Philip Whiteley's Blog

March 23, 2010

Intensification of ignorance

Filed under: Uncategorized — felipewh @ 4:35 pm

If ‘we have lived through an information revolution’, according to the hype of the past few years, we ought never to have been better informed. Yet crises based upon ignorance seem to occur again and again.

The problem with the cliché about the ‘information revolution’ is that it does not really refer to information at all, but data. This is a very different thing.

The last 20 years have witnessed a transformation in the speed and ease with which data about economies and companies can be collated and disseminated.

The problems are two-fold. The anachronistic assumption that financial data ought to be the primary source of information about an economy persists. It is widely believed that economies consist of money. They don’t. They consist of people, making economic decisions. This means that economic data is, at best, inadequate for informing us on economic decisions.

The second, closely allied, problem is that much economic data is rubbish, because it’s based on aggregation, securitisation or benchmarking. Computerisation based on bogus assumptions has led to an intensification and acceleration of ignorance. This is a major explanatory factor for the repeated crises we have seen: in the Argentinian debt crisis; the dotcom failures; the Enron scandal, the banking collapses and the Euro crisis. The common factor has been a near exclusive reliance on financial data for major economic decisions, without the recognition that such data would be hopelessly incomplete at best and downright misleading at worst.

Paul Blustein’s book on the Argentinian crisis, And the Money Kept Rolling In, published in 2005, was a foretaste of what was to come in the credit crisis and the Greek crisis. I am almost embarrassed on behalf of the buy-side investors to report the measurements that guided them in the run-up to this disaster. They used a benchmarking tool called ‘EMBI-plus’, which tracked the percentage of debt held by different emerging economies. Because investors were following themselves in herds, it resulted in the perverse incentive to continue lending heavily to the most indebted countries, even where the recommendation was to be ‘underweight’. The practice ‘virtually forced these investors to lend vast sums to Argentina even if they feared the country was likely to default in the long run,’ wrote Blustein.

Investors operated in complete ignorance of the actual economy of Argentina; as completely ignorant as Soviet managers were when they told themselves comforting tales about productivity on their Five Year Plans.

It ended up with Ponzification: Argentina borrowing money so that it could pay existing creditors, and ultimately so that it could pay interest on the money it owed creditors until it all went pop. This was not a victimless phenomenon; some ordinary folk lost their life savings. The investment banks, having driven up the bubble, then shorted Argentina as it fell. They are allowed to keep all their profits.

I have written for years about the uselessness of much financial data in ‘informing’ investors about a company. It seems the same colossal errors are made about entire countries. The economic ‘information’ flashing up on investment bankers’ screens is often about as useful as a Grimm fairy tale.

An information revolution? That will take another 100 years, at least.

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