The Econophysics Blog

This blog is dedicated to exploring the application of quantiative tools from mathematics, physics, and other natural sciences to issues in finance, economics, and the social sciences. The focus of this blog will be on tools, methodology, and logic. This blog will also occasionally delve into philosophical issues surrounding quantitative finance and quantitative social science.

Sunday, January 28, 2007

Even more tyranny of the power law -- An audit of affluence (Financial Times)

The following is an article from the Weekend section of the Financial Times (Jan. 26, 2007). You can consider this to be more evidence to support my fears over what I have termed the 'Tyranny of the Power Law'. One of the research articles that the FT piece cites as evidence for decrease in meritocracy in the U.S.A. (as measured by decrease in intergenerational income mobility) is found at the Social Science Research Network. This study is in line with other econometric and/or economic studies showing similarly disturbing trends toward an American plutocracy (as opposed to meritocracy).

I find all of this to be disturbing enough to post the article in full on this blog. I strongly believe in meritocracy. We desperately need more of it not less. I hope you will agree.


An audit of affluence
By Chrystia Freeland
Financial Times,
Published: January 26 2007 15:25 | Last updated: January 26 2007 15:25

When I was reporting on Russia in the 1990s, one of my friends’ favourite observations was that “everything Marx taught us about communism was false but everything he taught us about capitalism was true”. As the nation’s vast natural resources were parcelled out among a handful of oligarchs, it was hard to disagree. But the Kremlin’s crony capitalism was so openly rigged that it was also easy to point out that the western version of a market economy was a different beast altogether.

The contrast seemed sharpest with the US. The great thing about this country, a European-born financier pointed out to me when I arrived last year, is that everyone believes he can succeed. For the billionaire, that made America the best place in the world to be a plutocrat. In Europe, he felt, when people saw a rich man they wondered how, as Proudhon famously observed, he had stolen his way to wealth: “But in America, when people see you are rich they ask themselves how they can become rich, too.”

This perceived equality of opportunity, and its impact on class relations, has long been a fond theme for America’s boosters. Alexis de Tocqueville was struck by how American servants weren’t very servile because “at any moment a servant may become a master and he aspires to rise to that condition”.

Nowadays that aspiration has looked harder to achieve. Two recent academic studies have found that some parts of Europe have become more meritocratic than the US: poor children in the Nordic countries stand a better chance of rising through society than their US counterparts. As for inequality of outcome, it has become so pronounced that it is being recommended as an investment strategy.

Citigroup analysts Ajay Kapur, Niall Macleod and Narendra Singh are leading advocates of this approach. They have coined the word “Plutonomy” to define countries – chiefly the US, Canada and the UK – where “economic growth is powered by and largely consumed by the wealthy few”. In a twist my Marx-schooled Russian friends would surely appreciate, they point out that savvy investors can take advantage of this trend by buying Plutonomy stocks, chiefly companies such as Bulgari and Richemont that produce “toys for the wealthy”.

The analysts offer a warning. In the Plutonomies, they point out, “political enfranchisement remains as was – one person, one vote”. This tricky fact “will probably, at some point, lead to a political backlash”. Indeed, as the 2008 race for the White House heats up, some politicians, notably former senator John Edwards, are picking up on the gap between rich and poor.

That could be dangerous for the plutocrats and a few seem to have realised that. You could call them the Buffett billionaires – those self-disciplined super-rich who have decided that frugality is wiser than flaunting it. A co-founder of a private equity group recently bragged to me that his Christmas present to his legendarily parsimonious wife was a “re-gift” – he got it in exchange for a fancy tie he had been given, which he took back to its Fifth Avenue vendor for store credit. A technology company boss told me this month he “doesn’t really like to consume” and that he tries to keep his business expenses to about $1,500 a week – a lot of money for ordinary North Americans but positively stingy for the CEO set.

In some New York circles, certain types of luxury consumption might even be becoming gauche. If, for example, you belong to Nora Ephron’s literary coterie I suspect you won’t be showing off one of the $2,600 handbags she gently mocks in her bestselling new collection of essays. A few executives who are still of the Bonfire of the Vanities school have found their habits to be worse than a faux pas – they turn out to be a sacking offence. This week’s scalp was Citigroup’s Todd Thomson, whose lavish office was nicknamed the “Todd Mahal” and included a wood-burning fireplace. Earlier this month it was Bob Nardelli, whose truculent defence of his compensation of more than $120m since joining Home Depot in 2000 helped provoke his ouster.

Conspicuous frugality is exactly the sort of self-preserving capitalist trick that ultimately defeated my Russian friends’ Soviet forebears. It is definitely an approach my own family’s most fervent capitalist – my penny-pinching, Glaswegian grandmother – would endorse. But I hesitate to predict that all of Manhattan will embrace her Scottish parsimony. One of my grandma’s signature habits is an absolute refusal to spend a quarter in our town’s parking meters, a philosophy particularly memorable if you have ever chauffeured her around, and around, and around Main Street in search of a free spot.

I thought of her when a very different sort of driver made headlines in The New York Times this week. The 92nd street Y – the exclusive Upper East Side pre-school which figured in Wall Street analyst Jack Grubman’s downfall – has warned parents their tots’ all-important letters of recommendation to kindergarten will be in jeopardy if their chauffeur-driven SUVs do not stop blocking the entrance to the school. Instead, their hired drivers have been instructed to find a legal parking spot or circle the block a few times while the parent or babysitter takes her toddler inside. That is good news for Plutonomy investors, but, at least when reporters are around, the smartest plutocrats might want to try taking the train.

More columns at

* Ajay Kapur, Niall Macleod, Narendra Singh, “Plutonomy: Buying Luxury, Explaining Global Imbalances,” Citigroup Research, October 16, 2005 and “Revisiting Plutonomy: The Rich Getting Richer,” March 5, 2006.

Copyright The Financial Times Limited 2007

Tuesday, January 23, 2007

Contango Fango: The languid state of oil & commodity prices

This post is a follow up to a previous blog post Glenn Gould and Commodity Prices (Nov. 9, 2006). The Economist magazine's Buttonwood column had an article on the ongoing languid state of oil and copper prices: Oil's not well: A fall in commodity prices raises concerns about the appetite for risky assets (Jan. 11, 2007). According to the article, January 9th of this year saw crude prices at an 18-month low. Copper prices, which had risen to lofty levels, aren't doing much better. All of this is despite rather compelling stories of increased geopolitical risk which should increase commodity prices and decrease emerging market asset values (it might have the latter effect, but it is not currently having the former effect).

The Buttonwood piece cites several reasons for why commodity prices are in a slump and also debunks some reasons that have been offered up for the current languidness of oil and copper prices. As I had suggested in the 'Glenn Gould ...' blog post, the slump probably has more to do with the fickleness of speculative capital than any of the rationales that have been offered up. Buttonwood concurs. As the article points out, speculation in commodities futures created a phenomena known as 'contango' -- where roll yields are negative (i.e., futures prices are higher than spot prices) and futures investors had a harder time making a profit (since they can't count on futures prices to rise to future spot prices). Factoring this in means that commodities speculators lost money even if the spot prices of commodities had remained high (and even that might no longer be true).

Sunday, January 21, 2007

Neuroeconomics of Spendthrifts vs Tightwads

John Tierney's column in the New York Times (January 16, 2007) discusses neuroscience / neuroeconomic research into the difference between the minds of spendthrifts versus the minds of tightwads. According to research done at Carnegie Mellon, the difference can be explained by the relative differences of how different people experience the pain of spending (or not spending): More pain from spending, more likely you are to be a tightwad; less pain, more likely you are to be a spendthrift. A lot of this type of research is carried out by using functional M.R.I. machines scanning subjects' brains as they make economic decisions in a laboratory setting.

Sunday, January 07, 2007

Experimental Economics Article on the FT

Tim Hartford's Undercover Economist column on the Arts & Weekend section of the Financial Times this week (Jan. 5, 2007) dealt with experimental economics. Experimental economists use the kinds of experiments run by psychologists and biologists to test out hypothesis and theories in economics and other branches of the social sciences. The most interesting part of the article was the idea of using the virtual world of online games as "a social-science supercollider." Anyone who has played some variant of Sims should see the potential in that type of experimental platform for economists.