Tuesday, January 27, 2009

A bit more 'bout Equilibrium

A diligent (and, in my view, quite perceptive) reader of this blog, STS, was curious about my views on equilibrium.

I marvel a bit at the confident use of the term equilibrium in a case where a system spends so much of its time out of equilibrium. It's almost a kind of magical thinking. But your point about the timescale of equilibration (or trend reversal, at any rate) is well taken. Markets have timescales which relate somewhat inversely to their depth and liquidity. I suspect a better way to think of market equilibrium would draw upon an analogy with the rather turbulent 'vacuum' in quantum field theory -- full of spontaneous creation and annihilation and anything but 'settled'.

Before addressing his views directly, let me warn that discussion of words such as "equilibrium" which are used alternatively to describe both external natural world phenomena and the relation of human consciousness thereto is fraught with great peril of miscommunication. It would perhaps be better to use different words for each: a) to describe a stasis in a physical system as an equilibrium b) to describe the human condition of one-ness with reality with another word, perhaps the Greek eudaimonia, or the Buddhist enlightenment to avoid confusion. For the sake of brevity, (and because I'm too lazy) I'll use "equilibrium" and hope this warning will be sufficient to express my meaning.

(Whew!, who knew pedantry would be so exhausting)

Onward and forward.

To directly answer STS's comment, my argument was not that markets specifically or human consciousness of reality, of which markets are but a small subset, more generally were at equilibrium but that they tended thereto. The distinction noted above comes into play here as the path of human consciousness to equilibrium with reality is, at times, non-linear, and sometimes quite violent. Moreover, the, in my view, tendency of human consciousness to equilibrium with reality is a process, not a state- it can always be improved.

The Greek word, apocalypse, speaks to the non-linear path of equilibration when false views long believed are suddenly exposed as such.

There is a Zen Koan (riddle-story) which might explain this point.

There once was a young man who wished to be enlightened as to the secrets of life and death. He went in search of a monk who lived alone near the summit of a mountain who was thought to know such things. After a long search, the young man found the monk and asked his question. The monk though for a while and then told the young man of a large tiger who lived in the valley below. "Put your head in the mouth of the tiger and you will learn the secrets you seek," advised the monk.

I'll play Bodhisattva and share my views on the koan- the true purpose thereof is to inspire the listener to think, thus its apparent unfinished-ness.

If the young man does not seek out the tiger, but instead contemplates the likely outcome of such an action, he chooses a path of less apocalyptic enlightenment. One "secret" of life and death is that we all die. Another secret which often remains hidden is how. If you young man seeks out the tiger and puts his head in its mouth, both that we die and how he dies will be revealed. This would be an apocalyptic path to enlightenment.

In either case the tendency is for human consciousness to equilibrate to reality, gracefully or violently.

Now, if we could only find the monk who advised world leaders seeking the path of monetary enlightenment to adopt the policies of the past few decades...for the tiger's jaws are closing.

Next up: Gordon Brown, who sold Britain's Gold for, in hindsight, peanuts, as Cassandra. He saw it coming.


Hombre said...

Dude, while I often find myself in agreement with you, in this case I differ. I'm a believer in the Austrian school, which posits that the economy is merely the aggregation of the actions of all individuals within said economy. Therefore, equilibrium at the macro level implies equilibrium at the micro level (if micro sums to macro).

And I ask myself, when am I at equilibrium? Sitting at my computer after a nice meal I suppose I'm close. But when it comes time to get the next meal I have to decide what to eat. Where to go to buy it. And if I'm making any sort of financial decision there's certainly no equilibrium there. Deciding to buy a car, which one to buy and then where to buy it is a very conscious choice. Deciding whether to move money out of cash and into gold, stocks or real estate is even more so (and I'd argue more fraught with emotion based on the herding behavior of others). I'd be curious to know how one "proves" the existence of equilibrium in economic/financial matters. Because I believe it does not exist.

I much prefer Soros's quote, which you've used on several occasions, that the secret is to find the trend that is false, ride it, and get off before it is discredited. That seems like a much more accurate depiction of economic behavior than equilibrium.

Dude said...

Thanks for the comment.

As I wrote, my argument is not that human awareness is "at equilibrium" but that it tends thereto, sometimes quite violently from a state of, in hindsight, confusion.

The Soros quote to which I refer is, "find the trend whose premise is false and bet against it." Betting against the trend whose premise is false is a bet on equilibrating awareness.

I don't posit that equilibrium "exists," it seems to me more an idea which can prove helpful or not in understanding.

STS said...


Thanks for your reply. Your Zen account is right on target, but the very fact that zen is the most appropriate language available to describe human reality is sad commentary on the state of social science. The Problem of Method is still sucking all the oxygen out of the room.

I'm finding the word "equilibrium" increasingly misleading because of the distracting connotation of "stasis". The economy is a dynamical system without stable attractors (apart from the uninteresting "in the long run we're all dead" equilibrium, of course).

The problem with "tending toward equilibrium" is that it presupposes a predictable direction of motion which will result after our momentum away from it is expended. But what really happens is more like an evolution of the system from one regime to another.

In each regime one (or a few) economic variables seem to be in the driver's seat -- build more houses!, structure more CDO's!, write more CDS!, etc. -- and there is some "spring" being compressed by this trend.

But when the spring (from our basic physical intuitions about equilibrium -- Hook's law and all) finally has enough energy to counteract the trend, what happens is not "restoration", but merely "overthrow". Once houses/CDO/CDS are no longer in the driver's seat, there isn't a glorious restoration of the "rightful" king. Just an open field waiting for some strong players ready to prey upon the abundance of whatever craziness the previous regime generated.

In terms of dynamical systems, we're agreed that it's reasonable to attempt to use differential equations to model the economy. (Lots of variables, though. Far too many to be tractable with our 'bronze age' statistical models.) But because the system has no closed, periodic, stable orbits (sorry Austrians, Real Business Cycles, Elliott Wave, et al.) we expend a lot of misplaced energy on descriptions we keep hoping will be predictive.

To recap: markets have episodes I've called "regimes". These "regimes" are like the zen seeker in your post, wanting to know both that and how he will die. All economic regimes die, but we lack the economic theory that would account scientifically for when and how.

We can agree that the tiger has just chomped down on the houses/CDO/CDS regime. What takes his place is still obscure.

Hombre: Soros is good on this subject. He has the right intuition, but hasn't been blessed with sufficient analytical and expository skill to make much of it. Well, he's made a heap of money, but in philosophical terms ... ;)