The Market, in the 4th Dimension

Governance, Philosophy, Politics, Social Theory

adamsmithThere is no shortage of opinion, much of it from folks more knowledgeable than I, about how we might make sense of the recent financial catastrophe. Still, I continue to be struck by the way in which a recollection of Adam Smith is apt. By this I mean Adam Smith in his actual writings, not in his mythicized persona – Smith seems to share with Charles Darwin the indignity of massive and sustained misunderstandings of his core ideas. This makes it all the more remarkable that, for us today, Smith’s vision of the market 230 years ago was so clear that he can help us understand even its recent, science fiction-like, turn.

As I see it, many of the central lessons of The Wealth of Nations are about a tempering of enthusiasm for market forces. At every turn, Smith is ready to specify what the market cannot do. It cannot answer the demands of infrastructure, for example, or education. I suspect he would have agreed with the phrase that occured to me after Katrina: The invisible hand doesn’t rebuild levees.

One of his least often noted but bedrock critical claims about the market is about the relationship between laborers and employers. Smith recognized that laborers are unique among “commodities” in the way they bid for the price of their own labor. The upshot of this is that, as soon as laborers are competing with each other for jobs, and thereby given a choice between no job and a job for a pittance, they will take the pittance. This can easily leave them working for wages below subsistence level.

So Smith concludes from this that the only broad market condition that stands a chance of improving the worker’s condition is an expanding market. If the market expands in space rapidly enough, finding more people to participate in buying and selling, then demand can be high enough for workers to be scarce, and for the rising tide indeed to raise all boats. But Smith notes that should the market stop expanding, or contract, things turn very bad for the worker, very quickly.

This is an old economic lesson, of course. And I am sure that it could be picked apart in particulars – it is, after all, a very broad way of talking about things. But what I want to consider for a moment is this notion of expansion in space, and wonder what happens when the market, effectively, runs out of space.

If a significant cause of the recent catastrophe was the ease of credit – many formerly unable to buy homes led to purchase them, most famously, but let us not forget the proliferation of consumer credit in the form of credit cards – then suddenly the so-called prosperity of the last fifteen years or so makes sense in Smith’s terms, as long as we’re willing to shift from thinking about expanding in the dimension of space to that of time.

Consider what credit is – it is effectively an agreement that a future you will actually purchase the item at hand. So in a way the expansion of credit (helped along by a proliferation of financial “instruments” and related technology) fulfilled, temporarily, exactly what Smith would have predicted. It expanded the market not in space, but forward in time, and the number of available consumers continued to grow. We expanded our market in the fourth dimension.

But of course, it could not be sustained. The bets we made with our future selves were overly hopeful, themselves grounded upon the promise of more of the same paper-thin prosperity. We were not actually finding new markets (which in the long run is a losing proposition in any case) – we were finding ways to sell to us, but in another time.

And it all came crashing down, back to the present.

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  1. Kalman Applbaum  •  Feb 10, 2009 @8:52 am

    With a little encouragement, we have also expanded our storage to all possible limits. Storage? I mean our garages, closets, trunks, and, with the help of digital compaction, our computers, ipods, etc. Then let us not, especially those of us from “supersize me” states like Wisconsin, forget that many of us have stretched our skins in the selfless service of expanding Smith’s market to prosperity. This includes the consumption of pharmaceuticals, which has enjoyed most of its growth in recent decades against the threat of invisible (i.e., asymptomatic) and future illnesses, as a prophylaxis to them. The natural environment is similarly a repository for our excesses. Finally, let’s consider what the French Neomarxists had to say about the consumption of advertising and images—of spectacles and simulacra. Guy Debord wrote: “The whole life of those societies in which modern conditions of production prevail presents itself as an immense accumulation of spectacles.” By contrast with physical consumption (of butterburgers or snowblowers, to choose Wisconsin examples again), the potential for the consumption of signs, they argued, was infinite. But of course this isn’t so, least of all when taken from the point of view of the carrying capacity of the various biospheres in which we live, work and excrete.

    An alternative (to Smith’s) way of looking at this is through the lens of Marx’s “primitive accumulation.” Marx was a lineal descendant of Smith. He saw the process by which values of various sorts (labor and land, notably) entered the market in more dangerous moral terms than Smith might have. Ernest Mandel, Andre Gunder Frank and then David Harvey translated the Marxist version of primitive accumulation into mega theses of imperialism, of the expansion of capitalism. (Extraordinarily, there is a youtube of Harvey explaining Marx’s primitive accumulation here:

    As regards time, I don’t know of explicit discussions of it as you pose it in the work of Smith, Marx or, since I mention them, the Neomarxists and World Systems Theorists. But that doesn’t mean the most important class of economic thinkers of our time has not considered it strategically. Consider how economists and business leaders in the 1950s, amid the first explosion of consumer credit spending, spoke of the necessity to expand consumption to meet the growing productive capacity of industry. Linking national economic interests to the logic of the time border-crossing character of contemporary market and marketing culture, Park J. Ewart, a professor of commerce at USC, reasoned:

    “Is it not true, that in the United States economy we are inventing credit transaction models and putting them to work in the interest of consumers? Are we not extending the borders of the market place into time and thus increasing the choices of consumers? Is consumer credit not another economic force in an expanding economy leading to higher and higher standards of living?”

    Strategically, for the businessmen who invented the credit card in the 1950s, the expansion of credit implicated more than just a degree difference with money. Marketing to the imaginary future-realm of credit entailed a wholly different course and methodology, in the understanding that consumers may not only spend more, but differently. Vacations, flamboyant sports gear, and the borderline luxury items such as the latest computer technology (which are a means to more credit spending at intangible sites of exchange) have all boomed as industries undoubtedly because of the growing availability of credit to pay for them.

    In light of how far we’ve gone, it is only euphemistic, not alarmist, to say, “We have mortgaged our future.” Better to say, as you yourself might, that we have gambled it away at very long odds indeed. The market fundamentalists are still waiting for the deux ex machina to drown government in the bathtub so we can all be free to spend our income tax, medicare and social security too. These are our insurance for the future. Placing them on the trading block—i.e., as mere “futures”—is the most dangerous proposal of all.

    I like your drawing a distinction between Smith’s own “tempered enthusiasm” for the market and how he has actually been read and used by the Liberty Fund people to argue for market fundamentalism. A worthy project would be to follow this teaser up with a serious essay on exactly how Smith would be reacting to the current events. This would both help recast the great thinker’s ideas in the true light in which they should be read, and would bring us possible insights on how we of this much smaller generation of economic thinkers should respond.

  2. Thomas  •  Feb 12, 2009 @3:56 pm

    Thank you, Kal – that is a literal and figurative expansion on these ideas that goes well beyond my quite limited expertise. And the Ewart quote is priceless – you quite rightly note how often it is that those bound up in or closer to these projects are the more likely to make these leaps of insight, thinking strategically as you say, than perhaps the good number of social theory-minded academics and others out there.

    As for the suggestion to write a more serious essay on the subject, I’m flattered by the recommendation, and maybe I’ll take a crack at it. My dog-eared and weathered Liberty Fund editions of Wealth of Nations and Theory of Moral Sentiments are close at hand. For now, I’m quite taken with the current buregeoning efforts by conservative thinkers to help pull themselves and the Republican party up off the mat by recasting Edmund Burke as a pragmatist (!). More on this soon coming to a blog near you.

  3. Suzanne Johnson  •  Feb 12, 2009 @7:28 pm

    Nice to see a blog on Smith coupled with a reference to science fiction (would like to hear more about that – an analysis on Dr Who, Pirate Planet, perhaps?). In considering the containment/expansion metaphor (I’m adding in containment to offset this notion of expansion) in terms of what you point out about our being overly hopeful with our future selves (betting on the good idea to use credit), I am trying to understand the relationship between materiality and cognition. How do we understand the impact on our behavior of the many aesthetic messages visually and otherwise absorbed from daily life – surrounding comforts, tech, media, subsistence, etc – that prompt imagining ever greater insurance against a painful, collapsing realm of reality? I do realize that we are talking about consumption, credit, a messy de-regulated market, and making safer bets on our future selves.

    It is easy for me to sit here and muse about deeper questions while families out of work struggle to make pressing ends meet. Yet, there are great historical examples of hope and creative innovations in the face of struggle which have seemed to inspire elevation out of these depths. With the recent financial crisis, many have been slammed into an existence of intense struggle, and no one would ever suggest they reign in their imaginations or hope of transcendence to a better place. So how would you suggest containing the imagined 4D? Clearly, real-time decisions are being made based on a future of unknowns, which not only lack an accurate reflection of reality but also require accepting the contradiction of drawing upon a perceived endless vat of finite resources. But don’t you know about the vertical greenhouse prospects?! (On expanding agriculture upwards not outwards – Columbia University Professor Dickson Despommier: )

    Kal partially answers the question of what needs to change in Free Markets and the Unfettered Imagination of Value (published in Anthropology Today) by saying that those with the professional performative pull to influence broader opinion and thought need to dig to their deeper belief about human nature (as NOT completely self-interested) in order to curtail the trend of self-interested producing/consuming. We can separate out our hope from our behavioral recklessness through a more accurately reflective shift in deeper assumptions about human nature and self-interest, but is there also a problem with our blindly expansive imagining? Let us assert that our imaginations are reflected or encouraged by the comforts of consuming (eg – new tech). Inventions and innovations come about in part via imagination, which is inextricably linked to a previous set of material inventions. Is there an impetus to transcend our present material state that you would recommend containing? For now I will bypass asking the question of why we might have this impetus to transcend – generalized hope, preservation, relief of suffering, escapist notions, neuroses, simply to get our kicks with something new. Kal suggests we contain our obsession with constantly mining ideas for value. And it is clear that the greater the divide between possibility and innovation, the greater is the risk.

    Obviously the market needs to be regulated. I’m not sure how these regulations play out, are implemented, drummed up, or themselves checked, but in no way do I want to challenge that thicket of necessary confusion. I agree with Kal that a worthy project would be to follow this up with a piece on how Smith would react to our current crisis. However, my lofty question here is about constraint on expansive imagination, which more specifically derives from a certain fascination in your notion of a 4D transcendent state of future hope. Sci Fi UNITE!

  4. Adam Hyland  •  Feb 12, 2009 @9:40 pm

    A more substantive comment later, but I knew I recognized that picture from somewhere.

  5. Thomas  •  Feb 12, 2009 @11:00 pm

    Yes, indeed, Adam. Do I need to do more than let the hover text point to its wikimedia commons origins (much appreciated, by the way)? Happy to change the text (or add a caption) if needed…

  6. Thomas  •  Feb 12, 2009 @11:10 pm

    @Suzanne: I do think that part of the implication here, as it was for Smith, is that some regulation is justified. Not regulation of imagination, but policy-based constraints in place to protect the vulnerable yet hopeful from the predations of the powerful and cynical. Usury laws were one such example. There is surely an illiberal quality here: The idea seems to be that the broader public (in their individual actions) may not, in fact, always know what is good for them.

    This is a long-established point of view, but one that has been out of fashion for some time. I also confess to be surprised to be someone making the point, since I am temperamentally suspicious of institutions. But when it’s a choice between a free market mania, driven by greed and bolstered by ideology, and the imperfect benefits of the regulation of desire, I end up choosing the latter.

    But you’re right – one of the problems that can arise is that excessive top-down protection from the vagaries of circumstance can run counter to innovation. On the other hand, mandates can also drive innovation (whether that be the Manhattan Project or the Apollo Space Program). I guess I tend to think that there is plenty of room for imagination even in the absence of privation – which I guess amounts to some version of the argument against the “starving artist.” :)

  7. Adam Hyland  •  Feb 13, 2009 @5:07 am

    No worries about the link. Though I should chide you for Hotlinking. :)

    All right. Oh, from the “science fiction” end of things, you might be interested in this: Paul Krugman, while doing his time in the dilithium mines as an assistant professor, wrote an article mocking the form and subject of most refereed papers in economics. The paper, titled The Theory of Interstellar Trade deals with exactly what you might expect it to. It’s fairly clever.

    I’ve always found the treatment of time by most economists to be very interesting. From a pedagogical standpoint, time enters in to the instruction path very late in the game. Most textbooks begin with “one period” (that is to say, static) models of guns or butter or what-not, and only proceed to “multi-period” well into their coverage of a subject. When they do introduce the notion of time, the tropes of the discipline are marched out to give some structure to the thing: people are rational, they prefer an apple today to an apple tomorrow, they make reasonable decisions about the future based on information at hand. That aside (and it truly may be brushed aside at the cost of simplicity), time represents an interesting and somewhat unique situation.

    Most economic decisions involve a sacrifice. I buy a coffee and I can’t spend that same dollar on a cookie. Nothing too difficult to grasp. But decisions made across time are unique in that (presumably) you cannot know your state of mind in the future. When I spend a dollar today I foreclose that same dollar’s purchases tomorrow. And when tomorrow comes, I have no means by which to undo yesterday’s decision. That dollar is taken from me as surely as if it had been robbed (Of course I still own the good I purchased yesterday, but I may not value it as much or it may not fetch as much on the market).

    Add into this mix credit. We have some picture of what the lifetime earnings of a worker will be in society. It makes something of an inverted U shape. Lower in the early years, where the worker hasn’t developed the skills or seniority to command a higher wage, then peaking over the 40-50s and decreasing slightly as she ages. It differs from person to person and career to career–shallower for an anthropologist than a football player, perhaps. The idea is then that we borrow while we are young from our earnings at the peak of that profile. Presumably our borrowing is sensible and we invest in our education. Sometimes it is not. Either way, someone is expected to have a fairly decent idea of our future ability to pay (or willingness, for that matter).

    Those elements, the necessity of expectations and the literal differences between choice over objects and choice over time, make me ponder the special nature of the fourth dimension in economics. Here it seems like we had a rare (though not unheard of) coincidence of failure in future expectations and an increased ability to trade on that failure.

    Had a longer post about houses as financial instruments in the 1990s and responses to low interest rates and what-not, but it didn’t seem too germane to the broader question at hand, so I snipped it.


  8. Thomas  •  Feb 13, 2009 @3:30 pm

    @Adam: Thank you for the Krugman article reference. I hadn’t heard of it, and enjoyed reading the full paper immensely. It’s telling in its own right (as you know, I bet, since you brought it up) about the difficulties involved in incorporating time into economic analysis.

    Not just time, really, and your further comments really underscore that. We can imagine time stretching on, but imagine as well so many things staying determinate or consistent across time frames that we can fool ourselves into positing structures or models for how things work that look authoritative when viewed from one angle, but which fall apart in the face of what time (at least in this universe) seems to entail: open-endedness, the contingent unfolding of circumstance. You do a great job of conveying just how skewed from the flow of experience economic models can become when confronted with incorporating time.

    And then you cycle back to reliable expectations, which I think is the right thing to do. The brute contingency of the universe shouldn’t lead us to throw up our hands, or imagine that everyone must do so as they face their own circumstance. Rather, there are “reliable” expectations, good enough to bet on, sometimes to bet the house on (oop — sorry, bad example), but they’re never perfect. In a way we are all, as Holmes put it for himself, “bettabilitarians;” we make bets with the universe which may or may not pay off.

    Which leads at last to the most interesting phrase of yours: “a rare (though not unheard of) failure in future expectations and an increased ability to trade on that failure.” That seems to be the notable thing here, from a broader historical context point of view. What are the conditions that make this kind of double-whammy of failure and compounded failure possible? One thinks of Schiller’s Irrational Exuberance, or Clifford Geertz’s Agricultural Involution — I’m guessing that Kal could add an argument about marketing and pharmaceuticals to the list. I suspect that technology, as it has for the financial markets, plays an important role in making these kinds of outcomes possible.

    (Oh, and gentle chiding acknowledged, hotlinking removed. :-) )

  9. Adam Hyland  •  Feb 13, 2009 @5:07 pm

    Further from the broader context (and part of the more detailed paragraphs I snipped), I’m reminded of a passage from Inventing Money: The story of Long-Term Capital Management and the legends behind it. Dunbar (the author) was describing some fixed income trades at Salomon brothers–the initial employer of many of the Long Term Capital Management “quants.” In describing options and interest rate risk he used what may have seemed like an innocuous example in 2000 but appears much more ominous today.

    He explains how mortgages are debts which are subject to interest rate risks–if you bought your house under a standard mortgage in 1981 (when the federal funds rate was about 20%), you might be pretty upset at the rate you are paying in 1994 (when the federal funds rate is about 5%). It would make sense at that point to refinance your mortgage, taking on a larger principal to pay at a lower rate. For Dunbar, this provided a teaching moment. A homeowner refinancing their home to negotiate a lower interest rate was exercising an option which they owned by virtue of owning the house itself. When interest rates dropped or the value of the home was expected to rise, homeowners would exercise this option more frequently. In one sense, this is hardly radical. Calling it an option is an interesting twist (and does actually provide some analytical traction for pricing it…but that is neither here nor there), but it isn’t exactly voodoo yet.

    At the same time, this little peek at the way we visualized home ownership proved instructive. One of the early postulated causes (much dismissed by economists, though I give it some credence) for the Dutch Tulip mania was the shift in attitudes toward the Tulips themselves. They moved from craft goods, differentiated among growers and strains to commodities and their exchange moved from growers to dealers and middlemen. Part of the complaints about “middlemen” in those days have a whiff of Antisemitism to them–or at least a good old fashion Protestant disdain for dealmakers. But the fact remains that whatever sense we had of intrinsic value was abstracted away by warrants, futures and options. Likewise as we saw the house as an investment property rather than a home we obscured our ability to gauge changes in value. If a home is a home it is difficult to see how it could rise in value, uninterrupted by any fluctuation. If, instead, the house is a vehicle for investment driven by multiple hidden options whose spot prices move with the London Interbanking Offering Rate and expected trends in home value…well it is a little easier to convince someone that they can get a risk free return.

  10. Thomas  •  Feb 24, 2009 @2:18 pm

    Very convincing, Adam. Your last few sentences to me perfectly convey how consequential changes in the “social imaginary” can be, even for such domains as the market, as against the fact that it is so frequently portrayed in an utterly cynical fashion. There is such a high degree of naturalism to understandings of the market, which obscures the import of just these kinds of historically specific changes in cultural expectations.

  11. Adam Hyland  •  Feb 27, 2009 @2:30 pm

    Naturalism is a good word for it. Richard Thaler and some other folks at Chicago’s GSB are doing some interesting work to move toward treating decision making as fundamentally path and context dependent. That’s the kind of research that gets lampooned as retreading past insights in psychology, political economy and philosophy, but (as you I’m sure know well) assaults on orthodoxy from without are always repelled. Change will have to come in the encultured language of economics and from some empirical data. And in a sense, economic understanding of the mind will lag that of neuroscience and psychology, but when it catches up the results will be helpful.

    As for books by Thaler, skip Nudge, read The Winner’s Curse.

    It’s also important to pause on that word “cynicism.” Economists and what-not do portray the market as a place free from romance or other non-pecuniary connections. The relentless force stamping out these systematic “failures” is arbitrage, something financial engineers were supposedly very good at. Assuming that arbitrage would enforce efficiency and efficiency would (most of the time) dictate rational behavior on average wasn’t that bad of a premise. What was even better (in my opinion), is starting from that assumption, observing data, and seeing where that assumption generated an anomalous result. That sentence sums up a good bit of behavioral finance from ~1970 on. Trouble is, we have difficulty determining where the anomaly lies; in the behavior, or our model of the behavior, or both. The REAL trouble comes from when we make a fundamental error in those assumptions.

    Perhaps an example.

    Felix Salmon (a smart cookie, BTW) has an article in the most recent Wired about a default risk correlation formula developed by a “quant” named David X. Li. Basically, the formula calculates the correlation in default risk on two collateralized debt obligation not by measuring default rates (there wasn’t a whole lot of data to go on, otherwise a simpler function would work) but by measuring prices on credit default swaps for those CDOs. CDS price goes higher, default appears more likely, if two bonds have similar movements in CDS prices, their default risk is expected to be positively correlated. Seems scary and complicated, but it isn’t that byzantine in comparison to some of the other stuff being used. The article revolved around the single number (the version of the correlation coefficient for that function) which expressed the relationship between those two CDOs–CDOs which were built from dozens of swaps, bonds, and other bits and pieces of financial architecture. Managers and financial analysts grew to rely on this function to determine how risky their portfolio was. Specifically, they relied on that single number without thinking about its underlying meaning or composition.

    This reminded me of what happened in the 1990s with something called Value at risk. VaR was designed to be a measure of exposure to an entire portfolio. You took all the stocks and bonds in a portfolio, determined their volatility (by using past data…this will become important), and then just figured out how much a portfolio would lose if a 1 standard deviation from the mean loss occurred (or two or three, depending on your risk aversion). That loss equaled how much liquid capital those investment banks would have on hand to cover margin calls and such. If you (a trader) suddenly had a big loss or a big change in volatility that made your VaR go up too high, they would just tell you to cash your accounts out–cut your losses. Ostensibly this was a risk management tool. Banks, investment banks, mutual fund managers would use it to keep from exposing themselves to too much risk. But managers reified this number as a single all inclusive measurement for risk and exposure. And when volatility on exchanges increased (remembering that volatility in the model just used past data) and distributions on returns followed something other than the normal distribution, managers would see losses well exceeding their VaR and their funds went belly up. That’s part of the LTCM story.

    In both cases, VaR and the Gaussian copula function, people replaced complex situations with a single number that could be compared across otherwise differentiated investments and could be grokked easily. We zero in on easy to read indicators. On Los Angeles class submarines, there are basically two depth gauges, an analog and a digital depth. The analog looks…well, like you would expect, a needle on a gauge face. The digital depth looks like the face of a big alarm clock. There are lots of incident reports about submarine crews “locking in” on digital depth and not checking that against other instruments–they would keep a certain depth on the digital depth meter, unaware that the meter was broken or frozen and that their real depth was changing. That’s not a good thing. Despite years of training (the guy sitting behind the helmsmen has probably been on submarines for over a decade) and multiple people (there are ~4 people in close proximity to that gauge and 4 people who are directly responsibly for ensuring that the submarine stays at depth XYZ), crews latch on to that measurement. Sometimes they have seen the analog depth and rejected it “incorrect” because it didn’t accord with the digital depth. There is a deep cognitive bias at work here, and it is the same one that causes otherwise trained and rational fund managers, whose whole job is to efficiently make money, to replace a complex system with a simple number.

  12. Mark Malaby  •  Oct 3, 2009 @1:57 am

    Hi Thomas, thanks for inviting me to your blog. Back in 1992, I wrote an architectural paper on the adverse effects of seeing ones house as a commodity. The main point of problem came from alienation at such a personal level. Houses evolve almost as biological shells in response to the natural enviornment such as materials at hand, climate, various family or individual functions and also the artificial environment, traditionally culture, but also increasingly legalities like building and planning codes, and of course the issues of finance Adam outlined above.

    The fourth dimension is very interesting in architecture going back to Gideon’s Space Time and Architecture, one of the great modernist architecture books. But, the more conservative or tradtional strains in architecture see the house and all of its codes and memories, its references to survival lessons learned and its shaping to survival furntions like bathing, eating and sleeping as a defense (the Fence) against time. It tradtionally creates security with timelessness ( ironically the great modernist measure of a masterpiece.)

    How can anyone feel anything other than alienation when they are afraid of putting a nail in a wall to hang a treasured picture because they are afraid of weakening the commodity value of their home? Ironically the result of the “free market” as many have noted is stupefying homogenaity in suburban tract developments. Everyone dreaming of a future when they can trade up this commodity for another.

    An alternate that is interesting is Oregon Truckhomes

    Here, a modern take on chattle homes, for a completely mobile labor force, outside the artificial environment for making a home (no building code, no financing) yet totally personal, no boundary between the maker, the owner and the inhabitant. And existing in four dimensions, three-space and time(motion).

    just some musings.

  13. wesley z. adamczyk  •  Nov 1, 2009 @10:20 pm

    Hello i have wondered how much you would to set your design up on my web logs for me, because i really like the look of your website but i do not know how to install such a sweet design.

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