Wednesday, June 12, 2013

Reasoning about Rationality: Why Bubbles are both Banal and Necessary ~ William Janeway

What follows is the link to William Janeway's lecture at the Field's Institute in November 2012: Reasoning about Rationality: Why Bubbles are both Banal and Necessary
The introduction is by Matheus Grasselli. Those interested in the slides, they can be downloaded here. The lecture is about 50 minutes in length followed by a 20 minute Q and A. For those interested in reconciling the innovation process amid conventional wisdom that evokes rationality and efficiency at every turn, this is the next best thing to reading his book, Doing Capitalism in the Innovation Economy: Markets, Speculation and the State.

If there is anything to take away from the lecture it is Janeway's belief, backed up by forty years as a successful capitalist in general and influential venture capitalist in particular, that bubbles are endogenous to financial capitalism; bubbles always burst; and bubbles can be focused on anything from tulips to real estate to information and communication technologies ('ICT') --some of which are productive, others not.

When the occasion arrives that the focus of a bubble is a fundamental new technology then there will be associated bubbles in the build out of that network and the search for what to do with that network. In the current context think about the advent of ICT in the early 1980s begetting the tech boom of the 1990s begetting the dot come mania of the late 90s which in turn have found capital looking for opportunities in areas ranging from social media, to big data and 3D computing in the 2010s. The latency of technological development repeats throughout history. It is arguably getting shorter but the uptake of green technologies appears to bear out the traditional view.

There is a wonkish flavour to the lecture where Janeway dissects tenets of neoclassical finance theory by going over much of the literature. Some of the papers he cites can be found here on Graselli's course page for Asset price bubbles: economics, mathematics and statistics. It should be noted that while Janeway earned a PhD in economics from Cambridge University under the supervision of Richard Kahn, he did not pursue academia as a vocation. He saw the writing on the wall whereby what he had learned at Cambridge would not be welcomed within the hallowed halls of tertiary learning in America --already so immersed and enamored was U.S. establishment with marginalism and Walrasian equilibrium where money is just a veil over barter. In a recent speech (Janeway October 11, 2012) he stated: 
In 1971, I left Cambridge University with a doctorate in Economics and an extraordinary intellectual endowment. Supervised by Richard Kahn, I had passed four years immersed in the economics of Keynes – not, that is to say, Keynesian Economics. This meant recognition, first, of the integration of economics and finance at every level, from the most micro scale of the individual consumer, entrepreneur and – especially – investor to the aggregate scale of the macroeconomy. Second, it carried with it a profound skepticism with respect to the notion of efficient markets and the promise of stable equilibrium. Third, it meant recognition of the inescapable ontological uncertainty under which economic and financial decisions are made. In consequence, I found that I could not teach Samuelson’s Neoclassical Synthesis, which what was on offer in the Departments of Economics across America. [emphasis added]
To sum up Janeway's lecture in a 2 x 2 matrix (below), it is that while bubbles always burst, those that burst in the equity market do relatively little harm compared to those in the credit markets as the latter compromise the banking system and paralyze the real economy.

Now, the idea that bubbles in the equity market do relatively little harm has less weight in the modern context when the social contract has been whittled away and people are forced to take on market risk for the sake of their own future retirement income (think of DC plans replacing DB plans). However, the general thrust of his argument remains valid: when the locus of speculation interests with the object of speculation in the top right quadrant (focusing on non-productivity enhancing asset investment) then a bursting is far more harmful than if a bursting were to occur in the bottom left quadrant (focusing on equity market funds going into productivity enhancing assets). In Janeway's way of thinking, there are necessarily one hundred busts for every gem. 

Summarizing Janeway's lecture in a 2 x 2 matrix

Janeway, . LSE public Lecture, "What I learned by Doing Capitalism." Last modified October 11, 2012. Accessed June 12, 2013.