Niall's virtual diary archives - March 2008

by . Last updated . This page has been accessed 4,608 times since the 30th August 2008.

You are connecting to the IPv4 version of this website from the IP address You can try the IPv6-only version if you want.



Tuesday 18th March 2008: 4.17am. As you have probably barely noticed, I have been busy "monetising" my website during the past month - the summary of which you can find on a new page "How to Monetise your Website". Lest you think me in terribly bad form given that nedprod hasn't had adverts previously, in fact back in 1998 when this site was first launched it had adverts almost from the start. Do you fancy seeing nedprod back then? Here's back on the 2nd December 1998! - as you'll see, not a great deal has changed - the site still looks quite similar, maybe not quite so polished, and yes there is the adverts at the top.

Back then in fact it was dead easy to have ActiveX controls run in Internet Explorer, and it was trivial to write a control which loaded on every nedprod page one visited. This control then went off and pretended to click on banners for a whole host of advertisers which obviously enough earned a person some cash. I never got much out of it - too few people visited the site back then - and also US dollar cheques were an absolute pain to work with. Nowadays the situation has at least improved that Paypal don't fuck non-US citizens over quite so quickly as they used to - I remember some ignorant Paypal fuck wit telling me that European banking systems were highly insecure and therefore they were going to impound my Paypal bank balance - I forget precisely why, but this guy was absolutely adamant that European banks were so unsafe that drastic treatment of myself was absolutely necessary. I pointed out that Switzerland was world renowned for strict banking laws, to which Paypal knob jockey actually claimed that Switzerland wasn't part of the practically "third world" European banking system. They're a lot nicer now to non-US citizens, but that's only because still competition from the likes of Moneybookers scared them. They still charge twice the fees for foreign currency conversions than anyone else - and far more than if your own bank did it for you despite that most banks would torture their own mothers to gain an extra penny (witness the recent subprime fiasco - and yet more taxpayers money bailing out the banking system - again!). I have absolutely no love for that company - they are just evil, even more so than banks.

Things have trundled along fairly okay last month or so. I've had two major fights with Megan, which is about par for the course, and all is currently generally well. I got one of the lads' stags in Budapest next weekend which has been very, very expensive but the recent sharp rise of the Euro against Sterling has made me well over £100 richer a month which is a rise of 40% in my disposable income - which literally feels like I have become vastly richer, as I only had about £250 a month left over after rent and bills. A lot of money has gone out recently - I bought a cheap Chinese knock off Holox BT-541 Bluetooth GPS receiver for £25 inc P&P and have been having much fun watching myself walking in real time on a hires satellite photo on my mobile phone which I stole from Google Maps using a perl script. It's actually a much better GPS receiver than its price suggests - it's a cheap implementation of the SkyTraq Venus 6 chipset which is very highly regarded by professionals and it happily keeps a eight satellite signal lock whilst in my pocket inside my house on the ground floor! That, quite simply, wasn't possible even three years ago with a GPS receiver costing thousands even military spec - and I contracted on missile guidance systems back in the 90's. I bet my father would be annoyed given all the money he's sunk on those fancy receivers he has. It's also very accurate, pretty close to 0.5m and it certainly knows when I cross the road on the tracking software. My only annoyance is that there's about a four second lag between me changing direction and it noticing - and of course its altitude tracking isn't reliably much better than a 300m resolution. The new European GPS replacement will fix these issues and then some - I hear it'll do 1cm accuracy!

My other big expense apart from the GPS receiver and the stag was finally acquiring a copy of the extremely rare The Self Organising Universe by Eric Jantsch. It cost me over £50, but that was a bargain given they usually go for over £100. I sadly haven't had time to read it yet - spent much of last week writing a PI generator using the ingenious Bailey-Borwein-Plouffe algorithm which was for my Masters application in High Performance Computing to Edinburgh University - the BBP formula lets you calculate any digit in PI you like without having to calculate any of the preceding ones. This week it's mostly been course readings for Creative Industries - you can see my latest coursework submissions here - and I have also been reading the highly depressing and famous Limits to Growth - the 30 year update for my dissertation which is on the topic of modelling the costs of climate change. Speaking of which, I have changed the subtitle of my upcoming book to Freeing Growth: A Neo-Capitalist Solution to Environmental Degradation and Social Ills as climate change is an inductive conclusion, whereas absolutely no one can pretend we aren't causing the next mass extinction of life on this planet as I type this. Here are the big (>20%) mass extinctions during the last billion years of planetary history that we know of:

? @ 850m-630m 49% @ 488m 49% @ 447m-444m 70% @ 380m-360m 70%-96% @ 251.4m 20% @ 200m 55% @ 65m
Glaciated Earth? Cambrian-Ordovician Ordovician-Silurian  Late Devonian Permian–Triassic Triassic-Jurassic Cretaceous–Tertiary

We're now into our eighth mass extinction in the sense that we have already passed 20% extinct - what they like to call the Holocene mass extinction. If we're sensible, it would be a good idea to try to avoid the worst of it while we still can. BTW, when I say that say "70% of all life died out", I more mean species not numbers of incarnations of those species - the latter fluctuates rapidly over time with little effect for the planet.

Anyway, it's now 6am so I'm going to go to bed as I gotta get up early and get the next creative industries seminar done ...

Later that morning at 12.42pm ... God I feel like a pig has shat in my brain - despite no alcohol consumption last night! I've worked hard last few days, trying to clear stuff for the stag this weekend and while I'm drinking this wonderful Honduran coffee, I'll finish what I began last night before I got distracted reading about mass extinctions, because I was going somewhere with it.

We know that glaciation (ice ages) are actually times of great vitality for the planet - though due to lack of hard evidence, it's very tough to know whether the 850m-630m very long glaciation was as severe as the rock evidence suggests - we do know that life in the seas was pretty good at least around the equator, so I'm going to assume that as with all ice ages, it was pretty fantastic to be alive even all that time ago. I know that's not common wisdom, but as I have mentioned in this diary before that has far more to do with our cultural preconceptions about cold than scientific reality. After all, it's not by accident that most extinctions happen right after an ice age when the planet is warming - and not before - because the amount of life on the planet shoots up massively the colder it gets, so it has to die off the warmer it gets. There are about 40% less in quantity now since the end of the last ice age 10,000 years ago! - but as just mentioned, it's the number of extinct species not incarnations of those species that matters.

If all that quantity dies off, then that means there is a lot of stress inside the system - certainly the most evolutionary change happens right after a great loss of quantity, so you tend to get explosions of new forms of life after glaciations for whom life is very easy because all the competition got killed off (eg; the post-glaciation Cambrian explosion at around 588m when something other than complex slime first evolved). One sits on the exponentially rising early part of the sigmoid curve and things are good - after all, that's how homo sapiens evolved. Interestingly, as my upcoming book shows, that exponentially rising part is also the beginning of falling in love - and even more interestingly, continually finding new curves to rise up is how one stays in love, with a single failure quite sufficient to break the system. Having realised this, and to some extent mastered it, is why I have been so blessed with being in love with quite a few women here in St. Andrews who, feeling the same in return, have looked after me and made my life very much worth living these last few months. I am extremely grateful!

If I get time next entry, I'd like to talk about how cooling = usually good and warming = usually bad translates into financial systems, specifically how we arrived at our current sub-prime liquidity problems. I'd like especially to talk about how money doesn't actually exist and never has done.

It's 1.30pm ... ok .... stupid seminar time, this time on Intellectual Property which I am looking forward to proposing a complete replacement thereof in my upcoming book. Y'all be happy!

Monday 24th March 2008: 6.53pm. Got back from the stag in Budapest yesterday and am slowly recovering today. I was so tired yesterday after the previous week so lacking in sleep that I was hallucinating quite profoundly - which certainly made the trip rather interesting!

I promised myself I wouldn't do any coursework today in order to give myself some rest. However, I wanted to continue the previous entry especially with the collapse of Bear Stearns last week - a classic, and very typical, example of how evil banks truly are - though, I must strongly add that Bear Stearns itself was hardly that evil and if anything, the fact it collapsed was precisely because it wasn't being evil enough. Before I begin, I use the term "bank" in a far wider sense than just the ones on the high street - I include investment houses, insurance companies, pension funds and private equity firms, and I even include the extremely wealthy (both individuals and corporations) who have always behaved a little like a bank by lending out money and investing in new enterprises. While I could use the term "investor" here, there is a huge difference between an investor off the street and these institutional investors.

Banks, since through their greed they partially caused the Great Depression in 1929 which let loose both Fascism and Socialism in the West, have ever since become partially protected entities by government - and thus in some ways, they have become a semi-official arm of government at the same time as governments have become semi-official arms of banks. I should explain that, because it's hardly a conventional viewpoint:- since well before the Roman empire, banks have bailed out governments with loans for wars and when the economy turns sour instead of raising taxes. However, since certainly the late 1970's, and many would say since colonial times, they have also told governments what to do and if governments don't comply, they are punished for it. Traditionally, governments were able to prevent banks having too much power by restricting capital movements, but with the advent of globalisation and instantaneous capital transfers, banks can both invest and withdraw vast amounts of capital in a very short time for almost no cost. Should a government be judged to not be behaving "well", its currency can be devalued, its industry starved of investment AND revenues and mass protest on the streets invoked.

However, there is a flip side. Banks compete with one another for profit, so when there is a boom they have a very nasty tendency of making ever increasingly unwise investments (this is called a "speculative bubble"). These seem wise at the time because when your colleagues do something, it becomes "normal" and more importantly, financial markets have always worked on a herd principle - and you can make a LOT of money by anticipating a herd movement and making an early investment. The problem is when the "correction" happens - when markets return to fundamentals, those last to react by yanking their money fail much like musical chairs.

Two banks who were very highly regarded in the last few years were Bear Stearns in the US and Northern Rock in the UK. They were so highly regarded because they were at the vanguard of the use of "structured investment" which is a variation by the way of the thing that caused Enron to collapse. Everyone you see had decided that Enron's managers were corrupt because "they had used structured investment to hide massive operating losses" - however, as is becoming severely clear of late, it is structured investment itself that is the cause of this problem. But I'll come back to that in a minute.

As with Bear Stearns and Northern Rock in Britain, taxpayers money to the tune of billions has been used to bail out failure in banks - that means less schools, hospitals and public services or higher taxes in return for keeping them afloat. This is a problem economics calls "moral hazard" because unlike in most industries, failure for any large bank in the financial industry since 1929 costs the taxpayer and not the bank itself - which therefore means that investors using banks (NOT the investors in the banks themselves) can happily egg on their bank to take obscene risks for obscene profits knowing that taxpayers will bail out failure.

In fairness, the industry itself tends to absorb its aborted own using government finance to prop itself up, and the government debt eventually gets repaid during the next obscene profits stage - not that, might I add, government sees any of that at all, they just get back their bonds (the loan) with interest repaid rather than getting a slice of the total profits made from their investment. Therefore, what is really happening here is that government (ie; taxpayers) insures banks against failure - government takes on the risk, while investors get all the profits. Thus the whole affair becomes a virtuous circle - government needs banks to prop up budget deficits through loans, while banks need government to bail them out every time they become too exuberant & greedy. Hence they effectively become convenient arms of one another - and each can "blame" the other to the taxpayers for when taxpayers lose out.

One can clearly see here that effectively the financial industry receives a massive public subsidy from the taxpayer, because these failures happen fairly frequently (roughly every seven years on average) and when they do, they are very expensive. How expensive might you ask? Well, you have to remember something very important - money doesn't exist ie; the value of money changes very rapidly indeed, especially in the modern world - and it changes FAR QUICKER than the book keeping shows because the accountants, working in retrospect, average it all out.

What do I mean by that? Well, why do these banks fail? The share price of Bear Stearns was trading at $93 a share only last month - it was swallowed by JP Morgan this month for just $2 a share. That in itself didn't wreck the company - almost all companies (and individuals actually!) fail for one reason alone - it's not the lack of money, it's the lack of cash flow ie; the lack of timely money. For example, if you want to move house, you need some extra money to pay for legal fees, time off work to look for new houses etc. - in other words, to effect change requires spending some money. Even if the house you're buying costs 25% of the house you're selling (so you'd have 75% of your current house's value in cash after the sale), if you have no money right now for those transaction fees then you are absolutely stuck. The nice, big, expensive house you currently own is worth nothing to you right now because you can't "liquidate" its value.

This is what is called "liquidity" in economics - the ability to convert some holding to cash. When the government bails out financial markets it is technically referred to as "pumping in liquidity" which simply means that government makes up some extra money and loans it to others, thus giving those others enough cash flow that they have time to sell off their big assets. Some of you might be exclaiming "the government 'makes up' some extra money"? Well yes - because governments at any time can literally print off as much money as they like, or gather in & burn as much of it as they like. At any stage they literally can decide "I had £100m. Now I have £200m" by literally pressing a few buttons on a computer keyboard.

So why doesn't the government just print off £1000 and give it to each of us? Unfortunately, if governments print too much money, inflation goes up ie; prices start rising, and your shiny new £1000 becomes rapidly worthless. That's what happened in the 1970's - a series of socialist governments tried just printing new money and giving it to poor people, and promptly money lost its value leading to all those riots and strikes. As the government currently bails out banks, we risk exactly the same problem - which is why just recently inflation has been rapidly shooting up with it well exceeding 4% in the US when bailouts have been running the highest.

Now we can see just how expensive bank failure is to the public - when banks fail, liquidity becomes very severely constrained indeed - in fact, it's why government has to step in with freshly printed liquidity because none of the other banks will loan any of its colleagues money. Why? Because of those unwise investments I mentioned earlier - when it becomes clear to everyone just how unwise those investments were, all the banks (quite correctly) lose trust in one another. One gets a vicious circle because cash flows become so constrained that failure sets in, then there is even more distrust that your banks are lying to you about how badly damaged their cash flow is by their unwise investments.

You have to bear in mind that in a large & complex organisation that no one can tell what the current cash flow is actually like. You can get some idea of what it was in the past - this is precisely what accountants are for - but it's next to impossible to know right this minute. Thus when sentiment turns bad, there is a suspicion of distrust that is very tough to break. Hence breaking it is very costly, because when the government loans that money, it is worth vastly more at the time than its face value - because put simply, you couldn't get that extra liquidity from anyone else at any price. Of course, none of this ever factors into balance sheets or official reports - but failure to inject liquidity in 1929 cost tens, maybe hundreds of trillions of dollars at today's prices given the whole world war that resulted.

I should quickly add here that inflation is actually the transfer of wealth from everyone in society to the government - it's literally a tax on everything. So therefore a 2% inflation rate means the transfer of 2% of ALL money's value to the government. Of course, the government sees almost none of that since the 1970's - most goes to the banks actually as they are the largest borrowers of freshly printed money, which is one of the reasons that the financial sector has been booming the last thirty years - and the rest goes to commodity producers, of which during the last thirty years it's mostly been to oil producers like Saudi Arabia. Even better, inflation is payback for past taxation ie; if you print extra money now you don't have to pay for it via inflation at least till a year later - equally if you stop printing extra money now, it takes at least a year for inflation to stop. As you can probably imagine, this is a horrendous temptation for governments especially running up to an election - which is why in the late 1970's, control over liquidity was given away by governments to central banks eg; the Federal Reserve in the US. They you see being bankers have simply handed out the inflation tax to their colleagues in payment for keeping inflation low.

So far so good? Banks make obscene profits during boom, some collapse during busts, the bigger of these get bailed out by government who steal off the entire of society by increasing later inflation in order to bail them out. That is literally a massive hidden tax - the US economy is worth $16 trillion in 2007, so when inflation rises from 1.8% to 4% in one year as it has in the US you can see that an additional $350 billion dollars has been reallocated from society to banks and commodity producers, and that was between a year to two years ago - we won't see the effects of the most recent bailouts for another year to eighteen months. Not all of that went to bailing out banks or to oil producers - quite a lot went to other commodity producers as we are running out of water, grain, meat, metals, gas and indeed all forms of energy or materials.

Ok, enough for tonight as I gotta go see Megan. I'll continue tomorrow - be happy!

Tuesday 25th March 2008: 1.51pm. Bleh I feel groggy! After coming back from a lovely time at Megan's where she cooked me lobster, I sat up smoking sheesha and reading the Economist which had just arrived. I was really rather glad to see they were writing about exactly what I had been writing about here, except that they were also calling for severe & swift disciplinary measures to be taken with implications of dealing with bank CEO's much as Enron's were - by hauling them out in handcuffs.

That I think unfair - they, like Enron's top brass, had very little choice in their behaviour. They are also being scapegoated because every single fucker in the entire community is guilty as sin of doing exactly the same, and they want sacrificial lambs quickly executed to deflect any possibility that the entire edifice may be called into question. And that, oddly enough, is exactly what I want to talk about next - why and how the hell all this came to be in the first place, and what should replace it? And what the hell does any of this have to do with biosphere warming and cooling with regard to biodiversity as mentioned in the entry before the last one?

I went through last entry about how the financial system works, how there are booms & busts and how both governments and banks form a virtuous circle which bails the other out of trouble by basically sucking wealth out of society. These are all very powerful people, and what I have just written about is rare to find printed - I hear that books by George Soros cover very similar ground. However don't get me wrong - all hierarchies involve a transfer of wealth from poor to rich, that's the privilege of leading one's populace, and it has been a consistent feature of all civilisations - so I have no moral problem per se that governments and banks conspire together to vampire off society. What I do have a problem with is the extent to which they try to hide their behaviour - see Confessions of an Economic Hitman by John Perkins - which they only let him publish well after the events in question.

I should also add that I have no problem per se either with important institutions being bailed out and the costs of their failure being taken on by society - in fact, as my upcoming book Freeing Growth shows, the single most important character of Western civilisation which has enabled its greatness is how well it handles failure. In most societies eg; eastern ones, failure is shameful and it is covered up, denied and not accepted - which in large part has led to the malaise in Japan in the past decade as bad loans haven't been written off. A similar problem currently faces China which has been financing much of its recent growth with negative real interest rate loans, which should they go bad, the Chinese mentality will try to hide rather than expose. A similar affliction has made Africa as bad as it is today - as I point out in my book, Winston Churchill was incompetent in his stint at the Admiralty in the first world war and directly killed tens of thousands of British servicemen with his ineptitude - yet he learned his weakness, so during World War Two he knew to delegate as much as possible to more competent others and had the lowest workload of any prime minister in nearly two hundred years. He was much better at being a charismatic leader than managing - yet had he been permanently blacklisted, Britain may well have lost WW2 without him. As I strongly reiterate in my book, failure and failing well is FAR more important than succeeding - and this is exactly opposite the logical positivist tradition of the West which tends to only see what happens rather than what was avoided.

This brings me to the topic of avoiding risk - and this one single topic has more than anything defined the modern world. Ignoring the vast realms of protective legislation (safety laws and such), financial economics in essence simplifies investment into "how best to externalise risk" ie; to shift risk to oneself onto someone else. I won't go into the mechanics of it - read about the CAPM if you'd like to know. In essence, you spread your investments between risky ones and less risky ones in order to maximise your total return for the least amount of risk - and one of the major assumptions of financial economics (like all economics) is that the market is infinitely large relative to any single investor, and therefore can receive infinite amounts of risk.

That works fine when a majority of investors aren't actively also trying to externalise their risk which until the 1980's was probably true. Thus the majority of investors were risk sinks and the risk sources could happily dump as much risk into them as they liked. Let me explain by an example: say you're a farmer who needs a minimum income next harvest of £10,000 otherwise you'll go bust. Now the weather is variable, sometimes you get a bumper harvest (say worth £20,000) but other times you might not (say £5,000). If you absolutely need that £10,000 as an absolute minimum, you can take out an insurance policy costing £5,000 which will guarantee that you'll get £15,000 no matter whether there is a bumper harvest or not. If there is a bumper harvest, the insurer gets £10,000 in profit, if not he loses £10,000.

What's just happened is that the farmer has externalised his risk. He, the risk source, has sold on his risk to another. We all do this every day with home insurance, and absolutely can one take out insurance on stock price movements. This can all get very complicated - one can take out an insurance contract (called a derivative, or future) on say if the price of X exceeds Y for longer than time Z but not if the price of A is lower than B at some other time C. This is what is called structured finance and the theory behind it is that you can plan for worst contingencies with the least loss in profits. This ability became fully legal in the 1980's, and has boomed since. Why?

It all has to do with balance sheets prepared by accountants to show profit & losses you see. There is a very thorny topic in accounting called "cost accounting" which is simply "how do you estimate the value of something" - believe it or not, many, if not most, costs are unknowable because their value is unknowable. As I showed last entry, the value of money oscillates vastly over very short periods of time and no one even realises it - which presents a horrendous problem for trying to present a realistic picture of how well a company is doing. Remember, if cash flow drops too low, all those buildings and factories become unsellable and thus become worthless overnight. Think of the example of that farm - he needs a minimum of £10,000 to keep operating, if he falls below that his entire farm becomes worthless overnight. I am exaggerating and over-simplifying to make my point, but in essence this is how it works. This is why firms try to externalise their risk as much as possible, because accountants when faced with a risky investment will apply a discount rate which means they hack off a percentage to reflect the chances of the investment going bad. For example, if you know that 5% of all your loans are currently going bad, it makes sense to write down the "true" value of your loans as being 5% less than what you lent out.

The trouble is that we live in a risky world, and the market is NOT infinite and can NOT take on infinite amounts of risk. It HAS to go somewhere, and when that somewhere overflows, it collapses. Banks take on risk from firms and individuals and try and diversify that risk onto others, but all they really can do is spread the risk around in the hope that if one part collapses, the others will support it. At some point though, too much risk accumulates in too many parts all at once, then the entire thing bombs and some other risk sink sucks in the risk. In the case of banks, it is government who takes on the risk - and as government IS the people, they just hand the risk right back to the people who sold it on in the first place - but in the new form of higher taxes, fewer schools and higher inflation.

So far so good? This stuff is NEVER taught at university level. You will NEVER hear any of that explained in any finance or economics course. The only way you'll ever hear of it is to read the Nobel prize winning authors who invented CAPM and such, and they mince their words so finely that it is extremely difficult to see what they are really truly saying. Yet the very brightest do understand this, and furthermore they understand that no one wants to hear that our entire civilisation is dooming itself - sadly they only tend to be explicit after they have retired and no longer need to attract research money.

Time for a little more detail on how exactly too much risk accumulates in one place and the whole thing dives. What I'm about to explain is a gross over-simplification, and it's a little inaccurate, but it's close enough to be good enough.

Remember our structured finance? Remember how it's basically a set of insurance contracts against some future eventuality? Well, after you've taken out the contract, you can sell it at any stage for what it's currently worth - so, our farmer may learn that the upcoming summer is almost certainly going to be a bumper harvest and therefore will sell his insurance early so he can reap all of the bumper harvest rather than the insurer getting it. Obviously, as more & more people realise that a bumper harvest is likely, such insurance contracts rapidly lower in price to whatever the average consensus is that the contract is worth - so obviously enough, if a bumper harvest is a near guarantee, then insuring against failure is very cheap. You thus get a zooming in to something's true value the closer it comes in time as more accurate information about the future becomes available.

This is both good and bad. When it works, it works well. Sadly, in the case of a speculative bubble, expected future values can vastly exceed something's true worth, and unlike investment shares in companies (on a stockmarket) which are legally protected so you can only lose what you invest and not a penny more, you can lose many hundreds of times your investment in these insurance contracts (also called derivatives, or futures). This is because, effectively, derivatives are basically gambling on the future, so if you take very good odds on the expected near guarantee that there will be a good harvest, if there is a highly unexpected very bad harvest you suddenly lose the inverse which is many hundreds (and sometimes thousands of times) your initial investment.

In the case of Bear Stearns and Northern Rock, they combined all of what I have just explained. So let's take Northern Rock - it is a high street bank which gives out mortgages to people. This debt comes with some risk, so Northern Rock takes out insurance against people not paying it back fully with Bear Stearns (this is called securitisation) and other banks because that removes the discount rate the accountants apply to account for potential bad debts - thus its mortgages become worth more, and thus so does the company. Bear Stearns then spreads around that risk still further with yet other banks. Then say the mortgage market very unexpectedly goes bad as it did in the US - suddenly you have a massive payout of the insurance polices, each chaining from one to the next to the next - but because each banks has externalised its risk to all the others, they ALL get it in the neck and they ALL lose a fantastic amount of money - currently quite a few trillion dollars at best estimates.

However that alone isn't what kills the banks - they're not that stupid, and there are regulations preventing really stupid behaviour since 1929. No, oddly enough what kills banks - or indeed any large organisation, including entire governments - is the very human emotion of loss of trust, just as it did in 1929. I mentioned this last entry in connection with the problem that no one knows what a firm's current cash flow looks like, and therefore no one knows whether the firm has any liquidity.

The problem becomes that when those banks are off making unwise investment choices as previously described, they are constantly upping what an unwise investment is worth at the time - it's why it seems wise, because the apparent high return appears to be worth the risk. That means that on the book accounts, their net worth sky rockets due to an accounting principle called Mark to Market which simply means that something is worth whatever you can currently sell it for, not what it might actually be worth say sometime later on. Sounds sensible right? But remember our house example - which becomes worthless if cash flow is too low to sell the property - under Mark to Market, because cash flow drops so severely from paying out all those insurance contracts, suddenly lots of other assets in the bank become very worthless very quickly. That means that when a correction happens, one's accounts suddenly go from being extremely healthy to being extremely poor in a matter of hours. So, generalising the example, when liquidity dries up as you can't sell anything due to lack of liquidity (a vicious circle), then via Mark to Market accounting your company becomes worthless very quickly. Do you understand now why Bear Stearn's share price dropped from $93 to $2 so quickly? It literally became worthless. Why? Because money's value changed so quickly & drastically! This is why I say that money doesn't exist!

Generalising still further, you can now see why failing to inject liquidity in 1929 made the entire world economy worth a fraction of its value very quickly indeed. Injecting too much liquidity causes inflation and once again the entire world economy gets ill very quickly. It's a constant balancing act - a fine line between recession and boom.

And do you now understand what structured investment actually does? It hides risk by getting it off your own balance sheet and into someone else's, it probably even reduces it somewhat, but does NOT eliminate it. By getting it off individual firm's balance sheets and onto some other firm's, it simply makes the entire edifice extremely complicated and highly delicate. This is what caused Enron to fail - I have investigated Enron in some detail, and I really doubt anyone in there actually knew they weren't making a profit because how it had structured its debt was so incredibly complicated that even with five years for accountants to study the books after its collapse, they still don't know how much of a profit or a loss Enron was making at any one time. To think Enron themselves knew as it was happening is wishful thinking - and as it's just happened again in the entire financial sector starting with US mortgages, I'm pretty sure they have been making paper profits for the last decade or so. They have probably actually been running at a massive loss for years - it's just the accounts didn't show it, but now they are beginning to do so.

And now you see we get onto the meaning of recessions and booms. Markets, as it is often said, mostly work via greed and fear - not two of the best human emotions. However before fear and greed can come into play, they require trust - that the accounts say something close to what is correct and that when a firm says it is healthy, that it really is healthy. When the accounts and annual reports suggest that most of the risk has been diversified off into securities (insurance contracts), and thus its balance sheet looks much healthier due to a much lower discount rate, a firm looks much less risky than it really is because the market cannot absorb infinite risk and thus feeds risk back onto all firms but just in a different fashion.

Next entry I'll tackle how precisely we developed such a ham-fisted, stupid, inefficient and counter-productive way of handling risk. We didn't use to just pass risk around like some ticking bomb, in fact America and Britain became world empires precisely through embracing often incredible risks and trying (& failing) repeatedly until they succeeded, often with terrible costs in lives. Be happy everyone!

Sunday 30th March 2008: 4.04pm. Phew, it's end of term at long, long last! Well, it was two days ago, but I have been catching up on my sleep as with the MSc in High Performance Computing interview on Friday, I didn't get much of it this past week. They accepted me BTW, but without help for the fees of £5,600 - which basically means I can't go as such a high fee would cripple me. So it's increasingly looking like it'll have to be Ireland for at least the coming year - it could be much worse I suppose. Let's hope that Megan can both get in and afford to go given what the dollar has been doing recently.

Some people weren't entirely agreeing with my entry two entries ago about ice ages being when the planet is at its healthiest and warm periods (like currently) are when it's most sick. Firstly, I should really have included known ice ages in that last table of mass extinctions:

30m-present 55% @ 65m 20% @ 200m 70%-96% @ 251.4m 350m-260m 70% @ 380m-360m 49% @ 447m-444m 460m-430m 49% @ 488m ? @ 850m-630m
Quaternary Glaciation Cretaceous–Tertiary Extinction Triassic-Jurassic Extinction Permian–Triassic Extinction Karoo Ice Age Late Devonian Extinction Ordovician-Silurian Extinction Andean-Saharan Ice Age Cambrian-Ordovician Extinction Glaciated Earth?

I didn't think that made the relationship clear, so here's a graph of temperature changes up 500m years ago. BTW I swapped the horizontal order above to match this graph:

Not hugely conclusive in either direction is it? But then the 18 isotope of Oxygen is only loosely correlated with temperature. Next I thought that this graph might be useful - it's the atmospheric levels of Carbon Dioxide (CO2), Temperature, Methane (CH4) and sun output during the last 400k years from the Vostok ice core:

This is much better - there is a clear link between CO2 levels and temperature. As the temperature falls, more plants consume more CO2 than is being produced by rock weathering and such and thus its level drops - this is opposite to our intuition of heat being good as we associate plants growing profusely in summer when it's hot. As you can see, between the punctuated rises in temperature, the drop in CO2 is more gradual than the drop in temperature indicating improving evolution of plant photosynthesis capability - mostly by improved location and shaping of the environment, but also somewhat due to genetic improvement. Methane also tracks temperature because methane is produced by decaying organic matter, and when it's cold those little bacteria work extremely slowly - hence why your fridge keeps food fresh for longer. The most interesting part is how it suddenly shifts to high temperatures and high CO2 and then takes some time to become colder and less CO2 relatively gradually - and I'll posit a cause later. Note also how rising sunlight levels do increase CO2 but always leave it lower next cycle. Finally, note how temperatures on this planet normally are 4C lower than at present!

Of course one might now say "well how do you know it isn't the CO2 and the methane which raises the temperature and not the other way round?". After all, both are potent greenhouse gases and man-made emissions of both are currently being strongly blamed for climate change? I think that this, more than any other point, is what confused people about me linking cooler temperatures with health.

And you'd be absolutely right - more greenhouse gases mean hotter planet, less greenhouse gases mean cooler planet. From that perspective, lots of gases and heat are good for plants so they grow lots and lower the gases, making it colder. This is the traditional viewpoint - but consider things from a biodiversity view:- more and more plants are required to keep those gases low, therefore there are a LOT more plants (and thus animals) around in total at the coldest point - if there weren't, greenhouse gas levels wouldn't become so low.

When you consider this angle, it becomes clear that it doesn't matter which causes the other, because they are one and the same thing. If you take a Gaia perspective ie; that the entire planet is one organism, then it simply becomes a case of whether Gaia has a fever or not (just like animals who also get hotter - not colder - when they get ill ie; lose structural cohesion, which I'll explain shortly). Oxygen and Methane are highly reactive chemically at our atmospheric pressure and temperature and simply do not persist in any environment for very long without reacting with something - so therefore the fact that a whole 21% of our atmosphere is pure Oxygen and has stayed that way for 2bn years (despite the 96% mass extinction at 250m!) is because an awful lot of very resilient photosynthetic organisms have kept it that way by extracting the carbon out of any CO2 they could find via sunlight and leaving lots of O2 around for more complex organisms to use (despite it being the most abundant & potent carcinogen in our environment by far). It's a cycle - plants can't grow without CO2 yet perversely, historically there are the most plants when CO2 levels are lowest precisely because of that fact - which has been amply proven via the fossil record:

One must remember that oxygen is a very powerful oxidiser - so much so that carbon, when reacting with oxygen, releases so much energy it turns air into an ionised plasma (also called a flame). That very same chemical reaction, the same that burns entire forests down in an inferno, is what drives you and me. That natural thing for that reaction to do is burn very hard, and very brightly - yet none of us burst into flames unless we are heated up sufficiently after which we do burn extremely well (try burning dried out meat some time - it has an energy density approaching that of crude oil, some 37MJ/kg). Why? Because, when healthy, our biochemical regulation system paces the reaction using a water solution and membranes to keep the chemicals apart and it only pumps the amount of energy required for combustion via ion transfer over the membranes. When we die, those membranes break down and anaerobic bacteria start eating us thus producing the familiar stench of decay. Just in case readers are still not absolutely convinced, I did a very crude merge of the two graphs:

There is so much going on in the graph that it's hard to describe, but one can see that the 96% extinction at 250m came at a time when Gaia was pretty unhealthy anyway - probably the reason it was the worst mass extinction that we know of, and also it took the longest to recover from. Sometimes biodiversity precedes temperature change, other times it's the opposite. I agree that from this evidence my opinion is still not proven - but equally, the more common association of "warm = good" is no more proven. A very good piece of news is that Gaia was at her healthiest point in 500m years before we started amplifying the minor mass extinction after the end of the last ice age 15,000 years ago.

Thermodynamically speaking, the point to take from all this is when things are at their most ordered, most cohesive, most healthy is when there is the greatest difference between energy source and final energy sink. For the biosphere, the temperature of the sun is pretty fixed at 6000K so it's at its healthiest when it is extracting the maximum possible amount of entropy from sunlight - which implies the coldest possible ambient temperature. See my diary entries during my summer of research for a lot more on this.

Now onto how this relates to financial markets. It recently occurred to me that a graph from my group Econometrics project on historical house prices in the UK last semester might be useful:

The red solid line (left axis) is the average house price divided by the average annual income per person in the UK - as you can see, it tended to stay around twenty times for much of British history and it still tends to return to that multiple. The green is the interest rate the bank sets and the purple is the rate of inflation. The blue dotted line is real interest rates, which is what the banks charge minus inflation. Traditionally, a sudden jump in this house price multiple indicated that large inflation was about to come within a year - what economists call "overheating" in an economy. As you can see, from about 1983 onwards, house price multiples have started to ignore the interest AND inflation rates quite noticeably - despite what monetary economics or the government thinks about it being a form of economic stabilisation control. Nevertheless, we must ask: why should this house price multiple move so independently of the underlying interest rate?

Here's what I think: a lot of talking heads on TV and newspapers are blathering about cheap credit being the cause of the recent financial crunch (because hedge funds, banks, big investors et al routinely borrow short-term money to cover their temporary massive losses on the derivatives market). This is simply untrue - in fact, the real interest rate sat around zero for much of recent British history and since the early 1980's it has returned to a few percent which is still about half its average during the boom times of the British empire. No I think it's far more a case of too much capital floating around - after the great boom of the 1990's, we simply have too much excess capital for the stockmarkets to absorb and as a result it has tried to find elsewhere to go eg; emerging markets or real estate. Too much of something does imply that it becomes cheaper - but I don't think that means cheaper in cost per se (after all, it can't go below the real interest rate in cost), but rather cheaper due to more of it being around and thus less work is needed to get it. China certainly has far more easy capital than it knows what to do with - in fact, it like other developing countries has actively turned capital away.

Too much capital is a rather unique situation in history - I can't think of another case apart from perhaps in Britain at the height of empire when foreign direct investment mushroomed. My instinct suggests that inflation will rise to wipe off the value of that excess capital, but I must agree that it should have already happened by now. Who knows what this means - I would personally guess that the national accounts are simply wrong and inflation has got lost off the balance sheet somewhere - but I do know that that house price multiple is going to drop back to at least 25 times and probably more - which means either that house prices fall or wages rise (which equals inflation). Just for reference, this is British empire foreign investment as taken from a 2nd year Economics essay I wrote:

As one can see, the empire saw a handsome average return of around 50% for its risky investments overseas. Furthermore, as the British economy wobbled (as you can see from the wildly oscillating outflows), the foreign income was a welcome source of stability during the recessions of 1839-1842, 1866-1870, 1877-1879, and the long recession 1890-1906.

Now money is a sort of energy - or rather, the movement of money is kinda like energy moving in that it has an effect on its surroundings and tends to lose some of its value during transit. For example, if you move money from A to B you pay a charge - you might not think you do of course because it's hidden via the clearing system, so when you transfer money or pay in a cheque it goes into clearing ie; takes a few days before it arrives. This is one of the greatest scams of modern finance because money moves in milliseconds, so all the banks really do is take your money and leave it in their own bank account for three or four days before sending it on. While there it earns interest you see which the bank takes as commission - meanwhile of course, you lose that interest.

This is why GDP growth, ie; the growth of the money value of how many final goods and services were produced, has some relation to actual economic growth. It's basically a measure of how much money has changed hands and is a very good indicator of how much effect our economy has had in total on everything. Unfortunately, it has much of its effect on our mental state rather than anything physical - after all, many wars have been fought over perceived wealth advantages which may or may not turn out to be warranted.

Financial markets are supposed to discover those goods & services which people will want next or want cheaper and funnel capital into those for an expected return beyond the bank interest rate corresponding to the amount of risk. As covered in recent entries, when markets believe the information they receive about upcoming goods & services, greed sets in, all is well and the money flows (ie; a boom). When it becomes apparent that that information is not to be trusted ie; because firms and analysts have started lying about the worth of these proposed investments, fear sets in and financing dries up (ie; a recession). Thus one can see that what drives the boom & bust cycle is trust in information:- when trust is high, interconnection & interaction is high and when trust is low, everyone hoards and boards up the windows.

I covered this before in previous entries, but now we need to relate this to the biosphere which undergoes a ~100,000 year ice age cycle and thus a ~100,000 year cycle of minor mass extinctions (of around 5-10%). Can you see yet how both processes are thermodynamically identical? If not, here's my best attempt to explain ...

What causes the loss of trust which causes a recession? It's the boom itself. Why? Because as the economy booms, there is a mad scrabble to get your money in there and the most sound investments will get oversubscribed first, leaving only the less sound ones for the excess (often borrowed) money to enter. There is an ever increasing incentive for investees to lie about the soundness of their proposed investment and likewise for the investor who wants to find superior returns for their capital, but being afraid of "losing out" they throw more & more caution to the wind. When reality sets in, trust gets lost - but note something really interesting: what causes a recession is too much capital available too easily.

This exactly mirrors how ice ages break down. At their coldest, total planetary biomass is at its peak - there is more abundant food available than at any other time as the biosphere wrings every last bit of entropy out of sunlight. In fact, there is too much food available too easily. You're probably thinking I'm mad here, but thermodynamically speaking, the more entropy you dissipate in a smaller space and time period, the exponentially higher the effects on the environment it causes. One effectively gets a compression of space and time from the entropy's viewpoint - which is also correct as in Physics we tend to hold light as the constant and relativise everything else around that. Time, in the sense of the rate of change caused to the environment, speeds up.

The problem is that all those numerous plants & animals being so diverse, interlocking & complicated that they cannot adapt to such increasing rates of change, caused by their own success, without losing structural cohesion (ie; a rising fever), and thus one gets a collapse. We do know however that total diversity exponentially rises over time, so after each iteration things are always better on average than before by some compounded percentage.

This is exactly the same process that drives the rise and falls of civilisations. It also is the same process that drives people going mad and recovering as I did. This notion of structural inflexibility - that the success of a system's structure generates so much change in its environment that it fails to adapt to changing conditions, so it collapses which forces adaptation - that is THE central thesis of my book, that we must deliberately & consciously deconstruct our society to make it vastly more flexible - that means eliminating most of our laws, social & legal structures, and in the process keeping what is absolutely required for our civilisation to continue - and not one iota more.

Hence the main points of my book: improve speed & breadth of transmission & quality of information in all areas so trust is not only kept higher, but over-simplifying complex issues avoided. Simplify laws to most essential guidelines instead of tombs of books no human could possibly know in their entirety. Move economy's focus from increasing physical output to increasing cognitive improvement. Remove as many incentives to lie or falsify as possible. Tax what people do NOT what they earn - this unifies social, moral & legal societal controls in one, coherent direction rather than the current mess where taxes punish good behaviour (eg; earning more money) and bad behaviour is untaxed (eg; crime).

Well I hope you all enjoyed my four part series on economics and biology - as you might be able to tell, a lot of this is being synthesised for my book though I'll be a lot more rigorous (and hopefully clearer) there. Ok, time for food and cleaning the house before Megan and Johanna get back. Be happy everyone!

Go to next month Go back to the archive index Go back to the latest entries

Contact the webmaster: Niall Douglas @ webmaster2<at symbol> (Last updated: 08 July 2012 20:15:38 +0100)