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Comment by avar | Hacker News Reader

Whenever I read one of these articles I'm struck by how disconnected the vast financial abstractions we've constructed are from reality.

Essentially they just discuss problems with the shared illusion (debt, bonds etc.), but not problems with what those abstractions actually mean.

What's going to happen in a few weeks to cause everything to come crashing down? We'll still have the same people working, the same infrastructure / factories etc.

I'm not saying the issues aren't real. Just that they're always discussed through so many layers of jargon to essentially be meaningless to someone who doesn't work in finance.

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I think the crux of the problem is that a fiat currency doesn't just attempt to capture the current resources, debts, and means of production for a country (or group of countries, in this case). There is also the element of future resources, debts, and means of production. I suspect uncertainty in the future is the main cause for all the recent problems, in the Eurozone and elsewhere.

Consider the times we are living in. It is likely that we are reaching a point that humanity has never faced before and will never face again (at least, not humanity as we recognize it). I like to call it "stationary phase", after the same concept that occurs in growing populations of bacteria.

Essentially, human population growth is beginning to decelerate. Changes in infant mortality and life expectancy are leading to vast demographic shifts that will most likely be permanent. What does this have to do with a fiat currency and debt?

Consider why one would take on debt. If I can acquire resources at a fixed constant rate, then it makes no sense to take on debt instead of simply saving up over time. Debt only makes sense when the means of production, and therefore resources available, accelerate over time. I can borrow now, because even though I have to pay back more later, I will have more even than what I need to pay back at that time.

So what causes means of production to accelerate? Lots of factors to be sure: more raw materials to exploit, gains in efficiency, etc. A very large factor, however, is accelerating population growth. Even if materials available and efficiency remain constant, more workers means more production and an accelerating growth in workers means an acceleration in the means of production over time.

But that's all coming to and end in the near future. So, to compensate, we could accelerate the exploitation of raw materials. Unfortunately, one of the most important raw materials for human economy, oil, is also decelerating in its rate of exploitation.

That puts the entire onus of accelerating means of production on increases in efficiency. Consider it a call to arms for knowledge workers around the world. The only other alternative is to fundamentally change the way that economies work. If we cannot accelerate the means of production, then we cannot run economies based on debt.

What makes this whole situation all the more interesting is that if population growth stabilizes at some future point (i.e. zero real growth), then we may be very close to reaching the point where current means of production are sufficient to satisfy the needs of the existing population. Ultimately, the need for debt is based on the desire to borrow from the future so that we can do what is necessary to accelerate means of production, so that the means of production can catch up with accelerating population growth. If everything gradually comes to a halt simultaneously, then we may just reach a "stationary phase" where the most important goal for economies is to remain stable, as opposed to today where the most important goal is exponential growth.

That, unfortunately, is the optimistic view. If things don't quite mesh up, expect the next century or so to be rather messy...

It's the exact same with programming. It's an abstraction on top of reality so that we can wrap our brains around it.

It's a complicated system with many moving parts that sometimes don't have any real world equivalents you can use to exemplify the issue.

Explaining a Collateralized debt obligation or a credit default swap is like explaining a Lisp macro to a non-programmer: Possibly but very hard.

I think this tendency to mythologize certain financial derivatives is weird. The concept of a macro is way more complex than the concept of a credit default swap. To demonstrate, here is (in my opinion) an explanation of credit default swaps that a person with no financial background should be able to understand.

A bond is a contract created and sold by an "issuer". The issuer can be a government or a company. Ownership of the bond entitles you to payments from the issuer. The specific number and size of payments varies from bond to bond. Once the issuer sells the bond to someone, that person can sell the bond to anyone else they want.

A credit default swap is a contract between two parties (neither of which is necessarily the aforementioned issuer) that are usually called the protection buyer and the protection seller. This contract is made in reference to someone called the reference entity. The protection buyer agrees to make a series of payments to the protection seller in exchange for the protection seller's promise that, in the case of a "credit event", they will give the protection buyer either some specified amount of money or some specified amount of bonds. The nature of the payments and the meaning of "credit event" vary from contract to contract, but generally a "credit event" is understood to have occurred if the reference entity (which is always an issuer) fails to make payments on some of the bonds it has sold. Either party in the contract is free to find someone else to take up their side of the trade at whatever price they can negotiate.

The only thing you needed to know to understand that was what a contract was, but if you want to understand macros, you really need to know what an interpreter is.

I think you're right about the basics of what a CDS is, but this doesn't really cover it. You also need to understand how the price of a CDS moves and why. Which can lead to much more complicated systems.

You're right, of course, but my point (and maybe I didn't make it very effectively) was that to acquire a similarly thorough understanding of macros would require way more information - I wasn't trying to make the point that a complete description of CDS could be given in a couple of paragraphs.

It's also complicated by the legal framework. My (limited) understanding of the problems with CDOs in 2008 was that multiple buyers could purchase insurance on the same bond. It's like if I could buy fire insurance on your house. If a lot of us did that and your house burned down, the insurer would have been on the hook for many times the cost of the underlying asset. This is why we had to bail out AIG.

When it's spelled out like that, the idea seems preposterous. But the legal framework allowed it -- in certain contexts. AIG et al call them "CDOs" instead of just "insurance" so they could avoid the more-restrictive legal framework governing the insurance industry.

And given that a typical CDO is the size of a Manhattan phone book (remember those?), there obviously is a lot of nuance that a lot of people did not understand.

You're thinking of CDS, not CDO. CDS stands for credit default swap(s) and CDO stands for collateralized debt obligation. You're right that a CDO would be really big if you printed out a formal specification, but that's because a CDO is special trust where the trustee buys and sells different securitized products and tranches out the payments to shareholders in the trust.

Also - AIG could have made the same mistake with conventional home insurance. Say they only keep 100 dollars of cash around and they decide to insure a million houses, each with a value of one dollar. If one ten thousandth of the houses burn down, AIG goes bankrupt. So it's not true that selling a dollar notional of home insurance is less risky than selling a dollar notional of CDS, because it could easily be the case that the expected payout on the CDS is higher. CDS are just harder to price. There are very robust statistics about houses burning down - the statistics on whether homeowners would default were a lot trickier to deal with.

It's an abstraction on top of reality so that we can wrap our brains around it.

And unfortunately, it can be a very leaky abstraction at times.

For example, most people have an implicit abstraction of money equals real things in their head, which causes them to believe certain claims about the relationship between the money supply and inflation, and this in turn leads to monetarily sovereign governments running deficits that are far too low to support a healthy economy.

Because if you only see that particular abstraction, you cannot see the effect of monetary saving. With that abstraction in mind, you can never understand the Paradox of Thrift.

I think tlammens said it best in the discussion from 6 hours ago:

"headlines like this are the cause of a recession rather than the facts behind it."

http://news.ycombinator.com/item?id=3280507

Not to be a negative nancy, but these discussions are really starting to bore me ... not because the underlying issues aren't important but because at this stage many vested parties are overhyping the issue.

An fun exercise is to ask random people you know why changes in interest rates are so important and so diligently reported by the press. My own experience is most people have no idea.

I think most people understand that lower interest rates mean it's easier to afford a larger mortgage or car loan.

That being said, the beauty of free markets is that individual agents don't have to understand macro (or even micro) economics to make good decisions: Prices provide all the information they need. Interest rates, materials cost, labor cost, dealer margin... who cares? All that matters is whether I think it's worthwhile to make a $300/month payment for this car.

That's why relatively stable prices are important. Uncertain future prices make the cost/benefit trade-off of economic decisions too complex for the average person to make rational choices.

Plus there is usually a seller trying to convince you why buying is such a great idea.

Most people have no idea because most people do not make any decisions based on interest rates. It just isn't material in their decisions.

If you tell me next thursday it will be rainy, I'll remember to bring my umbrella. But tell me interest rates go up and it doesn't really affect my decision to get a mortgage or not. Either, I've found the perfect house with a mortgage that is affordable (in which case I sign) or I haven't. At no point does knowledge of the interest rate make any difference in my decision.

I think the real reason its reported as its a nice round figure that is a barometer of sorts on the economy. Great for providing some meat around a story. Bonus points for sounding like the sorts of thing smart and respectable people would want to know. I'd be interested in your opinion about why changes in interest rates are so important for the press.

The interest rate is a measure of the leverage you can apply when buying that mortgage.

Lower interest rates mean more leverage. Increased leverage increases risk.

If they lower the interest rate, you can buy a more expensive home.. but you increase the risk you'll lose all your equity from a small change in house prices.

Right now in the US, more than 30 percent of homeowners are underwater on their mortgage.

If they decide to raise interest rates and you have a variable rate mortgage or have to renew it, your mortgage payments can shoot skyhigh.

Either way, record low rates make the system susceptible to systemic shocks and cascade failures.

Free trade and de-regulation means capital is free to flow quickly around the world. Investors can lose faith and a country can go from solvent to bankrupt in a matter of months. Interest rates shoot up and anyone caught with debt races to pay it off with dwindling incomes while the payments get bigger every day.

I think that in this case the reporter doesn't understand what's going on behind the abstraction.

One thing that might happen is that some country's equivalent of our treasury dept will realize that they're not going to be able to make the next set of payments on their bonds.

People understand when you start talking about the unemployment rate.

I think the problem is that the underlying reality is so complex that you can't really talk about it quantitatively. Those shared illusions reduce to simple numbers some extremely difficult concepts.

As far as what's going to happen in a few weeks to cause everything to come crashing down, I think the problem essentially boils down to people making promises they can't keep, or end up not wanting to keep. This has been going on for a long time, and the sudden event at the end is basically just a critical mass of people realizing that it's been going on for a long time. The disconnect between sudden shift in the markets and no corresponding sudden shift in the infrastructure, workers, etc., is, I think, that lack of realization.

This is just how I see it, as a humble finance layman.

The problem (or one of them) is that if the euro splits up into many separate currencies, the values (exchange rates) of those currencies are probably going to fluctuate greatly. This causes all kinds of problems for governments, banks, companies, and even individuals as the value of your debt, the cost of supplies, the price of your exports, etc. all change dramatically.

It's possible to split up the euro the same way it was put together: peg the national currencies to a pseudo-Euro for a transitional period. There might not be enough time for that to work in a crisis, though.

That's not a problem, that's the entire point. The PIIGS (Portugal, Ireland, Italy, Greece, Spain) switch to national currencies, print money to pay their debt, and suffer the effects of inflation. That's precisely the mechanism by which a breakup would 'solve' the euro crisis.

Huh? Debt is so simple a four year old can understand it. You give me money now and I give you money later. Many financial instruments are more complicated, but bubbles in even the worst ones are the stuff of recessions, whereas systematic monetary and credit crises are the stuff of depressions.

It's possible you're referring to the monetary system itself, which can be confusing. However, monetary issues have historically been much worse under regimes of "real" money, even when you take into account this current crisis. Illusory money done correctly has a lot of nice properties, and a big problem with the euro is that it doesn't have one of the key prerequisites--monetary, fiscal, and economic union in one. When a country can be drained of its credit supply because it's doing slightly worse than others, that's an undesirable monetary regime, and in the end threatens everyone.

>Huh? Debt is so simple a four year old can understand it. You give me money now and I give you money later.

Except that the four year old would be wrong when it comes to fractional reserve banking. I'm trying to imagine how a four year old would understand "You give me a piece of paper promising to pay the money back, and as long as I haven't done it too much (based on the money I have), I create money out of thin air and balance it with your promise to repay."

i think a 4 year old would understand that, and think it is a wonderful scam, if she could get away with it.

If I had a four year old, I would totally want her to be like that.

"Debt is so simple a four year old can understand it"

There is a difference between rational understanding and the way people act.

Even if a four year old would rationally understand debt, I am not sure that, if you offer a four year old a hundred sweets on the condition that (s)he will pay you back ten more sweets in a year, the typical four year old would decline.

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