Locklin on science

In which I have a laugh at economists: whistling at the abyss

Posted in econo-blasphemy, history, philosophy by Scott Locklin on July 31, 2011

I never studied economics. Don’t pretend to understand it. Don’t want to understand it any more than I want to understand Voodoo theology or radical feminism: it seems to me a pernicious form of anti-knowledge. Some of it makes a little bit of sense (maybe voodoo theology does too: dunno), but looking at it like a visitor from another planet (MFM Osborne or Joe McCauley are reasonable approximations, being from planet Physics), it doesn’t look much different from schools of medieval medicine, punctuated by occasional linear regression models. There aren’t generally falsifiable models, and when there are, people seem awfully reluctant to test them. Economic schools seem to grow up around charismatic prophet types, and the arguments for their validity seemed to be along the lines of “Rabbi X said Y, and lo, he was correct.” I think everyone on the internet has seen the Hayek vs Keynes rap, which is about as good an introduction as one could hope for to this sort of thing. I think the intellectual content of a posing rap battle is about as much as one can hope for in this sort of argument as well; ultimately, it’s just a dong wagging contest.

Hayek’s views on economics are, I think (and someone please correct me if this is a misapprehension) closer to the conventional thinking in the 1920s. Keynes views seem to be something approaching the conventional wisdom in the 21st century. Austrian views are “conservative” and Keynes is “liberal” (in the American sense anyhow). This is a broad generalization; most modern Keynesians have some Austrian ideas, and vice-versa, but ultimately, the debate between these guys boils down conflict between these two ideas:

  1. Expansion of debt is inevitably followed by economic recession (Austrian Business Cycle Theory).
  2. Economic recession is ameliorated by deficit spending (Keynesian idea).

The historical battleground they fight their idea on is the Great Depression and WW-2; the events which formed the modern world. The modern Keynesian view is that “Austrian” ideas made the great depression worse. The government, according to them, should have engaged in lots of deficit spending, and that would have magically made things all better. After all, things only got better after WW-2, when we engaged in lots of deficit spending, right? I’m certain the Keynesians have all manner of regression models with which to “prove” this idea, but ultimately, they’re only using one set of data points, and only a couple of variables. This school of thought seems to have won the modern day; we’re at WW-2 levels of deficit spending now. Of course, we’re not spending the money on the same things at all. It’s not clear to me how the Austrians account for the financial success of the United States (and Japan and Germany and the Soviet Union) in the post WW-2 era, but it seems likely to be an equally specious shaggy dog story.

I don’t know if any school of thought argues that the war itself had something to do with things, but I’m going to argue exactly that; call it the Heraclitus school of economics. Seems like an obvious thing to me. I can’t “prove” it using regression models, or by being a college professor or whatever nebulous vril economists use to “prove” their points, but it seems as ultimately convincing as anything else. My toy model does something few economic ideas since Pareto has done: it takes into account the fact that we’re talking about large groups of actual human beings, rather than utility optimizing economic robots.

To reiterate: in Krugmanistan, the prevailing idea seems to be that printing a lot more money will magically make things all better, because dropping lots of bombs on Germany and Japan seemed to be good for the American economy in WW-2. To a Keynesian economist, it was the magic of the printing press. Not the fact that the US developed new technologies, invested in vast new industrial infrastructure, mobilized its entire population, brainwashed its civilians into working double shifts for small amounts of money (and buying lots of government debt), brainwashed its military aged men into fighting a war in distant countries, displaced vast segments of the population to work in factories; hell, we even put women to work in factories. All those other countries did the same thing. Car makers and other manufacturers built giant ships, aircraft which couldn’t have been built before, new kinds of vehicles, tanks, atomic bombs, jets; radio makers made huge strides in electronics, computers and other electronic techologies: and all these companies retained the ability to produce these new technologies after the war was over. Entirely new forms of economic output were possible after the war which weren’t possible before. To name five obvious ones: Airlines, Computers, Atomic power, Highway travel, Rocketry. These new technologies and manufacturing capabilities became new industries which provided people with jobs and further economic output creating things which were figments of people’s imaginations a decade previous. The United States (and all those other countries) made a hail Mary investment in their infrastructure, and transformed their people into fanatical worker bees. The amateur businessman could look at this as an investment in the country; an investment in the employees and the infrastructure. By accident, it was a reasonably intelligent investment for future growth. And after that, the economy did a lot better. Economists want you to believe it had something to do with printing money or business cycles.

I don’t buy the arguments of economists. I think the reason things changed for the better after WW-2 is people were transformed into something they weren’t before, and the national infrastructure was transformed into something a lot more capable than it was before. I do think availability of money is important (duh), and deflation is generally worse than inflation, but if you asked me why WW-2 was followed by a period of prosperity in the US, the above is my reason: nothing to do the magical printing of money or lack therof. Single factor regression models rarely work on systems more complicated than a couple of diodes: why should I be impressed by spurious regression on ancient data?

Another thing economists don’t seem to notice much: the nature of the population. Taking only one variable: mean age seems important to me. Old people don’t work or innovate as much as young people. Old people also have more money than young people, and they do things like invest this money in hopes of making rent on it. Basically, finance is the loaning of old people money to young people, so young people can do useful things with the money, like start businesses. Populations in all industrialized countries are getting older. This means there is a surplus of old people money seeking young people to invest in. This is why interest rates are low, despite all the printing of money going on everywhere. If there were more young people, we’d be in a completely different pickle. This single fact pretty much makes rubbish of any statistical model based on historical data: we’ve reached a fundamental change point which is unprecedented in economic history. There are no historical regimes in which there were lots of old people money chasing young people to invest in. The idea of fitting an economic model to something in the 1930s and expect it to be relevant today …. I might as well trade a model based on 1930s IBM stock prices.

Me? I’m not an economist, or a prophet. I work for a living. I don’t have any answers, and I don’t have any bright ideas as to how to fix the mess we’re in. I’m pretty sure nobody else does either; certainly no politicians alive today are saying anything remotely sensible -it’s all magical thinking, and genuflections before long dead sacred idols. Since I’m of a scientific bent, I wouldn’t mind running some experiments. It seems to me the country is large enough this sort of thing is possible. Hopefully we don’t have one forced on us.

Music, molecules and misanthropy (econophysics part 1)

Posted in econophysics, philosophy by Scott Locklin on February 2, 2010

I make no secret of my disdain for “social scientists.” Most social science is just some guy telling you a story, and pretending to be a big shot. It isn’t much different to me than some ancient bearded fellow at the campfire explaining lightning as sparks from Thor’s hammer. Economists shouldn’t be so bad. They have actual numeric data, data on the economy itself, financial data and individual data. They have grand theories about how the world works. They should be able to do something. But their ideas usually have the substance of political ideology. If they’re feeling particularly ambitious, they’ll wire their idiot ideology up to some weaksauce math like Granger causality.

Physicists are people interested in modeling things from first principles. They occasionally try to come up with some more interesting models than professional economists have come up with thus far. For example, consider a bunch of people in an auditorium listening to some bad opera music. According to something like standard utility theory, each person in the audience will clap based on how much they individually enjoyed the opera. The collective clapping function is the linear sum of the individual clapping functions. If you believe standard utility theory, every individual in the crowd has N claps worth of utility in them, and will give those N claps according to when they precious well intend to clap and stop. Same thing with standing ovations.

Ever been in one of these audiences? If you have, and you paid attention, you’d notice that people mostly clap and stop clapping in total synchrony with people around them. Same thing with standing. Occasionally some brave person will stand prematurely, and the social forces in the theater will force him back down again. Then the damn fool will stand up again when the rest of the crowd tells him it is OK. Same thing with clapping, or stopping clapping. Some people will stop clapping before those around them do. They sit uncomfortably for a while, then they start clapping again, until everyone else around them decides to stop. You can also observe patterns and defects in the behavior of people in this social lattice: there may be a group on the right, or towards the front who are more enthusiastic or subject to peer pressure.

“people, or spin-1/2 particles? hard to say from far enough away; everything looks small”

As it turns out, this behavior can be modeled pretty well using the ferromagnetic random field Ising model; a model which derives magnetic properties based on how microscopic spins in a substance work and interact with each other. In a ferromagnet, such spins have what amounts to peer pressure from exchange forces arising from the Pauli exclusion principle. A random field is added to each spin location to give a “tendency” to an individual clapper (or a spin). An overall driver field is added to provide a stimulus (this field can be 0, like when there is no external magnetic field, or they turn out the lights). And you can vary the strength of the “peer pressure” forces between spins or clappers. You can observe all the phenomena of ferromagnetism: domain walls, echos and hysteresis in the social lattice of the clapping opera fans. One of the interesting results¬†of all this is that, in systems with a lot of peer pressure, you can get very abrupt drop off of clapping without a sharp change in the driver field (aka, how much the lights come on after the Opera). In fact, this is sometimes observed, generally in societies with strong peer pressures. Even when it is not abrupt, the drop off follows a pretty distinct scaling law. The details of such models are mostly in the network type, which, in the case of concert halls, is a square lattice, like the one shown below.

“+/- denotes opinion, color is tendency, and the big arrow an external driver field”

I’m not the only person to think of using Ising models to model crowd behavior; there is a small industry of econo-physicists who use such models. I originally read about it years ago in a book called Synergetics by Hermann Haken (a book which has been formative in my way of looking at the world). Not only are these kinds of models pretty good at reproducing phenomenology, as J.P. Bouchaud and friends proved, they’re even pretty good at reproducing actual numbers in more or less controlled experiments. They’re good at other things too; for example, such networks can reduce to Hopfield nets in some approximations. Which rather indicates they’re also useful for modeling how individuals make certain kinds of decisions as well. In other words; not only do you act like you are one of these spin-1/2 particles, in many situations, you act like your brain is made up of a scale free network of them. The same models can be used to model advertising or political campaigns, rumors, mass hysterias and fashion trends. And the numbers match up pretty well. I’ve seen the model applied to all kinds of things. I even know about a way of mapping it onto the Bass diffusion model.


“The end of a clapping session. Note rapid fall off; the black curve dies off faster than the echo time of the room it happened in, meaning social pressure to stop clapping travels faster than the speed of sound -I stole the graph from a paper by Q. Michard and J.P. Bouchaud” which is well worth your attention if you like this brief treatment

Consider all this the next time you are in a concert hall clapping for some trained baboon who thinks he is Ludwig von Beethoven, and the dimwits next to you are going into transports over what a wonderful performance it was (of course it was wonderful; they paid $300 for the seats!). Do you find yourself clapping because you think the monkey deserves it? Or do you find yourself clapping because you’re a molecule in a lattice of humanity? What does that say about you in the rest of your day to day life? How much of what you do and think you are is just because of social pressure? How many celebrated trends and movements, no more enduring and dignified than a spin-1/2 particle helplessly flopping around in response to other mindless spin-1/2 particles? Let’s face it; if you know someone else who has similar opinions to yours, if you run in a crowd, if there are others who are like you: this is probably why. You have to be pretty misanthropic to grasp this on an emotional level, but it’s something philosophers have been saying for centuries, and now a days you can actually write code which models it.

The implications for trading trends are obvious. Since people in “peer pressure” situations can ¬†change their minds abruptly, one needs to be ready for the flip over, or at least aware of the nonlinear conditions which can lead to an abrupt change in people’s positions. Are their hints as to when people are going to stop clapping? Well, let’s talk about that in part two. Professor Didier Sornette seems to think so. Sornette worked with the Random Field Ising model, but his fame has come from a sort of scaling law he has come up with dealing with trend followers and opinion bubbles.

A peregrination on the nature of money

Posted in philosophy by Scott Locklin on December 1, 2009

I’ve never studied economics. What I have read of economics appears to be ideology combined with bad math. Since so much of what passes for modern thought is annoying ideology combined with bad math, I try to avoid such unpleasantry. History, on the other hand, I always have time for. I would like to think using history to think about mysterious concepts like money is useful, but maybe not. It amuses me to do so in any case.

What is money? As I see it, money is a measure of economic output, which is used to create liquidity in markets, and which is backed by social agreement. Without money, you can’t buy things. If you can’t buy things, you’re stuck with your own economic output to make a living. Have fun dirt farming.

The earliest form of money was commodities. If you wanted a horse, you’d trade some grain for it. Later on, people learned to love silver and gold, and the rarity and density of these metals made them useful to trade for other things. The fact that gold was rare, inert and next to impossible to fake made gold that much more valuable than other materials as a trading instrument. The Lydians were the first to invent coin money in the 600’s BC. Coin money was a standardized mass of precious metal with a proof mark on it. People seem to think commodities are good hedges against inflation, and this is sometimes true, but, for example, Europe experienced hyper inflation in the 1500s and 1600s when Spain brought enormous gold hoards into the European economy. In a commodities denoted economy, if there is a sudden increase in supply of a commodity without an increase in economic output, inflation follows. Nobody did any more useful work, but there was more money. Therefore, you needed more money to buy a given amount of work, or anything else. If an increase in the supply of gold was accompanied by a similar increase in productivity, everything would balance out. For example, if your increase in gold comes from inventing the steam engine, you can use the gold to buy all kinds of other stuff made with steam engine productivity. On the other hand, if you only use gold for money, and experience a huge increase in per-capita productivity without an increase in the amount of gold, money doesn’t circulate freely; you get deflation. This means, holding gold is a better idea than spending it on stuff. This happened in the 1930s in America. This is why the 1930s sucked. This is also why people who want to return to the gold standard are insane. Gold works great when your society and economy doesn’t change much, but when it does, you need more flexible kinds of money. Another way to think of it: imagine your society has one hundred people with X pounds of gold. Now imagine hundreds more goldless people start to move in. Your gold becomes more valuable, so you’re less inclined to spend it as long as people keep moving in. That’s deflation. Now imagine your population of 100 people with X pounds of gold catches plague. The amount of gold stays the same, but the number of people who can do work gets smaller, so you get inflation.

A slightly different form of money is commodity backed money. In the old days, for example, the British Pound was backed by a pound of sterling silver. The first form of commodity backed money I know about was from ancient Sumeria, where they used clay figurines of goats to represent real goats. Between 1945 and 1971 (or 1973, depending how you count it), the US dollar was backed by gold reserves, though it was illegal for individuals to own gold reserves of their own, to prevent a run on the bank. Why? Because the Federal Reserve didn’t have enough gold in it to pay every depositor off. So, even though we used to have gold backed paper money, it was really just an idea of being paid off in gold. Between 1945 and 1971 nearly all forms of money in the world were based on US dollars. We had large gold reserves because we looted the world of gold as payment for WW-2. Since nobody else had any gold, and there really wasn’t enough physical gold, the convenient method of exchange was the dollar, as symbol of gold. The fact that all currencies were based on the dollar was not necessarily a good system for anybody (and it periodically had to be adjusted by moron economists: whenever it was, it caused huge problems), but it is an important historical fact. Commodity backed money is simple to understand. It’s just a convenient symbol for the stuff it’s backed by. In principle, it’s equivalent; just more portable. While people may look at that era as an, um, “golden era of hard currency, they somehow overlook the fact that the gold was a social fiction. I’m certain we didn’t have as much gold as dollars, though I don’t know how well this is documented, or even where it would be documented. The gold standard was really an idea, rather than a big pile of metal.

Another form of money is fiat money. That’s what we use now since the dissolution of the Breton Woods agreement. This agreement was broken in 1968, because the US was systematically devaluing its currency to fund Johnson’s “great society” programs, the Vietnam war, and the Space Program. Gold began to float against the dollar in 1971, basically because we didn’t have any more gold to keep up the social fiction. Now, US dollars are worth whatever you want to pay for them. In some ways, dollars are a bet on the US economy, which remains the largest, most stable and most productive in the world, despite all the present horrors. So, people still tend to base their currencies on dollars. Especially when they do a lot of business with America, which virtually everyone does. Problems can happen, however. If you export a lot to America, and your currency is fixed to dollars, you have to buy American debt. Which means, you’re buying your own currency, setting it on fire and sending America stuff in exchange for the currency you set on fire. This more or less works, until the debt becomes close to your GDP. Once the trade imbalance becomes severe, a correction is inevitable, and unfortunately for the holder of the bonds, they end up being worth a lot less. Fiat money is a bet that the US government will give you stuff if you give them dollars. Fiat money in America was originally issued by states to pay state taxes with.

Fiat money was not invented in 1971. America had gone on and off this type of money many times in its history. The glorious Song Dynasty in China invented fiat money in the 10th century. It was generally used by governments through out history when they wanted to fund large projects, like wars. It has many advantages over commodity backed money; for example, you can easily make more of it if your economy expands. If you have less money than you need to run your economy, you get big problems, like Great Depressions. Why buy anything when your money is a better investment than the economy itself? Currency which is a better investment than the economy itself is an abomination which negates its own purpose. Let that sink in: it is important and as far as I can tell, irrefutable.

If you have too much currency in circulation for your economic output, you get inflation, which is a sort of tax on people who have too much money saved up. Inflating currency on purpose can be done to avoid deflation; as the Fed is attempting now. Inflating currency on purpose can be done to avoid paying debts, as the Germans did after Versailles. You generally don’t want too much inflation, or your money isn’t worth anything (post WW-1 Germany), and so it isn’t useful for trade, but it is really just as harmful if money deflates even a little bit. When currency becomes more valuable over time, people will sit on their dumb pile of money, and nothing will ever happen. America and most of the world in the 1930s was an example of not enough money in circulation. One of the reasons the fascists (and, more obviously, the Swedes) did so well economically, is they issued fiat money. When you read the primary sources for the history of the Great Depression, you can see that all of FDR’s crazy ideas were ham-fisted attempts to create inflation without actually going into debt (Hoover was doing the same thing; I don’t know why he gets such a bad rap). The real answer was much simpler; create more money. When FDR did this to fund the destruction of Europe and Japan, the economy finally got better.

A prevalent but mysterious form of money is “credit money,” which is fiat money backed by banks, rather than by governments. People make a lot of noise about how credit money is some new form of supreme evil. Credit money is actually very old. Any time a bank would issue cheques or notes which were not backed by gold, they invented credit money. Now a days, banks issue credit money when they sell bonds. You can think of fiat money as a form of credit money issued by a government. But banks issue even more money by writing loans which are backed by bonds. In the old days, this was even more obvious: banks actually would issue their own notes. You might have “Wells Fargo dollars.” In more recent times, this sort of money is created by banks and hedge funds issuing derivative securities or exotic bonds, either backed by nothing, or backed by other securities; securities for which there may or may not be a market, and which may or may not have actual value. The use of credit money seems to help more than it hurts, as it allows private entities to create money when liquidity is needed by the economy to do things like, say, buy lots of stupid houses in the suburbs. Credit money is no different in principle than the government selling “war bonds.” You’re just funding different kinds of activity. Is it a bubble? Not a bubble? The way to answer the question is, is the credit money used for something worth investing in.

One of the little appreciated facts of American history: the Westward expansion was funded mostly by credit money. Banks and companies would set up shop with tiny gold reserves, people would use their money as currency, and the banks would regularly explode, making the issued money worthless paper. Why on earth would anyone back such a hare brained scheme? Simple, really: there was no other form of money available, because the government removed vast amounts of money from circulation in the form of greenbacks (fiat money which funded the Civil War) and silver notes. That, combined with the very real economic expansion brought on by new technologies and exploitation of new resources in the American West required much more money than was available. So, seemingly silly monopoly money was the only game in town. This caused problems to the people who held a lot of cash backed by an exploding bank, but it solved more problems than it caused, as it enabled markets, trade and economic growth at an important time in American history. You think derivatives are complicated? At the outbreak of civil war, there were over 7000 different kinds of Bank issued credit money in circulation in America; and there were no computers to sort this all out. Yet, America in that era was a Capitalist marvel; one of the greatest economic and industrial expansions of human history was funded on credit money. Sure, we were in the Long Depression but it was also the gilded age. “Funny money” works just fine, if your purpose is to get people to do useful work. The point of money isn’t to keep something in the bank like most people think: the purpose of money is to circulate. The “funny money” was used directly for what it is good for: people worked for it, and the fruits of their labor continued to exist after the money disappeared: aka, all of America West of the Mississippi. All the rail lines, mines, buildings, plumbing: they’re mostly still there. Sort of like all the houses, fabs and facebooks which were built in the 00’s, when that pile of credit money disappeared.

So, history indicates money is a measure of economic output backed by social agreement, which is used to create liquidity in markets. This sort of historical definition probably implies all kinds of other interesting questions, like what is a market, a bank, economic output, liquidity and so on. I’m not real interested in creating a school of economics, but it’s good to get to some kind of basic understanding of this sort of thing without looking through someone else’s blinders.

For a view into current events, I think Krugman is uncharacteristically spot on:
http://krugman.blogs.nytimes.com/2009/10/19/americas-chinese-disease-not-quite-what-you-think/

And on a lighter note:

applications of financial ideas to everyday life

Posted in philosophy by Scott Locklin on September 12, 2009

The capital assets pricing model (CAPM) was developed by Bill Sharpe in 1964. The basic idea is, your expected rate of return on an investment is proportional to the risk you take:

capm

The derivation of CAPM assumes a lot of things, for example that you are on the “efficient frontier.” The efficient frontier means you will maximize your returns if you make smart risky bets. For example, playing russian roulette is extremely risky, but it only pays off if you’re a character in the Deer Hunter -otherwise Russian roulette is very far from most people’s efficient frontier.

Like most “laws” of finance, CAPM is only approximately true, but it is still a broadly useful model. If you look at stocks with big rates of return, and run the machinery, you see that they have a high beta: a high risk versus the market average risk. It’s easier to think about with a concrete example: if you bought GE shares in 1998 and sold them in 2007, you’d make a little money. If you bought Ebay shares in 1998, you’d have made bank. Of course, you may have bought Pets.com in 1998, in which case you would have lost your entire investment. Both Pets.com and Ebay were inherently risky propositions, as nobody really knew if they were ideas which would take off, let alone of they were well run companies. If you gamble on risk, you might get a big payout, or you might get nothing.

People make a big deal about the philosophical implications of weird things in physics. For example, the seeming psychedelic unreality of quantum mechanics is often used by mush-headed people to justify whatever solipsistic spiritual nonsense they believe in. This was great discovery to me when I was a dorky grad student. When I discovered that women who believe in “new age” ideas will find you incredibly interesting if you mention Hilbert space, I’m pretty sure Alzo Sprach Zarathustra was playing in the background, like when the Ape-man in 2001 discovered that you can kick ass using bone clubs. At last I found a way to use Hilbert space for something in my everyday life! I’m pretty sure my discovery is the source of all the quantum mechanical mystical gobbledygook out there; surely other people noticed this as well. Certainly my theory makes more sense than the idea that quantum mechanics as weird mysticism has anything to do with actual reality.


“This is what it was like when I discovered an application of Hilbert space to everyday life!”

Regardless of the prurient uses of Hilbert spaces, the fact of the matter is, life is a lot more like finance than it is like misunderstandings of post 1920s physics. Finance is a purely human endeavor, so you’d expect the laws of finance to have some bearing on everyday life.

In ordinary life, CAPM is a useful law. People who take risks have more rewarding lives than people who don’t. People who don’t take risks end up living lives with the consistency of bland porridge, and are often struck down by the chances of fortune no matter how hard they try to live an orderly life. I am pretty sure that the only time your life will be risk-free is when you are dead, sort of like your financial life is only risk free when you have no money. The closer you get to a risk free life, the closer to waiting for death you are. It’s an odd phenomenon that people who live in modern societies are so often miserable. I used to think it was because life was too soft. Now I think it’s more related to the fact that modern life doesn’t contain enough perceived risk to make it seem worth living. Human beings are adapted to a world of random chance; we like taking chances. Deprived of chance, we become miserable.

20421_635992i

Most people don’t think of themselves as gamblers; they prefer to think of themselves as people who make deliberate and rational choices in a deterministic world. Modern society is set up to give us all the illusion that we can be protected from all risk. Tort law in America is set up with the assumption that everything works in a Cartesian fashion, for example. There is very little allowance for randomness and fate: someone or something is always held responsible for bad things. The way modern people think about life, if you don’t eat enough broccoli, you’ll die of cancer, or if you eat too much bacon, your heart will explode. The reality of things is you will probably die of cancer, stroke or a heart attack no matter what you do. If not, you got into a car wreck: driving cars is a risk most people willingly take which is much more serious and deadly than eating bacon.

Similarly, people misunderstand the role of risk and randomness in their professional lives. Most people, for example, get jobs. A job seems like a relatively risk-free lifestyle. Jobs certainly remove virtually all upside potential, so you’d expect to be compensated with lower volatility. I think a lot of people are now finding out they mis-calibrated their job volatility risk. Is a job on the efficient frontier? Probably not as often as you might think. For example: if you attempt a career in physics in the 21st century, your chances of having a nice life are fairly low. The probability of actually getting a job in physics is fairly low. Even if you manage a job in physics by being lucky, marshaling all of your military and naval power, and having no life for a couple of decades, you’ve basically gotten yourself a job which pays about the same as being a cop or an auto mechanic (I know: I’ve done all three). Job security … well, tenure appears safe for now, but I’m of the opinion that higher education is another speculative bubble: so, best of luck with that. Some might argue that the potential for great discoveries outweighs all these low expectations; guts for glory as it were. By my calculations, moving to Hollywood and getting a job as a waiter in hopes of becoming a celebrity has a higher probability of success than hoping to become an immortal in the world of physics. How many great breakthroughs in physics have you heard of in the last 50 years? Can anyone name any? Yet, there are 47,000 members of the American physical society, each one of them at least secretly hoping at one time or another to win the lottery. I guess probability theory isn’t taught correctly in physics grad school. That’s probably a factor in why nobody understands quantum mechanics. A fun irony of all this: their career choice makes modern physicists much more the gamblers than, say, quants. I’d like to think this is because quants understand CAPM.

When you come to appreciate the fact that life inherently involves randomness and gambling, you can start taking risks that make sense. The casino is a great metaphor for life; potentially filled with fun and games, but random and with a mean expectation of zero. Once you understand that your life is governed by the laws of probability rather than Cartesian determinism, it becomes easier to accept the vicissitudes of fate. Once you realize that most decisions in life involve significant risk and uncertainty, you can start making intelligent decisions about your life. Once you understand the applications of CAPM to your life, you can realize your own efficient frontier. People may think I’m some sort of mad scientist for advocating treating your life as a gambling game, but you can see this at work in many individual lives.

2661894

If life worked according to Cartesian determinism, you’d expect chess players to do very well in life, and gamblers to do poorly. What we observe in life is the exact opposite. Great chess players who are capable of calculating complex moves many steps ahead have horrible chaotic lives. They think they can plan things and understand the world using determinism, and this world view fails them. Poor Bobby Fischer, one of the greatest chess wizards who ever lived, had a miserable life. His belief in determinism turned him into a raving madman, hardly capable of the simplest of human interactions. Gary Kasparov, a man capable of beating supercomputers at chess, tried his hand at Russian politics and failed miserably. By contrast, the colossi who rest their feet upon the world of politics, finance and industry are gamblers: almost every last one of them. From Julius Caesar to T. Boone Pickens; games of chance have taught great men how to win in life using probability theory. Gambling games teach you to remain calm in the face of fortune and keep your wits about you, as you wait for the right time to place your bets. Autistic deterministic games like chess may train logic and the memory, but they teach you nothing about life.

“It is a great piece of skill to know how to guide your luck even while waiting for it.” -Baltasar Gracian
craps-1