My understanding is that if one can’t simplify the basic principle into an understandable narrative, he either doesn’t possess good understanding of the subject, or is trying to bullshit you. In physics, the things that are really well understood can be made into a simple and straightforward narrative, while those that require head-spinning formulas and look more like c++ code than human language are the least well established and are most likely to evolve in the future.

The same goes with economy. Every time I’ve seen excessive complexity of the narrative, it was because someone had a vested interest in bullshitting everyone by adding layers of unnecessary complexity needed to hide some form of deception. For instance, the entire sup-prime mortgage crisis was essentially a scam, that was pulled off exactly because it was hidden in so much obscurity, unclear language, and, essentially, code. The complexity is not always there to hide foul play – mostly it is to create an illusion of great expertise, where simple concepts are intentionally related in overly complex terms in order to create an impression of user’s great knowledge and competence. I have the same issues with mathematics – some things are usually defined in such a complex way I usually feel very stupid for not understanding it, until I finally do, and then I can usually explain the concept in very simple, clear terms which completely dispel the “magic” of obscure terminology that actually made it almost impossible for me to understand the concept in the first place.

This is the reason why I explain things in a very simple, straightforward narrative. Of course, one can endlessly bitch about accuracy of this or that detail, but I find that unimportant. It’s essential for one to understand how the cogs and gears work, and then you can research the details as much as you like. I think that’s how all the good theories are made: by cutting through the pretense and irrelevant detail to the essence of what’s happening, and then you can model it mathematically to your liking. Essentially, Feynman and Nash formulated the basics of quantum electrodynamics and game theory in a canteen, one by playing with paper plates and watching the patterns of them falling, and the other by watching people interact and cutting through to the basic underlying motivations. It resulted in complex theories, but started by cutting through complexity in order to reach the simplicity of the basic principles which you could explain to a smart 10 year old.

The problem with economy is that when you don’t cut through bullshit, you lose money, and that can translate into losing a significant portion of your life. It is therefore essential that we really understand what is going on, how things work, why they work and why they fail. I am not alone in this belief – Warren Buffet, for instance, is a strong advocate of cutting through bullshit before you invest your money in something, because the quickest way to lose money is to invest in what you don’t understand, or to shift your money chaotically based on short-term events, instead of calmly implementing a long-term strategy. Essentially, great minds cut through bullshit, while small minds thrive in it.

So, as an example, I will break apart the 2008 crisis.

A derivative is, essentially, a paper that derives its value from an underlying real asset. For instance, paper money started as a derivative of gold, like today’s gold bonds. A mortgage loan contains a “security”, essentially a document which allows you to sell someone’s house if he doesn’t pay the installments regularly. These securities can be traded in their own right, and when you’re a big mortgage company, you can play very strange games, such as bundling many mortgage securities in a single package, in which bad mortgages (the ones where the loan shouldn’t have even been approved in the first place because he doesn’t earn enough money to be likely to repay the loan), euphemistically called “sub-prime”, are bundled together with the good ones in order to dilute the risk. This is very similar to the dangerous practice of some blood banks that pooled all the blood together before testing it for HIV. The resulting pool diluted the HIV positive blood below the threshold where the tests could reliably detect presence of the virus, but it was still infectious. That’s how the mortgage companies played the system: they understood the rules according to which risk-assessment was to be assigned to the entire bundle of securities by the rating agencies, and sold quite a large number of bad (“sub-prime”) mortgages to non-paying customers, and insured the entire package as a bundle to get a good insurance price and rating. However, this coincided with the point when the outsourcing policy backfired at the American economy, and a lot of people lost jobs. Having lost their jobs, they could no longer repay the loans. Combined with the already substantial number of the sub-prime mortgages on the market, this resulted in a huge number of defaults on mortgage loans. No problem, you’ll say, just repossess the houses and sell them, real estate is a good investment. But that’s the case only when the market as a whole is healthy and you sell individual houses. When you already exhausted the number of people who can afford to buy real-estate, to the point where you sold sub-prime mortgages for years, and now even the good ones defaulted, this means that the demand is zero and you just had a huge surge on the supply side, flooding the market with houses nobody can really afford. And then the banks said “no problem, the loans are insured”, and then the insurance companies defaulted because they played the system and lost. And then, when the loans themselves proved to be worthless, all the derivatives on those loans, including the emission of a significant portion of US currency, proved to be worthless. The American government had to choose between seeing the entire economy fold, and raising the stakes, and it chose the latter, printing trillions of new dollars in order to prop-up the corrupt and broken system. Since foreign currency is heavily based on US currency ever since Breton Woods and later the petrodollar, all hell broke loose, because America essentially transferred the cost of their crisis and of the rescue of their economy to the rest of the world, which had to buy those essentially worthless new dollars, unbacked by neither gold nor real assets, in order to buy crude oil on the market. This essentially pumped assets from the rest of the world into America, and created a chain of events which made the other countries reconsider their reliance on American currency as the basis of international trade, and as they attempted to save themselves from this vampire-transfusion event which created a never-ending global depression that threatens to pull everyone under, America intervened even more aggressively to bring the disobedient countries in line, mostly by instigating “color revolutions” and “springs” of all kinds, collapsing governments and fomenting civil wars in or near the “disobedient countries”, relying more and more on hard instead of soft power.

And the cautionary tale is that the reality of the situation was lost in the complexity of the narrative that has been told to the public. When you cut through the bullshit, you get to understand that the entire show of American prosperity is not due to their superior political or economic system, and that they don’t really practice either democracy or the free market. If they practiced democracy, the citizens would never vote for saving the greedy financial industry and the state by transferring the debt to taxpayers and foreign countries (in fact, Iceland showed what a real democracy would do). If they really practiced free market economy, nobody would be “too big to fail” and the state wouldn’t intervene to save failed bankers. This was such an enormous abuse of trust vested into America by its allies and friendly countries, that it essentially ended the petrodollar era and catapulted the world into very dangerous times that lie ahead. I wonder if the other countries think that America, like its banks, is too big to fail.