Lead/Lag

In control engineering, the concepts of stability and instability precede the design of the control algorithms themselves. As an engineering student, studying and understanding the behavior of dynamic system is a prerequisite to controlling them. As elementary it is as an engineering concept, it often seems to be beyond our collective comprehension as a society, even if it is well within our individual grasp. While most of us may scratch our heads when looking at a Nyquist Plot, we do understand that you’ve got to start backing off the accelerator even before you get up to your desired speed.

When I was a younger man, I had a roommate who drove a Datsun 280Z. This was a nifty little car. Price-wise, it was accessible to the young, the working class, without breaking the bank like. Not only was it affordable to buy but it was affordable to own. It was a pleasure to drive and, top it all off all, it was fairly impressive performance-wise. I nice example of the “roadster” style.

We took a few summer road trips together and, on more than one occasion, he asked me to drive so he could take a nap, sober up, or just monkey with his cassette deck. Before letting me drive for the first time, he gave me a bit of a run down on his car’s performance. “Don’t go over 90 mph,” he warned me, as the car would shake violently shortly after crossing the 90 mark on the speedometer. Needless to say, the car never shook itself apart while I was driving. Perhaps that was because, as a conscientious and responsible youth, I would never exceed the speed limit. Perhaps it was because it he wasn’t entirely correct about the circumstances under which his car would have vibration issues.

My point is, most of us have a gut understanding of frequency response and stability and the struggles of controlling it. The seriousness of the problem is exposed in the design of mechanical systems and, in particular, those that incorporate high-frequency rotation of components. Deeper understanding and mathematical analyses are necessary prerequisites to assembling a piece of machinery that will hurtle through the night at speeds approaching 100 mph. In the case of my friend’s Datsun, as cyclic energy is induced into a system, it is possible for those inputs to resonate in the spring-like manifestations of the system’s passive structure. Without proper analysis and design, a vehicle’s suspension system might well start to exhibit extreme vibration at high speeds. The same applies to any dynamic system. We are all familiar with the violently-shaking washing machine, whether we have one in own home or not.

Naturally, the mathematics apply to non-mechanical systems as well. Often the effects are far more serious than a shaking car or a jumping washing machine. In electric circuits, resonance can produce seemingly impossibly-high voltages and currents. Water hammer in a hydraulic system can crush equipment and cause explosions. The analyses that help us understand these physical phenomenon, I’ll argue today, would also help us understand interactions in social systems and the effect of a “black swan event,” if we allow them to.

It’s the Stupid Economy

The sometimes-sizeable gap between “gut feel” and mathematical certainty is particularly common to complex systems. Coincidentally, our body politic is eager to tackle the most complex of systems, attempting to control them through taxation and regulation. The global climate and national economies seem to be a recent, and often interconnected, favorite. I shall leave the arguments of climate science and engineering to others and, today, focus on the economy. When it comes the politics of the economy, I have noticed a pattern. When it comes to the intersection of economics and politics, the thinking is shockingly short-term. Shocking, because the economic environment may be the number one predictor for the outcome of an election. A good economy strongly favors the incumbents whereas economic misery almost guarantees a changing of the guard. You would think that if the economic conditions are what matter most to us, when it comes to our one contribution to the governance of society, we’d be eager to get it right. Yet, what seems matter most are the economic conditions on the day of the polling. Four years of economic growth doesn’t mean much if the economy tanks on the 30th of October.

In something of a mixed blessing, the recent political free-for-all has challenged this shortsightedness, at least somewhat. President Obama, for years, blamed his predecessor for recession and deficit spending, despite a negative economic climate persisting for years into his term. He even famously took credit for the positive economic indicators during his successor’s term. His opponents, of course, sought to do the opposite. The truth is far more nuanced than any care to admit, but at least popular culture is broaching the subject. Most of us know that if “the economy” is looking up the day after the President signs off on a new initiative, it wasn’t his signature that did it. Or, more accurately, it can’t possibly account for the entirety of the impact, which may take months or years to reveal its full effect.

Going Viral

We have a further advantage when it comes to talking about the interaction between the economy, the novel coronavirus, and the resultant economic shutdown. The media has inundated us with bell curves and two-week lags. Most of us can appreciate the math that says if a Governor closes bars and restaurants today, we shouldn’t yet be looking for the results in our statistics tomorrow. Nonetheless, our collective grasp of dynamic systems and probabilities is tenuous under the best of circumstances. Mix in high levels of fear and incessant media hype, and even things that should be obvious become lost in the surrounding clamor.

Shift the playing field to economics and the conversation gets even murkier.

“The economy” is at the high-end of complex and chaotic systems. It is, after all, not an external system that we can observe and interact with, nor is it subject to the laws of physics. Rather, it is the collective behavior all of us, each and every individual, and how we interact with each other to produce, consume, and exchange. Indeed, one might speculate on where the boundaries really lie. It seems a bit insensitive label everything as “economic activity” during a health crisis, but what is it that we can exclude? Waking and sleeping, each of us are in the process of consuming food, water, clothing, and shelter. Most social interactions also involve some aspect of contract, production, or consumption. Even if we can isolate an activity that seems immune to all that, all human activity still occurs within that structure that “society,” and thus “the economy, provides.

Within that framework, anyone who claims to “understand” the economy is almost certainly talking about a simplified model and/or a restricted subset of economic activity. Either that, or they are delusional. Real economic activity cannot be understood. Even if the human mind was vastly more capable, the interaction of every human being on the planet is, quite simply, unpredictable. Because of this, we use proxies for economic activity as a way to measure health and the effects of policy. GDP and GDP-growth are very common. Stock market performance substitutes for economic health in most of our minds and in the daily media. Business starts, unemployment numbers, average wages – each of these are used to gauge what is going on with the economy. However, every one of these metrics is incomplete at best and, more often than not, downright inaccurate in absolute terms.

Of course, it isn’t quite as bad as I make it out to be. GDP growth may contain plenty of spurious data, but if we seek to understand what is included and not included, and apply it consistently, we can obtain feedback that guides our policymaking. For example, we could assume that noisy prices associated with volatile commodities are not relevant to overall inflation numbers, or we can exclude certain categories when calculating GDP for the purpose of determining inflation. As long as we’re comparing apples to apples, our policy will be consistent.

What happens, though, when we get the economic equivalent of a hydraulic shock? In this case, our models of the economic world no longer apply and the world enters into an entirely unpredicted and unpredictable realm. We know this. What I want to explore, however, is what happens to our ability to “control” that system. My guess is it fails. It fails because we, again collectively, don’t appreciate the characteristics of dynamic systems. Yes, we understand it in terms of the heuristics we’ve traditionally used. Interest rates have to be raised before inflation kicks in to keep it from spiraling out of control. But what inflation will result from a $5 trillion stimulus at a time of 30% unemployment? Do we need higher or lower interest rates. In other words, when our traditional metrics fail us, will we truly appreciate the complex nature of the system?

In Control

During our imposed down-time, I re-watched an excellent film about the now-10-plus-year-old financial crisis induced by the housing market. The film The Big Short was made in 2015 based on Michael Lewis’ 2010 book of the same name. It dramatizes the subprime housing market collapse as seen by a handful of investors who saw it coming. As much as the story seems, today, in our distant past, there are those among us who feel that what we witnessed in 2008 was just the opening chapters in a longer tale. Whether a housing crisis is our past or our future, there are lessons to be applied to the present day.

The film’s story opens in 2005. Investor Michael Burry, reading the details of mortgage-backed security prospectuses, determines that the housing market is unstable and the financial instruments built upon it are doomed to fail. Unable to take a contrarian financial position using existing instruments, he commissions the creation the Credit Default Swap to allow him to bet that the mortgage market will fail. The film concludes when Burry, and several others who bet against the housing market, liquidate their positions at a profit, sometime after Spring, 2008. The real-life Burry had actually been analyzing data from 2003 and 2004 before making his predictions and his commitment. Burry later wrote a piece for the New York Times saying that the housing market failure was predictable as much as four or five years out.

Putting this another way, by 2004 or 2005, the massive financial crisis of 2008-2010 had already happened, we just didn’t realize it yet. One might argue that sometime in those intervening four years, sanity might have come over America’s banks and the prospective home-owners to whom they were lending, but of course it didn’t. The reasons are many why it didn’t; why perhaps it couldn’t. Thus the events that all-but-inevitably put us on the road to global financial advance happened [four, five, more?] years in advance of what we would consider the start of the crisis. Unemployment numbers didn’t recover until 2014. That implies that for the individual, perhaps someone becoming unemployed and being unable to find a new position circa 2014, the impact of the collapse may have taken more than a decade to manifest itself.

Again, lets look at it from a different angle. Suppose I wanted to avoid the tragedy to that individual who, in 2014, became unemployed. Let’s imagine that, as a result of his lack of employement, he died. Maybe it was suicide or opioid addiction. Maybe the job loss turned into a home loss and his whole family suffered. Suppose as a policy maker, I wanted to take macro-economic action to avoid that unnecessary death. How soon would I have had to act? 2003? 2000? Sometime in the 1990s?

Next Time

All of this comes to mind today as a result of the talk I am seeing among my fellow citizens. People are angry, although that isn’t entirely new. Some are angry because their livelihoods have been shut down while others are angry that folks would risk lives and health merely to return to those livelihoods. In the vast majority of cases, however, the fear is about near term effects. Will my restaurant go bankrupt given the next few weeks or months of cash-flow? What will the virus do two weeks after the end of lockdown? Will there be a “second wave” next fall? A recent on-line comment remarked that, although the recovery phase would see bumps along the road, “We’ll figure it out. We always do.”

Statistically, that sentiment is broadly reflected in the population at large. A summary of poll data through the end of March (http://www.apnorc.org/projects/Pages/Personal-impacts-of-the-coronavirus-outbreak-.aspx) suggested similar thinking. A majority of those currently out-of-work see no problems with returning “once it’s over.” In fact, a majority figure that by next year they’ll be as good as or better off financially than they are now. Statements like “we’ll get through this and come out stronger than ever” can be very motivational, but extending that to all aspects of economic and financial health seems a bit blind.

We’re losing track the macro-economic implications for the personally experienced trees. We’ve all see the arguments. Is it better to let grandpa die so that the corner burger shack can open back up a few weeks earlier? The counter argument cites the financial impact of a keeping the economy mostly-closed-down for a few more weeks. This isn’t the point, though, is it? On all sides of the argument it seems that the assumption is that we can just flip everything back on and get back to business. We are oblivious to the admittedly unanswerable question – how much damage has already been done?

Unprecedented

Word like “historic” and “unprecedented” are tossed around like confetti, but not without reason. In many ways our government and our society have done things – already done things, mind you – that have never happened before in the history of man. At first, the “destruction” seemed purely financial. Restaurants being shut down meant as loss in economic activity; a destruction of GDP. But is that even a real thing? Can’t we just use a stimulus bill to replace what is lost and call it even? But as April turns into May, we’re starting to see stories of real and literal destruction, not just lost opportunity. Milk is dumped because it can’t be processed. Vegetables are plowed under. Beef and chickens are killed without processing. This is actual destruction of real goods. Necessary goods. How can this go away with a reopening and some forgivable loans?

None of the experience gained through the financial crises of my lifetime would seem to apply. Even the Great Depression, while correct in magnitude, seems to miss the mark in terms of methodology. We’re simultaneously looking at a supply shock, a consumer depression, and inflationary fiscal policy. It’s all the different flavors or financial crisis, but all at the same time. Imagine a hydraulic shock in a some rotating equipment where the control system itself has encountered a critical failure. I’ve decided that, for me, the best comparison is the Second World War. Global warfare pulled a significant fraction of young men out of the workforce, many never to return. Shortages ravaged the economy, both through the disruption of commerce as well as the effects of rationing. A sizeable percentage of the American economic output was shipped overseas and blown up; gone.

Yet we got through it. We always do.

But we did so because we were willing to make sacrifices for the good of the nation and the good of the free world. We also lost a lot of lives and a lot of materiel. If “we” includes the citizens of Germany or the Ukraine, the devastation to society and culture was close to total, depending on where they called home. So, yes, civilization came through the Second World War and, as of a year or so ago, were arguably better than ever, but for far too many that “return to normalcy” took more than a generation. Will that be the price we have to pay to “flatten the curve?”

 

 

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