I'll bet you Debt to Donuts ...

There's been much well-deserved razzing of Reinhardt and Rogoff for their Excel error and their ... interesting choices about which data to exclude.

Brad DeLong did a post last week building off the work of a Berkeley grad student, Owen Zidar. Zidar put observations about countries into 50 bins of equal size, grouping observations by debt as a percentage of GDP, and looking at average growth over the following 5 years. When he plotted it, he got this chart:

Today DeLong revisited  the subject and added in a line at 90%, and then the average growth rate to the left of the line (countries with debt below 90% of GDP) and the average growth rate to the right of the line (countries with debt higher than 90% of GDP).

The moral of the story: slightly slower growth; no cliff. (And as people have been pointing out since R&R's paper in 2010, the causality isn't clear in any case.)

Looking at DeLong's modification, I was struck by those two particularly low bins just to the right of the 90% line. So if we were instead to draw the line at something like 95%, we'd take the lowest and third-lowest observations out of the "high-debt" group and put them in the "low-debt" group. And since those two dots were lower than the average in either group, the group they left would see its average go up, and the group they joined would see its average go down.

My drawing above is just an eyeballing approximation since I haven't taken the time to ask Zidar for his binned-up data, but the lines do have to move in the direction I've shown. It seems unlikely that this little shift has such a big effect that the countries with debt below 95% actually do worse than countries above, but we can say for sure that by placing the cutoff at 95% instead of at 90%, the effect of high debt moves in the direction of being trivial.

But notice something peculiar. Countries with debt greater than 90% do in fact perform worse than countries with debt greater than 95%. It's those two horrible dots between 90% and 95%.

What if we have three groups? Less than 90%, greater than 95%, and the middle. We get something like this:

Obviously, the real problem is neither high debt nor low debt, but debt in the very narrow window of 90 to 95% of GDP. That stuff's just a catastrophe. Talk about threshold effects. It's reminiscent of the "donut hole" in patient reimbursement that was built into the Medicare prescription drug benefit under GW Bush, only narrower.

Put another way, we're looking at something like this:

http://blogs.wsj.com/photojournal/2010/05/27/pictures-of-the-day-407/

The solution is clear. When your debt is approaching 90% from below, putting on the brakes might accomplish nothing useful. You'll merely slow down enough to go tumbling off the edge of the debt cliff into the 90-95 chasm. What you need to do is load up on debt big time--accelerate hard, make sure you clear the gap.

(Thanks ClipArt!)

Once you're on the other side, it's clear sailing.

Gee, it sure is a snap cooking up important public-policy findings when you know what to do with the data. Maybe I, too, can work for the Peterson Institute ...

UPDATE: Here's a post-length comment on Crooked Timber that's worth a read about the state of economics. (And the original post is short and sweet: scroll up and enjoy it.)

Poker and the problem of the social sciences

Recent research found that arm movements in poker players were more informative about the players' hands than their faces were.

http://www.signaturepokerchips.com/casino-chips/casino-chips-tale.htm

Test subjects were non-experts in poker. They were shown three different types of footage of players at a poker championship:

1. Showing just the faces
2. Showing just the arms and hands moving chips into the pot
3. Showing the whole upper body

The test subjects had to guess how strong a hand the players had.

When they saw the whole upper body, they did no better than chance.

When they saw just the face, they did worse than chance.

And after those two observations, you may not be surprised to learn that when they saw just the hands, they did better than chance.

The researcher's hypothesis was that players who were confident about their cards would have less anxiety and this would show itself in smoother arm movements. The evidence he gathered seems to support that idea.

These were expert poker players--the footage was from the 2009 World Series of Poker--so it seems they've learned not merely how to hide the quality of their cards through a stoic "poker face"; they can actually use their face to lie to you. But their arms still give them away.

Neither the HuffPo article nor the NPR story I heard this morning drew the conclusion that seemed obvious to me. As this knowledge spreads, there will certainly be hard-core poker players who start paying attention to their arms. They'll try to learn to control their arms so that they can bluff just as well with a limb as with a lip.

It may be that the connection between anxiety and smooth motion is harder to overcome than the facial tells they've already mastered, but it would be surprising if there weren't some improvement possible.

And if that happens, think about what will have happened here.

The fitness of credit

Adrian Kuzminski put a comment on the end of “Is God on our side?” wondering about central banking, usury, and other practices that seem “highly problematic, to say the least.” I started to respond, but it got long for a comment, so I turned it into a post.

In the talk that the blog posts are drawn from, there is an implication that was more explicit in an earlier version. When you have an excessively virulent organism that's doing damage to an ecosystem, there are two possible outcomes: The ecosystem evolves some defenses and the organism tones down its virulence, so that the ecosystem can live with the disease; or the ecosystem crashes.

There's not necessarily a preference for one outcome or the other. The ecosystems we see around us, the ones that are still functioning, are the ones that didn't crash. That's part of evolution having God on its side: Try lots of different things; some will work, some won't; the ones that work will go on.

Humanity as a whole succeeded using the same strategy, at least as far as the early modern age. Societies in some places collapsed (sometimes through being too "virulent"), but societies elsewhere had relationships with their environment that had greater long-term functionality, so they persisted.

In that framework, two things worry me about our current situation. The first is the way that fossil fuels empower “overshoot.” Every wild animal species is exclusively dependent on sunlight captured its plant neighbors, and (for carnivores) processed by its animal neighbors. Every wild plant is exclusively dependent on the sun, and on the services of neighboring plants and animals that help maintain viable growing conditions. A “virulent” member of such a community gets pretty quick feedback: as it damages its environment, it limits its own ability to prosper, and so it adapts or dies.

Fossil fuels allow us to escape from what elsewhere I called the “solar constraint.” 300 years ago, we could only draw on solar energy, concentrated in human or animal muscles, or in trees we could burn, or in wind or water we could use to drive a mill. Except for the wind (and partially the water), we ourselves were dependent on the biological health of the creatures around us.

Today, we’re not fully independent of ecosystem function—it seems unlikely we ever could be—but we can compensate for a lot of damage. Our fertilizers, pesticides, and irrigation allow us (for now) to produce larger crops than our ancestors could, even as we impoverish the ecosystems of which our farms are a part. And in the economy as a whole, it’s not ecosystems supplying our motive power and our heat to do whatever it is we want to do—it’s oil, coal, and natural gas (and some nukes, and a little wind and solar …). With fossil fuels at our disposal, we can go pretty far in damaging our ecosystems without feeling a limitation in our ability to eat, or drive, or have cool gadgets.

The Easter Islanders arguably did themselves in via overshoot. Fossil fuels allow us to practice overshoot on a global scale.

My second worry is exactly this issue of the global scale—specifically, the global monoculture we’ve been creating. Societies crashed and burned in the past, and other societies kept on keeping on, and eventually picked up the pieces. But if our society becomes a global social monoculture, then who is there to keep on keeping on?

Evolution always “works” in the sense that some form of life is more successful than its neighbors and thus persists, while the neighbors die off. But evolution doesn’t guarantee any particular species a glorious future for its descendants. Or any future at all. Just because evolution works doesn't mean it will work for us.

So to bring this back to Adrian’s point. Credit systems themselves can be an adaptive social technology; they allow to coordinate actions not just across an economy, but across time. But like anything, they can become virulent. Or they can be adaptive in one environment (when there’s easy access to more energy), and destructive in another. If they’re “highly problematic,” that doesn’t mean they didn’t evolve, nor does it invalidate an evolutionary-ecological understanding of what an economy is, how it works, and the path it took to become what it is.

It’s worth noting that Adrian has a book coming out next month, The Ecology of Money. I had the opportunity to preview it, and it’s well worth a read. Though of course I didn't agree with everything in it (I rarely do).

In particular, I’m less down on central banking than Adrian is—it seems to me an extension of fractional-reserve banking, a phenomenon with its own issues, but one which it would be “problematic” to try to get rid of.

Anyway, that’s more of the routine good cheer that you can always find around here.