BESTism, or how we can save capitalism from hollow consumerism

Before you dive into this piece, you might want to go back and read the original blog piece in which I introduced BESTism. It will save us both some time! 

You back already? That was a suspiciously fast read, but OK!

So as you know from having read that original piece (which you totally read, right?!), my goal is to suggest an alternative to our current system of consumerism in an effort to save capitalism from itself, because my feeling is that if we don't, the ever-widening inequality of our current system and the sense of purposelessness it brings will eventually cause it to collapse, and that would be catastrophic for our society.

Let's start by attacking and destroying a false premise, to wit: that capitalism and consumerism are essentially synonymous and the latter is inevitable in the former. You have only to examine other capitalist countries to see that in fact there is nothing inevitable about it if the people and their leaders choose to avoid it. We have not taken than route here in the US, so our economy is 70% based on consumer demand. And look where it has left us. Most people feel our country is on the wrong track. Millions of Americans feel hopeless and without a sense of purpose, driving addictions and suicide rates to ever-higher peaks. Opioid addiction is skyrocketing. Suicide rates have risen an astonishing 30% in just 17 years. I even think our obesity epidemic is partially due to this sense of hopelessness: we are becoming a nation of nervous, emotional eaters.

I believe these trends are tied to how hollow we collectively feel our pursuits are. There is no unifying sense of purpose. There is no moonshot. No war on poverty. No grand goals and projects to make us feel that we are all contributing to something bigger than we are as individuals. To change that, I propose we refocus our economic activity, not through command-and-control communism, but by a modified form of safety-net capitalism in which we direct more resources towards Building,  Exploration, Science, and Teaching.

Let me go ahead and rip a Band-Aid off for you right now: this absolutely means higher taxes for everyone. But before you balk too loudly at that, I ask you to consider not the COST of your current tax burden but your RETURN on it. Are you happy as a citizen? Are you economically secure and confident that you could stay that way if you encountered any setback? Are you healthy and assured of coverage if that changes? Are you confident in the infrastructure you rely on every day? If you answered no to those questions, or even most of them, then you should consider that perhaps you're getting a poor return on your investment with your taxes.

Before we move on to the BEST, let's start with two dependencies: health and basic economic security. If you don't have those two things, nothing else matters and you can't focus on the 'big picture,' since you are forced to spend all your energy on merely surviving  (which is key to why Republicans' success relies on keeping people poor and unhealthy). And right now, too many Americans don't have those basics. So to me, any successful system in the 21st century is going to have to have two features: universal healthcare and basic guaranteed income. I believe the simplest route to providing those is to expand Medicare to everyone, allow the importation of cheaper drugs from places like Canada, allow Medicare to use its leverage to negotiate better drug prices, and to send every US citizen and legal resident aged 18 and older $1040.83 a month (in 2019 dollars, adjusted by the trailing year CPI minus 0.5% every year, and fully adjusted for inflation every five years). Parents would also receive $368.33 per month per minor dependent. To keep the system simple, to avoid fraud, and to avoid rural voters becoming resentful of urban ones, I do not think we should make regional/urban COL adjustments. If local municipalities want to make up the difference, they can introduce local schemes to do that, funded by local taxes. For example, New York City may wish to introduce a local tax to supplement their UBI (universal basic income), given that one can't even rent a room in that city at that rate. Another advantage of UBI is that it eliminates our complex web of welfare programs. Combined with universal Medicare, we could eliminate dozens of programs, from Medicaid to SNAP to CHIP. And while yes, taxes would be quite high, keep in mind that your income is now supplemented and you never have to worry about healthcare premiums (except for Medicare supplements) and everyone is getting the UBI, so you're getting back a lot of that money. One question many people will want to ask is, does EVERYONE get the UBI? And the answer is yes. The goal is to avoid class resentment. We all get the exact same check every month, and everyone pays in. (And speaking of paying in, this system assumes we lift the cap on Social Security contributions. Retirement should be simplified, too, with Social Security payments simply becoming a threefold increase in your UBI check starting on your 68th birthday.)

A supplementary way to ensure everyone has the basics is to make work worthwhile. That means a minimum wage of $15 per hour for everyone aged 18 and over, to be phased in over four years,  and then to increase to $20 within four years of that. After that, we should permanently solve the minimum wage issue by pegging it to the CPI. It should increase automatically by the CPI minus 0.5% points every year, and have a catch-up with CPI every five years. (This is to avoid sparking inflation.) 

The above measures would be paid for by the appropriate combination of payroll, capital gains, and dividend taxes, and a yearly 4% wealth tax on the value of everyone's non-retirement stock/bond/mutual fund portfolios and bank accounts, with the first $10,000,000 exempt (with that threshold to increase automatically by the CPI every year).

So, now we have healthy citizens who don't live in constant fear of losing their jobs. All but the very least materialistic people are still incentivized to work, because very few people are happy living on such a paltry sum (though at least you won't starve if you're one of those people). Now we can focus on actually accomplishing something as a society, by dedicating more to doing our B.E.S.T.

1) Building. Think about all the ancient civilizations you studied in school. Rome. Egypt. Greece. Tell me the first thing that comes to mind. If you're like most people, I suspect your brain immediately conjured up images of amphitheaters, coliseums, pyramids, and temples. In short, the legacy you associate with these civilizations is most tangibly expressed in the buildings they left behind for us. What will future civilizations think of us based on our own works? Not much, quite frankly. They might be impressed with a few isolated works of architectural genius and a stadium or two. But mostly their archaeologists will just scratch their heads and say, "well, they certainly liked their strip malls and Starbucks, didn't they?"  

Another challenge for our country is our crumbling infrastructure. Thanks to the GOP's "Starve the Beast" philosophy, our investment in infrastructure has been entirely too low for decades now. The American Society of Civil Engineers gives us a D+. And I find that to be generous. Collapsing bridges, crumbling roads, outdated airports, poor public transportation: our country is quite literally falling apart. 

My recommendation is to drive both cultural and non-consumerist economic growth by making massive investments in building and infrastructure, both to leave a better legacy and to increase our current quality of life.

To the first goal, I would love to see every state and all five territories submit plans for a state monument to commemorate each locale's people, history, and culture, to be financed by the states and territories but with each dollar matched 1:1 in federal funds. Each state's legislature would approve the final project and its location, with Congress having a say in approving the matching funds in each individual case. Think St. Louis Arch, Statue of Liberty, etc.

To the second goal, we need to invest, invest, invest. To that end, I would suggest a ten-year, 2.8% tax on every transaction in the United States, including B2B ones and all capital gains and dividends (on top of current taxes). After 10 years, it would drop to a permanent 1.8%. In addition, we would need a permanent $1-a gallon-gas tax, to be increased by the trailing CPI + 0.1% every year. This is only fair: American drivers are not currently paying for the roads and bridges they drive on. Furthermore, this tax helps cover the negative economic, health, and environmental externalities associated with driving, and also offers a strong incentive for people to economize on gas consumption and seek alternative forms of transportation. 

This massive investment in infrastructure wouldn't just be about getting an A+ on our roads, bridges, railroads, ports, and airports. It would also be about expanding our transportation options, with investments in regional high-speed rail and, if the technology pans out, hyperloops.

2) Exploration. Few things gave Americans as much pride as our accomplishments during the Space Race of the 1950s to early 1970s. Putting a human being on the moon was an achievement for the  ages and to this day, half a century later, it stands as an enduring reminder of our former greatness. We can return to that greatness by kicking off a new, ambitious Space Race. But we should not just look to space: our oceans represent another Final Frontier, with so much of them still unexplored. Such exploration could teach us volumes about biodiversity, ocean sustainability, even basic biology and zoology, since we would doubtless discover new species. So aside from investing far more in NASA and getting them on their way to a quick return to the moon and a Mars landing by 2032, we should also establish an Oceanographic Exploration Agency. Finally, while it may sound like outlandish science fiction, we should also invest more in the greatest exploration of all: SETI (Search for Extraterrestrial Intelligence), or at any rate for basic extraterrestrial life. Research in this area in the past decade has shown that, with the right investment, our generation may be the last to think itself alone in the universe. I am not suggesting we have much hope of actually communicating with any alien civilizations. Unfortunately, the physics and the sheer size of the distances between star systems make this is highly unlikely if not impossible. But we are living in an age where we may yet be able to prove the existence of such life, even if it turns out to be simple in nature.

These initiatives would be funded by a 0.2% tax on all transactions in the United States, including B2B ones and including capital gains and dividends (on top of current taxes).

3) Science. Basic science drives technology. Technology drives change. Change drives culture and gives society a sense of direction. I think we need to invest far more in basic scientific research, with the benefits shared with all. I believe this can be done within our existing framework of universities, colleges, and government agencies, so to me this is just a simple question of investing more money through university/college grants and agency budget increases for agencies like DARPA, NIH, NIMH, CDC, etc. We also need to spur innovation in clean energy research, and nothing motivates innovation like necessity. I therefore propose that we phase in a simple mandate that wouldn't even require Congressional action: over the next ten years, every business with more than 50 employees that does government contracting work must be able to demonstrate it is getting 10% of its energy from renewables, increasing 10 percentage points each year. This will drive demand from energy consumers, and that will in turn drive innovation and change among energy providers. Another simple step requiring only executive action would be to declare that effective immediately, the US government will only purchase electric or hybrid vehicles for all its civilian vehicle fleet acquisitions. 

4) Teaching. Education isn't just a goal for its own sake. A better-educated society is a happier, more productive society, not to mention a society better equipped to drive the three goals above. The first thing we have to do is stop failing our poor communities. Since so much of school funding is driven by the local tax base, poor communities are stuck in a vicious cycle: too poor to educate their kids, who then grow up to get lower-paying jobs, which keeps the tax base low, which keeps school funding low. To solve this, I think we need to look at the poorest 40% of school systems in the United States and invest enough in them from federal funds to bring their spending levels up to the national median each year. To keep local government from slashing funds in order to qualify for more funds, we would measure this by the per-capita income of the residents of the school system, not by the amount of funds the locality chooses to dedicate, and funding levels would be judged by where they stood before the program was announced. These funds would be no-strings-attached. Let the local school systems decide how to educate their kids. The only caveat would be that we would need to set maximums for capital investments and minimums for teach salaries, because American school systems have an unfortunate tendency to over-invest in the former and under-invest in the latter compared to other countries.

Higher education. I hate the idea of government price controls. I truly do. Command-and-control economies always fail. But our colleges and universities are drunk with power. They know kids need those diplomas, so they keep jacking up tuition prices, often to spend on the most unnecessary of "investments." As a result, the ratio of tuition to average income gets more unsustainable every year. I propose a 30-year moratorium on real-dollar increases in tuition, with both private and public universities limited to tuition increases equal to the CPI minus one percentage point each year or wage growth minus one percentage point each year, whichever is lower. This needs to last a generation to undo the obscene increases of the past generation, increases that have seen the end of the age when people could work their way through school on their own and the dawn of the age of massive student debt. Tight regulations and oversight would be required in order to avoid the creation and exploitation of loopholes. (Think "Oh, we didn't increase TUITION. We increased USER FEES. See, that's totally different!") I also propose that all college students receive $2000 per month while enrolled in school, with assistance ending for any student whose overall GPA falls below 1.8 on the 4-point system. This assistance would last two years for an Associate's degrees, four years for a Bachelor's degree (five in special cases, e.g. some engineering undergraduate degrees that take five years). Students would be on their own for graduate work. Finally,  we need to reverse the law that made it illegal to include student debt in bankruptcies. There is no rational reason this debt should be excluded. It was a sell-out to the student loan industry, nothing more. 

These goals would be funded by a 5% tax on every transaction in the United States, including B2B ones, and on all capital gains and dividends.

In all cases where we raise money from taxes on transactions, this would include on sales to or from the government. It may sound silly for the government to pay itself taxes, but it's important we capture revenue from the entire economy, so the taxes would be transferred from the purchasing agency to the IRS.

One final word on revenue. To achieve our goals, we are going to have to address the elephant in the room: our out-of-control and irrational military spending. I am not a dove. In a world in which authoritarian regimes like Russia and China are on the rise, we cannot unilaterally disarm or even slightly weaken our military readiness. But our budget long ago stopped being about military readiness and efficiency. It is about delivering pork to Congressional districts and to the defense contractors who pay the lobbyists and contribute to campaign funds. Consider the fields of tanks that have never been and will never be used (and the military knew that when they bought them); the planes that were obsolete before they went into production; the ships that don't even work. These are all billions and billions of wasted dollars that do absolutely nothing to strengthen America. Quite the contrary: they weaken us. Meanwhile, our soldiers are paid disgracefully and often do not have the things they need. And don't even get me started on how shabbily we treat our veterans.

So what needs to happen? We need to establish a non-partisan, Congressionally-appointed commission to do a two-year, program-by-program audit and evaluation of the entire military budget for all branches. We need to evaluate not just programs but bases, both domestic and foreign, as well as all inventory, all with only one question in mind: does this help us face the threats of the 21st century, including the three main threats (terrorism, cyber warfare, and the potential for wars with China and Russia)? If it doesn't, it needs to go. Also, we need to pay our soldiers better, especially the enlisted ones. I think it is very realistic to cut military spending by 15%, increase pay for enlisted by 10% and commissioned officers by 5%, and actually INCREASE our military readiness and strength in the process. This needs to be a standing committee once its work is done, because we need to rely on them, not partisan pork-seekers in Congress, to evaluate what is best for our defense. Congress could agree to pass only legislation that includes commission-approved programs and budgets. This takes the political pressure off of them, as they can say to constituents that they are bound to obey the recommendations of the program. This could easily save us $120 billion a year.

So there it is. That is my model for how capitalism can save itself. No big takeovers of industry by the government. Minimal interference in the capitalist free markets. Just an investment in making us a healthy, happy, educated society with a sense of common purpose and a dedication to leave a livable planet and a vibrant legacy for our children and our descendants.

Living with Consequences: Principles v People

What I have never been able to understand about the reasoning of the American Republican party, is how it manages to separate principle from consequence with no apparent self-awareness whatsoever. It's tempting to label this as simple, blatant and willful hypocrisy or bad intentions, but that is too easy: we can't just dismiss a significant portion of the population as evil and leave it at that. For one thing, I personally know several Republicans who suffer this disconnect in their thinking, and I can tell you that they are not evil people. Quite the contrary: some are among the kindest people I know. Some are also quite bright, as are many Republicans (despite what left-wing talking heads would like you to believe), so we can't set their beliefs aside as the inevitable outcome of unintelligent people making policy.

So whence the disconnect? I think it stems from two things: 1) an inability to empathize with anyone outside your own sphere of direct experience and 2) an inability to connect principles on the one hand with the logical consequences of acting on those principles on the other. I won't touch that first point as I am neither psychologist nor father confessor. Lack of empathy is a personal problem people need to address through self-examination. But let's look at some examples of that second point.

1) Principle: A combination of small government/low taxes increases freedom and thus happiness. Practical consequence: poor services and infrastructure reduce the quality of life for all. This wouldn't be so bad if Republicans admitted the relationship between these two and asserted that the consequence was worth the principle. But they defiantly refuse to admit that there is a direct, indisputable link between starving a government of funds and that government being unable to provide services and infrastructure that everyone, Republicans included, takes for granted. You hear examples of this all the time, every time you hear a Republican friend complain about potholes or bad schools or poor funding for the police in one breath, while in the next breath bemoaning their high tax burden. There is no such thing as a free lunch: you either pay the price for civilization (i.e., taxes) or you live without the trappings of a civilized society, leading to generally low levels of life satisfaction. Ah, Republicans counter, but wait! It's not that we are saying that all taxes are bad, just that we could have all these nice things with current taxation if only the government didn't waste so much/wasn't so bloated. There's just one small problem with this argument: it has little basis in reality. I am not suggesting the government doesn't waste money. No government since the dawn of civilization could make such a boast. But if you actually take the time to look at the US federal budget and cut away every single thing you could conceivably consider as wasteful, then add in all the things we all want (but that some of us refuse to pay for), you come up with a total that is greater than the sum of taxation that Republicans are willing to pay. Don't take my word for it. Look at the federal budget. Cut away whatever you hate (foreign aid, assistance to the poor, whatever); leave the stuff you like (military spending, servicing the debt in order not to default, Social Security and Medicare, national parks, law enforcement, etc.) and add in what it would take to meet the needs not currently being met (the ones you complain about all the time, e.g. poor roads and bridges, unevenly and poorly funded schools, understaffed agencies that make you wait longer than you'd like, etc., etc.). I guarantee you that unless you are the most hard-core libertarian around, you still have a budget whose needs are not met by the size and revenues of our current government. Do the math. You will be amazed.

2) Principle: government debt is bad and must be stopped at all costs. Practical consequence: starving the economy, harming our creditworthiness and creating an unstable economic environment. First a major correction to the conventional wisdom that right-wing governments are more responsible with spending that left-wing governments: this simply isn't true, either here in the US or in Europe, as I showed in a 2012 post. The indisputable, easily verifiable fact is that most of the current US federal debt was run up under Republican administrations. But let's put aside blame and focus on consequences. The fact is that national debt is not (despite the folksy wisdom of some populists) anything like extravagant household credit card debt; it can be and often is an investment in growth, and, depending on interest rates and needs, can be a very smart thing to have. For example, if you have a bridge that is falling apart today and you can borrow $100,000 at 3% to fix it now versus waiting til it collapses in five years and spending $10,000,000 to rebuild it, is debt bad here? If unemployment is high now and that is draining resources from unemployment funds while also reducing the tax base, is it better to allow that to continue with no debt or invest in fixing both the drain on resources and the damaged tax base? Government debt is an investment tool. When used wisely, it is not inherently evil. Granted, we have often used it very unwisely, but for those cases, you might want to look more at Reagan in the 1980s and Bush II in the 2000s, when all we got were irresponsible,  deficit-ballooning tax cuts and huge spending programs that did nothing to boost the long-term health of the economy.

3) Principles: government shouldn't tell the private sector how much to pay workers and government aid to the poor in unsustainable. Practical consequence: a poor minimum wage that has failed to keep up with inflation means that there is ever MORE pressure for the government to help the poor. You want to reduce Medicaid and welfare and food stamps? Much of this money goes not to the so-called 'idle poor' but to the working poor, including the lower ranks of our disgracefully-paid military servicemen and -women. So you can't have your cake and eat it, too: we either have to insist on a decent minimum wage and benefits to allow the working poor to support themselves, or you have to accept higher expenditures on aid to the poor. You can't have both a low minimum wage and a self-reliant lower economic class. It simply isn't realistic. Again, no free lunch.

4) Principle: sex education is immoral and it corrupts children. Practical consequence: higher teen pregnancy rates and more abortions, two things Republicans also decry. There are few areas where disregard for the practical consequence of principles does more harm than here. The bottom line is that abstinence-only 'education' simply doesn't work. Giving children the real facts about sex, birth control and sexually transmitted diseases, is far more effective at reducing teen pregnancy, the demand for abortions and STDs. This is not an opinion: there are mountains of data to prove this. Don't believe me? Try looking at a map of the distribution of teen pregnancies and STDs and comparing them to the red state v blue state electoral map and tell me you don't see a pattern.

I could go on, but the picture is clear: Republican principles are completely divorced from their practical outcomes. But what causes this disconnect? I think part of it is the nature of what drives the Republican mentality: unquestioning conformity to principles that are often seen as either divinely mandated or as part of an obligatory legacy of the Founding Fathers. I can't understand the logic of either of these. Even if I believed in a god, it would be one who cared about the actual outcomes for its children. And as for the Founding Fathers, the one thing people forget is that their real legacy is a framework in which we are free to create (and re-create) our own country for our own times. With all due respect to them, they were creatures of their age, and I don't know about you, but I don't want to live in the 18th century. They were a wise group, but they were, by our modern standards, also pretty misogynistic and racist. I do not judge them for that: we are all products of the age in which we live; but neither do I set such people as infallible demi-gods to whose values and ideas and structures I must cling. And they never expected us to: that's why the Constitution is a living, changeable document and one subject to the tradition of juris prudence, a tradition that allows us to adapt this document to changing values and circumstances. Such malleability is key if we are to maintain our Constitution in an ever-changing world. The Fathers couldn't have foreseen ICBMs and Uzis, the end of slavery and the liberation of women and minorities.

So how do we work with people who believe that they cannot be wrong because their principles come from on high? Well.....we don't. Sorry. Not that I don't want to, not that I don't wish we could, but by definition of who they are, it simply isn't possible to treat with the more radical wing, especially the Tea Party extremists, because their mentality leads them to classify reason and compromise as treason. You can't negotiate with someone who believes he is divinely instructed to do what, and only what, he thinks is necessary, facts and the practical consequences be damned. So all we can do is build as large a coalition as possible of liberals, centrists and the ever-fewer reasonable right-wingers and try to work around, over and under this group and wait for what always happens to reactionaries: their burial by the crushing judgement of history and the unstoppable (if slow) wave of change. The worse they can do is slow us down for a while. 

The Capitalist Case for Government

Libertarians are an interesting lot. They espouse the idea that almost any government is bad government, that the role of the state should be limited to national defense and a select few other tasks. To the extent they are talking about civil liberties, I tend to agree with them: I see no reason for any Leviathan to tell me whom to marry, what drugs I am permitted to ingest, what I can or can’t say, what a woman chooses to do with her body, etc.

But when it comes to what the government should do, what role it should play in the economy and infrastructure, I become confused. As you delve deeper into libertarian beliefs (and on this subject they are joined by right-wing Republican beliefs), you soon learn that they are rooted in a deep faith in capitalism and the wisdom of the markets, in the benevolent guidance of the ‘invisible hand’. But the idea that the state has no role to play in the economy is in fact quite anti-capitalist because it ignores a fundamental underpinning of capitalism, something so basic that it is really part of the definition of capitalism: comparative advantage.

The concept of comparative advantage was first described by the father of economics himself, Adam Smith. I’ll let Mr. Smith sum it up in his own words: "If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage." Of course, it doesn’t have to be a foreign country: it can be any entity that has an advantage over you in how efficiently or cheaply it produces a good or service. This isn’t just a principle or an abstract idea: it’s a mathematically provable fact. If you take two goods (or services) and I produce one well and you produce another well, protectionism or any other means of excluding you from production or market participation makes no sense as we are both materially better off if we trade. In fact, it goes even further: even if I am better at both of these things than you are, we are still both materially better off if I perform the task where my skill most exceeds yours and you perform the other.

So what does all this have to do with why libertarians, and right-wing Republicans who claim to be capitalists, shouldn’t object to the many things modern governments do? It’s because with quite a lot of the tasks required to survive and thrive in modern life, governments enjoy a distinct comparative advantage over individuals and even corporations and other organizations. Let’s take safety inspections as an example. A strict libertarian says that safety of the food supply should be left to producers, because it is in their best interest not to poison their customers, who, if so poisoned, would punish them by not buying their products.* A single, centralized governmental food safety organization enjoys a distinct comparative advantage over private industry here, and certainly over individuals. The collective cost of all Americans being responsible for their own food safety testing is ridiculously higher than what a single agency would cost to perform this task for us all. Even when compared to industry doing the testing (assuming we were foolish enough to trust them to do so), government still enjoys the cost advantage through economies of scale and centralization that help avoid redundant costs and resources. So why not be good capitalists and pay them to do it through our taxes?

The same principle applies to a vast array of goods and services. Health insurance is another, much as American Republicans and libertarians deny it. The verifiable fact is that programs like Medicare and Medicaid have far less costly overhead and operating expenses than do private insurance companies, who must pay for things like marketing and who of course must make a profit. At the other end of the spectrum is something like manufacturing, a task government is quite ill-suited to perform because, due to elasticity of demand, competition is key to (and effective at) driving efficiency and innovation, and a government take-over of such a task would by definition eliminate such competition. And therein lies one of the keys to deciding what government should and shouldn’t do: price elasticity of demand. That’s just a fancy way of saying that people will demand something like healthcare service at roughly the same level regardless of price (so it is quite inelastic). You don’t say, ‘no thanks, I’ll just leave that arm broken or let that cancer grow because the price is too high’ the way you would decide to walk or take the bus if car prices went up too much. That’s why it does make sense for healthcare insurance to be a government task while car manufacturing is best left to the private sector: prices for cars are quite elastic since people have many options, thus ensuring that there will be fierce competition among makers to innovate and keep costs low through efficiency as otherwise they lose business either to competitors or to alternative means of transportation. The list of examples could go on and on: roads, emergency services, schools on the one side; manufactured goods and value-added professional services on the other side.

So if our libertarian and conservative friends want to be good little capitalists, let them prove their understanding of capitalism by applying a reasoned, rational test - versus an emotional, irrational and ideological one - when deciding what the government should and shouldn't do. If government enjoys a comparative advantage, and especially if the good or service in question suffers from highly inelastic demand, then let them do it and pay them a fair price (through reasonable taxation) to do so; else, leave it to the private sector.

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*Let’s put aside for the moment the absurdity of allowing people to die in order to allow the market to adjust itself. Let’s also put aside the fact that poisoning with chemicals and impurities can take years if not decades, thus leaving companies with a profit motive to continue poisoning in the short to medium term with no fear of retribution from the marketplace during the lifetime of current management.

What the European Debt Crisis ISN’T: A Contrarian View

The conventional wisdom of late is that the debt crisis in Europe is a result of profligacy and poor public policy leading to out-of-control public debt, which in turn causes higher interest rates, which in turn choke growth. The sentiment here in the U.S. seems to be that such results are the natural outcome of overly-liberal policies of public spending on social programs, pensions, etc. I'm interested in examining these assumptions and seeing if they are truly valid. Having done so, the result is a contrarian view, one that seeks to cast the European debt crisis in a new light.

The roots of the European Debt Crisis arguably go back decades, all the way back to the beginnings of post-war European economic growth, social program planning and pan-European integration. The crisis itself, however, began in February of 2010, when Greece’s struggle to put its financial affairs first gained widespread public exposure when their government announced drastic measures to increase revenue and cut spending. Since then, the crisis has spread to other countries and now threatens the very foundations of the European Union and the very existence of its common currency.

Given the vast size of the economy of the Eurozone and the large number (17) of different sovereign countries in it, any attempt to analyze the entire scope of the crisis as it impacts all the relevant countries, would stretch to a (lengthy) book, so I'll limit the scope to eight players: Greece (since it is there that the crisis originally flared up), Spain and Portugal (typical representatives of other developing, heavily-indebted Western European Eurozone economies), France and Germany (because these are the pillars of the Eurozone and the prime movers behind European unity since World War II), as well as Italy, Netherlands and Belgium (representing wealthier Western economies). This selection gives us a good cross-section of the Western European politico-economic scene.

I will use this cross-section of the European Union (EU) to examine the nature and consequences of the debt crisis, taking the contrarian view that far from being a crisis caused by public spending, it is in fact a crisis of perception and of overly-conservative, anti-Keynesian government policies.

A note re terminology: in the context of this analysis, I'll often refer to ‘poor’ and ‘rich’/’wealthy’ countries. It must be stressed that these are relative terms appropriate only to the European context. For example, Greece may be ‘poor’ by Western European standards, but by global standards, it is in fact quite wealthy.

What the Debt Crisis ISN’T

The general sense one gets from observers of the debt crisis is that unmanageable sovereign debt is primarily a problem stemming from poorer countries in the zone and often associated with excessive government largesse (which in turn is associated with left-wing governing parties who favor higher social spending). The talking heads and pundits in the media also make much of the 100% threshold: a country that owes more than it produces in Gross Domestic Product (GDP) in a given year must be a country beyond hope. (One wonders why one calendar year is somehow such a magical figure? Why not debt v two years of GDP? Or six months? From a quantitative point of view, this ratio is arbitrary.) However, my analysis of these eight countries’ debt and political situations from 1995 to present reveals a very different picture. First let us look at debt as a percentage of GDP for the eight countries:


Fig. 1: Debt as % of GDP, 1995-2010

Of the three countries consistently above the group’s 16-year average, one was (relatively) poor Greece, but the other two were Italy and the Belgium, two wealthy countries with strong, advanced economies. And of the three with the lowest debt levels vis-à-vis GDP, we find two are poorer (Spain and Portugal) and only one is a wealthy country (Netherlands).

Perhaps it is a question of political ideology then? Are tax-and-spend leftist parties running up wild debts? Again, reality is quite different from expectations. If we examine these countries’ debt as percentage of GDP in years when they were ruled by left-leaning parties v years when they were ruled by right-leaning parties, a startlingly consistent picture arises:


Fig. 2: Debt as percentage of GDP in selected countries under Left v Right governments

In every single case (albeit by an extremely slim one in Portugal), the average percentage of debt was higher on average under right-leaning governments than under left-leaning ones. For the group over the 16-year period, the gap was 8.2 percentage points.

Regardless of who ran up the debt and the characteristics of countries that have done so, does high debt by itself lead to ruin? Obviously not. Let’s take that arbitrary 100% threshold and look at countries that have such high levels of debt. In the 2000s, before the debt crisis, the three ‘worst’ debt countries noted above (Italy, Greece and Belgium) had GDP growth of on average 1.48%, practically indistinguishable from that of the ‘best’ (Portugal, Netherlands, Spain) at 1.44%.

What about the impact of high public debt on interest rates? It is often argued that the very high level of public debt in several European countries has been the culprit for higher interest rates, which in turn put a chokehold on growth. But as Henri Sterdyniak argued in his presentation to the Franco-German Conference in May of 2010, this is not a tenable argument, given that the higher levels of public investment (and thus debt) merely offset lower borrowing by the private sector, leading to no net increase in debt. In his view, it is thus “ridiculous to pretend that high public debt will bring high interest rates.”

So if these high levels of public debt are not caused by out-of-control left-wing spending binges in poorer countries, they are not choking growth, not leading (directly) to higher interest rates, then what exactly is the crisis about? In my view, it is a crisis of governments being driven to panicked and ill-advised policy shifts by markets that insist on austerity and restraint at exactly the time that traditional Keynesian economic policy tells us we should be doing the exact opposite. This alternative viewpoint is not unique: analysts such as Sterdyniak take the same position.

As evidence to support this thesis, look just outside the Eurozone at the United Kingdom. Following their election victory in 2010, the new Conservative government implemented severe austerity measures to get government spending and debt under control. The impact on the economy has been noticeable: in the four quarters prior to austerity measures taking effect (Q4 of 2009 through Q3 of 2010), UK economic growth lagged Eurozone growth by less than 1/3 of a percentage point. In the subsequent four quarters (Q4 2010 through Q3 2011), that spread more than doubled to .75 percentage points of growth. Applying Okun’s rule of thumb and given the size of the UK labor force, this translates into thousands of more unemployed British workers, which in turn only reduces the tax base even more, while increasing the strain on already curtailed public services, thus reinforcing a vicious cycle with very real human costs.

Unringing the Bell: European Integration Too Advanced for Retreat

Regardless of the causes and consequences, the question must be asked: can Europe simply turn back? The knock-on effect of the crisis from one country to the next is a result of these countries being bound together by a single currency, so could the Eurozone simply go back to the pre-2000 world and restore their national currencies, freeing up each country to pursue its own fiscal policies independently? In a word, no.

First of all, the euro is not the only thing – or even necessarily the most important thing – binding the 17 countries of the Eurozone (not to mention the 27 of the wider EU) together. Economic integration began long before currency integration, and it has advanced too far to be unraveled without serious consequences. One stark example of this is the debt itself: it is spread around Europe in a complex web of interdependence such that, for example, French investors have USD 365 billion worth of exposure to Italian debt; Germany USD 117 billion in Spanish debt; and Spain USD 325 billion worth of UK debt. So no country can afford to see any other country go under without serious consequences for its own economy.

Economic interdependence aside, there is also just the sheer legal and financial complexity that would accompany any attempt to turn back the clock. Consider the billions (if not trillions) of euros worth of personal/consumer debts, contracts, purchase orders and other agreements currently in effect and denominated in euros. Now imagine these 17 countries reverting back to their respective francs, marks, pesetas, etc., and trying to revalue these old currencies in light of new realities and then adjusting terms, payments and contracts accordingly. The resulting lawsuits alone would be a nightmare.

So it is unlikely that Europe can go back. But how can it move forward when the Eurozone members have such varying levels of debt, creditworthiness, local policy and sometimes conflicting needs? There is a growing consensus among Eurozone leaders that the status quo will not hold. In December, European leaders met at a summit whose aim was nothing less than the salvation of the euro through ever-tighter integration and stricter rules. By the end of the week, the road map was clear: for better or worse, there was no going back.

Conclusion

I've sought to look at the European Debt Crisis in a new light. The resulting analysis has shown that the crisis is quite different in nature than the ‘talking heads’ have portrayed it, both with respect to cause and impact. I've also shown that the reaction to the crisis in the form of austerity measures, may in fact have proven counter-productive. Finally, I've shown that for all the perils of integration, the Eurozone countries cannot go backwards: a way forward must be found.

Unexpected Things from the Left

People whose political leanings are obvious, tend to be equally obvious in their proclamations. Republicans talk about tax cuts, deregulation, God and the flag. Liberals like me talk about regulation, fair taxation, effective government programs, freedom of speech, etc. So every once in a while I think it's a good idea for people from one side of the aisle to talk about ideas they like from the other side. Here are a few of mine.

Corporate taxation. Liberals love the idea of taxing corporations, because many on the left see it as some sort of punishment to inflict on institutions we see as inherently evil. I couldn't disagree more. First of all, corporations aren't evil: corporations are simply abstract legal entities devoid of any human qualities, and as such, they are incapable of evil. The humans who run them, on the other hand ARE capable of evil, but they are not directly impacted by how much or little their corporations are taxed, as evidenced by the out-sized pay-packets they receive regardless of corporate performance. Where corporations excel, however, is creating jobs. So why do we want to tax them at all? Every dollar they keep is a dollar that can go towards job creation, while every dollar that goes to the wealthiest people who invest in them, is a dollar towards idle capital that does little for the country. This is what Republicans like Eisenhower knew, which is why the marginal tax rates on personal income were so high. So, leave corporations alone and raise the marginal tax rate on personal incomes. In other words, tax the hell out of the people behind the corporations, but leave the real job creators, the corporations themselves, alone.

Foreign policy: Contrary to expectations, many (most?) liberals are not anti-war; just anti-stupid-war. This is clearly seen in the way many of my fellow liberals and I distinguish between the Iraq and Afghanistan wars: we opposed the former because the intelligence was flaky at best and anyway Saddam wasn't involved with 9/11; we supported the latter because the Taliban proved themselves to be an actual threat to the US and as such were fair game.

Illegal immigration: I part company with many of my fellow liberals on this issue. I have nothing against immigrants and certainly nothing against the many ethnic minorities who make up the immigrant population. I think it's foolish and hypocritical of anyone of non-Native American descent to oppose immigration, since such people wouldn't be here without it. But immigration can't be a free-for-all and turning a blind eye to illegal immigration isn't fair to the people who wait patiently to come to this country legally. There's also the question of rule of law: we take our strong institutions and rule of law for granted here, but there's nothing inevitable about them and they can be weakened over time if as a country we routinely allow large groups of people to ignore laws just so we can either assuage our liberal guilt (on the left) or pander to business's need for cheap labor (on the right). Soon we will start to flout other laws as expediency demands it. Soon thereafter, corruption overtakes the system and the country we love is gone, destroyed not at the hands of the immigrants, but at the hands of the citizens who neglected rule of law.

I am in favor of something pretty shocking: taxing the poor and giving to the rich. OK, it's not actually as bombastic as it sounds. I am actually in favor of equalizing wealth disparities through greater net redistribution towards the poor. But one thing I learned when living in Norway is that for such equalizing policy to work, all members of society have to be seen as contributing, just as all must benefit. If only one segment of the population contributes (those making over a certain amount) while it is only those below them economically who benefit, resentment and bitter division are inevitable. We see this all too vividly in our current political and social discourse. The poor resent the rich and the rich resent what they see as subsidizing the poor, who pay no net income tax. So bring everyone into both the giving and receiving. Everyone who earns anything, even one penny, should have to pay some of that in tax, however small the amount may be. In this way they have the self-respect of knowing they are contributors and the wealthy can't claim that only they are giving. On the other side of the economic spectrum, we should oppose attempts to introduce means-testing for Social Security. Do the rich NEED that extra money? No. But does society need all contributors to be beneficiaries to maintain the social contract? Absolutely. So by all means cap Social Security, but don't eliminate it for the rich, or we will suffer even more division. Having said that, though, this also justifies removing the income contribution cap: the wealthy should have to pay their percentage of Social Security contributions on ALL income, with no limit.

The Case of the Disappearing Money

If Republicans, conservatives and many Americans of any political stripe are to be believed, the single greatest and most urgent mystery in modern times is this: where is all the money disappearing to?! If we believe them, every dime you pay in taxes, every penny that goes into a government job or contract, every nickel paid to fund anything done by the government, simply vanishes. That's why, by their reasoning, taxes should be as low as possible: every dollar not paid in taxes goes to the economy, while every dollar paid to the government simply vanishes into thin air, never to be seen again.

OK, they admit, the money doesn't disappear, but it isn't used as efficiently by the big, bad ol' government as it could be used by the Glorious and Patriotic, Wonderful PRIVATE SECTOR! (Cue marching band and fireworks! Serve the apple pie!) And everyone - and I do mean almost everyone, including most Democrats in this country - buys into this, to the point that it is simply a given in our national dialogue. President Obama, for example, takes it as the gospel truth that tax cuts=more prosperity.

And as we saw just this past week, this Mystery of the Disappearing Money also applies to the costs of conforming to regulations. President Obama did what he always does these days and caved to Republicans by withdrawing his administration's plan to tighten smog regulations because it would 'cost' tens of billions of dollars at a time when the economy needs the money to create jobs. So he has implicitly accepted that money spent on these measures just turns to dust and blows away.

Just one small problem with this reasoning: it makes no sense whatsoever and is not supported by facts or reality. (Other than that, though, it's perfectly reasonable.) Let's look at the cost of conforming to regulations that improve air quality, for example. Let's say it is the worst-case scenario and it's tens of billions of dollars. Do those tens of billions of dollars simply go into a giant paper-shredder? No, they go into contracts with other companies to implement particulate- and pollution-reduction measures, and those contracts create new jobs. They go into the purchase of new equipment to reduce pollution and waste, again creating jobs and making the polluters more efficient to boot (which has long-term economic benefits of its own). And on the savings side, the effects of lower levels of smog redirect billions away from healthcare costs and into sectors where the same money can create more new jobs.

And what about all that 'wasteful' government spending? It's certainly true that governments do have a talent for inefficiency and waste, as all large organizations do; but it's by no means true that the government is always worse than the private sector, and in many cases it is considerably better. For example, Medicare actually delivers healthcare at a more efficient rate than do private insurers. And as we have just seen very recently, when you compare the performance of government-run foreign aid, reconstruction and military support services and infrastructure to such programs carried out by private contractors, turns out big, bad ol' Uncle Sam is far more cost-effective and efficient than the private sector, where not only costs are higher but corruption and waste are rampant.

And one must distinguish between government spending and government investment. The former is expenditure on a short-term need that while important to meet, may not lead to any positive return down the road. But government investment is money spent by the government to ensure long-term needs - ones that can not be met by the private sector - are met in order to support the economy and society of our country. Those investments normally have positive returns on investment, returns that can and should be measured and made public to set them apart from mere 'spending'. Take roads and other infrastructure projects. The private sector is simply never going to step up and say, 'hey, let's pay billions of dollars to improve roads, rebuild bridges and replace our rotting, dangerous sewage, drainage and water management systems in this country.' But without that investment, the private sector will lose more and more money over the coming years due to everything from supply chain disruptions caused by poor roads to closures caused by preventable flooding and water-supply interruptions. Addressing those issues will save billions and create a lot of jobs in the process, while delaying them does us no favors anyway: a repair that might take $5,000 today may cost 2-3 times that much if we wait too long.

But wouldn’t raising taxes to balance the budget and repair our embarrassingly-poor infrastructure just make the wealthiest Americans scared to invest? After all, we keep hearing that trillions of dollars in cash are sitting on the sidelines due to investor skittishness. Republicans point to this huge cache and claim that its owners are just chomping at the bit to invest it, but alas, with so many regulations and taxes, what’s a billionaire to do? What utter and complete hogwash. These claims do not bear up under even modest scrutiny. In fact, the existence of all that sidelined money is an argument in favor of taking the opposite approach favored by Republicans: the wealthiest 5% of Americans, the ones who are sitting on these trillions, have absolutely no motivation whatsoever to invest it in jobs, even if conditions were ideal, so why keep their taxes low and allow them to accumulate even more money just to see it sidelined, too? With such vast wealth concentrated into so few hands, those people no longer need to invest to secure their financial futures. At some point, it is simply safer to live on that accumulated wealth, especially when the economy is uncertain. In short, they have no motivation to create jobs and add value for the economy. But if we taxed those wealthiest Americans and invested that money in the economy by funding things like sorely-needed infrastructure improvements, we could force that money off the sidelines and push it into the hands of the lower 95%, who simply have no choice but to spend and invest it, since they have unmet needs and must still work hard and invest to secure their futures.

So, we want to create millions of new jobs and get this country moving again? Then let’s do what past Republican and Democratic presidents alike have known to be the sensible thing: return to a tax policy that discourages the accumulation of idle capital and that uses a high marginal personal tax rate to keep funds flowing through the system. Use those high marginal tax rates on the wealthiest to balance the budget, cut corporate taxes and rebuild this country. Then step back and watch our America get back to work.

Lies, Damned Lies and....Averages

Mark Twain famously said that there are three kinds of lies: Lies, Damned Lies and Statistics.* I'd amend that: Lies, Damned Lies and Averages. Averages hide a multitude of sins, lies and distortions, especially in politics. Consider a statement like this:

"My fellow Americans, consider the past ten years: on average household income has increased 28%. The average American now has 49% more money invested in stocks."**

People nod and agree how wonderful things must be on paper, even if personally they do not feel richer or better off....and with good reason. Consider the analogous situation:

I have 100 pies. You have 2 pies. On average we have 51 pies, even though I have 50 times more pies than you do. Tomorrow I get ten more pies and you lose one pie. On AVERAGE, pie ownership has increased almost nine percent. On AVERAGE, we each have more pies than yesterday and on AVERAGE (and at aggregate level), the total number of pies is going up. But are you better off that you were yesterday? Certainly not. Oh, well....at least 'on average' things are going swimmingly.

When wealth in this country is finding its way into fewer and fewer hands and as the gap between the richest and poorest continues to grow, dishonest people distract from this by touting averages in exactly these ways, proving once again that in the hands of talented political consultants, even the truth can be used to lie. Until people start learning to dig deeper, we will continue to be bamboozled by people who assure us that on average, things are going well, even when it's just a tiny sliver of the population that is benefiting.

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*Actually, he attributed the quote to someone else, but there's no evidence that person ever said it, so we may as well call it Twain.

**These are not the actual figures; this is just an example.

Of Gracchi, Gross Domestic Product and Growing Unrest

Looking at the riots in the UK and (earlier this year) Greece, I have to say that I am reminded of Rome in the final days of the Republic. The gulf between rich and poor was growing ever wider, more and more people were dispossessed even as the wealthiest patricians grew ever richer. A revolution was stirring and two brothers, the Gracchi, hoped to ride it by leveraging the power of the plebes to effect change. They were each in turn murdered by a patrician class determined to preserve its power. Within another century, the Republic was swept away in favor of empire and the aspirations of plebes were dashed for another couple of thousand years. In short, there was a revolution and it was successful: it was a revolution by the ruling class to ensure their power would be cemented for a very long time to come. And it worked.

In the early 20th century, the 'plebes' tried again. This time they were successful. And that turned out even worse! We got three generations of mind-numbing, soul-crushing, oppressive dictatorships in the name (but scarcely to the credit or benefit of) the working classes. So revolution from the bottom up was just as helpful as from the top down.*

So perhaps instead of revolutions from either direction, we could perhaps have the wisdom to see the telltale signs of growing disaffection and take rational, reasonable, measured steps to stave off any radical moves from the top or from the bottom? Maybe Western governments need to take the British and Greek riots as wake-up calls and address the underlying causes of discontent . Across the developed world, people are fed up with the working and middle classes having to bail out and pay the price for what is increasingly looking like an oligarchic kakistocracy.

And as far as telltale signs go, how is the looting the poor in London committed different from the looting the banks did of that (and my) country? They were bailed out by everyone (poor included) while their executives were receiving huge bonuses and while the politicians who were supposed to be regulating them were at best absent, at worst complicit. If that's not looting, what is? Why is that morally better than smashing a window and grabbing a TV? My point is not to condone the rioting. It was wrong, period. But I just don't think it was that much morally worse than what the patrician class was already doing (and the riots caused a lot less monetary damage than the bailouts). But how many of those bankers went to jail? Again, I am not - REPEAT NOT - condoning the riots and their violence and destruction. I merely question the wisdom of our society's decision to condemn them while accepting other, equally immoral acts.

I do not say this to rabble-rouse. I am no Bolshevik or revolutionary for any class of people. I mean this as a warning sign: if we kill the Gracchi OR the czars, either way the story ends in blood and tears.

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*This is of course a gross oversimplification, but what do you want? It's a blog and I summed it up in two paragraphs!

B.E.S.T.

Since the collapse of the colonialist/mercantilist era, all the great economic -isms have been centered on how national economies can increase, maintain, and internally distribute their fortunes. The hows were always predicated on the whys: we created and maintained wealth in a capitalist economy through free-market mechanisms because we believed that the wealth of the individual was an extension of the freedom of the individual; or we created and maintained a command-and-control economy through centralized planning because we believed that the wealth of the society was an extension of the responsibilities of the individual towards the society.

Spoiler alert! Looks like capitalism is more or less in the lead. We are still arguing about degrees, but there is now no major debate, even in 'communist' countries*, about the suitability of the free-market capitalist model. So for the sake of argument, let's call it settled.

So the -isms of the 21st century must turn on very different questions. It is no longer a question of how we gain our wealth, but how we spend it and how we build the legacies we endow with our wealth. And make no mistake: it is a huge amount of wealth, despite the setbacks of recent years. Compared to any other time in history, people in developed countries are better off than ever before. Your average lower-middle class American enjoys better food, shelter, and technology than any medieval emperor could even imagine.

If you are a pure free-market capitalist, the answer to how to spend this wealth is very simple: have few to no taxes and let people spend their money freely, with little to no obligation towards society. If you are of that mindset, you might as well stop reading right now. You won't like a single word of what I have to say.

Now that the pure free-marketeers have exited stage right and in a huff, let's discuss some alternative models. The very idea that there are alternative models seems to scare many people. As soon as one says, "I have an alternative to free-market capitalism", our 20th-century minds automatically react negatively, working on the assumption that one must mean some variant of socialism. But remember that we have moved past that conversation entirely. Again, this isn't about how we accumulate wealth. This is an entirely new conversation not about how we get it, but how we spend it.

At this point, most people might say that how we spend it is in fact a function of how we got it: if free-market capitalism worked for getting the wealth, must we not simply spend it on the same principle, as free-wheeling consumers? My answer is simple: spending it how ever we like isn't making us happy as a society and is perpetuating a culture of debt and emptiness, and an overall sense that we have no collective (and often even individual) purposes as a community. The easy part about positing this belief is that I do not need to provide proof of it: I think that any Western citizen reading this will instantly connect with and feel exactly what I mean here, which is itself all the proof I require. If I am wrong, please write and tell me how our society provides a sense of community and direction, of purpose and legacy, of pride of place in history, of patrimony we happily pass along to the next generation. I look forward to hearing it! I do not expect my inbox to overflow.

So what can we do to provide a fulfilling outlet that will make all the hard work and hard-won wealth seem worth the effort? My proposal is summed up with a simple acronym: BEST. Building, Exploration, Science and Teaching. BESTism - for what is a belief worth if it is not instantly converted to an -ism? - is a reaction and alternative to the simple consumerism that we all thought was the only possible product of capitalism. It's my attempt to say that we don't have to reject capitalism in order to reject many of its ills, because those ills are not necessary outcomes of the system, but are instead unnecessary outcomes of what we do with the wealth created by that system.

I'd like to explore the details of BEST in future postings, but for now will close with a counter-point to the single most obvious objection to the idea. The clever free-marketeer will say, "But without that reviled consumerism, there would be no wealth or capitalism upon which to base these fine pursuits." I reject that argument for the very simple reason that it is factually inaccurate: contrary to popular opinion in the US, money spent on public works, education and exploration, does not simply disappear into thin air; quite the contrary: that money fuels growth and jobs in ways that often surpass those of the private sector, not least of all because such efforts strongly engage the private sector.


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Footnotes:

*How ironic that one of the few remaining communist countries, China, is in fact the most capitalist of all.

Fun with Artificial Intelligence, Part II

As promised when I initially wrote about artificial intelligence (and specifically about Eureqa), I have been playing around with economic data and have come up with some interesting results. After running dozens of experiments using different combinations of data and allowing Eureqa to use different computational operations, I have come to a fascinating conclusion: in terms of what helps the AI fit equity performance data points to a model based on all data available to it, it seems equities don't 'care' about anything but how we, the consumers, think about the economy, regardless of how well- or ill-informed we are about the economy. Give the AI GDP data, CPI, unemployment, CD rates (to provide opportunity cost), even prior year stock performance and price-to-earnings data: if you also provide consumer confidence data, it will systematically discard every other data type save that one. In some simulations with solutions that have similar complexity and fit, it might also use Fed Funds rate and/or CD rates, which I see as opportunity-cost stand-ins. But for the most part, it just wants to know, "How do you feel about the economy, regardless of how well or poorly it is actually performing and regardless of how much you even really understand it?"

As I said in the prior post, I am far from convinced that such data-mining can offer realistic predictive models. But ironically, the fact that the AI prefers the least rigid, least 'rational' data type, in fact makes me less skeptical about its predictive power. My reasoning is this: if the AI chose models that were based strictly on 'hard' data such as CPI, etc., I would suspect it was simply data-mining and that the results would be useless outside the confines of the already-given universe of data points, since equities markets are inherently irrational and are driven by things far less quantifiable than, say, GDP; but the very fact that it chooses the least 'rational' data type, consumer confidence, tells me that it may indeed be coming up with a decent predictive model, since it seems fitting that it has chosen the one data type that combines rigid metrics but applies them to decidedly 'soft' data (that is, consumer sentiment).

So the proof will be in the pudding, I guess. But that pudding will take quite a while to cook, so don't hold your breath. Meanwhile, for what it's worth, I will shortly add some of the predicted values from various experiments. Then we'll sit back and see what happens!

My next project is GDP. I want to see what data types the AI most prefers for predicting the performance of the US economy.

Fun with Artificial Intelligence

I have been having a ball for the past week playing with Eureqa, an AI I mentioned in an earlier post. Eureqa is the brainchild of Profs. Schmidt and Lipson at Cornell. When it comes to data, my main fascination has always been economic data, so I have been toying with trying to find models that best account for why equities markets move in one direction or another. As I said in that previous post, there are far too many irrational factors involved in the movement of equities markets to come up with the S&P 500's answer to E=MC². Even if you managed to come up with a more or less reasonable predictive model, the theoretical economic characteristic of so-called 'perfect knowledge' eventually becomes not-so-theoretical economic reality; people begin operating under this new spotlight; next thing you know, the model is dead precisely because everyone knows about it and therefore behaves in ways not predictable by the model (since this new knowledge and resulting behavior are themselves major new variables).

Quite aside from the fact that eventual knowledge of a good model would itself make the model obsolete, is the fact that there is a HUGE difference between an equation that explains data and an equation that reveals cause and effect for data. Just ask all the people who have wasted good time and money 'data-mining' the history of equities markets. A perfect example is O'Shaughnessy's 'What Works on Wall Street'. The author dug through decades of data on the stock market and came up with elaborate models showing what would have been extremely effective ways of making money....assuming one had the knowledge of the entire period, but had gained that knowledge at the beginning of the period studied. It's amazing to me that an internet search of this man still pulls up almost universally positive, glowing articles and interviews, despite the fact that the mutual funds that he opened in the 1990s, funds entirely built on his 'research', were abject failures. He managed to spin this somehow, get out of mutual funds, and open a private wealth management company. This allowed him to continue making money and claiming he was right all along, but in fact freeing him to use completely unrelated methods of investing (since he isn't required to divulge his techniques). So he is undoubtedly a gifted marketer, and obviously even a good money manager...as long as he isn't following his own advice.

If this is all still (quite understandably) rather abstruse, I'll illustrate with a metaphor. Imagine you stand outside on the street corner and observe the weather and the passing of cars and people. Three out of ten days it rains. On those days, you notice people wearing raincoats. You also notice there are no open convertibles. Data-mining your way to 'good' equations tells you that an absence of convertibles and a presence of raincoats cause it to rain. That's an example of mixing up cause and effect. In another example, imagine that you observe that on the days it rained, you observed ten percent more people named Jane. Aha! An excess of Janes is causing rain! No, this is just coincidence.* I could go on, but for more examples of these kinds of problematic reasoning, there's a far better resource: read Crimes Against Logic by Jamie Whyte. This book is one of my top fifteen all-time favorites, not so much because it taught me anything I didn't already know (though it did that, too), but because he so eloquently and clearly expressed ideas I had known well but that I had been unable to articulate.

However, an inability to find well-performing predictive models for equities markets, doesn't mean that feeding such data in Eureqa is itself useless. By watching how Eureqa treats all the different variables, you start to see how they interact and which ones haven't even a correlative relationship with equities market performance. For example, Eureqa rarely seems to 'care' much for inflation. There appears to be very little correlation. BUT, it does 'care' quite a lot about the Fed Funds rate, which is essentially the public policy reaction to inflation. It also 'likes' CD rates, which might be a decent stand-in for opportunity costs, though that implies some cause-and-effect (CD rates are low -> opportunity cost of foregoing them in favor of equities is low -> I will buy equities -> everyone does same -> equity prices rise)**, which requires a heavier burden of proof, one that I am far from meeting. And employment? Almost always tosses that out as irrelevant very quickly. But it 'loves' consumer confidence, which suggests that while the markets don't 'care'*** about how many people are out of work, they care very much about how confident people feel in the economy (which is presumably in turn driven by how many of them have jobs, though not directly). But again, there is no straight cause-and-effect here. You can't say Consumer Confidence = y ergo stock performance will = z as an exact function of y.

Early days yet, but so far, so fun! After I get bored with this round of experiments, I think I'll move on to GDP.
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Footnotes:

*Don't even get me started on people who say 'I don't believe in coincidences.' Do you have ANY idea what kind of universe we would live in WITHOUT A HUGE LOT OF COINCIDENCES? Randomness permeates the very fabric of existence. The 'problem' is that our human brains have evolved with this incessant need to find patterns. I say this facetiously because of course that very same 'problem' is doubtless one of the very core elements of our intelligence, not to mention a key explanation to our very survival as a species. But it does have the unfortunate side-effect of making us see Jesus in breakfast food far too often.

**This introduces an intriguing interplay itself. Perhaps the opportunity cost (in form of CD rates or T-bills) must reach a certain threshold before prompting consideration of equities, but that consideration is in turn colored by the confidence one has in the markets and the overall economy (as measured by U of M consumer confidence index?), and that interplay in turn drives the degree to which investors commit to equities, thus determining the demand for (and therefore value of) those equities. Add in a dash of price-to-earnings data (i.e., the 'real' cost of 'buying' the earnings behind an equity) and you might just have some soup worth tasting.

***Please forgive the anthropomorphic words here. And if you are a lefty like me, do not fall into the temptation of attributing 'feelings' to markets. That a market does not move in reaction to a tragedy like high unemployment, does NOT mean that the people who make up those markets do not care about unemployed people. The phenomenon is merely an observed outcome of the aggregate behavior of the people acting in the market, not the 'evil' intent of any group of people within the market. I enjoy demonizing Wall St fat-cats as much as the next liberal, but do so for their individual behaviors, not those of the markets in which they act.