Tuesday, October 6, 2015

World's First Economist

An imaginary conversation with Fan Li

“Okay, what is your best idea?” I inquired of the ancient sage.
“Things that work. Suspenders hold up pants. Most economic concepts don’t hold up anything. They need the support of facts, authorities and long-winded explanations. If support exists at all it is usually a contentious balancing act or a weak link.

“That is why I like Chinese and Market Economics. Chinese Economics is taught like Geography. In a Geography class you learn the names of countries. The name is never in dispute or requires a proof. Names are facts. The location of cities, the length of rivers, the height of mountains, and the depth of lakes are all facts. The price of Barbie dolls, the amount of milk fat in a dairy product, the make of new cars sold at the local dealership, the weight of a sack of flour are all facts. The western economic approach is composed of equations and concepts: supply and demand, velocity of money, natural rate of unemployment, monopoly, Income Elasticity of Demand, equity, assets, returns, etc. All these concepts are subject to interpretation,” Fan Li explained.

Fan Li is considered the first economic thinker. He lived south of modern day Shanghai in the 6th century B.C. near an area of fresh water lakes and lowland agriculture. Unlike the western economic tradition that looks at people as equal and similar acting, Fan Li emphasizes knowing and evaluating customers and suppliers. This gets to the issue of which customers will be granted credit and which will be denied credit. Fan Li states each participant in an economic activity should have their character evaluated. A business person should have the “ability to know people's character. You must perceive evidence of characteristics from experience.” This gets to the idea of whether a person can fulfill the commitment they are making. The western tradition is based on social rights and the legal system’s interpretation of those rights. Does the person have the legal right to enter into a contract? Whether the person can fulfill the contract is left to the party making the contract.

I think you can see where the western tradition leads to trouble like occurred in the Housing Bubble of 2007. Loan originators looked only at the market to see whether they could sell the loans they were originating. The originators felt their responsibility extended only as far as ensuring the loans met the legal requirements of HUD and the GSEs. In the Chinese tradition begun by Fan Li the originator would evaluate the character and ability of the borrower to repay the loan. If such an approach was applied in the United States between 2004 and 2007 there would have been no Housing Bubble.

Fan Li’s system involved evaluating each borrower. This is the way the western tradition began, but it was subverted when the state stepped in to expand the qualifying pool of people. The government’s actions to set qualification hurdle tests destroyed the individual evaluations that Fan Li and early bankers established. Removing this step from the loan qualification system removed the support of reasoned evaluation from the loan portfolio. Everyone was evaluated according to an inflexible set of standards established by HUD. HUD relaxed the qualification hurdle to include groups of people who lacked financial maturity. The result was a built-in failure rate like a circus clown wearing trousers six sizes too big without suspenders. Exposure was guaranteed.

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