Libertarian Democrat Point Of View: An Eccentricity: This is how scientists have deceived themselves and everyone else about their business, but without any real disadvantage

Thursday, March 26, 2009

This is how scientists have deceived themselves and everyone else about their business, but without any real disadvantage

Paul Feyerabend (1975)

Against Method

Outline of an anarchistic theory of knowledge

Source: Analytical Index (being a sketch of the main argument) and the concluding chapter from Against Method (1975) publ. Humanities Press. Just the Analytical Table of Contents and Concluding Chapter reproduced here.

Science is an essentially anarchistic enterprise: theoretical anarchism is more humanitarian and more likely to encourage progress than its law-and-order alternatives.
This is shown both by an examination of historical episodes and by an abstract analysis of the relation between idea and action. The only principle that does not inhibit progress is: anything goes.
For example, we may use hypotheses that contradict well-confirmed theories and/or well-established experimental results. We may advance science by proceeding counter-inductively.
The consistency condition which demands that new hypotheses agree with accepted theories is unreasonable because it preserves the older theory, and not the better theory. Hypotheses contradicting well-confirmed theories give us evidence that cannot be obtained in any other way. Proliferation of theories is beneficial for science, while uniformity impairs its critical power. Uniformity also endangers the free development of the individual.
There is no idea, however ancient and absurd, that is not capable of improving our knowledge. The whole history of thought is absorbed into science and is used for improving every single theory. Nor is political interference rejected. It may be needed to overcome the chauvinism of science that resists alternatives to the status quo.
No theory ever agrees with all the facts in its domain, yet it is not always the theory that is to blame. Facts are constituted by older ideologies, and a clash between facts and theories may be proof of progress. It is also a first step in our attempts to find the principles implicit in familiar observational notions.
As an example of such an attempt I examine the tower argument which the Aristotelians used to refute the motion of the earth. The argument involves natural interpretations - ideas so closely connected with observations that it needs a special effort to realise their existence and to determine their content. Galileo identifies the natural interpretations which are inconsistent with Copernicus and replaces them by others.
The new natural interpretations constitute a new and highly abstract observation language. They are introduced and concealed so that one falls to notice the change that has taken place (method of anamnesis). They contain the idea of the relativity of all motion and the law of circular inertia.
Initial difficulties caused by the change are defused by ad hoc hypotheses, which thus turn out occasionally to have a positive function; they give new theories a breathing space, and they indicate the direction of future research.
In addition to natural interpretations, Galileo also changes sensations that seem to endanger Copernicus. He admits that there are such sensations, he praises Copernicus for having disregarded them, he claims to have removed them with the help of the telescope. However, he offers no theoretical reasons why the telescope should be expected to give a true picture of the sky.
Nor does the initial experience with the telescope provide such reasons. The first telescopic observations of the sky are indistinct, indeterminate, contradictory and in conflict with what everyone can see with his unaided eyes. And, the only theory that could have helped to separate telescopic illusions from veridical phenomena was refuted by simple tests.
On the other hand, there are some telescopic phenomena which are plainly Copernican. Galileo introduces these phenomena as independent evidence for Copernicus while the situation is rather that one refuted view - Copernicanism - has a certain similarity with phenomena emerging from another refuted view - the idea that telescopic phenomena are faithful images of the sky. Galileo prevails because of his style and his clever techniques of persuasion, because he writes in Italian rather than in Latin, and because he appeals to people who are temperamentally opposed to the old ideas and the standards of learning connected with them.
Such 'irrational' methods of support are needed because of the 'uneven development' (Marx, Lenin) of different parts of science. Copernicanism and other essential ingredients of modern science survived only because reason was frequently overruled in their past.
Galileo's method works in other fields as well. For example, it can be used to eliminate the existing arguments against materialism, and to put an end to the philosophical mind/body problem (the corresponding scientific problems remain untouched, however).
The results obtained so far suggest abolishing the distinction between a context of discovery and a context of justification and disregarding the related distinction between observational terms and theoretical terms. Neither distinction plays a role in scientific practice. Attempts to enforce them would have disastrous consequences.
Finally, the discussion in Chapters 6-13 shows that Popper's version of Mill's pluralism is not in agreement with scientific practice and would destroy science as we know it. Given science, reason cannot be universal and unreason cannot be excluded. This feature of science calls for an anarchistic epistemology. The realisation that science is not sacrosanct, and that the debate between science and myth has ceased without having been won by either side, further strengthens the case for anarchism.
Even the ingenious attempt of Lakatos to construct a methodology that (a) does not issue orders and yet (b) puts restrictions upon our knowledge-increasing activities, does not escape this conclusion. For Lakatos' philosophy appears liberal only because it is an anarchism in disguise. And his standards which are abstracted from modern science cannot be regarded as neutral arbiters in the issue between modern science and Aristotelian science, myth, magic, religion, etc.
Moreover, these standards, which involve a comparison of content classes, are not always applicable. The content classes of certain theories are incomparable in the sense that none of the usual logical relations (inclusion, exclusion, overlap) can be said to hold between them. This occurs when we compare myths with science. It also occurs in the most advanced, most general and therefore most mythological parts of science itself.
Thus science is much closer to myth than a scientific philosophy is prepared to admit. It is one of the many forms of thought that have been developed by man, and not necessarily the best. It is conspicuous, noisy, and impudent, but it is inherently superior only for those who have already decided in favour of a certain ideology, or who have accepted it without having ever examined its advantages and its limits. And as the accepting and rejecting of ideologies should be left to the individual it follows that the separation of state and church must be supplemented by the separation of state and science, that most recent, most aggressive, and most dogmatic religious institution. Such a separation may be our only chance to achieve a humanity we are capable of, but have never fully realised.

The idea that science can, and should, be run according to fixed and universal rules, is both unrealistic and pernicious. It is unrealistic, for it takes too simple a view of the talents of man and of the circumstances which encourage, or cause, their development. And it is pernicious, for the attempt to enforce the rules is bound to increase our professional qualifications at the expense of our humanity. In addition, the idea is detrimental to science, for it neglects the complex physical and historical conditions which influence scientific change. It makes our science less adaptable and more dogmatic: every methodological rule is associated with cosmological assumptions, so that using the rule we take it for granted that the assumptions are correct. Naive falsificationism takes it for granted that the laws of nature are manifest and not hidden beneath disturbances of considerable magnitude. Empiricism takes it for -ranted that sense experience is a better mirror of the world than pure thought. Praise of argument takes it for granted that the artifices of Reason give better results than the unchecked play of our emotions. Such assumptions may be perfectly plausible and even true. Still, one should occasionally put them to a test. Putting them to a test means that we stop using the methodology associated with them, start doing science in a different way and see what happens. Case studies such as those reported in the preceding chapters show that such tests occur all the time, and that they speak against the universal validity of any rule. All methodologies have their limitations and the only 'rule' that survives is 'anything goes'.

The change of perspective brought about by these discoveries leads once more to the long-forgotten problem of the excellence of science. It leads to it for the first time in modern history, for modern science overpowered its opponents, it did not convince them. Science took over by force, not by argument (this is especially true of the former colonies where science and the religion of brotherly love were introduced as a matter of course, and without consulting, or arguing with, the inhabitants). Today we realise that rationalism, being bound to science, cannot give us any assistance in the issue between science and myth and we also know, from inquiries of an entirely different kind, that myths are vastly better than rationalists have dared to admit.' Thus we are now forced to raise the question of the excellence of science. An examination then reveals that science and myth overlap in many ways, that the differences we think we perceive are often local phenomena which may turn into similarities elsewhere and that fundamental discrepancies are results of different aims rather than of different methods trying to reach one and the same 'rational' end (such as, for example, 'progress', or increase of content, or 'growth').

To show the surprising similarities of myth and science, I shall briefly discuss an interesting paper by Robin Horton, entitled 'African Traditional Thought and Western Science'.' Horton examines African mythology and discovers the following features: the quest for theory is a quest for unity underlying apparent complexity. The theory places things in a causal context that is wider than the causal context provided by common sense: both science and myth cap common sense with a theoretical superstructure. There are theories of different degrees of abstraction and they are used in accordance with the different requirements of explanation that arise. Theory construction consists in breaking up objects of common sense and in reuniting the elements in a different way. Theoretical models start from analogy but they gradually move away from the pattern on which the analogy was based. And so on.

These features, which emerge from case studies no less careful and detailed than those of Lakatos, refute the assumption that science and myth obey different principles of formation (Cassirer), that myth proceeds without reflection (Dardel), or speculation (Frankfort, occasionally). Nor can we accept the idea, found in Malinowski but also in classical scholars such as Harrison and Cornford, that myth has an essentially pragmatic function or is based on ritual. Myth is much closer to science than one would expect from a philosophical discussion. It is closer to science than even Horton himself is prepared to admit.

To see this, consider some of the differences Horton emphasises. According to Horton, the central ideas of a myth are regarded as sacred. There is anxiety about threats to them. One 'almost never finds a confession of ignorance and events 'which seriously defy the established lines of classification in the culture where they occur' evoke a 'taboo reaction' .4 Basic beliefs are protected by this reaction as well as by the device of 'secondary elaborations" which, in our terms, arc series of ad hoc hypotheses. Science, on the other hand, is characterised by an essential scepticism; 'when failures start to come thick and fast, defence of the theory switches inexorably to attack on it'.' This is possible because of the 'openness' of the scientific enterprise, because of the pluralism of ideas it contains and also because whatever defies or fails to fit into the established category system is not something horrifying, to be isolated or expelled. On the contrary, it is an intriguing 'phenomenon' - a starting-point and a challenge for the invention of new classifications and new theories. We can see that Horton has read his Popper well. A field study of science itself shows a very different picture.

Such a study reveals that, while some scientists may proceed as described, the great majority follow a different path. Scepticism is at a minimum; it is directed against the view of the opposition and against minor ramifications of one's own basic ideas, never against the basic ideas themselves. Attacking the basic ideas evokes taboo reactions which are no weaker than are the taboo reactions in so-called "primitive societies." Basic beliefs are protected by this reaction as well as by secondary elaborations, as we have seen, and whatever fails to fit into the established category system or is said to be incompatible with this system is either viewed as something quite horrifying or, more frequently, it is simply declared to be non-existent. Nor is science prepared to make 'a theoretical pluralism the foundation of research. Newton reigned for more than 150 years, Einstein briefly introduced a more liberal point of view only to be succeeded by the Copenhagen Interpretation. The similarities between science and myth are indeed astonishing.

But the fields are even more closely related. The massive dogmatism I have described is not just a fact, it has also a most important function. Science would be impossible without it." 'Primitive' thinkers showed greater insight into the nature of knowledge than their 'enlightened' philosophical rivals. It is, therefore, necessary to re-examine our attitude towards myth, religion, magic, witchcraft and towards all those ideas which rationalists would like to see forever removed from the surface of the earth (without having so much as looked at them - a typical taboo reaction).

There is another reason why such a re-examination is urgently required. The rise of modern science coincides with the suppression of non-Western tribes by Western invaders. The tribes are not only physically suppressed, they also lose their intellectual independence and are forced to adopt the bloodthirsty religion of brotherly love - Christianity. The most intelligent members get an extra bonus: they are introduced into the mysteries of Western Rationalism and its peak - Western Science. Occasionally this leads to an almost unbearable tension with tradition (Haiti). In most cases the tradition disappears without the trace of an argument, one sim ply becomes a slave both in body and in mind. Today this development is gradually reversed - with great reluctance, to be sure, but it is reversed. Freedom is regained, old traditions are rediscovered, both among the minorities in Western countries and among large populations in non-Western continents. But science still reigns supreme. It reigns supreme because its practitioners are unable to understand, and unwilling to condone, different ideologies, because they have the power to enforce their wishes, and because they use this power ' just as their ancestors used their power to force Christianity on the peoples they encountered during their conquests. Thus, while an American can now choose the religion he likes, he is still not permitted to demand that his children learn magic rather than science at school. There is a separation between state and church, there is no separation between state and science.

And yet science has no greater authority than any other form of life. Its aims are certainly not more important than are the aims that guide the lives in a religious community or in a tribe that is united by a myth. At any rate, they have no business restricting the lives, the thoughts, the education of the members of a free society where everyone should have a chance to make up his own mind and to live in accordance with the social beliefs he finds most acceptable. The separation between state and church must therefore be complemented by the separation between state and science.

We need not fear that such a separation will lead to a breakdown of technology. There will always be people who prefer being scientists to being the masters of their fate and who gladly submit to the meanest kind of (intellectual and institutional) slavery provided they are paid well and provided also there are some people around who examine their work and sing their praise. Greece developed and progressed because it could rely on the services of unwilling slaves. We shall develop and progress with the help of the numerous willing slaves in universities and laboratories who provide us with pills, gas, electricity, atom bombs, frozen dinners and, occasionally, with a few interesting fairy-tales. We shall treat these slaves well, we shall even listen to them, for they have occasionally some interesting stories to tell, but we shall not permit them to impose their ideology on our children in the guise of 'progressive' theories of education. We shall not permit them to teach the fancies of science as if they were the only factual statements in existence. This separation of science and state may be our only chance to overcome the hectic barbarism of our scientific-technical age and to achieve a humanity we are capable of, but have never fully realised. Let us, therefore, in conclusion review the arguments that can be adduced for such a procedure.

The image of 20th-century science in the minds of scientists and laymen is determined by technological miracles such as colour television, the moon shots, the infra-red oven, as well as by a somewhat vague but still quite influential rumour, or fairy-tale, concerning the manner in which these miracles are produced.

According to the fairy-tale the success of science is the result of a subtle, but carefully balanced combination of inventiveness and control. Scientists have ideas. And they have special methods for improving ideas. The theories of science have passed the test of method. They give a better account of the world than ideas which have not passed the test.

The fairy-tale explains why modern society treats science in a special way and why it grants it privileges not enjoyed by other institutions.

Ideally, the modern state is ideologically neutral. Religion, myth, prejudices do have an influence, but only in a roundabout way, through the medium of politically influential parties. Ideological principles may enter the governmental structure, but only via a majority vote, and after a lengthy discussion of possible consequences. In our schools the main religions are taught as historical phenomena. They are taught as parts of the truth only if the parents insist on a more direct mode of instruction. It is up to them to decide about the religious education of their children. The financial support of ideologies does not exceed the financial support granted to parties and to private groups. State and ideology, state and church, state and myth, are carefully separated.

State and science, however, work closely to-ether. Immense sums are spent on the improvement of scientific ideas. Bastard subjects such as the philosophy of science which have not a single discovery to their credit profit from the boom of the sciences. Even human relations are dealt with in a scientific manner, as is shown by education programmes, proposals for prison reform, army training, and so on. Almost all scientific subjects are compulsory subjects in our schools. While the parents of a six-year-old child can decide to have him instructed in the rudiments of Protestantism, or in the rudiments of the Jewish faith, or to omit religious instruction altogether, they do not have a similar freedom in the case of the sciences. Physics, astronomy, history must be learned. They cannot be replaced by magic, astrology, or by a study of legends.

Nor is one content with a merely historical presentation of physical (astronomical, historical, etc.) facts and principles. One does not say: some people believe that the earth moves round the sun while others regard the earth as a hollow sphere that contains the sun, the planets, the fixed stars. One says: the earth moves round the sun - everything else is sheer idiocy.

Finally, the manner in which we accept or reject scientific ideas is radically different from democratic decision procedures. We accept scientific laws and scientific facts, we teach them in our schools, we make them the basis of important political decisions, but without ever having subjected them to a vote. Scientists do not subject them to a vote - or at least this is what they say - and laymen certainly do not subject them to a vote. Concrete proposals are occasionally discussed, and a vote is suggested. But the procedure is not extended to general theories and scientific facts. Modern society is 'Copernican' not because Copernicanism has been put on a ballot, subjected to a democratic debate and then voted in with a simple majority; it is 'Copernican' because the scientists are Copernicans and because one accepts their cosmology as uncritically as one once accepted the cosmology of bishops and cardinals.

Even bold and revolutionary thinkers bow to the judgement of science. Kropotkin wants to break up all existing institutions - but he does not touch science. Ibsen goes very far in unmasking the conditions of contemporary humanity - but he still retains science as a measure of the truth. Evans-Pritchard, Lévi-Strauss and others have recognised that 'Western Thought', far from being a lonely peak of human development, is troubled by problems not found in other ideologies - but they exclude science from their relativisation of all forms of thought. Even for them science is a neutral structure containing positive knowledge that is independent of culture, ideology, prejudice.

The reason for this special treatment of science is, of course, our little fairy-tale: if science has found a method that turns ideologically contaminated ideas into true and useful theories, then it is indeed not mere ideology, but an objective measure of all ideologies. It is then not subjected to the demand for a separation between state and ideology.

But the fairy-tale is false, as we have seen. There is no special method that guarantees success or makes it probable. Scientists do not solve problems because they possess a magic wand - methodology, or a theory of rationality - but because they have studied a problem for a long time, because they know the situation fairly well, because they are not too dumb (though that is rather doubtful nowadays when almost anyone can become a scientist), and because the excesses of one scientific school are almost always balanced by the excesses of some other school. (Besides, scientists only rarely solve their problems, they make lots of mistakes, and many of their solutions are quite useless.) Basically there. is hardly any difference between the process that leads to the announcement of a new scientific law and the process preceding passage of a new law in society: one informs either all citizens or those immediately concerned, one collects 'facts' and prejudices, one discusses the matter, and one finally votes. But while a democracy makes some effort to explain the process so that everyone can understand it, scientists either conceal it, or bend it, to make it fit their sectarian interests.

No scientist will admit that voting plays a role in his subject. Facts, logic, and methodology alone decide - this is what the fairy-tale tells us. But how do facts decide? What is their function in the advancement of knowledge? We cannot derive our theories from them. We cannot give a negative criterion by saying, for example, that good theories are theories which can be refuted, but which are not yet contradicted by any fact. A principle of falsification that removes theories because they do not fit the facts would have to remove the whole of science (or it would have to admit that large parts of science are irrefutable). The hint that a good theory explains more than its rivals is not very realistic either. True: new theories often predict new things - but almost always at the expense of things already known. Turning to logic we realise that even the simplest demands are not satisfied in scientific practice, and could not be satisfied, because of the complexity of the material. The ideas which scientists use to present the known and to advance into the unknown are only rarely in agreement with the strict injunctions of logic or pure mathematics and the attempt to make them conform would rob science of the elasticity without which progress cannot be achieved. We see: facts alone are not strong enough for making us accept, or reject, scientific theories, the range they leave to thought is too wide; logic and methodology eliminate too much, they are too narrow. In between these two extremes lies the ever-changing domain of human ideas and wishes. And a more detailed analysis of successful moves in the game of science ('successful' from the point of view of the scientists themselves) shows indeed that there is a wide range of freedom that demands a multiplicity of ideas and permits the application of democratic procedures (ballot-discussion-vote) but that is actually closed by power politics and propaganda. This is where the fairy-tale of a special method assumes its decisive function. It conceals the freedom of decision which creative scientists and the general public have even inside the most rigid and the most advanced parts of science by a recitation of 'objective' criteria and it thus protects the big-shots (Nobel Prize winners; heads of laboratories, of organisations such as the AMA, of special schools; 'educators'; etc.) from the masses (laymen; experts in non-scientific fields; experts in other fields of science): only those citizens count who were subjected to the pressures of scientific institutions (they have undergone a long process of education), who succumbed to these pressures (they have passed their examinations), and who are now firmly convinced of the truth of the fairy-tale. This is how scientists have deceived themselves and everyone else about their business, but without any real disadvantage: they have more money, more authority, more sex appeal than they deserve, and the most stupid procedures and the most laughable results in their domain are surrounded with an aura of excellence. It is time to cut them down in size, and to give them a more modest position in society.

This advice, which only few of our well-conditioned contemporaries are prepared to accept, seems to clash with certain simple and widely-known facts.

Is it not a fact that a learned physician is better equipped to diagnose and to cure an illness than a layman or the medicine-man of a primitive society? Is it not a fact that epidemics and dangerous individual diseases have disappeared only with the beginning of modern medicine? Must we not admit that technology has made tremendous advances since the rise of modern science? And are not the moon-shots a most impressive and undeniable proof of its excellence? These are some of the questions which are thrown at the impudent wretch who dares to criticise the special position of the sciences.

The questions reach their polemical aim only if one assumes that the results of science which no one will deny have arisen without any help from non-scientific elements, and that they cannot be improved by an admixture of such elements either. 'Unscientific' procedures such as the herbal lore of witches and cunning men, the astronomy of mystics, the treatment of the ill in primitive societies are totally without merit. Science alone gives us a useful astronomy, an effective medicine, a trustworthy technology. One must also ' assume that science owes its success to the correct method and not merely to a lucky accident. It was not a fortunate cosmological guess that led to progress, but the correct and cosmologically neutral handling of data. These are the assumptions we must make to give the questions the polemical force they are supposed to have. Not a single one of them stands up to closer examination.

Modern astronomy started with the attempt of Copernicus to adapt the old ideas of Philolaos to the needs of astronomical predictions. Philolaos was not a precise scientist, he was a muddle-headed Pythagorean, as we have seen, and the consequences of his doctrine were called 'incredibly ridiculous' by a professional astronomer such as Ptolemy. Even Galileo, who had the much improved Copernican version of Philolaos before him, says: 'There is no limit to my astonishment when I reflect that Aristarchus and Copernicus were able to make reason to conquer sense that, in defiance of the latter, the former became mistress of their belief' (Dialogue, 328). 'Sense' here refers to the experiences which Aristotle and others had used to show that the earth must be at rest. The 'reason' which Copernicus opposes to their arguments is the very mystical reason of Philolaos combined with an equally mystical faith ('mystical' from the point of view of today's rationalists) in the fundamental character of circular motion. I have shown that modern astronomy and modern dynamics could not have advanced without this unscientific use of antediluvian ideas.

While astronomy profited from Pythagoreanism and from the Platonic love for circles, medicine profited from herbalism, from the psychology, the metaphysics, the physiology of witches, midwives, cunning men, wandering druggists. It is well known that 16th- and 17th-century medicine while theoretically hypertrophic was quite helpless in the face of disease (and stayed that way for a long time after the 'scientific revolution'). Innovators such as Paracelsus fell back on the earlier ideas and improved medicine. Everywhere science is enriched by unscientific methods and unscientific results, while procedures which have often been regarded as essential parts of science are quietly suspended or circumvented.

The process is not restricted to the early history of modern science. It is not merely a consequence of the primitive state of the sciences of the 16th and 17th centuries. Even today science can and does profit from an admixture of unscientific ingredients. An example which was discussed above, in Chapter 4, is the revival of traditional medicine in Communist China. When the Communists in the fifties forced hospitals and medical schools to teach the ideas and the methods contained in the Yellow Emperor's Textbook of Internal Medicine and to use them in the treatment of patients, many Western experts (among them Eccles, one of the 'Popperian Knights') were aghast and predicted the downfall of Chinese medicine. What happened was the exact opposite. Acupuncture, moxibustion, pulse diagnosis have led to new insights, new methods of treatment, new problems both for the Western and for the Chinese physician.

And those who do not like to see the state meddling in scientific matters should remember the sizeable chauvinism of science: for most scientists the slogan 'freedom for science' means the freedom to indoctrinate not only those who have joined them, but the rest of society as well. Of course - not every mixture of scientific and non-scientific elements is successful (example: Lysenko). But science is not always successful either. If mixtures are to be avoided because they occasionally misfire, then pure science (if there is such a thing) must be avoided as well. (It is not the interference of the state that is objectionable in the Lysenko case, but the totalitarian interference that kills the opponent instead of letting him go his own way.)

Combining this observation with the insight that science has no special method, we arrive at the result that the separation of science and non-science is not only artificial but also detrimental to the advancement of knowledge. If we want to understand nature, if we want to master our physical surroundings, then we must use all ideas, all methods, and not 'just a small selection of them. The assertion, however, that there is no knowledge outside science - extra scientiam nulla salus - is nothing but another and most convenient fairy-tale. Primitive tribes have more detailed classifications of animals and plants than contemporary scientific zoology and botany, they know remedies whose effectiveness astounds physicians (while the pharmaceutical industry already smells here a new source of income), they have means of influencing their fellow men which science for a long time regarded as non-existent (Voodoo), they solve difficult problems in ways which are still not quite understood (building of the pyramids; Polynesian travels), there existed a highly developed and internationally known astronomy in the old Stone Age, this astronomy was factually adequate as well as emotionally satisfying, it solved both physical and social problems (one cannot say the same about modern astronomy) and it was tested in very simple and ingenious ways (stone observatories in England and in the South Pacific; astronomical schools in Polynesia - for a more detailed treatment and references concerning all these assertions c.f. my Einführung in die Naturphilosophie). There was the domestication of animals, the invention of rotating agriculture, new types of plants were bred and kept pure by careful avoidance of cross fertilisation, we have chemical inventions, we have a most amazing art that can compare with the best achievements of the present. True, there were no collective excursions to the moon, but single individuals, disregarding great dangers to their soul and their sanity, rose from sphere to sphere to sphere until they finally faced God himself in all His splendour while others changed into animals and back into humans again. At all times man approached his surroundings w' h wide open senses and a fertile intelligence, at all times he made incredible discoveries, at all times we can learn from his ideas.

Modern science, on the other hand, is not at all as difficult and as perfect as scientific propaganda wants us to believe. A subject such as medicine, or physics, or biology appears difficult only because it is taught badly, because the standard instructions are full of redundant material, and because they start too late in life. During the war, when the American Army needed physicians within a very short time, it was suddenly possible to reduce medical instruction to half a year (the corresponding instruction manuals have disappeared long ago, however. Science may be simplified during the war. In peacetime the prestige of science demands greater complication.) And how often does it not happen that the proud and conceited judgement of an expert is put in its proper place by a layman! Numerous inventors built 'impossible' machines. Lawyers show again and again that an expert does not know what he is talking about. Scientists, especially physicians, frequently come to different results so that it is up to the relatives of the sick person (or the inhabitants of a certain area) to decide by vote about the procedure to be adopted. How often is science improved, and turned into new directions by non-scientific influences! it is up to us, it is up to the citizens of a free society to either accept the chauvinism of science without contradiction or to overcome it by the counterforce of public action. Public action was used against science by the Communists in China in the fifties, and it was again used,, under very different circumstances, by some opponents of evolution in California in the seventies. Let us follow their example and let us free society from the strangling hold of an ideologically petrified science just as our ancestors freed us from the strangling hold of the One True Religion!

The way towards this aim is clear. A science that insists on possessing the only correct method and the only acceptable results is ideology and must be separated from the state, and especially from the process of education. One may teach it, but only to those who have decided to make this particular superstition their own. On the other hand, a science that has dropped such totalitarian pretensions is no longer independent and self-contained, and it can be taught in many different combinations (myth and modern cosmology might be one such combination). Of course, every business has the right to demand that its practitioners be prepared in a special way, and it may even demand acceptance of a certain ideology (I for one am against the thinning out of subjects so that they become more and more similar to each other; whoever does not like present-day Catholicism should leave it and become a Protestant, or an Atheist, instead of ruining it by such inane changes as mass in the vernacular). That is true of physics, just as it is true of religion, or of prostitution. But such special ideologies, such special skills have no room in the process of general education that prepares a citizen for his role in society. A mature citizen is not a man who has been instructed in a special ideology, such as Puritanism, or critical rationalism, and who now carries this ideology with him like a mental tumour, a mature citizen is a person who has learned how to make up his mind and who has then decided in favour of what he thinks suits him best. He is a person who has a certain mental toughness (he does not fall for the first ideological street singer he happens to meet) and who is therefore able consciously to choose the business that seems to be most attractive to him rather than being swallowed by it. To prepare himself for his choice he will study the major ideologies as historical phenomena, he will study science as a historical phenomenon and not as the one and only sensible way of approaching a problem. He will study it together with other fairy-tales such as the myths of 'primitive' societies so that he has the information needed for arriving at a free decision. An essential part of a general education of this kind is acquaintance with the most outstanding propagandists in all fields, so that the pupil can build up his resistance against all propaganda, including the propaganda called 'argument'. It is only after such a hardening procedure that he will be called upon to make up his mind on the issue rationalism-irrationalism, science-myth, science-religion, and so on. His decision in favour of science - assuming he chooses science - will then be much more 'rational' than any decision in favour of science is today. At any rate - science and the schools will be just as carefully separated as relig' ion and the schools are separated today. Scientists will of course participate in governmental decisions, for everyone participates in such decisions. But they will not be given overriding authority. It is the vote of everyone concerned that decides fundamental issues such as the teaching methods used, or the truth of basic beliefs such as the theory of evolution, or the quantum theory, and not the authority of big-shots hiding behind a non-existing methodology. There is no need to fear that such a way of arranging society will lead to undesirable results. Science itself uses the method of ballot, discussion, vote, thou-h without a clear grasp of its mechanism, and in a heavily biased way. But the rationality of our beliefs will certainly be considerably increased.

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Don's Hermeneutics: Like Rabbi Yishmael's Rules, Only Not

"Searle's Sagacity":

"If a person can't explain something simply, then they don't know what they're talking about. The only exception being Kant."

"Corollary to Searle's Sagacity":

"questions should be simple and comprehensible, and meant to elicit a simple explanation."

"Samuel Johnson's Dictum":

One thing about passing fifty years of age is that I now feel old enough to invoke what I call Samuel Johnson's Dictum. It is thus: If I invoke a view based on an author that I read in the past, and that view is not actually held by that author, I'm more than willing to claim the view as originating with me. The beauty of this Dictum is that it is self-referential. It is based upon my reading of Johnson and on Boswell, but I can't remember the actual references that led me to believe that Johnson believed something like this. In any case, I do.

"Burke's Principle":

Another of my motley list of nostrums is what I call Burke's Principle. Burke's Principle holds that there is a distinction between:
1) Political Theory: A theory of the perfect society, the good life, etc. Your general political philosophy.
2) Politics: The rather messy art of governing which involves dealing with what is possible on earth and compromising as the need arises.

"Burke's Rule":

"All government, indeed every human benefit and enjoyment, every virtue, and every prudent act, is founded on compromise and barter. "

"Burke's Paradox":

"Mere parsimony is not economy. Expense, and great expense, may be an essential part in true economy."

"Burke's Prescience":

"You can never plan the future by the past.

Letter to a Member of the National Assembly (1791)"

"Burke's Wisdom":

"A very great part of the mischiefs that vex the world arises from words.

Letter to Richard Burke"

"Bagehot's Principles":

1) If the Fed exists, it will be the Lender Of Last resort, and that has to be taken in to account in real world Political Economy. It should lend freely in a crisis to solvent banks.

2) The rules for LOLR( from here on down this includes any government guarantee ) intervention should be clear, public, and followed, otherwise Moral Hazard is ineffective. All guarantees must be explicit.

3) The terms must be onerous.

4) The LOLR should get something valuable in return.

Here are a few others:

5) The taxpayer's interests should come first.

6) Moral Hazard needs to be constantly applied by quickly liquidating problem banks in normal times.

7) Any entity receiving a guarantee will have to be supervised or regulated effectively, and violations should be quickly and severely punished.

8) There is no doubt that any entity receiving a LOLR guarantee will need to be more conservative in its practices in order to limit the liability of the taxpayer.

9) There should be a class of financial concerns that can act more freely, but they should not receive LOLR guarantees. They will be strictly supervised or regulated though, and are subject to laws against fraud, etc."

Sources which back up my view of Bagehot:

http://www.pittsburghlive.com/x/pittsburghtrib/opinion/columnists/guests/s_593875.html

"Who can forget the end of "Planet of the Apes" when Charlton Heston, kneeling before the half-buried remains of the Statue of Liberty, slams his fists into the sand and cries, "You maniacs! You blew it up! Ah, damn you ... damn you all to hell!"

Now imagine the same scene, but with a half-buried Morgan Stanley building standing in for Miss Liberty and a time-traveling Walter Bagehot playing the lead and you've got the perfect Hollywood dramatization of the real-life tragedy that, with luck, is having its denouement on Wall Street.

Bagehot? The great Victorian man of letters, best remembered today as the second and most celebrated editor of the British magazine The Economist, wasn't exactly a hunk. But he certainly could have delivered those futile last lines with real conviction, for he was among the first to recognize the vast destructive potential of that newfangled weapon of Victorian finance: the modern central bank.

Bagehot first alerted readers to this potential and offered his suggestions for containing it in an article that appeared in The Economist after the great panic and credit crisis of 1866. That panic witnessed the spectacular collapse of Overend, Gurney & Co., which had long been Great Britain's premier investment house.

Bagehot understood that, during such panics, the Bank of England alone commanded the confidence needed to serve other financial firms as a "lender of last resort." But as Bagehot put it later in his book "Lombard Street: A Description of the Money Market" (1873), the bank's "faltering way" -- its arbitrary and inconsistent use of its unique lending powers -- tended only to make things worse.

"The public," Bagehot wrote, "is never sure what policy will be adopted at the most important moment: it is not sure what amount of advance will be made. ... And until we have on this point a clear understanding with the Bank of England, both our ability to avoid crises and our terror at crises will always be greater than they would otherwise be."

The ultimate source of trouble, Bagehot believed, was the very existence of the Bank of England and the special privileges it enjoyed. But because nothing save a revolution seemed likely to do away with the "Old Lady of Threadneedle Street," as it was called, Bagehot's preferred, practical solution was for the bank expressly to commit itself to lending freely during crises, though on good collateral only, and at "penalty" rates.

The restrictive provisions were supposed to limit aid to otherwise solvent firms panic had rendered illiquid.

Bagehot's recommendation has since become a sort of master precept of central banking -- albeit one that's mainly honored in the breach by central bankers.

To be fair to today's central bankers, there's never been much agreement on how to apply Bagehot's rule in practice. Just what do "good collateral" and "penalty rates" mean in times like these?

While no one might precisely be able to define good collateral -- and one can debate whether the rate at which banks offer to lend unsecured funds to other banks, known as the London Interbank Offered Rate, or LIBOR rate, plus 8 percent constitutes a "penalty" rate -- who even pretends that recent central bank lending has been based on good collateral?

But rescuing insolvent firms is the least of it. The real damage comes from the Treasury's utter lack of any consistent last-resort lending rule. The recently enacted financial institutions bailout bill does little to clarify this.

That's just the sort of thing that troubled Bagehot almost a century and a half ago, when central banks were still in their swaddling clothes. Yet central bankers and governments still don't get it, despite the lip service they pay to this great thinker from our past."

http://www.theweeklystandard.com/Content/Public/Articles/000/000/015/921taekw.asp?pg=1

"The Unwisdom of Crowds
Financial panics still require what Walter Bagehot prescribed--that practical men violate their own principles.
by Christopher Caldwell
12/22/2008, Volume 014, Issue 14

Neither Barack Obama nor John McCain had much of value to say about the financial crisis as it raged through the headlines this fall. Rather than shred their campaign strategies, they played it safe, as most politicians would have. But in the name of justice we ought to recall that there was one candidate who did foresee our predicament with considerable accuracy when it still lay far in the future. Ron Paul, in almost every speech he made during the Republican primaries, spoke of bubbles, reckless credit growth, and the "unsustainability" of present policy. So why isn't there more demand for the common-sense solutions he put forward? Because common sense is not much use in a financial panic.

This was the great discovery of Walter Bagehot, the prolific 19th-century essayist and journalist, who was editor of the Economist from 1860 to 1877. (His name rhymes with gadget.) Ninety-nine percent of the time, common sense is a synonym for practicality. But in a serious banking crisis, doing the commonsensical thing--hunkering down and counting your pennies--has proved to be not practical at all. Bagehot's Lombard Street is an insider's look at the Bank of England, and at the principles on which political and financial leaders act when advanced economies come under pressure. Those principles are depressing in the extreme for anyone with an uncomplicated idea of how a democracy works. But they are effective. That is why, in the so-called Anglo-Saxon world, Bagehot's book still provides the bedrock of policy thinking during financial emergencies, including our present one.

Lombard Street was published in 1873, seven years after the sudden collapse of Overend, Gurney & Co., a bank that lost £11 million, spread panic among investors, sparked a run, and became "the model instance of all evil in business." The crisis made such a deep impression on British finance and government that the country did not have another bank run for 141 years--not until Northern Rock collapsed in the summer of 2007. (English investors must have longer memories than American ones. Most of our own noxious subprime mortgages were contracted, and the securities built on them concocted, after Enron became our own model instance of evil in 2001.) It was the Bank of England that took charge of averting panic, during the Overend, Gurney crisis and thereafter. It did so by injecting credit into the economy, by bailing people out. Bagehot approved of this. Many ordinary retailers could not pay their suppliers until they got the money for the things they sold. Without credit, they would be ruined, and the ruin would spread to those to whom they owed money. This was not a question of moral failing, it was just the way a modern economy worked.

But the modern economic system interacts with the modern political system--democracy--in a rather uncomfortable way. Indeed, at more than one juncture in Lombard Street, Bagehot framed the problem of booms and busts as part of the "increasingly democratic structure of English commerce." People in a democracy are most comfortable when their institutions do the same things that they would do as individuals. In a crisis, banks--like everyone else--reflexively hoard their money. But a central bank must do the opposite. It must lend freely.

This was the most basic affront to common sense that the Bank of England presented, but it was not the worst. The worst was that the bank could carry out its necessary duties as a lender of last resort only by breaking the law. The basis of the bank's operating procedure--and of its soundness--was the Bank Act of 1844. We would call it a regime of sound money. It included stringent caps on the ratio of notes issued to reserves held. These caps were hewed to when the economy was running smoothly. Yet at the time Bagehot was writing, a quarter century later, the law had already been suspended three times. Not just that. "No similar occasion has ever yet occurred," Bagehot wrote, "in which it has not been suspended." So the law on which the solvency of the British nation rested was ironclad, except when someone felt a need to break it.

Stranger still, never did the Bank of England acknowledge its duty as the lender of last resort. Some of its governors even denied that any such duty existed. Bagehot thought the bank should come clean about what it really was:

There should be a clear understanding between the Bank and the public that, since the Bank hold our ultimate banking reserve, they will recognise and act on the obligations which this implies--that they will replenish [the reserve] in time of foreign demand as fully, and lend it in times of internal panic as freely and readily, as plain principles of banking require.

But there was a reason for the central bankers' dissembling. If the bank ever acknowledged a duty to rescue banks by generous extensions of credit, it would create a form of moral hazard. Thomson Hankey, a Bank of England director whom Bagehot much admired (and to whom the financial writer James Grant devotes an admiring essay in his new book Mr. Market Miscalculates), called Bagehot's lender-of-last-resort views "the most mischievous doctrine ever broached in the monetary or banking world in this country."

In practice, Bagehot was right and Hankey was wrong. The bank was beyond question the lender of last resort. In principle, Hankey was right and Bagehot was wrong. Unless there was a real, credible threat that a bank would be allowed to fail, the guarantee of rescue would simply get priced into any financial bubble that developed, making things worse when the bubble popped. The situation required what we would now call "strategic ambiguity"--both Hankey's doctrine and Bagehot's practice, which contradicts it.

The situation today requires the same mix. Central banking is thus often a high-stakes game of chicken. And sometimes, when banks enter the game insufficiently scared, it will be played out to the end. It certainly was in September when the U.S. Treasury terrified the financial world by not coming to the rescue of Lehman Brothers. This was a catastrophe in terms of Bagehot's practice, but it will produce benefits in terms of Hankey's principle. It will discourage people from paying more than is reasonable for assets on the belief that they come equipped with an insurance policy (the promise of a central bank rescue) that has been underwritten by taxpayers. The Republicans who nearly derailed the Treasury's Troubled Assets Relief Program in September played a similar role.

A final problem is that there are limits to how accountable a central bank can be. Everyone is always hollering for clear rules and transparency. But a dirty secret of regulation is that it frequently influences conduct most effectively when it is capricious and opaque. Any regulatory system will reveal its vulnerabilities over long use. If it addresses economic problems in a predictable way, savvy investors will find a way to "game" that predictability. You can draw an analogy with antidepressant drugs. There is no permanent right match of medication for a depressive. Antidepressants work only until the mind (or is it the brain?) finds a way around them, at which point a new, unfamiliar drug must be substituted. In the same way, no matter how good the content of a regulatory regime, it must change periodically if big market players are to be kept from profiting off it.

As Bagehot outlined his system, he was conscious that the practical realities of banking required him to heap paradox upon paradox. There is a hint of both Andrew Jackson and Thomas Aquinas in the way he referred to central banking as an "unnatural" thing in its very conception. "The business of banking ought to be simple," he wrote. "If it is hard it is wrong." If it is hard, the banker is either delegating poorly or has entangled his institution in complex transactions where it has no business. According to Bagehot, "Adventure is the life of commerce, but caution, I had almost said timidity, is the life of banking."

Centralizing a society's cash reserves is complicated, reckless, and artificial:

A republic with many competitors of a size or sizes suitable to the business, is the constitution of every trade if left to itself, and of banking as much as any other. A monarchy in any trade is a sign of some anomalous advantage, and of some intervention from without. . . . The natural system of banking is that of many banks keeping their own cash reserve, with the penalty of failure before them if they neglect it.

In his ideas of company size, Bagehot harkened back to the 18th century rather than ahead to our own. To modern eyes, Bagehot is, as a factual matter, simply wrong. The natural tendency under free-market conditions is towards consolidation, and even monopoly. If you want small firms, you must protect them through government--whether this means Teddy Roosevelt-ian trust-busting, French-style subsidies to tobacconists, the EU's hounding of Microsoft, or the NIMBY anti-Wal-Mart campaigns aimed at preserving Mom-and-Pop stores. Bagehot sometimes contradicted himself on this point, noting also that "a large bank always tends to become larger, and a small one tends to become smaller," but his application of the word unnatural to a large central bank was frequent and must be taken as his settled view. It is curious that Bagehot, a contemporary of Marx, came to the opposite (and false) conclusion about how firms evolve.

Where Bagehot would agree with Marx is in his belief that there is something predictably destabilizing about modern economies. You don't need banks to have a precarious economy, or one liable to speculation--Bagehot noted that there were no banks, as we would understand them, in 1720, at the time of the South Sea Bubble and the Mississippi Scheme. But modern banking is precarious by design. "In exact proportion to the power of this system is its delicacy," he wrote. "I should hardly say too much if I said its danger." The power, delicacy, and danger all have the same source. In fact they are just different names for the same thing: leverage.

At the very opening of the book, Bagehot illustrates with exquisite simplicity how, at least in a boom economy, traders on margin can "harass and press upon, if they do not eradicate, the old capitalist." The old capitalist in question is the poor sap who believes all this stuff about neither-a-borrower-nor-a-lender-be and is foolish enough to be using his own cash:

If a merchant have £50,000 all his own, to gain 10 per cent on it he must make £5,000 a year, and must charge for his goods accordingly; but if another has only £10,000, and borrows £40,000 by discounts (no extreme instance in our modern trade), he has the same capital of £50,000 to use, and can sell much cheaper. If the rate at which he borrows be 5 per cent, he will have to pay £2,000 a year; and if, like the old trader, he make £5,000 a year, he will still, after paying his interest, obtain £3,000 a year, or 30 per cent, on his own £10,000. As most merchants are content with much less than 30 per cent, he will be able, if he wishes, to forego some of that profit, lower the price of the commodity, and drive the old-fashioned trader--the man who trades on his own capital--out of the market.

Later, Bagehot showed that this need for leverage is no different for those selling money than it is for those selling dry goods. The banker can no more choose not to lend than the merchant can choose not to borrow:

The bill-broker has, in one shape or other, to pay interest on every sixpence left with him, and that constant habit of giving interest has this grave consequence: the bill-broker cannot afford to keep much money unemployed. He has become a banker owing large sums which he may be called on to repay, but he cannot hold as much as an ordinary banker, or nearly as much, of such sums in cash, because the loss of interest would ruin him.

In finance, once you can have leverage, you must have leverage. Once you have some leverage, getting more of it than your competitors is a matter of survival. And when governments and central banks debate whether to loosen or tighten up money, they face a constant clamor from the financial world to permit more leverage still. That is why, even in democracies, the instruments of monetary policy tend to be kept far from the influence of voters, and even hidden from view. Otherwise, credit tends to spiral. Bubbles result.

Nothing could be more foolish than to assume that this process of spiraling speculation is unleashed by "greed," unless by greed you mean human nature. Credit spirals are a darker aspect of the world Adam Smith described in The Wealth of Nations and Bernard de Mandeville did in the Fable of the Bees. Just as society can be improved by the uncoordinated action of the selfishly motivated, an economy can collapse for reasons having nothing to do with anybody's cupidity.

We should be moral in the way we think about money, but a credit system tends to make a mess of moral accounting. Bagehot described London's financial district as "a sort of standing broker between quiet saving districts of the country and the active employing districts." Decent, puritanical Suffolk farmers want to put their money in a safe place; Lancashire entrepreneurs want money to put to work. Thanks to London bankers, both can follow their wishes and make a profit in the process. We have an idea that the Suffolk dairyman is the "moral" party here (he's saving) and the Lancashire speculator the "immoral" one (he's gambling). But, once a banking system intervenes, they are both gambling and they are both saving. In good times you are welcome to mouth the folkloric cliché that holds farmers to be better people than financiers. When depression looms, you had better realize that the rain falls on the just and the unjust.

Many Americans who have wound up underwater on their houses and maxed out on their credit cards are greedy, climbing, brand-intoxicated, materialistic shopaholics who thought the world owed them a living. But just as many of them are not. They are trapped, as surely as financial institutions are, in a system based on wild borrowing. Participation in this system is not exactly required, but it is not exactly optional, either. One's quality of life is determined not just by one's purchasing power but also by one's relative economic standing. Chagrin at seeing one's neighbors get richer faster may be a sign of bad character, but do not for a minute assume there is nothing to feel chagrin about! When it comes to the very goods people deem most essential--the proper mate; the schooling of one's children; the size, location, elegance, and comfort of one's house--relative standing is more important than absolute wealth.

Those who kept their money in savings banks in the 1990s lost out to those who did things we are supposed to disapprove of, like "spending money they didn't have," borrowing profligately to invest in stocks and even bonds, which appreciated at an average of 15 percent a year over the decade. Among rich people, how one entered the present decade had more to do with how one had done in the stock market than with how one had done in the labor market. Is that just? Of course it's not! It's easy to see now. But while the boom was going on there was all sorts of rationalizing about why it was okay that the social hierarchy should be reordered through stock and housing speculation. One line of argument was that people who did not have a ton of money in stocks, as well as those who rented rather than bought the houses they lived in, were foolish. This line of argument peaked at the turn of the decade, when Americans elected a president who had argued that the public was foolish for not launching its retirement savings onto the open seas of the stock market.

Bagehot saw that a speculative mania eventually sweeps up everyone in its path. "Every great crisis reveals the excessive speculations of many houses which no one before suspected," he wrote, "and which commonly indeed had not begun or had not carried very far those speculations, till they were tempted by the daily rise of price and the surrounding fever." Avaricious people get hurt, but it is in the nature of crashes that they are not the ones who get hurt most. A tragic figure present in almost every historic account of speculation and collapse in history is the person who believed, year after year, that the boom was an illusion, and held himself aloof until, at the very last minute, whether out of self-doubt or deference to the opinions of his fellow man, he entered the fray and was (having bought at the top, rather than the bottom, of the market) wiped out. What a wicked irony! His punishment is as much for his long and wise forbearance as for his momentary weakness.

So the "cultural contradictions of capitalism" run deeper than we thought. The classic idea, as laid out in their different ways by the economist Joseph Schumpeter and the sociologist Daniel Bell, is that capitalism rewards diligence; diligence produces wealth; wealth begets idleness; and idleness undermines capitalism. But when, as now, push comes to shove, we can ask whether there is really anything particularly capitalist about the virtues of diligence and self-restraint. The real capitalist virtues appear to be optimism and luck. From a central-banking perspective, the cultural contradictions are not results of capitalism but elements of it.

The problem with central banking is that it reacts to a system that has been mismanaged by rewarding the managers. That is why objections to central banking, although they can come from the right (Ron Paul, Jim Bunning) or the left (Barney Frank, William Greider), tend to be populist. Bagehot was no populist. He was comfortable with the idea that what some people think should be more important than what other people think:

Almost all directors who bring special information labor under a suspicion of interest; they can only have acquired that information in present business, and such business may very possibly be affected for good or evil by the policy of the Bank. But you must not on this account seal up the Bank hermetically against living information.

Although he would surely fault Treasury Secretary Hank Paulson for many things, the criticism most often heard at present--that Paulson is too close to former colleagues on Wall Street, where he worked for years as CEO of Goldman Sachs--would strike Bagehot as misplaced.

Because it is on Wall Street, alas, that "the state of credit" is to be determined:

The state of credit at any particular time is a matter of fact only to be ascertained like other matters of fact; it can only be known by trial and inquiry. And in the same way, nothing but experience can tell us what amount of "reserve" will create a diffused confidence.

To be blunt, credit is successfully reestablished when financial elites say, "When." Credit is close to a synonym for the mood of the ruling class. To say an economy is based on credit is to say it is based on animal mysteries. Glamour, prestige, élan, sprezzatura, cutting a figure . . . that is what the economy is made of. It is a rather terrifying thought. Viewed as Bagehot viewed it, from the perspective of a central bank in a crisis, an advanced economy looks an awful lot like a primitive economy."

http://blogs.iht.com/tribtalk/business/globalization/?p=680

"Loyal readers, please take a moment to check out Gretchen Morgenson’s column this week. She’s taken a close look at the buyout of Bear Stearns organized by the Federal Reserve, and she has come to an intriguing conclusion: that the Fed not only wanted to prevent financial havoc - it also wanted to deter speculators who were betting on big banks to fail.

Adherents of the Walter Bagehot school of central banking - and I have been among them at times - have cried foul at the sight of big bailouts and the granting of emergency credit at low interest rates. The Bagehot argument is that emergencies that arise from the risks that banks have chosen to take should not be treated with overwhelming sympathy. Emergency credit should be offered, yes, but at rates that will make banks think twice about using the safety net again. That’s not the case this time around (neither in the United States nor in Britain, and probably not in Europe either by the time the folks in Brussels are finished), so the central banks may be telling financial institutions that they can take silly risks without fear of disaster.

But if Morgenson is right, there is a long-term purpose here, too: to reduce the winnings of those who bet on failure, and thus to reduce the incentives to bring that failure to pass. And let’s face it, the speculators aren’t operating in a vacuum; their bets can start to snowball with market sentiment, as they did against Lehman Brothers last week. Still, the Bagehot argument (often called moral hazard) is also a powerful one - which one do you agree with?"

http://blogs.wsj.com/economics/2007/08/20/from-bagehot-to-bernanke/

"In his 1873 book “Lombard Street,” the closest thing to a user’s guide to central banking, Walter Bagehot criticized the Bank of England’s handling of earlier panics by responding “hesitatingly, reluctantly, and with misgiving.”

Federal Reserve Chairman Ben Bernanke, who has read his Bagehot and kept a copy in his Princeton office when he was a professor, responded to recent developments first by pumping money into the markets through the New York Fed’s open-market operations and then last week by easing the terms on loans to banks from the Fed’s discount window.

Bagehot (pictured at right) still makes for good reading at times like this.

“What is wanted and what is necessary to stop a panic is to diffuse the impression, that though money may be dear, still money is to be had. If people could be really convinced that they could have money if they wait a day or two, and that utter ruin is not coming, most likely they would cease to run in such a mad way for money. Either shut the Bank at once, and say it will not lend more than it commonly lends, or lend freely, boldly, and so that the public may feel you mean to go on lending. To lend a great deal, and yet not give the public confidence that you will lend sufficiently and effectually, is the worst of all policies; but it is the policy now pursued.”

Robert Feldman, Morgan Stanley’s chief economist for Japan, writes in a note today that it’s key to distinguish between internal discredit — private domestic lenders retreating — and external discredit, which Bagehot defined as a foreign drain on a bank’s money. (Bagehot’s solution to the problem of external discredit is to still lend freely but “at very high rates.”) That doesn’t apply in today’s floating rate system, Feldman says, and exchange rates don’t provide a good substitute, with the dollar’s drop against the yen suggesting we have external discredit while the strengthening against the euro saying we don’t.

Feldman writes: “My view is that the modern counterpart of ‘external discredit’ is moral hazard. The credit of the U.S. IS a problem, since no one knows how big the subprime and related housing market problems really are. Given how poorly banks know their clients, the ‘high rates’ part should come into play. There is no way to re-establish confidence unless those who have made loans to questionable borrowers pay a price for rash lending. Only then will markets regain confidence that risk is under control.

“The next stage of the credit problem — and whether it affects the real economy seriously — depend on eliminating the moral hazard,” Feldman says. “The faster the moral hazard in eliminated, the less impact on the real economy.”

Fed officials are acutely aware of the moral hazard, having resisted action for weeks to not be seen as bailing out risky investments. But they also don’t want a crisis to feed on itself. The Fed stressed its statement, in lowering the discount rate for banks, that it would accept “a broad range of collateral…including home mortgages and related assets.” The central bank sought to reassure a market that had been roiled by risky investments in subprime mortgages.

That’s how the Bank of England halted a panic in 1825, as Bagehot recounts: “A panic, in a word, is a species of neuralgia, and according to the rules of science you must not starve it. The holders of the cash reserve must be ready not only to keep it for their own liabilities, but to advance it most freely for the liabilities of others. They must lend to merchants, to minor bankers, to ‘this man and that man,’ whenever the security is good. In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them. The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. ‘We lent it,’ said Mr. Harman, on behalf of the Bank of England, ‘by every possible means and in modes we had never adopted before; we took in stock on security, we purchased Exchequer bills, we made advances on Exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some occasions over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power.’ After a day or two of this treatment, the entire panic subsided, and the ‘City’ was quite calm.”

http://www.realclearmarkets.com/articles/2008/03/bagehot_central_banking_and_th.html

"Bagehot advocated in 1873 that a Lender of Last Resort in a crisis should lend at a penalty rate to solvent but illiquid banks that have adequate collateral. The doctrine has been criticised as having no place in our modern interbank market, but this is wrong. Bagehot’s prescription aims to eliminate the coordination problem of investors at the base of the crisis. It is still a useful guide for action when the interbank market stalls.1 It makes clear that discount-window lending to entities in need may be necessary in a crisis.

Bagehot's doctrine, however, is easy to state and hard to apply. It requires the central bank to distinguish between institutions that are insolvent and those that are merely illiquid. It also requires them to assess the collateral offered. Central banks, because of information limitations, are bound to make mistakes, losing face and money in the process. This doesn’t mean they should not try.
Poor collateral versus massive liquidity

The collateral should be valued under “normal circumstances”, that is, in a situation where the coordination failure of investors does not occur. This involves a judgment call in which the central bank values the illiquid assets. A central bank that only takes high quality collateral will be safe, but will have to inject much more liquidity and/or set lower interest rates to stabilise the market. This may fuel future speculative behavior. Some of this may have happened in the Greenspan era, in the aftermath of the crisis in Russia and LTCM, and after the crash of the technological bubble. The ECB and the Federal Reserve have accepted now partially illiquid collateral that the market would not. This seems appropriate and releases pressure to lower interest rates to solve the problem, something that should be done only if there are signs of deterioration in the real economy. The problem is that central banks are extending the lender of last resort facility outside the realm of traditional banks to entities, like Bear Stearns, that they do not supervise and, therefore, over which they do not have first hand information. How does the Fed know whether Bear Stearns or other similar institutions are solvent? It seems that the Fed is not following Bagehot’s doctrine here.

Finally, if banks and investors are bailed out now, why should they be careful next time? This is the moral hazard problem: help to the market that is optimal once the crisis starts has perverse effects in the incentives of market players at the investment stage. The issue is that only when the moral hazard problem is moderate does it pay to eliminate completely the coordination failure of investors with central bank help. When the moral hazard problem is severe, a certain degree of coordination failure of investors - that is, allowing some crises - is optimal to maintain discipline when investing and, amending Bagehot, some barely solvent institutions should not be helped."

http://www.house.gov/jec/imf/blueprnt.htm

"This goal is not new. In fact, it underlay Walter Bagehot's (1873) classic policy prescriptions for domestic central banking: to lend freely at a penalty rate on good collateral. Bagehot argued an elastic and immediate supply of liquidity was essential to an effectively structured lender of last resort, and that appropriate loss sharing rules in the form of collateral requirements and penalty interest rates would discourage abuse of the safety net."

http://online.wsj.com/public/article_print/SB120908336730343529.html

"By slashing interest rates too much in 2007-2008, the Fed has accentuated the foreign drain and thus made the alleviation of the domestic drain more difficult. Yet, despite this mistake, Bagehot would approve of other actions the Fed has taken to deal with the domestic drain by unblocking specific impacted domestic markets. These include (1) swapping Treasury bonds for less safe private bonds, (2) opening its discount window to shaky borrowers, and (3) maybe even rescuing Bear Sterns. He would also approve of the relaxation of capital constraints on Fannie Mae, Freddy Mac and so on, for mortgage lending. Yet these measures will be insufficient if the foreign drain continues.

To repeat Bagehot's Rule: "very large (domestic) loans at very high rates are the best remedy for the worst malady of the money market when a foreign drain is added to a domestic drain." The Fed, and the U.S. government more generally, have so far got it only half right."

http://findarticles.com/p/articles/mi_m2751/is_56/ai_55015114/pg_6

"More than a century ago, a British economic journalist, Walter Bagehot, set out the classical principles for a central bank acting as lender of last resort: lend freely in a crisis at a penalty rate against collateral. Adapted to international lending, Bagehot's rule is the proper rule for a restructured, more effective IMF."

http://maverecon.blogspot.com/2007/08/central-banks-in-time-of-crisis.html

"In a number of recent blog contributions, we have sketched the role of a modern central bank as ‘market maker of last resort’ (MMLR). This MMLR is the analogue, in a world where intermediation is increasingly through financial markets, to Bagehot’s lender of last resort (LOLR) in a world where most intermediation took place through banks (see e.g. Willem H. Buiter and Anne C. Sibert “The Central Bank as the Market Maker of last Resort: From lender of last resort to market maker of last resort"; Willem H. Buiter “Central banks as market makers of last resort, again”; Willem H. Buiter and Anne C. Sibert “A missed opportunity for the Fed”).

The market maker of last resort function can be fulfilled in two ways. First, the central bank can make outright purchases and sales of a wider range of securities than they currently do. Second, central banks can accept a wider range of securities as collateral in repos, and in collateralised loans and advances at the discount window than they currently do. Following Bagehot’s rule, the MMLR should buy these securities outright or accept them as collateral only on terms that would imply a stiff financial penalty to the owner. The central bank of course already applies a liquidity ‘haircut’ even to liquid instruments offered as collateral in repos or at the discount window. Because the MMLR would have to establish a buying price ‘in the dark’, that is, unaided by recent relevant market prices, and would inevitably take on much more credit risk than central banks have become accustomed to, the ‘haircuts’ should be severe – a financial version of ‘short back and sides’.

http://www.independent.org/pdf/tir/tir_07_3_wood.pdf

"Further crises in 1857 and 1866 prompted the debate between Bagehot and
Thomson Hankey, a director and former governor of the Bank of England. Notwithstanding
the Bank’s undoubted responsibility, as trustee of the nation’s reserve, to
support the financial markets, Bagehot wrote:
If we ask how the Bank of England has discharged this great responsibility,
we shall be struck by three things: first, . . . the Bank has never by any
corporate act or authorised utterance acknowledged the duty, and some of
its directors deny it; second, (what is even more remarkable), no resolution
of Parliament, no report of any Committee of Parliament (as far as I know),
no remembered speech of a responsible statesman, has assigned or enforced
that duty on the Bank; third (what is more remarkable still), the distinct
teaching of our highest authorities has often been that no public duty of
any kind is imposed on the Banking Department of the Bank; that, for
banking purposes, it is only a joint stock bank like any other bank; that its
managers should look only to the interest of the proprietors and their
dividend; that they are to manage as the London and Westminster Bank or
the Union Bank manages. (1873, 153–54)
Although the Bank usually in the end supplied the market, its “faltering way”
caused needless uncertainty and more severe panics than if it communicated clearly
that it could be counted on (Bagehot 1873, 64). According to Bagehot, the rules—
to lend freely at penalty rates on sound collateral—under which assistance would be
provided should be stated also.
The public is never sure what policy will be adopted at the most important
moment: it is not sure what amount of advance will be made. The best
palliative to a panic is a confidence in the adequate amount of the Bank
reserve, and in the efficient use of that reserve. And until we have on this
point a clear understanding with the Bank of England, both our liability to
crises and our terror at crises will always be greater than they would
otherwise be. (1873, 196–97)"

One which doesn't quite:

http://www.portfolio.com/views/blogs/market-movers/2008/05/13/bernanke-on-bagehot?rss=true

"Bernanke on Bagehot

I doubt a week has gone by since last summer during which I haven't seen some pundit or other trot out Walter Bagehot's dictum that in the event of a credit crunch, the central bank should lend freely at a penalty rate. More often than not, this is contrasted with the actions of the Federal Reserve, which seems to be lending freely at very low interest rates.

Ben Bernanke, in a speech today, addressed this criticism directly:

What are the terms at which the central bank should lend freely? Bagehot argues that "these loans should only be made at a very high rate of interest". Some modern commentators have rationalized Bagehot's dictum to lend at a high or "penalty" rate as a way to mitigate moral hazard--that is, to help maintain incentives for private-sector banks to provide for adequate liquidity in advance of any crisis. I will return to the issue of moral hazard later. But it is worth pointing out briefly that, in fact, the risk of moral hazard did not appear to be Bagehot's principal motivation for recommending a high rate; rather, he saw it as a tool to dissuade unnecessary borrowing and thus to help protect the Bank of England's own finite store of liquid assets. Today, potential limitations on the central bank's lending capacity are not nearly so pressing an issue as in Bagehot's time, when the central bank's ability to provide liquidity was far more tenuous.

I'm no expert on Walter Bagehot, and in fact I admit I've never read Lombard Street. But I'll trust in Bernanke as an economic historian on this one, unless and until someone else makes a persuasive case that Bagehot's penalty rate really was designed to punish the feckless rather than just to preserve the Bank of England's limited liquidity."

"So, we have, what I will call "Grant's Graham For Investing":

1) Decent Size

2) Current Assets Exceed Liabilities By Two Times

3) 10 Continuous Years Of Profit

4) 20 Continuous Years Of Dividends

5) 10 Years Of Earnings Growth Exceeding 33%

6) Price To Earnings Ratio Less Than 15

7 ) Price To Book Ratio Less Than 1.5"

"Cake As Gift Theory":

Now, I feel similarly about government incentives. When Fannie and Freddie tempted investors, this led to the housing bubble. I think that I'm going to call this the Cake As Gift Theory. I hand you a cake assuming that you have the good sense to eat it over time, and you gorge yourself and eat it at one sitting and get sick. Clearly I'm responsible for this by handing you the cake. Give you a gift or incentive, clearly I must assume that it will cause you to be irrational.

"Spigot Theory":

One other pet theory I have about finance, besides Bagehot's Principle, is the Spigot Theory. I might rename it. It applies to the low rate of interest or the sloshing pool of money explanations for the current crisis. Turn the tap too far, then you can't stop the tub from overflowing, even if you're a human agent standing right next to the tub. I call this a mechanistic explanation as opposed to an explanation based on human agency.

"The Pragmatic Milton Friedman Principle":

The Pragmatic Milton Friedman Principle. Friedman introduced a concept called the Negative Income Tax. He proposed it saying that it was a pragmatic compromise between the Welfare State and a basic libertarian position.

"Hardy's Harangue": To Me:

"There is no scorn more profound, or on the whole more justifiable, than that of the men who make for the men who explain. Exposition, criticism, appreciation, is work for second-rate minds. "

"Titchmarsh's Two Truths":

1)"Perhaps we could regard numbers as a sort of medium of exchange, like money. Most people are really interested in the goods and services which the world offers, and to them money is only a symbol for these. But it is not a meaningless symbol. A system of barter, in which we do without money and merely exchange goods, would be very inconvenient, and practically impossible in a complicated society. So a system in which we reduce all mathematics to statements such as "I have more fingers than you have noses" would be too cumbrous to contemplate seriously. Numbers are symbols, and very useful and interesting ones. To mathematicians who work with them every day they acquire a reality at least equal to that of anything else. "

2) "The question what numbers are has been much debated by philosophers, and they do not seem to have reached any agreement about it. There is nothing particularly surprising or distressing about this. It has been said that mathematicians are happy only when they agree, and philosophers only when they disagree. Philosophic doubts about the nature of number have never prevented mathematicians from getting on with their calculations, or from agreeing when they have got the right answer. So perhaps the situation is satisfactory to all parties. "

"Thoreau's Truth":About Government:
"I heartily accept the motto, "That government is best which governs least"; and I should like to see it acted up to more rapidly and systematically. Carried out, it finally amounts to this, which also I believe--"That government is best which governs not at all"; and when men are prepared for it, that will be the kind of government which they will have. Government is at best but an expedient; but most governments are usually, and all governments are sometimes, inexpedient."

"Will's Warning": Concerning The Use Of "Socialism":
Hyperbole is not harmless; careless language bewitches the speaker's intelligence. And falsely shouting "socialism!" in a crowded theater such as Washington causes an epidemic of yawning.

"Kling's Principle":About Regulated Banks And Unregulated Financial Entities
"The banks seem to find a way to take risks, and the unregulated folks seem to find a way to get guarantees."

"Janeway's Dictum": On Political Economy
"Political economy is not a science, it's a clinical art, like medicine."

"Cowen's Creed": On Policies

"YOU CAN’T TURN BAD TO GOOD The good New Deal policies, like constructing a basic social safety net, made sense on their own terms and would have been desirable in the boom years of the 1920s as well. The bad policies made things worse. Today, that means we should restrict extraordinary measures to the financial sector as much as possible and resist the temptation to “do something” for its own sake."

"Hendry's Heartfelt":

"I antagonise people,' says Hugh Hendry. 'It's part of my skill set."

"Diebel's Dare:

"You can’t be forced out further on the yield curve than a perpetual.”

"Peston's Promise": Good Until ...

"And, as I've been pointing out for some time, we are being asked to provide life support to a swathe of the real economy, from steel makers to car manufacturers.

The Government will succumb and will lend taxpayers' money to non-financial companies.

In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out."

"Trader's Narrative's Due Diligence":

"The process of investigation undertaken by an party to gather material information on actual or potential risks involved in a financial transaction or relationship."

The Quotes Above

W. Bagehot, R.W. Emerson, M. Proust, W.H. Auden, W. Bagehot, P.Levine

Read J.L. Austin "A Plea For Excuses" here:

http://www.ditext.com/austin/plea.html

Read " Reflections on the Revolution in France by Edmund Burke 1790" here:

http://www.constitution.org/eb/rev_fran.htm

P. Levine reading "They Feed They Lion"

http://www.ibiblio.org/ipa/poems/levine/they_feed_they_lion.php

Read H.D. Thoreau " On Civil Disobedience " here:

http://sunsite.berkeley.edu/Literature/Thoreau/CivilDisobedience.html

Read W. Bagehot " Lombard Street" here:

http://bagehot.classicauthors.net/LOMBARDSTREET/LOMBARDSTREET9.html

Read Irving Fisher's "The Debt-Deflation Theory Of Great Depressions" here:

http://fraser.stlouisfed.org/docs/meltzer/fisdeb33.pdf

Read H.D. Thoreau "Walking" here:

http://www.ecotopia.org/ehof/thoreau/walking.html

About Rabbi Ishmael's Rules, see here:

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

Read E.C. Titchmarsh on "Counting" here:

http://www-groups.dcs.st-and.ac.uk/~history/Extras/Titchmarsh_Counting.html

Read Granville Barker's "Voysey Ineritance" here:

http://books.google.com/books?hl=en&id=jFNFAAAAIAAJ&dq=the+voysey+inheritance&printsec=frontcover&source=web&ots=7TZP8W9Hlh&sig=yEoasq-eebAqE6H0iOnVaJhqFRs&sa=X&oi=book_result&resnum=4&ct=result#PPA6-IA3,M1

Read Henry James "The Sacred Fount" here:

http://www2.newpaltz.edu/~hathaway/sacredfount.html

Read "The Calculus Of Consent" here"

http://www.econlib.org/library/Buchanan/buchCv3Cover.html

Read "Did Reagan Rule In Vain? A Closer Look at True Expenditure Levels in the United States and Europe by Jacob Funk Kirkegaard " here:

http://petersoninstitute.org/publications/interstitial.cfm?ResearchID=1096

Read "The Postulates Of Political Economy" by Bagehot here:

http://books.google.com/books?id=ZrA-AAAAIAAJ&dq=bagehot+political+economy&printsec=frontcover&source=bl&ots=dN6OiMA8wi&sig=gV8nfKIxA1hYR9oAIxvQFdNZD0w&hl=en&ei=15uXSZf7CoKqsAPHz-mLAQ&sa=X&oi=book_result&resnum=2&ct=result#PPP1,M1

Read W.Buiter "Helicopter Money" here:

http://www.nber.org/~wbuiter/helijpe.pdf

Read Remarks by Governor Ben S. Bernanke
Before the National Economists Club, Washington, D.C.
November 21, 2002 Deflation: Making Sure "It" Doesn't Happen Here"

http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm#f8

Jackson's Rules Of The Road

I'm going to be a happy idiot
And struggle for the legal tender
Where the ads take aim and lay their claim
To the heart and the soul of the spender
And believe in whatever may lie
In those things that money can buy
Thought true love could have been a contender
Are you there?
Say a prayer for the pretender
Who started out so young and strong
Only to surrender

Gotta do what you can just to keep your love alive
Trying not to confuse it with what you do to survive

And in the end they traded their tired wings
For the resignation that living brings
And exchanged loves bright and fragile glow
For the glitter and the rouge
And in the moment they were swept before the deluge

Don't confront me with my failures
I had not forgotten them

But its a long way that I have come
Across the sand to find you here among these people in the sun
Where your children will be born
You'll watch them as they run
Oh its so far the other way my life has gone

I caught a ride into the city every chance I got
I wasn't sure there was a name for the life I sought
Now I'm a long way gone down the life I got
I don't know how I believed some of the things I thought

Rock me on the water
Sister will you soothe my fevered brow
Rock me on the water, maybe Ill remember
Maybe Ill remember how
Rock me on the water
The wind is with me now
So rock me on the water
Ill get down to the sea somehow

But you said "morocco" and you made me smile
And it hasn't been that easy for a long, long while
And looking back into your eyes I saw them really shine
Giving me a taste of something fine
Something fine

V. Frankl

"In camp too, a man might draw the attention of a comrade working next to him to a nice view of the setting sun shining through the tall trees of the Bavarian woods (as in the famous water color by Dürer), the same woods in which we had built an enormous, hidden munitions plant. One evening, when we were already resting on the floor of our hut, dead tired, soup bowls in hand, a fellow prisoner rushed in and asked us to run out to the assembly grounds and see the wonderful sunset. Standing outside we saw sinister clouds glowing in the west and the whole sky alive with clouds of ever-changing shapes and colors, from steel blue to blood red. The desolate grey mud huts provided a sharp contrast, while the puddles on the muddy ground reflected the glowing sky. Then, after minutes of moving silence, one prisoner said to another, 'How beautiful the world could be!'

Libertarian Democrat Point Of View: An Eccentricity

Thursday, March 26, 2009

This is how scientists have deceived themselves and everyone else about their business, but without any real disadvantage

Against Method

Outline of an anarchistic theory of knowledge

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Don's Hermeneutics: Like Rabbi Yishmael's Rules, Only Not

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Libertarian Democrat Point Of View: An Eccentricity

Thursday, March 26, 2009

This is how scientists have deceived themselves and everyone else about their business, but without any real disadvantage

Against Method

Outline of an anarchistic theory of knowledge

No comments:

Facebook Badge

My Blog List

Other Sites

Don's Terms Of Reference

Don's Hermeneutics: Like Rabbi Yishmael's Rules, Only Not

The Quotes Above

From "The Snowfall" by D. Justice

Jackson's Rules Of The Road

Blog Archive

V. Frankl

About Me

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