Finance - Hey I have a computer model too !!!

Mathematics is in my view the most important tool in the progress of human race. In 2006, I was working on some computer based tools to facilitate computer programming on a client's proprietary architecture. I read somewhere that a wise man once said "Given 10 hours to complete some work, I will spend 6 hours getting the right tools for that work". And I agree from my experience too.

But, nothing comes easy in this world. Mother nature n all :). There are two sides to this coin I believe.

1. A person might be using less tools.

2. A person might be using some tools and believing that they are the right tools.

In practical, I have never observe someone ever using all the correct tools needed. With time, new tools are invented and we realize their importance and start using them in their respective domain. That's the human genius. From stone tools, wheels, metal tools, machines, automobile, computers, and lots more. One can just keep going. Awesome. Isn't it.

Imagine I need to go 10 miles away to a grocery store. Changes are high that I won't walk. I might drive car, bike or may be bicycle. Assume that fortunately I got only bicycle (this is no typo. Bicycle keeps us healthy), then I may take an hour to reach there. Fair. This was case 1. But, I got hold of my brother's bike and confident that I will drive it easily (though I don't drive bikes often), I decided to ride his Honda bike to grocery. You can see the risk involved. This is case 2.

I want to highlight that believing the tool we are using is the right tool without enough evidence and experimentation is risky and dangerous.

This is what happens with financial industry. They develop some tool which account for few common variables and take decisions blindly based on that. Even more shocking is the blind faith in rating agencies which have been rating almost every popular financial instrument without expertise in that area.

The financial marketplace works with numerous handles like inflation, savings, interest rates, liquidity, relation with other world currencies, leverage, and many more. And their combined impact on the marketplace is not an easy task to model. That would involve complex mathematics and computer fire power. Miss some variable and one can get a 1-2 blow on face.

Thats what happened with financial industry last year in 2008. Even top investment banks like Goldman Sachs (GS) got indirect support from Fed to survive in form of AIG bailout which eliminated counterparty risk for GS.

We people make this marketplace. And we are no binary machines. Our behavior as a crowd can be very random. Taking into account the human psychology is very important to understand and play the market. Computer model should not be blindly followed. Models should be tested with large historical datasets and future market changes should be accounted for with a sense of doubt.

Only after rigorous testing, one can say that "Hey I have a computer model too !!!"

What this blog is all about?

Hi there,

The blog http://coinsize.blogspot.com will be a log of my view about economy, socioeconomics, and impact of money on other subtle issues. Issues that we all homo sapiens face in the world in 21th century.

I am a believer that money and in particular 'currency' shapes the way we people spend our life and shape the society.

Coin Size highlights my view that some wise, simple, and fundamental thoughts pave the way for us in the future. Often there are negative forces that behold decisions for our human race and planet at large. Sometimes, it is the random outcome of self interest of million and billions of people that shape our market place. They may be investors, consumers, or people misguided/misled by their (political) leaders and even democratically selected governments.

I believe that the most important handle of all is the currency. Roughly, upto 1870s there was no paper currency is wide circulation. Then came the US dollar notes. And the economic and social landscape changed for ever as paper currencies were devalued by governments from time to time and currently all major world currencies are fiat currencies.

To understand more about currency, fiat currency, US dollar notes read the following:

http://en.wikipedia.org/wiki/Fiat_money

http://en.wikipedia.org/wiki/United_States_Note

http://en.wikipedia.org/wiki/United_States_dollar

http://en.wikipedia.org/wiki/Federal_Reserve_Note

Fiat currency simply means a currency not pegged (measured) against some physical commodity like gold. It is a currency which government has declared to be a legal tender for financial transactions.

Earlier gold coin where the currency. Gold can't be printed by any individual or government at will. Now, say that the government is under debt and it can't pay government employees, soldiers. Or the government wants to rescue some people or organizations under debt. Then what. Government can't print gold coins overnight in large proportion to existing base even by mining gold from earth. Here comes the paper currencies and further down the lane comes the fiat currencies. We will be discussing currencies very often on this blog and musing some thoughts about how to play the economic environment we have been handed.

Some gentleman said that in economics if something can't work that way, it won't remain that way. (Not exactly the same words :) ). But, the duration can be much longer than our life span. Cumulative imbalances have been building in western economies since decades. Credit Boom bust have brought fun and sorrow to many countries. So, the path we take is more important than the final destination.

Hope you will enjoy the blog.