Posted by: John Vandivier | June 21, 2013

Calling Didier’s Economic Bluff

Tldr – While Didier’s talk is interesting, he fails to sufficiently defend or even describe his methodology.

There is a great debate in economics about the ability to control economic systems. The Austrian, Classical and Free Market views emphasize that markets are not fully controllable. These views are opposed by Neokeynesianism which, while allowing that markets are sometimes useful, considers that economic systems can and often should be manipulated in order to, supposedly, produce superior-to-free-market outcomes. A variety of economic schools fall in between.

Didier Sornette is an interesting economist with a background in physics and a decided bent toward Neokeynesianism. Physics-based and other hard science based economic modelling has been a trend lately and fits in nicely with the NK view that economic systems are more mechanical than psychological.

Sornette has done research into the so-called “King Effect.” Sornette’s research continues the evidence that economics obeys certain metaphysical regularities. Here is his recent “TED Talk,” which goes over his theory and applies it in the prediction of an upcoming bubble:

Sornette calls the outliers “Dragon Kings.” How fitting as the Dragon is the image of Satan in Christianity. As such, in Christianity it represents the height of deception and pride. Sornette apparently misses the irony of his own use of the word, thinking that name Dragon King evokes a sense of empowerment.

Sornette talks of the Black Swan as well. The idea of the Black Swan well encapsulates the idea of the weakness of the human condition. A man who has only ever seen white swans sees a black one and suddenly realizes that he can not trust his own deductive reasoning. It captures the idea, as Sornette says and I agree, “of unpredictability, unknowability, that the extreme is fundamentally unknowable.” (5:00 mark in video.)

Sornette animates his Dragon King burning the Black Swan in a satanic metaphor. Sornette is smart enough to clarify that his predictions are only accurate to within a statistical confidence interval, however even that is flawed in the absolute as demonstrated in the logic of my old LUP. Long story short, statistics are useless if you don’t know the data you are looking for and not all causes of all bubbles can be known as per the LUP, which is the same general principle as the Black Swan, but with a more thorough proof, that the extreme is fundamentally unknowable.

Sornette compares economic signals with mechanical signals such as acoustic emissions of a rocket, Braxton Hicks Contractions before birth, precursor signals to epileptic seizures and others. Economic signals are partly mechanical and also partly intelligent. This is demonstrable via Austrian economics via Thymology, that people make economic choices as a predictable result of their particular worldview. I wonder if the fact that economic signals resemble these other kinds of signals so closely implies that there is in fact an intelligence underlying these other signals, as we can demonstrably prove there exists inside of economic signals.

Sornette interestingly apparently predicted the April Bitcoin correction. In my view Bitcoin corrected because it was overvalued. Even the term overvalued implies an objective value, which I have created a proof for and will disclose in later posts, but which both Austrians and Neokeynesians reject. Sornette also talks about the fact that his work of bubble analysis is based on the idea that a market can be overvalued, but he doesn’t give specifics into how they identify overvaluation. Furthermore, he doesn’t give specifics as to whether or not or how the direction of correction is predicted. Will the “dragon” explode up or down when it corrects? Will it possibly shift pressure to a different market and how so? Maybe I expect too much from a small TED Talk.

The specific bubble that Sornette predicts will occur in this presentation is a USD monetary bubble resulting from quantitative easing (9:20 in the video). How will this bubble correct? Hypervaluation of the USD or a drop in value of the USD? Will there be predictable political acts? Will the pressure be shifted from currency to commidities, securities or war in a predictable fashion? Knowing that there will be an outlier is interesting but ultimately useless unless we are informed of how to cope with or prevent that situation.

One great technique Sornette talks about, and I think more people should use, is a method of being able to predict something about a market without causing a self-fulfilling prophecy. One problem with market information is that if a big academic, investor or news agency says X will happen in a market, the expectations of the market often adjust so powerfully so as to bring that event into reality. Sornette has pioneered a method of encrypting his predictions such that they will be documented before an event but not understood until after the event in order to prove that his prediction was true or false regardless of the self-fulfilling market expectations feedback loop! That is a straight up stroke of genius and something I want to try myself. He mentions that because of self-fulfilling prophecies the world has really been unable to create a truly stringent economic science until cryptography, and I agree.

He talks about the fact that he was able to avoid a bubble in a certain isolated case. Where is his method? I want to see this. Austrians like Ron Paul predicted the Great Recession with a priori reasoning. What is amazing is that he seems to have been able to do this, at least in a few cases, alongside a time table, whereas others like myself using a priori reasoning have been able to make predictions, but only into broad categories of time such as long run, short run or mid run. The one example he gives hard data on was a 6-month timetable of prediction. Is this because he decided a priori there would be a short run effect and 6 months, halfway through the standard prediction of a short run, was the least error prone possible guess? Or did he have an advanced methodology?

In conclusion Sornette states that his research will help guarantee that a Great Recession or other economic shock will never occur again. As interesting and useful as his research is, in particular because he didn’t disclose the details of his analytic methodology, I have to call his bluff on this one. The black swan wins, extremity is fundamentally unknowable, and, while I encourage him to continue his research, that doesn’t mean I’m for the empowerment of economic manipulation or centralization which his NK bent would probably call for.

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