Asia Times: The wreck of modern finance

[marmar]

The wreck of modern finance
By Martin Hutchinson


Over the past 30 years, the capital markets have been restructured through the tenets of modern finance in its various forms, which together have gained six Nobel Prizes (Modigliani, Sharpe, Markowitz, Miller, Merton, Scholes) and might have generated a couple more (Fama and Black.) This has been enormously profitable for the financial services sector, which has doubled its share of US economic output. As we are only now coming to see, it has proved pretty well disastrous for the global economy as a whole.

The most fundamental error of the modern financial edifice was its assumption of randomness in market movements, without a true understanding of the conditions necessary for randomness to hold. The laws of probability and the idea of randomness were generated by the 17th century French mathematician Blaise Pascal, who used them to help in winning card games, roulette and other activities in which tiny physical variations cause a discrete change in results. Since tiny physical variations are themselves unpredictable, their results are truly random.

This true randomness almost never holds for economic activities. Some of them are governed by complex underlying equations, impossible for mediocre mathematicians to solve, which produce pseudo-random "chaotic" behavior, in which prices or other variables appear to move randomly but are in reality mostly determinate. The interaction between economic variables is partly random (itself partly caused by inadequacies in our ability to measure economic quantities quickly) and partly determined by these kinds of complex non-linearities.

Other economic variables are also not random, and may not be governed by discoverable laws; they are simply unknown. Next year's gross domestic product, for example, is theoretically determinable from factors we could already know (plus a few random elements). But it is mostly not random; we simply do not know what it will be. ..........(more)

The complete piece is at: http://www.atimes.com/atimes/Global_Economy/KE20Dj02.html

[izquierdista]

1. About those Nobels

There is no "Nobel Prize" in economics. There is a "Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel" that tries to siphon some of the credibility of the Nobel Prize into the dismal policy swamp known as economics.

[bemildred]

2. Bush the Elder called it "Voodoo economics" long ago.

But essentially it is just a sort of herd-thinking about money, and has nothing to do with science or even rational thought, since either one of those would require that one do some actual observation of what happens in the real world to verify the accuracy of one's hypotheses.

This fellows critique of the supposedly mathematical underpinnings of economic theory are sound.

http://en.wikipedia.org/wiki/Supply-side_economics