The Physics of Wall Street: a brief History of Predicting the Unpredictable

A New Manhattan Project 
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ematical physics known as gauge theory. (the early mathematical 
development of modern gauge theory — the topic on which Wein-
stein wrote his dissertation — was largely the work of Jim Simons, the 
mathematical physicist turned hedge fund manager who founded re-
naissance technologies in the 1980s.) Gauge theories use geometry to 
compare apparently incomparable physical quantities. this, Malaney 
and Weinstein argued, was precisely what was at issue in the index 
number problem — although there, instead of incomparable physical 
quantities, one was trying to compare different economic variables.
It was an unusual, highly technical way of thinking about econom-
ics. this made Malaney a little nervous, since she didn’t know how 
economists unaccustomed to such high-level mathematical analysis 
would react. But she decided to pursue the project for her disserta-
tion after she showed it to her advisor, a superstar in the Harvard eco-
nomics department named eric Maskin. (He would go on to win the 
2007 nobel Prize in economics, for work he had already done before 
meeting Malaney.) Maskin told her the idea was great. He believed 
she’d made real progress on an important topic, one with long-term 
political and economic implications. She finished the dissertation dur-
ing the summer of 1996 and began to think about applying for tenure-
track jobs at top research universities. With such a groundbreaking 
thesis topic and the support of her advisor, she had every reason to 
think she’d be a competitive candidate for these highly desirable posi-
tions. She was living the academic dream.
How much is money worth? this might seem like an odd question. 
for most people, money doesn’t have intrinsic value. the value of 
money comes from what you can do with it. Perhaps money can’t buy 
you love, but it sure can buy you orange juice, or a pair of pants, or a 
new car. And over time, the amount of money it takes to buy that same 
orange juice, pair of pants, or new car changes. Usually, goods become 
more expensive over time (at least if you look at the price tags alone); 
grandparents the world over will tell you how little a chocolate bar 
used to cost, or a movie ticket. A nickel, we’re told, went a lot farther in 
1950 than it does now. this decrease in the value of money over time is 
what we usually call inflation.

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But how do you measure inflation? It’s not as though all prices go 
up evenly across the board. even as some goods have become more 
expensive with time, others have become cheaper. consider that the 
price tag for an Apple II, one of the first mass-produced personal com-
puters, with a breakneck processor speed of 1MHz and a whopping 
48KB of memory, was $2,638 when it first went on sale in 1977. nowa-
days, almost thirty-five years later, you can get a desktop computer 
with a processor over three thousand times as fast, and with a hundred 
thousand times more memory, for a fraction of that — just a few hun-
dred dollars. So what if chocolate is more expensive: computing power 
is now dirt cheap by 1970s standards.
one way in which economists deal with this problem is by looking 
at how prices change across a broad range of products. they do this by 
tracking the price of what is called a standard market basket: an imagi-
nary shopping cart filled with groceries and household commodities 
like gasoline and heating oil, as well as services like education, medical 
care, and housing. this is what’s used to calculate the cPI, which is ef-
fectively the average price of the various goods and services in the cart. 
By looking at price changes for many different items in this way, you 
can get a rough estimate of how far a dollar (or a euro, or a yen) goes 
today, as compared to sometime in the past. Gasoline prices might 
spike over the course of a few months, while computer prices might 
drop gradually over a few years, but the change in the standard market 
basket is supposed to be a relatively stable indication of how much 
spending power changes with time.
Given the role that the cPI plays in calculating things like infla-
tion, it’s important to get it right. Unfortunately, this is a difficult thing 
to do. for one, what should go into the market basket? People with 
different lifestyles often spend their money very differently: a family 
with children living in upstate new York buys very different things 
(for instance, winter coats and heating oil) from a single man living 
in Southern california (surfboards?); farmers in Iowa have different 
needs and preferences from coal workers in West virginia. It is hard to 
see how a single market basket could reflect the full variation of these 
different lifestyles. for this reason, the U.S. Bureau of Labor Statistics, 
which calculates the cPI in America, actually produces many different 
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t h e p h y s i c s o f wa l l s t r e e t

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