“The world of finance hails the invention of the wheel over and over again,
often in a slightly more unstable version.”
- John Kenneth Galbraith, A Short History of Financial Euphoria, 1994
Financial markets finally caught a whiff of economic reality these past two weeks, erasing more than $5 trillion of global wealth in seven short trading days. It was the worst market correction since the onset of the financial crisis in late 2008, and it may just be the beginning. A final bombshell dropped late on Friday evening as Standard & Poors held true to its word and robbed the United States of its AAA rating for the first time in history.

As Canadians sparred over fake lakes, budget-busting security, and the global capitalist conspiracy, the world’s twenty most influential leaders convened in Toronto this past June to negotiate a response to the worst financial crisis in generations. At issue was an age old debate between two economic philosophies: stimulus as a life vest versus stimulus as a straitjacket. The pro-life camp was championed by consumerist America and its global supply chain. The pro-restraint camp was led by conservative Germany and its regional demand chain. At risk were millions of jobs, trillions in debt, and quite possibly the fate of our modern political economy.

Armies of bulls and bears are camped out on either side of the great debate over the future of the global economy. Armed with the latest statistics and plenty of financial incentive, both sides are engaged in massive media campaigns to rally anyone left on the fence — principally retail investors who were either burned in the great collapse of 2008-09 or sat out the fast and furious rally over the past 14 months. As the rhetoric heats up, it becomes increasingly difficult to choose sides. A careful examination of these competing wagers provides a more holistic perspective for anyone brave enough to join the fight.

Much like the shifting partisan politics which rules Washington in 2- to 4-year cycles, stewardship of the Federal Reserve has ebbed and flowed between neo-Keynsians and Austrians since the birth of American central banking nearly 90 years ago. Two of the Fed’s greatest leaders and keenest minds have crafted American monetary policy for most of the last three decades, and yet they couldn’t be more different.
This is their story.

In the midst of a global financial pandemic, private enterprise finds itself under the public microscope yet again — as it did during the 1930s after a century of unbridled growth and later in the 1970s after decades of stifling regulatory oversight. With this 21st century changing of the guard, the theoretical bases for free market capitalism are now under academic and legislative review. At the heart of the debate is the accuracy of the economic models taught to college students around the planet as though they were immutable physical laws.

This TED talk by mathematician Steven Strogatz “shows how flocks of creatures (like birds, fireflies and fish) manage to synchronize and act as a unit when no one’s giving orders”. The parallels to market behavior and financial panic are implicit but obvious. We often perceive of our decisions during a crisis as unique and self-preservational, but the tendency toward spontaneous order is a powerful impulse. Coordinated reaction to natural threats, be it a hungry seal or predator hawk, can often increase a group’s biological fitness and probility of survival, while a coordinated reaction to financial crises can actually amplify individual risk – like Strogatz’s example of London’s Millenium Bridge – and only make matters worse…

This time series from Robert Shiller puts recent house price fluctuations and their associated derivatives in an important historical perspective…

Faith in the underlying mechanics of portfolio theory and market efficiency has certainly contributed to humanity’s recent leap forward in wealth, productivity, private innovation, and global integration. But that same numerology has since crippled our aging financial system and triggered the worst global recession in nearly a century. Perhaps it’s time to reassess the value – and the logic – of bleeding edge finance.
As Professor Janeway points out in the following interview, treating securities like molecules, subject to the same variable distributions, “random walks”, differential equations, and reductionist math simply compounds the short-sighted actions of a few scientists-turned-gamblers. Not only does it greatly overstate the predictive power of econometric analysis, but it also understates the tremendous dangers of financial engineering. …

Imagine learning for the very first time — contrary to public opinion and centuries of contemporary science — that the world was actually round. Imagine being that first group of scientists (regents and spiritual leaders) or politicians (again, regents and spiritual leaders) or shell-shocked shepherds who grazed for thousands of years through the countrysides of the known world, convinced that if they wandered just a little too far, they might, in fact, fall right off the edge of the planet.
Life in those days was distinctly two-dimensional. There were the heavens, and there was the earth, and never the twain should meet. Stars were but holes in a giant celestial blanket while various pagan deities pulled the moon and the sun through …