Tag: Keynes

A flow I can ride, rather than a storm I should fear

My editorial on You Tube

I am in an intellectually playful frame of mind, and I decide to play with Keynes and probability. It makes like 4 weeks that I mess around with the theory of probability, and yesterday my students told me they have a problem with Keynes. I mean, not with Sir John Maynard Keynes as a person, but more sort of with what he wrote. I decided to connect those two dots. Before John Maynard Keynes wrote his ‘General Theory of Employment, Interest, and Money’, in 1935, he wrote a few other books, and among them was ‘A Treatise on Probability’ (1921).

I am deeply convinced that mathematics expresses our cognitive take on that otherwise little known, chaotic stuff we call reality, fault of a better label. I am going to compare John Maynard Keynes’s approaches to, respectively, probability and economics, so as to find connections. I start with the beginning of Chapter I, entitled ‘The Meaning of Probability’, in Keynes’s Treatise on Probability,   

‘Part of our knowledge we obtain direct; and part by argument. The Theory of Probability is concerned with that part which we obtain by argument, and it treats of the different degrees in which the results so obtained are conclusive or inconclusive. In most branches of academic logic, such as the theory of the syllogism or the geometry of ideal space, all the arguments aim at demonstrative certainty. They claim to be conclusive. But many other arguments are rational and claim some weight without pretending to be certain. In Metaphysics, in Science, and in Conduct, most of the arguments, upon which we habitually base our rational beliefs, are admitted to be inconclusive in a greater or less degree. Thus for a philosophical treatment of these branches of knowledge, the study of probability is required. […] The Theory of Probability is logical, therefore, because it is concerned with the degree of belief which it is rational to entertain in given conditions, and not merely with the actual beliefs of particular individuals, which may or may not be rational. Given the body of direct knowledge which constitutes our ultimate premises, this theory tells us what further rational beliefs, certain or probable, can be derived by valid argument from our direct knowledge. This involves purely logical relations between the propositions which embody our direct knowledge and the propositions about which we seek indirect knowledge. […] Writers on Probability have generally dealt with what they term the “happening” of “events.” In the problems which they first studied this did not involve much departure from common usage. But these expressions are now used in a way which is vague and ambiguous; and it will be more than a verbal improvement to discuss the truth and the probability of propositions instead of the occurrence and the probability of events’.

See? Something interesting. I think most of us connect the concept of probability to that experiment which we used to perform at high school: toss a coin 100 times, see how many times you have tails, and how many occurrences of heads you had etc. Tossing a coin is empirical: we make very little assumptions and we just observe. How is it possible, then, for anybody to even hypothesise that probability is a science of propositions rather than hard facts?

Now, here is the thing with John Maynard Keynes (and I address this passage to all those of my students who struggle with understanding what the hell did John Maynard mean): John Maynard Keynes had a unique ability to sell his ideas, and his ideas came from his experience. Whatever general principles you can read in Keynes’s writings, and however irrefutable he suggests these principles are, John Maynard tells us the same kind of story that everybody tells: the story of his own existence. He just tells it in so elegantly sleek a way that most people just feel disarmed and conquered. Yet, convincing is not the same as true. Even the most persuasive theorists – and John Maynard Keynes could persuade the s**t out of most common mortals – can be wrong. How can they be wrong? Well, when I fail to own my own story, i.e. when I am just too afraid of looking the chaos of life straight in the eyes (which is elegantly called ‘cognitive bias’), then I tell just the nice little story which I would like to hear, in order to calm down my own fear.      

Let’s try to understand John Maynard Keynes’s story of existence, which leads to seeing probabilities as a type of logic rather than data. I browse through his ‘Treatise on Probability’. I’m patient. I know he will give himself away sooner or later. Everybody does. Well, let’s say that according to my experience of conversations with dead people via their writings, each of them ends up by telling me, through his very writing, what kind of existential story made him tell the elegantly packaged theoretical story in the title of the book. Gotcha’, Sir Keynes! Part I – Fundamental Ideas – Chapter III, ‘The Measurement of Probabilities’, page 22 in the PDF I am linking to: ‘If we pass from the opinions of theorists to the experience of practical men, it might perhaps be held that a presumption in favour of the numerical valuation of all probabilities can be based on the practice of underwriters and the willingness of Lloyd’s to insure against practically any risk. Underwriters are actually willing, it might be urged, to name a numerical measure in every case, and to back their opinion with money. But this practice shows no more than that many probabilities are greater or less than some numerical measure, not that they themselves are numerically definite. It is sufficient for the underwriter if the premium he names exceeds the probable risk. But, apart from this, I doubt whether in extreme cases the process of thought, through which he goes before naming a premium, is wholly rational and determinate; or that two equally intelligent brokers acting on the same evidence would always arrive at the same result. In the case, for instance, of insurances effected before a Budget, the figures quoted must be partly arbitrary. There is in them an element of caprice, and the broker’s state of mind, when he quotes a figure, is like a bookmaker’s when he names odds. Whilst he may be able to make sure of a profit, on the principles of the bookmaker, yet the individual figures that make up the book are, within certain limits, arbitrary. He may be almost certain, that is to say, that there will not be new taxes on more than one of the articles tea, sugar, and whisky; there may be an opinion abroad, reasonable or unreasonable, that the likelihood is in the order—whisky, tea, sugar; and he may, therefore be able to effect insurances for equal amounts in each at 30 per cent, 40 per cent, and 45 per cent. He has thus made sure of a profit of 15 per cent, however absurd and arbitrary his quotations may be’.  

See? Told you he’s got a REAL story to tell, Sir Keynes. You just need to follow him home and see whom he’s hanging with. He is actually hanging with financial brokers and insurers. He observes them and concludes there is no way of predicting the exact probability of complex occurrences they essentially bet money on. There is some deeply intuitive mental process taking place in their minds, which makes them guess correctly if insuring a ship full of cotton, for reimbursable damages worth X amount of money, in exchange of an insurance premium worth Y money.

The story that John Maynard Keynes tells is through his ‘Treatise on Probability’ is the story of the wild, exuberant capitalism of the early 1920ies, right after World War I, and after the epidemic of Spanish flu. It was a frame of mind that pushed people to run towards a mirage of wealth, and they would run towards it so frantically, because they wanted to run away from memories of horrible things. Sometimes we assume that what’s can possibly catch us from behind is so frightening that whatever we can run towards is worth running forward. In such a world, probability is a hasty evaluation of odds, with no time left for elaborate calculations. There are so many opportunities to catch, and so much fear to run away from that I don’t waste my time to think what an event actually is. It is just the ‘have I placed my bets right?’ thing. I think I understand it, as I recently experienced very much the same (see A day of trade. Learning short positions).

The very same existential story, just more seasoned and marinated in the oils of older age, can be seen in John Maynard Keynes’s ‘General Theory of Employment, Interest, and Money’. I read the ‘Preface’, dated December 13th, 1935, where the last paragraph says: ‘The composition of this book has been for the author a long struggle of escape, and so must the reading of it be for most readers if the author’s assault upon them is to be successful,—a struggle of escape from habitual modes of thought and expression. The ideas which are here expressed so laboriously are extremely simple and should be obvious. The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds’. The same line of logic is present in country-specific prefaces that follow, i.e. to national translations of ‘General Theory’ published in Germany, France, and Japan.

In 1935, John Maynard Keynes had lived the exuberance of the 1920ies and the sobering cruelty of the 1930ies. He felt like telling a completely new story, yet the established theory, that of classical economics, would resist. How can you overcome resistance of such type? One of the strategies we can use is to take the old concepts and just present them in a new way, and I think this is very largely what John Maynard Keynes did. He took the well-known ideas, such as aggregate output, average wage etc., and made a desperate effort to reframe them. In the preface to the French edition of ‘General Theory’, there is a passage which, I believe, sums up some 50%, if not more, of all the general theorizing to be found in this book. It goes: ‘I believe that economics everywhere up to recent times has been dominated, much more than has been understood, by the doctrines associated with the name of J.-B. Say. It is true that his ‘law of markets’ has been long abandoned by most economists; but they have not extricated themselves from his basic assumptions and particularly from his fallacy that demand is created by supply. Say was implicitly assuming that the economic system was always operating up to its full capacity, so that a new activity was always in substitution for, and never in addition to, some other activity. Nearly all subsequent economic theory has depended on, in the sense that it has required, this same assumption. Yet a theory so based is clearly incompetent to tackle the problems of unemployment and of the trade cycle. Perhaps I can best express to French readers what I claim for this book by saying that in the theory of production it is a final break-away from the doctrines of J.- B. Say and that in the theory of interest it is a return to the doctrines of Montesquieu’.

Good. Sir Keynes assumes that it is a delicate thing to keep the economic system in balance. Why? Well, Sir Keynes knows it because he had lived it. That preface to the French edition of ‘General Theory’ is dated February 20th, 1939. We are all the way through the Great Depression, Hitler has already overtaken Austria and Czechoslovakia, and the United States are in the New Deal. Things don’t balance themselves by themselves, it is true. Yet, against this general assumption of equilibrium-is-something-precarious, the development which follows, in ‘General Theory’ goes exactly in the opposite direction. John Maynard Keynes builds a perfect world of equations, where Savings equal Investment, Investment equals Amortization, and generally things are equal to many other things. Having claimed the precarity of economic equilibrium, Sir Keynes paints one in bright pink.

I think that Keynes tried to express radically new ideas with old concepts, whence the confusion. He wanted to communicate the clearly underrated power of change vs that of homeostasis, yet he kept thinking in terms of, precisely, homeostasis between absolute aggregates, e.g. the sum of all proceedings anyone can have from a given amount of business is equal to the value conveyed by the same amount of business (this is my own, completely unauthorized summary of the principle, which Keynes called ‘effective demand’).  

The ‘General Theory of Employment, Interest, and Money’ was somehow competing for the interest of readers with another theory, phrased out practically at the same moment, namely the theory of business cycles by Joseph Alois Schumpeter. I perceive the difference between the respective takes by Keynes and Schumpeter, on the general turbulence of existence, in the acknowledgment of chaos and complexity. Keynes says: ‘Look, folks. This, I mean that whole stuff around, is bloody uncertain and volatile. Still, the good news is that I can wrap it up, just for you, in an elegant theory with nice equations, and then you will have a very ordered picture of chaos’. Joseph Alois Schumpeter retorts: ‘Not quite. What we perceive as chaos is simply complex change, too complex for being grasped once and for all. There is a cycle of change, and we are part of the cycle. We are in the cycle, not the other way around (i.e. cycle is not in us). What we can understand, and even exploit, is the change in itself’.

Where do I stand in all that? I am definitely more Schumpeterian than Keynesian. I prefer dishevelled reality to any nicely ordered and essentially false picture thereof. Yes, existence is change, and any impression of permanence is temporary. My recent intellectual wrestling with stochastic processes (see We really don’t see small change) showed me that even when I use quite elaborate analytical tools, such as mean-reversion, I keep stumbling upon my purely subjective partition of perceivable reality into the normal order, and the alarming chaos (see The kind of puzzle that Karl Friedrich was after).

A vision of game comes to my mind. This is me vs universe. Looks familiar? Right you are. That’s exactly the kind of game each of us plays throughout time. I make a move, and I wait for the universe to make its own. I have a problem: I don’t really know what kind of phenomenon I can account as move made by the universe. I need to guess: has the universe already made its move, in that game with me, or not yet? If I answer ‘yes’, I react. I assume that what has just happened is informative about the way my existence works. If, on the other hand, I guess that the universe has not figured yet any plausible way to put me at check, I wait and observe. Which is better, day after day: assuming that the universe made its move or sitting and waiting? I can very strongly feel this dilemma in my learning of investment in the stock market. Something happened. Prices have changed. Should I react immediately, or should I wait?

I provisionally claim that it depends. The universe moves at an uneven speed. By ‘provisionally’ I mean I claim it until I die, and then someone else will take on claiming the same, just as provisionally. Yet, all that existential instability acknowledged, there are rhythms I can follow. As regards my investment, I discovered that the most sensible rhythm to follow beats on the passive side of my investment portfolio. Every month, I collect the rent from an apartment, downtown, and I invest that rent in the stock market. I discovered that when I orchestrate my own thinking into that monthly rhythm of inflow in equity, it sort of works nicely. I collect the rent around the 5th day of each month, and for like one week beforehand, I do my homework about the market. When the rent comes, I have a scenario in mind, usually with a few question marks, i.e. with uncertainty to deal with. I play my investment game for 1 – 3 days, with occasional adjustments, and this is my move. Then I let the universe (the stock market in this case) make its own move over the next 3 – 4 weeks, and I repeat the same cycle over and over again.

I make a short move, and I let the universe making a long move. Is it a sensible strategy? From my point of view, there are two reasons for answering ‘yes’ to that question. First of all, it works in purely financial terms. I have learnt to wait patiently for an abnormally good opportunity to make profits. When I go too fast, like every day is a decision day, I usually get entangled in a game of my own illusions, and I lose money on transactions which I don’t quite understand. When I take my time, pace myself, and define a precise window for going hunting, usually something appears in that window, and I can make good money. Second of all, it is something I have sort of learnt generally and existentially: chaos is there, and I am there, and a good way to be alongside the chaos is to find a rhythm. When I follow my beat, chaos becomes a flow I can ride, rather than a storm I should fear.

That thing about experiments: you don’t really know

My editorial

One of the spots my internal bulldog keeps sniffing around is the junction of monetary systems and technological change, and one of the most interestingly smelling bones in that spot is labelled ‘cryptocurrencies and renewable energies’. There is that Estonian project called WePower and there are those loose thoughts I have been weaving for months, now, about a cryptocurrency pegged to local markets of renewable energies. I named that currency ‘The Wasun’ (see for example ‘Conversations between the dead and the living (no candles)’ or ‘Giants invisible to muggles, or a good, solid piece of research work’ ). Now, I am putting together a research project concerning the broadly spoken industry of FinTech, and one of the threads in that scientific fabric is the possible way of experimenting with the idea of cryptocurrencies connected to the market of renewable energies.

And so I imagine the most basic experimental framework for this specific case: a trading environment, designed with the Blockchain technology, and in this environment, a token of cryptocurrency equivalent to 1 kWh (kilowatt hour) of energy from renewable sources. Just for the sake of having fun with my own ideas, I return to that old name for the token: 1 Wasun = 1 kWh from renewable energies. In order to be scientifically honest, if I want that Wasun to be really well experimented about, I need its dark sibling, the antithetic shadow: 1 Fossil = 1 kWh from fossil fuels. Pushing my scientific honesty even further, I introduce one more token: 1 WTH = 1 kWh from whatever source comes the first, indiscriminately.

Now, I do what every curator in every art exhibition fears a bit: I let people in. People can buy and sell Wasuns, Fossils, or WTH. The initial price for each will be the same, i.e. the market price for one 1 kWh of electricity. The experiment has two plans: the purely economic one, involving the observation of prices and quantities, and the behavioural – anthropological one, which assumes the observation of human behaviour. We observe, how do the exchange rates of those three tokens change over time, together with the quantities issued and traded. Note: each of the three tokens can be, technically, traded against the other two, as well as against a reference currency: euro, dollar etc. At the behavioural plan, we observe the way that participants make up their mind, and the way they pass from innovative behaviour to more and more ritualized patterns.

At this stage, two versions of the experiment come to my mind: market-constrained, and unconstrained. The market-constrained experiment would involve real kilowatt hours being traded in that experimental environment. At some moment (to be defined), participants could get real electricity for their Wasuns, Fossils, or their WTH, or the equivalent of that electricity in a fiat currency. Fiat currency is a name frequently given to what we call “normal money”. Fiat comes from Latin, and means ‘benediction’. In this case, the benediction comes from a central bank. In this constrained version, participants to my experiment have relatively strong a motivation to make realistic decisions, and this is a plus. Just as in electricity, a plus has sort of a symmetrical minus, and the minus means that somebody has to pay those bills at the end. More realistic a motivation in participants equals higher costs of the experiment in the organizing entity. In the market-unconstrained version, the tokens are purely virtual: no participant earns any claim on any kilowatt hour or on its market value. It allows driving down the costs of the experiment, but takes a lot of real motivation away from the participants.

Any experiment should bring useful results. Creating and maintaining an experimental environment is an effort, which deserves a reward. When I say ‘useful’, one of the most immediate questions that pops up in my mind is ‘useful to whom?’. Who could be deriving substantial gains from well-tested solutions in this specific domain? Cryptocurrencies enter into the broad category of FinTech, and they are based on a specific technology called Blockchain. Financial institutions, and providers of FinTech digital utilities are the most obvious beneficiaries of a good, solid experiment with cryptocurrencies connected to the market of renewable energies. Still, suppliers of energy, as well as the suppliers of technologies for producing energy could have something to gain in that experiment.

An experiment should test something hard to peg down in other ways, a factor of risk, kind of uncertain in its happening, and kind of valuable in its variance. Here, really, Bob’s my uncle. The answer is simple: human behaviour is the main factor of uncertainty both in finance and in technological change, and it is a bearer of value. The most obvious experiment in that field consists in prototyping several, alternative solutions of a cryptocurrency attached to the market of renewable energies, and observing the users’ behaviour when they get the possibility of testing these solutions. The basic characteristics of such a prototype are: a) the technological platform used to convey the whole financial scheme b) the initial valuation of the cryptocurrency and the way it is supposed to change c) the essential financial function of the cryptocurrency, i.e. payment (liquidity) or accumulation d) the amount of energy, in kilowatt hours, attached to the amount of cryptocurrency issued, and, as I think about it, there would be an (e) as well, namely e) how is the given cryptocurrency being issued (mining, contract etc.) and what additional, financial services are going to be attached.

Testing uncertain things, in the prospect of making them more predictable, can always do with a set of sensible hypotheses. Looking for anything that can happen is interesting, but when you think about it, anything that can possibly happen is actually anything we think can happen, and so it is useful to phrase explicitly what we think. Formulating hypotheses is a smart way of doing it. I start hypothesising with something kind of most elementary in my view: the distinction between massive, systematic absorption of innovation, on the one hand, and the incidental absorption at the fringe of social fabric. Thus, I formulate my first experimental hypothesis as a dichotomy of two claims: the absorption of any given prototype of cryptocurrency attached to the market of renewable energies is going to be [claim #1.1] massive and dominant in the behaviour of users, so as to create a structurally stable, ritualized pattern of behaviour, or [claim #1.2, antithetic] incidental and sporadic a pattern of behaviour in users, essentially unstable as a structure. As for the connection between the frequency of happening and structural stability, you can consult what I wrote recently in ‘Fringe phenomena, which happen just sometimes’ .

That first hypothesis is something elementary regarding the absorption of any innovation whatsoever. Innovative behaviour in users is just one of the horses in the team that pulls that cryptocurrency-to-be. There is another: financial behaviour. The most elementary distinction that comes to my mind in this respect is the classical Keynesian ‘to be liquid or not to be liquid, that is the question’, or, in slightly more scientific terms, the dichotomy between liquidity and speculative accumulation. We can go and grab some cryptocurrency in order to pay with right now, or, conversely, in order to accumulate it for unspecified, future liquidity. John Maynard Keynes used to make that distinction referring to propensities in human behaviour. Whilst I find those Keynesian distinctions elegant and well-rounded, I find them hard to apply in practice. Propensity is something I can hardly pin down empirically, I mean how frequently do I have to do something in order to name it ‘propensity’? If I follow the given pattern of behaviour fifteen times out of one hundred, does it already deserve the name of ‘propensity’, or, maybe, should I add some more incidences?

That graceful indefiniteness in the Keynesian thought makes me think about something more precise in terms of theory, and so I turn to Milton Friedman and his quantitative monetary equilibrium, P*T = M*V for those somehow closer friends, where P is the current index of prices, T stands for the volume of transactions in the units of real output of the economy, M is the monetary mass supplied, and V is the velocity of said monetary mass. If people generally use money for paying, the velocity of money, measured as V = [P*T]/M, remains fairly constant. It means, in other terms, that any change in the amount of monetary mass supplied should, logically, cause a proportional change in prices. On the other hand, when money is being hoarded, and users build speculative positions with it, the velocity of money decreases. The link between the supply of money and prices weakens. My money, in this case, is the cryptocurrency I am testing, and is nominal amount, i.e. the number of tokens issued, corresponds to the M variable. The volume T is the number of kilowatt hours of renewable energy traded for those tokens, and P stands for the (average) price of one kilowatt hour.

My second, experimental hypothesis regarding that monetary side of the thing is, once again, antithetic. It says that [claim #2.1] that the freedom of issuing a cryptocurrency attached to the market of renewable energy, combined with unconstrained supply of said energy, is going to produce speculative behaviour, i.e. the hoarding of tokens and decreasing velocity in their circulation, without direct leverage upon the price of energy. I am grounding that claim, somehow intuitively, both in my own research and in the article by Dirk G. Baur, Kihoon Hong and Adrian D.Lee . Antithetically, I formulate [claim #2.2], namely that the issuance of cryptocurrencies attached to the market of renewable energies is going to produce just liquidity in users, i.e. those tokens will have constant velocity, without significant speculative positions.

You can notice that when I formulate experimental hypotheses, I do so in slightly different a manner from my normal hypothesising, i.e. I use that construct of antithetic, internally structured set of claims. This is a very intuitive approach from my part, and from the part of most human beings as a matter of fact. The habit of classifying phenomena in two antithetic categories, sometimes designated as the rule of excluded third, is very deeply rooted in our culture. The classical, Aristotelian logic is based on this pattern (you can find a lot of interesting stuff about it in the writings of my great, and defunct compatriot, Alfred Korzybski). It is just that thing about experiments: you don’t really know what kind of results they are going to bring, and, basically, the more ambitious is the scientific design of an experiment, the more surprises it produces.

I am consistently delivering good, almost new science to my readers, and love doing it, and I am working on crowdfunding this activity of mine. You can consider going to my Patreon page and become my patron. If you decide so, I will be grateful for suggesting me two things that Patreon suggests me to suggest you. Firstly, what kind of reward would you expect in exchange of supporting me? Secondly, what kind of phases would you like to see in the development of my research, and of the corresponding educational tools?