The Great Divergence

[kandrathe]

Stocks go up. Stocks go down. My point is - your idea of "ludicrous," an obvious loser, still would have net you 10% annual, despite having been at an unsustainable peak when you would have bought, and just following a major crash when you sold.

Had you bought at 100ish, in the early 2000s doldrums, then sold at 750 at the height of 2007, you'd have made a killing - about 22% annual. But then, if wishes were ponies, then beggars would ride, and if the stock market worked backwards, we'd all make a hobo of Warren Buffett.

At the point I thought it was ludicrous, I looked earnestly at the stocks projected sales to earnings ratios. Based upon their potential earnings, the stock wasn't worth $200 at that time. Greenspan was correct in calling it "irrational exuberance" at that time. But, in 2000, it was just a blind bet on something new and cool. Any IPO with relation to anything labelled "web based" went to a market cap higher than some blue chip stocks in a week. How many of those companies are still in existence? Not such a good bet then in 2000. And, unless you really knew Google would survive, you couldn't say Google was any better than them. Although it was established, but remember, this was before Google even had ads.

Ok, in your opinion then, companies using stimulus money to hire people they couldn't afford is better than having them eventually hired by companies that can afford them?

Funny, I seem to recall arguing that to you, when you suggested massive tax credits for businesses to hire extra workers as a solution to unemployment.

You're trying to frame this as a choice between "make work" employment and "real" employment. The real choice is between "make work" employment and unemployment - otherwise, why is there 10% unemployment? And yes, that's a benefit to the "make work" employed worker, albeit an expensive one.

I was advocating more of a hiring bonus thinking that a company can make a decision about the benefit of one time boon, versus depending on the government to fund the position. I guess the "smart" companies should have thought about "What happens in Jan 2011?" too.

I would frame this type of bogus "stimulus" as giving money to a company to temporarily employ someone they cannot afford, rather than using the money (or lack of revenue from a tax credit) to enable the company to be able to afford to hire people. The first is what did happen, in temporarily funding someone working, rather than have that person collecting unemployment, as opposed to actually stimulating the economy allowing the business to hire someone they needed, and could afford to hire.

Per the Iraq War: There's hedging your bets, and then there's the side you come down on. Are you really telling me that your position was one of opposition to the war? Or just distaste at having to pay for it all because France and Russia weren't interested? (Edit: Cagey, you were. But the one consistent theme is that Saddam *must* be "dealt with," and that existing methods weren't working. If you opposed the war, you certainly had an odd way of saying so.)

I almost always oppose war, except in cases of defense against direct attack. At that time even, I tended to couch my statements to try to show or guess at the rationale used by the administration.

I believed they must have had secret knowledge of something bigger and more sinister. In that, I was wrong. They had suspicions, but no actual hard evidence of anything. Any of us can construct a bogeyman, and justify acts of extreme violence to defend ourselves from scary fiction.

It might seem then, since I'm not railing against the US, or their actions, that I'm in agreement with their actions. Usually not. I'm actually opposed to most government action, since it's needlessly coercive and violent.

This might shock you... I was a peace activist in college during the 1980's and a student leader and founder of our campus's peace studies student organization. There was a Progressive Student Organization, that always resorted to confrontational civil disobedience almost weekly to get attention. I found a group a students who wanted to work for peace, but didn't think getting arrested in violent clashes with the authorities was a very rational or mature way to accomplish or demonstrate a commitment to non-violent social change. During that time I was really into Buddhism, and I studied many eastern philosophies, and dabbled in training in about 6 or so different martial arts over the next 15 years.

At the time they attacked Iraq, I felt they hadn't really done enough bring things back to serious negotiation. The UN weapons inspectors had hardly had a chance, before the gung-ho Neo-Cons war hawks marched in. I remember being awed by the US military power, and thankful that I wasn't an Iraqi. The hope of the UN was to be an organization that promoted peace, and provided a forum for addressing grievances without resorting to war. It's hard to have credibility in that when your nation is one of the largest manufacturers and suppliers of weapons to the worlds conflicts. And, that at the drop of a pin, we are willing to rush in with advisors, and escalate conflicts to full blown warfare. I just think sometimes for the people in power, that they find war to be good for business.

I opposed our intervention in the Balkans war, and subsequent nation building. I thought our attempts to help Africa were half baked, but I felt compassion for the people who were suffering. I am upset that the UN did near nothing to abate suffering and the millions of deaths in Darfur, Rwanda, Ethiopia, Somalia, Zimbabwe, Sudan, etc. etc. etc.

Did you really predict that there wouldn't be many people living in Africa by 2010? I should really be keeping a list.)

I can't remember this one. Was this due to AIDS, war and stuff?

"[2000] began with 24 million Africans infected with the virus. In the absence of a medical miracle, nearly all will die before 2010. Each day, 6,000 Africans die from AIDS. Each day, an additional 11,000 are infected." — Lester R. Brown, HIV Epidemic Restructuring Africa’s Population, World Watch Issue Alert, 31 October 2000

The infection rate is still growing at about 10% per year. In 2008, there were about 35 million Africans infected with HIV, out of the billion that live there. The ravaging of Africa due to disease, corruption and war is ongoing, but slower than I thought obviously. The global recession has set things back a bit, and we're not bumping into "peak oil" shortages yet. Although, we're on course for a bigger global crisis on the horizon. I just don't know exactly which resource shortage will trigger it first, Oil, Food, or Water.

[Jester]

I was advocating more of a hiring bonus thinking that a company can make a decision about the benefit of one time boon, versus depending on the government to fund the position. I guess the "smart" companies should have thought about "What happens in Jan 2011?" too.

I would frame this type of bogus "stimulus" as giving money to a company to temporarily employ someone they cannot afford, rather than using the money (or lack of revenue from a tax credit) to enable the company to be able to afford to hire people. The first is what did happen, in temporarily funding someone working, rather than have that person collecting unemployment, as opposed to actually stimulating the economy allowing the business to hire someone they needed, and could afford to hire.

I think my brain exploded trying to figure out what you just said.

Let's see. You oppose "bogus stimulus", giving money to a company to temporarily employ someone they can't afford.

You support "using ... money" (tax credits) to "enable the company to be able to afford to hire people" by giving them a "hiring bonus".

So, in one case, you're giving the company money on the condition that they hire people. In the other, you're giving the company money when they hire people.

I'm not seeing how this is materially different, except perhaps that in scenario 2 they could just fire them immediately.

-Jester

[kandrathe]

I think my brain exploded trying to figure out what you just said.

Let's see. You oppose "bogus stimulus", giving money to a company to temporarily employ someone they can't afford.

You support "using ... money" (tax credits) to "enable the company to be able to afford to hire people" by giving them a "hiring bonus".

So, in one case, you're giving the company money on the condition that they hire people. In the other, you're giving the company money when they hire people.

I'm not seeing how this is materially different, except perhaps that in scenario 2 they could just fire them immediately.

If it's a tax credit for hiring, you might be wise to stipulate that you only get the credit for employees who worked for more than X months.

The tax credit would not subsidize the employment of a person, but just be a tax write off allowing a company to keep more profits for one year. It certainly would be worthwhile to keep the tax credit bonus as a fraction of the persons salary paid.

[Jester]

If it's a tax credit for hiring, you might be wise to stipulate that you only get the credit for employees who worked for more than X months.

Edit: Okay, I think I get what you're saying. Tax credit for new hires, on a permanent or semi-permanent basis, as a % of their salary, kicks in only after a certain number of months. I know what I'd do as a business if faced with that opportunity: Replace my entire labour force.

Being charitable, I suppose you could simply apply it uniformly to all workers, regardless of whether they're new hires or not. That would lower the marginal costs of hiring and decrease the savings from firing - a direct incentive to employment.

So, yes, that should work. Probably a more efficient method than what has been adopted. Expensive, though - we're talking about subsidizing every worker in the whole country. But if it got the government borrowing money and giving it to people who would spend it, then hey, great.

-Jester

[kandrathe]

If it's a tax credit for hiring, you might be wise to stipulate that you only get the credit for employees who worked for more than X months.

Edit: Okay, I think I get what you're saying. Tax credit for new hires, on a permanent or semi-permanent basis, as a % of their salary, kicks in only after a certain number of months. I know what I'd do as a business if faced with that opportunity: Replace my entire labour force.

Being charitable, I suppose you could simply apply it uniformly to all workers, regardless of whether they're new hires or not. That would lower the marginal costs of hiring and decrease the savings from firing - a direct incentive to employment.

So, yes, that should work. Probably a more efficient method than what has been adopted. Expensive, though - we're talking about subsidizing every worker in the whole country. But if it got the government borrowing money and giving it to people who would spend it, then hey, great.

Right. Congress could choose how big a benefit they wanted to make, but in theory, you could greatly help out small businesses this way. To limit the cost you could cap the benefit to 100 employee's per company.

I'd doubt very big corporations will move on employment until they see a substantial increase in orders or production forecasts.

Relating to our prior discussion on Boom and Bust cycles...

"Though disputed, Austrian scholars assert that the boom then, is actually a period of wasteful malinvestment, a "false boom" where the particular kinds of investments undertaken during the period of fiat money expansion are revealed to lead nowhere but to insolvency and unsustainability. It is the time when errors are made, when speculative borrowing has driven up prices for assets and capital to unsustainable levels, due to low interest rates "artificially" increasing the money supply and triggering an unsustainable injection of fiat money "funds" available for investment into the system, thereby tampering with the complex pricing mechanism of the free market. "Real" savings would have required higher interest rates to encourage depositors to save their money in term deposits to invest in longer term projects under a stable money supply. According to von Mises's work, the artificial stimulus caused by bank-created credit causes a generalized speculative investment bubble, not justified by the long-term structure of the market." -- Wikipedia

Wouldn't you consider it possible that sub-prime lending, NINJA loans, and easy credit accelerated speculative borrowing in housing causing the price to bubble? People paid more than they should have, and lenders gave credit to those they shouldn't have. Couple that with the malinvestment of CDS of Mortgage backed securities with risk affixed one time at the time of purchase. The rapidly rising price of homes inspired a construction boom, creating thousands of jobs and economic activity surrounding the bubble. If you are a follower of this theory then, you'd believe that the current vast manipulation of the market will result in another bubble, and subsequent bust once this false economic activity concludes. If we are going to have a free market, then it will need to find its own equilibrium at a slower speed.

"The financial crisis of 2007-2010 has resulted in a revival of interest in the Austrian business cycle theory [30], but has also resulted in a revival of interest of theories more critical of Austrian theory, such as Keynesianism and Post-Keynesian economics.[31] After the United States housing bubble began its decline in 2006, Peter Schiff, a supporter of the Austrian school, made some predictions[32] regarding a housing crash in the US, though (as of early 2009) Schiff's investment firm had not been able to profit from strategies based on his predictions.[33][34] Ron Paul also spoke about the Austrian business cycle repeatedly throughout his 2008 presidential campaign." -- Wikipedia

I was thinking specifically of something I read from Hayek (another hero of mine). I need to read Friedman's critique, but I sense there is something he missed. My experiences with systems analysis tend to favor the “inchworm” effect for the causes of many systemic failures. During boom periods, economic success feeds attitudes of continued success resulting in increased production. More production occurs, resulting in more activity, and more success. This feedback accelerates throughout the system until any defect occurs destabilizing the system. Often the destabilization in the system can be absorbed, but sometimes it leads to further perturbations and errors, which cause a cascade of failure.

This happens in data flows, traffic flows, and the flow of commerce. As it turns out, it also happens in nature. I might have mentioned this before, but I once resolved an issue with train derailments due to a computerized grain hopper. Every train car was filled to exactly equal weight which after the train gained speed resulted in a harmonic wave in the cars, and they'd eventually jump off the tracks. We had to add code into the hopper programming to vary the weight to prevent harmonic motion.

Consider this article in the NYT on econophysics... Then there is the budding field of Financial Seismology...

[Jester]

The flaw in the Austrian business cycle is not that it predicts easy credit booms and credit crunch busts. That's empirically true, although it's long on the "it's going to happen" and not on the "when, and how much". It's that it predicts that the bust is characterized by a sudden withdrawal of investment (true) and an increase in consumer spending (false). An overspending in the investment goods sector is matched by an underspending on consumer goods. This leads them to believe that the cycle will correct itself without needing to increase demand - it's a sectoral shift, not a structural problem. Therefore, no room for government to step in, no sir, just the private sector minding its own business.

But demand is down across the board. Consumers are not increasing spending. They're not even holding spending flat. They're squirrelling away as much cash as they can, in bills, bonds, and gold. And that, unlike the Austrian scenario, is not going to lead to automatic recovery, since if everyone is betting on tomorrow, there's nobody betting on today. Thus, investment stagnates until the outlook improves, leading to a further flight to safety, leading to yet more stagnation. Snap goes the trap.

-Jester

Afterthought: If you believe some kind of "unstable system" theory of economic collapse, then you are very much in the Minskyite camp, or maybe off in the nonlinear market tails with Taleb.

[kandrathe]

But demand is down across the board. Consumers are not increasing spending. They're not even holding spending flat. They're squirrelling away as much cash as they can, in bills, bonds, and gold. And that, unlike the Austrian scenario, is not going to lead to automatic recovery, since if everyone is betting on tomorrow, there's nobody betting on today. Thus, investment stagnates until the outlook improves, leading to a further flight to safety, leading to yet more stagnation. Snap goes the trap.

I agree that consumers do not increase spending into the bust cycle. I don't remember that being apart of the theory. With today's modern communications, when something pops, everybody quits buying, and they all run for cover within the same month or week.

I worked for a manufacturing firm once that based spending decisions (like raises, and hiring) on their 18 month forecasts which were surprisingly accurate. So they ran for cover about a year and a half before the recession would hit.

The controversial parts of the ABC from what I recall (esp. as evoked by Rothbard, and Von Mises) were that monetary expansion distorts the structure of production in an unsustainable way, that it explains the "sudden general cluster of business errors.", that it provides the best explanation for why downturns hit the capital goods sectors especially hard, and that it is the only way to explain the existence of inflationary depressions (or "stagflation"). These controversial parts are not supported as Friedman observed by a careful examination of history. There are inconsistencies, which is why I wouldn't place myself as a die hard Von Mises devotee, but I believe that the Austrians have made great contributions to understanding our economy. In going back to look at Von Mises explanations, he identifies a period of low interest rates with the boom, and a period of re-adjustment with the bust. Barring other assumptions, he does not predict an increase in employment during the boom, or a decrease during the bust. And, you are correct in that it would predict an increase in output during the bust. That is not supported by our observations of recession activity.

Again, while I would prefer for the government to keep their hands off as much as is possible, when times are bad, and people are hurting and struggling, they expect their government to come to their aid. The Austrian advice of allowing the economy to heal itself is politically suicidal, and allows for pains too great for people to bear. So, the second best approach from my ultra libertarian perspective would be for the government to encourage the economy in ways that do not distort it. Any unnatural distortion will need to readjust itself eventually. For example, building a a great pyramid for our great ruler Barack Obama. We'd temporarily employ a massive number of people, increase the consumption of quarried stone, and there would be an upsurge in economic activity supporting the building site and the builders. But, at the end of it, we'd have a bunch of people skilled in pyramid building who are again unemployed, the market for stone would return to its normal level, and all the businesses that sprang up to support the building, and builders would lose their customers. Much of the "shovel ready projects" that were funded by the first stimulus were just like the pyramid built for Obama. They had little economic purpose, they temporarily employed some people, and provided some local economic relief, but once completed had no sustained improvement. The Obama hand out of $400 to single workers, and $800 to working couples was quickly spent on the mortgage or rent, and normal monthly expenses as was the bulk of the 100 weeks of unemployment. People continued to buy mostly what they were required to buy, only for many now they were paid for by federal deficit spending.

If your going to be progressive, then you'd get together with your like minded ideologues and envision what the future should look like, and then use your stimulus money to enable that as the easiest path. Obama talked big about "green jobs", but where is the grand plan? How about high speed trains connecting all of the US major cities? A public and private partnership of railroads, and unions should be able to make that happen.

Or, as I suggested, break ground on 100's of new nuclear power plants, and actually make the tough decision to build the spent fuel recovery facility in Yucca mountain. We'd get short term stimulus engaging many builders, etc. Then we'd get increases employment supplying and running the plants, and reprocessing the fuel. We'd decrease our reliance on foreign oil, and the domestic use of coal. We'd take our money out of the hands of our opponents, like Hugo Chavez. Then, there is the increased supply of power, which would reduce the costs of production, and increase America's competitiveness, and profitability. If we really want to compete globally, we'd make arrangements with the southern states to create some open immigration zones (ever wonder why there are border checks north of San Deigo?) where American industry can employ anyone from any nation who shows up for work.

P.S. I would definitely put economic theory into non-linear equations.

[Zenda]

Could you give an example? Most of the esoteric financial instruments in use are pretty clear, based on real things, however much they're aggregated, shuffled, or disassembled. They're either someone's debt, sliced and diced and repackaged, or they're insurance against something happening (essentially, a bet), or they're options or obligations to buy or sell something or another at a future date. None of that should require a constant influx of capital, although most peoples' bets are strongly in favour of the economy growing (tough to be an investor if it isn't.)

Sorry for not getting back at this earlier, but other matters required too much of my attention. However, I still felt the obligation to give a (short) reply, even though this no longer seems a topic of interest.

Financial constructions are indeed like bets, but they are not always based on market fluctuations of actual goods. Historically, they might have been, but things have changed. Let's take futures, for example. In 1970, the futures market was largely dominated by agricultural products, with the rest being in precious metals. In 2004, that same market is for about 75% based on financial instruments (graph).

Also, I didn't mean to say that some outside influx of capital is required. Rather, it provides for that by itself. Trading in financial instruments is often done by arbitrage pricing mechanisms. This allows for making profits without dealing in actual goods, without risk, and even without initial investments on the deal.

arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit at zero cost.

[--Pete]

Hi,

. . . actually make the tough decision to build the spent fuel recovery facility in Yucca mountain.

Just a technical point, and I hope Lissa chimes in because I'm not that familiar with the technology. Rather than one recovery point in Yucca mountain, which would involve shipping radioactive material to and from nuclear plants throughout the country, I think local recovery points would be safer. If the technology is not too expensive, and it might not be if the process is standardized and the tools are built 100 at a time instead of individually, there could even be one recovery site per nuclear plant. That would eliminate almost all the risks of transportation and reduce the need for additional security.

--Pete

[kandrathe]

. . . actually make the tough decision to build the spent fuel recovery facility in Yucca mountain.

Just a technical point, and I hope Lissa chimes in because I'm not that familiar with the technology. Rather than one recovery point in Yucca mountain, which would involve shipping radioactive material to and from nuclear plants throughout the country, I think local recovery points would be safer. If the technology is not too expensive, and it might not be if the process is standardized and the tools are built 100 at a time instead of individually, there could even be one recovery site per nuclear plant. That would eliminate almost all the risks of transportation and reduce the need for additional security.

--Pete

I could live with that. It makes good sense to keep the hot stuff where there are people who are equipped, and know how to handle it.

[Jester]

Trading in financial instruments is often done by arbitrage pricing mechanisms. This allows for making profits without dealing in actual goods, without risk, and even without initial investments on the deal.

Almost definitionally, arbitrage is not the problem - someone must have already owned something, and someone else must want to buy it, for the arbitrageur to make money buying and reselling it.

Now, maybe there are things (certain kinds of financial instruments) that people shouldn't be allowed to buy or sell at all, for structural safety reasons. But that's a different issue from arbitrage.

-Jester

[Zenda]

Almost definitionally, arbitrage is not the problem - someone must have already owned something, and someone else must want to buy it, for the arbitrageur to make money buying and reselling it.

I didn't say there was a problem with arbitrage. What problem are you thinking about?

Also, with options you never need to buy or sell goods. With futures, the holder is only obligated to sell goods, and only when a buyer of the goods wants these for the agreed 'future' price. For simple buying and reselling of goods on the same market, no arbitrage is needed.

[Jester]

I didn't say there was a problem with arbitrage. What problem are you thinking about?

The problem of people dealing in non-real goods?

For simple buying and reselling of goods on the same market, no arbitrage is needed.

That's what arbitrage *is*. You buy something, then resell it at a profit. Nothing more, nothing less.

-Jester

[Zenda]

The problem of people dealing in non-real goods?

How would that be a problem?

That's what arbitrage *is*. You buy something, then resell it at a profit. Nothing more, nothing less.

Wiki says it's quite a bit more.

Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time.

[Jester]

How would that be a problem?

You tell me. Or, rather, you already did:

The value of 'real' money is guaranteed by authorities, as you say, but the value of 'phantom' money is only promised by its users. Real money cannot be issued by just anyone, while phantom money can simply be created by inventing something abstract and assigning it a value, which is 'backed' mostly by already owned phantom wealth, and only for a small percentage by real wealth. Such 'sophisticated' methods typically require a constant influx of new capital, like any other pyramid scheme, so the total amount of phantom money needs to grow. This is what mostly drives the divergence, imo.

Wiki says it's quite a bit more.

You appear to be going with what wiki calls the "common" as opposed to the "academic" usage. My own opinion (admittedly, as an academic) is that the "common" usage is incorrect - it is only arbitrage (risk-free trading) if you make certain (wrong) assumptions about statistics and the movement of prices. Specifically, by underestimating tail risk, they assume that large losses are 1 in a bazillion (basically impossible) when in fact they are much more frequent. That's not real arbitrage, it's a massively risky bet disguised as arbitrage.

However, even so, they are dealing in actual commodities, or actual debt, or actual contractual obligations. There is nothing fictitious about what they are doing, except of course the fiction that they have eliminated risk.

-Jester

[Zenda]

How would that be a problem?

You tell me. Or, rather, you already did:

The value of 'real' money is guaranteed by authorities, as you say, but the value of 'phantom' money is only promised by its users. Real money cannot be issued by just anyone, while phantom money can simply be created by inventing something abstract and assigning it a value, which is 'backed' mostly by already owned phantom wealth, and only for a small percentage by real wealth. Such 'sophisticated' methods typically require a constant influx of new capital, like any other pyramid scheme, so the total amount of phantom money needs to grow. This is what mostly drives the divergence, imo.

Just forwarding growing phantom capital as a possible exlanation for the current divergence. Where do I label something a problem?

You appear to be going with what wiki calls the "common" as opposed to the "academic" usage. My own opinion (admittedly, as an academic) is that the "common" usage is incorrect

So it's only your opinion that I'm wrong. I can live with that

[Jester]

Just forwarding growing phantom capital as a possible exlanation for the current divergence. Where do I label something a problem?

You don't believe that the growing inequality is a problem? You don't believe that pyramid schemes are a problem?

You appear to be going with what wiki calls the "common" as opposed to the "academic" usage. My own opinion (admittedly, as an academic) is that the "common" usage is incorrect

So it's only your opinion that I'm wrong. I can live with that

No, it's not "only my opinion". It is my opinion, of course, but there are good reasons for it.

Arbitrage is an idea. Its proper and original meaning was a risk-free trade by buying one commodity, and selling it directly back for a higher price. Some people deluded themselves with fancy models into believing that a certain type of statistically calculated trade was equivalent to arbitrage. It isn't, and it never was. But they thought it was, so they called it "statistical arbitrage". Their mistake does not redefine the word.

Or, put another way, just because your grocery store puts the tomatoes in with the vegetables, doesn't mean it is one, nor is it just a matter of opinion. The colloquial definition is "good enough," but in the end, it's wrong.

For a more rigorous discussion, try the New Palgrave Dictionary of Economics. It goes into achingly high detail, and also discusses how the mathematics of arbitrage led to asset pricing modes, and much of modern finance. Now, I think these models are critically flawed in their overreliance on errors being normally distributed, when in fact they are much riskier ("fat tails").

But, in the end, the more complex derivations that rely on arbitrage as a principle, valid or not, trace back mathematically to exactly what I said: Arbitrage is about buying something at one price, then selling it back at a higher price, risk-free.

-Jester

[Zenda]

You don't believe that the growing inequality is a problem? You don't believe that pyramid schemes are a problem?

No. Large inequality might lead to problems, or be a symptom of problems, but I don't see how it would be a problem in itself. The same goes for pyramid schemes.

Arbitrage is an idea. Its proper and original meaning was a risk-free trade by buying one commodity, and selling it directly back for a higher price. Some people deluded themselves with fancy models into believing that a certain type of statistically calculated trade was equivalent to arbitrage. It isn't, and it never was. But they thought it was, so they called it "statistical arbitrage". Their mistake does not redefine the word.

I don't really care who was first to use the word properly. I only mentioned arbitrage as one of the mechanisms that can induce autonomic growth of phantom capital, and used Wiki to get more information on it. I understand this issue is important to you, as a student of Economic History, but unless you want to imply that 'academic' arbitrage is what's in use, and that it could never induce this autonomic growth, it is beside the point, imo.

Arbitrage is about buying something at one price, then selling it back at a higher price, risk-free.

As I said before: Buying something at the current price on a given market, and selling later at the same market for a higher then-current price does not require arbitrage, by definition. Academic or otherwise.

[Jester]

No. Large inequality might lead to problems, or be a symptom of problems, but I don't see how it would be a problem in itself. The same goes for pyramid schemes.

But this is silly. It's like saying that heart attacks don't kill people, only lack of oxygen to the brain does. Or that lack of oxygen to the brain doesn't kill people, only brain cell death does. If there is a phenomenon that leads causally and directly to serious problems (pyramid schemes!), then it's just pointless nitpicking to say it's not the schemes that cause the problems. By that kind of logic, nothing causes anything. Things would be just "symptoms" of other things.

I don't really care who was first to use the word properly. I only mentioned arbitrage as one of the mechanisms that can induce autonomic growth of phantom capital, and used Wiki to get more information on it. I understand this issue is important to you, as a student of Economic History, but unless you want to imply that 'academic' arbitrage is what's in use, and that it could never induce this autonomic growth, it is beside the point, imo.

What is "phantom capital"? Even the most faulty arbitrage models are methods of finding prices, and on the basis of those prices, making trades. That means buying and selling things, even if those things are debts, options, futures, etc. Those things have specific meanings traceable back to the bread and butter commodities, even if their relationship is somewhat abstract. There is no "phantom" here - actual value is involved, however much it may stand at arm's length. Starting up the process with "no capital" involves shorting, and shorting involves credit - a type of capital.

As I said before: Buying something at the current price on a given market, and selling later at the same market for a higher then-current price does not require arbitrage, by definition. Academic or otherwise.

Arbitrage is not about selling something *later*, nor did I ever say it was. That's a different process - moving commodities over time. Arbitrage is about taking a gap between a known buying and selling price, and making a profit from closing it. Unless you have a crystal ball, you can't know prices in the future, and so "arbitrage" becomes risky - that is, not arbitrage at all.

-Jester

[kandrathe]

What is "phantom capital"? Even the most faulty arbitrage models are methods of finding prices, and on the basis of those prices, making trades. That means buying and selling things, even if those things are debts, options, futures, etc. Those things have specific meanings traceable back to the bread and butter commodities, even if their relationship is somewhat abstract. There is no "phantom" here - actual value is involved, however much it may stand at arm's length. Starting up the process with "no capital" involves shorting, and shorting involves credit - a type of capital.

I don't think the balloon problems stem from the people who engage in arbitrage. They tend to do as you say, and really do know what they are buying and the risks involved.

I'd focus on something tangible that balloons, such as housing.

Real-estate tends to be prone to malinvestment. According to David Wheelock (St. Louis Fed) the same reckless bubble in real-estate precipitated the crash in 1929. Generally, the number of dwellings plus rental properties should correlate to the number of people inhabiting the general area. When shortages occur, the prices tend to rise and building booms since those with land bought cheap can now build a bunch of houses and make a tremendous profit. However, the side effect is that all home values rise giving everyone the feeling that they have more wealth. Where I live, the home values nearly doubled from 2000 to 2007 (as well as the property taxes). The Las Vegas area had the biggest growth boom during this period (both in housing and jobs), and I don't think it is unrelated that their foreclosure rates (1 in 86), and unemployment rates (U6 as high as 25%, now around 21.5%) are the highest in the nation (on par with those during the Great Depression). The correction is occurring the strongest where "malinvestment" was at it's worst.

There is your phantom money. How could homes suddenly be worth double in such a short time. Prices become ludicrous (just as I explained about Google before they had an income strategy). People took larger and larger risks, and then couple that with relaxing banking standards where lenders also took bigger and bigger risks in lending their money to people that may never pay it back. Or, perhaps the issue lies with greedy loan originators that deceptively package loans, and then sell them off wrapped up as mortgaged backed securities. As we discovered during the congressional hearings, many of the Wallstreet insiders knew what was going on (borderline fraud), but they viewed it as an opportunity to make money by betting against their own employers, or company.

Obviously, the assets were eventually packed to be worth a couple trillion or so more than they were actually worth. When the balloon popped, the contraction over-corrected due to the uncertainty of just which loans would be considered malinvestment. This also froze the credit market, since suddenly nearly everyone in the financial world had over leveraged their borrowing, compared to their *actual* reserves. Housing still has not found its true price (again similar to the 1930's), since it is politically distasteful to force millions of people (weighted against the working poor, and minorities) out of homes for which they cannot afford to make payments.

What Would Milton Friedman Say?

I found the statement by Thomas Macurdy at end of that article prophetic, written the October before Obama won the election. "If this election goes the way it looks as though it's going to go, then the political system is about to get a major overcorrection to the left. And that means the American people are about to get an extreme illustration of just how badly government intervention screws stuff up. If Milton were here, he'd tell us to remember what happened during the Clinton administration. After just two years, the Republicans ended up in control of both houses of Congress."

Now all we need is a trade war with China to bring about the neo Smoot-Hawley.