Wednesday, 21 May 2008

The joke of non-linear supply and demand

Posted by: Ian Angell
{Ash's latest posting has prompted me to write this piece}

“You can take a horse to water, but you can’t make it drink. The trick is not making the horse drink, but making it thirsty.”

“Business isn’t selling something you have to someone who needs it, but something you don’t have, to someone who doesn’t need it.”

The old jokes are always the best, and nowadays the joke is on anyone who enters a commodity market wanting to buy something, rather than just using it as a place to park/gamble money in futures options. And who are the suckers who actually want to buy? Everyone who needs food to eat, fuel for energy, raw materials for production. Phinaes T. Barnum put his finger right on it: “there’s one born every minute.”

With all the uncertainty in the banks worldwide, where do the ‘jokers’ place their money to take advantage of the ‘suckers’? Into the markets for commodities, which have become a Barnum and Bailey Circus.

The jokers believe they can use the demand/supply curves so beloved of economists to advantage, but they miss the point, and their jokes rebound. These jokers either demand but don’t want the commodities, or supply but don’t have the ‘goods.’ What they don’t realise is that their preconceptions of these curves actually feed back and affect the underlying data, and consequently negate the curves themselves by triggering an ‘uncertainty principle.’ In the linear world of theory, the consequences of an action stop with a reaction; in the non-linear world of practice who knows what havoc the feedback will cause?

Pointing mathematical instruments at the market complexity in the practical world of ‘non-linear supply and demand’ can only create instability, because the only certainty is uncertainty.

There’s no point in measuring something that will change the moment it is measured, and because it is being measured - like the nonsense of British healthcare targets: surgeons push dying patients out of the operating theatre into the corridor, so that ‘death in surgery’ figures are kept low.

In conditions like today’s commodity markets, the jokers are setting off a non-linear positive feedback sequence, triggering a chain of events within a system that affects their analysis, something the jokers themselves don’t appreciate. The meaning created when they interpret the supply and demand through their own personal filters, is invalidated by the very act of interpreting.

The systemic nature of this situation is often neglected due to the fact that the smug jokers are using the curves to second-guess meaning in the minds of others. When those ‘others’ also contain large numbers of jokers, all confident that they can take advantage of their superior(!) economic (and hence linear) knowledge, then the joke is on them. They are all thinking the same way, and this multiply-reinforcing subjective interpretation will always totally distort the objective world of data.

Goodhart’s Law comes into play. Charles Goodhart, a distinguished LSE Professor, famously noted: “any observed statistical regularity will tend to collapse once pressure is placed on it for control purposes”.

Thus the jokers too have become suckers. Welcome to the cosmic joke that is non-linear supply and demand.

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