chinese central bank seems to be explicitly modeled on the bancor concept.

The aim is to create a currency in which nations could hold a portion of their national reserves - as doubtless they would continue to hold and use both national currencies (chiefly the dollar) and metal. This currency would be issued and managed by a global institution - and it would likely require reformation of the world's various international bodies, which anachronistically reflect the interests of the victors of the second world war.

(EN: The concept of a world currency is a theory that has been mulled over repeatedly - the conclusion being that if it is wanted, it can be established at any time by anyone. Further, if it requires force of government to make people adopt it, then it isn't really wanted. That said, the potential collapse of the dollar presents an excellent opportunity for an independent global currency to be introduced.)

Pressure on the surplus countries

The leading problem in the present global economy is in the tendency of some countries, such as China, to run persistent large surpluses, which causes other countries to run at correspondingly persistent and large deficits. The author's suggestion would be for the body that governs the new global currency to place a tax on any reserve holdings.

Naturally, this would be less than exciting to the nations who feel secure in maintaining surpluses, but the creation of a global currency would alleviate one of their main causes for anxiety: the collapse of the US dollar, which would annihilate the value of their hordes of dollar-denominated securities.

The author expects that Americans would be likewise disenchanted at ceding ownership of the de factor global currency, but they would gain in exchange access to markets that would be compelled to pull their weight in the generation of aggregate world demand.

Ultimately, the vast stock of dollar assets in China is a time bomb for both sides: the Chinese face enormous losses if the dollar loses its value, and the Americans face the constant threat of economic destabilization should China decide to dump its dollars onto the market.

Conceded, this scheme for a new global currency and global bank seems farfetched, but today's circumstances call for an ambitious solution. And given that the economy has become globalized it seems sensible, and likely inevitable, that currency will need to follow.

Reforming economics

The author regards the present state of economics as "a disaster and a disgrace" that completely failed to see the current crisis coming and has offered very little helpful advice in its wake. It has become an academic topic, effete and removed from the world, and entirely disinterested in practical matters.

Although there are a few exceptions, most academic economists ling to the idea that their subject is relevant and of interest to the wider world - when in fact it has become "a modern form of medieval scholasticism" of not use to anyone. Journals of economics contain articles of "startling irrelevance, badly thought out and appallingly badly written ... destined to be read by no on outside a narrow coterie of specialists."

As with many academic disciplines, it started as a practical examination: Smith, Ricardo, Malthus, and the body of classical economists approached economics as a study of human behavior with a very specific and practical goal.

By the 1970s, the nature of economics had changed - the philosophical approach became more of a mathematical one, and academics sought to elevate economics to the level of a pure science. Unfortunately, this effort neglected applied science - and the author asserts it would have been better off had practitioners sought to emulate Edison rather than Einstein.

The problem of taking a mathematical approach to anything is that it requires simplification: anything that is not quantifiable must be ignored, and equations are based on very simplistic equations. This led practitioners away from the real world and toward the data that is a partial and often inaccurate reflection of it, developing and testing theories against the evidence "or more truthfully, to torture the data in pursuit of support for their theories."

Going further, the author insists that "modern economics has turned itself into a religion" and finance theory is merely a branch of this poisoned plant. The practical consequences of this was that they had nothing to offer: obsessively working over their mathematical models, they didn't see the crisis coming and, because their models were constructed on the parameters of a normal market, they had no ide as to how to put things right.

What needs to happen is pretty clear: economics needs to be returned to reality.

The ranks of academics need to be thinned, to cut from their herd the effete theorists who are so far removed from reality that they have nothing practical to offer society or their students. The subject of economics, and especially the branch of finance, needs to be restored to the humble, practical subject that it once was and should become again.

Students of economics should have a basic grasp of mathematics, but more importantly they need to master abstract reasoning. They should be given a sound knowledge of history, know how to read a balance sheet, we familiar with the issues and controversies of the present and recent past, be able to draw conclusions about the past and marshal a tenable argument for the future.

Specifically, they should not seek mastery of "the pyrotechnics of higher mathematics" that are baffling to the layman and even to many of their peers. Complex mathematics has long been used as legerdemain to silence opposition and gain mindless obedience. And in general, there is no value in any field of study that fails to produce theories that a layman can clearly understand and apply without the constant involvement of academics.

This process has already begun with the rise of "behavioral economics," an approach that makes a causal connection between psychology and economic behavior. The author considers this to be "a major advance" that has the potential to move economics onto the road of relevance and usefulness.

Ideally, economics will become more like medicine: a body of knowledge that considers universal truths but adapts itself in practice to the needs of the patient - and which has an overall goal of wellness and an ethic of doing no harm.

As a start, the reformed subject must let go of the "ludicrous pretense" that the economic system is likened to a finely tuned machine, and instead acknowledge that it is based on human behavior, which is inherently messy and irrational at times.

With this, he turns again to Keynes, for three major points:

  1. Economic activity is permeated by fundamental uncertainty; it is not a pure science, cannot be made into one, and should not be treated as if it were such.
  2. Many of the factors that affect the economy are entirely psychological and depend on people to have the confidence to overcome their hesitation, which arises from uncertainty
  3. Consequently, the larger the scope on which one considers economics, the more instable and fragile it will become, and the less likely it will follow a rational course.

These points also have significant implications to the study and practice of finance: the idea that risk is accurately or adequately measured by the variance of past returns is completely flawed. Those who manage investments will need to stop calculating based on the past and start thinking imaginatively about the future.

The author believes that there will still be a place for those whose approach to economics is highly mathematical - in the far corners of academia where they can ponder what-if scenarios without disturbing the rest of society. They do occasionally have something of interest to offer, but we don't need quite so many of them, and we do not need them on the front lines

The author turns again to Keynes for a definition of what a good economist should be like. Keynes regarded economics as "an easy subject at which very few excel" because the master economist must

The academic world of economics has evolved far away from this ideal, and the author is "far from confident" that it will achieve it in the near future. Nevertheless, this is what is needed.

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