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'The Physics of Wall Street': The Most Arrogant Book in the World?

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Did physicists invent the modern global derivatives economy? Part 1 of an ongoing series.

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Editor's note: The following column is the first part of an ongoing series of articles by Aaron Brown examining the claims made in The Physics of Wall Street: A Brief History of Predicting the Unpredictable, a new book by James Owen Weatherall.

MINYANVILLE ORIGINAL Many people will recognize the arrogance of some physicists captured in the comic panel below by Randall Munroe, also known as xkcd, who happens to be a physicist himself (the original has some additional amusing mouse-over text). Not all physicists act this way, of course, but it's a particular flavor of arrogance seldom found in non-physicists. I suspect it springs from the astonishing success of 20th century physics in explaining mysteries of the universe, commanding gigantic research budgets (the United States spent more money on nuclear weapons than the combined value of all physical assets in the country, excluding real estate, and the Soviet Union bankrupted itself trying to keep up-plus many billions more were spent on physics adventures including space exploration and colliders) and building weapons of unparalleled mass destruction. Knowledge, money, and the power to destroy all life on Earth can go to anyone's head.

I have had the honor to discuss mathematical finance with some of the great physicists in the world, including Richard Feynman and Murray Gell-Mann, and also with the physicist most accomplished in finance, Emanuel Derman. None of them act anything like the physicist in the comic. Emanuel is actually humble, and while no one would apply that adjective to Feynman or Gell-Mann, both were intensely interested in learning about new fields, and judicious in their opinions-hanging-judge "judicious" perhaps-very, very firm but open-minded and fair.

I have more often had the lesser honor of discussing the same topics with physicists of fainter accomplishment in physics and finance. Some of them listened as carefully as the superstars above, others were as tone deaf as the xkcd version. Physicist Dr. James Owen Weatherall sets a new standard, however. His new book, The Physics of Wall Street, must rank among the most arrogant books of all time.

"Arrogant" does not imply "stupid." The author is clearly a very smart guy, just one who has not devoted five brain cells to thinking about finance, nor five minutes of real attention to any person who knows anything about it. He has done the world an important service. His book contains the crudest forms of the basic errors many people with quantitative training and zero experience in any form of risk-taking make when first considering finance. He expresses these classic errors with unusual clarity and firmness. This provides me with the opportunity to use him as a Euthyphro to my Socrates (yes, I am no less arrogant than Weatherall, but in the field of finance I know much more).

Over the last 60 years, the world has evolved from a financial system based on credit-backed, national-government-issued paper money firmly linked to physical gold to a borderless derivatives economy. Weatherall's thesis is that physicists are responsible for this change.

Defending that claim is a tall order. The 60 years divides naturally into four 15-year periods. From 1950 to 1965, the basic theory was developed. From 1965 to 1980 a second generation of researchers gathered massive empirical data and lobbied for legal and regulatory changes like the elimination of the gold standard, the introduction of financial futures and options trading, the "big bang" reforms breaking institutional oligopolies, deregulation of financial services, reduction in financial repression, and democratization of financial markets. Also in this period, students trained in these ideas built successful businesses, bypassing the traditional financial system: index funds instead of broker-managed accounts, money market funds instead of bank accounts, electronic trading instead of manual orders, securitization rather than intermediated funding, and many others.
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