1/22/2009

Dear Paul,

I am preparing a paper for the next year American Economics Association annual meeting. The following is the preliminary Abstract.

Title: Key Question On Financial Crisis: "Do Economists Really Know How To Determine Price And Rate Of Return?"

Abstract

One of the most important questions, if not the most important question, for solving the financial crisis is: "Do the economists know how to determine the price?" It should be apparent by now that the financial crisis occurs because THE PRICE IS WRONG. From over thirty years of development and market testing of the valuation software based on its solution of value, which predicted both the Savings and Loan Crisis and the Subprime Woe, Post-Science Institute, which is formed by mathematical scientists and real estate practitioners, believes that it is very unlikely that the economists know how to determine the price claim which can be simply refuted by showing a correct method of price determination. A correct method must be deterministic, where the number of equation equals the number of unknowns, with consistent results without anomalies. A popularly accepted correct solution of value would be the first step toward a rational society and an end to financial crises.

We can narrow down the problem of economics to the problem of value. Describing economic problems with mathematics (Paul Samuelson) does not solve problems. Doing rigorous mathematics without practical experience, which is the only way to learn the problem, (Gerard Debreu and Kenneth Arrow) can only produce qualitative results. Milton Friedman is the only economist with some useful results, but his Free Market will become a historical joke because the market is not free and is regulated by non-violable laws of nature. We need some mathematically rigorous thinkers with real estate investment experience to judge the current state of economics. Thanks for picking this most fundamental question for discussion.

With best regards,
Hugh

I believe the correct answer is yes indeed there is an economic event waiting to happen that will completely change the current neo-classical economic paradigm, and that is ecological economics. The basic principle of ecological economics as describe by Herman Daley, Josh Farley, Brian Czhec, and others, is that we live in a finite world that is near capacity and that economics is a subset of the world's ecosystem/environment and not the other way around. The environment is not a subset of economics. In addition, most ecological theories and principles can and should be incorporated into economic theory. Otherwise we will continue on the path to destruction assuming that economic growth can can continue indefinitely. I encourage everyone to explore ecological economics and steady state economy theory.

Dear Paul,

Thank you for posing the question on economics mathematics. And, now we are really getting into the crust of the trouble with economics. This could be an excellent place to start by getting into economics mathematics, which I believe should occupy the center of the debate on the economics contribution to the financial crisis, particularly, to the fundamental problem of price determination.

As a mathematical scientist, I strong endorse Gerard Debreu (and Ken Arrow, who is not a pure mathematician as Debreu) General Economic Analysis, except that the temporal calculation on page 34 of his book "Theory of Value" is incorrect. The "existence" of a general equilibrium is what Gerry K. meant by existence theorems. Up to now, I have found no other theory in economics I would accept due mostly to their lack of rigor.

Diophantine analysis try to fit economics into solvable mathematical problems. It follows the long tradition of Robert Dorfman, Paul Samuelson, Robert Solow in trying to introduce mathematics into economics, starting with linear programming and expanding into diophantine analysis. Since Gerry is against it, too, we don need to get into it, except that David Hilbert, my teacher teacher teacher, speculated, but later proven wrong, that all diophantine problem are solvable.

Regarding econometrics, I completely disagree with the view of Gerry, that it is the only useful field in economics. Econometrics is used primarily in time-series analysis of mainly the price.

Price changes with any change in expected future consequences extending to infinity in time (Debreu and Arrow). The change in expected future consequences will never stop because infinity, by definition, will never arrive. Thus, the price is not subject to empirical time-series analysis, which uses past data, and all the econometrics analyses based on time-series of past price data are complete waste of time and funding. Time-series analysis on the price should be stopped. The US Savings and Loan Crisis was caused by the market comparison approach, which compares to past price, even when the real estate market has crashed.

Economists should continue the work of Gerard Debreu. Unfortunately, only Arrow is still alive to promote this direction of research. Not being trained as a mathematician or even a scientist, Arrow probably will not insist on mathematical rigor, except for himself and his own students.

The general problem of value involves an infinite number of non-linear equations, as Debreu describes in his book, assuming that the temporal dependence of the equations is solved. When the consideration of the expected future consequences is not taken to infinity in time, the mathematical problem is non-deterministic, where the number of equations is less than the number of unknown prices. From common sense, any happening, no matter how far in the future, can affect the decision now.

My comment tries to clarify some of the technical points. I am not trying to fully prove my point here, but to suggest that we should all follow this type of discussion involving the foundation of economics, especially, on price determination, during, and for solving, the financial crisis.

With best regards,
Hugh

I purchased a Mobile Home Financed by Bank of America. $29,000.00. Paid $1,500.00 down. After a few Months, the Bank sold my contract to a Company by the Name of Green Point Credit. Who later Changed their Name To Green Tree. Green Point lost my payments many times But I payed with a Check from my Credit Union and Got a copy of the Check that They had signed. Proving That I had made the payment. This Loan was set up on the Amortization table. For a $27.500 loan, they changed it to $29.000.00 Loan, They would profit by $87,000.00 + the $29,000.00 making the Mobile Home cost $116,000.00. I had to hire A Lawyer to make them except payment from the Credit Union. I asked for a amortization table of the payments, The table started when they Changed their Name to Green Tree. I'll be 105 years old when the Mobile home is paid for but the value will only be $2,000.00
when it paid for. No one has asked the Banks about the amortization table and why the loan is never paid for in full. Out Government is helping the Banks rob the people in this system of paying off a loan. I ask again, why hasn't anyone said anything about the "Amortization Table"?

The economics of collecting money these days is not braking their legs if they don't pay, just take their house.. You are great, thank you.
Don.

Dear Paul,

I hope that your very educated readers and friends will continue to debate on the topic of the foundation of economics. The following article further elaborates on my previous views. The Federal Reserve has promised me to look into and have a debate on valuation, but you and NewsHour might give the discussion a head-start. The new administration needs right away valuation to value troubled assets, and rate of return calculation to determine funding priorities.

As I am watching Australian Open (our most viewed "jumpulse" post on tennis.com predicts winners and losers), I remember that my students have numerous debates with the followers of Austrian Economics. You can find most discussions by search (strangely) "non-violable" (laws of nature in economics, which are not considered by the Austrian School and Milton Friedman in his Free Market). In particular, a very long debate can be found in the web blog Unforeseen Contingencies. By the way, our valuation software (Infinite Spreadsheet) calculates the amortization with just one line program statement. Thank you for expanding your consideration into economics mathematics, beyond economics ideology.

Best regards,
Hugh

Subject: Econometrics vs. Infinite Spreadsheet; Science vs. Social Science

Empirical verification is the bulwark of science, but is possible when a deterministic set of data can be collected. For example, one can calculate the acceleration of a falling ball from the height of the ball and the time to drop to the ground in the equation Height = Acceleration x Time Squared/2, assuming the acceleration is a constant. And from the acceleration and the height, one can predict the time. The acceleration of gravitation is a time-invariant quantity, and formula is a non-violable law of nature.

Empirical verification is not possible when infinity is involved because a deterministic set of data can never be collected, for infinity never arrives. For example, value depends on all the future benefits and losses extending to infinity in time, and cannot be empirically determined because infinity never arrives. One can never empirically verify if $800 per ounce of gold is the right price because the price of gold will change continually to infinity in time. The price is a time-variant quantity, which changes continually to infinity in time. According to Kant, Debreu, etc., infinity can only exists in the mind, an a priori knowledge. Thus, involving infinity, social science is fundamentally different from science.

Ecology, as well as economics, involves infinity. Infinite spreadsheet could be another term for ecology. To determine anything we do to our environment, we must consider the expected consequences to infinity in time. Finite resource particularly needs infinite consideration. For example, funding of various energy projects is hampered more by not knowing their true values than their technical difficulties. In any case, the values of these environmental projects should be determined based on their rates of return, before their funding. Or, in a rational society, which does not exist today, social science should come before science, for the priority of scientific projects should depends on value calculated in social science.

Econometrics tries to extend the scientific concept of comparing to the past to economics. Science deals exclusively with time-invariant quantities and formulas, which are non-violable laws of nature in science. ONLY TIME-INVARIANT QUANTITIES CAN BE DETERMINED BY COMPARING TO THE PAST.

To be sure, the inputs to the infinite spreadsheet, in order to be expressed to infinity in time, have to be expressed as approximate time-invariant quantities. But, the price has to be calculated based on the expectation of all the factors affecting the price to infinity in time; in this sense, the price depends on past data, but should not be compared directly, itself. The scientific concept of comparing to the past is applied to the inputs, not the price. Thus, econometrics is useful for determining using time-series analysis the inputs affecting the price, but not the price itself, which depends on the future, not the past.

In conclusion, the standard of rigor of science is empirical verification, and the standard of rigor of social science has to be mathematical rigor because empirical verification is not possible for value or decision, which is the foundation of social science. ###
Post-Science Institute 1-23-2009