The Queen – Your Queen – My Queen

The Queen, alas, I have never met in person. But I had four encounters of a kind.

E.R.II entered my life on a stamp. A stamp noticeable not least for having not a word on it?

“…I guess the English were the first to have stamps? Like everything else, having invented the Industrial Revolution…” is how big brother might have explained it once he had told me all about die Englische Königin.

Soon after, Queen Elizabeth miraculously turned up for real. Just a few metres away she was gently gliding past, smiling little waves from the open top Mercedes.

The third was in the parched late summer of 1976, an encounter on a dusking central London road, eyes almost meeting inside a fleeting flash of The Queen’s gaze from inside a gigantic Rolls Royce cabriolet floating past.

The fourth was in 2017, by letter. And yes, it was all about money…

caw/gm post 9-2019 : Ten years after the 2008 crisis I came across an old Guardian article :

Queen finally finds out why no one saw the financial crisis coming

Her Majesty gets the answer to her question – four years after she asked it – on a tour of the Bank of England

One doesn’t normally keep the Queen waiting. But on Thursday Her Majesty finally received an answer to a question she first asked four years ago: why did nobody notice the “awful” financial crisis earlier?

As she toured the Bank of England’s gold vault, Sujit Kapadia, an economist and one of the Bank’s top financial policy experts, stopped the Queen to say he would like to answer the question she first posed to academics at the London School of Economics at the height of the financial crisis in 2008. “Oh,” she said, slightly taken aback, as Kapadia went on to explain that as the global economy boomed in the pre-crisis years, the City had got “complacent” and many thought regulation wasn’t necessary.

The Queen, who appeared quite animated during the discussion, said: “People got a bit lax … perhaps it is difficult to foresee [a financial crisis].”

Kapadia told Her Majesty that financial crises were a bit like earthquakes and flu pandemics in being rare and difficult to predict, and reassured her that the staff at the Bank were there to help prevent another one. “Is there another one coming?” the Duke of Edinburgh joked, before warning them: “Don’t do it again.”  …   As the Queen walked out of the building in the heart of the City towards a large crowd gathered outside, she said of her visit: “Very interesting, isn’t it?”

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Having just discovered Steve Keen I decided to write to The Queen:

The Queen, Seventeen, Halloween…

Recently I discovered David Orrell’s Quantum Economics. Here is an excerpt from Chapter 8 : Entangled Clouds  (all bold emphases mine)

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Let the confabulation begin

On a visit to the London School of Economics in November 2008 , Queen Elizabeth famously asked her hosts : ‘Why did no one see it coming ?’ ( Economists are tired of hearing this story brought up . However , the issue has never been properly settled by something like a public enquiry ; it was historic in nature and inspired the call for alternatives to mainstream economics ; and as seen below , the answers supplied over the years have proved quite revealing . )

The Queen finally received a response from the LSE in July the next year , which concluded that ‘ the failure to foresee the timing , extent and severity of the crisis and to head it off , while it had many causes , was principally a failure of the collective imagination of many bright people , both in this country and internationally , to understand the risks to the system as a whole ’ .

A related question , though , was why did no one – see it ? Consider for example the discussion at the US Federal Open Market Committee Meeting in December 2007 , when it was later determined that the recession had already begun . ‘ Overall ’ , reads the transcript , ‘ our forecast could admittedly be read as still painting a pretty benign picture : despite all the financial turmoil , the economy avoids recession and , even with steeply higher prices for food and energy and a lower exchange value of the dollar , we achieve some modest edging – off of inflation . So I tried not to take it personally when I received a notice the other day that the Board had approved more frequent drug – testing for certain members of the senior staff , myself included . [ Laughter ] ’

In fact the prediction wasn’t unconventional in the least , it was merely reflecting common opinion . The same month the OECD predicted that the slowdown in US housing ‘is unlikely to trigger a recession’ . And a study by IMF economists showed the consensus of forecasters in 2008 was that not one of 77 countries considered would be in recession the next year ( 49 of them were ) . That isn’t a ‘ Michael Fish moment ’ – it is a weather forecaster protesting that the storm that has already begun and is blowing down people’s houses isn’t actually a storm , as he is marched off for his drug test . Rather than helping economists see into the future , their models were preventing them from noticing what was going on outside their windows .

In 2008 testimony, Alan Greenspan told Congress that the forecasting miss happened because ‘ the data inputted into the risk management models generally covered only the past two decades , a period of euphoria ’ . That is like a weather forecaster saying they did not see the storm coming because it had been sunny for so long . ( Compare Steve Martin’s ‘ wacky weatherman ’ character Harris K . Telemacher in L.A . Story , whose forecasts of fine weather are always the same – ‘ So I pretape the weather and some sailors lost their boats , big deal ! ’ Nobel laureate economist Robert Lucas provided an innovative excuse for forecast error when he clarified in a 2009 article for The Economist that ‘ simulations were not presented as assurance that no crisis would occur , but as a forecast of what could be expected conditional on a crisis not occurring ’ . That is like a weather forecaster saying their forecast was explicitly based on no storms . ( A conditional forecast is one of the form ‘If X, then Y, ceteris paribus’ – see discussion of this clause in Chapter 4 . The usage here reflects the fact that standard models treat crises as being caused by random external shocks.)

In 2010 , during a US House of Representatives hearing on ‘ the promise and limits of modern macroeconomic theory in light of the current economic crisis ’ , a robust defence of traditional modelling approaches was provided in testimony – which as we’ll see , doesn’t seem to have dated much – by V.V . Chari from the Federal Reserve Bank of Minneapolis . According to Chari , ‘ All the interesting policy questions involve understanding how people make decisions over time and how they handle uncertainty . All must deal with the effects on the whole economy . So , any interesting model must be a dynamic stochastic general equilibrium model . From this perspective , there is no other game in town … The only alternatives are models in which the modeler does not clearly spell out how people make decisions . Why should we prefer obfuscation to clarity ? ’  ( Indeed , it frequently seems that just by calling their models dynamic , stochastic , and general , DSGE modellers have somehow ruled out all other approaches – like a weather forecaster saying that their General Circulation Model which missed the storm is still the only game in town , because any model must be general and involve circulation.

Chari offered three reasons why these models ‘ failed to predict the recent financial crisis ’ and more precisely ‘failed to emphasize the risks to which the economy was exposed in the period before the crisis’. The first was Greenspan’s excuse that the models were calibrated to a period in history when economic fluctuations in the US were relatively small . The second reason was that ‘we deemphasized the insights of the theoretical literature on the perverse effects of government bailouts because understanding these effects requires that we impute even more rationality and foresight to economic agents than we currently impute’. In other words, rational economic man was insufficiently rational.

The third reason was lack of funds . As a solution, Chari suggested more of the same: ‘ after all, when the AIDS crisis hit , we did not turn over medical research to acupuncturists . In the wake of the oil spill in the Gulf of Mexico, should we stop using mathematical models of oil pressure? Rather than pursuing elusive chimera dreamt up in remote corners of the profession, the best way of using the power in the modeling style of modern macroeconomics is to devote more resources to it.’ (Quantum approaches would presumably be right out.) He ended with a rousing plea for ‘ substantially more resources’ to go towards this ‘severely underfunded’ research programme – even if such equilibrium models must be one of the longest running , best funded and least successful international modelling efforts in the history of applied mathematics.

In 2011 , John Cochrane wrote that ‘ It is fun to say that we did not see the crisis coming , but the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going’ (again since changes are due to random shocks ) . Future laureate Eugene Fama agreed that his theory ‘ did quite well in this episode ’ . ( Nobel – prize winning weather forecaster: ‘It is fun to say we didn’t predict the storm , but at least our prediction that we couldn’t predict it was spot – on . ’ ) In 2015 , at an event called ‘ The Genius of Economics’, laureate Paul Krugman said the crisis ‘ came as a shock to me as to almost everyone’ ; of the few people who did predict it , ‘ they also saw five crises that didn’t happen coming so it doesn’t quite count ’ , and ‘ there’s always going to be something out there that you miss’. (Weather genius accusing other , successful forecasters of always predicting a storm.)

In a 2015 Rethinking Economics debate , Dutch economist Pieter Gautier told students that ‘ we know that it is difficult to predict a crisis . We can say what we can do when a crisis occurs , such as having enough liquidity . Meanwhile , we know how we can try to prevent crises , such as making sure that banks have enough equity . Unfortunately , we don’t always listen to economists . ’ Unfortunately , we did : all the risk models that were used by financial institutions to price those complex derivatives , for example , were based on standard economic theories , including the efficient market hypothesis . That was the problem .

Why we missed the storm : more great forecasting excuses from the crisis

My work as an applied mathematician involves providing forecasts , and I know how hard it is to make accurate predictions ( I even wrote a book on the topic ) .
But when predictions do go badly wrong , the experience often offers useful information that can be used to update and improve your forecasting model . This can be a difficult process , especially since it may involve changing your mental model of reality as well ; but in economics it seems to be taking an unusually long time , as shown by the range of explanations and excuses supplied over the years .

Glenn Stevens , Governor of the Reserve Bank of Australia , in 2008 : ‘ I do not know anyone who predicted this course of events . This should give us cause to reflect on how hard a job it is to make genuinely useful forecasts . ’

Ben Bernanke musing in a 2009 commencement address : ‘ Like weather forecasters , economic forecasters must deal with a system that is extraordinarily complex , that is subject to random shocks [ from the weather gods ? ] , and about which our data and understanding will always be imperfect … Mathematicians have discussed the so – called butterfly effect , which holds that , in a sufficiently complex system , a small cause – the flapping of a butterfly’s wings in Brazil – might conceivably have a disproportionately large effect – a typhoon in the Pacific . ’

Future Nobel laureate Tom Sargent in a 2010 interview : ‘ It is just wrong to say that this financial crisis caught modern macroeconomists by surprise . ’ 54 ( The non – modern ones were presumably dead , so even less surprised . ) US Federal Reserve report from 2010 : DSGE models ‘ are very poor in forecasting , but so are all other approaches ’ . 55 ( Funny how this was mentioned less before the crisis . 56 )

The Bank of England’s Sujit Kapadia to Queen Elizabeth on her visit in 2012 : ‘ People thought markets were efficient , people thought regulation wasn’t necessary … people didn’t realise just how interconnected the system had become . ’

Nick Macpherson ( aka The Lord Macpherson of Earl’s Court ) , former head of the UK Treasury , in 2016 : ‘ I see myself as one of a number of people … who failed to see the crisis coming , who failed to spot the build – up of risk . This was a monumental collective intellectual error . ’

Christopher Auld from the University of Victoria , in a 2017 Times Higher Education article : ‘ Economists don’t claim to be able to make unconditional forecasts of future states of a system as complex as the macroeconomy ’ , and criticism which relegates the field to ‘ failed “ weather ” forecasting is not just misguided , it is anti – intellectual and dangerous ’ .

A 2017 Prospect article in which six eminent UK economists respond to ‘ dangerous ’ ( but more dangerous than flawed economic models ? ) and ‘ ill – informed expert bashing ’ of their profession from ‘ Writers , students and even some social scientists from other disciplines ’ ( mathematicians , physicists , quants , etc . are not mentioned ) : ‘ Like most economists , we do not try to forecast the date of the next financial crisis , or any other such event . We are not astrologers , nor priests to the market gods . We analyse data . Gigas and gigas of data . ’ ( Since the crisis , economists have distanced themselves from the whole business of macroeconomic forecasting and risk analysis , by emphasising that they apply their theories to many other things as well . * )

Andrew Haldane , chief economist at the Bank of England , in 2017 : ‘ Michael Fish getting up : “ Someone’s called me , there’s no hurricane coming but it will be windy in Spain . ” It is very similar to the sort of reports central banks issued pre – crisis , that there is no hurricane coming but it might be very windy in sub – prime . ’ ( Michael Fish answered that his forecast was ‘ better than the Bank of England’s ’ . 61 )

Paul Krugman , responding directly to ‘ The Queen’s question ’ – and summing up some of the lines in this chapter – as part of the ‘ Rebuilding Macroeconomic Theory Project ’ in 2018 : ‘ My answer may seem unsatisfying , but I believe it to be true : for the most part what happened was a demonstration of the old line that predictions are hard , especially about the future . It’s a complicated world out there , and one’s ability to track potential threats is limited … If you like , it’s as if meteorologists with limited resources concentrated those resources in places that had helped track previous storms , leading to the occasional surprise when a storm comes from an unusual direction … My bottom line is that the failure of nearly all macroeconomists , even of the saltwater [ Krugman’s ] camp , to predict the 2008 crisis was similar in type to the Met Office failure in 1987 , a failure of observation rather than a fundamental failure of concept . Neither the financial crisis nor the Great Recession that followed required a rethinking of basic ideas . ’ ( What then would it take ? )

The penny drops

While , as shown in the box above , many mainstream economists have continued to make excuses for their epic forecasting miss , not all have been so sanguine . George Akerlof and Robert Shiller wrote in their 2015 Phishing for Phools : ‘ It is truly remarkable that so few economists foresaw what would happen . There are about 2 ¼ million article and book listings regarding finance and economics on Google Scholar . That may not indicate enough economist – monkeys to randomly type Hamlet , but it should have been enough to generate quite a few papers that would tell how Countrywide , WaMu , IndyMac , Lehman , and many , many others would in short order flame out and crash . We should have known that their positions in mortgage – backed securities and credit default swaps were fragile . At the time we should have also foreseen the future vulnerabilities of the euro . ’ The authors ascribe this to the ‘ mental frame ’ of economists which sees markets as fundamentally efficient , blames pathologies on externalities , and ignores the fact that ‘ competitive markets by their very nature spawn deception and trickery , as a result of the same profit motives that give us our prosperity ’ . ( An exception was Shiller , who himself pointed out in 2005 that the US housing market was in a bubble . 64 ) Indeed , this points to a basic contradiction in neoclassical models , which assumes on the one hand that people are rational utility – optimisers , and on the other hand that they will always honour contracts – so no systematic fraud from bankers , or ‘ jingle mail ’ from homeowners returning the keys rather than pay their mortgage .

In July 2016 , Narayana Kocherlakota – who like Chari was formerly a president of the Federal Reserve Bank of Minneapolis – noted in a report that ‘ we simply do not have a settled successful theory of the macroeconomy ’ . A couple of months later Paul Romer, who is now chief economist at the World Bank , released a paper called ‘The Trouble With Macroeconomics’ in which he described the area as a ‘pseudoscience’ because the models are packed with implausible assumptions and parameters that are made up to give reasonable – looking answers , and all changes are attributed to external shocks ( Chari responded by saying that ‘ Burning down the edifice , and saying we’ll figure out what we’ll build on its foundations later , just does not seem like a constructive way to proceed ’ , though it would be a start ) .

Finally , some ten years after the crisis began , in a May 2017 speech , Portuguese economist Vítor Constâncio of the European Central Bank told his audience : ‘ In the prevalent macro models , the financial sector was absent , considered to have a remote effect on the real economic activity . In these model frameworks , macroeconomic fluctuations resulted mostly from technological or productivity shocks or from monetary policy unexpected measures . The economy was supposed to be mostly self – correcting and move quickly towards its steady state . No defaults of any agent were possible . Thus , excessive debt could not be a problem . As many wrote , for any debtor there was a creditor and so debt was a non – event at the macro level . This ignored the fact that banks create money by extending credit ex nihilo within the limits of their capital ratio . ’ ( Weather forecaster : with the benefit of hindsight , it may have been a mistake to leave out all the wet stuff . ) One reason perhaps for this omission is that , as discussed in Chapter 5 , the ability of private banks to create money out of nothing was only spelled out by the Bank of England in 2014 .

Constâncio’s comment points to the real issue , which is not that mainstream economists failed to predict ‘ the timing , extent and severity ’ ( as the London School of Economics put it ) of some freak storm – economists have never been held to any such standard of forecasting skill , and no one asked for an exact date . It is that they could not have predicted or warned of the crisis , even in principle . Furthermore , the models directly contributed to the crisis both by creating a false sense of security , and by enabling the financial sector to develop increasingly risky and dangerous products . The efficient market hypothesis did not perform well during the crisis , unless you count creating it . Because the models could not understand the causes of the crisis , they were not useful for suggesting the appropriate policy responses afterwards . And the main reason for this failure is even simpler than leaving out things like deception and trickery ( Akerlof and Shiller ) , or insufficient data / rationality / funding ( Chari ) – it is because the models left out money ( which of course is a main cause of deception and trickery ) . Only by doing so could economists maintain the illusion that independent rational consumers and producers with set supply and demand curves drive the economy to a stable equilibrium through what amounts to barter . Chari mocked the idea that we should ‘ stop using mathematical models of oil pressure ’ in the event of an oil spill , but in economics the problem was that money – what David Hume called the oil of trade , what Jean – Baptiste Say compared to ‘ oil in a machine ’ – wasn’t there . 69 It was therefore impossible to detect that the housing bubble was feeding the money supply , which was feeding the housing bubble , and so on , with complex derivative schemes helping to hide the risk .

By interpreting crises as random shocks , the models also eliminated any sense of responsibility for failing to prevent them . According to Dean Baker ( who presciently warned in a 2005 paper with David Rosnick that for economists to miss the housing bubble would be an ‘ act of extraordinary negligence ’ 70 ) , a rough but conservative estimate would be that it cost each person in the US around $ 27,000 in lost earnings – to say nothing of the human impact in terms of things like mental health and youth unemployment – so ‘ how about a little accountability for economists when they mess up ? ’ 71 Many people lost their jobs , but it seems no economists did . Remarkably , in the US their salaries even ‘ reached a historical high during the recession year of 2009 ’ , which as Kocherlakota noted in 2016 , ‘ might help explain the lack of a paradigm shift in macroeconomic research ’ .

Hush, money

In fact , while the story that no one , apart from a few perma – bears , saw the crisis coming is popular with mainstream economists , the reality is that a good number of people did warn of the crisis – including Baker and Rosnick , William White , Ann Pettifor , Steve Keen , Michael Hudson , Paul Wilmott , Nassim Nicholas Taleb , Nouriel Roubini , Robert Shiller , and traders like those featured in The Big Short , to name some of the better – known ones . They did this – not by constantly predicting disaster , as Krugman claimed , or by random chance – but by focusing on the role of debt , finance , and the banking system . Given , then , that these things were effectively absent from the models used by mainstream economists , the question is why experts would not mention this drawback during testimony ; why central bankers only felt fit to remark on it during conference speeches several years later ; and why , as Joseph Stiglitz noted in 2017 , DSGE models and their underlying assumptions are not just still in use , but ‘ have become a dogma , with little incentive to call them into question especially in a context of peer – reviewed publications ’ . To find the answer , we need to adopt a quantum approach , look at the context , seek out entanglements , and consider the effect of the observer – or in this case , the economist – on the system being studied .

One clue is provided by Robert Lucas , who wrote that ‘ The construction of theoretical models is our way to bring order to the way we think about the world , but the process necessarily involves ignoring some evidence or alternative theories – setting them aside . That can be hard to do – facts are facts – and sometimes my unconscious mind carries out the abstraction for me : I simply fail to see some of the data or some alternative theory . ’  Other people , he says , ‘ will see the blind spot … keep what is good , and correct what is not ’ . This seems a reasonable description of the modelling process ; but in this case the blind spot was very large , and no one corrected it . Or rather , no insider corrected it . Why ?

As mentioned in the previous discussion of quantum cognition , our decisions are shaped by context , including our own mental frames , conscious or unconscious ; and as Akerlof and Shiller note , the mental frame of economists was affected by their view of the economy as a rational , efficient system . One way to think of this is in terms of aesthetics , which , as I have argued elsewhere , plays a surprisingly strong role in science . Science in general has long been dominated by a type of machine aesthetic , where a beautiful model is one that exhibits the classical qualities of symmetry , unity , and stability – at least in its ideas , if not the actual execution . An early example was the Greek model of the cosmos , which saw the heavenly bodies as being encased in beautifully symmetric crystalline spheres ( even if epicycles had to be added to make the model work ) . In economics , we have neoclassical economics , with its perfectly rational and symmetric models ( again until epicycles are added ) . Money – with its complex , multi – faceted , nonlinear , and shapeshifting nature – doesn’t fit in this neat and tidy picture .

As Paul Krugman put it quite accurately in 2009 , ‘ The economics profession went astray because economists , as a group , mistook beauty , clad in impressive – looking mathematics , for truth ’ . ( For this lapse , John Cochrane responded in a journal article by comparing Krugman to ‘ an AIDS – HIV disbeliever , a creationist or a stalwart that maybe continents do not move after all ’ . The Pythagorean good / evil division is very much alive when it comes to the scientific aesthetic – see the box at the end of the next chapter.) But while aesthetics is certainly a powerful influence on the way we see the world, it still doesn’t quite explain why it took so long for the truth about these economic models to leak out through official channels . And this points to a more worldly form of entanglement : that between the economics profession and the financial sector, who were happy to keep money – and therefore themselves – out of the picture . After all, if you were a banker , which narrative would you prefer : that the crisis was caused by banks , or –official version– that it was the result of efficiency and rationality ?

As economist Barry Eichengreen noted in 2009 , in academic economics there is ‘ a subconscious tendency to embrace the arguments of one’s more “ successful ” colleagues in a discipline where money , in this case earned through speaking engagements and consultancies , is the common denominator of success ’ . This issue was highlighted in Charles Ferguson’s documentary The Inside Job , which found that the influence of private money on the profession played a key role in the crisis . As he wrote in 2010 , ‘ These days , if you see a famous economics professor testify in Congress , or write an article , there is a good chance he or she is being paid by someone with a big stake in what’s being debated . Most of the time , these professors do not disclose these conflicts of interest , and most of the time their universities look the other way . ’ A 2012 study in the Cambridge Journal of Economics concluded that ‘ economists almost never reveal their financial associations when they make public pronouncements on issues such as financial regulation ’ and noted that ‘ Perhaps these connections helped explain why few mainstream economists warned about the oncoming financial crisis ’ . In 2016 , philosopher Alan Jay Levinovitz found while researching this topic that ‘ Every economist I interviewed agreed that conflicts of interest were highly problematic for the scientific integrity of their field ’ . That is like a forecaster failing to predict a storm because it would be bad for their show’s sponsors . ( Economists often either seem to be genuinely unaware that there is an ethical component to their work , including things like forecasts , or take it for granted that they are acting correctly .

It is therefore ironic that V.V . Chari also brought up severe underfunding as being a main culprit for his profession’s failure to warn of the crisis . The truth is that DSGE models are a waste of money . That is why quants don’t use them to make predictions . And there is a remarkable symmetry in the fact that financial companies are funding economists whose mental frames are rotated in just such a direction that they have a blind spot for those same financial companies . The question is not necessarily one of explicit corruption – the influence may be as much unconscious as conscious – but more the creation of a certain context and set of beliefs . When Stanford’s Anat Admati sat down with academics and policy – makers to discuss the role of the financial sector in the crisis , she found that ‘ many would not engage . It was very disturbing . I realized that we hit a raw nerve in banking … It felt like I encountered a sort of religion , where people want to believe certain things to be true . ’

This selective blindness is further cultivated by economics textbooks , which shape the opinions not only of students but of future economists , policy – makers , economic journalists , and the public in general . As we have seen , a basic but also poorly understood feature of money is that most of it is created by private banks when they issue loans . Charging interest on these loans is a highly profitable business , which is the main reason banks dominate stockmarkets around the world and their buildings dominate skylines in major cities . Yet as Norbert Häring observed in 2014 , there is a ‘ complete absence in all major textbooks of any mention of the pecuniary benefit ’ , which as he suggests , ‘ points to a taboo imposed by the interest of a very powerful group ’ .

Money is not an externality , it is about as internal as you can get ; and omitting money , credit , and a quadrillion dollars ’ – worth of derivatives from the models is not the same as missing a forecast – it is missing reality .The real reason economists didn’t see the crisis coming was because they ignored its entangled , quantum nature . The message for quantum economics is clear : acknowledge the role of money , both in models and in the profession itself . For as always with quantum systems , context matters ; and far from being detached observers , economists are very much involved . …”…

see also

David Orrell’s Quantum Money Magic – a must-read for would-be economists