Looking for new paradigms

Gavyn Davies, ex-head of global economics at Goldman Sachs, ex-chairman of the BBC, said something interesting in the FT yesterday.

He wrote, “Michael Feroli at JP Morgan suggests a useful way of looking at this. Long term bond yields are equal to the sum of short rate expectations, plus a risk premium which represents the additional volatility and reinvestment risk in long-dated assets.”

Bankers, economists and financiers are entering uncharted territory — as are we all. They are finding that their old assumptions and understandings about the way the world works no longer hold. The fact that Gavyn Davies even mentions the Michael Feroli comment shows that in order to find a way forward they are having to make a new, deeper, sense of things they thought they knew already, in the light of the new evidence we now have.

For day-to-day purposes it is fine to assume that the world is flat. It certainly appears that way. But when you try to do something more stretching, like sail across the Atlantic ocean or fly to a city 10,000 miles away, old understandings break down and is important to understand that the Earth is actually shaped like a large ball. This understanding matters both in terms of choosing the right heading to get to your chosen destination, and in terms of how much effort/fuel it costs you to get there.

Bankers, financiers and economists will be going through a similar challenging of their existing paradigms right now.

That may seem a little bit of an abstract comment — but if we all truly understood how our world works then we’d be finding it a lot easier to find a way forward at the moment. And we probably wouldn’t have got ourselves into this mess in the first place.

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