Chaos -- Mathematical and Financial

As I write this, the impact of the $700 billion rescue plan is uncertain, but I strongly suspect it will still be uncertain long after this column appears.

In fact, the uncertainty that usually accompanies complex proposals is what this column is about -- that and the wisdom of acknowledging this uncertainty.

The most honest and productive answer to questions about the effects of economic policy is rarely heard: "Duh, I don't know."

Of course, it's well-known that political and economic affairs are not very predictable, but in addition to all the traditional reasons for this fact are some surprising mathematical ones as well.

These mathematical reasons are deep and ensure that much (not all, of course) of economic and political commentary and forecast is empty. It's usually after-the-fact and no more on target than the farmer/marksman who had hundreds of bull's-eyes on the wall of his barn each with a bullet hole in its center. When asked how he did it, the farmer admitted that he first made the shot and afterward drew the bull's-eye around it.

Football Commentary Versus Simplistic Economic Analysis

Consider the typical analysis of the economy. It generally isolates one or two factors (or their absence) as the cause of this or that malady. There is generally more sophistication in football play-by-play broadcasting.

In general, too little notice is taken of the interconnectedness of the variables in question. Interest rates have an impact on unemployment rates which in turn influence revenues; to a varying extent budget deficits affect trade deficits, which sway interest rates and exchange rates; consumer confidence may rouse the stock market (and vice versa), which alters other indices; natural business cycles of various periods are superimposed on one another; an increase in some quantity or index positively (or negatively) feeds back on another, reinforcing (weakening) it and being in turn reinforced (weakened) by it.

These as well as lax or non-existent regulation and a myriad of other complicating and interacting factors characterize the economy.

The situation is made even worse by a lack of transparency. One reason for the present credit crunch crisis is that banks and investors were not always aware of which mortgages were in the particular packages being offered as securities and, hence, of what risks they were assuming.

Ironically the proposed solution to the problem -- the bailout -- is, at least at this writing, also almost completely opaque.

Secretary of the Treasury Henry Paulson initially put together a three-page proposal devoid of details and then had the temerity to request $700 billion with no judicial or legislative oversight!

It is likely that this proposed financial shock and awe wouldn't have been any more effective than the military version, but neither can we be sure about the considerable revision and expansion of the bill passed on Friday.

Chaos, Pool Tables and the Economy

The mathematical discipline usually referred to as chaos theory and the associated notion of a non-linear dynamical system are relevant to these economic complexities.

Don't run away. I'll skip the defintion of such a system and simply illustrate it, as I have before, with an example -- a pool table on which approximately 30 round obstacles have been fastened in haphazard placement.

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