I have to admit our Trading Model (over on the Peoplenomics side of things) has been hard to believe. All through this broo-hah over the Ukraine situation, the Model has remained firmly bullish. And, amazingly, the S&P hit 1,876.53 yesterday, putting in yet-another high.
What the Model is telling us is that the Bernanke-turned-Yellen Fed is closely watching their computer models, just as we watch our own.
At the core of it is rumored to be something called the DSGE which has a Wiki entry more articulate than me at this hour:
Dynamic stochastic general equilibrium modeling (abbreviated DSGE or sometimes SDGE or DGE) is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics. The DSGE methodology attempts to explain aggregate economic phenomena, such as economic growth, business cycles, and the effects of monetary and fiscal policy, on the basis of macroeconomic models derived from microeconomic principles.
Sounds like the financial version of WOPR, doesn’t it?
I’d tell you this is a picture of how it works, but not quite.
You see, this is a famous drawing of how something called “Reductionism” may be envisioned? At its core in an insight into how ‘intelligent thinking’ works.
It’s all about how people “class” their observations.
It starts off with noticing that some animals – like snakes – have no legs. Yet other animals do. And some animals have two legs, and some of these (about 7-billion, plus or minus a birth control pill) are humans.
And we all pretty much “work the same” in terms of underlying “software.”
Of course, how your software is programmed varies widely. Some parents program jihad, while others program crusades. Language limits as do passed on beliefs. The number of people who actually self-program (tearing everything down and rebuilding) is maybe 3-5%. Everyone else gets to just run with onboard code. Freakin EPROM society.
The “E” being electronic media which can do limited rewrites which is why advertising exists.
Which has what to do with the market’s new highs? Oh, that….
Well, you can look at the DSGE code, rumored to be used by the Fed and other macroeconomic econometricians (pretty good for one cuppa coffee, huh?) and they can – over time – load in enough supporting data tables, that the DSGE can do a pretty good job of predictive economics. So much so, that one might be tempted to believe that there is nothing between the market and moon.
But, of course, there is.
The first major problem is what happens when interest rates turn.
Remember how the DSGE likely (may) think the markets work: A 1% interest rate implies that a $1 dollar dividend should give a $100 stock price. But suppose that the prevailing interest rate begins to climb and goes to 2%. What then?
In that scenario, the $1 dollar stock dividend now only justifies a $50 stock price, since bonds and stocks are always dueling over who offers the best returns for investors.
When the interest rate climbs to 5% (which is around normal over the very long term) the same $1 dividend-paying stock is whacked down to a $20 proposition.
Key lesson here: The decline of the market (to maybe as little as one/fifth of its present price) needs only a major interest rate hike to “make it real.”
And that’s why I want you to go over to the long term bond chart and watch it like a hawk because as goes interest rates, so goes the financial world.
The second point about this morning is that the previous work in DSGE’s has likely been augmented now with “machine learning” such that additional inferences (and levels of precision) may be in the works.
In a 2011 paper, the Divisions of Research & Statistics and Monetary Affairs Federal Reserve Board, Washington, D.C. have this delightfully revealing paper titled “How Useful are Estimated DSGE Model Forecasts?” This part of the abstract is key:
“Our finding is the DSGE model analogue of the literature documenting the recent poor performance of macroeconomic forecasts relative to simple naive forecasts since the onset of the Great Moderation. While this finding is broadly consistent with the DSGE model we employ{ie, the model itself implies that under strong monetary policy especially inflation deviations should be unpredictable, a wrong” model may also have the same implication. We therefore argue that forecasting ability during the Great Moderation is not a good metric to judge the usefulness of model forecasts.”
I suspect the “Great Moderation” refers to the decline of interest rates since the 1980’s – about as tough a forecasting world as you’ll see. But now, we “get it.”
Now toss in modern machine-learning tools and who’s to say the DSGE can’t become adaptive, and do a better job of calling the economic shot than humans?
Remember, machine learning of legal proceedings is already predicting outcomes of high court decisions somewhere north of 75% accurate while panels of expert lawyers are running about 66%. One of those (pard this) “Oh shit, we really are becoming obsolete” moments.
Which delivers us to this morning’s economic ponder: What IF the Fed and other central banks around the world a) have been sharing DSGE models and b) what if they have applied machine-learning and c) what if the “managed economy” is slowing being smithed into the first rolling “wheel” by the coders in the back room?
To be sure, there would still be variations in the model (as trading is inherently noisy) but as we see in the market recently, there’s an underlying tendency and that begs the question: While everyone’s off worried about prepping, World War III, energy shortages to come, and all that, what are the REAL IMPLICATES of someone in the back room coming up with a machine-learning enhanced approach to DSGE that could deliver the Holy Grail of economists?
A managed economy.
You look at the inputs that are possible (on mood-swings) and answer me this:
“If you had access to the kind of mood-swing information that the NSA has, and if you could plug that “mood data” into a super-DSGE, don’t you think a managed economy might become doable?”
It would be the “story of the century” but wouldn’t admission be a public relations nightmare? Especially if, for example,. the G20 was playing in “synchronized-swimming” fashion?
But it would explain the power of the spy agencies and it would explain why Congress hasn’t whacked off the NSA and CIA (financial) nuts when the NY Times and McClatchy papers run stories about how the CIA [purportedly] spied on Senate staff looking into waterboarding and the like.
“Do you want an economy, or don’t you?” would be the quiet question over a key dinner, or two. “We own the economic outcomes across the board. Now be a good patriot so we can continue the data feed that lets it all happen…”
Ad hoc data sharing and use for machine learning is a real fact, though not much covered.
It’s an interesting insight, unprovable one way or t’other, but if the news fits, wear it.
Crimea Sakes, What Next?
Meantime, the Crimea (autonomous zone, which sounds like a zone from Star Trek, but again I digress) has voted to join Russia.. Since peeps in the area mostly speak Russia, it’s a “well, duh…” but I’ve been talking sense for weeks and no one cares.
Just remember, we’re on the side with the managed economy…which was, if my feeble is still working, something that was one of the BIG bugaboos of Soviet Communism, but’cha see how everyone trades places in history? Their managed economy was BAD and we attacked what? CENTRAL PLANNING!
OMG it’s so Redickingfokulous.
The press meantime, unable to see the mirror keeps parroting Hillary likening Putsy to Hitler. And again (as I look at the wreckage of the ACA) I ask…where have all the mirrors gone?
I must have missed the bill in congress making Central Planning an OK religion now in ‘Merica. But it worked the other way when we wuz pimpin dah Cold War.
Who knew? And even now, who says it? Cultural programming is, oh, so vital.
Meantime, Back with the FlashGov of Ukraine
All of which gets us to the “club” and who’s in, and who’s out. Notice this morning that the financial assets of the ousted president of Ukraine have been frozen by the EU.
Of course, they would be idiots for keeping money in EU banks when there are more flexible haunts like some of the Caribbean islands and Hong Kong, but that’s this morning’s war-by-other-means report.
Oh, except to mention the Russia Today report who quit on the air. The Daily Beast summary is a good read.
Flip-side action: Russia is saying (through friendly Xinhua) that Ukraine membership in NATO is impossible. Oh? Watch closely then, now that the West has discovered a push-back tool.
This about guarantees that with the Western loan guarantees, NATO membership will be a one-page application with a rubber stamp ready and NATO commanders ready to roll. Just not yet is all…
Overall, we are where we were when the whole thing began: The EU wants Ukraine not just for its domestic resources, but to control pipelines from Russia and the like. Russia would just as soon die (in multiple megaton flashes) than be invaded by Europe again and/or lose their warm water port.
Putin as a choice: Throw in with the managed global economy/ new world order, or go it alone or with China and the BRICs and wait for the West to implode when the economic system goes out of model parameters.
Trouble is, he doesn’t know what those parameters are because Snowden can only tell him so much and how the models run…no telling.
So we put the whole thing on simmer for a couple of more weeks while Ukraine becomes NATO and the Russians move things along in background, beefing in Crimea, and we sit back to watch the Dow follow the other indices to new highs shortly.
Then all the generals and others who are well-connected, in background, can load up on shorts and we will have another crisis (a month or two), billions more pocketed, and so the world turns.
Human progress is thus the replacement of clubs and sticks with nukes and software. Not sure if that’s much to be proud of, but it is what it is.
Strategic Stockpiles
Meantime, our framing of present history as the “Manufacturer’s Resource Wars” continues with this addendum from our Winnipeg news analyst:
Dear Mr. Ure,
Titanium dioxide appears to have many uses and the BBC reports of Americans who have been convicted of selling production methods to the Chinese government-owned Pangang Group.
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