A Fed economist by the name of Kartik Athreya published a paper, subsequently pulled from Google Docs, but preserved by Karl Denninger (thanks, Carl), entitled “Economics is Hard. Don’t Let Bloggers Tell You Otherwise.” The thrust of this paper is to assert that no-one without a Ph.D. in economics can have a sufficient grasp of macroeconomics, in particular, to have any meaningful opinion on the subject.

Writers who have not taken a year of PhD coursework in a decent economics department (and passed their PhD qualifying exams), cannot meaningfully advance the discussion on economic policy.

This is actually a very interesting document for two reasons. First of all, it tells us a lot about the writer and illustrates the inbred culture of the Fed, which is almost certainly the largest employer of economics Ph.D.’s in the world and the largest source of funding for economics in academia. The result is a “Fed school” of thought which dominates the field of economics. Secondly, it illustrates the structural fallacies inherent in the academic study of economics. These fallacious assumptions are the root of the continuing failure of modern economics to provide accurate forecasts and sound advice to policy makers.

We should think of the Fed as akin to the doctrinal arm of the Vatican, with the current Fed Chairman, Mr Bernanke, playing the role of the Pope. As we all know, when the Pope makes a doctrinal assertion ex cathedra, he is by definition infallible. This works in theology because there is no way to test the Pope’s fallibility. Theology covers matters spiritual, which have no objective reality. Years of study are required to become a theologian, because the only way to participate in the discourse is to be familiar with the hundreds of years of discussion, debate and doctrine which form the structure of theology.

And the author is quite right about modern economics. To participate in the discourse, one must be familiar with the thought process and the only way to do that, as a practical matter, is to get your Ph.D. However, that discourse bears little relationship to the real world. That is why Mr Bernanke’s assertions about the state of the economy and its future path are so consistently wrong. But the culture is so strong that it shrugs off objective evidence and the discourse continues. If Mr Bernanke says it is so, then it must be so. Any data or evidence that contradicts Mr Bernanke’s official statements is ignored or rationalized. And hundreds of economists go home happy as the flow of taxpayer money into their pockets continues. None of them would dare to mention that the Emperor has no clothes because to do so would jeopardize their livelihood. And bloggers who pipe up and mention the nakedness of the Emperor must clearly be ridiculed and marginalized as unqualified to perceive the beauty of his garments.

Why is modern economics so broken? The paper is revealing. It mentions in passing the Fallacy of Composition. The problem really is the Fallacy of Decomposition – the notion that it is possible to to decompose a modern economy into a number of discrete components, like the pistons and crankshaft of an engine, which work together. When you do that, the thought process goes, then you can build a model which shows how the components work together and learn how to make the economy better – or worse. The author does concede that the interactions between the components are complex and subtle, making this analysis “hard.”

The author spends a lot of bits talking about the importance of internal coherence of these models – getting the accounting right, implying that bloggers don’t. But the accounting, in the real world, takes care of itself. It is built into the system. When I hand over a dollar bill at the cash register, it doesn’t magically become a two dollar bill. He misses the real problem, and that is that breaking down a society so dynamic and interconnected cannot, in my opinion, possibly work.  When we are talking about “the economy,” we are talking about our entire global society in all its richness and diversity. There are really no pieces that can be treated in isolation anymore. When you build a model, you are creating an abstraction which means that you are discarding complexity -  information -  in the hope of creating a simpler structure that is tractable to whatever tools you are using, usually statistical. Then you analyze the behavior of your model, and compare it to the real world to see if it successfully predicts its behavior. Which is where you need to be disciplined and reject the model when it fails to do so. But of course you’ve put a lot of work in at this point and you might just overlook some of the model’s failings and try to tweak others (well it got GDP right although it didn’t get employment anywhere close, oops, better apply for another grant). Now, unlike Mr Athreya, I might be wrong and someone will produce a model of the economy that actually works. So far it hasn’t happened, despite billions of dollars thrown at the problem over the years. In fact, I suspect there is more at work here than it simply being “hard.” I suspect it may not be possible for epistemological (complete model may not be knowable) or computability (may be knowable but not solvable) reasons, but it is late and I’m not going to expound on either.

Instead, it is necessary to treat the economy (and society) holistically. It is a living thing like a human being. You can observe its behavior and predict it, to a degree, without knowing or modelling the details of what is going on inside it. We know that we cannot do that because we don’t understand a number of important things, like for example consciousness.

As a humble blogger, I can take a broad perspective. I can, for example, study history so that I can do things such as recognize when the economy is running a fever. I may not know why, although I can guess, but often it doesn’t matter. I am a professional speculator, not an economist. I can look at the entire economy and social system, I do not need to narrow my view and risk oversimplifying in order to fit the world into the framework of a model. I have been pretty good at understanding the state of the economy and its future trajectory for more than twenty years, although I must say that I’ve consistently underestimated the extent and duration of bubble conditions. For sure, I have done better than the Fed although I possess no Ph.D. in economics (I’m an engineer). My approach works for me.

Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveler, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;

Then took the other, as just as fair,
And having perhaps the better claim,
Because it was grassy and wanted wear;
Though as for that the passing there
Had worn them really about the same,

And both that morning equally lay
In leaves no step had trodden black.
Oh, I kept the first for another day!
Yet knowing how way leads on to way,
I doubted if I should ever come back.

I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.

Robert Frost

Obama and Geithner went to the G20 and asked the rest of the world to keep spending itself into bankruptcy for “a little while longer”. They got a “NO” from around the world. For this, I am and we should all be thankful. The world is turning away from the road to disaster. Not that things are going to be wonderful – indeed, they will be very bad – but there is a light at the end of the tunnel. Very small and very far away, but a light nonetheless.

The gang of idiots running the U.S. – The “New Jack Keynesians” – are doubtless going to try to force the US to try to go it alone with big fiscal imbalances. This means that the US is going to continue running up big trade and current account deficits with the rest of the world. Until the debt markets lower the boom. Which they will. It may be that the U.S., being so politically corrupt, will be driven in to a private disaster far worse than that experienced by the rest of the world. Can democracy be restored in the U.S.? We will see.

I understand that the Dems in Congress have decided not to produce a 2010 spending budget. Presumably because the result would be to send taxpayers running to the polls screaming for their heads when they saw the numbers thus disclosed. it does show that Congress has now completely lost any anchor to reality. The Fed, not to be outdone where Keynesian idiocy is concerned, is reported (by the FT) to be considering a $5 trillion QE program (if $2 trillion didn’t work, then obviously it wasn’t enough). Obama is even trying to get the rest of the G20 to join in this insane (in the Einsteinian sense) effort to spend the country into prosperity.

Hopefully cooler heads will prevail. It is interesting to note that the European governments, being democracies, are responding to the legitimate concerns of their citizens in respect of excessive deficit spending. The U.S., of course, does not as the concerns of the voters became irrelevant to The Party years ago.

Well the “financial reform” legislation ended up being completely gutted. For the sake of cosmetic reform, the banks allowed limitations on things they weren’t doing anyway in return for no limitations on the things they wanted to do. The SEC was given the right to impose fiduciary responsibilities, but no instructions to do so. And so on. What a joke.

Bank shares are up substantially this morning as Congress confirmed that the fix was in, and the banks would get what they paid for. Disgusting.

Apparently, General Stanley McChrystal has tendered his resignation to Obama in the wake of indiscreet remarks reported in Rolling Stone. General McChrystal is in charge of one of the US’s many futile “wars,” this one in Afghanistan. He appears to be frustrated with the incompetence and lack of leadership in the Obama administration. Of course, he has my sympathy to some extent. The main problem is Afghanistan itself, of course. Many nations have taken a run at sorting out the Afghans in one way or another, including the Soviets and the British, all, like the Americans, without success. I thought it worthwhile to post some highlights of the British adventure.

Couldn’t resist. And now back to our regularly scheduled programming.