In last week’s Thoughts from the Frontline I talked about the Age of Transformation, attempting to refute Robert’s Gordon rather stark and gloomy view of the future growth potential of the economy. That letter generated a rather significant amount of reader response, both pro and con, as not everyone agrees with my decidedly optimistic long-term view of the future. It might be fun and thought-provoking, in fact, to do a letter that deals with some of the issues you raised. I really do have some of the smartest readers of any economics and investing letter out there.
Inside what was a long letter even for me, I buried a few quotes from George Gilder’s latest book, Knowledge and Power. I am not simply reading this book, I am thinking through it, as some of what he writes is truly pivotal for my own thought process.
For this week’s Outside the Box, George has graciously allowed me to reproduce chapters 1 and 3 from his book. It helps that George is a gifted wordsmith and a raconteur of the highest order. He doesn’t bury his insights in dry economics-speak that demands intense concentration if you are to stay focused on the topic. Rather, he draws you into and through the topic, until you find yourself on a delightful Slip ‘n Slide of thought. I think you will get a lot out of reading these chapters, and I strongly suggest you consider reading the whole book. It is an important one.
Chilton Capital's REIT Composite was up 6.1% last month, compared to the MSCI U.S. REIT Index, which gained 4.4%. Year to date, Chilton is up 6.3% net and 6.5% gross, compared to the index's 8.8% return. The firm met virtually with almost 40 real estate investment trusts last month and released the highlights of those Read More
I write this note as I am wrapping up three days of meetings with my partners at Altegris Investments and Mauldin Economics, focusing on how to deliver better products and services to you. And we’ve enjoyed a few late-night conversations about where the world is going and how to surf the inevitable and the profitable.
In a few hours I will be off to Dubai and Riyadh, with maybe even a side trip to Abu Dhabi, after a very long layover in London, where I will jump into town to have lunch with Simon Hunt and delve deep into the happenings in China and Europe. I’ll also bounce a few ideas off him for this weekend’s letter.
I am really kind of excited about this trip, as all these places are new territory for me. You have a great week, and I will send you this weekend’s letter from Dubai.
Your wondering what I will find out there analyst,
John Mauldin, Editor
Outside the Box
Knowledge and Power
By George Gilder
Chapter One: The Need for a New Economics
Economic life is full of surprises. We cannot predict the value of our homes or prices on the stock market from day to day. We cannot anticipate illness or automobile accidents, the behavior of our children or the incomes of our parents. We cannot know the weather beyond a week or so. We cannot gauge what course of college study will yield the best lifetime earnings or career. We are constantly startled by newspaper headlines or the eruptions of TV events. We are almost entirely incapable of predicting the future.
Yet from Adam Smith’s day to our own the chief concern of the discipline has been to render economic events unsurprising. Given a supply x of corn and a demand y, the price will be z. Change x or y and hold all else equal and the price will instead be a predictable z?. The discernment of orderly rules governing the apparent chaos of life was a remarkable achievement and continues to amaze. Economists such as Steven Leavitt of Freakonomics fame and Gary Becker of the University of Chicago became media stars for their uncanny ability to unveil what “we should have known.” Closer investigation, however, reveals that even these ingenious analysts are gifted chiefly with 20-20 hindsight. They prosper by explaining to us what has happened more than by anticipating the future with prescient investments.
The passion for finding the system in experience, replacing surprise with order, is a persistent part of human nature. In the late eighteenth century, when Smith wrote The Wealth of Nations, the passion for order found its fulfillment in the most astonishing intellectual event of the seventeenth century: the invention of the calculus. Powered by the calculus, the new physics of Isaac Newton and his followers wrought mathematical order from what was previously a muddle of alchemy and astronomy, projection and prayer. The new physics depicted a universe governed by tersely stated rules that could yield exquisitely accurate predictions. Science came to mean the elimination of surprise. It outlawed miracles, because miracles are above all unexpected.
The elimination of surprise in some fields is the condition for creativity in others. If the compass fails to track North, no one can discover America. The world shrinks to a mystery of weather and waves. The breakthroughs of determinism in physics provided a reliable compass for three centuries of human progress.
Inspired by Newton’s vision of the universe as “a great machine,” Smith’s theory—launched in The Wealth of Nations in 1776—sought to find similarly mechanical predictability in economics. In this case, the “invisible hand” of market incentives plays the role of gravity in classical physics. Codified over the subsequent 150 years and capped in Alfred Marshall’s Principles of Economics, the classical model remains a triumph of the human mind, an arrestingly clear and useful description of economic systems and the core principles that allow them to thrive.
Ignored in all this luminous achievement, however, was the one unbridgeable gap between physics and any such science of human behavior: the surprises that arise from free will and human creativity. The miracles forbidden in deterministic physics are not only routine in economics, they constitute the most important economic events. For a miracle is simply an innovation, a sudden and bountiful addition of information to the system. Newtonian physics does not admit of new information of this kind—describe a system and you are pretty much done. Describe an economic system and you have described only the circumstances—favorable or unfavorable—for future innovation.
In Newton’s physics, the equations encompass and describe change, but there is no need to describe the agent of this change, the creator of new information. (Newton was a devout Christian but his system relieved God or his angels of the need to steer the spheres.) In an economy, however, everything useful or interesting depends on agents of change called entrepreneurs. An economics of systems only—an economics of markets but not of men—is fatally flawed.
As the eminent mathematician Gregory Chaitin has pointed out, for human and biological processes, the calculus does not suffice. He writes: “Life is plastic, creative! How can we build this out of static, eternal, perfect mathematics? We shall use post-modern math…open not closed math, the math of creativity…”
Flawed from its foundation, economics as a whole has failed to improve much with time. As it both ossified into an academic establishment and mutated into mathematics, the Newtonian scheme became a mirage of determinism in a tempestuous world of human actions. Economists became preoccupied with mechanical models of markets and uninterested in the willful people who inhabit them.
Some economists become obsessed with market efficiency and others with market failure. Generally held to be members of opposite schools—“freshwater” and “saltwater,” Chicago and Cambridge, liberal and conservative, Austrian and Keynesian—both sides share an essential economic vision. They see their discipline as successful insofar as it eliminates surprise—insofar, that is, as the inexorable workings of the machine override the initiatives of the human actors.
“Free market” economists believe in the triumph of the system and want to let it alone to find its equilibrium, the stasis of optimum allocation of resources. Socialists see the failures of the system and want to impose equilibrium from above. Neither spends much time thinking about the miracles that repeatedly save us from the equilibrium of starvation and death.
The late financial crisis was perhaps the first in history actually to be caused by economists. Entranced by statistical models, they ignored the larger dimensions of human creativity and freedom. To