Friday, December 27, 2013

No Capital Investments?

The Economist wrote an article “More bricks, fewer bubbles” early December that said that no one is quite sure why monetary loosening (QE) has so little effect on investment.  The answer is simple: capital investment is partially for replacement and partially for growth. As long as industrial production is lower than the 2008 peak in industrial capacity, there is no need for investment in growth.
The considerations behind this are described in the Flostock Laws of Demand, which can be found on 

Stocks have a memory

Strange idea that a collection of goodies can have a memory. When you see pebbles on a beach, they don't look as if they have a memory. Yet I don't mean this in some sort of strange philosophical way: I believe stocks really have a memory, in the sense that a future change is already embedded in the stock before the future arrives. This can be the direction of the change, or the intensity, or the force.
Maybe this becomes more easy to understand if you include some thermo: When I did not know the answers to a thermodynamica question as a student, I just filled in: "because then the system moves tot the lowest energy level", and that is still the best answer to many questions about why things are happening.
The same is true for stocks with a memory: the stocks know there is a lower energy level and they would like to go there. A bucket full of marbles on a hill top that has just been toppled has a memory: the markbles "remember" that they will start rolling downhill. A bank account remembers it can deplete, so a credit card is burning in your pocket. When you start a holiday game with a full bank account, you know it is going to go down. A country full of youngsters knows it can expect revolution. A city full of hooligans knows it will see riots and drunkeness.
More practically, if you are the manager of a warehouse with a certain inventory and your boss wants you to increase the inventory towards a desired level, ordering new products and going to the desired inventory is like going to a lower energy level. In this sense the inventory had a memory of where it would want to be. If you have ordered a new gadget and it is being flown to your doorstep by a drone, the pipeline of goods in transit (also a stock) has a memory of where it is going.
An ocean full of warm water has a memory in the sense that the huricanes are already in the process of becoming. A class full of children has a memory of creating chaos. A chimney that has not been cleaned for a long time will ignite when the conditions are right. A car moving at a certain fixed speed has a memory in the sense that it will continue to do so untill it is stopped. So inertia is a form of memory. Kinetic energy is a memory property of a stock (e.g. the car).  Potential energy is a memory. And a banking account has potential energy. A warehouse has the potential to order replenishments. An empty stomage has the potential to be filled by eating.

Stocks have much more memory than flows. Flows stop flowing immediately when stopped. When eatign stops the flow stops. But the stomage can still be half-empty, so it remembers that more eating should be done.

So stocks have a memory.

Thursday, December 12, 2013

Bubbles are not bubbles

Economic bubbles are always compared with soap bubbles, but that introduces a misunderstanding, because economic bubbles are always flows, never stocks, while soap bubbles are objects, so more like stocks.  Soap bubbles "accumulate".

People probably use the analogy because they have no better way of picturing a flow. In general it is difficult to draw a flow, any flow. When you want to draw a river, normally you draw the banks, and the meandering. The trees next to it. When you want to draw the wind, you show clouds or leaves, floating in the wind. Or you show a giant cloud with a face that is blowing stripes of wind from his mouth.   In the same way it is difficult to picture a stream of goods or a flow of money. Movement is difficult to catch and difficult to picture. An inflated flow is also difficult to picture. The picture is static, the flow is dynamic.  The tulip mania and the south sea bubbles were not called bubbles in their time, because people did not look at them in a graph!

Is a price bubble a stock or a flow? Price has a flow character, I believe, much more than a stock character. It depends on transactions, on demand & supply, typical flows. What about a sentiment bubble like confidence (e.g. in bitcoins)? Yeah, that is a stock and indeed a bubble, filled with thin air. When punctured it will deflate fast.  But this is just the confidence behind the real bubble, which is price and transactions, so the real bubble that we talk about is a flow. Confidence itself is normally not depicted as a bubble.

Another point where this analogy goes wrong is when an economic bubble bursts. In reality it means that a flow reduces fast in size. The feeling we get from the soap bubble analogy is that some protective shield (like the membrane of the soap bubble) is punctured with as result that some pressure escapes and pieces of membrane spat on the floor. In economic bubbles there is no membrane, and there is no escaping pressure.

"So what?", you might say.

This is relevant because the analogy sets us on the wrong foot: when we study an economic bubble, we have to see it as a flow, not as a stock. A stock responds to a pulse completely different from a flow. Most stocks are integrals of flows, that means they accumulate a flow or they bleed into a flow. Stocks are therefore much more inert and more stable over time than flows. This gives a false sense of stability to economic bubbles.
An economic flow is always going from one stock to another stock, based on decisions by people (or based on algorithms in computers programmed by people). If people decide to do nothing, the flows stop immediately, but the stocks remain stable.  When we would see economic flows as flows, people would easier understand that an economic bubble is always finite because the stock where the flow comes from is finite.

So bubble is the wrong word.

Is there an alternative? How should we call an inflated, a swollen stream?  A comparison with an overflowing river that rises above its dikes is maybe appropriate. Maybe a dike in which a small breach is broadened by the overflowing river and a small stream grows into a giant flow.

I don't know. Any of the readers maybe?

Thursday, December 5, 2013

How do you like your Gini?

The End of History
Since the fall of communism, now more than 20 years ago, history as a struggle has ended according to Francis Fukuyama in his ground breaking book The End of History and the Last Man. There are no serious people any more who claim that communism is a realistic alternative for free market, democratic capitalism. Since then a lot of commentators said that state capitalism, as practiced e.g. in Singapore and China, could be an alternative for democratic capitalism. This piece of History has not ended yet, so it is too early to tell which system will survive. But I don't believe in state capitalism.

Quatro Politica
There are too many wrong investments in state capitalism and not enough checks and balances. The Trias Politica should be expanded to a "Quatro Politica", and the fourth power, Business, should also be handled as a separate force. The other three forces are needed as a counter balance to the overwhelming forces of global Businesses. Think e,.g, of the military Industrial complex for which Eisenhower warned us, the lobying forces in "Supercapitalism" by Robert Reich, or -closer to home- the obscure funding behind some political parties in Holland.

All parties in the middle
Since the "end of history" in Europe, the fundamental differences between the old political parties are eroding. The importance of religion as a factor in politics had already been going down much longer. Now, communist parties are gone and traditional socialist parties have moved to the middel ground of the political spectrum.  As a result the old and comfortable left-right or communist - capitalist split is gone. All political parties have difficulty positioning themselves to keep their voters loyal.

How do you like your Gini?
The Gini curve (Italy,1912) can be used for measuring the spread of income in a population. The population is sorted on income, than accumulated into a graph, with vertical cumulative income and horizontal cumulative people. This is the Gini curve and it always runs from the left bottom corner to the right top corner. Depending on the spread of income the Gini curve is more round or more flat. When everyone has the same income, the theoretical communist ideal, the curve is a straight line. Needless to say that it was not achieved in communism: this was one of the reasons the system failed. When 90% of income is earned by 10% of the population, the curve goes almost vertical in the beginning, then makes a turn in the top left corner and goes almost horizontal to the top right corner. This was the shape in the dark ages, when absolute rulers were exploiting there population.
Economic discussion in parliaments everywhere is now dealing with the shape of this Gini curve. Representatives of lower income basically want a flatter curve, while free market adepts want a round Gini. Both try to argue that their view is best for society and for the economic growth as a whole. Venezuela and Cuba are trying hard to prove that a flat curve is wrong. A too round Gini has strong undesirable effects, such as extreme poverty and state debt. Ironically, recent American capitalism as well as the Russian oligarchy confirm this. The Gini-discussion is mixed with a debate about justice and equality, because there is probably not just one answer, but a reasonably large "sweet spot" for the ideal shape. Within that sweet spot the ethical discussion can be held.

What to vote?
What now? The result is that voters no longer know what to vote, because the Gini discussion is boring and technical and has a lot of unknowns and make-believes. Voters do not vote for the nuance of the sweet spot: they start to float and do not give the final call on what to do. The alternative is let history sort it out, but it takes years before the effects of a change in Gini become visible. History as a judge is ruthless, but slow. History convicted fascisme after 20 years, and needed more than 100 years to disprove communism. Now History is already taking 30 years to evaluate state capitalism.

Unwanted by effects
The result is that new parties come up around mono themes like age, animal rights, environment, euro- or xenofobia. Voters (who do not understand the Gini discussion and who no longer vote what the priest says) are shopping around for a nice face or a narrow interest or an underbelly feeling. Parliaments are no longer peopled by the best and the brightest, tried and tested in a long upward career of service to the country, but by opportunistic followers of populists who temporarily catch the limelight. This is not a good development, because it is making our democracy volatile. Maybe it is an unavoidable stage of development towards a true End of History.