Derivatives and the Singularity

In the weekend's New York Times, a can't-miss article from Richard Dooling on the economics of the singularity. In spite of its unlikely title, "The Rise of the Machines" offers the best explanation I've read on what exactly the heck a derivative is. So far a lot of stories discuss the bailout: is it wise? They focus on the effects of wall street on main street. They focus on the personal tragedies of financial titans as if we're trying to make schadenfreude our national pastime. But what's always elusive in these (otherwise satisfying) narratives about motivation is what it was the analysts were actually trying to accomplish. Exactly what is a credit default derivative?

It's a "fake" currency in the same way that paper money is a fake currency based on real gold. Unfortunately, the new currency is so complex that only a machine could understand it.

It was easy enough for us humans to understand a stick or a dollar bill when it was backed by something tangible somewhere, but only computers can understand and derive a correlation structure from observed collateralized debt obligation tranche spreads. Which leads us to the next question: Just how much of the worldâ''s financial stability now lies in the â''handsâ'' of computerized trading algorithms?

The unfortunate part is, Dooling says, that the Unabomber already made Dooling's case for him--in back in 1995:

But we are suggesting neither that the human race would voluntarily turn power over to the machines nor that the machines would willfully seize power. What we do suggest is that the human race might easily permit itself to drift into a position of such dependence on the machines that it would have no practical choice but to accept all of the machinesâ'' decisions. ... Eventually a stage may be reached at which the decisions necessary to keep the system running will be so complex that human beings will be incapable of making them intelligently. At that stage the machines will be in effective control. People wonâ''t be able to just turn the machines off, because they will be so dependent on them that turning them off would amount to suicide.

Add that to the list of singularity predictions.

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