Paul Samuelson

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pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

No one read books anymore. It was also because most finance scholars had ceased to care about the hard work of making judgments about risk and return in the stock market. Who needed judgment, after all, when everybody knew that stock price movements were completely random? CHAPTER 4 A RANDOM WALK FROM PAUL SAMUELSON TO PAUL SAMUELSON The proposition that stock movements are mostly unpredictable goes from intellectual curiosity to centerpiece of an academic movement. WHEN PAUL SAMUELSON ARRIVED AT the Massachusetts Institute of Technology in 1940, allowed to slip away from Harvard by an economics department chairman who valued neither math geeks nor Jews, the engineering-dominated school didn’t even offer a Ph.D. in economics. Within a decade, MIT had built a department around Samuelson that left Harvard’s in the shade.

The chapter in Markowitz’s book is titled “Return in the Long Run.” And the whole saga is laid out in vastly more detail in William Poundstone, Fortune’s Formula (New York: Hill and Wang, 2005), esp. 192–97. 25. As recalled by Mark Rubinstein. CHAPTER 4: A RANDOM WALK FROM PAUL SAMUELSON TO PAUL SAMUELSON 1. Jürg Niehans, A History of Economic Theory: Classic Contributions 1720–1980 (Baltimore: Johns Hopkins University Press, 1990). 2. Paul A. Samuelson, Economics: An Introductory Analysis (New York: McGraw-Hill, 1948), 570, 573. 3. Michael Szenberg, Aron Gottesman, and Lall Ramrattan, Paul Samuelson: On Being an Economist (New York: Jorge Pinto Books, 2005), 85. 4. The student, Richard Kruizenga, was chiefly interested in describing the securities and sketching their history. Samuelson wanted more. Recalled Kruizenga, “He had the ability to see what the real issue was, from an economist’s standpoint: How do you value these things?”

A Random Walk from Fred Macaulay to Holbrook Working Statistics and mathematics begin to find their way into the economic mainstream in the 1930s, setting the stage for big changes to come. The Rise of the Rational Market 3. Harry Markowitz Brings Statistical Man to the Stock Market The modern quantitative approach to investing is assembled out of equal parts poker strategy and World War II gunnery experience. 4. A Random Walk from Paul Samuelson to Paul Samuelson The proposition that stock movements are mostly unpredictable goes from intellectual curiosity to centerpiece of an academic movement. 5. Modigliani and Miller Arrive at a Simplifying Assumption Finance, the business school version of economics, is transformed from a field of empirical research and rules of thumb to one ruled by theory. 6. Gene Fama Makes the Best Proposition in Economics At the University of Chicago’s Business School in the 1960s, the argument that the market is hard to outsmart grows into a conviction that it is perfect.


pages: 330 words: 77,729

Big Three in Economics: Adam Smith, Karl Marx, and John Maynard Keynes by Mark Skousen

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Albert Einstein, banking crisis, Berlin Wall, Bretton Woods, business climate, creative destruction, David Ricardo: comparative advantage, delayed gratification, experimental economics, financial independence, Financial Instability Hypothesis, full employment, Hernando de Soto, housing crisis, Hyman Minsky, inflation targeting, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, liberation theology, liquidity trap, means of production, microcredit, minimum wage unemployment, money market fund, open economy, paradox of thrift, Pareto efficiency, Paul Samuelson, price stability, pushing on a string, rent control, Richard Thaler, rising living standards, road to serfdom, Robert Shiller, Robert Shiller, rolodex, Ronald Coase, Ronald Reagan, school choice, secular stagnation, Simon Kuznets, The Chicago School, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, Tobin tax, unorthodox policies, Vilfredo Pareto, zero-sum game

Government expenditures on goods and services, which had been running at under 15 percent of GNP during the 1930s, jumped to 46 percent by 1944, while unemployment reached the incredible low of 1.2 percent of the civilian labor force" (Lipsey, Steiner, and Purvis 1987, 573). Paul Samuelson Raises the Keynesian Cross As noted earlier, Keynes died in 1946, right after the war. It would be left to his disciples to lead the charge and create a "new economics." Fortunately for Keynes, a young wunderkind was ready to till his shoes. His name was Paul Samuelson, and he would write a textbook that would dominate the profession for more than an entire generation. The year was 1948, one of those watershed years that occasionally crops up in economics. Remember 1776, 1848, and 1871? In early 1948, the Austrian emigre Ludwig von Mises, secluded in his New York apartment, was typing a short article, "Stones into Bread, the Keynesian Miracle," for a conservative publication, Plain Talk.

He cherished his children, yet saw them die prematurely from malnutrition and illness or drove them to suicide. Marx protested the evils of exploitation in the capitalist system, and yet, according to one biographer, he "exploited everyone around him—his wife, his children, his mistress and his friends—with a ruthlessness which was all the more terrible because it was deliberate and calculating" (Payne 1968, 12). Paul Samuelson adds, "Marx was a gentle father and husband; he was also a prickly, brusque, egotistical boor" (Samuelson 1967b, 616). In sum, Marx ranted about the inner contradictions of capitalism, yet he himself was constantly beset by inner dissension. Marx's Christian Faith The most surprising irony is that Karl Marx—considered one of the most vicious opponents of religion—was brought up a Christian though many of his ancestors were rabbis.

Under capitalism, the rate of profit has failed to decline, even while more and more capital has been accumulated over the centuries. 2. The working class has not fallen into greater and greater misery. Wages have risen substantially above the subsistence level. The industrial nations have seen a dramatic rise in the standard of living of the average worker. The middle class has not disappeared, but expanded. As Paul Samuelson concludes, "The immiserization of the working class . . . simply never took place. As a prophet Marx was colossally unlucky and his system colossally useless" (1967, 622). 3. There is little evidence of increased concentration of industries in advanced capitalist societies, especially with global competition. 4. Socialist Utopian societies have not flourished, nor has the proletarian revolution inevitably occurred. 5.


pages: 389 words: 109,207

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

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Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

Walking along the street, Kelly held his hand to his head. “Wait a minute!” he cried out. Moments later, he slumped to the sidewalk. He was dead of a brain hemorrhage at the age of forty-one. Kelly would thereafter be known for an incidental connection to a movie he never saw—and for the gambling formula that would carry his name on to posterity. PART THREE Arbitrage Paul Samuelson PAUL SAMUELSON LOVED HARVARD. The love was not entirely requited. By the age of twenty-five, Samuelson had published more journal articles than his age. This distinction seemed to count little at Harvard, where Samuelson was boxed into a low-paying post as an economics instructor. Tenure was a remote prospect. One of Samuelson’s colleagues had been passed over for tenure because he had a disability.

—Johann Wolfgang von Goethe CONTENTS Prologue: The Wire Service PART ONE: ENTROPY Claude Shannon • Project X • Emmanuel Kimmel • Edward Thorp • Toy Room • Roulette • Gambler’s Ruin • Randomness, Disorder, Uncertainty • The Bandwagon • John Kelly, Jr. • Private Wire • Minus Sign PART TWO: BLACKJACK Pearl Necklace • Reno • Wheel of Fortune • More Trouble Than an $18 Whore • The Kelly Criterion, Under the Hood • Las Vegas • The First Sure Winner in History • Deuce-Dealing Dottie • Bicycle Built for Two PART THREE: ARBITRAGE Paul Samuelson • The Random Walk Cosa Nostra • This Is Not the Time to Buy Stocks • IPO • Bet Your Beliefs • Beat the Market • James Regan • Resorts International • Michael Milken • Robert C. Merton • Man vs. Machine • Why Money Managers Are No Good • Enemies List • Widows and Orphans PART FOUR: ST. PETERSBURG WAGER Daniel Bernoulli • Nature’s Admonition to Avoid the Dice • Henry Latané • The Trouble with Markowitz • Shannon’s Demon • The Feud • Pinball Machine • It’s a Free Country • Keeping Up with the Kellys • Though Years to Act Are Long • All Gambles Are Alike • A Tout in a Bad Suit • My Alien Cousin PART FIVE: RICO Ivan Boesky • Rudolph Giuliani • With Tommy Guns Blazing • The Parking Lot • Welcome to the World of Sleaze • Ultimatum • Princeton-Newport Partners, 1969–88 • Terminator • The Only Guy on Wall Street Who’s Not a Rat PART SIX: BLOWING UP Martingale Man • Kicking and Screaming • I’ve Got a Bad Feeling About This • Thieves’ World • Fat Tails and Frankenstein • Survival Motive • Eternal Luck • Life’s Rich Emotional Experiences PART SEVEN: SIGNAL AND NOISE Shannon’s Portfolio • Egotistical Orangutans • Indicators Project • Hong Kong Syndicate • The Dark Side of Infinity Notes Bibliography Acknowledgments Prologue: The Wire Service THE STORY STARTS with a corrupt telegraph operator.

“He wrote beautiful papers—when he wrote,” explained MIT’s Robert Fano, a longtime friend. “And he gave beautiful talks—when he gave a talk. But he hated to do it.” In 1958 Shannon accepted a permanent appointment as professor of communication sciences and mathematics at MIT. Almost from his arrival, “Shannon became less active in appearances and in announcing new results,” recalled MIT’s famed economist Paul Samuelson. In fact Shannon taught at MIT for only a few semesters. “Claude’s vision of teaching was to give a series of talks on research that no one else knew about,” explained MIT information theorist Peter Elias. “But that pace was very demanding; in effect, he was coming up with a research paper every week.” So after a few semesters Shannon informed the university that he didn’t want to teach anymore.


pages: 298 words: 95,668

Milton Friedman: A Biography by Lanny Ebenstein

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affirmative action, banking crisis, Berlin Wall, Bretton Woods, Deng Xiaoping, Fall of the Berlin Wall, fiat currency, floating exchange rates, Francis Fukuyama: the end of history, full employment, Hernando de Soto, hiring and firing, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Arrow, labour market flexibility, Lao Tzu, liquidity trap, means of production, Mont Pelerin Society, Myron Scholes, Pareto efficiency, Paul Samuelson, Ponzi scheme, price stability, rent control, road to serfdom, Robert Bork, Ronald Coase, Ronald Reagan, school choice, school vouchers, secular stagnation, Simon Kuznets, stem cell, The Chicago School, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Thorstein Veblen, zero-sum game

Among the most significant leaders in the profession in the United States with whom he has interacted over his career who were not at Chicago (though even some have Chicago connections) are Franco Modigliani, Paul Samuelson, John Kenneth Galbraith, and James Tobin. None of these men share his ideological perspective and all are considered modern liberals. Modigliani, who won the Nobel Prize in Economics in 1985, remembered Friedman from the perspective “never of friendship, but of real professional respect.” Modigliani recalled an early interaction with Friedman when the former was a young scholar at Chicago in 1948–49. He wrote a letter to the editor suggesting increased government taxation to replace price controls and rationing. Friedman was “indignant”: “Your suggestion . . . is immoral, shame on you! It’s a trick to make fun of the rules of the market. The rules of price formation must be allowed to work freely without any manipulation.”1 Paul Samuelson no doubt views himself in the same way that Friedman viewed himself (though neither, of course, expresses it): as the leading economist of his generation.

I also had the opportunity to meet David’s wife, Elizabeth, and to have a telephone conversation with Milton’s nephew Alan Porter. Friedman’s longtime secretary, Gloria Valentine, was encouraging and helpful. Others who gave interviews include Gary Becker, Anna Jacobson Schwartz, Lester Telser, Larry Sjaastad, Thomas Sowell, Sam Peltzman, Stephen Stigler, Larry Wimmer, John Turner, and the late D. Gale Johnson. Paul Samuelson sent a useful letter with reactions to some questions. For my biography of Hayek, I had the opportunity to interview W. Allen Wallis, Edwin Meese, and Ronald Coase, among others, and to talk briefly on the phone with Aaron Director. I also thank in particular J. Daniel Hammond, Robert Leeson, and William Frazer for their work on Friedman; the University of California at Santa Barbara for use of its library and interlibrary loan program; the Hoover Institution on War, Revolution and Peace for use of its Friedman archive; the Intercollegiate Studies Institute and Young America’s Foundation for participation in conferences on Friedman; the Liberty Fund for participation in a conference on Frank Knight; Walter Mead for encouragement and assistance; Tom Schrock for continuing advice; Mark Skousen for calling various articles to my attention; Joe Atwill and Curtis Ridling, and Cyndy x Phillips for reviewing the manuscript; and Nik Schiffmann and Lee Gientke for research contributions.

Changes in prices reflect changes in the supply of and demand for goods, thereby guiding production. If prices go up, other things being equal, more goods will be produced. If prices go down, the opposite will occur. Prices are an informationbestowing mechanism. Theoretically, Viner influenced Friedman more than anyone else, and it was from Viner that Friedman learned microeconomics. Stories of Viner’s toughness and even ferocity as a teacher were and remain legion. Paul Samuelson, an economics undergraduate at Chicago at the same time that Friedman was a graduate student and who received the Nobel Prize in Economics in 1971, recalls Viner’s “famous” 301 course in economic theory. During it, students “sat tensely around the table.”3 If Viner called on a student three times and the student could not provide satisfactory answers, the student was out of the class. Frank Knight was the other leading member in the department when Friedman was a graduate student.


pages: 425 words: 122,223

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

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Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, stochastic process, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

Merton, Merton Miller, Franco Modigliani, Barr Rosenberg, Mark Rubinstein, Paul Samuelson, Myron Scholes, William Sharpe, James Tobin, Jack Treynor, and James Vertin. Each of them spent long periods of time with me in interviews, and most of them engaged in voluminous correspondence and telephone conversations as well. All of them read drafts of the chapters in which their work is discussed and gave me important criticisms and suggestions that enrich virtually every page of the book. Most of them also provided their photographs. Each in his own way contributed to my understanding of the subject matter well beyond the chapters that were their immediate concern. In this regard, I hope I may be forgiven if I single out Paul Samuelson, my friend of more than fifty years. He served uncomplainingly as my mentor, inspiration, and inexhaustible research associate from the very beginning; the accumulation of handwritten wisdom that passed from his fax to my fax is a treasure in itself.

“The Art of Forecasting, From Ancient to Modern Times.” Cato Journal (January). Merton, Robert C. 1973. “Theory of Rational Option Pricing.” Bell Journal of Economics and Management Science, Vol. 4 (Spring), pp. 141–183. Merton, Robert C. 1974. “On the Pricing of Corporate Debt: the Risk Structure of Interest Rates.” Journal of Finance, Vol. XXIX, No. 2 (May), pp. 449–470. Merton, Robert C. 1983. “Paul Samuelson’s Financial Economics.” In Paul Samuelson and Modern Economic Theory, Cary E. Brown and Robert M. Solow, eds. New York: McGraw-Hill Book Company. Merton, Robert C. 1988. Personal statement (unpublished manuscript). Merton, Robert C. 1989. “On the Application of the Continuous-Time Theory of Finance to Financial Intermediation and Insurance.” The Geneva Papers on Risk and Insurance, Vol. 14 (July), pp. 225–262.

Hansell (1989). 2. I am grateful to McCloskey (1992) for the quotation from Dante. 3. Wien (1990). 4. Institutional Investor staff (1977). 5. The editor of this book read the term in a journal article of the 1970s. 6. Vosti (1990). 7. Treynor, PC&I. 8. Judson (1979). 9. Gould (1991). 10. Vertin (1974). PART I Setting the Scene Chapter 1 Are Stock Prices Predictable? It is doubtful. Paul Samuelson, economist and Nobel laureate, once remarked that it is not easy to get rich in Las Vegas, at Churchill Downs, or at the local Merrill Lynch office. All investors, professionals as well as amateurs, acknowledge the truth of this observation. Even smart people have a hard time getting rich by predicting stock prices. Some people never try to outguess the market: they simply hang on to the stocks they inherited, bought long ago, or acquired in some employer-sponsored savings program.


pages: 403 words: 111,119

Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist by Kate Raworth

3D printing, Asian financial crisis, bank run, basic income, battle of ideas, Berlin Wall, bitcoin, blockchain, Branko Milanovic, Bretton Woods, Buckminster Fuller, call centre, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, choice architecture, clean water, cognitive bias, collapse of Lehman Brothers, complexity theory, creative destruction, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, dematerialisation, Douglas Engelbart, Douglas Engelbart, en.wikipedia.org, energy transition, Erik Brynjolfsson, ethereum blockchain, Eugene Fama: efficient market hypothesis, experimental economics, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, Financial Instability Hypothesis, full employment, global supply chain, global village, Henri Poincaré, hiring and firing, Howard Zinn, Hyman Minsky, income inequality, Intergovernmental Panel on Climate Change (IPCC), invention of writing, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, land value tax, Landlord’s Game, loss aversion, low skilled workers, M-Pesa, Mahatma Gandhi, market fundamentalism, Martin Wolf, means of production, megacity, mobile money, Mont Pelerin Society, Myron Scholes, neoliberal agenda, Network effects, Occupy movement, off grid, offshore financial centre, oil shale / tar sands, out of africa, Paul Samuelson, peer-to-peer, planetary scale, price mechanism, quantitative easing, randomized controlled trial, Richard Thaler, Ronald Reagan, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Simon Kuznets, smart cities, smart meter, South Sea Bubble, statistical model, Steve Ballmer, The Chicago School, The Great Moderation, the map is not the territory, the market place, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, Torches of Freedom, trickle-down economics, ultimatum game, universal basic income, Upton Sinclair, Vilfredo Pareto, wikimedia commons

The value of diagrams, he believed, was far greater. ‘The argument in the text is never dependent upon them; and they may be omitted,’ he wrote, ‘but experience seems to show that they give a firmer grasp of many important principles than can be got without their aid; and that there are many problems of pure theory, which no one who has once learnt to use diagrams will willingly handle in any other way.’29 It was Paul Samuelson, however, who decisively placed imagery at the heart of economic thought in the second half of the twentieth century. Known as the father of modern economics, Samuelson spent his seven-decade career at the Massachusetts Institute of Technology (MIT) and on his death in 2009 he was heralded as ‘one of the giants on whose shoulders every contemporary economist stands’.30 He was enamoured of equations and diagrams, and he profoundly influenced the use of both in economic theory and teaching.

Samuelson’s first major work was the book of his doctoral dissertation, Foundations of Economic Analysis. Published in 1947, it was aimed at the hard-core theorist, and was unapologetically mathematical: equations, he believed, should be the mother tongue of professional economists, serving to cut through muddled thinking and replace it with scientific precision. He wrote his second book, however, for an utterly different audience, and only thanks to a twist of fate. Paul Samuelson: the man who drew economics. At the end of the Second World War, US college enrolments ballooned as hundreds of thousands of ex-servicemen returned home in search of the education that they had missed and the jobs that they desperately needed. Many opted to study engineering – essential for post-war construction – and were required to learn a little economics along the way. Samuelson was, at the time, a 30-year-old professor at MIT and a self-declared ‘whippersnapper go-getter in esoteric theory’.

‘I don’t care who writes a nation’s laws – or crafts its advanced treatises – so long as I can write its economics textbooks,’ he declared in later years, ‘The first lick is the privileged one, impinging on the beginner’s tabula rasa at its most impressionable state.’34 Samuelson’s 1948 Circular Flow diagram, which depicted income flowing round the economy as if it were water flowing round plumbed pipes. A long struggle of escape Paul Samuelson was not alone in appreciating the extraordinary influence wielded by those who determine how we begin. His teacher and mentor, Joseph Schumpeter, also realised that the ideas handed down to us can be very hard to shake off, but he was determined to do so, to make way for his own insights. As Schumpeter wrote in his 1954 History of Economic Analysis, In practice we all start our own research from the work of our predecessors, that is, we hardly ever start from scratch.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, naked short selling, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

There is now a much greater volume of trading in these derivatives, in commodities futures and in options markets, in credit default swaps and mortgage-backed securities, in foreign exchange futures and bond futures than in the traditional market for corporate securities. Yet, before the publication of the theory from the great minds Fischer Black and Myron Scholes, we knew little about how to price such financial derivatives. Meanwhile, Robert Merton, a disciple of the great mind Paul Samuelson, was rapidly extending the relatively static models of finance to a dynamic context that more effectively included time. In creating dynamic models of finance, he was able to more fully describe the evolution of markets over time. The techniques he developed, originally with the market for options in mind, even more clearly delineated finance from economics. By its very nature, finance must model the evolution of prices over time that is simply less relevant within the traditional study of economics.

With the additional motivation to continue with his schooling with the onset of the Second World War, John attended Harvard University for a second Master’s, which he completed in 1942. He earned a PhD in business administration from Harvard in 1946. By all accounts, Harvard was impressed with Lintner. Upon receipt of his PhD, he was asked to remain at the university under a three-year paid membership to the Harvard Society of Fellows to pursue a research agenda as he saw fit. As a Harvard fellow, he followed in the footsteps The Early Years 51 of the great mind Paul Samuelson, who is documented in the fourth book of this series. Following his fellowship, Lintner was offered an assistant professorship in business administration at Harvard Business School in 1946, an associate professorship in 1951, a full professorship in 1956, and the George Gund Professor of Economics and Business Administration from 1964 until his untimely death in 1983. He died before the 1990 awarding of the Nobel Prize for the CAPM.

However, there remained little options activity until the Chicago Board Options Exchange (CBOE) created a much broader and more liquid forum for their exchange that would lower transactions costs and ease trading. In fact, warrants, or company-issued options, originally played a relatively larger role in futures securities trading vis-à-vis options than they do today. This explains why pioneering work by scholars such as the great mind Paul Samuelson initially studied warrants rather than options in the mid-1960s. A new exchange The Chicago Board of Trade (CBOT) is the world’s oldest futures exchange. It was created in 1848 to satisfy the need for farmers to secure buyers The Times 101 of the bounty of the US Midwest breadbasket and for merchants and processors to ensure a steady supply at a predictable price. This commodity exchange formulated standardized forward contracts, called futures contracts, to reduce uncertainties and hence facilitate credit for buyers.


pages: 494 words: 132,975

Keynes Hayek: The Clash That Defined Modern Economics by Nicholas Wapshott

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airport security, banking crisis, Bretton Woods, British Empire, collective bargaining, complexity theory, creative destruction, cuban missile crisis, Francis Fukuyama: the end of history, full employment, Gordon Gekko, greed is good, Gunnar Myrdal, if you build it, they will come, Isaac Newton, Joseph Schumpeter, liquidationism / Banker’s doctrine / the Treasury view, means of production, Mont Pelerin Society, mortgage debt, New Journalism, Northern Rock, Paul Samuelson, Philip Mirowski, price mechanism, pushing on a string, road to serfdom, Robert Bork, Ronald Reagan, Simon Kuznets, The Chicago School, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Malthus, trickle-down economics, War on Poverty, Yom Kippur War

He accommodated counterarguments posed by friends and collaborators, and attempted to anticipate objections from classical economists. As simple as he tried to make his case, however, much of his reasoning remained beyond the reach of the lay reader. As he explained, “I cannot achieve my object of persuading economists to re-examine critically certain of their basic assumptions except by a highly abstract argument.”20 Paul Samuelson,21 the Massachusetts Institute of Technology economist who was to become Keynes’s greatest evangelizer, summed up the accomplishment of The General Theory: “It is a badly written book, poorly organized,” he wrote. “It is arrogant, bad-tempered, polemical, and not overly generous in its acknowledgements. It abounds with mares’ nests and confusions. . . . Flashes of insight and intuition intersperse tedious algebra.

“The truth would make us free, and fully employed too.”45 Such was the sense of excitement and expectation in the winter of 1935 when The General Theory was about to be published in Britain that Harvard undergraduates arranged for special consignments to be dispatched across the Atlantic the minute it was available. As soon as the boxes of books arrived, they pounced on them to be among the first to read the revolutionary ideas revealed in the text. As Tobin recalled, “Harvard was becoming the beachhead for the Keynesian invasion of the New World.”46 Paul Samuelson, described by Galbraith as “almost from the outset . . . the acknowledged leader of the younger Keynesian community,”47 recorded the spirit of feverish exhilaration that surrounded the arrival of Keynes’s masterwork in Harvard in February 1936. “The General Theory caught most economists under the age of thirty-five with the unexpected virulence of a disease first attacking and decimating an isolated tribe of South Sea islanders,” he recalled.

Harris, was another late convert to Keynes and rivalled Hansen in his prodigious output of books, as both author and editor, spreading the new Keynesian credo. He used to open his lectures with, “I am Seymour Harris, Professor of Economics at Harvard University and author of 33 books,” all of which were about Keynes. But for all Hansen and Harris’s industry on behalf of the Keynesian cause, they did not trump Paul Samuelson’s best-selling Keynesian primer, Economics: An Introductory Analysis, published in 1948, which was instantly to become the most influential economic textbook since Principles of Economics, Alfred Marshall’s definitive exposition of the classical economic case. Thus in the course of just a few years, Keynes captured the hearts and minds of many young American economists. The spectacular rise in his influence on the thinking of American academic economists can clearly be seen by the number of mentions he received in learned journals.


pages: 252 words: 73,131

The Inner Lives of Markets: How People Shape Them—And They Shape Us by Tim Sullivan

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Airbnb, airport security, Al Roth, Alvin Roth, Andrei Shleifer, attribution theory, autonomous vehicles, barriers to entry, Brownian motion, centralized clearinghouse, Chuck Templeton: OpenTable, clean water, conceptual framework, constrained optimization, continuous double auction, creative destruction, deferred acceptance, Donald Trump, Edward Glaeser, experimental subject, first-price auction, framing effect, frictionless, fundamental attribution error, George Akerlof, Goldman Sachs: Vampire Squid, Gunnar Myrdal, helicopter parent, information asymmetry, Internet of things, invisible hand, Isaac Newton, iterative process, Jean Tirole, Jeff Bezos, Johann Wolfgang von Goethe, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, late fees, linear programming, Lyft, market clearing, market design, market friction, medical residency, multi-sided market, mutually assured destruction, Nash equilibrium, Occupy movement, Pareto efficiency, Paul Samuelson, Peter Thiel, pets.com, pez dispenser, pre–internet, price mechanism, price stability, prisoner's dilemma, profit motive, proxy bid, RAND corporation, ride hailing / ride sharing, Robert Shiller, Robert Shiller, Ronald Coase, school choice, school vouchers, sealed-bid auction, second-price auction, second-price sealed-bid, sharing economy, Silicon Valley, spectrum auction, Steve Jobs, Tacoma Narrows Bridge, technoutopianism, telemarketer, The Market for Lemons, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, trade route, transaction costs, two-sided market, uranium enrichment, Vickrey auction, Vilfredo Pareto, winner-take-all economy

The men who follow in the rest of this chapter were some of the main protagonists in the early days of this history, but by no means the only ones. To tell the complete story would require a book of its own. What we’re after is, instead, the broader path that economics took to become a pristine, mathematical discipline. “Let Me Write the Textbooks” Economics’ postwar trajectory is captured, in a sense, by following the career of Paul Samuelson, one of the preeminent economists of the twentieth century. He’s credited with not only helping economics develop a common language but also exposing this new language to the wider world. His economics textbook sold over four million copies during its decades-long reign as the bible for introductory economics courses worldwide. Samuelson, a prodigy who entered the University of Chicago at the age of sixteen during the height of the Great Depression, received his PhD in economics from Harvard in 1941.

He seems, to the best of our observation, content pondering big questions in the relaxed and unhurried manner that’s defined his career: when we e-mailed him to ask if he would talk to us about his classic paper on asymmetric information, “The Market for ‘Lemons,’” he responded, “Sure, happy to talk whenever is good for you.”5 In explaining how he came to do the work that ultimately won him a Nobel Prize, the Berkeley economist recalled his experiences as a PhD student at MIT in the 1960s (in the economics department built by Paul Samuelson). He arrived at graduate school just as economists were starting to get past the extreme abstraction that had ruled the profession in earlier decades. When initially confronted with the question of what inspired him to write about the used car market in the paper that made him famous, Akerlof didn’t talk first about unemployment (a failure of standard models that has troubled Akerlof throughout four decades as an economist), or 1960s economics counterculture, or any other economic phenomenon.

You can only confront these questions if you consider the strategic choices companies like Microsoft or Coke might make to try to ensure they’re the only game in town, and the regulatory decisions an enlightened government might choose to make sure they aren’t. Tirole’s Theory of Industrial Organization remains the standard reference on the topic, despite being published nearly three decades ago. (It also has more than thirteen thousand citations on Google Scholar, which is extremely unusual for a textbook; it’s about twice as many citations as Paul Samuelson’s classic Economics text, even though the latter is fifty years older.11) Tirole’s Nobel is emblematic of the postwar trend in economics—begun by George Akerlof’s market for lemons paper and continued by the many applied theorists that followed—toward tailoring models to circumstance. As a result, it’s hard to boil his opus down to media-friendly sound bites. As he told Binyamin Appelbaum of the New York Times after his prize had been announced: “There’s no easy line in summarizing my contribution and the contribution of my colleagues. . . .


pages: 270 words: 73,485

Hubris: Why Economists Failed to Predict the Crisis and How to Avoid the Next One by Meghnad Desai

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3D printing, bank run, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, BRICs, British Empire, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, correlation coefficient, correlation does not imply causation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, German hyperinflation, Gunnar Myrdal, Home mortgage interest deduction, imperial preference, income inequality, inflation targeting, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, market bubble, market clearing, means of production, Mexican peso crisis / tequila crisis, mortgage debt, Myron Scholes, negative equity, Northern Rock, oil shale / tar sands, oil shock, open economy, Paul Samuelson, price stability, purchasing power parity, pushing on a string, quantitative easing, reserve currency, rising living standards, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, seigniorage, Silicon Valley, Simon Kuznets, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, women in the workforce

The economists who enthusiastically adopted Keynes’s theory did not much like the marginal efficiency of capital as a concept and replaced the investment relationship by the accelerator principle, a formulation first proposed by an American economist, J. M. Clark. The idea was that business people added to their capital stock if they had experienced or expected a rise in their sales. At the aggregate level, this was translated into change in GDP, actual or expected. As a consequence, the role of interest rates was completely downgraded. The Keynesian model was simplified to a multiplier-accelerator model by Paul Samuelson, the first economist to so christen the model when he explored the possibility of cycles using Keynesian logic.3 As to Keynes’s monetary theory, followers concluded that monetary policy would be ineffective as a tool for recovery. They also took seriously Keynes’s idea that in the long run it would be necessary to drive the interest rate to zero. Keynes was worried that rich societies would suffer from excess savings, which would act as a barrier to high demand and hence prevent full employment.

Thus, to give Keynes credit for the escape of the economy from depression would be to commit an anachronism, or at least an exaggeration. The cure for the Great Depression, much of which had ended before 1936, was perhaps more due to international exchange rate depreciation, and in Britain a loose monetary policy. Renewal of Attack on Keynesian Economics The postwar hegemony of Keynesian economics was complete in universities. At Harvard, Alvin Hansen became the proselytizer for Keynesian ideas. His students Paul Samuelson, James Tobin, James Duesenberry, and Lloyd Metzler went on to dominate postwar economics teaching in the US. Hansen stripped any subtlety from Keynes’s theory even more than had Hicks. His famous Keynesian Cross diagram concentrated on the multiplier and tried to show how total expenditure – consumption determined by income and investment (taken to be given) – determined output. All you needed to know was a couple of straight lines.

On this basis, and reckoning with the difficulty faced by the worker in cutting his real wage so as to equalize his marginal disutility to the wage, Keynes proposed an alternative – a more general theory of how employment was determined. Innovations such as the consumption function, while they spoke of individual behavior, were macroeconomic and were not related to microeconomic concepts such as demand curves or the utility functions of consumers. The marginal efficiency of capital was argued in terms of a single investor, but somehow aggregated for the economy as a whole. Paul Samuelson (1915–2009), as the High Priest of economics (albeit at a very young age, being not yet 40 by 1950), cut through the Gordian knot and opined that Keynesian economics at a macro level gave us the tools to achieve full employment, which allowed micro economics come into its full play. This dichotomous, some would say schizophrenic, compromise was called the neoclassical-Keynesian synthesis. The basic objections of the rejectionists were conceded.


pages: 998 words: 211,235

A Beautiful Mind by Sylvia Nasar

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Al Roth, Albert Einstein, Andrew Wiles, Brownian motion, cognitive dissonance, Columbine, experimental economics, fear of failure, Gunnar Myrdal, Henri Poincaré, invisible hand, Isaac Newton, John Conway, John Nash: game theory, John von Neumann, Kenneth Arrow, Kenneth Rogoff, linear programming, lone genius, market design, medical residency, Nash equilibrium, Norbert Wiener, Paul Erdős, Paul Samuelson, prisoner's dilemma, RAND corporation, Ronald Coase, second-price auction, Silicon Valley, Simon Singh, spectrum auction, The Wealth of Nations by Adam Smith, Thorstein Veblen, upwardly mobile, zero-sum game

Whether or not this was true, Birkhoff’s bias had prevented him from taking advantage of the emigration of the brilliant Jewish mathematicians from Nazi Germany.27 Indeed, Harvard also had ignored Norbert Wiener, the most brilliant American-born mathematician of his generation, the father of cybernetics and inventor of the rigorous mathematics of Brownian motion. Wiener happened to be a Jew and, like Paul Samuelson, the future Nobel Laureate in economics, he sought refuge at the far end of Cambridge at MIT, then little more than an engineering school on a par with the Carnegie Institute of Technology.28 William James, the preeminent American philosopher and older brother of the novelist Henry James, once wrote of a critical mass of geniuses causing a whole civilization to “vibrate and shake.”29 But the man in the street didn’t feel the tremors emanating from Princeton until World War II was practically over and these odd men with their funny accents, peculiar dress, and passion for obscure scientific theories became national heroes.

Williams convinced the Air Force to let RAND create two new divisions, economics and social science. By the time Nash arrived, a “trust” of game theory research had grown up at RAND including such game theorists as Lloyd S. Shapley, J. C. McKinsey, N. Dalkey, F. B. Thompson, and H. F. Bohnenblust, such pure mathematicians as John Milnor, statisticians David Blackwell, Sam Karlin, and Abraham Girschick, and economists Paul Samuelson, Kenneth Arrow, and Herbert Simon.13 Most of the RAND military applications of game theory concerned tactics. Air battles between fighters and bombers were modeled as duels.14 The strategic problem in a duel is one of timing. For each opponent, having the first shot maximizes the chance of a miss. But having the better shot also maximizes the chance for being hit. The question is when to fire.

The military, as well as industry, loomed awfully large, so large that MIT’s armed, plainclothes campus security force existed solely for the purpose of guarding the half-dozen “classified” sites scattered around the campus and preventing those without proper security clearances and identification from wandering in. ROTC and courses in military science were required of all MIT’s two-thousand-plus undergraduate men.6 The academic departments like mathematics and economics existed pretty much to cater to the engineering student — in Paul Samuelson’s words, “a pretty crude animal.”7 All counted as “service departments,” gas stations where engineers pulled up to get their tanks filled with obligatory doses of fairly elementary mathematics, physics, and chemistry.8 Economics, for example, had no graduate program at all until the war.9 Physics had no Nobel Laureates on its faculty at the time.10 Teaching loads were heavy — sixteen hours a week was not uncommon for senior faculty — and were weighted toward large introductory courses like calculus, statistics, and linear algebra.11 Its faculty were younger, less well known, and less credentialed than Harvard’s, Yale’s, or Princeton’s.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

Similarly, the best forecast of where Citigroup’s stock will be trading this time next week is the current price. For fifty years, Bachelier’s thesis was largely unread. In 1954 or 1955, nobody seems to recall for sure, Jimmy Savage, a statistician at the University of Chicago who had coauthored several important papers about risk with Milton Friedman, happened across a book that Bachelier had written in 1914. He sent a note to a number of people he knew, including Paul Samuelson, the famous MIT economist, asking if they had heard of the Frenchman. Samuelson dug a copy of Bachelier’s thesis out of the MIT library, and it impressed him. The coin-tossing model was resurrected: by the early 1960s, Samuelson and a number of other economists were publishing papers claiming that stock prices followed a random walk. One of these authors was Eugene Fama, an Italian American from Boston who was still in his early twenties.

Lucas was born in Yakima, a modest city in the apple-growing country of Washington state, in 1937. As an undergraduate at the University of Chicago, he majored in history. After spending a year as a graduate student in the history department at Berkeley, he moved back to Chicago and enrolled in the Ph.D. program in economics. In preparation for his classes with Friedman and his colleague George Stigler, whom Chicago students knew as “Mr. Macro” and “Mr. Micro,” Lucas read Paul Samuelson’s Foundations of Economic Analysis, which had first appeared in 1947, and which presented economics as a branch of applied mathematics. “I loved the Foundations,” Lucas later recalled. “Like so many others in my cohort, I internalized its view that if I couldn’t formulate a problem in economic theory mathematically, I didn’t know what I was doing. I came to the position that mathematical analysis is not one of many ways of doing economic theory: it is the only way.

His mother, who met his father while she was in graduate school, came from a bookish family of German Jews. Akerlof was a bright and studious kid. In high school, he later recalled, “I belonged to a small group of students, who in today’s terminology would be called nerds . . . Socially, I was a misfit. I failed to understand why my classmates spent the typical free afternoon watching American Bandstand.” At MIT, Akerlof studied under Paul Samuelson and Robert Solow, two of the leading figures of postwar economics. By the early 1960s, the subject had been divided into several mutually antagonistic camps. The high theorists were busy debating the intricacies of general equilibrium and game theory. Out in Chicago, Friedman and his followers were pursuing their own libertarian path. At MIT and most other American universities, a pragmatic, if not wholly consistent, mélange of Marshallian microeconomics and Keynesian macroeconomics held sway.


pages: 565 words: 164,405

A Splendid Exchange: How Trade Shaped the World by William J. Bernstein

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Admiral Zheng, asset allocation, bank run, Benoit Mandelbrot, British Empire, call centre, clean water, Columbian Exchange, Corn Laws, David Ricardo: comparative advantage, deindustrialization, Doha Development Round, domestication of the camel, double entry bookkeeping, Eratosthenes, financial innovation, Gini coefficient, God and Mammon, ice-free Arctic, imperial preference, income inequality, intermodal, James Hargreaves, John Harrison: Longitude, Khyber Pass, low skilled workers, non-tariff barriers, Paul Samuelson, placebo effect, Port of Oakland, refrigerator car, Silicon Valley, South China Sea, South Sea Bubble, spice trade, spinning jenny, Steven Pinker, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, transcontinental railway, upwardly mobile, working poor, zero-sum game

As so famously put by Keynes: Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.21 Trade's modern scribblers-David Ricardo, Richard Cobden, Eli Heckscher, Bertil Ohlin, Wolfgang Stolper, and Paul Samuelson-will help us to understand the massive upheavals seen in our ever more integrated global system. Although the structure of this book is chronological, its many interwoven narratives will supersede the flow of mere dates and events. For example, two closely related stories, the south Arabian incense trade and the domestication of the camel, both span thousands of years. At the other extreme, the memoirs of medieval travelers who left us extensive and intact records of their journeys-Marco Polo, the Moroccan legal scholar Ibn Battuta, and the Portuguese apothecary Tome Pires- will provide isolated but detailed snapshots of world trade spanning only a few decades.

This disastrous legislation gave rise to virulent antiAmericanism, devastated international commerce, and contributed in no small part to the outbreak of the Second World War. Cordell Hull, the longestserving American secretary of state, clearly discerned the damage to world security done by the tariff wars of the early twentieth century and laid the groundwork for the GATT and WTO. By courtesy of the United States House of Representatives. This photograph of economists Wolfgang Stolper (left) and Paul Samuelson (right) was taken fifty years after they developed a theorem that explained who wins, and who loses, with free trade. BY courtesy of the University of Michigan Press. On December 13, 1577, a five-vessel flotilla under the command of Francis Drake left Plymouth, England. Drake's secret charge from Queen Elizabeth was threefold: to repeat Magellan's circumnavigation, to establish trade with the Spice Islands, and to plunder Iberian shipping.

Rather, Smoot-Hawley represented the high tide of worldwide protectionism that flowed on the new global agricultural trade. The story begins with a brief tour of twentieth-century trade theory . The great premodern thinkers in the field-Henry Martyn, Adam Smith, and David Ricardo-described the overall benefits of free trade. They understood but largely ignored the fact that a significant minority of inno cent people were usually harmed. Their twentieth-century descendants- Bertil Ohlin, Eli Heckscher, Paul Samuelson, and Wolfgang Stolper- provided a framework that identifies who wins, who loses, and how they react. By 1860, northern Europe, basking in the warm glow of the repeal of the Corn Law, the signing of the Cobden-Chevalier Treaty, and the "tariff disarmament" that followed, seemed firmly on the road to free trade. This pleasant and profitable voyage would not last long. Cheaper transport means price convergence.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

Rather than sharing the economies of scale with fund owners, fund managers have arrogated these profits to themselves. (When we talk money rather than basis points measured in hundredths of 1 percent, we get a far better picture of the staggering profit in fund management.) Owning a mutual fund management company has often proved rewarding beyond the dreams of avarice—owning mutual funds, far less so. Back in 1967, Paul Samuelson hit the proverbial nail on the head when he told a Congressional hearing that, “there was only one place to make money in the mutual fund business—as there is only one place for a temperate man to be in a saloon—behind the bar and not in front of it . . . so I invested in a management company.” When he decided that public ownership of management companies would be not only a boon for the managers who worked behind the bar, as it were, but also a bane for the fund owners who enjoyed their libations in front of the bar, he was wiser than he could have imagined.2 Costs and Returns The role of fund costs in shaping fund returns is no longer arguable.

The official underwriting of First Index Investment Trust came in at just $11.3 million, a 93 percent shortfall from our goal, tiny proceeds that were insufficient for the Trust to own all 500 stocks in the S&P 500 Index. When the underwriters brought me the news of the failure, they suggested that we just call the whole thing off and cancel the deal. I remember saying: “Oh, no we won’t. Don’t you realize that we now have the world’s first index fund?” The Professor, the Student, and the Index Fund Nobel Laureate economist Paul Samuelson played a major role in the creation of the first index fund. More than 25 years earlier, I’d hinted at the idea of an index fund in my 1951 Princeton University senior thesis, titled “The Economic Role of the Investment Company.” I had always loved contrarian ideas that challenged the status quo, and was often inspired to take the road less traveled by. And, yes, just as Robert Frost promised, “that has made all the difference.”

Thanks largely to the high grade that I was awarded on my senior thesis on the mutual fund industry (a long way from the macroeconomics of Dr. Samuelson’s book!), I graduated magna cum laude in Economics. On July 5, 1951, I entered the mutual fund industry, joining Walter Morgan’s pioneering Wellington Management organization. A Priceless Endorsement From that lowly beginning in 1948, and then through his support for that first index mutual fund in 1975, my association with Paul Samuelson grew ever closer and warmer. In 1993, I asked him to endorse my first book—Bogle on Mutual Funds. He demurred. But to my utter astonishment he told me that he would prefer to write the foreword. Some excerpts: The same surgeon general who required cigarette packages to say: “Warning, this product may be dangerous to your health” ought to require that 99 out of 100 books written on personal finance carry that same label.


pages: 226 words: 59,080

Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik

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airline deregulation, Albert Einstein, bank run, barriers to entry, Bretton Woods, butterfly effect, capital controls, Carmen Reinhart, central bank independence, collective bargaining, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Donald Davies, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, Fellow of the Royal Society, financial deregulation, financial innovation, floating exchange rates, fudge factor, full employment, George Akerlof, Gini coefficient, Growth in a Time of Debt, income inequality, inflation targeting, informal economy, information asymmetry, invisible hand, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labor-force participation, liquidity trap, loss aversion, low skilled workers, market design, market fundamentalism, minimum wage unemployment, oil shock, open economy, Pareto efficiency, Paul Samuelson, price stability, prisoner's dilemma, profit maximization, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, school vouchers, South Sea Bubble, spectrum auction, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, trade liberalization, trade route, ultimatum game, University of East Anglia, unorthodox policies, Vilfredo Pareto, Washington Consensus, white flight

Once a model is stated in mathematical form, what it says or does is obvious to all who can read it. This clarity is of great value and is not adequately appreciated. We still have endless debates today about what Karl Marx, John Maynard Keynes, or Joseph Schumpeter really meant. Even though all three are giants of the economics profession, they formulated their models largely (but not exclusively) in verbal form. By contrast, no ink has ever been spilled over what Paul Samuelson, Joe Stiglitz, or Ken Arrow had in mind when they developed the theories that won them their Nobel. Mathematical models require that all the t’s be crossed and the i’s be dotted. The second virtue of mathematics is that it ensures the internal consistency of a model—simply put, that the conclusions follow from the assumptions. This is a mundane but indispensable contribution. Some arguments are simple enough that they can be self-evident.

The theorem on its own settles little in real-world policy debates. But no one could deny that, thanks to it and the literature it has spawned, we understand much better than we ever did the circumstances under which Adam Smith’s Invisible Hand does and does not do its job.‡ Let’s turn now to another important example of how economic modeling helps clarify arguments that may be somewhat counterintuitive. In 1938, a young Paul Samuelson was challenged by Stanislaw Ulam, the Polish-American mathematician, to state one proposition in the social sciences that is both true and nontrivial. Samuelson’s answer was David Ricardo’s Principle of Comparative Advantage. “Using four numbers, as if by magic, it shows that there is indeed a free lunch—a free lunch that comes with international trade.”5 Ricardo’s demonstration, back in 1817, that specialization according to comparative advantage produces economic gains for all countries was as simple as it is powerful.6 The nontrivial nature of the principle is obvious by how often it is misunderstood, even among sophisticated commentators.

These wrinkles move us away from general-purpose models and take us back, again, to specific models that may be relevant in different settings. The big theories in the end deliver less than what they promise. They are shallow approaches that identify the proximate causes but need to be backed up with considerable detail, necessarily specific to context. As I’ve highlighted, they are best thought of as a scaffolding. The Theory of Business Cycles and Unemployment Ever since Paul Samuelson’s doctoral dissertation, published in 1947 as Foundations of Economic Analysis, economics has been split between microeconomics and macroeconomics. The domain of microeconomics is price theory, the ideas covered in the previous section. Macroeconomics deals with the behavior of economic aggregates—inflation, total output, and employment, in particular. Macroeconomics takes as its central questions the up-and-down fluctuations in economic activity that economists call the “business cycle.”

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

For most long-term investors, inflation-indexed bonds should dominate nominal bonds in a portfolio. 8 For an excellent review of this literature see Luis M. Viceira and John Y. Campbell, Strategic Asset Allocation: Portfolio Choice for Long-Term Investors, New York: Oxford University Press, 2002. Also see Nicholas Barberis, “Investing for the Long Run When Returns Are Predictable,” Journal of Finance, vol. 55 (2000), pp. 225–264. Paul Samuelson has shown that mean reversion will increase equity holdings if investors have a risk aversion coefficient greater than unity, which most researchers find is the case. See Paul Samuelson, “Long-Run Risk Tolerance When Equity Returns Are Mean Regressing: Pseudoparadoxes and Vindications of ‘Businessmen’s Risk’” in W. C. Brainard, W. D. Nordhaus, and H. W. Watts, eds., Money, Macroeconomics, and Public Policy, Cambridge: MIT Press, 1991, pp. 181–200. See also Zvi Bodie, Robert Merton, and William Samuelson, “Labor Supply Flexibility and Portfolio Choice in a Lifecycle Model,” Journal of Economic Dynamics and Control, vol. 16, no. 3 (July–October 1992), pp. 427–450.

Click here for terms of use. 24 PART 1 The Verdict of History the risk and return on stocks and bonds are not physical constants, like the speed of light or gravitational force, waiting to be discovered in the natural world. Despite the overwhelming quantity of historical data, one can never be certain that the underlying factors that generate asset prices have remained unchanged. One cannot, as in the physical sciences, run repeated controlled experiments, holding all other factors constant while estimating the value of the parameter in question. As Nobel laureate Paul Samuelson is fond of saying, “We have but one sample of history.” Yet one must start by analyzing the past in order to understand the future. The first chapter showed that not only have fixed-income returns lagged substantially behind those on equities but, because of the uncertainty of inflation, bonds can be quite risky for long-term investors. In this chapter one shall see that because of the changing nature of risk over time, portfolio allocations depend crucially on the investor’s planning horizon.

The stock market has been surging to new all-time highs almost daily, driving down dividend yields to record lows and sending price-to-earnings ratios skyward. Is this bullishness justified? The audience wants to know if the economy is really going to do well enough to support these high stock prices. This chapter is an adaptation of my paper “Does It Pay Stock Investors to Forecast the Business Cycle?” in Journal of Portfolio Management, vol. 18 (Fall 1991), pp. 27–34. The material benefited significantly from discussions with Professor Paul Samuelson. 1 “Science and Stocks,” Newsweek, September 19, 1966, p. 92. 2 Peter Lynch, One Up on Wall Street, New York: Penguin Books, 1989, p. 14. 207 Copyright © 2008, 2002, 1998, 1994 by Jeremy J. Siegel. Click here for terms of use. 208 PART 3 How the Economic Environment Impacts Stocks The economist’s address is highly optimistic. He predicts that the real gross domestic product of the United States will increase over 4 percent during the next four quarters, a very healthy growth rate.


pages: 662 words: 180,546

Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

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Alvin Roth, Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, Bretton Woods, Brownian motion, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, full employment, George Akerlof, Goldman Sachs: Vampire Squid, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, information asymmetry, invisible hand, Jean Tirole, joint-stock company, Kenneth Arrow, Kenneth Rogoff, knowledge economy, l'esprit de l'escalier, labor-force participation, liberal capitalism, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, Pareto efficiency, Paul Samuelson, payday loans, Philip Mirowski, Ponzi scheme, precariat, prediction markets, price mechanism, profit motive, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, school choice, sealed-bid auction, Silicon Valley, South Sea Bubble, Steven Levy, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Vilfredo Pareto, War on Poverty, Washington Consensus, We are the 99%, working poor

The footnote (*) to the text reads: “I guess the big exception to this is if you want to discard methodological individualism altogether, but the theoretical enterprises that took this route (such as structuralism) don’t seem to me to be prospering.” 28 Quiggin, Zombie Economics, p. 83, 129, 121, 87. 29 Paul Krugman blog, http://krugman.blogs.nytimes.com/2010/11/26/the-instability-of-moderation/#more-14713, November 26, 2010. 30 See, for instance, the letter of Paul Samuelson to Assar Lindbeck, February 14, 1977, in Box 4, Folder “Nobel Nominating Committee,” Paul Samuelson Papers, Perkins Library, Duke University. 31 This literature became so prevalent that this footnote offers just a representative sampling: Backhouse, The Puzzle of Modern Economics; Brock and Colander, “Complexity, Pedagogy, and the Economics of Muddling Through”; Colander, “The Death of Neoclassical Economics”; Colander, Holt, and Rosser, “Live and Dead Issues in the Methodology of Economics” and “The Changing Face of Economics”; J.

This is itself a pungent symptom of zombie thought, and is widely found across the board of the “legitimate left” of the economics profession, from Paul Krugman to Joseph Stiglitz to Adair Turner to Amartya Sen to Simon Johnson. Paul Krugman, feeling secure in his status, has conveniently confessed to the derangement: The brand of economics I use in my daily work—the brand that I still consider by far the most reasonable approach out there—was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasizes the way the economy can develop magneto trouble, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

However, the historical divergence comes with neoclassical economics in that most other sciences do not then banish their members who point out the inconsistencies and worry over their meaning. Nor do they simply expel the proponents of one side of the theory in order to maintain doctrinal purity, as happened with the rational-expectations movement and its epigones. During the Cold War, the economics profession was growing more exclusive, but was not completely intransigently intolerant of rival doctrines, for reasons of ideological appearances. For instance, evidence from the Paul Samuelson archives suggests he really did nominate Joan Robinson for the Bank of Sweden economics “Nobel.”30 Things really ratcheted upward in terms of imposed conformity only after the Fall of the Wall, for equally obvious political reasons. However, the apogee of denial of divergent thought occurred during the Great Bubble. A very strange literature sprang up in the early 2000s, asserting that there was no such thing as neoclassical economics anymore, in the sense that the legitimate orthodox economics profession had explored every possible analytical divergence from the rigid Walrasian general equilibrium model of days past, and someone, somewhere, sometime had built formal models addressing the previously heterodox concerns.31 Rationality?


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

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affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, Plutocrats, plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

Indeed this takes one of the authors (Akerlof) back to a memory from more than four decades ago. He was taking a class on monetary theory given by Paul Samuelson at MIT in the spring of 1964. Samuelson related that a member of President Dwight Eisenhower’s Council of Economic Advisers, Raymond Saulnier, had proposed the following idea. It might be possible to attain low unemployment in the short run, at the cost of high inflation. But as that inflation occurred, expectations about inflation would increase, so that maintenance of the low level of unemployment would entail higher inflation. That argument should sound familiar—although in this class it was related by Paul Samuelson, not Milton Friedman. But the ending of the argument does not remind us of Milton Friedman. Samuelson concluded that although this was an intriguing idea, it might not be indicative of the way the world worked.

They have been losing their jobs, their houses, and their dreams. But recessions do have at least one silver lining: the cut they take into economic life reveals how capitalist societies really work. To give one example, Keynes’ General Theory, written in the heart of the Great Depression, gave us for the first time an understanding of how macro economies really behave. That is why it was so inspiring, prompting Paul Samuelson to say, in 1946, that the Keynesian revolution, which appeared during the Great Depression, has infected the thinking of virtually every economist. But as the memory of the Great Depression has faded, so too has an appreciation and understanding of Keynesian theory. For the past year we have been seeing a great deal of excellent reportage on how we got into the current mess. Economists and Wall Street financiers invented new ways to carve up debt obligations, such as mortgages.

It is indicative how important it is to macroeconomics that just four years later, James Tobin, an arch foe of Milton Friedman, would declare in his own presidential address to the American Economic Association that “an economic theorist can, of course, commit no greater crime than to assume money illusion.”11 Tobin failed to mention that money illusion had been standard fare just four years earlier. It lay at the heart of the views on macroeconomics of some of the century’s leading economists, including Keynes, Paul Samuelson, Robert Solow, Irving Fisher, Franco Modigliani, and Tobin himself. Presumption We see Fisher’s and Keynes’ unadulterated money illusion as a remarkably naïve belief. It was in need of serious revision. But that does not mean that one should jump to the opposite extreme. It is not necessarily true that, on the contrary, there is no money illusion at all. That is only one possibility.


Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business process, butterfly effect, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, Chance favours the prepared mind, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical arbitrage, Steven Pinker, stochastic process, survivorship bias, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

Because of studies like this, FFJR’s coauthor Michael Jensen boasted in 1978 that “there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis.”29 Fama has become one of the most influential financial economists of his generation through his work on the Efficient Markets Hypothesis. The free market Chicago School of economics is usually associated with its most eloquent champion, Milton Friedman, but the Efficient Markets Hypothesis has become at least as prominent a hallmark, thanks to Gene Fama. EFFICIENT MARKETS UNPACKED Two economists with very dissimilar styles of thought, Paul Samuelson and Eugene Fama, reached the same conclusion about efficient markets. Fama’s fascination with computers, data, and statistical analysis led him down a very different intellectual path to the Efficient Markets Hypothesis than Samuelson’s elegant, simpleminded, physics-inspired version. But both men’s versions of the Efficient Markets Hypothesis have the same Zenlike, counterintuitive flavor: the more efficient the market, the more random the sequence of price changes in the market.

If just one of them is contradicted by the data, the theory can and should be rejected, and the field moves on to the next theory (and as long as there are assistant professors out there trying to get tenure, there’s always a next theory). Because science is a human endeavor, some scientists can be difficult to convince, especially if they played a role in creating or upholding an earlier theory. However, like evolution, science itself is an ongoing process also subject to natural selection. Paul Samuelson often remarked, “Science progresses funeral by funeral,” paraphrasing the great physicist Max Planck with a pithy if somewhat morbid characterization of the process of scientific discovery. In the end, the better theory has the last laugh, and scientific knowledge accumulates slowly but surely, one prediction at a time. In fact, one way to measure the power of a scientific theory is by the number of correct predictions it makes.

In 1947, the seeds of an alternate theory were planted by an unassuming graduate student working on a topic that most economists would have dismissed as irrelevant to their field. These ideas were eventually pushed out of the economic mainstream by true believers in market rationality. In that year, Herbert Simon published his Ph.D. thesis, Administrative Behavior. It appeared, ironically enough, the same year as Paul Samuelson’s Ph.D. thesis, Foundations of Economic Analysis. Administrative Behavior was a remarkably underwhelming title for a classic that would become the Magna Carta of the field of organizational behavior and, like Samuelson’s Foundations, is still in print today. SIMON SAYS SATISFICE Herbert Alexander Simon was an outsider to economics: his primary background wasn’t in mathematics or physics, but in what we would today call management science.


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

Briefly stated, the argument is that even if people are not capable of actually solving the complex problems that economists assume they can handle, they behave “as if” they can. To understand the “as if” critique, it is helpful to look back a bit into the history of economics. The discipline underwent something of a revolution after World War II. Economists led by Kenneth Arrow, John Hicks, and Paul Samuelson accelerated an ongoing trend of making economic theory more mathematically formal. The two central concepts of economics remained the same—namely, that agents optimize and markets reach a stable equilibrium—but economists became more sophisticated in their ability to characterize the optimal solutions to problems as well as to determine the conditions under which a market will reach an equilibrium.

And he frowned upon “those working men who, before prohibition, could not resist the lure of the saloon on the way home Saturday night,” which was then payday. Quite evidently, from Adam Smith in 1776 to Irving Fisher in 1930, economists were thinking about intertemporal choice with Humans in plain sight. Econs began to creep in around the time of Fisher, as he started on the theory of how Econs should behave, but it fell to a twenty-two-year-old Paul Samuelson, then in graduate school, to finish the job. Samuelson, whom many consider to be the greatest economist of the twentieth century, was a prodigy who set out to give economics a proper mathematical foundation. He enrolled at the University of Chicago at age sixteen and soon went off to Harvard for graduate school. His PhD thesis had the audacious but accurate title “Foundations of Economic Analysis.”

Yet when this game is played in the laboratory, 40–50% of the players cooperate, which means that about half the players either do not understand the logic of the game or feel that cooperating is the just the right thing to do, or possibly both. The Prisoner’s Dilemma comes with a great story, but most of us don’t get arrested very often. What are the implications of this game for normal life? Consider a related game called the Public Goods Game. To understand the economic significance of this game, we turn back to the great Paul Samuelson, who formalized the concept of a public good in a three-page paper published in 1954. The guy did not belabor things. A public good is one that everyone can consume without diminishing the consumption of anyone else, and it is impossible to exclude anyone from consuming it. A fireworks display is a classic example. Samuelson proved that a market economy will undersupply public goods because no one will have an incentive to pay much of anything for them, since they can be consumed for free.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Given that these assumptions do not hold perfectly in the real world, there have been reformulations of the theorem to account for taxes. This was not an obvious result before its publication, and it ultimately generated a flurry of literature in the field of corporate finance on the role of capital structure and its interaction with asset pricing. Paul Samuelson and Bridging the Gap in Derivatives Theory We now come full circle within the discussion of the evolution of asset pricing theory and return to the pricing of derivatives. The man who, in a sense, connected the earlier work of Louis Bachelier to that of Black and Scholes, described later, was Paul Samuelson. Samuelson made a stunning breadth of contributions to economics until the end of his life at the age of ninety-four. Hailing from Gary, Indiana, he studied at the University of Chicago in the early 1930s, taking several classes alongside such distinguished classmates as Milton Friedman.

John Maynard Keynes, perhaps the most influential economist of the period, if not of the last century, saw much of both his own savings and the endowment assets of King’s College he helped manage lost in the Crash. Irving Fisher, too, suffered from the crisis. Not only was he bullish before the Crash, he published in 1930 after the events of October of the previous year saying that much of the manufacturing sector was undervalued. Paul Samuelson, too, conducted his own retrospective game in which he covered up the dates and looked at only the fundamentals at the time to see if he would have bought or sold. He has said, “I discovered that I would have been caught by the 1929 debacle.”17 Even the apparent market wizard Jesse Lauriston Livermore, the Great Bear of Wall Street, who had called the top and who made substantial sums shorting stocks ahead of both the Panic of 1907 and the Crash of 1929, would see his fortune wiped out some five years later from ill-fated speculative plays.

Albert Einstein would describe this same phenomenon in one of his famous 1905 papers. The mathematical underpinnings of this description of randomness could be applied not only to the motions of small particles but also to the movements of markets. Bachelier’s work did not seem to have an immediate and profound influence on those markets, however. Though it did have some effect, as it showed up in applied probability books and in some prestigious journals, it was really when Paul Samuelson came across Bachelier’s work decades later that this contribution was appropriately appreciated by the financial community.3 Bachelier, though not as lauded as he may have deserved to be among the financial community of his day, was the father of modern mathematical finance. The Emergence of Investment Theory 231 Irving Fisher: Net Present Value Whereas Bachelier employed advanced mathematics to think about the price of a derivative, Irving Fisher used mathematics in an approach to a more fundamental question: how does one value the price of the underlying asset (that is, an asset that is not a derivative)?


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The Accidental Theorist: And Other Dispatches From the Dismal Science by Paul Krugman

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Bonfire of the Vanities, Bretton Woods, clean water, collective bargaining, computerized trading, corporate raider, declining real wages, floating exchange rates, full employment, George Akerlof, George Gilder, Home mortgage interest deduction, income inequality, indoor plumbing, informal economy, invisible hand, Kenneth Arrow, knowledge economy, life extension, lump of labour, new economy, Nick Leeson, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, price stability, rent control, Ronald Reagan, Silicon Valley, trade route, very high income, working poor, zero-sum game

Because economics touches so much of life, everyone wants to have an opinion. Yet the kind of economics covered in the textbooks is a technical subject that many people find hard to follow. How reassuring, then, to be told that it is all irrelevant—that all you really need to know are a few simple ideas! Quite a few supply-siders have created for themselves a wonderful alternative intellectual history in which John Maynard Keynes was a fraud, Paul Samuelson and even Milton Friedman are fools, and the true line of deep economic thought runs from Adam Smith through obscure turn-of-the-century Austrians straight to them. And so it doesn’t really matter whether supply-side economics makes any sense, or even whether it goes down to a crushing electoral defeat. The supply-siders will always have a safe haven in the world of Free Enterprise Institutes and Centers for the Study of Capitalism, outlets for their views in the pages of Forbes and the Wall Street Journal, and new recruits who never tire of saying the same things again and again.

You must be prepared to work through little models before you can use the big words—in fact, it is usually a good idea to try to avoid the big words altogether. If you balk at this task—if you think that you are too grown-up for this sort of thing—then you may sound impressive and sophisticated, but you will have no idea what you are talking about. A Good Word for Inflation Many years ago, Paul Samuelson memorably cautioned against basing economic policy on “shibboleths,” by which he meant slogans that take the place of hard thinking. Strictly speaking, this was an incorrect use of the word: The OED defines a shibboleth as “A catchword or formula adopted by a party or sect, by which their adherents or followers may be discerned, or those not their followers may be excluded.” But in a deeper sense Samuelson probably had it right: Simplistic ideas in economics often become badges of identity for groups of like-minded people, who repeat certain phrases to each other, and eventually mistake repetition for self-evident truth.

Let me quote from the textbook (by William Baumol and Alan Blinder) that I assigned when I taught Economics 1 last year: “When a firm pollutes a river, it uses some of society’s resources just as surely as when it burns coal. However, if the firm pays for coal but not for the use of clean water, it is to be expected that management will be economical in its use of coal and wasteful in its use of water.” In other words, when it comes to the environment, we do not expect the free market to get it right. So what should be done? Going all the way back to Paul Samuelson’s first edition in 1948, every economics textbook I know of has argued that the government should intervene in the market to discourage activities that damage the environment. The usual recommendation is to do so either by charging fees for the right to engage in such nasty activities—a.k.a. “pollution taxes”—or by auctioning off rights to pollute. Indeed, as the extraordinary response to the climate-change statement reminds us, the idea of pollution taxes is one of those iconic positions, like free trade, that commands the assent of virtually every card-carrying economist.


pages: 237 words: 50,758

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

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Andrew Wiles, Asian financial crisis, Berlin Wall, bonus culture, British Empire, business process, Cass Sunstein, computer age, corporate raider, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, Long Term Capital Management, Louis Pasteur, market fundamentalism, Myron Scholes, Nash equilibrium, pattern recognition, Paul Samuelson, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

Byrne, The Whiz Kids: The Founding Fathers of American Business—and the Legacy They Left Us (New York: Bantam Doubleday Dell, 1993). 3 Friedrich von Hayek, Law, Legislation and Liberty, (Chicago: University of Chicago Press, 1973), vol. 1, “Rules and Order,” p. 49. 4 Ibid. 5 Adam Ferguson, An Essay on the History of Civil Society (1767; reprint, Edinburgh: Edinburgh University Press, 1966), p. 122. 6 David Hume, Essays: Moral, Political, Literary (1777; reprint, ed. Eugene F. Miller, Indianapolis: Liberty Classics, 1985), book II, chapter XII. Chapter 19: Very Well Then, I Contradict Myself—How It Is More Important to Be Right Than to Be Consistent 1 Paul Samuelson, Foundations of Economic Analysis (1947; reprint, Cambridge, MA: Harvard University Press, 1966). 2 Paul Samuelson, “Altruism as a Problem Involving Group Versus Individual Selection in Economics and Biology,” American Economic Review 83, no. 2 (May 1998), pp. 143–8. 3 Francis M. Cornford, Microcosmographia Academica (Cambridge: Bowes & Bowes, 1908), chapter VII. 4 Walt Whitman, “Song of Myself,” in Leaves of Grass (1855; reprint, Hertfordshire, UK: Wordsworth Editions, 2006), p. 69. 5 F.

Even if our objectives are multiple, and unquantifiable, and perhaps ill defined or incommensurable, we still have to make concrete choices. Dame Helen Gardner included some poems in her anthology and left out countless others. Accountants have to report on whether a measure of profit reflects a true and fair view. If we are consistent in our choices, then we are maximizing our utility—or at least we are maximizing something. This idea, first clearly articulated in Paul Samuelson’s Foundations of Economic Analysis1 sixty years ago, rescued economics from a muddle born of nineteenth-century utilitarianism and enabled the subject to become queen of the social sciences. The theory of rational choice dominates economic thinking today, and its influence has spread to politics, psychology and sociology. By denying maximization, we deny rational choice. Obliquity therefore contradicts the theory that has been the most influential doctrine in the social sciences for at least forty years.


pages: 356 words: 103,944

The Globalization Paradox: Democracy and the Future of the World Economy by Dani Rodrik

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affirmative action, Asian financial crisis, bank run, banking crisis, bilateral investment treaty, borderless world, Bretton Woods, British Empire, capital controls, Carmen Reinhart, central bank independence, collective bargaining, colonial rule, Corn Laws, corporate governance, corporate social responsibility, credit crunch, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, Doha Development Round, en.wikipedia.org, endogenous growth, eurozone crisis, financial deregulation, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, George Akerlof, guest worker program, Hernando de Soto, immigration reform, income inequality, income per capita, industrial cluster, information asymmetry, joint-stock company, Kenneth Rogoff, labour market flexibility, labour mobility, land reform, liberal capitalism, light touch regulation, Long Term Capital Management, low skilled workers, margin call, market bubble, market fundamentalism, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, microcredit, Monroe Doctrine, moral hazard, night-watchman state, non-tariff barriers, offshore financial centre, oil shock, open borders, open economy, Paul Samuelson, price stability, profit maximization, race to the bottom, regulatory arbitrage, savings glut, Silicon Valley, special drawing rights, special economic zone, The Wealth of Nations by Adam Smith, Thomas L Friedman, Tobin tax, too big to fail, trade liberalization, trade route, transaction costs, tulip mania, Washington Consensus, World Values Survey

The rather dramatic decline in support for economic globalization in major countries like the United States reflects this new trend. The proportion of respondents in an NBC/Wall Street Journal poll saying globalization has been good for the U.S. economy has fallen precipitously, from 42 percent in June 2007 to 25 percent in March 2008. And surprisingly, the dismay has also begun to show up in an expanding list of mainstream economists who now question globalization’s supposedly unmitigated virtues. So we have the late Paul Samuelson, the author of the postwar era’s landmark economics textbook, reminding his fellow economists that China’s gains in globalization may well come at the expense of the United States; Paul Krugman, the 2008 Nobelist in Economics, arguing that trade with low-income countries is no longer too small to have an effect on inequality in rich nations; Alan Blinder, a former U.S. Federal Reserve vice chairman, worrying that international outsourcing will cause unprecedented dislocations for the U.S. labor force; Martin Wolf, the Financial Times columnist and one of the most articulate advocates of globalization, expressing his disappointment with the way financial globalization has turned out; and Larry Summers, the Clinton administration’s “Mr.

Significantly, there are mutual gains from trade even if India produces both sets of goods at lower productivity (higher labor costs) than England does. India need only be not as bad in textiles as it is in other manufactures. What creates comparative advantage is differences across nations in comparative costs, not in absolute costs. This is a powerful argument and one that critics of free trade often fail to fully digest before taking it on. As Paul Samuelson once suggested in response to a challenge by a mathematician with little respect for the social sciences, it is probably the only proposition in economics that is at once true and non-trivial. “That it is logically true need not be argued before a mathematician,” Samuelson said; “that it is not trivial is attested by the thousands of important and intelligent men who have never been able to grasp the doctrine for themselves or to believe it after it was explained to them.”4 Fallacious reasoning often substitutes for intelligent commentary on trade.

In a famous but apocryphal quote attributed to Abraham Lincoln, the Great Emancipator is supposed to have said, I do not know much about the tariff, but I know this much, when we buy manufactured goods abroad, we get the goods and the foreigner gets the money. When we buy the manufactured goods at home, we get both the goods and the money.5 Of course this is exactly the kind of mercantilist fallacy that Martyn (and Adam Smith, David Ricardo, and Paul Samuelson after him) wanted to refute. The true cost of consuming a good is the labor and other scarce resources we have to employ to obtain it, not the money that facilitates the transaction. Public Skepticism on Trade Such fallacies tend to make economists impatient with objections to free trade and dismissive of those who would want to interfere with it. It is easy to pooh-pooh many anti-trade arguments because they make little sense upon scrutiny.


Gaming the Vote: Why Elections Aren't Fair (And What We Can Do About It) by William Poundstone

affirmative action, Albert Einstein, Debian, desegregation, Donald Trump, en.wikipedia.org, Everything should be made as simple as possible, global village, guest worker program, hiring and firing, illegal immigration, invisible hand, jimmy wales, John Nash: game theory, John von Neumann, Kenneth Arrow, manufacturing employment, Nash equilibrium, Paul Samuelson, Pierre-Simon Laplace, prisoner's dilemma, Ralph Nader, RAND corporation, Ronald Reagan, Silicon Valley, slashdot, the map is not the territory, Thomas Bayes, transcontinental railway, Unsafe at Any Speed, Y2K

On Koopman's advice, Arrow switched to the more upbeat name "general possibility theorem" in his dissertation. Afterward, he and almost everyone else reverted to the more accurate-and dismal-name. The audacious nihilism of Arrow's proof was quickly compared to Coders. "The search of the great minds of recorded history for the perfect democracy, it turns out, is the search for a chimera, for logical self-contradiction," wrote MIT economist Paul Samuelson in 1952. "New scholars all over the world-in mathematics, politics, philosophy, and economics-are trying to salvage what can be salvaged from Arrow's devastating discovery that is to mathematical politics what Kurt Coders 1931 impossibility-of-proving-consistency theorem is to mathematical logic." 51 GAMING THE VOTE No century before the twentieth could have been shocked by the revelation that the social contract is founded on as flimsy a foundation as mathematics itself.

Indeed, it has been said that democ~ racy is the worst form of government except all those other forms that have been tried from time to time:' That was the optimistic view. To look at it another way, Arrow's theorem says that election outcomes can be decided by quirks of procedure as much as the voters' authentic wishes. That better recalls a remark, probably apocryphal, attributed to Joseph Stalin: 'Those who cast the votes decide nothing. Those who count the votes decide everything," Upon the 1972 announcement of Arrow's Nobel Prize, Paul Samuelson supplied the now-standard journalist's gloss: "What Kenneth Arrow proved once and for all is that there cannot possibly be ... an ideal voting scheme," To some extent, Arrow's theorem refutes the notion of a "will of the people." We all believe in a public will, envisioning it in our own political image-that is to say, as decisive and self-consistent. This belief makes it easy to be optimistic about democracy.

Had the voters left their scores for x and y unchanged after z dropped out, the winner would have been unchanged. What Arrow's x, y, and z really demonstrate is that strategic voting can change the outcome of a range vote. This observation is equally true of ranked systems, of course. Arrow conceded that "the above result appears to depend on the particular method of choosing the units 255 GAMING THE VOTE of utility. But this is not true, although the paradox is not so obvious in other cases." Paul Samuelson echoed this thought in a 1967 symposium, saying, in effect, that an Arrow-style impossibility theorem can be proved for range voting. Samuelson must have been thinking of a proof involving Arrow's original, ranking version of irrelevant alternatives. That said, it's easy to show that range voting meets all of Arrow's conditions with the reasonable tweak I just mentioned. "The conditions follow trivially from the definition" of range voting, says Hillinger.


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Pivotal Decade: How the United States Traded Factories for Finance in the Seventies by Judith Stein

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1960s counterculture, affirmative action, airline deregulation, anti-communist, Ayatollah Khomeini, barriers to entry, Berlin Wall, blue-collar work, Bretton Woods, capital controls, centre right, collective bargaining, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, deindustrialization, desegregation, energy security, Fall of the Berlin Wall, falling living standards, feminist movement, financial deregulation, floating exchange rates, full employment, Gunnar Myrdal, income inequality, income per capita, intermodal, invisible hand, knowledge worker, laissez-faire capitalism, liberal capitalism, Long Term Capital Management, manufacturing employment, market bubble, Martin Wolf, new economy, oil shale / tar sands, oil shock, open economy, Paul Samuelson, payday loans, post-industrial society, post-oil, price mechanism, price stability, Ralph Nader, RAND corporation, reserve currency, Robert Gordon, Ronald Reagan, Simon Kuznets, strikebreaker, trade liberalization, union organizing, urban planning, urban renewal, War on Poverty, Washington Consensus, working poor, Yom Kippur War

.’ … People have accepted the fact that government has got to plan as well as individuals in this country.”9 Keynesianism was in its heyday in the United States in the 1960s when Presidents John Kennedy and Lyndon Johnson cut taxes by $11.6 billion to increase aggregate demand and investment. (Spending on military items for the war in Vietnam helped, too.) The resulting investment rates of 16 and 17 percent, as a percentage of GDP, equaled those of the boom of the mid-1950s. Paul Samuelson proclaimed, with the hubris of the era, “By the proper choice of monetary and fiscal policy we as the artists, mixing the colors of our palette, can have the capital formation and rate of current consumption that we desire.”10 Governments could choose tax, spending, and monetary policies to produce full employment. In 1969, the unemployment rate fell to 3.9 percent. Economists became an honored breed.

Returning from a trip to Japan in November, Connally remarked that monetary uncertainty could continue for “an almost indefinite period” and that the United States would not suffer if it did.92 These words produced hysteria among the foreign policy elites. Hormats warned Kissinger that Europe would become hostile and the United States would become a “scapegoat” for Europe’s economic woes.93 Leading economists across the spectrum, from Milton Friedman to Paul Samuelson, predicted a trade war if things were not settled soon.94 Amplified by daily warnings from foreign embassies that the sky was falling, Shultz concluded at the end of October that now that “we have their attention” it was time to move on negotiations.95Connally and Shultz got down to work. Nixon’s economic package attempted to alter exchange rates and open up European and Japanese markets in order to restore U.S. affluence in 1971.

Even if this viewpoint was true in the 1950S, was it still true in the 1970s, when American corporations produced abroad? To answer that question the nation had to address the changing structure of the economy. Economist Wassily Leontief, Nobel Prize winner in 1973, proposed to do just that. Leontief asserted that keeping the American “economy in good working order required more than just watching a few major statistics and making changes in the budget and money supply,” the main tools of Keynes. Recall Paul Samuelson’s comment twenty years earlier: “Whatever rate of capital formation the American people want to have, the American system can, by proper choice of fiscal and monetary program contrive to do.”70 It did not seem to be true. Walter Heller, who had helped make Keynesianism the state religion of the 1960S, confessed to fellow economists at the end of 1973 that “the energy crisis caught us with our parameters down.


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Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

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Albert Einstein, Alvin Roth, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Bayesian statistics, Big bang: deregulation of the City of London, Bretton Woods, buttonwood tree, capital asset pricing model, cognitive dissonance, computerized trading, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Lloyd's coffeehouse, endowment effect, experimental economics, fear of failure, Fellow of the Royal Society, Fermat's Last Theorem, financial deregulation, financial innovation, full employment, index fund, invention of movable type, Isaac Newton, John Nash: game theory, John von Neumann, Kenneth Arrow, linear programming, loss aversion, Louis Bachelier, mental accounting, moral hazard, Myron Scholes, Nash equilibrium, Paul Samuelson, Philip Mirowski, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, Thomas Bayes, trade route, transaction costs, tulip mania, Vanguard fund, zero-sum game

The following people also made significant contributions to my work and warrant my deepest appreciation: Kenneth Arrow, Gilbert Bassett, William Baumol, Zalmon Bernstein, Doris Bullard, Paul Davidson, Donald Dewey, David Durand, Barbara Fotinatos, James Fraser, Greg Hayt, Roger Hertog, Victor Howe, Bertrand Jacquillat, Daniel Kahneman, Mary Kentouris, Mario Laserna, Dean LeBaron, Michelle Lee, Harry Markowitz, Morton Meyers, James Norris, Todd Petzel, Paul Samuelson, Robert Shiller, Charles Smithson, Robert Solow, Meir Statman, Marta Steele, Richard Thaler, James Tinsley, Frank Trainer, Amos Tversky,* and Marina von N. Whitman. Eight people generously undertook to read the manuscript in its entirety and to give me the benefit of their expert criticisms and suggestions. Each of them, in his own way, deserves major credit for the quality of the content and style of the book, without bearing any responsibility for the shortcomings it contains.

Hence, statistical methods in economics are useless except for descriptive purposes, "but the diehards don't seem to be aware of this."6 Morgenstern was impatient with the assumption of perfect foresight that dominated nineteenth-century economic theory. No one, he insisted, can know what everybody else is going to do at any given moment: "Unlimited foresight and economic equilibrium are thus irreconcilable with each other."' This conclusion drew high praise from Frank Knight and an offer by Knight to translate this paper by Morgenstern from German into English. Morgenstern appears to have been short on charm. Nobel Laureate Paul Samuelson, the author of the long-run best-selling textbook in economics, once described him as "Napoleonic.... [A]lways invoking the authority of some physical scientists or other."*' Another contemporary recalls that the Princeton economics department `just hated Oskar."9 Morgenstern himself complained about the lack of attention his beloved masterpiece received from others. After visiting Harvard in 1945 he noted "none of them" had any interest in game theory.10 He reported in 1947 that a fellow economist named Ropke said that game theory "was Viennese coffeehouse gossip."

This `can get' [the winnings he can expect] is, of course, presumed to be a minimum; he may get more if others make mistakes (behave irrationall y)."19 This stipulation has posed a major problem for critics, including distinguished behavioral psychologists like Daniel Ellsberg and Richard Thaler, whom we will meet later. In a highly critical paper published in 1991, the historian Philip Mirowski asserted, "All is not well in the House of Game Theory-in every dreamhouse a heartache-and signs of pathology can no longer be ignored."20 He cites criticisms by Nobel Prize winners Henry Simon, Kenneth Arrow, and Paul Samuelson. He claims that game theory would never have amounted to anything had von Neumann not sold it to the military; he even goes so far as to speculate, "Some laid the blame for the escalation of nuclear weaponry directly at the door of game theory."21 Indeed, Mirowski claims that Morgenstern was a "godsend" to von Neumann because he proposed economists as an audience for game theory when no one else was interested.


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More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

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Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, Paul Samuelson, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs

Some said he might be leaving for good, but others had their doubts; “there’s as much chance of Michael giving up Wall Street for a year as there is of Vladimir Horowitz giving up the piano permanently,” one friend insisted.49 As it turned out, Steinhardt managed to stay away from trading until the fall of the following year. Then he stormed back, broke up with his partners, and marched into the 1980s. 3 PAUL SAMUELSON’S SECRET In famous congressional testimony in 1967, the great economist Paul Samuelson delivered his verdict on the money-management industry. Citing a recent dissertation by a PhD candidate at Yale, he suggested that randomly chosen stock portfolios tended to beat professionally managed mutual funds. When the House banking committee chairman sounded incredulous, the professor stood his ground. “When I say ‘random,’ I want you to think of dice or think of random numbers or a dart,” he emphasized.1 Three years later, Samuelson became the third economist to win the Nobel Prize, but the recognition did not mellow him one bit.

Dan Dorfman, “Sabbatical for a Superstar,” Esquire, August 29, 1978, p. 12. CHAPTER THREE: PAUL SAMUELSON’S SECRET 1. Justin Fox, The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street, (New York: HarperCollins, 2009), p. 124. 2. Peter L. Bernstein, Capital Ideas Evolving (Hoboken, NJ: John Wiley & Sons, 2007), p. 113. 3. Samuelson explains, “Fama’s theory of the random walk and mine are not the same. Mine is that there are no easy pickings…. If you read the numerous papers I have written on the efficient-market hypothesis, you will realize it is not a dogma. If you can get information early, before it is widespread, you can’t help but get very rich.” Paul Samuelson, interview with the author, February 5, 2008. 4. Bernstein, Capital Ideas Evolving, p. 143. 5.

Library of Congress Cataloging-in-Publication Data Mallaby, Sebastian. More money than god: hedge funds and the making of a new elite / Sebastian Mallaby. p. cm. Includes bibliographical references. ISBN: 1-101-45721-X 1. Hedge funds. 2. Investment advisors. I. Title. HG4530.M249 2010 332.64'524—dc22 2009053253 To my parents, Christopher and Pascale CONTENTS Introduction: The Alpha Game 1. BIG DADDY 2. THE BLOCK TRADER 3. PAUL SAMUELSON’S SECRET 4. THE ALCHEMIST 5. TOP CAT 6. ROCK-AND-ROLL COWBOY 7. WHITE WEDNESDAY 8. HURRICANE GREENSPAN 9. SOROS VERSUS SOROS 10. THE ENEMY IS US 11. THE DOT-COM DOUBLE 12. THE YALE MEN 13. THE CODE BREAKERS 14. PREMONITIONS OF A CRISIS 15. RIDING THE STORM 16. “HOW COULD THEY DO THIS?” CONCLUSION: SCARIER THAN WHAT? Acknowledgments Appendix I: Do the Tiger Funds Generate Alpha?


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Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

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accounting loophole / creative accounting, banking crisis, banks create money, barriers to entry, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, butterfly effect, capital asset pricing model, cellular automata, central bank independence, citizen journalism, clockwork universe, collective bargaining, complexity theory, correlation coefficient, creative destruction, credit crunch, David Ricardo: comparative advantage, debt deflation, diversification, double entry bookkeeping, en.wikipedia.org, Eugene Fama: efficient market hypothesis, experimental subject, Financial Instability Hypothesis, fixed income, Fractional reserve banking, full employment, Henri Poincaré, housing crisis, Hyman Minsky, income inequality, information asymmetry, invisible hand, iterative process, John von Neumann, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market microstructure, means of production, minimum wage unemployment, money market fund, open economy, Pareto efficiency, Paul Samuelson, place-making, Ponzi scheme, profit maximization, quantitative easing, RAND corporation, random walk, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Schrödinger's Cat, scientific mainstream, seigniorage, six sigma, South Sea Bubble, stochastic process, The Great Moderation, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, total factor productivity, tulip mania, wage slave, zero-sum game

Yet after several exchanges, the leading bishop of the true believers had conceded that the heretics were substantially correct. Summing up the conflict in 1966, Paul Samuelson observed that the heretics ‘merit our gratitude’ for pointing out that the simple homilies of economic theory are not in general true. He concluded that ‘If all this causes headaches for those nostalgic for the old time parables of neoclassical writing, we must remind ourselves that scholars are not born to live an easy existence. We must respect, and appraise, the facts of life’ (Samuelson 1966: 583). One might hope that such a definitive capitulation by as significant an economist as Paul Samuelson would have signaled a major change in the evolution of economics. Unfortunately, this was not to be. While many of the bishops have conceded that economics needs drastic revision, its priests preach on in a new millennium, largely unaware that they lost the holy war thirty years earlier.

These contours were therefore christened ‘indifference curves.’ 3.5 Indifference curves: the contours of the ‘utility hill’ shown in two dimensions Since indifference curves were supposed to represent the innate preferences of a rational utility-maximizing consumer, economists turned their minds to what properties these curves could have if the consumer could be said to exhibit truly rational behavior – as neoclassical economists perceived it. In 1948, Paul Samuelson codified these into four principles: Completeness: If presented with a choice between two different combinations of goods, a consumer can decide which he prefers (or can decide that he gets the same degree of satisfaction from them, in which case he is said to be indifferent between them). Transitivity: If combination A is preferred to combination B, and B to C, then A is preferred to C.

In doing so however, it should never be forgotten that a given wealth distribution rule [imposed by the ‘benevolent central authority’] is being adhered to and that the ‘level of wealth’ should always be understood as the ‘optimally distributed level of wealth.’ (Ibid.: 118; emphasis added) These high-level texts, though, are at least honest that there is a problem in aggregating from the individual consumer to the market demand curve. Undergraduate students instead are reassured that there is no problem. Paul Samuelson’s iconic undergraduate textbook makes the following didactic statement about how a market demand curve is derived, and whether it obeys the ‘Law of Demand,’ which flatly contradicts the SMD results: The market demand curve is found by adding together the quantities demanded by all individuals at each price. Does the market demand curve obey the law of downward-sloping demand? It certainly does.


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The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

In 1945, Ira Mosher, the leader of the National Association of Manufacturers, denounced the “unmitigated warfare that has been waged for a decade against the free competitive enterprise system.”10 Perhaps a little of that sentiment may have filtered into the School of Commerce, despite the generally pro-government outlook of Greenspan’s generation. Besides, university economics faculties were caught in a sort of time warp. By 1945, John Maynard Keynes’s ideas had been embraced by New Dealers in Washington, but they did not yet dominate the undergraduate curriculum the way they did after 1948, the year in which Paul Samuelson, the self-described “brash whippersnapper go-getter” at the Massachusetts Institute of Technology, published his classic introductory textbook, Economics.11 Samuelson’s text cemented in the minds of undergraduates the case for a mixed economy, and if Greenspan had been exposed to it at the start of his studies, it is at least conceivable that he might have developed differently. “No longer is modern man able to believe ‘that government governs best which governs least,’” Samuelson declared confidently in his textbook; and his writing’s profound influence on students just a few years younger than Greenspan can be gauged from the vehemence with which conservatives denounced it.12 In God and Man at Yale, published in 1951, William F.

In theory, higher interest rates might deter consumers and companies from borrowing to spend; in theory, this might reduce demand for products, raw materials, and workers, avoiding bottlenecks and inflation. But most economists believed that other factors mattered more than interest rates: shifts in workers’ negotiating power, gains in productivity by companies, new opportunities to sell abroad—any of these could have a more pronounced effect on prices.3 “Today few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle,” Paul Samuelson declared in the first edition of his famous textbook, published in 1948.4 In the words of the monetary historian Robert Hetzel, “After World War II, monetary policy was an orphan.”5 On the last day of January 1951, Truman impressed upon the Fed’s leaders the gravity of the Korean crisis. He summoned the entire membership of the Fed’s interest-rate-setting body, the Federal Open Market Committee (FOMC), over to the White House and did his best to frighten them.

Keynes had taught how to combat economic slowdowns by running a government budget deficit, and neo-Keynesians had grasped how slumps could be averted by the central bank as well: low interest rates, hitherto regarded principally as a means of helping the government to borrow, were now understood as a tool of economic management.2 “The supply of money, its availability to investor borrowers, and the interest cost of such borrowings can have important effects on [GNP],” Paul Samuelson instructed in the 1961 edition of his bestselling textbook, revising the dismissal of monetary policy in his 1948 edition.3 “The worst consequences of the business cycle . . . are probably a thing of the past,” Samuelson wrote confidently, and conservative economists agreed.4 At the end of 1959, Greenspan’s mentor Arthur Burns proclaimed, “The business cycle is unlikely to be as disturbing or troublesome to our children as it was to us and our fathers.”5 It was not just that economists understood how to prevent recessions.


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A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

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3Com Palm IPO, accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Nathan Rothschild made millions in the market when his carrier pigeons brought him the first news of Wellington’s victory at Waterloo before other traders were aware of the victory. But today, the information superhighway carries news far more swiftly than carrier pigeons. And Regulation FD (Fair Disclosure) requires companies to make prompt public announcements of any material news items that may affect the price of their stock. Moreover, insiders who do profit from trading on the basis of nonpublic information are breaking the law. The Nobel laureate Paul Samuelson summed up the situation as follows: If intelligent people are constantly shopping around for good value, selling those stocks they think will turn out to be overvalued and buying those they expect are now undervalued, the result of this action by intelligent investors will be to have existing stock prices already have discounted in them an allowance for their future prospects. Hence, to the passive investor, who does not himself search for under- and overvalued situations, there will be presented a pattern of stock prices that makes one stock about as good or bad a buy as another.

Although the preponderance of statistical evidence supports the view that market efficiency is high, some gremlins are lurking about that harry the efficient-market theory and make it impossible for anyone to state that the theory is conclusively demonstrated. Finding inconsistencies in the efficient-market theory became such a cottage industry during the 1990s and early 2000s that I will devote an entire chapter (chapter 11) to the market anomalies and so-called predictable patterns that have been uncovered. Moreover, I worry about accepting all the tenets of the efficient-market theory. As the quote from Paul Samuelson indicates, the theory holds that, at any time, stocks sell at the best estimates of their intrinsic values. Thus, uninformed investors buying at the existing prices are really getting full value for their money, whatever securities they purchase. This line of reasoning is uncomfortably close to that of the “greater fool” theory. We have seen ample evidence in Part One that stocks sometimes do not sell on the basis of anyone’s estimate of value (as hard as this is to measure)—that purchasers are often swept up in waves of frenzy.

Despite all the evidence to the contrary, suppose an investor still believed that superior investment management really does exist. Two issues remain: First, it is clear that such skill is very rare; and second, there appears to be no effective way to find such skill before it has been demonstrated. As I indicated in chapter 7, the best-performing funds in one period of time are not the best performers in the next period. The top performers of the 1990s had dreadful returns in the first decade of the 2000s. Paul Samuelson summed up the difficulty in the following parable. Suppose it was demonstrated that one out of twenty alcoholics could learn to become a moderate social drinker. The experienced clinician would answer, “Even if true, act as if it were false, for you will never identify that one in twenty, and in the attempt five in twenty will be ruined.” Samuelson concluded that investors should forsake the search for such tiny needles in huge haystacks.

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

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Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, business process, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, full employment, George Akerlof, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, John von Neumann, linear programming, Loma Prieta earthquake, Long Term Capital Management, margin call, market friction, market microstructure, martingale, merger arbitrage, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Richard Feynman, Richard Stallman, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

Source: Upstream Technologies. 78 JWPR007-Lindsey May 7, 2007 16:44 Evan Schulman 79 Upstream Lattice was sold to State Street Bank, and placed in its brokerage division. I learned once again that I was not suited for work in a large organization. Mark Hoffman and I moved on to establish Upstream Technologies in late 1999. The goal of Upstream was to apply the tools, discipline, and quality control that quants had developed for institutional use to individual accounts, even the very small ones. We recruited Paul Samuelson, previously chief investment officer at Panagora, and a set of talented youngsters. It was clear that for the taxable investor individually managed accounts dominate mutual funds. Mutual funds generate taxable distributions (often including short-term capital gains), and investors are unable to take advantage of the unrealized losses in the fund’s underlying portfolio. Properly constructed individually managed accounts offer the same level of pretax returns as mutual funds but can take advantage of shortterm losses and avoid short-term gains, client by client.

The paper we wrote about within-horizon risk won a Graham and Dodd Award, and our within-horizon risk measures are now widely used throughout the industry.4 Full-Scale Optimization. A couple of years ago, I wrote a short piece for Peter Bernstein in which I showed the mathematical equivalence of portable alpha strategies with currency overlay strategies. Soon after publication, I received a note from Paul Samuelson critiquing my approach and mean-variance analysis in general. He argued that computational power now enables us to maximize plausible utility functions numerically, based on the entire distribution of returns, not just the first JWPR007-Lindsey May 7, 2007 17:15 Mark Kritzman 257 two moments. He suggested that I try his approach and compare the differences, which of course I did. I discovered that the mean-variance approximation performed quite well for variations of power utility, even with significantly nonnormal return distributions.

I discovered that the mean-variance approximation performed quite well for variations of power utility, even with significantly nonnormal return distributions. However, utility functions that incorporated kinks or inflection points proved problematic for mean-variance analysis. Given the growing popularity of hedge funds and the concern for thresholds that many investors had, I worked with my colleagues, Tim Adler, Jan-Hein Cremers, and Sébastien Page to develop a robust full-scale optimization algorithm.5 As a consequence of Paul Samuelson’s critique and my eagerness to understand it, we introduced an entirely new way of constructing portfolios that easily addresses nonnormality and a wide range of utility functions. Efficient Trading. Institutional investors often reallocate their portfolios to shift their asset mixes or to shuffle their investment managers. Often they delegate the execution of these portfolio reallocations to transition specialists who are positioned to trade cost-effectively, usually because they can cross trades internally.


pages: 409 words: 118,448

An Extraordinary Time: The End of the Postwar Boom and the Return of the Ordinary Economy by Marc Levinson

affirmative action, airline deregulation, banking crisis, Big bang: deregulation of the City of London, Boycotts of Israel, Bretton Woods, Capital in the Twenty-First Century by Thomas Piketty, car-free, Carmen Reinhart, central bank independence, centre right, clean water, deindustrialization, endogenous growth, falling living standards, financial deregulation, floating exchange rates, full employment, George Gilder, Gini coefficient, global supply chain, income inequality, income per capita, indoor plumbing, informal economy, intermodal, invisible hand, Kenneth Rogoff, knowledge economy, late capitalism, linear programming, lump of labour, manufacturing employment, new economy, Nixon shock, North Sea oil, oil shock, Paul Samuelson, pension reform, price stability, purchasing power parity, refrigerator car, Right to Buy, rising living standards, Robert Gordon, rolodex, Ronald Coase, Ronald Reagan, Simon Kuznets, statistical model, strikebreaker, structural adjustment programs, Thomas Malthus, total factor productivity, unorthodox policies, upwardly mobile, War on Poverty, Washington Consensus, Winter of Discontent, Wolfgang Streeck, women in the workforce, working-age population, yield curve, Yom Kippur War, zero-sum game

Anxiety was contagious, made worse by signs that inflation was rising once again. Shortly after New Year’s Day of 1973, stock prices began a long and painful decline around the world. From Great Britain to the United States to Hong Kong and Japan, more than half the value of investors’ holdings of corporate shares would be wiped out within two years.3 Economic forecasters simply closed their eyes to the stock market’s decline, taking comfort in the American economist Paul Samuelson’s quip that “Wall Street indexes predicted nine of the last five recessions.” In the early weeks of 1973, the market’s message of impending collapse was not only unwanted but completely unbelievable. Things were simply too good. January 1973 was the second-busiest month ever for US home-builders, and home prices were rising smartly in Great Britain and Japan. A West German government study judged that 1973 was “the beginning of a new cyclical upturn,” with the economy likely to grow by 6 percent.

The asset price bubble that decimated Japanese households’ finances in the 1990s; the thousands of bank failures in the United States between 1980 and 1994; the deep downturn, fed by excessive lending to unqualified borrowers, that began in Europe and the United States in 2008, bringing painfully high unemployment and threatening the very survival of the European Union—all can be traced to political efforts to make economies grow faster than productivity advances would allow. It was a fool’s errand. The American economist Paul Samuelson put it well: “The third quarter of the Twentieth Century was a golden age of economic progress. It surpassed any reasoned expectations. And we are not likely to see its equivalent soon again.”20 Acknowledgments This book, I suppose, began with my own personal history. I was a student in West Germany at the time of the 1973 oil crisis, and I experienced both the euphoria of car-free Sundays and the queues of ill-tempered drivers desperate for gasoline.

The Guardian, December 21, 1972; David Gumpert, “Rise in Demand Causes Shortage of a Variety of Materials, Parts,” Wall Street Journal, December 8, 1972; President’s Council of Economic Advisers, Economic Report of the President, 1973, 82; Bank of Japan, Monthly Economic Review, January 1973, 1; “Commentary,” Bank of England Quarterly Bulletin 13 (March 1973): 6; John L. Hess, “Forecasters’ Word Is ‘Boom,’” New York Times, January 7, 1973; Charles Reeder, The Sobering Seventies (Wilmington, DE: DuPont, 1980), 101. 3. E. Philip Davis, “Comparing Bear Markets—1973 and 2000,” National Institute Economic Review 183 (2003): 78–89. 4. Paul Samuelson, “Science and Stocks,” Newsweek, September 19, 1966; memo from Dr. Ranz, BMWi, to various cabinet ministers, “Angepasste mittelfristige Zielprojektion bis 1976,” March 20, 1973, BA, B 102/248423; Don Oberdorfer, “Japanese Economy Is Booming Again,” Washington Post, January 14, 1973. 5. OECD Economic Outlook 13 (June 1973): 102. 6. Memorandum of discussion, Federal Open Market Committee, February 13, 1973, 17; US Central Intelligence Agency, Office of Economic Research, “Oil Companies Compensate for Dollar Devaluation: The Geneva Agreement,” Foreign Relations of the United States (FRUS), vol. 36, 264. 7.


pages: 339 words: 88,732

The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies by Erik Brynjolfsson, Andrew McAfee

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2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, 3D printing, access to a mobile phone, additive manufacturing, Airbnb, Albert Einstein, Amazon Mechanical Turk, Amazon Web Services, American Society of Civil Engineers: Report Card, Any sufficiently advanced technology is indistinguishable from magic, autonomous vehicles, barriers to entry, basic income, Baxter: Rethink Robotics, British Empire, business intelligence, business process, call centre, Chuck Templeton: OpenTable, clean water, combinatorial explosion, computer age, computer vision, congestion charging, corporate governance, creative destruction, crowdsourcing, David Ricardo: comparative advantage, digital map, employer provided health coverage, en.wikipedia.org, Erik Brynjolfsson, factory automation, falling living standards, Filter Bubble, first square of the chessboard / second half of the chessboard, Frank Levy and Richard Murnane: The New Division of Labor, Freestyle chess, full employment, game design, global village, happiness index / gross national happiness, illegal immigration, immigration reform, income inequality, income per capita, indoor plumbing, industrial robot, informal economy, intangible asset, inventory management, James Watt: steam engine, Jeff Bezos, jimmy wales, job automation, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kevin Kelly, Khan Academy, knowledge worker, Kodak vs Instagram, law of one price, low skilled workers, Lyft, Mahatma Gandhi, manufacturing employment, Marc Andreessen, Mark Zuckerberg, Mars Rover, mass immigration, means of production, Narrative Science, Nate Silver, natural language processing, Network effects, new economy, New Urbanism, Nicholas Carr, Occupy movement, oil shale / tar sands, oil shock, pattern recognition, Paul Samuelson, payday loans, price stability, Productivity paradox, profit maximization, Ralph Nader, Ray Kurzweil, recommendation engine, Report Card for America’s Infrastructure, Robert Gordon, Rodney Brooks, Ronald Reagan, Second Machine Age, self-driving car, sharing economy, Silicon Valley, Simon Kuznets, six sigma, Skype, software patent, sovereign wealth fund, speech recognition, statistical model, Steve Jobs, Steven Pinker, Stuxnet, supply-chain management, TaskRabbit, technological singularity, telepresence, The Bell Curve by Richard Herrnstein and Charles Murray, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, total factor productivity, transaction costs, Tyler Cowen: Great Stagnation, Vernor Vinge, Watson beat the top human players on Jeopardy!, winner-take-all economy, Y2K

For instance, the new satellite accounts created by the Bureau of Economic Analysis estimate that investment in R&D capital accounted for about 2.9 percent of GDP and has increased economic growth by about 0.2 percent per year between 1995 and 2004.26 It’s hard to say exactly how large the bias is from miscounting all the types of intangible assets, but we are reasonably confident the official data underestimate their contribution.* New Metrics Are Needed for the Second Machine Age It’s a fundamental principle of management: what gets measured gets done. Modern GDP accounting was certainly a huge step forward for economic progress. As Paul Samuelson and Bill Nordhaus put it, “While the GDP and the rest of the national income accounts may seem to be arcane concepts, they are truly among the great inventions of the twentieth century.”27 But the rise in digital business innovation means we need innovation in our economic metrics. If we are looking at the wrong gauges, we will make the wrong decisions and get the wrong outputs. If we measure only tangibles, then we won’t catch the intangibles that will make us better off.

What should the top tax rate be? Disagreements over these questions often seem so entrenched that there can be no common ground. But there’s actually quite a bit of it. Whether you study from the best-selling introductory textbooks Principles of Economics, written by Harvard’s Greg Mankiw, a conservative economist who advised George Bush and Mitt Romney, or Economics: An Introductory Analysis, written by MIT’s Paul Samuelson, a liberal advisor to John Kennedy and Lyndon B. Johnson, you’ll learn many of the same things.* Across good Econ 101 textbooks, and across good economists, there’s far more agreement about government’s role in promoting economic growth than you might expect from the more vitriolic public debates in the media. We agree with this Econ 101 playbook as well, and think it will remain central to any appropriate response as machines continue to race ahead.

Later advocates included philosopher Bertrand Russell and civil rights leader Martin Luther King, Jr., who wrote in 1967, “I am now convinced that the simplest approach will prove to be the most effective—the solution to poverty is to abolish it directly by a now widely discussed measure: the guaranteed income.”3 Many economists on both the left and the right have agreed with King. Liberals including James Tobin, Paul Samuelson, and John Kenneth Galbraith and conservatives like Milton Friedman and Friedrich Hayek have all advocated income guarantees in one form or another, and in 1968 more than 1,200 economists signed a letter in support of the concept addressed to the U.S. Congress.4 The president elected that year, Republican Richard Nixon, tried throughout his first term in office to enact it into law. In a 1969 speech he proposed a Family Assistance Plan that had many features of a basic income program.


pages: 267 words: 71,123

End This Depression Now! by Paul Krugman

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airline deregulation, Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, capital asset pricing model, Carmen Reinhart, centre right, correlation does not imply causation, credit crunch, Credit Default Swap, currency manipulation / currency intervention, debt deflation, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, full employment, German hyperinflation, Gordon Gekko, Hyman Minsky, income inequality, inflation targeting, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, low skilled workers, Mark Zuckerberg, money market fund, moral hazard, mortgage debt, negative equity, paradox of thrift, Paul Samuelson, price stability, quantitative easing, rent-seeking, Robert Gordon, Ronald Reagan, Upton Sinclair, We are the 99%, working poor, Works Progress Administration

Louis, was a marginalized figure throughout his professional life, and died, still marginalized, in 1996. And to be honest, Minsky’s heterodoxy wasn’t the only reason he was ignored by the mainstream. His books are not, to say the least, user-friendly; nuggets of brilliant insight are strewn thinly across acres of turgid prose and unnecessary algebra. And he also cried wolf too often; to paraphrase an old joke by Paul Samuelson, he predicted around nine of the last three major financial crises. Yet these days many economists, yours truly very much included, recognize the importance of Minsky’s “financial instability hypothesis.” And those of us, again like yours truly, who were relative latecomers to Minsky’s work wish that we had read it much earlier. Minsky’s big idea was to focus on leverage—on the buildup of debt relative to assets or income.

One might think that these solutions could still be considered technocratic, and separated from the broader question of income distribution. Keynes himself described his theory as “moderately conservative in its implications,” consistent with an economy run on the principles of private enterprise. From the beginning, however, political conservatives—especially those most concerned with defending the position of the wealthy—fiercely opposed Keynesian ideas. And I mean fiercely. Paul Samuelson’s textbook Economics, whose first edition was published in 1948, is widely credited with bringing Keynesian economics to American colleges. But it was actually the second entry. A previous book, by the Canadian economist Lorie Tarshis, was effectively blackballed by right-wing opposition, including an organized campaign that successfully induced many universities to drop the book. Later, in his God and Man at Yale, William F.


pages: 235 words: 62,862

Utopia for Realists: The Case for a Universal Basic Income, Open Borders, and a 15-Hour Workweek by Rutger Bregman

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autonomous vehicles, banking crisis, Bartolomé de las Casas, basic income, Berlin Wall, Bertrand Russell: In Praise of Idleness, Branko Milanovic, cognitive dissonance, computer age, conceptual framework, credit crunch, David Graeber, Diane Coyle, Erik Brynjolfsson, everywhere but in the productivity statistics, Fall of the Berlin Wall, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Gilder, George Santayana, happiness index / gross national happiness, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, income inequality, invention of gunpowder, James Watt: steam engine, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Kevin Kelly, Kickstarter, knowledge economy, knowledge worker, Kodak vs Instagram, labour market flexibility, labour mobility, low skilled workers, means of production, megacity, meta analysis, meta-analysis, microcredit, minimum wage unemployment, Mont Pelerin Society, Nathan Meyer Rothschild: antibiotics, Occupy movement, offshore financial centre, Paul Samuelson, Peter Thiel, post-industrial society, precariat, RAND corporation, randomized controlled trial, Ray Kurzweil, Ronald Reagan, Second Machine Age, Silicon Valley, Simon Kuznets, Skype, stem cell, Steven Pinker, telemarketer, The Future of Employment, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, Tyler Cowen: Great Stagnation, universal basic income, wage slave, War on Poverty, We wanted flying cars, instead we got 140 characters, wikimedia commons, women in the workforce, working poor, World Values Survey

“We’re now self-sufficient, income-earning artists,” she told the researchers.36 Among youth included in the experiment, almost all the hours not spent on paid work went into more education. Among the New Jersey subjects, the rate of high school graduations rose 30%.37 And thus, in the revolutionary year of 1968, when young demonstrators the world over were taking to the streets, five famous economists – John Kenneth Galbraith, Harold Watts, James Tobin, Paul Samuelson, and Robert Lampman – wrote an open letter to Congress. “The country will not have met its responsibility until everyone in the nation is assured an income no less than the officially recognized definition of poverty,” they said in an article published on the front page of The New York Times. According to the economists, the costs would be “substantial, but well within the nation’s economic and fiscal capacity.”38 The letter was signed by 1,200 fellow economists.

The Ultimate Yardstick From the wreckage of depression and war, the GDP emerged as the ultimate yardstick of progress – the crystal ball of nations, the number to trump all others. And this time, its job was not to bolster the war effort, but to anchor the consumer society. “Much like a satellite in space can survey the weather across an entire continent so can the GDP give an overall picture of the state of the economy,” economist Paul Samuelson wrote in his bestselling textbook Economics. “Without measures of economic aggregates like GDP, policymakers would be adrift in a sea of unorganized data,” he continued. “The GDP and related data are like beacons that help policymakers steer the economy toward the key economic objectives.”21 At the start of the 20th century the U.S. government employed a grand total of one economist; more accurately, an “economic ornithologist,” whose job was to study birds.


pages: 72 words: 21,361

Race Against the Machine: How the Digital Revolution Is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy by Erik Brynjolfsson

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Amazon Mechanical Turk, Any sufficiently advanced technology is indistinguishable from magic, autonomous vehicles, business process, call centre, combinatorial explosion, corporate governance, creative destruction, crowdsourcing, David Ricardo: comparative advantage, easy for humans, difficult for computers, Erik Brynjolfsson, factory automation, first square of the chessboard, first square of the chessboard / second half of the chessboard, Frank Levy and Richard Murnane: The New Division of Labor, hiring and firing, income inequality, intangible asset, job automation, John Markoff, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Khan Academy, Kickstarter, knowledge worker, labour mobility, Loebner Prize, low skilled workers, minimum wage unemployment, patent troll, pattern recognition, Paul Samuelson, Ray Kurzweil, rising living standards, Robert Gordon, self-driving car, shareholder value, Skype, too big to fail, Turing test, Tyler Cowen: Great Stagnation, Watson beat the top human players on Jeopardy!, wealth creators, winner-take-all economy, zero-sum game

People with little economics training intuitively grasp this point. They understand that some human workers may lose out in the race against the machine. Ironically, the best-educated economists are often the most resistant to this idea, as the standard models of economic growth implicitly assume that economic growth benefits all residents of a country. However, just as Nobel Prize-winning economist Paul Samuelson showed that outsourcing and offshoring do not necessarily increase the welfare of all workers, it is also true that technological progress is not a rising tide that automatically raises all incomes. Even as overall wealth increases, there can be, and usually will be, winners and losers. And the losers are not necessarily some small segment of the labor force like buggy whip manufacturers. In principle, they can be a majority or even 90% or more of the population.


pages: 590 words: 153,208

Wealth and Poverty: A New Edition for the Twenty-First Century by George Gilder

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affirmative action, Albert Einstein, Bernie Madoff, British Empire, capital controls, cleantech, cloud computing, collateralized debt obligation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversified portfolio, Donald Trump, equal pay for equal work, floating exchange rates, full employment, George Gilder, Gunnar Myrdal, Home mortgage interest deduction, Howard Zinn, income inequality, invisible hand, Jane Jacobs, Jeff Bezos, job automation, job-hopping, Joseph Schumpeter, knowledge economy, labor-force participation, margin call, Mark Zuckerberg, means of production, medical malpractice, minimum wage unemployment, money market fund, money: store of value / unit of account / medium of exchange, Mont Pelerin Society, moral hazard, mortgage debt, non-fiction novel, North Sea oil, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, Ponzi scheme, post-industrial society, price stability, Ralph Nader, rent control, Robert Gordon, Ronald Reagan, Silicon Valley, Simon Kuznets, skunkworks, Steve Jobs, The Wealth of Nations by Adam Smith, Thomas L Friedman, upwardly mobile, urban renewal, volatility arbitrage, War on Poverty, women in the workforce, working poor, working-age population, yield curve, zero-sum game

By the early seventies, however, a national consensus had been reached favoring a program of “welfare reform” designed to conceal such realities, not only from welfare families but from all American families. A negative income tax was to be established, distributing money to perhaps one-third of all Americans as automatically and comprehensively as the IRS takes it from the rest of us. Poverty was to be abolished by redistribution. Endorsed on various occasions by such diverse voices as Richard Nixon, Milton Friedman, George McGovern, Paul Samuelson, and—above all in eloquent persistence—Daniel Patrick Moynihan, it was an idea whose time had apparently come. But no sooner had the consensus prevailed, so it seemed, than it collapsed. Senator Moynihan announced, with great courage and simplicity, “I was wrong.” Books and articles poured forth, declaring that the present welfare system, for all its manifest faults, was, as it were, “our welfare system, right or wrong,” an almost geological feature, one expert described it, with rocks and rills and purpled hills like America itself.

Government spending plummeted by nearly two-thirds between 1945 and 1947, and 150,000 government regulators were laid off along with perhaps a million other civilian employees of government. Disbanded were such managerial agencies as the War Production Board, the War Labor Board, and the Office of Price Administration beloved of John Kenneth Galbraith. Confidently predicting doom was every Keynesian economist. Sounding exactly like his Nobel laureate successor Paul Krugman supporting trillions in new “stimulus” in 2010, Paul Samuelson in 1945 prophesied “the greatest period of unemployment and dislocation which any economy has ever faced.” In an account of these events, CATO economist Arnold Kling observed that “as a percentage of GDP the decrease in government purchases was larger than would result from the total elimination of government today.” Rather than a depression, though, economic growth surged by 10 percent over two years and the civilian labor force expanded by 7 million workers.

This policy is leading to capital losses, real estate depreciation, disinvestment, capital flight, skilled emigration, and contraction of private employment. Obama administration policy was so drastically negative toward the creations of the private economy that change could release huge positive energies. Once again discredited will be Keynesian pessimists. As dramatically as the post-war recovery of the 1950s confounded Paul Samuelson’s jeremiad, the responses of U.S. entrepreneurs can again galvanize an American century. We just need to adopt a full supply-side solution. ACKNOWLEDGMENTSb WEALTH AND POVERTY ARE the prime concerns of economics, but they are subjects too vast and vital to be left to economists alone. Although economists have provided me with some of my most valued counsel—and I will be acknowledging them in numbers—this book is in part an essay on the limitations of contemporary economics in analyzing the sources of creativity and progress in all economies.


pages: 497 words: 153,755

The Power of Gold: The History of an Obsession by Peter L. Bernstein

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Albert Einstein, Atahualpa, Bretton Woods, British Empire, California gold rush, central bank independence, double entry bookkeeping, Edward Glaeser, falling living standards, financial innovation, floating exchange rates, Francisco Pizarro, German hyperinflation, Hernando de Soto, Isaac Newton, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, large denomination, liquidity trap, long peace, money: store of value / unit of account / medium of exchange, old-boy network, Paul Samuelson, price stability, profit motive, random walk, rising living standards, Ronald Reagan, seigniorage, the market place, The Wealth of Nations by Adam Smith, Thomas Malthus, too big to fail, trade route

As readers will note in Chapters 17 and 18, this fascinating material brought the times to life as nothing else could have. The following people also provided significant assistance along the way and deserve my warmest thanks: Barbara Boehm, Ulla BuchnerHoward, Mike Clowes, Barclay Douglas, Hans Falkena, Rob Ferguson, Benjamin Friedman, Milton Friedman, Alan Greenspan, James Howell, Henry Hu, Steve Jones, Dwight Keating, Leora Klapper, Benjamin Levene, Richard Rogalski, Paul Samuelson, Ronald Sobel, and Gentaro Yura. Convention dictates that the author relieves all of the above from any responsibility for errors that may remain in the manuscript. Charlie Kindleberger decries this convention, pointing out that the author, after all, depended on the authority of these individuals in preparing the work and should not be expected to check out the accuracy of their suggestions.

Now the other nations are economically strong, and the time has come for them to bear their fair share of the burden of defending freedom around the world. The time has come for exchange rates to be set straight.... There is no longer any need for the United States to compete with one hand behind its back.... We are not about to ease up and lose the economic leadership of the world.6 "They've really shot both barrels," observed the President of Bankers Trust Company on Monday morning. Paul Samuelson, the Nobel Prize-winning economist, asserted in an article for the New York Times that "The President had no real choice. His hand was forced by the massive hemorrhage of dollar reserves of recent weeks.... For more than a decade the American dollar has been an overvalued currency.... [The new policy] also helps Japan ... since it is foolish for Japan to give away goods without being repaid for them in equivalent goods."

*This superb essay deserves reading in full, both for its analysis of the past and the accuracy of its predictions for the future. *Knox, Secretary of War during World War II, was famous for his remark about the Japanese when he put his arm around the shoulder of T. V. Tsoong, the Chinese Ambassador: "Don't worry, T. V., we'll lick those yellow bastards yet." *1 heard this story as a Harvard undergraduate in the late 1930s; Professor Paul Samuelson of MIT was good enough to confirm it in personal correspondence. *Leffingwell regularly sent Norman food packages during World War II and carried on an active correspondence with his old friend. `Both men died before they could see the product of their work in full flower, Keynes in April 1946 and White in August 1948. Given the ultimate shape of the Bretton Woods system, there is reason to believe that White was the dominant partner, with Keynesrepresenting the poor relation-playing second fiddle.


pages: 1,205 words: 308,891

Bourgeois Dignity: Why Economics Can't Explain the Modern World by Deirdre N. McCloskey

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Admiral Zheng, agricultural Revolution, Albert Einstein, BRICs, British Empire, butterfly effect, Carmen Reinhart, clockwork universe, computer age, Corn Laws, creative destruction, dark matter, David Ricardo: comparative advantage, Donald Trump, Edward Lorenz: Chaos theory, endogenous growth, European colonialism, experimental economics, financial innovation, Fractional reserve banking, full employment, George Akerlof, germ theory of disease, Gini coefficient, greed is good, Howard Zinn, income per capita, interchangeable parts, invention of agriculture, invention of air conditioning, invention of writing, invisible hand, Isaac Newton, James Watt: steam engine, John Maynard Keynes: technological unemployment, John Snow's cholera map, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, long peace, means of production, Naomi Klein, New Economic Geography, New Urbanism, Paul Samuelson, purchasing power parity, rent-seeking, road to serfdom, Robert Gordon, Ronald Coase, Ronald Reagan, sceptred isle, Scientific racism, Scramble for Africa, Shenzhen was a fishing village, Simon Kuznets, Slavoj Žižek, spinning jenny, Steven Pinker, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, tulip mania, union organizing, Upton Sinclair, urban renewal, V2 rocket, very high income, working poor, World Values Survey, Yogi Berra

Consumers and producers, economists say, maximize utility “subject to constraints,” such as the laws against murder and theft, or the regulations of the Internal Revenue Service, or the customs of Bedouin hospitality, or the Ford Way of doing business. In other words, the main character in North’s story is always Max U, that unlovely maximizer of Utility,Homo prudens — never Homo ludens or Homo faber or Homo hierarchus or, as I and most non-economist social scientists would claim, Homo loquens, the speaking humanoid. “Max U,” you see, is a man with the last name “U” who has peopled the arguments of economists since Paul Samuelson in the late 1930s elevated him to a leading role. The joke is that the only way that an economist knows how to think about life after Samuelson is to watch Mr. Max U Max-imizing a Utility function, U(X,Y). Ha, ha. Max U cares only for the virtue of prudence, and even “prudence” defined in an especially narrow way, that is, “knowing what your appetites are and knowing how to satisfy them.” Never mind what the novelist Samuel Butler truly wrote around 1880: “There is no greater sign of a fool than the thinking that he can tell at once and easily what it is that pleases him.”3 In Yiddish such a fool would be a goyisher kop, a gentile jerk, by which is meant a man without learning or reflection or prayer.

A world without a United States might have permanently turned after 1945 against the Industrial Revolution, just as a world without Britain and Holland would not have developed bourgeois dignity and liberty in the first place.57 A deeper reply is that the turn to the left, and many of the turns to the right, did in fact stop the Industrial Revolution, at any rate in the places where anti-innovation was well and truly tried. To be sure, in 1945 it looked like market societies were exhausted, and that giving socialism and the welfare state a serious trial even in the United States was in the cards. The best economists, such as Joseph Schumpeter, Alvin Hansen, John Maynard Keynes, Oskar Lange, Paul Samuelson, and Abba Lerner, thought at the time — with greater or lesser pleasure at the thought — that the world was moving from capitalism to socialism, whether or not the embattled democracies survived. Many people were impressed by the Soviet successes of the 1930s, whatever their human costs, and were very impressed by Stalin’s victory over Hitler. They could not see that in the longer run, when opportunities for imitation had been used up, central-planning socialism could not achieve real innovation.

Build giant factories and full speed ahead. 368 Nonetheless as late as 1984 John Kenneth Galbraith was writing that “the Soviet system has made great material progress in recent years is evident both from the statistics and from the general urban scene. . . . One sees it in the appearance of solid well-being of the people on the streets [Galbraith did not perhaps spend much time in the provinces]. . . and the general aspect of restaurants, theaters, and shops. . . . Partly, the Russian system succeeds because, in contrast with the Western industrial economies, it makes full use of its manpower.” In 1985 the great economist Paul Samuelson wrote that “what counts is results, and there can be no doubt that the Soviet planning system has been a powerful engine for economic growth. . . . The Soviet model has surely demonstrated that a command economy is capable of mobilizing resources for rapid growth.” In 1989 Lester Thurow asked, “Can economic command [that is, the industrial policy that Thurow advocated] significantly. . . accelerate the growth process?


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

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3D printing, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, knowledge economy, labor-force participation, labour mobility, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

The Ford and Carnegie foundations in particular, but also others like the Walgreen Foundation (established by the communist-hating drugstore titan Charles Walgreen), began giving donations to support an approach to business that would make it seem more serious and weighty, a “real science” to be contended with. Business and economics education began to develop a notion of itself as a hard science. One of the watershed moments for this new school of thought was the publication in 1947 of economist Paul Samuelson’s Foundations of Economic Analysis, which laid out the case for a new approach to economic thinking—one that resembled the abstract, hyperrational field of physics much more than the messy reality of the social sciences. Indeed, the language of the time makes it clear that the elites were a bit embarrassed about any ties that business education might have to actual factory floors. “The day of the truly professional general management man isn’t here yet, but it’s not far away.

The assets of all stock and bond mutual funds had risen from $5.2 trillion in 1999 to around $13 trillion in 2014. But despite a more than doubling of the industry’s asset base, fees have actually risen, too, by a whopping 81 percent—from $48 billion to $87 billion.22 “The staggering economies of scale that characterize money management have been largely arrogated by fund managers to themselves, rather than shared with their fund shareholders,” concludes Bogle. Or, as the great economist Paul Samuelson put it presciently in 1967, “I decided that there was only one place to make money in the mutual fund business—as there is only one place for a temperate man to be in a saloon, behind the bar and not in front of the bar. And I invested in…[a] management company.”23 In lieu of pouring all your money into Fidelity or BlackRock, there are any number of studies that tell us how much better off we are investing the Vanguard way, in low- or no-fee index funds.

Financial Analysts Journal 29, no. 4 (July–August 1973): 41–44. 18. Ameriprise Financial, “Ameriprise Financial Completes Columbia Management Acquisition,” news release, May 3, 2010. 19. Bogle, The Clash of the Cultures, 117–18. 20. Rana Foroohar, “Why Some Men Are Big Losers,” Time, June 10, 2013. 21. Bogle, “Big Money in Boston,” 138. 22. Bogle Senate testimony, September 16, 2014. 23. Paul Samuelson, Institute Professor, Massachusetts Institute of Technology, statement before the hearing on Mutual Fund Legislation of 1967 by US Senate Committee on Banking and Currency, August 2, 1967. 24. Author interview with Buffett for this book. 25. “Against the Odds: The Costs of Actively Managed Funds Are Higher than Most Investors Realise,” Economist, February 20, 2014. 26. Wells Fargo, “2015 Affluent Investor Survey,” conducted by Harris Poll, July 2015. 27.


pages: 741 words: 179,454

Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

In his doctoral dissertation, he laid out the argument that stock prices were random, reflecting all available information relevant to its value. Prices followed a random walk and market participants could not systematically profit from market inefficiencies. The EMH does not require market price to be always accurate. Investors force the price to fluctuate randomly around its real value. As economist Paul Samuelson put it: “if one could be sure that a price will rise, it would already have risen.”6 The EMH was the finance version of The Price Is Right, the corollary of Chicago’s belief in free markets. Reviewing Markowitz’s work, David Durand observed that the “argument rests on the concept of the Rational Man.” Durand did not think such a creature existed and thought the whole thing had “an air of fantasy.”7 Corporate M&Ms In the late 1950s, Franco Modigliani and Merton Miller, two professors at Carnegie Mellon University, developed two propositions influencing a company’s capital structure (the mix of debt and equity) and dividend policy.

If the stock price goes up then the value of the call option increases but you suffer a loss on the shares, as you have to buy them back at the higher price. By adjusting the ratio of options to the shares, you can construct a portfolio where the changes in the value of the options and shares exactly offset, at least, for small movements in the stock price. Working as research assistant to Paul Samuelson, Robert Merton was also working on option pricing. Merton introduced an idea—continuous time mathematics. Black and Scholes assumed that the portfolio would be rebalanced to keep it free of risk by changing the number of shares held at discrete time intervals. Merton forced the time intervals into infinitely small fragments of time, effectively allowing continuous and instantaneous rebalancing.

Within her inner circle—known ironically as the collective—the promoter of individual liberty did not tolerate dissent. Her stifling worldview encompassed politics, interior design, and dancing. Despite a failure to create a lasting legacy or political movement, Rand remains an influence on conservative thinking. The New York Times dubbed Rand the “novelist Laureate” of the Reagan administration, citing her influence on Greenspan.13 Paul Samuelson, the economist, recalled that: The trouble is that [Greenspan] had been an Ayn Rander. You can take the boy out of the cult but you can’t take the cult out of the boy. He actually had instructions, probably pinned on the wall: “Nothing from this office should go forth which discredits the capitalist system. Greed is good.”14 Like his mentor, Greenspan was his own splendid creation. Celebrity Central Banking Greenspan reveled in the age of celebrity central bankers: “The only central bankers ever to achieve...rock star status....


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What Went Wrong: How the 1% Hijacked the American Middle Class . . . And What Other Countries Got Right by George R. Tyler

8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, bank run, banking crisis, Basel III, Black Swan, blood diamonds, blue-collar work, Bolshevik threat, bonus culture, British Empire, business process, capital controls, Carmen Reinhart, carried interest, cognitive dissonance, collateralized debt obligation, collective bargaining, commoditize, corporate governance, corporate personhood, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, crowdsourcing, currency manipulation / currency intervention, David Brooks, David Graeber, David Ricardo: comparative advantage, declining real wages, deindustrialization, Diane Coyle, Double Irish / Dutch Sandwich, eurozone crisis, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Gordon Gekko, hiring and firing, income inequality, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, labour market flexibility, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, pension reform, performance metric, pirate software, Plutocrats, plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Sand Hill Road, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen: Great Stagnation, union organizing, Upton Sinclair, upwardly mobile, women in the workforce, working poor, zero-sum game

Leaders in these nations reacted with dispatch, transforming the dangers of global integration into broadly based prosperity. Protectionism was avoided and even aggressively attacked when identified abroad. These nations didn’t experience an American-style stagnation of wages and offshoring of jobs. Instead, Australia and northern Europe pursued policies informed by the best and brightest trade economists of our age. Drawing on the theories of David Ricardo, for example, economists Paul Samuelson and Wolfgang F. Stolper had concluded as early as 1941 that international trade creates long-term losers as well as winners. So leaders abroad crafted remediation: a balance of clever mechanisms maximizing the gains from globalization and broadcasting those gains to families, while minimizing its harm to jobs and wages. This reality reveals the hollowness of complaints by American firms such as Apple that routinely warn about high American labor costs and mediocre skill levels.

Central banks attract criticism for two main reasons: First, they create credit, which always raises the risk of credit bubbles, deep recessions and inflation; that’s why conservatives with the Austrian School endorse the discipline of the gold standard. Milton Friedman disagreed with them, placing his faith in robotic monetary growth targets administered by the Fed, rejecting fears of the Austrian School’s Henry Hazlitt. President Nixon ignored the Austrians (and also the advice of Nobel Laureate Paul Samuelson) in favor of Friedman when he abandoned gold in mid-August 1971. Unlike the Austrians, President Nixon and his successors like President Reagan and Alan Greenspan perhaps never read the most famous fable of the German literary giant, Johann Wolfgang Goethe. It’s right there in Faust: the creation of paper money is mere alchemy.23 History has proven Hazlitt, Samuelson, and Goethe right and Friedman wrong.24 Second, as mentioned, conservatives like Hayek believe that central banks are too easily captured by the business community, with monetary policies adopted for political ends.

The much greater magnitude of growth in the skilled labor category in Europe is a first surprise, the tip of the iceberg: the IMF economists determined that skilled-sector employment in Europe grew much more strongly than in America amid globalization. We will return to this evidence of European economic prowess in a moment. Unsurprisingly, as we see in Table 4, American and European workers in relatively unskilled, labor-intensive sectors fared less well. That’s consistent with the famous conclusion reached in 1941 by Wolfgang F. Stolper and Paul Samuelson, which is the source of the received wisdom among economists that freer trade permanently harms some employees in rich democracies.8 The IMF analysts concluded that the unskilled worker share of total wages fell somewhat sharply in both America and Europe. The Impact of Technology Progress and Globalization on Unskilled Labor 1980 2003 Labor’s income share in unskilled sectors1 United States 25% 18% Europe2 34% 24% Index of unskilled employment United States 100% 121% Europe 100% 86% Table 4. 1 Measured as share of economy-wide value added. 2 Includes: Austria, Belgium, Denmark, Finland, France, Germany, Italy, Norway, Portugal, and Sweden.


pages: 381 words: 101,559

Currency Wars: The Making of the Next Gobal Crisis by James Rickards

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Asian financial crisis, bank run, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, high net worth, income inequality, interest rate derivative, John Meriwether, Kenneth Rogoff, labour mobility, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, private sector deleveraging, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, sovereign wealth fund, special drawing rights, special economic zone, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, War on Poverty, Washington Consensus, zero-sum game

Only massive government interventions involving bank capital, interbank lending, money market guarantees, mortgage guarantees, deposit insurance and many other expedients prevented the wholesale collapse of capital markets and the economy. With few exceptions, the leading macroeconomists, policy makers and risk managers failed to foresee the collapse and were powerless to stop it except with the blunt object of unlimited free money. To explain why, it is illuminating to take 1947, the year of publication of Paul Samuelson’s Foundations of Economic Analysis, as an arbitrary dividing line between the age of economics as social science and the new age of economics as natural science. That dividing line reveals similarities in market behavior before and after. The collapse of Long-Term Capital Management in 1998 bears comparison to the collapse of the Knickerbocker Trust and the Panic of 1907 in its contagion dynamics and private resolution by bank counterparts with the most to lose.

In the face of any one of these crises—financial, natural or military—the United States would be forced to resort to emergency measures, as had FDR in 1933 and Nixon in 1971. Bank closings, gold seizures, import tariffs and capital controls would be on the table. America’s infatuation with the Keynesian illusion has now resulted in U.S. power being an illusion. America can only hope that nothing bad happens. Yet given the course of events in the world, that seems a slim reed on which to lean. Financial Economics At about the same time that Paul Samuelson and others were developing their Keynesian theories, another group of economists were developing a theory of capital markets. From the faculties of Yale, MIT and the University of Chicago came a torrent of carefully reasoned academic papers by future Nobel Prize winners such as Harry Markowitz, Merton Miller, William Sharpe and James Tobin. Their papers, published in the 1950s and 1960s, argued that investors cannot beat the market on a consistent basis and that a diversified portfolio that broadly tracks the market will produce the best results over time.


pages: 364 words: 101,286

The Misbehavior of Markets by Benoit Mandelbrot

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Albert Einstein, asset allocation, Augustin-Louis Cauchy, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black-Scholes formula, British Empire, Brownian motion, buy low sell high, capital asset pricing model, carbon-based life, discounted cash flows, diversification, double helix, Edward Lorenz: Chaos theory, Elliott wave, equity premium, Eugene Fama: efficient market hypothesis, Fellow of the Royal Society, full employment, Georg Cantor, Henri Poincaré, implied volatility, index fund, informal economy, invisible hand, John Meriwether, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market microstructure, Myron Scholes, new economy, paper trading, passive investing, Paul Lévy, Paul Samuelson, Plutocrats, plutocrats, price mechanism, quantitative trading / quantitative finance, Ralph Nelson Elliott, RAND corporation, random walk, risk tolerance, Robert Shiller, Robert Shiller, short selling, statistical arbitrage, statistical model, Steve Ballmer, stochastic volatility, transfer pricing, value at risk, Vilfredo Pareto, volatility smile

There, he met another ADL man, Jack Treynor—the same who had devised, but not published, an asset-pricing model around the same time as Sharpe. Black began to study it, and became hooked. “The notion of equilibrium in the market for risky assets had great beauty for me,” he recalled. He tried applying the model beyond stocks, to bonds, cash, and finally, to warrants, a close cousin of options. Now, many smart people before Black had tried to find a formula for valuing warrants or options—including Bachelier and Paul Samuelson, the MIT economist. One common problem was that, to figure out what an option or warrant was worth today, they thought they had to know what the underlying stock would be worth at expiration—that is, how far “in the money” or “out of the money” the option would end up being. But that was a hopeless approach. If you could predict that, you would not be a struggling young economist much longer.

His mother died of cancer when he was sixteen, and then he developed scar tissue on his corneas that, until corrected surgically ten years later, made it hard for him to read. “Out of necessity I became a good listener,” Scholes later recalled. “I learned to think abstractly and to conceptualize the solution to problems.” He went on to get a doctorate in economics from the University of Chicago, and was then offered a teaching job at MIT. There, several smart young economists had gathered around economists Paul Samuelson, Franco Modigliani, and Paul Cootner (the first two eventually won Nobels). And on Tuesday evenings, a workshop on finance met to discuss new issues. There, Scholes and Black got to know each other. Together, they took up Black’s work again. They made an odd couple—the austere, reserved Harvard man and the temperamental, disputatious Canadian. They focused on Black’s earlier, counterintuitive insight: When valuing an option, you do not need to know how the game will end—that is, what the stock price will finally be when the option expires.


pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

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accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, central bank independence, collective bargaining, commodity trading advisor, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, information asymmetry, Jean Tirole, job satisfaction, Joseph Schumpeter, Kenneth Arrow, knowledge worker, labour market flexibility, law of one price, light touch regulation, Long Term Capital Management, low skilled workers, mandatory minimum, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, old-boy network, open economy, Pareto efficiency, Paul Samuelson, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, Vilfredo Pareto, working-age population, World Values Survey

The money must be transformed into capital goods, and the method for doing so is not part of neoclassical theory. Any attempt to model this transformation inevitably points to fundamental problems of the neoclassical theory of capital and income distribution (Keen 2001/2008). MARKET POWER 159 The 1960s and ’70s saw a protracted fight over neoclassical capital theory, the so-called Cambridge Capital Controversy. Neoclassical economists, including Paul Samuelson and Robert Solow from MIT (the Massachusetts Institute of Technology), defended neoclassical capital theory against an attack from economists working in Cambridge, England, chiefly Joan Robinson and Piero Sraffa. The English economists attacked the neoclassical notion that the (relative) price of the two factors of production, labor and capital, determines how much of each is used. Since capital has very different forms, the neoclassicals resort to adding up the market values of capital goods to measure the aggregate capital.

There would be a menu of different possible equilibriums, both better and worse. They would have to be chosen, by chance, the government or somebody else. As the different equilibriums are likely to be associated with rather different distributions of income between capitalists and workers, whoever had the power to see that their side’s preferred distribution was selected would be of key importance. 160 ECONOMISTS AND THE POWERFUL Paul Samuelson admitted defeat at the first World Congress of the Econometric Society in Rome in 1965, which is documented in the November 1966 edition of the Quarterly Journal of Economics. Samuelson concluded the Congress by stating that the neoclassical rule that falling interest rates lead to increasing capital intensity cannot be universally true, admitting in effect that the neoclassical theory of capital is faulty.


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Servant Economy: Where America's Elite Is Sending the Middle Class by Jeff Faux

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back-to-the-land, Bernie Sanders, Black Swan, Bretton Woods, BRICs, British Empire, call centre, centre right, cognitive dissonance, collateralized debt obligation, collective bargaining, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, David Brooks, David Ricardo: comparative advantage, falling living standards, financial deregulation, financial innovation, full employment, hiring and firing, Howard Zinn, Hyman Minsky, illegal immigration, indoor plumbing, informal economy, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, Long Term Capital Management, market fundamentalism, Martin Wolf, McMansion, medical malpractice, mortgage debt, Myron Scholes, Naomi Klein, new economy, oil shock, old-boy network, Paul Samuelson, Plutocrats, plutocrats, price mechanism, price stability, private military company, Ralph Nader, reserve currency, rising living standards, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, school vouchers, Silicon Valley, single-payer health, South China Sea, statistical model, Steve Jobs, Thomas L Friedman, Thorstein Veblen, too big to fail, trade route, Triangle Shirtwaist Factory, union organizing, upwardly mobile, urban renewal, War on Poverty, We are the 99%, working poor, Yogi Berra, Yom Kippur War

This is not what Adam Smith, David Ricardo, and the classical advocates of free trade had in mind. But the actual content of these agreements was unimportant to economists defending intellectual dogma. Indeed, a survey of the economists who supported the first of these deals, NAFTA, showed that only one in nine had actually read the treaty itself.4 Not even the venerable Nobel Prize winner Paul Samuelson, a founder of the neoliberal economics that dominated postwar economic policy and a staunch supporter of free trade, was exempt from the contempt of the academic inquisition that tolerates no heresy. When Samuelson suggested in a 2004 article that the United States might not, after all, benefit from free trade, he was dismissed as an old man who had lost his marbles.5 His point was simply that the dogma that free trade was a win-win for everyone had become dubious as (1) highly skilled workers overseas became increasingly cheaper to hire, (2) the gains from producing goods more cheaply elsewhere went to capital rather than labor, and (3) the United States lost a comparative advantage in expanding industries.

More than Ever,” Economic Policy Institute Briefing Paper 182, February 2007, http://www.gpn.org/bp182.html. 3. Gordon Lafer, Neither Free nor Fair: The Subversion of Democracy under NLRB Elections, American Rights at Work, July 2007, http://www.americanrightsatwork.org/publications/general/neither-free-nor-fair.html. 4. Pat Choate, Dangerous Business: The Risks of Globalization (New York: Alfred A. Knopf, 2008), 140. 5. Paul Samuelson, “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supportive of Globalization,” Journal of Economic Perspectives 18, no. 3 (Summer 2004): 135–146. 6. Heidi Shierholz, Jared Bernstein, and Lawrence Mishel, The State of Working America, 2008/2009 (Washington, DC: Economic Policy Institute, 2008). 7. “Outsourcing Innovation,” Bloomberg Businessweek, March 21, 2005. 8.


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The Irrational Economist: Making Decisions in a Dangerous World by Erwann Michel-Kerjan, Paul Slovic

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Andrei Shleifer, availability heuristic, bank run, Black Swan, Cass Sunstein, clean water, cognitive dissonance, collateralized debt obligation, complexity theory, conceptual framework, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, Daniel Kahneman / Amos Tversky, endowment effect, experimental economics, financial innovation, Fractional reserve banking, George Akerlof, hindsight bias, incomplete markets, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, iterative process, Kenneth Arrow, Loma Prieta earthquake, London Interbank Offered Rate, market bubble, market clearing, money market fund, moral hazard, mortgage debt, Pareto efficiency, Paul Samuelson, placebo effect, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, source of truth, statistical model, stochastic process, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, ultimatum game, University of East Anglia, urban planning, Vilfredo Pareto

For example, in the Stern Review, it is implicitly assumed that all decisions about the mitigation of climate change should be made immediately. I suggest that one should instead approach the climate change problem and the energy problem by solving them via stochastic dynamic calculus, as in continuous-time finance with predictable assets returns. (This approach was developed in 1969 by American economists and Nobel Laureates Robert Merton and Paul Samuelson.) There are indeed clear links to the literature of dynamic finance: (1) Preserving a nonrenewable resource, or reducing emission of CO2 under a constraint of maximum concentration, is equivalent to an increase in saving; (2) the uncertainty about the stock of the resource, or the uncertainty about the desirable maximum concentration of CO2, is parallel to income uncertainty in the standard consumption-portfolio problem; (3) emitting greenhouse gases when the environmental impact is uncertain is equivalent to investing in a risky asset.

The science behind this hinges on the interaction of three main effects—ocean surface temperatures, vertical wind shear, and atmospheric humidity—but these may not all act in the same direction. For example, while higher water temperatures and higher humidity can increase the intensity of cyclones, increased vertical shear may tend to destroy the vortex and thereby break up the storms. See “Hurricanes in a Warmer World,” Union of Concerned Scientists (2006). 5 This is a tricky issue. Paul Samuelson’s well-known paper (“Risk and Uncertainty: A Fallacy of the Law of Large Numbers,” Scientia, April/May 1963) urges caution regarding the pitfalls in repeated gambles and the issue of how far risk can be diversified through inter-temporal mechanisms. 6 Dwight Jaffee, Howard Kunreuther, and Erwann Michel-Kerjan, “Long-Term Insurance for Addressing Catastrophe Risk,” Working Paper # 14210, National Bureau of Economic Research (2008).


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The Great Divergence: America's Growing Inequality Crisis and What We Can Do About It by Timothy Noah

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assortative mating, autonomous vehicles, blue-collar work, Bonfire of the Vanities, Branko Milanovic, call centre, collective bargaining, computer age, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, Deng Xiaoping, Erik Brynjolfsson, feminist movement, Frank Levy and Richard Murnane: The New Division of Labor, Gini coefficient, Gunnar Myrdal, income inequality, industrial robot, invisible hand, job automation, Joseph Schumpeter, low skilled workers, lump of labour, manufacturing employment, moral hazard, oil shock, pattern recognition, Paul Samuelson, performance metric, positional goods, post-industrial society, postindustrial economy, Powell Memorandum, purchasing power parity, refrigerator car, rent control, Richard Feynman, Richard Feynman, Ronald Reagan, shareholder value, Silicon Valley, Simon Kuznets, Stephen Hawking, Steve Jobs, The Spirit Level, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, union organizing, upwardly mobile, very high income, Vilfredo Pareto, War on Poverty, We are the 99%, women in the workforce, Works Progress Administration, Yom Kippur War

Among laborers engaged in manufacturing men’s clothing, for instance, a 1 percent increase in the foreign-born proportion of a city’s population lowered wages by 1.5 to 3 percent.12 Surveying the economic literature in 2006, the economists Timothy Hatton (of Australian National University and the University of Essex) and Jeffrey Williamson (of Harvard) calculated that in 1910 unskilled wages in the United States would have been about 9 to 14 percent higher had there been no immigration between 1870 and 1910.13 Did the Great Compression, the long and prosperous midcentury period during which incomes became more equal and stayed that way, owe a debt to the immigration restrictions imposed in the 1920s? The Nobel Prize–winning economist Paul Samuelson thought so. “By keeping labor supply down,” he wrote in his bestselling economics textbook, a restrictive immigration policy “tends to keep wages high.”14 Less than a decade after the 1965 immigration law reopened the spigot, middle-class incomes were stagnating, and by 1979 inequality was increasing. It’s therefore logical to suspect that the Great Divergence was the product of legal and undocumented immigrants yearning to breathe free.

The average monthly wage is $449, or about one tenth the average in the United States.3 When a manufacturing nation with an aggressively mercantilist trade policy and a preposterously huge pool of cheap labor (that’s China) sells a lot of stuff to a manufacturing nation with a much smaller, more prosperous labor pool (that’s the United States), the outcome will be lower wages for workers in the more prosperous nation. Or so established economic theory tells us. The theory in question is the Stolper-Samuelson theorem, first elaborated in a 1941 paper by two young economists, Wolfgang Stolper (of Swarthmore and later the University of Michigan) and Paul Samuelson (of MIT). Samuelson, who considered himself “the midwife, helping to deliver Wolfie’s brainchild,” would go on to write the twentieth century’s bestselling economics textbook and to win the Nobel Prize. Fifty years after the theorem’s debut, the Columbia economist Jagdish Bhagwati wrote, “I know of no major international economic theorist today who would not trade an arm and a leg” for its authorship.4 The Stolper-Samuelson theorem challenged the notion dating back to David Ricardo that everybody benefited when trade between nations proceeded unimpeded.


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Losing Control: The Emerging Threats to Western Prosperity by Stephen D. King

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Admiral Zheng, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, BRICs, British Empire, capital controls, Celtic Tiger, central bank independence, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, demographic dividend, demographic transition, Deng Xiaoping, Diane Coyle, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, German hyperinflation, Gini coefficient, hiring and firing, income inequality, income per capita, inflation targeting, invisible hand, Isaac Newton, knowledge economy, labour market flexibility, labour mobility, liberal capitalism, low skilled workers, market clearing, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, Naomi Klein, new economy, old age dependency ratio, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, rent-seeking, reserve currency, rising living standards, Ronald Reagan, savings glut, Silicon Valley, Simon Kuznets, sovereign wealth fund, spice trade, statistical model, technology bubble, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas Malthus, trade route, transaction costs, Washington Consensus, women in the workforce, working-age population, Y2K, Yom Kippur War

He named it California after a sixteenth-century Spanish novel (The Exploits of Explanadían) in which there was a reference to a mythical island of that name ruled by Calafía, a pagan queen. California properly fell into Spanish hands in 1769 following the establishment of a number of missions up and down the land. Mexico gained its independence from the Spanish in 1821. 6. See, for example, Paul Samuelson’s article ‘Where Ricardo and Mill rebut and confirm arguments of mainstream economists supporting globalization’, Journal of Economic Perspectives, 18.3 (2004), pp. 135–46. 7. See, for example, Alan G. Ahearne; Joseph E. Gagnon; Jane Haltmaier; Steven B. Kamin, Preventing Deflation: Lessons From Japan’s Experience in the 1990s. published by the Federal Reserve in 2002 and available at http://www.federalreserve.gov/pubs/ifdp/ 2002/729/ifdp729.pdf. 8.

Countries and regions that, at the time of writing, still had an explicit dollar peg included the Caribbean nations, Cuba, the Democratic Republic of Congo, Ecuador, Equatorial Guinea, Hong Kong, Liberia, Malaysia, Nigeria, Oman, Panama, Saudi Arabia, Singapore, Syria and the United Arab Emirates (source: Bloomberg). 15. Bela Balassa, ‘The purchasing power parity doctrine: a reappraisal’, Journal of Political Economy, 72 (1964), pp. 584–96; Paul Samuelson, ‘Theoretical notes on trade problems’, Review of Economics and Statistics, 23 (1964), pp. 145–54. 16. The minutes and transcripts of FOMC meetings can be found at http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. CHAPTER 6: HAVES AND HAVE-NOTS 1. Remarks made in Heber Springs, Arkansas, at the dedication of Greers Ferry Dam, 3 October 1963 2. From speech given to the GMB Union on 5 June 2007 3.


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Priceless: The Myth of Fair Value (And How to Take Advantage of It) by William Poundstone

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availability heuristic, Cass Sunstein, collective bargaining, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, East Village, en.wikipedia.org, endowment effect, equal pay for equal work, experimental economics, experimental subject, feminist movement, game design, German hyperinflation, Henri Poincaré, high net worth, index card, invisible hand, John von Neumann, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, loss aversion, market bubble, mental accounting, meta analysis, meta-analysis, Nash equilibrium, new economy, Paul Samuelson, payday loans, Philip Mirowski, Potemkin village, price anchoring, price discrimination, psychological pricing, Ralph Waldo Emerson, RAND corporation, random walk, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, ultimatum game, working poor

Two, utility excused economists from paying much attention to psychology. Economists were mainly interested in forging an exact mathematical science. With a few exceptions, they didn’t want to bother with measuring the psychological aspects of money. They much preferred to assume it could be done in principle. Utility is a powerful idea (so goes the prospectus) because its imaginary price tags determine all economic decisions. MIT economist Paul Samuelson developed this notion into his doctrine of “revealed preference.” This appealingly sensible thesis says that the only way to learn about utility is to look at the choices people make. Choices reveal all that we can know of utility, and utility in turn determines the prices that consumers are willing to pay. When someone is given a free choice between A and B, he simply consults his invisible price tags and chooses the one with the higher utility.

A man who feels the trunk reports that an elephant is like a snake; a man who feels the side says an elephant is like a wall; one who feels a leg compares the elephant to a pillar. “Each of the blind men was partly right,” says a character in an old Walt Kelly Pogo cartoon. “Yeah,” his friend adds, “but they were all mostly wrong.” Twelve Cult of Rationality The Las Vegas experiment threw down the gauntlet. By using real people and real money, Lichtenstein and Slovic had invaded economists’ turf. Their experiment was a challenge to Paul Samuelson’s doctrine of revealed preference, a bulwark of modern economics. In some situations at least, revealed preferences weren’t so revealing at all. Choices failed to predict the prices people would pay. As Lichtenstein put it: “If you can’t talk about a preference, what the hell can you talk about?” There was a knee-jerk, visceral rejection of preference reversal. “The first time I talked about it to a group of economists, I was astounded,” Lichtenstein recalled.


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Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

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Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, fixed income, global village, hindsight bias, Kenneth Arrow, Long Term Capital Management, loss aversion, mandelbrot fractal, mental accounting, meta analysis, meta-analysis, Myron Scholes, Paul Samuelson, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, Richard Feynman, road to serfdom, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Turing test, Yogi Berra

Independence is a requirement for working with the (known) math of probability. What has gone wrong with the development of economics as a science? Answer: There was a bunch of intelligent people who felt compelled to use mathematics just to tell themselves that they were rigorous in their thinking, that theirs was a science. Someone in a great rush decided to introduce mathematical modeling techniques (culprits: Leon Walras, Gerard Debreu, Paul Samuelson) without considering the fact that either the class of mathematics they were using was too restrictive for the class of problems they were dealing with, or that perhaps they should be aware that the precision of the language of mathematics could lead people to believe that they had solutions when in fact they had none (recall Popper and the costs of taking science too seriously). Indeed the mathematics they dealt with did not work in the real world, possibly because we needed richer classes of processes—and they refused to accept the fact that no mathematics at all was probably better.

Whenever they both seemed to make the same mistake of reasoning they ran empirical tests on subjects, mostly students, and discovered very surprising results on the relation between thinking and rationality. It is to their discovery that we turn next. FLAWED, NOT JUST IMPERFECT Kahneman and Tversky Who has exerted the most influence on economic thinking over the past two centuries? No, it is not John Maynard Keynes, not Alfred Marshall, not Paul Samuelson, and certainly not Milton Friedman. The answer is two noneconomists: Daniel Kahneman and Amos Tversky, the two Israeli introspectors, and their specialty was to uncover areas where human beings are not endowed with rational probabilistic thinking and optimal behavior under uncertainty. Strangely, economists studied uncertainty for a long time and did not figure out much—if anything, they thought they knew something and were fooled by it.


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Marx: A Very Short Introduction by Peter Singer

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clockwatching, means of production, Paul Samuelson, source of truth

.), Marx & Engels: Basic Writings on Politics and Philosophy (Doubleday Anchor, New York, 1959). The expression ‘a really human morality’ cited on p. 82 comes from Engels’s Anti-Dühring, also reprinted in Feuer, at p. 272. The quotation from Hegel on p. 20 is from The Philosophy of History (trans. J. Sibree, ed. C. J. Friedrich, Dover, New York, 1956), p. 19. The contemporary economist quoted on p. 76 is Paul Samuelson, writing in the American Economic Review, vol. 47 (1957), p. 911. Further Reading Writings by Marx Marx wrote so much that the definitive edition of all the writings of Marx and Engels, now in the process of publication in East Germany, will take twenty-five years and a hundred volumes to complete. A more modest English edition of Collected Works began appearing in 1975, published by Lawrence and Wishart; it will eventually contain about fifty volumes.


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With Liberty and Dividends for All: How to Save Our Middle Class When Jobs Don't Pay Enough by Peter Barnes

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Alfred Russel Wallace, banks create money, basic income, Buckminster Fuller, collective bargaining, computerized trading, creative destruction, David Ricardo: comparative advantage, declining real wages, deindustrialization, diversified portfolio, en.wikipedia.org, Fractional reserve banking, full employment, hydraulic fracturing, income inequality, Jaron Lanier, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, land reform, Mark Zuckerberg, Network effects, oil shale / tar sands, Paul Samuelson, profit maximization, quantitative easing, rent-seeking, Ronald Coase, Ronald Reagan, Silicon Valley, sovereign wealth fund, the map is not the territory, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Tyler Cowen: Great Stagnation, Upton Sinclair, Vilfredo Pareto, wealth creators, winner-take-all economy

But before I show how, it’s worth exploring other ways to spread nonlabor income broadly. A citizen s income. A basic income guarantee, or citizen’s income, is an equal amount paid by government to all, with the money coming from general taxes. There’s no means test and the income is unconditional. Leading advocates have included economists Robert Theobald and Nobel Prize winner James Tobin.1 In 1968, Paul Samuelson, John Kenneth Galbraith, and 1,200 other economists signed a document supporting the idea.2 Four years later, a modest version ($1,000 per person per year) was proposed by presidential candidate George McGovern, whom Tobin advised. Called a “demogrant,” it was poorly explained, badly received, and quickly withdrawn. No major US politician has proposed anything like it again, though the idea has caught on in Europe (see chapter 9).


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Capital in the Twenty-First Century by Thomas Piketty

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accounting loophole / creative accounting, Asian financial crisis, banking crisis, banks create money, Berlin Wall, Branko Milanovic, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, central bank independence, centre right, circulation of elites, collapse of Lehman Brothers, conceptual framework, corporate governance, correlation coefficient, David Ricardo: comparative advantage, demographic transition, distributed generation, diversification, diversified portfolio, European colonialism, eurozone crisis, Fall of the Berlin Wall, financial intermediation, full employment, German hyperinflation, Gini coefficient, high net worth, Honoré de Balzac, immigration reform, income inequality, income per capita, index card, inflation targeting, informal economy, invention of the steam engine, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, market bubble, means of production, mortgage debt, mortgage tax deduction, new economy, New Urbanism, offshore financial centre, open economy, Paul Samuelson, pension reform, purchasing power parity, race to the bottom, randomized controlled trial, refrigerator car, regulatory arbitrage, rent control, rent-seeking, Robert Gordon, Ronald Reagan, Simon Kuznets, sovereign wealth fund, Steve Jobs, The Nature of the Firm, the payments system, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, trade liberalization, very high income, Vilfredo Pareto, We are the 99%, zero-sum game

Furthermore, the fact that the Soviet Union joined the victorious Allies in World War II enhanced the prestige of the statist economic system the Bolsheviks had put in place. Had not that system allowed the Soviets to lead a notoriously backward country, which in 1917 had only just emerged from serfdom, on a forced march to industrialization? In 1942, Joseph Schumpeter believed that socialism would inevitably triumph over capitalism. In 1970, when Paul Samuelson published the eighth edition of his famous textbook, he was still predicting that the GDP of the Soviet Union might outstrip that of the United States sometime between 1990 and 2000.17 In France, this general climate of distrust toward private capitalism was deepened after 1945 by the fact that many members of the economic elite were suspected of having collaborated with the German occupiers and indecently enriched themselves during the war.

Nevertheless, the “U-shaped curve” of the capital/income ratio in the twentieth century is smaller in amplitude in the United States than in Europe. Expressed in years of income or output, capital in the United States seems to have achieved virtual stability from the turn of the twentieth century on—so much so that a stable capital/income or capital/output ratio is sometimes treated as a universal law in US textbooks (like Paul Samuelson’s). In comparison, Europe’s relation to capital, and especially private capital, was notably chaotic in the century just past. In the Belle Époque capital was king. In the years after World War II many people thought capitalism had been almost eradicated. Yet at the beginning of the twenty-first century Europe seems to be in the avant-garde of the new patrimonial capitalism, with private fortunes once again surpassing US levels.

If the long-term capital stock is only three years of national income, then the return on capital will rise to 10 percent. And if the savings and growth rates are such that the capital stock represents ten years of national income, then the return on capital will fall to 3 percent. In all cases, the capital share of income will be 30 percent. The Cobb-Douglas production function became very popular in economics textbooks after World War II (after being popularized by Paul Samuelson), in part for good reasons but also in part for bad ones, including simplicity (economists like simple stories, even when they are only approximately correct), but above all because the stability of the capital-labor split gives a fairly peaceful and harmonious view of the social order. In fact, the stability of capital’s share of income—assuming it turns out to be true—in no way guarantees harmony: it is compatible with extreme and untenable inequality of the ownership of capital and distribution of income.


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Wall Street: How It Works And for Whom by Doug Henwood

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, affirmative action, Andrei Shleifer, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, borderless world, Bretton Woods, British Empire, capital asset pricing model, capital controls, central bank independence, computerized trading, corporate governance, corporate raider, correlation coefficient, correlation does not imply causation, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, debt deflation, declining real wages, deindustrialization, dematerialisation, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, experimental subject, facts on the ground, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, George Gilder, hiring and firing, Hyman Minsky, implied volatility, index arbitrage, index fund, information asymmetry, interest rate swap, Internet Archive, invisible hand, Irwin Jacobs, Isaac Newton, joint-stock company, Joseph Schumpeter, kremlinology, labor-force participation, late capitalism, law of one price, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, London Interbank Offered Rate, Louis Bachelier, market bubble, Mexican peso crisis / tequila crisis, microcredit, minimum wage unemployment, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, oil shock, Paul Samuelson, payday loans, pension reform, Plutocrats, plutocrats, price mechanism, price stability, prisoner's dilemma, profit maximization, publication bias, Ralph Nader, random walk, reserve currency, Richard Thaler, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, selection bias, shareholder value, short selling, Slavoj Žižek, South Sea Bubble, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Nature of the Firm, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, transcontinental railway, women in the workforce, yield curve, zero-coupon bond

While modern financial markets seem sublimely complex, they're essentially composed of several basic instruments and institutional participants. Most of the instruments, despite their apparent novelty, are quite old, their age measured better in centuries than decades. What are these markets, and who populates them? stocks To many people, the stock market is Wall Street, and the New York Stock Exchange (NYSE) is the stock market. A recent edition of Paul Samuelson's warhorse economics text even described the exchange as the "hub" of capitalism, with no further explanation. Geography reinforces this perception; the NYSE stands at the intersection of Broad and Wall, at the spiritual epicenter of Manhattan's financial district. But in fact, stock market trading volume is dwarfed by trading in bonds and foreign exchange, and the NYSE itself accounts for a declining share of stock market volume.

Though generally left-of-center, post-Keynesians range from those like Paul Davidson, who are strongly pro-capitalist, through social democrats and, at the extreme, to economists who combine Keynesian theories of finance with a Marxian analysis of production and a hostility to capitalism as a system. The latter trace their pedigree to Michal Kalecki; other ur-figures include Nicholas Kaldor and Joan Robinson. Davidson insists on spelling it "Post Keynesian." He said (personal communication) this was to distinguish his brand of thought from the "brand of neoclassical synthesis Keynesianism" that Paul Samuelson was calling post-Keynesian in the 1970s. The hyphen's absence, said Davidson, is "a matter of product differentiation." Even Davidson, however, is regarded as outre by the mainstream of the economics profession. For a brief overview, see Holt (1996). 4. Fixed capital consists mainly of machinery and buildings; working capital, of materials in the process of production; and liquid capital, of inventories (Keynes CWV, p. 116). 5.


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The Quants by Scott Patterson

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Albert Einstein, asset allocation, automated trading system, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Meriwether, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

The future, therefore, is random, a Brownian motion coin flip, a drunkard’s walk through the Parisian night. The groundwork for the efficient-market hypothesis had begun in the 1950s with the work of Markowitz and Sharpe, who eventually won the Nobel Prize for economics (together with Merton Miller) in 1990 for their work. Another key player was Louis Bachelier, the obscure French mathematician who argued that bond prices move according to a random walk. In 1954, MIT economist Paul Samuelson—another future Nobel laureate—received a postcard from Leonard “Jimmie” Savage, a statistician at Chicago. Savage had been searching through stacks at a library and stumbled across the work of Bachelier, which had largely been forgotten in the half century since it had been written. Savage wanted to know if Samuelson had ever heard of the obscure Frenchman. He said he had, though he’d never read his thesis.

He once remarked that the fund sifts through data for identifiable patterns in prices. “Patterns of price movements are not random,” he said, a shot across the bow of the efficient-market random walkers such as Eugene Fama. “However, they’re close enough to random so that getting some excess, some edge out of it, is not easy and not so obvious, thank God.” After chuckling at this cryptic statement, Simons added: “God probably doesn’t care.” One day in 2003, Paul Samuelson came to speak at Renaissance’s headquarters in East Setauket. The MIT economist and Nobel laureate had long held that it was impossible to beat the market. He qualified that statement by saying that if anyone could do it, they would hide away and not tell anyone about their secret. “Well, it looks like I’ve found you,” Samuelson said to the laughter of the wealthy quants of East Setauket. How does Renaissance detect nonrandom price movements?


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The Social Animal: The Hidden Sources of Love, Character, and Achievement by David Brooks

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Albert Einstein, asset allocation, assortative mating, Atul Gawande, Bernie Madoff, business process, Cass Sunstein, choice architecture, clean water, creative destruction, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, deliberate practice, disintermediation, Donald Trump, Douglas Hofstadter, Emanuel Derman, en.wikipedia.org, fear of failure, financial deregulation, financial independence, Flynn Effect, George Akerlof, Henri Poincaré, hiring and firing, impulse control, invisible hand, Joseph Schumpeter, labor-force participation, loss aversion, medical residency, meta analysis, meta-analysis, Monroe Doctrine, Paul Samuelson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, school vouchers, six sigma, Steve Jobs, Steven Pinker, the scientific method, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Walter Mischel, young professional

But over the course of the twentieth century, the rationalist spirit came to dominate economics. Physicists and other hard scientists were achieving great things, and social scientists sought to match their rigor and prestige. The influential economist Irving Fisher wrote his doctoral dissertation under the supervision of a physicist, and later helped build a machine with levers and pumps to illustrate how an economy works. Paul Samuelson applied the mathematical principles of thermodynamics to economics. On the finance side, Emanuel Derman was a physicist who became a financier and played a central role in developing the models for derivatives. While valuable tools for understanding economic behavior, mathematical models were also like lenses that filtered out certain aspects of human nature. They depended on the notion that people are basically regular and predictable.

Denis Diderot. 21 This mode, as Guy Claxton Guy Claxton, The Wayward Mind: An Intimate History of the Unconscious (New York: Little, Brown Book Group, 2006). 22 Lionel Trilling diagnosed Lionel Trilling, The Liberal Imagination: Essays on Literature and Society (New York: New York Review of Books, 2008), ix–xx. 23 “deals with introspection” Robert Skidelsky, Keynes: The Return of the Master (New York: PublicAffairs, 2009), 81. 24 Paul Samuelson applied Clive Cookson, Gillian Tett, and Chris Cook, “Organic Mechanics,” Financial Times, November 26, 2009, http://www.ft.com/cms/s/0/d0e6abde-dacb-11de-933d-00144feabdc0.html. 25 George A. Akerlof and Robert Shiller George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters (Princeton, NJ: Princeton University Press, 2010), 1. 26 Jim Collins argues Jim Collins, “How the Mighty Fall: A Primer on the Warning Signs,” Businessweek, May 14, 2009, http://www.businessweek.com/magazine/content/09_21/b4132026786379.htm.


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Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis by Anatole Kaletsky

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bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, bonus culture, Bretton Woods, BRICs, Carmen Reinhart, cognitive dissonance, collapse of Lehman Brothers, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, deglobalization, Deng Xiaoping, Edward Glaeser, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, F. W. de Klerk, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, George Akerlof, global rebalancing, Hyman Minsky, income inequality, information asymmetry, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, laissez-faire capitalism, Long Term Capital Management, mandelbrot fractal, market design, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage debt, new economy, Northern Rock, offshore financial centre, oil shock, paradox of thrift, Pareto efficiency, Paul Samuelson, peak oil, pets.com, Ponzi scheme, post-industrial society, price stability, profit maximization, profit motive, quantitative easing, Ralph Waldo Emerson, random walk, rent-seeking, reserve currency, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, statistical model, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, too big to fail, Vilfredo Pareto, Washington Consensus, zero-sum game

Better still, the neoclassical synthesis, in contrast to the classical economics of the nineteenth-century, made room for the post-Depression political realities of welfare safety nets and active demand management to stabilize business cycles, by explaining that the Fordist economic machine needed occasional lubrication, “pump-priming,” and “kickstarting” by a benignly probusiness government. Thus the new paradigm was able to co-opt both the Left and the Right. Conservatives were happy to describe the new orthodoxy as the neoclassical synthesis, while progressives such as Paul Samuelson and Robert Solow felt able to call it neo-Keynesian economics. In this process of accommodation to the postwar ideological consensus, however, the most important insight of macroeconomics was lost: Financial instability was no longer recognized as a natural consequence of uncertainty about the future; financial cycles were now merely aberrations caused by imperfections that could, at least in theory, be ironed out by government intervention.

He famously advised President Hoover to allow the Great Depression to run its course, to “Liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate ... It will purge the rottenness out of the system.” Mellon quotation from Herbert Hoover’s autobiography, The Memoirs of Herbert Hoover: Vol. 3, The Great Depression, 31-32. For more details, see Chapter 11. 4 This accelerator-multiplier concept, first proposed by Sir Roy Harrod, was later refined by Paul Samuelson and Sir John Hicks and became the standard Keynesian business cycle model. 5 Justin Lahart, “In Time of Tumult, Obscure Economist Gains Currency,” Wall Street Journal, August 18, 2007. 6 George Soros, The Soros Lectures: At the Central European University. 7 Alan Greenspan, “The Challenge of Central Banking,” remarks at the Annual Dinner and Francis Boyer Lecture of the American Enterprise Institute for Public Policy Research, Washington, DC, December 5, 1996.


pages: 435 words: 127,403

Panderer to Power by Frederick Sheehan

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Asian financial crisis, asset-backed security, bank run, banking crisis, Bretton Woods, British Empire, call centre, central bank independence, collateralized debt obligation, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, deindustrialization, diversification, financial deregulation, financial innovation, full employment, inflation targeting, interest rate swap, inventory management, Isaac Newton, John Meriwether, Long Term Capital Management, margin call, market bubble, McMansion, Menlo Park, money market fund, mortgage debt, Myron Scholes, new economy, Norman Mailer, Northern Rock, oil shock, Paul Samuelson, place-making, Ponzi scheme, price stability, reserve currency, rising living standards, rolodex, Ronald Reagan, Sand Hill Road, savings glut, shareholder value, Silicon Valley, Silicon Valley startup, South Sea Bubble, supply-chain management, supply-chain management software, The Great Moderation, too big to fail, transaction costs, trickle-down economics, VA Linux, Y2K, Yom Kippur War, zero-sum game

Greenspan was not a prolific contributor to academic journals. 27“Economists Sift Jobs and Stocks,” New York Times, December 28, 1959, p. 39. 28 “Wall Street Worries,” Time, January 26, 1962. “The New Economics” In 1961, John Kennedy was a fresh face in the White House. He recruited advisors who promoted the “New Economics,” largely, an American version of John Maynard Keynes’s beliefs. A leading proponent was Paul Samuelson: a graduate of the University of Chicago, of Harvard University, a kingpin of the Massachusetts Institute of Technology’s rise as an economic think tank, and a fervent flag waver for the efficient market hypothesis (EMH).29 In 1970, Samuelson would be awarded the Nobel Prize in economic sciences. Samuelson was Kennedy’s primary economic advisor. Viewing a sluggish economy in 1961, Samuelson wrote “what definitely is not called for is a massive program of hastily devised public works whose primary objective is merely that of making jobs and getting money pumped into the economy.”30 In November 1962, he warned Kennedy that he must cut taxes to avoid a recession: If —and only if—Congress passed a tax cut, by 1964, “events will be working clearly and strongly our way.”

He told the National Press Club that he welcomed a “vibrant debate” at the Fed on the economy’s ability to grow.44 Larry Summers, Rubin’s deputy secretary of the treasury, gave a speech that steamrolled Greenspan. Only an accredited economist could think it made sense: “We cannot and will not accept any ‘speed limit’ on American growth.”45 No speed limit was applied to either the stock market or to the house mortgage market, the engines for growth over the next decade. The MIT-and Harvard-trained Summers, nephew of Nobel Prize–winning economist Paul Samuelson, leads the Obama administration’s brain trust. Beckner continued: “Fed officials deny these election-year attempts to pressure them had any impact, but thereafter Greenspan and others went to great lengths to deny they wanted to restrain growth.”46 Magnifying glass in hand, Beckner sniffs the trail: “In his February 20, 1996 … testimony, Greenspan … said the Fed would ‘welcome’ faster growth.”47 Beckner spoke to a “former Fed official” shortly before Clinton blessed Greenspan’s third term as chairman: “Alan Greenspan is so dedicated to trying to get himself reappointed that he is willing to compromise some of his independence in order to do so.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

Yet another was the simplistic and mistaken mantra that ‘one cannot get out of debt by increasing it further’. The crucial point, however, is that the new debtors are not the same as the old ones. It is necessary for the creditworthy to borrow when those who are no longer creditworthy cannot. If everybody tries to cut down on borrowing and spending at the same time, the result will be a depression: that is the ‘paradox of thrift’ – a phrase first popularized by the late Nobel laureate, Paul Samuelson.68 Yet another explanation was politics. In the US, for both electoral and ideological reasons, the Republican Party was irrevocably opposed to the idea that the government could do anything useful about the economy except by leaving it alone, and so could not tolerate the possibility that the Obama administration might prove the opposite in the aftermath of the biggest economic crisis for eighty years.

Keynes introduced this phrase in his classic book, The General Theory of Employment, Interest and Money (London: Macmillan, 1936). 65. Richard Koo, The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession (Singapore: John Wiley, 2008). 66. ‘Leaders’ Statement: The Pittsburgh Summit’, http://www.ft.com/cms/s/0/5378959c-aa1d-11de-a3ce-00144feabdc0.html. 67. ‘The G-20 Toronto Summit Declaration’, 26–27 June 2010, http://www.g20.utoronto.ca/2010/to-communique.html. 68. Paul Samuelson, Economics, first edition (New York: McGraw-Hill, 1948). 69. Martin Wolf, ‘The Toxic Legacy of the Greek Crisis’, Financial Times, 18 June 2013, http://www.ft.com/cms/s/0/b31dd248-d785-11e2-a26a-00144feab7de.html. 2. The Crisis in the Eurozone 1. Financial Times, 5 September 2011. 2. Tony Barber, ‘Greece Rapped for Understating Deficit’, Financial Times, 20 October 2009. 3. European Commission, Economic Forecast Autumn 2008, 6/2008, http://ec.europa.eu/economy_finance/publications/publication13290_en.pdf. 4.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, Gunnar Myrdal, haute couture, illegal immigration, income inequality, industrial cluster, information asymmetry, intangible asset, invention of the telephone, invention of the wheel, invisible hand, John Meriwether, John Nash: game theory, John von Neumann, Kenneth Arrow, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, light touch regulation, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, Pareto efficiency, Paul Samuelson, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, Right to Buy, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Vilfredo Pareto, Washington Consensus, women in the workforce, yield curve, yield management

Their lives are riven by the conflict between social and economic values which arise when societies with very different standards of living are close together-as in Mexico's proximity to the United States, or the dual economy of South Africa. Economists and Rationality ••••••••••••••••••••••••••••••••••••• The Chicagoan emphasis on rationality is taken to extreme lengths. 1 But it is almost a badge of honor among mainstream economists to seek explanations in rational or self-regarding behavior. Often, this is achieved by stretching the meaning of rationality. The approach is caricatured by Paul Samuelson. 2 "When the governess of infants caught in a burning building reenters it unobserved on a hopeless mission of rescue, casuists may argue 'she did it only to get the good feeling of doing it. Because otherwise she wouldn't have done it."' As Samuelson observes, this "explanation" is "not even wrong." Rationality is generally used by economists in one or the other of two senses. Rationality as consistency, and rationality as self-regarding materialism. 3 Neither of these corresponds to the ordinary meaning of the word rational.

These economists found support from a business community ready to promote their views (to influence public policy, not business policy) and organizations such as the American Enterprise Institute, the Cato Institute, and the Hoover Institute helped give them a popular platform. The arguments put forward by Greg Mankiw that I quote on page 201 are more intellectual than those Ronald Reagan, Margaret Thatcher, or either George Bush would espouse, but these politicians draw comfort from the perception that solid academic arguments can be found in support of their positions. And they influence a generation of students. As Mankiw himself observes, quoting Paul Samuelson, the most successful of all writers of economics textbooks: "I don't care who writes a nation's laws, or crafts its advanced treaties, if I can write its economics textbooks." 23 (This is before Mankiw took a position in the Bush administration.) Current Policy Controversies ••••••••••••••••••••••••••••••••••••• But a majority of working economists-including the leaders of the neoclassical tradition, such as Kenneth Arrow and Paul Samuelsonwere, like most social scientists, predominantly liberal.


pages: 505 words: 142,118

A Man for All Markets by Edward O. Thorp

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3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy low sell high, carried interest, Chuck Templeton: OpenTable, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, compound rate of return, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative finance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, statistical arbitrage, stem cell, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

The Kelly-Thorp method requires no joint distribution or utility function. In practice, one needs the ratio of expected profit to worst-case return—dynamically adjusted (that is, one gamble at a time) to avoid ruin. That’s all. Thorp and Kelly’s ideas were rejected by economists—in spite of their practical appeal—because of economists’ love of general theories for all asset prices, dynamics of the world, etc. The famous patriarch of modern economics, Paul Samuelson, was supposedly on a vendetta against Thorp. Not a single one of the works of these economists will ultimately survive: Strategies that allow you to survive are not the same thing as the ability to impress colleagues. So the world today is divided into two groups using distinct methods. The first method is that of the economists who tend to blow up routinely or get rich collecting fees for managing money, not from direct speculation.

Unknown to Einstein, his equations describing the Brownian motion of pollen particles were essentially the same as the equations that Bachelier had used for his thesis five years earlier to describe a very different phenomenon, the ceaseless, irregular motion of stock prices. Bachelier employed the equations to deduce the “fair” prices for options on the underlying stocks. Unlike Einstein’s work, Bachelier’s remained generally unknown until future Nobel laureate (1970) Paul Samuelson came across it in a Paris library in the 1950s and had it translated into English. Bachelier’s paper appeared in 1964 in The Random Character of Stock Market Prices, edited by Paul Cootner and published by the MIT Press. Part of my early self-education in finance, this collection of articles applying scientific analysis to finance strongly influenced me and many others. Bachelier had assumed that changes in stock prices followed a bell-shaped curve, known as a normal or Gaussian distribution.


pages: 190 words: 53,409

Success and Luck: Good Fortune and the Myth of Meritocracy by Robert H. Frank

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2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, Amazon Mechanical Turk, American Society of Civil Engineers: Report Card, attribution theory, availability heuristic, Branko Milanovic, Capital in the Twenty-First Century by Thomas Piketty, carried interest, Daniel Kahneman / Amos Tversky, David Brooks, deliberate practice, en.wikipedia.org, endowment effect, experimental subject, framing effect, full employment, hindsight bias, If something cannot go on forever, it will stop - Herbert Stein's Law, income inequality, invisible hand, labor-force participation, labour mobility, lake wobegon effect, loss aversion, minimum wage unemployment, Network effects, Paul Samuelson, Report Card for America’s Infrastructure, Richard Thaler, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Rory Sutherland, selection bias, side project, sovereign wealth fund, Steve Jobs, The Wealth of Nations by Adam Smith, Tim Cook: Apple, ultimatum game, Vincenzo Peruggia: Mona Lisa, winner-take-all economy

Why, for example, do many more than half of us believe ourselves to be in the top half of any given talent distribution? And why do so many of us downplay luck’s importance in the face of compelling evidence to the contrary? One plausible explanation, I’ll argue, is that people with more realistic beliefs about their talents and about luck’s importance may actually find it more difficult to muster the will to overcome the difficult obstacles that litter every path to success. The economist Paul Samuelson once said, “Never underestimate the willingness of a man to believe flattering things about himself.” Samuelson was not a behavioral economist, but he clearly recognized that people’s self-assessments were often higher than warranted by objective evidence. In surveys, for example, more than 90 percent of people describe themselves as above-average drivers. The same self-assessment was reported by more than 80 percent of drivers surveyed while they were in the hospital recovering from accidents, many of which they had surely caused themselves.

The Chomsky-Foucault Debate: On Human Nature by Noam Chomsky, Michel Foucault

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new economy, nuremberg principles, Paul Samuelson, theory of mind

Orthodox economics was very briefly challenged by students who wanted to undertake a fundamental critique of the functioning of the capitalist economy; students questioned the institutions, they wanted to study Marx and political economy. Perhaps I can illustrate this once again with a personal anecdote: In the spring of 1969 a small group of students in economics here in Cambridge wanted to initiate a discussion of the nature of economics as a field of study. In order to open this discussion, they tried to organize a debate in which the two main speakers would be Paul Samuelson, the eminent Keynesian economist at MIT (today a Nobel laureate), and a Marxist economist. But for this latter role they were not able to find anyone in the Boston area, no one who was willing to question the neoclassical position from the point of view of Marxist political economy. Finally I was asked to take on the task, though I have no particular knowledge of economics, and no commitment to Marxism.

Masters of Mankind by Noam Chomsky

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affirmative action, American Legislative Exchange Council, Berlin Wall, failed state, God and Mammon, income inequality, Intergovernmental Panel on Climate Change (IPCC), land reform, Martin Wolf, means of production, nuremberg principles, offshore financial centre, oil shale / tar sands, Paul Samuelson, Plutocrats, plutocrats, profit maximization, Ralph Waldo Emerson, Silicon Valley, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, union organizing, urban renewal, War on Poverty, Washington Consensus, Westphalian system

The only question of this sort seriously at issue, in this study of the American Academy of Arts and Sciences, is the relative power of owners, management, and technostructure in control of the corporation. Popular control of economic institutions is of course not discussed. 29. Alfred D. Chandler Jr., “The Role of Business in the United States: A Historical Survey,” Daedelus, Winter 1969. 30. Chandler, “The Role of Business in the United States.” The experience prompted the following remark by Paul Samuelson: “It has been said that the last year was the chemist’s war and that this one is the physicist’s. It might equally be said that this is an economist’s war.” New Republic, September 11, 1944. Cited in Robert Lekachman, The Age of Keynes (New York: Random House, 1966). Perhaps we might regard the Vietnam War as another “economist’s war,” given the role of professional economists in helping maintain domestic stability so that the war might be fought more successfully. 31.

Beat the Market by Edward Thorp

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beat the dealer, compound rate of return, Edward Thorp, margin call, Paul Samuelson, RAND corporation, short selling, transaction costs

The most serious threat comes from the halls of academe. The scientific analysis of securities prices has been pursued in Ameri- 193 can universities with increasing intensity during recent years. Some of the important papers appear in The Random Character of Stock Prices, published by the M. I. T. Press. The last part of the book discusses work in options, including warrants. One of the nation’s leading mathematical economists, Paul Samuelson of M. I. T., has studied warrants for eleven years [15]. This group, undoubtedly aware of the technique of hedging, must eventually recognize the enormous profit potential of the basic system and related methods. We learned just how widespread the concept of hedging was when Ed Thorp addressed the Air Force Eleventh Annual Summer Scientific Conference. In his discussion of recent developments in probability and game theory, he said there was now a stock market system which produced 25% per year with high safety, and that large fluctuations in market price had a comparatively small effect on the profits.


pages: 182 words: 53,802

The Production of Money: How to Break the Power of Banks by Ann Pettifor

Ben Bernanke: helicopter money, Bernie Madoff, Bernie Sanders, bitcoin, blockchain, borderless world, Bretton Woods, capital controls, Carmen Reinhart, central bank independence, clean water, credit crunch, Credit Default Swap, cryptocurrency, David Graeber, David Ricardo: comparative advantage, debt deflation, decarbonisation, distributed ledger, Donald Trump, eurozone crisis, fiat currency, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, interest rate derivative, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Rogoff, light touch regulation, London Interbank Offered Rate, market fundamentalism, Martin Wolf, mobile money, Naomi Klein, neoliberal agenda, offshore financial centre, Paul Samuelson, Ponzi scheme, pushing on a string, quantitative easing, rent-seeking, Satyajit Das, savings glut, secular stagnation, The Chicago School, the market place, Thomas Malthus, Tobin tax, too big to fail

As the governor of the Bank of England at the time, Mervyn King, explained in 2012, ‘The dominant school of modern monetary policy theory – the New Keynesian model as it is called – lacks an account of financial intermediation, so money, credit and banking play no meaningful role.’2 Yet policies based on this vacuum in economic theory still prevail in all western treasuries and in major university economics departments. Unbelievably, they are informed by the economist Paul Samuelson’s barter-based theory of money and credit: ‘Even in the most advanced industrial economies, if we strip exchange down to its barest essentials and peel off the obscuring layer of money, we find that trade between individuals or nations largely boils down to barter.’3 With money and money-creation helpfully obscured by economists, and regulation trained on meaningless capital adequacy targets, business is better than usual for credit-creating commercial bankers, even while their balance sheets effectively remain under water.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

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Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

Confidence, whether justified or not, is convincing, especially when there aren’t many “facts of the matter.” This may be why market pundits seem so much more certain than, say, sports commentators, who are comparatively frank in acknowledging the huge role of chance. Efficiency and Random Walks The Efficient Market Hypothesis formally dates from the 1964 dissertation of Eugene Fama, the work of Nobel prize-winning economist Paul Samuelson, and others in the 1960s. Its pedigree, however, goes back much earlier, to a dissertation in 1900 by Louis Bachelier, a student of the great French mathematician Henri Poincare. The hypothesis maintains that at any given time, stock prices reflect all relevant information about the stock. In Fama’s words: “In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities already reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future.”


pages: 296 words: 82,501

Stuffocation by James Wallman

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3D printing, Airbnb, back-to-the-land, Berlin Wall, big-box store, Black Swan, BRICs, carbon footprint, Cass Sunstein, clean water, collaborative consumption, commoditize, creative destruction, crowdsourcing, David Brooks, Fall of the Berlin Wall, happiness index / gross national happiness, high net worth, income inequality, Intergovernmental Panel on Climate Change (IPCC), James Hargreaves, Joseph Schumpeter, Kitchen Debate, Martin Wolf, mass immigration, McMansion, means of production, Nate Silver, Occupy movement, Paul Samuelson, post-industrial society, Post-materialism, post-materialism, Richard Florida, Richard Thaler, sharing economy, Silicon Valley, Simon Kuznets, Skype, spinning jenny, The Signal and the Noise by Nate Silver, Thorstein Veblen, Tyler Cowen: Great Stagnation, World Values Survey, Zipcar

Through information gleaned from the income accounts, economists assessed the country’s capacity to produce the military goods that were essential in arming the US and its allies. They also designed the financial instruments that paid for them, and they planned the air force’s bomb strikes on Germany, in order to cause the most damage to the Nazi war effort. Their input proved so valuable that the economist Paul Samuelson would later claim that World War II had been “the economists’ war”. That may have been overstating the case, but by the time peace returned, the discipline of economics, and its practitioners, had arrived. In 1946, Congress established the Council of Economic Advisers to the President, cementing the role of economics at the heart of government. And by the late 1950s, with backing from the International Monetary Fund, had been adopted by all countries.


pages: 209 words: 80,086

The Global Auction: The Broken Promises of Education, Jobs, and Incomes by Phillip Brown, Hugh Lauder, David Ashton

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active measures, affirmative action, barriers to entry, Branko Milanovic, BRICs, business process, business process outsourcing, call centre, collective bargaining, corporate governance, creative destruction, credit crunch, David Ricardo: comparative advantage, deindustrialization, deskilling, Frederick Winslow Taylor, full employment, future of work, glass ceiling, global supply chain, immigration reform, income inequality, industrial cluster, industrial robot, intangible asset, job automation, Joseph Schumpeter, knowledge economy, knowledge worker, labour market flexibility, low skilled workers, manufacturing employment, market bubble, market design, neoliberal agenda, new economy, Paul Samuelson, pensions crisis, post-industrial society, profit maximization, purchasing power parity, QWERTY keyboard, race to the bottom, Richard Florida, Ronald Reagan, shareholder value, Silicon Valley, sovereign wealth fund, stem cell, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, Thomas L Friedman, trade liberalization, transaction costs, trickle-down economics, winner-take-all economy, working poor, zero-sum game

This is why we need to consider the wider context of economic change that has witnessed the rising economic power of China along with the other BRIC economies. If we see the question of offshoring purely in terms of neoclassical theories of free trade, we miss the much larger point about how economic power in terms of capital, knowledge, innovation, and investment is being transformed. Instead of the win-win scenario painted by free trade evangelists, some Americans are losing out. Leading American economists such as Paul Samuelson, Ralph Gomory, and William Baumol have shown that, even within neoclassical trade theory, it is possible to see that there are conditions under which some countries lose while others gain. Their argument is not that all trade is harmful to a country’s interests but that under certain conditions, “the improvement of one country’s productive capabilities is attainable only at the expense of another country’s general welfare.”


pages: 242 words: 68,019

Why Information Grows: The Evolution of Order, From Atoms to Economies by Cesar Hidalgo

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Ada Lovelace, Albert Einstein, Arthur Eddington, assortative mating, Claude Shannon: information theory, David Ricardo: comparative advantage, Douglas Hofstadter, Everything should be made as simple as possible, frictionless, frictionless market, George Akerlof, Gödel, Escher, Bach, income inequality, income per capita, industrial cluster, information asymmetry, invention of the telegraph, invisible hand, Isaac Newton, James Watt: steam engine, Jane Jacobs, job satisfaction, John von Neumann, New Economic Geography, Norbert Wiener, p-value, Paul Samuelson, phenotype, price mechanism, Richard Florida, Ronald Coase, Rubik’s Cube, Silicon Valley, Simon Kuznets, Skype, statistical model, Steve Jobs, Steve Wozniak, Steven Pinker, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, total factor productivity, transaction costs, working-age population

These are models where constraints on both money and resources are honored, and where supply, demand, and population are determined endogenously from the models. To achieve its goal, the new economic geography uses a number of theoretical tricks that help make these models tractable. These include the use of Dixit and Stiglitz’s monopolistic competition model (Avinash K. Dixit and Joseph E. Stiglitz, “Monopolistic Competition and Optimum Product Diversity,” American Economic Review 67, no. 3 [1977]: 297–308) or Paul Samuelson’s iceberg costs (Paul A. Samuelson, “The Transfer Problem and Transport Costs, II: Analysis of Effects of Trade Impediments,” Economic Journal 64, no. 254 [1954]: 264–289). Yet the highly stylized nature of the models has limited their empirical validation. In fact, early efforts to calibrate the models found that these have a tendency to agglomerate that was stronger than that observed in the real economy (see, for example, Paul Krugman, “What’s New About the New Economic Geography?

Rethinking Camelot by Noam Chomsky

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anti-communist, Berlin Wall, cuban missile crisis, Fall of the Berlin Wall, fear of failure, Howard Zinn, land reform, Monroe Doctrine, Norman Mailer, Paul Samuelson, Ronald Reagan

The Nixon years were “the nadir for the CIA.”55 Johnson and Nixon, then, should have been the targets for CIA resentment and plots, not JFK. There seems to be little promise here. Others have argued that Kennedy’s threat was to the business elite and the wealthy, a position hard to square with fiscal policies that overwhelmingly benefited higher income groups, according to an analysis in the National Tax Journal, including the 1962 investment credit (“a bribe to capital formation,” in Paul Samuelson’s phrase) and the Revenue Act of 1964 proposed by Kennedy just before his assassination, which “provided for regressive personal and corporate income tax cuts,” economists Du Boff and Herman observe. Note also that no policies relevant to the various theories about Kennedy-the-reformer were reversed under LBJ; those most opposed by the right were extended.56 Some have brought forth Latin America as the sign of Kennedy’s incipient radicalism.


pages: 251 words: 76,128

Borrow: The American Way of Debt by Louis Hyman

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asset-backed security, barriers to entry, big-box store, cashless society, collateralized debt obligation, credit crunch, deindustrialization, deskilling, diversified portfolio, financial innovation, Ford paid five dollars a day, Home mortgage interest deduction, housing crisis, income inequality, market bubble, McMansion, mortgage debt, mortgage tax deduction, Network effects, new economy, Paul Samuelson, Plutocrats, plutocrats, price stability, Ronald Reagan, statistical model, technology bubble, transaction costs, women in the workforce

The rising housing prices did not result from either rising incomes or rising demographics but from speculation made possible by low interest rates, pure and simple. Another observation could have been made at the micro-economic level. If you ever have had the pleasure of taking Economics 101, you have studied how supply and demand determine markets. Adam Smith first came up with them in Wealth of Nations, but you would have probably learned them from the Nobel Prize–winning economist Paul Samuelson in his economics textbook, aptly named Economics, which he first published in 1948 and which continued to be used—albeit through many editions—until the early twenty-first century. You would have learned that if prices go up, consumer demand will go down. This feedback between price and demand creates stable markets. In the coincidence of interest where the price offered by the buyer and the price asked by the seller intersects, the market is in equilibrium.


pages: 261 words: 81,802

The Trouble With Billionaires by Linda McQuaig

battle of ideas, Bernie Madoff, Big bang: deregulation of the City of London, British Empire, Build a better mousetrap, carried interest, collateralized debt obligation, computer age, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Douglas Engelbart, Douglas Engelbart, employer provided health coverage, financial deregulation, fixed income, full employment, George Akerlof, Gini coefficient, income inequality, Intergovernmental Panel on Climate Change (IPCC), invention of the telephone, invention of the wheel, invisible hand, Isaac Newton, Jacquard loom, Jacquard loom, Joseph-Marie Jacquard, laissez-faire capitalism, land tenure, Mark Zuckerberg, market bubble, Martin Wolf, mega-rich, minimum wage unemployment, Mont Pelerin Society, Naomi Klein, neoliberal agenda, Northern Rock, offshore financial centre, Paul Samuelson, Plutocrats, plutocrats, Ponzi scheme, pre–internet, price mechanism, purchasing power parity, RAND corporation, rent-seeking, rising living standards, road to serfdom, Ronald Reagan, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, trickle-down economics, Vanguard fund, very high income, wealth creators, women in the workforce

In the United States, the impressiveness of the Keynesian assault on classical thinking was breathing new life into the flagging spirits of New Deal reformers. At Harvard, long a bastion of classical economics, a new crop of young economists was transforming the university into a hotbed of Keynesian activism. That new crop included many who would go on to be senior policy advisers and prominent commentators in the postwar years – John Kenneth Galbraith, Paul Samuelson, James Tobin and Robert Solow. Galbraith recalled that while classical economics continued to be taught in Harvard classes by day, ‘in the evening and almost every evening from 1936 onwards almost everyone in ‌the Harvard community discussed Keynes’.12 The ideas were even reaching a popular audience. There was an enormous popular appeal in the way Keynes put the problem of unemployment front and centre, whereas the classical school treated employment as a mere byproduct of achieving good economic fundamentals, a reward for good clean living.


pages: 239 words: 69,496

The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, assortative mating, Benoit Mandelbrot, Brownian motion, capital asset pricing model, carried interest, collective bargaining, corporate governance, corporate raider, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, follow your passion, George Akerlof, Gordon Gekko, greed is good, housing crisis, income inequality, information asymmetry, Isaac Newton, Jony Ive, Kenneth Rogoff, Louis Bachelier, moral hazard, Myron Scholes, new economy, out of africa, Paul Samuelson, Pierre-Simon Laplace, principal–agent problem, Ralph Waldo Emerson, random walk, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, Steve Jobs, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, transaction costs, zero-sum game

Capital Ideas: The Improbable Origins of Modern Wall Street. 1st ed. New York: Free Press, 1992. The original works in this stream of research are well discussed in this pioneering paper: Fama, Eugene. “Efficient Capital Markets: A Review of Theory and Empirical Work.”Journal of Finance 25, no. 2 (May 1970): 383–417. In particular, Fama is generous with his referencing of earlier work, including that of Paul Samuelson, Bill Sharpe, Benoit Mandelbrot, Paul Cootner, Jack Treynor, and others. This lecture is an excellent source on the ideas of efficient markets: Fama, Eugene. “A Brief History of the Efficient Market Hypothesis.” Lecture, Masters of Finance. February 12, 2014. https://www.youtube.com/watch?v=NUkkRdEknjI. An alternative stream of important research on this topic was triggered by Grossman, Sanford J., and Joseph E.


pages: 287 words: 82,576

The Complacent Class: The Self-Defeating Quest for the American Dream by Tyler Cowen

affirmative action, Affordable Care Act / Obamacare, Airbnb, Alvin Roth, assortative mating, Bernie Sanders, Black Swan, business climate, circulation of elites, clean water, David Graeber, declining real wages, deindustrialization, desegregation, Donald Trump, drone strike, East Village, Elon Musk, Ferguson, Missouri, Francis Fukuyama: the end of history, gig economy, Google Glasses, Hyman Minsky, Hyperloop, income inequality, intangible asset, Internet of things, inventory management, knowledge worker, labor-force participation, labour mobility, low skilled workers, Marc Andreessen, Mark Zuckerberg, medical residency, meta analysis, meta-analysis, obamacare, offshore financial centre, Paul Samuelson, Peter Thiel, purchasing power parity, Richard Florida, security theater, sharing economy, Silicon Valley, Silicon Valley ideology, Skype, South China Sea, Steven Pinker, Stuxnet, The Great Moderation, total factor productivity, Tyler Cowen: Great Stagnation, upwardly mobile, Vilfredo Pareto, working-age population, World Values Survey

Those numbers may to some degree understate real wages, because the methods of collecting inflation statistics do not capture all improvements in the quality of goods since 1969; those quality improvements, such as better-tasting chocolate, improve our lives but are not always easy to measure. Even so, a median wage decline over such a long period of time seems to go far beyond the bounds of what can be explained by statistical error alone. Imagine Milton Friedman and Paul Samuelson sitting around a table in 1969, debating the future of the economy. In their lifetimes, they’d observed roughly a doubling of living standards every generation. Imagine they are assuming that there will be no nuclear war, that communism will fall, and that the world moves significantly closer to near-free trade. Now, we ask, what do you expect to happen to the male median wage over the course of the next forty-five or so years?


pages: 266 words: 76,299

Ever Since Darwin: Reflections in Natural History by Stephen Jay Gould

Alfred Russel Wallace, British Empire, correlation coefficient, Drosophila, European colonialism, invisible hand, Isaac Newton, Monroe Doctrine, Paul Samuelson, Scientific racism, sexual politics, the scientific method

As one major conclusion, they find that male panhandlers are “far more successful approaching a single female or a pair of females than a male and female together; they were particularly unsuccessful when approaching a single male or two males together.” But not a word about urban fear or the politics of sex—just some statements about chimps and the genetics of altruism (although they finally admit that reciprocal altruism probably does not apply—after all, they argue, what future benefit can one expect from a panhandler). In the first negative comment on Sociobiology, economist Paul Samuelson (Newsweek, July 7, 1975) urged sociobiologists to tread softly in the zones of race and sex. I see no evidence that his advice is being heeded. In his New York Times Magazine article of October 12, 1975, Wilson writes: In hunter-gatherer societies, men hunt and women stay at home. This strong bias persists in most [my emphasis] agricultural and industrial societies and, on that ground alone, appears to have a genetic origin.… My own guess is that the genetic bias is intense enough to cause a substantial division of labor even in the most free and most egalitarian of future societies.… Even with identical education and equal access to all professions, men are likely to continue to play a disproportionate role in political life, business and science.


pages: 1,073 words: 302,361

Money and Power: How Goldman Sachs Came to Rule the World by William D. Cohan

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asset-backed security, Bernie Madoff, buttonwood tree, collateralized debt obligation, corporate governance, corporate raider, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversified portfolio, fear of failure, financial innovation, fixed income, Ford paid five dollars a day, Goldman Sachs: Vampire Squid, Gordon Gekko, high net worth, hiring and firing, hive mind, Hyman Minsky, interest rate swap, John Meriwether, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, mega-rich, merger arbitrage, moral hazard, mortgage debt, Myron Scholes, paper trading, passive investing, Paul Samuelson, Ponzi scheme, price stability, profit maximization, risk tolerance, Ronald Reagan, Saturday Night Live, South Sea Bubble, time value of money, too big to fail, traveling salesman, value at risk, yield curve, Yogi Berra, zero-sum game

“He doesn’t have the capability and he’s not broad-based. I’m not sure it’s the right thing.” But Corzine stood up for Steck. “Shut the fuck up,” Corzine said. “He just saved the firm.” Steck became a partner. CHAPTER 13 POWER One of the people Goldman hired as a consultant during its consultant-hiring spree was Lawrence Summers, a Philadelphia-born Harvard economist whose two uncles—Paul Samuelson and Kenneth Arrow—had both won Nobel Prizes in economics. Summers’s parents, Robert and Anita, were also economics professors. During the summer of 1986, when Rubin and Friedman were still the co-heads of Goldman’s fixed-income group, Jacob Goldfield, a precocious and gifted young Goldman trader, suggested to Rubin that he and Summers should meet. Goldfield grew up in the Bronx, where his mother was a clerk in the New York City Health Department and his father had a small store, wholesaling women’s clothing.

Politicians need cash, and bankers crave power, if only to prove to themselves they have a higher purpose than becoming obscenely wealthy. In 1991, while he was still an economics professor at Harvard, Summers wrote an influential chapter, “Planning for the Next Financial Crisis,” that appeared in a book published by the National Bureau of Economic Research. Other chapters in the book were written by economists Hyman Minsky, Paul Volcker, William Poole, and Paul Samuelson, Summers’s uncle. “It used to be said that a repeat of the depression of the 1930s was inconceivable now that governments better understood how to manage their economies,” Summers wrote. “Yet, both Latin America and Europe have suffered economic downturns during the 1980s on a scale comparable to the 1930s. And, in 1987, the world’s stock markets suffered the greatest one-day drop in their history.

“We will have some new strategic opportunities, and we will go into acquisition mode,” he said. “I am not talking about mergers, but acquisitions.” As an example, Corzine could have mentioned Goldman’s May 1997, roughly $100 million acquisition of Commodities Corporation, a $2 billion managed futures, commodities, and currencies hedge fund based in Princeton, New Jersey, that counted among its founders Paul Samuelson, Larry Summers’s uncle. —— INTERNECINE WARFARE ASIDE, in the aftermath of the IPO announcement, Goldman Sachs seemed to be floating on a cloud: the partners were united behind a task (underwriting an IPO) for which they were the world’s experts and behind a cause (themselves) that provided them with all the incentive they could ever need to execute flawlessly. The valuation being bandied about for the firm seemed to grow daily—$30 billion, $35 billion, even $40 billion didn’t seem far-fetched.


pages: 654 words: 191,864

Thinking, Fast and Slow by Daniel Kahneman

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Albert Einstein, Atul Gawande, availability heuristic, Bayesian statistics, Black Swan, Cass Sunstein, Checklist Manifesto, choice architecture, cognitive bias, complexity theory, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, delayed gratification, demand response, endowment effect, experimental economics, experimental subject, Exxon Valdez, feminist movement, framing effect, hindsight bias, index card, information asymmetry, job satisfaction, John von Neumann, Kenneth Arrow, libertarian paternalism, loss aversion, medical residency, mental accounting, meta analysis, meta-analysis, nudge unit, pattern recognition, Paul Samuelson, pre–internet, price anchoring, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, Robert Metcalfe, Ronald Reagan, The Chicago School, The Wisdom of Crowds, Thomas Bayes, transaction costs, union organizing, Walter Mischel, Yom Kippur War

Thirty years later, when Amos introduced me to their work, he presented it as an object of awe. He also introduced me Bima a me Bimto a famous challenge to that theory. Allais’s Paradox In 1952, a few years after the publication of von Neumann and Morgenstern’s theory, a meeting was convened in Paris to discuss the economics of risk. Many of the most renowned economists of the time were in attendance. The American guests included the future Nobel laureates Paul Samuelson, Kenneth Arrow, and Milton Friedman, as well as the leading statistician Jimmie Savage. One of the organizers of the Paris meeting was Maurice Allais, who would also receive a Nobel Prize some years later. Allais had something up his sleeve, a couple of questions on choice that he presented to his distinguished audience. In the terms of this chapter, Allais intended to show that his guests were susceptible to a certainty effect and therefore violated expected utility theory and the axioms of rational choice on which that theory rests.

Because we are susceptible to WY SIATI and averse to mental effort, we tend to make decisions as problems arise, even when we are specifically instructed to consider them jointly. We have neither the inclination nor the mental resources to enforce consistency on our preferences, and our preferences are not magically set to be coherent, as they are in the rational-agent model. Samuelson’s Problem The great Paul Samuelson—a giant among the economists of the twentieth century—famously asked a friend whether he would accept a gamble on the toss of a coin in which he could lose $100 or win $200. His friend responded, “I won’t bet because I would feel the $100 loss more than the $200 gain. But I’ll take you on if you promise to let me make 100 such bets.” Unless you are a decision theorist, you probably share the intuition of Samuelson’s friend, that playing a very favorable but risky gamble multiple times reduces the subjective risk.


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Age of Greed: The Triumph of Finance and the Decline of America, 1970 to the Present by Jeff Madrick

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accounting loophole / creative accounting, Asian financial crisis, bank run, Bretton Woods, capital controls, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, desegregation, disintermediation, diversified portfolio, Donald Trump, financial deregulation, fixed income, floating exchange rates, Frederick Winslow Taylor, full employment, George Akerlof, Hyman Minsky, income inequality, index fund, inflation targeting, inventory management, invisible hand, John Meriwether, Kitchen Debate, laissez-faire capitalism, locking in a profit, Long Term Capital Management, market bubble, minimum wage unemployment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, new economy, North Sea oil, Northern Rock, oil shock, Paul Samuelson, Philip Mirowski, price stability, quantitative easing, Ralph Nader, rent control, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Ronald Reagan: Tear down this wall, shareholder value, short selling, Silicon Valley, Simon Kuznets, technology bubble, Telecommunications Act of 1996, The Chicago School, The Great Moderation, too big to fail, union organizing, V2 rocket, value at risk, Vanguard fund, War on Poverty, Washington Consensus, Y2K, Yom Kippur War

(Even the least ideological old-guard Chicago professors argued that any fiscal stimulus should be at most a stopgap, removed as soon as possible.) Many American economists, who up to the Great Depression and even World War II were mostly avowed classical theorists, now quickly converted to Keynesianism. The converts included Alvin Hansen, an influential Harvard professor, who had earlier argued that the nation’s technological advances were simply petering out, and also young newcomers to the profession like Paul Samuelson and John Kenneth Galbraith. To Friedman, any views that promoted government spending as a way to stabilize economies and promote prosperity were not merely wrongheaded but seen as pandering to the majority by promising more social programs. Moreover, government itself had its own greedy expansionist motives, he believed. “Ever since the New Deal,” as Friedman put it, “a primary excuse for the expansion of government activity at the federal level has been the supposed necessity for government spending to eliminate unemployment.”

Barry Goldwater and his associates, familiar as they were with Friedman’s writings, named him chief economic adviser for the 1964 presidential campaign. His talent for popular writing and equally for articulate public speaking, rare for most economists, raised his visibility in the media. In 1964, The New York Times Magazine asked him to write a summary of Goldwater’s economic plans. In 1966, Newsweek offered him a column alternating with renowned Keynesians, notably Paul Samuelson. He made television appearances at a time when financial coverage on TV was scant. In particular, The Wall Street Journal editorialists exalted his theoretical powers and promoted his views time and again. Almost every suggestion Friedman made in Capitalism and Freedom was taken up by serious proponents over the next forty-five years. Some were adopted by the nation. The call to privatize Social Security has frequently been sounded since the 1980s and 1990s; increases in minimum wage were successfully avoided for long periods of time; a version of a negative income tax for the poor rather than direct outlays (the U.S.


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

He stressed that market prices, especially the overall market level, can deviate from fundamental values even if we agree that it is hard to beat the market (difficult to profit from such deviations). Summers’ commentary during the 2007–2009 crisis, and his academic work 20 years earlier, emphasized the destabilizing potential of various positive-feedback loops (vicious or virtuous cycles) that occasionally overwhelm normal self-stabilizing forces in a market economy. An equity market bubble is an extreme form of aggregate market overvaluation. Paul Samuelson once conjectured that the stock market is microefficient but macroinefficient—that relative prices are close to being correct but that the overall market level is prone to overvaluations or undervaluations. The limits-to-arbitrage literature buttresses “Samuelson’s dictum”. Recall the greater risk in arbitraging away overall market valuation: given a lack of close substitutes for a position in the market index, directional equity market or bond market risk cannot be effectively hedged or diversified away.

., if they are a random walk) the volatility of average annual returns falls with a longer horizon, and if stock returns are a random walk with upward drift (i.e., positive expected return) the likelihood of negative cumulative returns falls with a longer horizon. Critics counter that the volatility of cumulative returns and the magnitude of potential losses increases with the time horizon. Kritzman (2000) reminds us of Paul Samuelson’s mathematical result that under certain conditions expected utility maximizers should hold a constant share of their wealth in risky assets irrespective of their investment horizon. Merely having a longer horizon does not make investors more risk tolerant as long as they have constant relative risk aversion, asset returns follow a random walk, and future wealth depends only on investment returns—not on human capital.


pages: 348 words: 99,383

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy's Only Hope by John A. Allison

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Affordable Care Act / Obamacare, bank run, banking crisis, Bernie Madoff, clean water, collateralized debt obligation, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, fiat currency, financial innovation, Fractional reserve banking, full employment, high net worth, housing crisis, invisible hand, life extension, low skilled workers, market bubble, market clearing, minimum wage unemployment, money market fund, moral hazard, negative equity, obamacare, Paul Samuelson, price mechanism, price stability, profit maximization, quantitative easing, race to the bottom, reserve currency, risk/return, Robert Shiller, Robert Shiller, The Bell Curve by Richard Herrnstein and Charles Murray, too big to fail, transaction costs, yield curve, zero-sum game

Every month, I read a difficult book (typically one that was not directly business-related) and referred the best books to our senior leadership team. I took the time for two weeks of education each year. Typically, one week would be related to economics and the other week would be devoted to studying philosophy. I particularly studied Austrian economics. Since most business leaders my age studied Keynesian economics from Paul Samuelson’s incredibly misleading college textbook, they were far easier for the Fed to mislead. A deep understanding of the Austrian economic school is a tremendous competitive advantage in making long-term economic decisions. (You should read Human Action by Ludwig von Mises.) Because we believe that the way to achieve optimal organizational performance is to allow individual employees to use their minds effectively, we operate with a highly decentralized organizational structure.


pages: 430 words: 109,064

13 Bankers: The Wall Street Takeover and the Next Financial Meltdown by Simon Johnson, James Kwak

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Andrei Shleifer, Asian financial crisis, asset-backed security, bank run, banking crisis, Bernie Madoff, Bonfire of the Vanities, bonus culture, break the buck, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, commoditize, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Edward Glaeser, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, financial intermediation, financial repression, fixed income, George Akerlof, Gordon Gekko, greed is good, Home mortgage interest deduction, Hyman Minsky, income per capita, information asymmetry, interest rate derivative, interest rate swap, Kenneth Rogoff, laissez-faire capitalism, late fees, light touch regulation, Long Term Capital Management, market bubble, market fundamentalism, Martin Wolf, money market fund, moral hazard, mortgage tax deduction, Myron Scholes, Paul Samuelson, Ponzi scheme, price stability, profit maximization, race to the bottom, regulatory arbitrage, rent-seeking, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Satyajit Das, sovereign wealth fund, The Myth of the Rational Market, too big to fail, transaction costs, value at risk, yield curve

.… The more placid days of the past were gone forever.”39 There was still no coherent program or ideology that laid out what the financial services industry should look like and what its relationship to the government should be. But that was changing. At the time, a movement was growing in the halls of America’s leading universities that would help transform the financial sector. This movement was the discipline of academic finance, pioneered by economists such as Paul Samuelson, Franco Modigliani, Merton Miller, Harry Markowitz, William Sharpe, Eugene Fama, Fischer Black, Robert Merton, and Myron Scholes, most of whom went on to win the Nobel Prize. These scholars brought sophisticated mathematics to bear on such problems as determining the optimal capital structure of a firm (the ratio between debt and equity), pricing financial assets, and separating and hedging risks.40 Academic finance had a tremendous impact on the way business is done around the globe.


pages: 279 words: 87,910

How Much Is Enough?: Money and the Good Life by Robert Skidelsky, Edward Skidelsky

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banking crisis, basic income, Bertrand Russell: In Praise of Idleness, Bonfire of the Vanities, call centre, creative destruction, David Ricardo: comparative advantage, death of newspapers, financial innovation, Francis Fukuyama: the end of history, full employment, happiness index / gross national happiness, income inequality, income per capita, informal economy, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, lump of labour, market clearing, market fundamentalism, Paul Samuelson, profit motive, purchasing power parity, Ralph Waldo Emerson, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, Tobin tax, union organizing, University of East Anglia, Veblen good, wage slave, wealth creators, World Values Survey, zero-sum game

Under these conditions, free trade can be at the expense of rich country jobs, since wages cannot be sufficiently flexible to maintain continuous full employment in the face of low wage competition. And even if jobs destroyed can always be replaced, the question remains whether the new jobs are as good as the old ones. The offshoring of jobs to China and India has caused the real incomes of many Western workers to fall or stagnate, despite the gains of trade.46 As Nobel Laureate Paul Samuelson put it in an interview, “being able to purchase groceries 20 percent cheaper at Walmart does not necessarily make up for the wage losses” suffered as a result of these goods being made in China.47 Even when trade does produce a surplus of winners over losers so that winners could in principle compensate losers, there is no guarantee that they will. Free trade is not necessarily beneficial for poor countries either.


pages: 311 words: 17,232

Living in a Material World: The Commodity Connection by Kevin Morrison

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barriers to entry, Berlin Wall, carbon footprint, clean water, commoditize, commodity trading advisor, computerized trading, diversified portfolio, Doha Development Round, Elon Musk, energy security, European colonialism, flex fuel, food miles, Hernando de Soto, Hugh Fearnley-Whittingstall, hydrogen economy, Intergovernmental Panel on Climate Change (IPCC), Long Term Capital Management, new economy, North Sea oil, oil rush, oil shale / tar sands, oil shock, out of africa, Paul Samuelson, peak oil, price mechanism, Ronald Coase, Ronald Reagan, Silicon Valley, sovereign wealth fund, the payments system, The Wealth of Nations by Adam Smith, trade liberalization, transaction costs, uranium enrichment, young professional

This trend underlined two things about commodities: firstly, the commodity markets alone are too small for fund managers who want to grow their funds to tens of billions of dollars; and secondly, the trading skills learnt in commodity trading are a solid grounding for trading in other financial markets. Jones, Kovner and Kooyker all worked at various stages of their careers with the same organization, Commodities Corporation, which at the time was a privately owned commodity fund set up by Paul Samuelson, the Nobel laureate. Samuelson, who is in his 90s and is still active at the Massachusetts Institute of Technology where he is Emeritus Professor of Economics, told me how Commodities Corporation was started with one of his former students Helmut Weymar,5 who was the chief cocoa buyer for Nabisco, the US biscuit and snack maker. Weymar was tired of the commute from his home in Princeton, New Jersey to Nabisco’s office in New York, and suggested to his TRADERS | 239 employers that he could continue doing their cocoa buying if he set up a trading company, which Nabisco agreed to do.


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

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asset allocation, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Jane Bryant Quinn, financial columnist for Newsweek and author of Making the Most of Your Money: "Indexing is for winners only." Ron Ross, author of The Unbeatable Market: "Carhart evaluated 1,892 equity funds for the period 1962 to 1993 for the equivalent of 16,109 'fund years.' He concluded, 'The results do not support the existence of skilled or informed mutual fund portfolio managers."' Paul Samuelson, first American to win the Nobel Prize in Economic Science: "The most efficient way to diversify a stock portfolio is with a low fee index fund. Statistically, a broadly based stock index fund will outperform most actively managed equity portfolios." Bill Schultheis, author of The Coffeehouse Investor: "Once you remove yourself from Wall Street's complete and total obsession with trying to beat the stock market average and accept the fact that approximating the stock market average is a rather sophisticated approach to the whole thing, building a successful common stock portfolio becomes an immensely gratifying experience."


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

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asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, break the buck, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

Bending Reality to Match the Textbook The next leg of my U.S. trip took me to Boston and Connecticut. There I met two more Nobel-winning finance professors—Robert Merton and Myron Scholes—who took Miller’s idea to its logical conclusion at a hedge fund called Long-Term Capital Management (LTCM). Scholes had benefited directly from Miller’s mentorship as a University of Chicago PhD candidate, while Merton had studied under Paul Samuelson at MIT. What made Merton and Scholes famous (with the late Fischer Black) was their contemporaneous discovery of a formula for pricing options on stocks and other securities. Again, the key idea was based on arbitrage, but this time the formula was much more complicated. The premise: A future or forward contract is very similar (although not identical) to the underlying security, which is why one can be used to synthesize exposure to the other.


pages: 364 words: 104,697

Were You Born on the Wrong Continent? by Thomas Geoghegan

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Albert Einstein, American Society of Civil Engineers: Report Card, banking crisis, Berlin Wall, Bob Geldof, collective bargaining, corporate governance, cross-subsidies, dark matter, David Brooks, declining real wages, deindustrialization, ending welfare as we know it, facts on the ground, Gini coefficient, haute cuisine, income inequality, John Maynard Keynes: Economic Possibilities for our Grandchildren, knowledge economy, knowledge worker, labour market flexibility, laissez-faire capitalism, low skilled workers, Martin Wolf, McJob, minimum wage unemployment, mittelstand, offshore financial centre, Paul Samuelson, payday loans, pensions crisis, Plutocrats, plutocrats, purchasing power parity, Ralph Waldo Emerson, Robert Gordon, Ronald Reagan: Tear down this wall, Saturday Night Live, Silicon Valley, The Wealth of Nations by Adam Smith, Thorstein Veblen, union organizing, Wolfgang Streeck, women in the workforce

And the more we cut their wages, health care, and pensions, the less competitive we get. I’d tell kids to read about Germany just to see how a social democracy (which we don’t have) would push our productive capacity into highly skilled jobs and also keep business from disinvesting in such jobs. After all, things could and probably will get even worse in the U.S., in terms of job loss. Our great economists who used to laud free trade (Paul Samuelson, Alan Blinder) are right to think that things are tanking here. But one good thing about a high-cost social democracy like Germany (or France or Sweden) is that it penalizes business when it disinvests. To shut down a plant is easy in the U.S. It’s a big pain in a social democracy, though. The employer has to come up with a “closing plan.” There has to be a plan for taking care of people, paying severance, etc.


pages: 337 words: 89,075

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

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accounting loophole / creative accounting, airline deregulation, Andrei Shleifer, asset allocation, Bretton Woods, buy low sell high, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, fixed income, frictionless, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, price mechanism, purchasing power parity, risk tolerance, risk-adjusted returns, risk/return, Ronald Reagan, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, survivorship bias, the market place, transaction costs, Y2K, yield curve, zero-sum game

The person (or company) upon whom a tax is levied can well experience no loss in net income if he passes the tax forward onto consumers or backward onto suppliers. Likewise, a person upon whom no tax has been levied can well suffer large net income losses as a consequence of taxes levied on others. (This analysis was correct, and I will soon get to the results.) In the words of Noble Laureate Paul Samuelson, Even if the electorate has made up its mind about how the tax burden shall be borne by individuals, the following difficult problems remain: Who ultimately pays a particular tax? Does its burden stay on the person on whom it is first levied? One cannot assume that the person Congress says a tax is levied on will end up paying that tax. He may be able to shift the tax; He may be able to shift it “forward” on his costumers by raising his price as much as the tax; or shift it “backwards” on his suppliers (wage earners, rent and interest receivers) who end up being able to charge him less than they would have done had there been no tax.


pages: 379 words: 109,612

Is the Internet Changing the Way You Think?: The Net's Impact on Our Minds and Future by John Brockman

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A Declaration of the Independence of Cyberspace, Albert Einstein, AltaVista, Amazon Mechanical Turk, Asperger Syndrome, availability heuristic, Benoit Mandelbrot, biofilm, Black Swan, British Empire, conceptual framework, corporate governance, Danny Hillis, Douglas Engelbart, Douglas Engelbart, Emanuel Derman, epigenetics, Flynn Effect, Frank Gehry, Google Earth, hive mind, Howard Rheingold, index card, information retrieval, Internet Archive, invention of writing, Jane Jacobs, Jaron Lanier, John Markoff, Kevin Kelly, lifelogging, lone genius, loss aversion, mandelbrot fractal, Marc Andreessen, Marshall McLuhan, Menlo Park, meta analysis, meta-analysis, New Journalism, Nicholas Carr, out of africa, Paul Samuelson, peer-to-peer, Ponzi scheme, pre–internet, Richard Feynman, Richard Feynman, Rodney Brooks, Ronald Reagan, Schrödinger's Cat, Search for Extraterrestrial Intelligence, SETI@home, Silicon Valley, Skype, slashdot, smart grid, social graph, social software, social web, Stephen Hawking, Steve Wozniak, Steven Pinker, Stewart Brand, Ted Nelson, telepresence, the medium is the message, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, trade route, upwardly mobile, Vernor Vinge, Whole Earth Catalog, X Prize

In so doing, he forced the recognition of a new reality by showing that it was possible to move an indisputable intellectual achievement out of the tradition of referee-gated journals bound to the stacks of university libraries into a new and poorly charted virtual sphere of the intellect. But while markets may drive exploration, the actual settlement of the frontier at times requires the commitment of individuals questing for personal freedom, and here the New World of the Internet shines. It is widely assumed that my generation failed to produce towering figures like Francis Crick, P. A. M. Dirac, Alexander Grothendieck, or Paul Samuelson because something in the nature of science had changed. I do not subscribe to that theory. Suffice it to say that issues of academic freedom have me longing to settle among the noble homesteaders now gathering on the efficient frontier of the marketplace of ideas. My intellectual suitcases have been packed for months now, as I try to screw up the courage and proper “efficient frontier mentality” to follow my own advice to the next generation: “Go virtual, young man.”


pages: 313 words: 101,403

My Life as a Quant: Reflections on Physics and Finance by Emanuel Derman

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Berlin Wall, bioinformatics, Black-Scholes formula, Brownian motion, capital asset pricing model, Claude Shannon: information theory, Donald Knuth, Emanuel Derman, fixed income, Gödel, Escher, Bach, haute couture, hiring and firing, implied volatility, interest rate derivative, Jeff Bezos, John Meriwether, John von Neumann, law of one price, linked data, Long Term Capital Management, moral hazard, Murray Gell-Mann, Myron Scholes, Paul Samuelson, pre–internet, publish or perish, quantitative trading / quantitative finance, Richard Feynman, Sharpe ratio, statistical arbitrage, statistical model, Stephen Hawking, Steve Jobs, stochastic volatility, technology bubble, the new new thing, transaction costs, value at risk, volatility smile, Y2K, yield curve, zero-coupon bond, zero-sum game

Its key insight is that the option is a mixture. Like the ancient Greeks' mythological centaur, part horse and part man, a call option is a hybrid, too-part stock and part bond. From this point of view, I came to regard the BlackScholes formula as a simple and sensible way of interpolating from the known market prices of a stock and a bond to the fair value of the hybrid. Several economists, Paul Samuelson among them, had come almost imperceptibly close to obtaining the Black-Scholes formula before Black and Scholes by means of this kind of reasoning. When you want to estimate the price of fruit salad, you average the prices of the fruit the mixture contains. In a similar vein, I thought of the option formula as a prescription for estimating the price of a hybrid by averaging the known market prices of its ingredients.


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, corporate raider, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Gunnar Myrdal, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, information asymmetry, intangible asset, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, liberation theology, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, Pareto efficiency, Paul Samuelson, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Vilfredo Pareto, Washington Consensus, working-age population, World Values Survey

 * So, comparative in comparative advantage refers to comparison between the products that a country can potentially produce. The possibility that one country is more efficient than another in producing the same product is already reflected in the term advantage. For a more detailed exposition of the theory, see Chapter 3, ‘My Six Year Old Son Should Get a Job’, in my book Bad Samaritans. * The theory is named after Eli Heckscher and Bertil Ohlin, the two Swedish economists who developed the idea, and Paul Samuelson, the American economist (and the author of the most famous economics textbook in the twentieth century), who perfected it. * Despite the fact that it was going to hurt US workers in industries like automobile and textiles, many Neoclassical economists advocated the NAFTA, the free-trade agreement with Mexico and Canada, on the ground that the national gains from increased trade are more than enough to compensate those (and other) losers.


pages: 274 words: 93,758

Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

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Andrei Shleifer, asset-backed security, Bernie Madoff, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, corporate raider, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, en.wikipedia.org, endowment effect, equity premium, financial intermediation, financial thriller, fixed income, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, Menlo Park, mental accounting, Milgram experiment, money market fund, moral hazard, new economy, Pareto efficiency, Paul Samuelson, payday loans, Ponzi scheme, profit motive, publication bias, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, the new new thing, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, Vilfredo Pareto, wage slave

See De Long, Shleifer, Summers, and Waldmann, “Noise Trader Risk in Financial Markets.” 18. See formulas 21 and 25 in J. Bradford De Long, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann, “The Size and Incidence of the Losses from Noise Trading,” Journal of Finance 44, no. 3 (1989): 688 and 690. 19. Gabaix and Laibson, “Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets,” p. 514. 20. Paul Samuelson, the MIT professor who wrote the leading textbook and set the tone of most standard economics in the post–World War II period, viewed “revealed preferences” as being at the heart of the theory of consumption. Regarding a formula derived from them, he wrote: “The importance of this result can hardly be overemphasized [sic]. In this simple formula are contained almost all of the meaningful empirical implications of the whole pure theory of consumer’s choice.”


pages: 378 words: 110,518

Postcapitalism: A Guide to Our Future by Paul Mason

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Alfred Russel Wallace, bank run, banking crisis, banks create money, Basel III, basic income, Bernie Madoff, Bill Gates: Altair 8800, bitcoin, Branko Milanovic, Bretton Woods, BRICs, British Empire, business process, butterfly effect, call centre, capital controls, Cesare Marchetti: Marchetti’s constant, Claude Shannon: information theory, collaborative economy, collective bargaining, Corn Laws, corporate social responsibility, creative destruction, credit crunch, currency manipulation / currency intervention, currency peg, David Graeber, deglobalization, deindustrialization, deskilling, discovery of the americas, Downton Abbey, drone strike, en.wikipedia.org, energy security, eurozone crisis, factory automation, financial repression, Firefox, Fractional reserve banking, Frederick Winslow Taylor, full employment, future of work, game design, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, Intergovernmental Panel on Climate Change (IPCC), Internet of things, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kevin Kelly, knowledge economy, knowledge worker, late capitalism, low skilled workers, market clearing, means of production, Metcalfe's law, money: store of value / unit of account / medium of exchange, mortgage debt, Network effects, new economy, Norbert Wiener, Occupy movement, oil shale / tar sands, oil shock, Paul Samuelson, payday loans, Pearl River Delta, post-industrial society, precariat, price mechanism, profit motive, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, RFID, Richard Stallman, Robert Gordon, Robert Metcalfe, secular stagnation, sharing economy, Stewart Brand, structural adjustment programs, supply-chain management, The Future of Employment, the scientific method, The Wealth of Nations by Adam Smith, Transnistria, union organizing, universal basic income, urban decay, urban planning, Vilfredo Pareto, wages for housework, women in the workforce

For a time in the 1930s, long-wave theory became influential in the West. The Austrian economist Joseph Schumpeter produced his own theory of business cycles, popularizing the term ‘Kondratieff Wave’. But once capitalism stabilized after 1945, long-wave theory seemed redundant. Economists believed state intervention could flatten out even the minor ups and downs of capitalism. As for a fifty-year cycle, the guru of Keynesian economics, Paul Samuelson, dismissed it as ‘science fiction’.3 And when the New Left tried to revive Marxism as a critical social science in the 1960s, they had little time for Kondratieff and his waves; they were looking for a theory of capitalist breakdown, not survival. Only a few diehards, mainly investors, remained obsessed with Kondratieff. In the 1980s, Wall Street analysts turned his careful provisional findings into a bunch of crude, predictive mumbo-jumbo.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

For example, even after the financial crisis, most models of the economy do not include debt and asset prices. The financial system is simply excluded from their calculations. Going back over a much longer period, economics has incorporated an extraordinarily crude conception of human nature, with its belief in a perfectly rational, utility-maximising, autonomous individual. More recently, the attempt initiated by the American economist Paul Samuelson in the 1940s to emulate the certainty of the physical sciences led economists to dispense completely with human nature in building their models. They also employ a simplifying concept known as ‘the representative agent’, which assumes, in effect, that everyone in the economy is the same. Another blind spot lies in economists’ tendency to downplay the importance of the institutional context of economies in their model building.


pages: 394 words: 85,734

The Global Minotaur by Yanis Varoufakis, Paul Mason

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active measures, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, business climate, capital controls, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, correlation coefficient, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, declining real wages, deindustrialization, endogenous growth, eurozone crisis, financial innovation, first-past-the-post, full employment, Hyman Minsky, industrial robot, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, light touch regulation, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market fundamentalism, Mexican peso crisis / tequila crisis, money market fund, mortgage debt, Myron Scholes, negative equity, new economy, Northern Rock, paper trading, Paul Samuelson, planetary scale, post-oil, price stability, quantitative easing, reserve currency, rising living standards, Ronald Reagan, special economic zone, Steve Jobs, structural adjustment programs, systematic trading, too big to fail, trickle-down economics, urban renewal, War on Poverty, Yom Kippur War

It was at this point that successive British governments began clutching at straws – namely, the ‘special relationship’, which turned the UK into a minor executor of US policy in exchange for privileged access to the US market for British multinationals and the linkage of the City of London to Wall Street. 7. Interestingly, Marjolin had spent his formative pre-war years as a Rockefeller fellow at Harvard. In fact, while there, he participated in a reading group dedicated to understanding Keynes’ General Theory. The other two participants were John Kenneth Galbraith (1908–2006) and Paul Samuelson (1915–2009). Galbraith was to spend the war as Roosevelt’s ‘price czar’, determining the prices of all major commodities. Samuelson won the Nobel Prize for Economics and is credited with introducing Keynes (albeit in an oversimplified and, I would argue, toxic form) to Americans. 8. In a radio interview some years ago, linguistics professor and political activist Noam Chomsky pointed out an interesting fact about the Marshall Plan – one that links the United States, France and Holland with European imperialism in Asia.

The Darwin Economy: Liberty, Competition, and the Common Good by Robert H. Frank

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carbon footprint, carried interest, Cass Sunstein, clean water, congestion charging, corporate governance, deliberate practice, full employment, income inequality, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Paul Samuelson, Plutocrats, plutocrats, positional goods, profit motive, Ralph Nader, rent control, Richard Thaler, Ronald Coase, Ronald Reagan, sealed-bid auction, smart grid, The Nature of the Firm, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, trickle-down economics, ultimatum game, winner-take-all economy

For a more detailed account of this explanation, see chapter 8 of my 1985 book, Choosing the Right Pond: Human Behavior and the Quest for Status, New York: Oxford University Press. 10. Richard Thaler and Cass Sunstein, Nudge, New Haven, CT: Yale University Press, 2007, p. 251. 11. Thomas C. Schelling, Micromotives and Macrobehavior, New York: W. W. Norton, 1978. 12. Karl Marx, Capital, New York: Modern Library, 1936, pp. 708–709. 13. See, for example, the title essay in my 2004 book, What Price the Moral High Ground? Princeton, NJ: Princeton University Press. 14. Paul Samuelson, “A Note on the Pure Theory of Consumers’ Behaviour,” Economica 5, 1938: 61–71. Chapter Four: Starve the Beast—But Which One? 1. Ronald Utt, “The Bridge to Nowhere: A National Embarrassment,” Heritage Foundation, October 20, 2005. 2. Project on Government Oversight, http://www.pogo.org/pogo-files/reports/ national-security/defense-waste-fraud/ns-wds-19990901.html. 3. “Conservative Advocate,” Morning Edition, National Public Radio, May 25, 2001, http://www.npr.org/templates/story/story.php?


pages: 338 words: 106,936

The Physics of Wall Street: A Brief History of Predicting the Unpredictable by James Owen Weatherall

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Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, Vilfredo Pareto, volatility smile

Bachelier had always been fascinated by probability theory, the mathematics of chance (and, by extension, gambling). If he could just imagine the French financial markets as a glorified casino, a game whose rules he was about to learn, it might not seem so scary. He repeated the mantra — just an elaborate game of chance — as he pushed forward into the throng. “Who is this guy?” Paul Samuelson asked himself, for the second time in as many minutes. He was sitting in his office, in the economics department at MIT. The year was 1955, or thereabouts. Laid out in front of him was a half-century-old PhD dissertation, written by a Frenchman whom Samuelson was quite sure he had never heard of. Bachelor, Bacheler. Something like that. He looked at the front of the document again. Louis Bachelier.


pages: 484 words: 104,873

Rise of the Robots: Technology and the Threat of a Jobless Future by Martin Ford

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3D printing, additive manufacturing, Affordable Care Act / Obamacare, AI winter, algorithmic trading, Amazon Mechanical Turk, artificial general intelligence, assortative mating, autonomous vehicles, banking crisis, basic income, Baxter: Rethink Robotics, Bernie Madoff, Bill Joy: nanobots, call centre, Capital in the Twenty-First Century by Thomas Piketty, Chris Urmson, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, computer age, creative destruction, debt deflation, deskilling, diversified portfolio, Erik Brynjolfsson, factory automation, financial innovation, Flash crash, Fractional reserve banking, Freestyle chess, full employment, Goldman Sachs: Vampire Squid, Gunnar Myrdal, High speed trading, income inequality, indoor plumbing, industrial robot, informal economy, iterative process, Jaron Lanier, job automation, John Markoff, John Maynard Keynes: technological unemployment, John von Neumann, Kenneth Arrow, Khan Academy, knowledge worker, labor-force participation, labour mobility, liquidity trap, low skilled workers, low-wage service sector, Lyft, manufacturing employment, Marc Andreessen, McJob, moral hazard, Narrative Science, Network effects, new economy, Nicholas Carr, Norbert Wiener, obamacare, optical character recognition, passive income, Paul Samuelson, performance metric, Peter Thiel, Plutocrats, plutocrats, post scarcity, precision agriculture, price mechanism, Ray Kurzweil, rent control, rent-seeking, reshoring, RFID, Richard Feynman, Richard Feynman, Rodney Brooks, secular stagnation, self-driving car, Silicon Valley, Silicon Valley startup, single-payer health, software is eating the world, sovereign wealth fund, speech recognition, Spread Networks laid a new fibre optics cable between New York and Chicago, stealth mode startup, stem cell, Stephen Hawking, Steve Jobs, Steven Levy, Steven Pinker, strong AI, Stuxnet, technological singularity, telepresence, telepresence robot, The Bell Curve by Richard Herrnstein and Charles Murray, The Coming Technological Singularity, The Future of Employment, Thomas L Friedman, too big to fail, Tyler Cowen: Great Stagnation, union organizing, Vernor Vinge, very high income, Watson beat the top human players on Jeopardy!, women in the workforce

Throughout the postwar period, advancing technology deposited money directly into the pockets of average workers as their wages rose in tandem with soaring productivity. Those workers, in turn, went out and spent their ever-increasing incomes, further driving demand for the products and services they were producing. As that virtuous feedback loop powered the American economy forward, the profession of economics was enjoying its own golden age. It was during the same period that towering figures like Paul Samuelson worked to transform economics into a science with a strong mathematical foundation. Economics gradually came to be almost completely dominated by sophisticated quantitative and statistical techniques, and economists began to build the complex mathematical models that still constitute the field’s intellectual basis. As the postwar economists did their work, it would have been natural for them to look at the thriving economy around them and assume that it was normal: that it was the way an economy was supposed to work—and would always work.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

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asset allocation, backtesting, Bernie Madoff, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

Malkiel laid out several advantages for the formation of an index fund that matched the market’s return, and even made a plea to mutual fund companies to sponsor an index fund, noting that “fund spokesmen are quick to point out you can’t buy the market averages. It’s time the public can.”1 Malkiel was not the lone voice pleading for index funds in the early 1970s. Several other prominent voices called out for passive options. One voice was MIT’s Paul Samuelson. He wrote a short and punchy 1974 article in the Journal of Portfolio Management entitled “Challenge to Judgment.” Samuelson struck at the heart of professional money managers by stating, “. . . the best of money managers cannot be demonstrated to be able to deliver the goods of superior portfolio-selection performance. . . . Superior investment performance is unproved.” He goes on to suggest that, “at the least, some large foundation should set up an in-house portfolio that tracks the S&P 500 Index—if only for the purpose of setting up a naïve model against which their in-house gunslingers can measure their prowess.”2 Charles Ellis, then president of Greenwich Associates and a respected investment advisor to charitable trusts, added to this chorus with his famous 1975 article, “The Loser’s Game.”


pages: 357 words: 95,986

Inventing the Future: Postcapitalism and a World Without Work by Nick Srnicek, Alex Williams

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3D printing, additive manufacturing, air freight, algorithmic trading, anti-work, back-to-the-land, banking crisis, basic income, battle of ideas, blockchain, Bretton Woods, call centre, capital controls, carbon footprint, Cass Sunstein, centre right, collective bargaining, crowdsourcing, cryptocurrency, David Graeber, decarbonisation, deindustrialization, deskilling, Doha Development Round, Elon Musk, Erik Brynjolfsson, Ferguson, Missouri, financial independence, food miles, Francis Fukuyama: the end of history, full employment, future of work, gender pay gap, housing crisis, income inequality, industrial robot, informal economy, intermodal, Internet Archive, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, late capitalism, liberation theology, Live Aid, low skilled workers, manufacturing employment, market design, Martin Wolf, mass immigration, mass incarceration, means of production, minimum wage unemployment, Mont Pelerin Society, neoliberal agenda, New Urbanism, Occupy movement, oil shale / tar sands, oil shock, patent troll, pattern recognition, Paul Samuelson, Philip Mirowski, post scarcity, postnationalism / post nation state, precariat, price stability, profit motive, quantitative easing, reshoring, Richard Florida, rising living standards, road to serfdom, Robert Gordon, Ronald Reagan, Second Machine Age, secular stagnation, self-driving car, Slavoj Žižek, social web, stakhanovite, Steve Jobs, surplus humans, the built environment, The Chicago School, The Future of Employment, Tyler Cowen: Great Stagnation, universal basic income, wages for housework, We are the 99%, women in the workforce, working poor, working-age population

It is the educational apparatus that indoctrinates new generations in the dominant values of a particular society, reproducing its ideology through the decades. In the education system, children learn the basic ideas of a society, respect for (in fact, submission to) the existing order, and the skills necessary to distribute them along different segments of the labour market.58 Transforming the educational system of intellectuals is therefore a key task in building a new hegemony.59 It is not for nothing that the Nobel Prize–winning economist Paul Samuelson wrote that: ‘I don’t care who writes a nation’s laws, or crafts its advanced treatises, if I can write its economics textbooks.’ Projects focused on changing this institutional element of society could focus on three broad goals: pluralising the teaching of economics, reinvigorating the study of leftist economics and expanding popular economic literacy. It is often forgotten, so deeply are we embedded in neoliberalism, that economics was once a relatively pluralist discipline.


pages: 370 words: 102,823

Rethinking Capitalism: Economics and Policy for Sustainable and Inclusive Growth by Michael Jacobs, Mariana Mazzucato

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3D printing, balance sheet recession, banking crisis, basic income, Bernie Sanders, Bretton Woods, business climate, Carmen Reinhart, central bank independence, collaborative economy, complexity theory, conceptual framework, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, crony capitalism, David Ricardo: comparative advantage, decarbonisation, deindustrialization, dematerialisation, Detroit bankruptcy, double entry bookkeeping, Elon Musk, endogenous growth, energy security, eurozone crisis, factory automation, facts on the ground, fiat currency, Financial Instability Hypothesis, financial intermediation, forward guidance, full employment, G4S, Gini coefficient, Growth in a Time of Debt, Hyman Minsky, income inequality, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), Internet of things, investor state dispute settlement, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, labour market flexibility, low skilled workers, Martin Wolf, mass incarceration, Mont Pelerin Society, neoliberal agenda, Network effects, new economy, non-tariff barriers, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, quantitative easing, QWERTY keyboard, railway mania, rent-seeking, road to serfdom, savings glut, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Steve Jobs, the built environment, The Great Moderation, The Spirit Level, Thorstein Veblen, too big to fail, total factor productivity, transaction costs, trickle-down economics, universal basic income, very high income

It is no exaggeration to say that the sweatshop is the foundation of the theory of perfect competition. The economics of the sweatshop, rooted in the ‘ideal’ of ‘perfect’ competition, provides the intellectual rationale for both an unregulated free-market economy in the American conservative tradition of Milton Friedman and an interventionist policy to mitigate market imperfections and confront market failures in the American liberal tradition of Paul Samuelson. Both figuratively and literally, the theory of the firm in perfect competition manifests the poverty of neoclassical economics. The Marxian theory of the productive firm To construct an economic theory of the productive enterprise, it is useful—and I would argue essential—to go back to Karl Marx’s explanation of the sources of surplus value laid out in his 1867 treatise, Das Kapital.9 In arguing that the sources of productivity cannot be found in the process of market exchange but rather are found in the process of production, Marx originated a critique of the theory of the market economy that remains as relevant today as it was in the nineteenth century.


pages: 336 words: 113,519

The Undoing Project: A Friendship That Changed Our Minds by Michael Lewis

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Albert Einstein, availability heuristic, Cass Sunstein, choice architecture, complexity theory, Daniel Kahneman / Amos Tversky, Donald Trump, Douglas Hofstadter, endowment effect, feminist movement, framing effect, hindsight bias, John von Neumann, Kenneth Arrow, loss aversion, medical residency, Menlo Park, Murray Gell-Mann, Nate Silver, New Journalism, Paul Samuelson, Richard Thaler, Saturday Night Live, statistical model, the new new thing, Thomas Bayes, Walter Mischel, Yom Kippur War

“Amos knew exactly what questions to ask,” said Redelmeier. “There were no awkward silences.” At the end of the lunch, Amos invited Redelmeier to visit him in his office. It didn’t take long before Amos was bouncing ideas about the human mind off Redelmeier, as he had bounced them off Hal Sox, to listen for an echo in medicine. The Samuelson bet, for instance. The Samuelson bet was named for Paul Samuelson, the economist who had cooked it up. As Amos explained it, people offered a single bet in which they have a 50-50 chance either to win $150 or lose $100 usually decline it. But if you offer those same people the chance to make the same bet one hundred times over, most of them accept the bet. Why did they make the expected value calculation—and respond to the odds being in their favor—when they were allowed to make the bet a hundred times, but not when they are offered a single bet?


pages: 345 words: 86,394

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

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Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

Richardson later worked on the mathematics for the causes of war. 1923 Wiener Norbert Wiener developed a rigorous theory for Brownian motion, the mathematics of which was to become a necessary modelling device for quantitative finance decades later. The starting point for almost all financial models, the first equation written down in most technical papers, includes the Wiener process as the representation for randomness in asset prices. See Wiener (1923). 1950s Samuelson The 1970 Nobel Laureate in Economics, Paul Samuelson, was responsible for setting the tone for subsequent generations of economists. Samuelson ‘mathematized’ both macro and micro economics. He rediscovered Bachelier’s thesis and laid the foundations for later option pricing theories. His approach to derivative pricing was via expectations, real as opposed to the much later risk-neutral ones. See Samuelson (1995). 1951 Itô Where would we be without stochastic or Itô calculus?


pages: 606 words: 87,358

The Great Convergence: Information Technology and the New Globalization by Richard Baldwin

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3D printing, additive manufacturing, Admiral Zheng, agricultural Revolution, air freight, Amazon Mechanical Turk, Berlin Wall, bilateral investment treaty, Branko Milanovic, buy low sell high, call centre, Columbian Exchange, commoditize, Commodity Super-Cycle, David Ricardo: comparative advantage, deindustrialization, domestication of the camel, Edward Glaeser, endogenous growth, Erik Brynjolfsson, financial intermediation, George Gilder, global supply chain, global value chain, Henri Poincaré, imperial preference, industrial cluster, industrial robot, intangible asset, invention of agriculture, invention of the telegraph, investor state dispute settlement, Isaac Newton, Islamic Golden Age, James Dyson, knowledge economy, knowledge worker, Lao Tzu, low skilled workers, market fragmentation, mass immigration, Metcalfe’s law, New Economic Geography, out of africa, paper trading, Paul Samuelson, Pax Mongolica, profit motive, rent-seeking, reshoring, Richard Florida, rising living standards, Robert Metcalfe, Second Machine Age, Simon Kuznets, Skype, Snapchat, Stephen Hawking, telepresence, telerobotics, The Wealth of Nations by Adam Smith, trade liberalization, trade route, Washington Consensus

In fact, when sources of comparative advantage cross international borders, it is not sure that all nations win. The basic point is simplicity itself. If the firms from a nation, say Austria, transfer technology abroad in a way that increases the international competition facing Austrian exports, then the Austrians working in Austria may well lose. The point has been made many times by many people—most famously by Nobel Prize winner Paul Samuelson in his 2004 article “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization.” As Samuelson puts it in his rotund phrasing, “This invention abroad that gives to China some of the comparative advantage that had belonged to the United States can induce for the United States permanent lost per capita real income.” Note that Samuelson was not linking the “invention abroad” to the second unbundling—that is my assertion.


pages: 339 words: 95,988

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven D. Levitt, Stephen J. Dubner

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airport security, Broken windows theory, crack epidemic, desegregation, Exxon Valdez, feminist movement, George Akerlof, information asymmetry, Joseph Schumpeter, Kenneth Arrow, mental accounting, moral hazard, More Guns, Less Crime, oil shale / tar sands, Paul Samuelson, peak oil, pets.com, profit maximization, Richard Thaler, school choice, sensible shoes, Steven Pinker, Ted Kaczynski, The Chicago School, The Market for Lemons, Thorstein Veblen, War on Poverty

I know, I know, I know: Wikipedia is one of the wonders of the online world. But if anyone ever needs a reason to be deeply skeptical of Wikipedia’s dependability, I urge you to click on the entry for “List of Economists,” which is introduced thusly: “This is an alphabetical list of well-known economists. Economists are scholars conducting research in the field of economics.” It is true that the list includes George Akerlof and Paul Samuelson and Jeffrey Sachs and even Steve Levitt. But if you want to see how truly pathetic Wikipedia can be, check out the sixth “economist” listed under “D”: that’s right, yours truly. Although some of my best friends are economists, I am very much not. (Note: soon after I posted this entry, a reader was helpful/mischievous enough to quickly amend the Wikipedia entry, deleting my name.) The point is that the greatest strength of Wikipedia is also its greatest weakness: pretty much anyone can contribute anything anytime to an “encyclopedia” that most casual users will assume is in fact encyclopedic, but which in fact changes regularly, depending on the input of its users.


pages: 831 words: 98,409

SUPERHUBS: How the Financial Elite and Their Networks Rule Our World by Sandra Navidi

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activist fund / activist shareholder / activist investor, assortative mating, bank run, barriers to entry, Bernie Sanders, Black Swan, Bretton Woods, butterfly effect, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, commoditize, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, diversification, East Village, Elon Musk, eurozone crisis, family office, financial repression, Gini coefficient, glass ceiling, Goldman Sachs: Vampire Squid, Google bus, Gordon Gekko, haute cuisine, high net worth, hindsight bias, income inequality, index fund, intangible asset, Jaron Lanier, John Meriwether, Kenneth Arrow, Kenneth Rogoff, knowledge economy, London Whale, Long Term Capital Management, Mark Zuckerberg, mass immigration, McMansion, mittelstand, money market fund, Myron Scholes, NetJets, Network effects, offshore financial centre, old-boy network, Parag Khanna, Paul Samuelson, peer-to-peer, performance metric, Peter Thiel, Plutocrats, plutocrats, Ponzi scheme, quantitative easing, Renaissance Technologies, rent-seeking, reserve currency, risk tolerance, Robert Gordon, Robert Shiller, Robert Shiller, rolodex, Satyajit Das, shareholder value, Silicon Valley, sovereign wealth fund, Stephen Hawking, Steve Jobs, The Future of Employment, The Predators' Ball, too big to fail, women in the workforce, young professional

Larry Summers, who is known to be a somewhat prickly intellectual genius, is atypical yet exemplary of the dynamics that rule the world of high-level networking: Despite courting controversy throughout his career, he occupies a central position that touches upon virtually all other networks. Ever restless and on the lookout for new challenges, pushing boundaries and climbing to new heights, Summers has had several exceedingly successful careers and held some of the most important positions in the U.S. government. His platinum resume was practically preordained in his DNA, as he is the son of two economists and the nephew of two Nobel laureates in economics, Paul Samuelson and Kenneth Arrow. His father taught at Yale University, and Samuelson had been an adviser to President Kennedy. Meteoric Rise Summers’s stellar professional rise occurred with lightning speed. He was accepted into the Massachusetts Institute of Technology at age sixteen and received tenure at Harvard University at only twenty-eight years old. That same year, personal tragedy struck when he was diagnosed with late-stage Hodgkin’s disease and endured nine grueling months of chemotherapy.


pages: 293 words: 88,490

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction by Richard Bookstaber

asset allocation, bank run, bitcoin, butterfly effect, capital asset pricing model, cellular automata, collateralized debt obligation, conceptual framework, constrained optimization, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, dark matter, disintermediation, Edward Lorenz: Chaos theory, epigenetics, feminist movement, financial innovation, fixed income, Flash crash, Henri Poincaré, information asymmetry, invisible hand, Isaac Newton, John Conway, John Meriwether, John von Neumann, Joseph Schumpeter, Long Term Capital Management, margin call, market clearing, market microstructure, money market fund, Paul Samuelson, Pierre-Simon Laplace, Piper Alpha, Ponzi scheme, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, Richard Feynman, Richard Feynman, risk/return, Saturday Night Live, self-driving car, sovereign wealth fund, the map is not the territory, The Predators' Ball, the scientific method, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, tulip mania, Turing machine, Turing test, yield curve

Non-Ergodicity: The Relevance of History, or Each Time It’s Different To obtain a reliable probability distribution about the course of a crisis, we’d have to draw a random sample from that future universe, and analyze that sample from the future to calculate statistically reliable characteristics of this future population. Because drawing a sample from the future is not possible, economists taking this approach assume that the future is drawn from the same distribution as the past. This justifies using historical data, and this assumption requires ergodicity. Paul Samuelson (1969, 184–85) wrote that if economists hope to remove economics from the realm of history and move it into the “realm of science” we must impose the “ergodic hypothesis.” Ergodicity is at the core of economics because it is the only way we can apply probabilities in a sensible way. When uncertainty is introduced to economic models, it is done with the formal machinery of probability theory.


pages: 488 words: 144,145