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# Bayesian Information Extraction Network

## 1 Information Extraction

Information extraction (ie) is the task of filling in template information from previously unseen text which belongs to a pre-defined domain. The resulting database is suited for formal queries and filtering. ie systems generally work by detecting patterns in the text that help identify significant information. Researchers have shown Freitag and McCallum (1999); Ray and Craven (2001) that a probabilistic approach allows the construction of robust and well-performing systems. However, the existing probabilistic systems are generally based on Hidden Markov Models (hmms). Due to this relatively impoverished representation, they are unable to take advantage of the wide array of linguistic information used by many non-probabilistic ie systems. In addition, existing hmm-based systems model each target category separately, failing to capture relational information, such as typical target order, or the fact that each element only belongs to a single category. This paper shows how to incorporate a wide array of knowledge into a probabilistic ie system, based on dynamic Bayesian networks (dbn)—a rich probabilistic representation that generalizes hmms.

Let us illustrate ie by describing seminar announcements which got established as one of the most popular benchmark domains in the field Califf and Mooney (1999); Freitag and McCallum (1999); Soderland (1999); Roth and Yih (2001); Ciravegna (2001). People receive dozens of seminar announcements weekly and need to manually extract information and paste it into personal organizers. The goal of an ie system is to automatically identify target fields such as location and topic of a seminar, date and starting time, ending time and speaker. Announcements come in many formats, but usually follow some pattern. We often find a header with a gist in the form “PostedBy: john@host.domain; Who: Dr. Steals; When: 1 am;” and so forth. Also in the body of the message, the speaker usually precedes both location and starting time, which in turn precedes ending time as in: ‘‘Dr. Steals presents in Dean Hall at one am.’’ The task is complicated since some fields may be missing or may contain multiple values.

This kind of data falls into the so-called semi-structured text category. Instances obey certain structure and usually contain information for most of the expected fields in some order. There are two other categories: free text and structured text. In structured text, the positions of the information fields are fixed and values are limited to pre-defined set. Consequently, the ie systems focus on specifying the delimiters and order associated with each field. At the opposite end lies the task of extracting information from free text which, although unstructured, is assumed to be grammatical. Here ie systems rely more on syntactic, semantic and discourse knowledge in order to assemble relevant information potentially scattered all over a large document.

ie algorithms face different challenges depending on the extraction targets and the kind of the text they are embedded in. In some cases, the target is uniquely identifiable (single-slot), while in others, the targets are linked together in multi-slot association frames. For example, a conference schedule has several slots for related speaker, topic and time of the presentation, while a seminar announcement usually refers to a unique event. Sometimes it is necessary to identify each word in a target slot, while some benefit may be reaped from partial identification of the target, such as labeling the beginning or end of the slot separately. Many applications involve processing of domain-specific jargon like Internetese—a style of writing prevalent in news groups, e-mail messages, bulletin boards and online chat rooms. Such documents do not follow a good grammar, spelling or literary style. Often these are more like a stream-of-consciousness ranting in which ascii-art and pseudo-graphic sketches are used and emphasis is provided by all-capitals, or using multiple exclamation signs. As we exemplify below, syntactic analysers easily fail on such corpora.

Other examples of ie application domains include job advertisements Califf and Mooney (1999) (rapier), executive succession Soderland (1999) (whisk), restaurant guides Muslea et al. (2001) (stalker), biological publications Ray and Craven (2001) etc. Initial interest in the subject was stimulated by ARPA’s Message Understanding Conferences (MUC) which put forth challenges e.g. parsing newswire articles related to terrorism (see e.g. Mikheev Mikheev et al. (1998)). Below we briefly review various ie systems and approaches which mostly originated from MUC competitions.

Successful ie involves identifying abstract patterns in the way information is presented in text. Consequently, all previous work necessarily relies on some set of textual features. The overwhelming majority of existing algorithms operate by building and pruning sets of induction rules defined on these features (srv, rapier, whisk, lp2). There are many features that are potentially helpful for extracting specific fields, e.g. there are tokens and delimiters that signal the beginning and end of particular types of information. Consider an example in table 1 which shows how the phrase “Doctor Steals presents in Dean Hall at one am.” is represented through feature values. For example, the lemma “am” designates the end of a time field, while the semantic feature “Title” signals the speaker, and the syntactic category nnp (proper noun) often corresponds to speaker or location. Since many researchers use the seminar announcements domain as a testbed, we have chosen this domain in order to have a good basis of comparison.

One of the systems we compare to (specifically designed for single-slot problems) is SRV Freitag (1998). It is built on three classifiers of text fragments. The first classifier is a simple look-up table containing all correct slot-fillers encountered in the training set. The second one computes the estimated probability of finding the fragment tokens in a correct slot-filler. The last one uses constraints obtained by rule induction over predicates like token identity, word length and capitalization, and simple semantic features.

rapier Califf and Mooney (1999) is fully based on bottom-up rule induction on the target fragment and a few tokens from its neighborhood. The rules are templates specifying a list of surrounding items to be matched and potentially, a maximal number of tokens for each slot. Rule generation begins with the most specific rules matching a slot. Then rules for identical slots are generalized via pair-wise merging, until no improvement can be made. Rules in rapier are formulated as lexical and semantic constraints and may include PoS tags. whisk Soderland (1999) uses constraints similar to rapier, but its rules are formulated as regular expressions with wild cards for intervening tokens. Thus, whisk encodes a relative, rather than absolute position of tokens with respect to the target. This enables modeling long distance dependencies in the text. whisk performs well on both single-slot and multi-slot extraction tasks.

Ciravegna Ciravegna (2001) presents yet another rule induction method (lp)2. He considers several candidate features such as lemma, lexical and semantic categories and capitalization to form a set of rules for inserting tags into text. Unlike other approaches, (lp)2 generates separate rules targeting the beginning and ending of each slot. This allows for more flexibility in subjecting partially correct extractions to several refinement stages, also relying on rule induction to introduce corrections. Emphasizing the relational aspect of the domain, Roth and Yoh Roth and Yih (2001) developed a knowledge representation language that enables efficient feature generation. They used the features in a multi-class classifier snow-ie to obtain the desired set of tags. The resulting method (snow-ie) works in two stages: the first filters out the irrelevant parts of text, while the second identifies the relevant slots.

Freitag & McCallum Freitag and McCallum (1999) use hidden Markov models (hmm). A separate hmm is used for each target slot. No preprocessing or features is used except for the token identity. For each hidden state, there is a probability distribution over tokens encountered as slot-fillers in the training data. Weakly analogous to templates, hidden state transitions encode regularities in the slot context. In particular prefix and suffix states are used in addition to target and background slots to capture words frequently found in the neighborhood of targets. Ray&Craven Ray and Craven (2001) make one step further by setting hmm hidden states in a product space of syntactic chunks and target tags to model the text structure. The success of the hmm-based approaches demonstrate the viability of probabilistic methods for this domain. However, they do not take advantage of the linguistic information used by the other approaches. Furthermore, they are limited by using a separate hmm for each target slot, rather than extracting data in an integrated way.

The main contribution of this paper is in demonstrating how to integrate various aspects of language in a single probabilistic model, to incrementally build a robust information extraction system based on a Bayesian network. This system overcomes the following dilemma. It is tempting to use a lot of linguistic features in order to account for multiple aspects of text structure. However, deterministic rule induction approaches seem vulnerable to the performance of feature extractors in pre-processing steps. This presents a problem since syntactic instruments that have been trained on highly-polished grammatical corpora, are particularly unreliable on weakly grammatical semi-structured text. Furthermore incorporating many features complicates the model which often has to be learned from sparse data, which harms performance of classifier-based systems.

## 2 Features

Our approach is statistical, which generally speaking means that learning corresponds to inferring frequencies of events. The statistics we collect originates in various sources. Some statistics reflect regularities of the language itself, while others correspond to the peculiarities of the domain. With this in mind we design features which reflect both aspects. There is no limitation on the possible set of features. Local features like part-of-speech, number of characters in the token, capitalization and membership in syntactic phrase are quite customary in the ie. In addition one could obtain such characteristics of the word as imagibility, frequency of use, familiarity, or even predicates on numerical values. Since there is no need for features to be local, one might find useful including frequency of a word in the training corpus or number of occurrences in the document. Notice that the same set of features would work for many domains. This includes semantic features along with orthographic and syntactic features.

Before we move on to presenting our system for probabilistic reasoning, let us discuss in some detail notation and methods we used in preliminary data processing and feature extraction. To use the data efficiently, we need to factor the text into “orthogonal” features. Rather than working with thousands of listems (generic words111A word is a sequence of alphabetical characters, which has some meaning assigned to it. This would cover words found in general and special vocabulary as well abbreviations, proper names and such.) in the vocabulary, and combining their features, we compress the vocabulary by an order of magnitude by lemmatisation or stemming. Orthographic and syntactic information is kept in feature variables with just a few values each.

### 2.0.1 Tokenization

Tokenization is the first step of textual data processing. A token is a minimal part of text which is treated as a unit in subsequent steps. In our case tokenization mostly involves separating punctuation characters from words. This is particularly non-trivial for separating a period Manning and Schutze (2001) since it requires identifying sentence boundaries. Consider a sentence: Speaker: Dr. Steals, Chief Exec. of rich.com, worth $`\$10.5`$ mil.

### 2.0.2 Lemmatisation

We have developed a simple lemmatiser which combines outcome of some standard lematisers and stemmers into a look-up table. Combined with lemmatisation is a step of spell checking to catch misspelled words. This is done by interfacing with the unix ispell utility.

### 2.0.3 Gazetteer

Our original corpus contains about 11,000 different listems. This does not take into account tokens consisting of punctuation characters, numbers and such. About 10% are proper nouns. The question of building a vocabulary automatically was previously addressed in ie literature(see e.g. Riloff Riloff (1996)). We use the intersection of two sets. The first set consists of words encountered as part of target fields and in their neighborhood. The second set consists of words frequently seen in the corpus. Aside from vocabulary there are two reserved values for Out-of-Vocabulary (OoV) words and Not-a-Word (NaW). For example see blank slots in the lemma row of Table 1. The first category encodes rare and unfamiliar words, which are still identified as words according to their part of speech. The second category is for mixed alpha-numerical tokens, punctuation and symbolic tokens.

### 2.0.4 Syntactic Categories

We used LTChunk software from U.of Edinburgh NLP group Mikheev et al. (1998). It produces $`47`$ PoS tags from UPenn TreeBank set Marcus et al. (1994). We have clustered these into 7 categories: cardinal numbers (cd), nouns (nn), proper nouns (nnp), verbs (vb), punctuation (.), preposition/conjunction (in) and other (sym). The choice of clusters seriously influences the performance, while keeping all $`47`$ tags will lead to large CPTs and sparse data.

### 2.0.5 Syntactic Chunking

Following Ray&Craven Ray and Craven (2001), we obtain syntactic segments (aka syntactic chunks) by running the Sundance system Riloff (1996) and flattening the output into four categories corresponding to noun phrase (np), verb phrase (vp), prepositional phrase (pp) and other (n/a). Table 1 shows a sample outcome. Note that both the part-of-speech tagger and the syntactic chunker easily get confused by non-standard capitalization of a word “Presents” as shown by incorrect labels in parenthesis. “Steals” is incorrectly identified as a verb, whose subject is “Doctor” and object is “Presents”. Remarkably, other state-of-the-art syntactic analysis tools Charniak (1999); Ratnaparkhi (1999) also failed on this problem.

### 2.0.6 Capitalization and Length

Simple features like capitalization and length of word are used by many researchers (e.g. SRV Freitag and McCallum (1999)) Case representation process is straightforward except for the choice of number of categories. We found useful introducing an extra category for words which contain both lower and upper case letters (not counting the initial capital letter) which tend to be abbreviations.

### 2.0.7 Semantic Features

There are several semantic features which play important role in a variety of application domains. In particular, it is useful to be able to recognize what could be a person’s name, geographic location, various parts of address, etc. For example, we are using a list of secondary location identifiers provided by US postal service, which identifies as such words like hall, wing, floor and auditorium. We also use a list of $`100000`$ most popular names from US census bureau; the list is augmented by rank which helps to decide in favor of first or last name for cases like “Alexander”. In general this task could be helped by using a hypernym feature of WordNet project Fellbaum (1998). The next section presents probabilistic model which makes use of the aforementioned feature variables.

## 3 BIEN

We convert the ie problem into a classification problem by assuming that each token in the document belongs to a target class corresponding to ether one of the target tags or the background (compare to Freitag Freitag and McCallum (1999)). Furthermore, it seems important not to ignore the information about interdependencies of target fields and document segments. To combine advantages of stochastic models with feature-based reasoning, we use a Bayesian network.

A dynamic Bayesian network (dbn) is ideal for representing probabilistic information about these features. Just like a Bayesian network, it encodes interdependence among various features. In addition, it incorporates the element of time, like an hmm, so that time-dependent patterns such as common orders of fields can be represented. All this is done in a compact representation that can be learned from data. We refer to a recent dissertation Murphy (2002) for a good overview of all aspects of Dynamic Bayesian Networks.

Each document is considered to be a single stream of tokens. In our dbn, called the Bayesian Information Extraction Network (bien), the same structure is repeated for every index. Figure 1 presents the structure of bien. This structure contains state variables and feature variables. The most important state variable, for our purposes, is “Tag” which corresponds to information we are trying to extract. This variable classifies each token according to its target information field, or has the value “background” if the token does not belong to any field. “Last Target” is another hidden variable which reflects the order in which target information is found in the document. This variable is our way of implementing a memory in a “memory-less” Markov model. Its value is deterministically defined by the last non-background value of “Tag” variable. Another hidden variable, “Document Segment”, is introduced to account for differences in patterns between the header and the main body of the document. The former is close to the structured text format, while the latter to the free text. “Document Segment” influences “Tag” and together these two influence the set of observable variables which represent features of the text discussed in section 2.

Standard inference algorithms for dbns are similar to those for hmms. In a dbn, some of the variables will typically be observed, while others will be hidden. The typical inference task is to determine the probability distribution over the states of a hidden variable over time, given time series data of the observed variables. This is usually accomplished using the forward-backward algorithm. Alternatively, we might want to know the most likely sequence of hidden variables. This is accomplished using the Viterbi algorithm. Learning the parameters of a dbn from data is accomplished using the em algorithm (see e.g. Murphy Murphy (2002)). Note that in principle, parts of the system could be trained separately on independent corpus to improve performance. For example, one could learn independently the conditional vocabulary of email/newsgroup headers, or learn a probability of part-of-speech conditioned on a word, to avoid dependence on external PoS taggers. Also prior knowledge about the domain and the language could be set in the system this way. The fact that etime almost never precedes stime as well as the fact that speaker is never a verb could be encoded in a conditional probability table (CPT). In large dbns, exact inference algorithms are intractable, and so a variety of approximate methods have been developed. However, the number of hidden state variables in our model is small enough to allow exact algorithms to work. Indeed, all hidden nodes in our model are discrete variables which assume just a few values. “DocumentSegment” is binary in {Header, Body} range; “LastTarget” has as many values as “Tag”—four per number of target fields plus one for the background.

## 4 Results

Several researchers have reported results on the CMU seminar announcements corpus, which we have chosen in order to have a good basis of comparison. The CMU seminar announcements corpus consists of 485 documents. Each announcement contains some tags for target slots. On average starting time appears twice per document, while location and speaker $`1.5`$ times, with up to $`9`$ speaker slots and $`4`$ location slots per document. Sometimes multiple instances of the same slot differ, e.g. speaker Dr. Steals also appears as Joe Steals222Obtaining $`100\%`$ performance on the original corpus is impossible since some tags are misplaced and in general the corpus is not marked uniformly—sometimes secondary occurrences are ignored.. Ending time, speaker and location are missing from $`48\%`$, $`16\%`$ and $`5\%`$ of documents correspondingly. In order to demonstrate our method, we have developed a web site which works with arbitrary seminar announcement and reveals some semantic tagging. We also make available a list of errors in the original corpus, along with our new derivative seminar announcement corpus333The corpus and demo for this paper are available from http://www.eecs.harvard.edu/~pesha/papers.html.

The performance is calculated in the usual way, by precision $`P=\frac{\text{correct answers}}{\text{answers produced}}`$ and recall $`R=\frac{\text{correct answers}}{\text{total correct}}`$ combined into $`F`$ measure geometrical average $`F=\frac{2PR}{P+R}`$. We report results using the same ten-fold cross validation test as other publications concerning this data set Roth and Yih (2001); Ciravegna (2001). The data is split randomly into training and testing set. The reported results are averaged over five runs. Table 2 presents a comparison with numerous previous attempts at the CMU seminar corpus. The figures are taken from Roth and Yih Roth and Yih (2001). bien performs comparably to the best system in each category, while notably outperforming other systems in finding location. This is partly due to the “LastTarget” variable. ”LastTarget” variable turns out to be generally useful. Here is the learned conditional probability table (CPT) for $`P(Target|LastTarget)`$, where the element $`(I,J)`$ corresponds to the probability to get target tag $`J`$ after target tag $`I`$ was seen. We learn that initial tag is stime or speaker with 2:1 likelihood ratio; etime is naturally the most likely follower to stime and in turn forecasts location.
Last Target     Current Tag   stime etime location speaker    none .66 0 .01 .33  stime .07 .46 .32 .14  etime .19 .002 .63 .18  location .37 .004 .02 .61  speaker .64 .002 .13 .22

Other variables turn out to be useless, e.g. the number of characters does not add anything to the performance, and neither does the initially introduced “SeenTag” variable which kept track of all tags seen up to the current position. Table 3 presents performance of bien with various individual features turned off. Note that figures for complete bien are slightly better than in Table 2 since we pushed the fraction of the training data to the maximum. Capitalization helps identify location and speaker, while losing it does not damage performance drastically. Although information is reflected in syntactic and semantic features, most names in documents do not identify a speaker. One would hope to capture all relevant information by syntactic and semantic categories, however bien does not fare well without observing “Lemma”. Losing the semantic feature seriously undermines performance in location and speaker categories—ability to recognize names is rather valuable for many domains.

Reported figures are based on 80%-20% split of the corpus. Increasing the size of training corpus did not dramatically improve the performance in terms of $`F`$ measure, as further illustrated by Figure 2, which presents a learning curve—precision and recall averaged over all fields, as a function of training data fraction. Trained on a small sample, bien acts very conservatively rarely picking fields, therefore scoring high precision and poor recall. Having seen hundreds of target field instances and tens of thousands of negative samples, bien learns to generalize, which leads to generous tagging i.e. lower precision and higher recall.

So far we provide results obtained on the original CMU seminar announcements data, which is not very challenging. Most documents contain the header section with all the target fields easily identifiable right after the corresponding key word. We have created a derivative dataset in which documents are stripped of headers and two extra fields are sought: date and topic. Indeed this corpus turned out to be more difficult, with our current set of features we obtain only $`64\%`$ performance on speaker and $`68\%`$ performance on topic. Date does not present a challenge except for cases of regular weekly events or relative dates like “tomorrow”. Admittedly, the bootstrapping test performance is not a guarantee of systems performance on novel data since preliminary processing, i.e. tokenization and gazetteering, as well as choice for PoS tag set, lead to a strong bias towards the training corpus.

## 5 Discussion

We have described how to integrate various aspects of language into a single probabilistic model, and to incrementally build a robust IE system based on a Bayesian network. Currently, we are working on learning the structure of bien automatically. It seems to subject itself nicely to structural em Friedman (1998); Murphy (2002). The first step is automatic selection of relevant features. Another direction of current work is using approximate inference. We have tried LBP (Loopy-belief Propagation) Murphy et al. (1999); Murphy (2002), but for the current structure of bien it seems to give no gain. More challenging applications which require larger, stronger connected networks, will benefit from approximate inference algorithms. It will enable quick on-line inference on the network learned off-line with exact methods, as well as learning for cases where exact inference is infeasible. One such network will result from integrating a PoS tagger and other feature extractors into bien. This is a natural extension of bien since various text processing routines are mutually dependent. Consider for example PoS tagging, sentence boundary detection and named entities recognition. Another complex bien structure will result if we try to better reflect complex relational information Califf and Mooney (1999); Roth and Yih (2001, 2002) e.g. to process cases like seminar cancellations and rescheduling; and handle multi-slot extraction, e.g. multiple seminar announcements and conference schedules.

## Acknowledgments

Kevin Murphy provided BNT, Kobi Gal helped to handle the corpus, anonymous reviewers gave helpful feedback.


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# Evidence from d+Au measurements for final-state suppression of high 𝑝_𝑇 hadrons in Au+Au collisions at RHIC

STAR Collaboration

(; )

## Abstract

We report measurements of single-particle inclusive spectra and two-particle azimuthal distributions of charged hadrons at high transverse momentum (high $`p_T`$) in minimum bias and central d+Au collisions at $`\sqrt{s_{\mathrm{NN}}}`$=200 GeV. The inclusive yield is enhanced in d+Au collisions relative to binary-scaled p+p collisions, while the two-particle azimuthal distributions are very similar to those observed in p+p collisions. These results demonstrate that the strong suppression of the inclusive yield and back-to-back correlations at high $`p_T`$ previously observed in central Au+Au collisions are due to final-state interactions with the dense medium generated in such collisions.

Energetic partons propagating through matter are predicted to lose energy through induced gluon radiation, with the magnitude of the energy loss depending strongly on the color charge density EnergyLoss . Partonic energy loss is potentially a sensitive probe of the matter created in high energy heavy-ion collisions, where a quark-gluon plasma may form if sufficiently high energy density is achieved. The energetic partons originate in the hard scattering of partons from the incoming nuclei. Direct measurement of jets resulting from parton fragmentation is difficult in nuclear collisions; nevertheless partonic energy loss can be studied using observables such as inclusive spectra and two-particle azimuthal distributions of high transverse momentum (high $`p_T`$) hadrons.

Measurements of high $`p_T`$ hadron production in ultrarelativistic interactions of heavy nuclei reveal strong suppression of both the single-particle inclusive yield STARHighpt130 ; PHENIXHighpt130 ; PHOBOSHighpt200 ; STARHighpt200  and back-to-back pairs (large azimuthal separation $`\mathrm{\Delta }\varphi `$) in the most-central, violent collisions, while near-side pairs (small $`\mathrm{\Delta }\varphi `$) exhibit jet-like correlations that are similar to those in proton+proton (p+p) collisions STARHighptCorrelations . One interpretation of these results is that, in the final state following the hard scattering, energetic partons traversing the dense medium in the core of the collision lose energy, and the observed jets are primarily those created from partons produced near the surface and directed outwards STARHighptCorrelations . Alternatively, the suppression might result from initial-state effects prior to the hard scattering, such as the saturation of gluon densities in the incoming nuclei KLM . Models incorporating either picture are capable of describing central Au+Au collision data STARHighpt200 . Initial- and final-state effects in Au+Au collisions can be separated through studies of deuteron(d)+Au collisions. Theoretical expectations for d+Au collisions at the Relativistic Heavy Ion Collider (RHIC) are given in KLM ; WangdAu ; LevaidAu ; KopeliovichdAu ; Accardi ; VitevdAu ; Eskola ; SpencerShadow ; BaierEtalSaturation . Within a perturbative QCD (pQCD) framework, the expected initial-state nuclear effects in d+Au collisions are multiple scattering prior to a hard collision, which has been used to explain the Cronin enhancement of the inclusive yield Antreysan , and shadowing of the parton distribution functions. Nuclear effects are expected to increase for more central collisions; thus the centrality dependence of observables measured in d+Au collisions also will help reveal their origin.

The STAR Collaboration reports measurements of the inclusive invariant $`p_T`$ distribution and two-particle azimuthal distributions at high $`p_T`$ for charged hadrons \[$`(\mathrm{h}^++\mathrm{h}^{})/2`$, approximated by the summed yields of primary $`\pi ^\pm `$, K<sup>±</sup>, p and $`\overline{\mathrm{p}}`$\] in minimum bias and central d+Au collisions at center of mass energy $`\sqrt{s_{\mathrm{NN}}}`$=200 GeV per nucleon pair. Comparison is made to measurements at $`\sqrt{s_{\mathrm{NN}}}`$=200 GeV in the same detector for Au+Au and p+p interactions STARHighpt200 ; STARHighptCorrelations . The inclusive yield is enhanced in d+Au collisions relative to binary-scaled p+p collisions, in contrast to the large suppression observed in central Au+Au interactions. Similar results are reported in PHENIXdAu ; PHOBOSdAu ; BRAHMSdAu . The d+Au two-particle azimuthal distributions are very similar to those observed in p+p collisions. These observations are consistent with expectations from pQCD models incorporating both the Cronin enhancement and nuclear shadowing WangdAu ; LevaidAu ; KopeliovichdAu ; Accardi ; VitevdAu , and are inconsistent with calculations that attribute the suppression in central Au+Au collisions to initial-state gluon saturation KLM .

STAR is a multi-purpose detector STARNIM  located at Brookhaven National Laboratory’s RHIC facility. For these measurements, the minimum bias trigger required at least one beam-rapidity neutron in ZDC-Au, the Zero Degree Calorimeter (ZDC) in the Au beam direction, which is assigned negative pseudorapidity ($`\eta `$). This trigger accepts 95$`\pm `$3% of the d+Au hadronic cross section $`\sigma _{hadr}^{dAu}`$. Trigger backgrounds were measured using beam bunches not in collision. Charged particle momenta were measured by the Time Projection Chamber in a 0.5 T solenoidal magnetic field.

After event selection cuts, the data set consists of $`10^7`$ minimum bias d+Au events. Data were analyzed using the techniques described in STARHighpt130 ; STARHighptCorrelations . The vertex was reconstructed in 93$`\pm `$1% of triggered minimum bias events. The spectra were corrected for trigger and vertex-finding efficiencies. Contamination of the spectra due to weak decay products was corrected based on HIJING HIJING . Results of an independent analysis, using a different technique for vertex reconstruction STARHighpt200 , agree with the reported spectrum within the relative normalization uncertainties at all $`p_T`$.

Centrality tagging of d+Au collisions is based on the raw (uncorrected) charged particle multiplicity within $`3.8<\eta <2.8`$, measured by the Forward Time Projection Chamber in the Au beam direction (FTPC-Au STARNIM ). The FTPC-Au multiplicity was examined in quadrants relative to the orientation of the leading charged hadron at mid-rapidity; auto-correlation effects were found to be negligible. An independent centrality tag, used as a cross-check, requires at least one beam-rapidity (spectator) neutron in ZDC-d, the ZDC in the deuteron beam direction. The cross section for this process in hadronic events was measured to be (19.2$`\pm `$1.3)% of $`\sigma _{hadr}^{dAu}`$. ZDC-d and FTPC-Au are separated by 8 rapidity units. Figure 1 shows the FTPC-Au multiplicity for minimum bias and ZDC-d neutron-tagged events. The latter have a strong bias toward low multiplicity.

The centrality tags were modeled using a Monte Carlo Glauber calculation STARHighpt130  incorporating the Hulthén wavefunction of the deuteronHulthenWF . In this model the mean number of binary collisions $`\mathrm{N}_{\mathrm{bin}}`$ is 7.5$`\pm 0.4`$ for minimum bias events and $`\sigma _{hadr}^{dAu}`$=2.21$`\pm `$0.09 b. Events with a neutron spectator from the deuteron comprise (18$`\pm `$3)% of $`\sigma _{hadr}^{dAu}`$ in the model. This event class is biased toward peripheral collisions, with $`\mathrm{N}_{\mathrm{bin}}`$=2.9$`\pm 0.2`$. The FTPC-Au multiplicity distribution was modeled by convoluting the Glauber model distribution of participants from the Au nucleus with the charged multiplicity distribution measured in $`2.5<|\eta |<3.5`$ for $`\overline{\mathrm{p}}`$+p collisions at $`\sqrt{s}`$=200 GeVUA5 . The FTPC-Au acceptance, efficiency and backgrounds were taken into account using HIJING HIJING  events in a GEANT model of the detector. Figure 1 shows the measurements for both minimum bias and ZDC-d neutron-tagged events, together with the corresponding Glauber model predictions. The model is validated by its agreement with both multiplicity distributions and with the ZDC-d single neutron cross section fraction. High FTPC-Au multiplicity therefore biases towards central collisions. Figure 1 shows the cut defining the 20% highest multiplicity collisions in the data. $`\mathrm{N}_{\mathrm{bin}}`$=15.0$`\pm `$1.1 for the 20% highest multiplicity collisions in the Glauber model, where the uncertainty includes the spread in values obtained with several alternative models.

Figure 2 shows the invariant inclusive $`p_T`$ distribution of $`(\mathrm{h}^++\mathrm{h}^{})/2`$ within $`|\eta |<0.5`$ for minimum bias and central d+Au collisions, together with that for p+p collisions from STARHighpt200 . The error bars are the quadrature sum of statistical errors and point-to-point systematic uncertainties. The normalization uncertainty for d+Au collisions is 10%.

Nuclear effects on hadron production in d+Au and Au+Au collisions are measured through comparison to the p+p spectrum using the ratio

$$R_{AB}(p_T)=\frac{d^2N/dp_Td\eta }{T_{AB}d^2\sigma ^{pp}/dp_Td\eta },$$
(1)
where $`d^2N/dp_Td\eta `$ is the differential yield per event in the nuclear collision $`A+B`$, $`T_{AB}`$=$`\mathrm{N}_{\mathrm{bin}}`$/$`\sigma _{inel}^{pp}`$ describes the nuclear geometry, and $`d^2\sigma ^{pp}/dp_Td\eta `$ for p+p inelastic collisions is determined from the measured p+p differential cross sectionSTARHighpt200 . In the absence of nuclear effects such as shadowing, the Cronin effect, or gluon saturation, hard processes are expected to scale with the number of binary collisions and $`R_{AB}(p_T)`$=1. Figure 3 shows $`R_{AB}(p_T)`$ for minimum bias and central d+Au collisions. The error bars are the quadrature sum of the statistical and point-to-point systematic uncertainties. $`R_{AB}(p_T)`$$`>`$1 for 2$`<`$$`p_T`$$`<`$7 GeV/c. $`R_{AB}(p_T)`$ for central and minimum bias d+Au collisions contain many common uncertainties, including dependence on the same p+p reference spectrum. The ratio of $`R_{AB}(p_T)`$ for central relative to minimum bias collisions, which factors out these common uncertainties, is 1.02$`\pm `$0.03 at 4 GeV/c. $`R_{AB}(p_T)`$ may be influenced by nuclear shadowing Eskola  and its centrality dependence SpencerShadow . Figure 3 also shows $`R_{AB}(p_T)`$ for central Au+Au collisionsSTARHighpt200 , exhibiting large suppression in hadron production at high $`p_T`$.

Figure 4(a) shows the two-particle azimuthal distribution $`D(\mathrm{\Delta }\varphi )`$, defined as

$$D(\mathrm{\Delta }\varphi )\frac{1}{N_{trigger}}\frac{1}{ϵ}\frac{dN}{d(\mathrm{\Delta }\varphi )},$$
(2)
for minimum bias and central d+Au collisions, and for p+p collisionsSTARHighptCorrelations . Only particles within $`|\eta |<0.7`$ are included in the analysis. $`N_{trigger}`$ is the number of particles within 4$`<`$$`p_T`$(trig)$`<`$6 GeV/c, referred to as trigger particles. The distribution results from the correlation of each trigger particle with all associated particles in the same event having $`2<p_T<p_T`$(trig), where $`ϵ`$ is the tracking efficiency of the associated particles. The normalization uncertainties are less than 5%.

The azimuthal distributions in d+Au collisions include a near-side ($`\mathrm{\Delta }\varphi 0`$) peak similar to that seen in p+p and Au+Au collisions STARHighptCorrelations  that is typical of jet production, and a back-to-back ($`\mathrm{\Delta }\varphi \pi `$) peak similar to that seen in p+p and peripheral Au+Au collisions STARHighptCorrelations  that is typical of di-jet events. The azimuthal distributions are characterized by a fit to the sum of near-side (first term) and back-to-back (second term) Gaussian peaks and a constant:

$$D(\mathrm{\Delta }\varphi )=A_N\frac{e^{(\mathrm{\Delta }\varphi )^2/2\sigma _N^2}}{\sqrt{2\pi }\sigma _N}+A_B\frac{e^{(|\mathrm{\Delta }\varphi |\pi )^2/2\sigma _B^2}}{\sqrt{2\pi }\sigma _B}+P.$$
(3)
Fit parameters are given in Table 1. Their systematic uncertainties are highly correlated between the data sets, and are less than 20% for $`\sigma _N`$ and less than 10% for all other parameters. The only large difference in the azimuthal distributions in p+p and d+Au collisions is the growth of the pedestal $`P`$. It increases with increasing $`\mathrm{N}_{\mathrm{bin}}`$, but is not proportional to $`\mathrm{N}_{\mathrm{bin}}`$ as might be expected for incoherent production. Both $`\sigma _N`$ and $`\sigma _B`$ exhibit at most a small increase from p+p to central d+Au collisions. A small growth in $`\sigma _B`$ is expected to result from initial-state multiple scattering Corcoran ; QiuVitev . The modest reduction in the correlation strengths $`A_N`$ and $`A_B`$ from p+p to central d+Au collisions is similar to that seen previously for peripheral Au+Au collisions STARHighptCorrelations .

Figure 4(b) shows the pedestal-subtracted azimuthal distributions for p+p and central d+Au collisions. The azimuthal distributions are shown also for central Au+Au collisions after subtraction of the elliptic flow and pedestal contributions STARHighptCorrelations . The near-side peak is similar in all three systems, while the back-to-back peak in central Au+Au shows a dramatic suppression relative to p+p and d+Au.

The contrast between d+Au and central Au+Au collisions in Figs. 3 and 4 indicates that the cause of the strong high $`p_T`$ suppression observed previously is associated with the medium produced in Au+Au but not in d+Au collisions. The suppression of the inclusive hadron yield at high $`p_T`$ in central Au+Au collisions has been discussed theoretically in various approaches (see STARHighpt200  for references). Measurements of central Au+Au collisions STARHighpt200  are described both by pQCD calculations that incorporate shadowing, the Cronin effect, and partonic energy loss in dense matter, and by a calculation extending the saturation model to high momentum transfer. However, predictions of these models differ significantly for d+Au collisions. Due to the Cronin effect, pQCD models predict that $`R_{AB}(p_T)`$$`>`$1 within $`2<p_T<6`$ GeV/c for minimum bias d+Au collisions, with a peak magnitude of 1.1-1.5 in the range $`2.5<p_T<4`$ GeV/c Accardi . The enhancement is expected to be larger for central collisions VitevdAu . The saturation model calculation in KLM  predicts $`R_{AB}(p_T)`$$`<`$1, with larger suppression for more central events, achieving $`R_{AB}(p_T)`$$`0.75`$ for the 20% most central collisions. In contrast, another saturation model calculation BaierEtalSaturation  generates an enhancement in $`R_{AB}(p_T)`$, similar to the Cronin effect, for both d+Au and Au+Au collisions. Figure 3 shows that $`R_{AB}(p_T)`$ is qualitatively different in d+Au and central Au+Au collisions: in d+Au, $`R_{AB}(p_T)`$ significantly exceeds unity. These results are consistent with expectations from pQCD calculations but not the saturation model in KLM . Scattering of the hadronic fragments of jets also may contribute to the suppression of the inclusive yield GallmeisterEtAl ; STARHighpt200 .

The azimuthal distributions of back-to-back jets and high $`p_T`$ di-hadrons have been observed to broaden in fixed-target p+nucleus collisions relative to p+p collisions, but are not strongly suppressed Corcoran . Slight broadening of the back-to-back hadron distribution in d+Au collisions at $`\sqrt{s_{\mathrm{NN}}}`$=200 GeV is also expected from pQCD models incorporating the Cronin effect QiuVitev . Predictions of the saturation model for the back-to-back hadron distributions require further theoretical development, though the rate may be suppressed due to a monojet contribution BtoBsaturation . Table 1 shows that the distribution of back-to-back high $`p_T`$ hadrons is not substantially modified in central d+Au collisions relative to p+p collisions, consistent with expectations from pQCD calculations.

In summary, we have reported the inclusive $`p_T`$ distributions and two-particle azimuthal distributions of high $`p_T`$ hadrons in minimum bias and central d+Au collisions at $`\sqrt{s_{\mathrm{NN}}}`$=200 GeV. Similar measurements for Au+Au and p+p interactions have revealed a striking suppression of both the inclusive hadron yield and the back-to-back correlations for central Au+Au collisions. If the suppression is the result of initial-state effects, it also should be observed in d+Au collisions. No suppression in d+Au collisions is observed. Rather, the inclusive yield is enhanced and the two-particle azimuthal distributions exhibit little change relative to p+p. These results suggest that the Cronin effect plays a significant role in d+Au collisions for $`2<p_T<7`$ GeV/c. We conclude that the suppression phenomena seen in central Au+Au collisions are due to final-state interactions with the dense system generated in the collision.

###### Acknowledgements.

We thank the RHIC Operations Group and RCF at BNL, and the NERSC Center at LBNL for their support. This work was supported in part by the HENP Divisions of the Office of Science of the U.S. DOE; the U.S. NSF; the BMBF of Germany; IN2P3, RA, RPL, and EMN of France; EPSRC of the United Kingdom; FAPESP of Brazil; the Russian Ministry of Science and Technology; the Ministry of Education and the NNSFC of China; SFOM of the Czech Republic, DAE, DST, and CSIR of the Government of India; the Swiss NSF.


text:
# Evidence of Fueling of the 2000 New Economy Bubble by Foreign Capital Inflow: Implications for the Future of the US Economy and its Stock Market

## 1 Introduction

According to more than a half-century of academic research, stock market prices move almost like a (slightly biased geometric) random walk . Improvements accounting for the presence of heavy tails in the distribution of returns and of volatility persistence have not modified significantly the view in the academic literature that the stock market is generally (weakly) efficient and arbitrages away potential winning investment strategies . A more elaborated understanding of potential gains was shown to be associated with risk: the return-risk trade-off theory holds that there are actually winning investment strategies but they come generally with increasing risks, so that a larger average return is a compensation for a larger risk . This constitutes one of the central insights of modern financial economics. There are two main versions of this return-risk trade-off. In the first one, if a security’s expected price change is positive, it may just be the reward needed to attract investors to hold the asset and bear the associated risks. In the second version, profits earned by industrious investors, who are willing to work hard to gather information and to develop winning strategies, may be viewed as economic rents that accrue to those willing to engage in such activities. This entails that perfectly informationally efficient markets are an impossibility, for if markets are perfectly efficient, the return to gathering information is nil, in which case there would be little reason to trade and markets would eventually collapse . Black proposed that “noise traders”, that is individuals who trade on what they think is information but is in fact merely noise, are the providers of the rents . More generally, at any time there are always investors who trade for reasons other than accruing capital gains–for example, those with unexpected liquidity needs–and these investors are willing to “pay up” for the privilege of executing their trades immediately. In agent-based models, this competition with such “producers” and the speculative investors can be shown to provide sustainable deviations from perfect market efficiency . Recent work in behavioral finance has also made clear that, in order to understand market behaviors, one needs to recognize that humans are governed by a number of non-rational considerations, such as overconfidence, extrapolation from small samples of evidence, loss aversion (reluctance to realize losses), representativeness, mental accounting, relative reference levels and self-esteem issues (reluctance to admit an erroneous investment decision) . Professional and private investors on the stock market have not waited for these academic developments to use so-called technical indicators (see for instance  and http://www.traders.com/). A significant component of the texture of stock market prices may thus be the result of patterns generated by such behavioral biases and by self-fulfilling technical indicators.

The most striking deviations from market efficiency are arguably the speculative bubbles followed by financial crashes. The post-mortem analysis of many financial bubbles (identified as such after their demise) have shown that their development follow essentially the same route. The following scenario underlying financial bubbles and crashes has repeated itself over the centuries and in many different locations since the famous tulip bubble of 1636 in Amsterdam, almost without any alteration in its main global characteristics .

1. This first stage is characterized by positive economic indicators. The bubble starts smoothly with some increasing production and sales (or demand for some commodity), in a relatively optimistic market. Investors form positive expectations for the future and consequently buy the market, pushing it up.
2. The attraction to investments with good potential gains then leads to increasing investments, possibly with leverage coming from novel sources of funds, often from international investors who are attracted by the potential for diversification and for boosting their revenue. This leads to further price appreciation.
3. This in turn attracts less sophisticated investors. In addition, leveraging is further developed with small down payment (small margins), which lead to a demand for stock rising faster than the rate at which real money is put in the market. In this regime, foreign investors are even more attracted by the smaller margin requirements and the more flexible investment rules that are often accompanying a strong bullish market 111Not all these ingredients may be simultaneously present in a given bubble.
4. At this stage, the behavior of the market becomes weakly coupled or practically uncoupled from real wealth (industrial and service) production. It is mostly the expectation of further capital gains which continues to attract investors, hoping to sell even higher what they buy at over-valued prices. The bubble is in regime of self-fulfilling expectations.
5. As the price skyrockets, some investors start to cash in their gains and they and others question the sustainability of the process. As a consequence, the number of new investors entering the speculative market may finally lose its momentum and the market may enter a phase of larger nervousness, until a point when the instability is revealed and the market collapses by the positive feedbacks creating the selling rush.

This scenario applies essentially to all market bubbles ending in crashes, including old ones such as the many bubbles and bursts in the USA during the 19th century, the bubble in the USA in the 1920s ending in the Oct. 1929 crash (the US market was considered to be at that time an interesting “emerging” market with good investment potentialities for national as well as international investors). In the positive sentiment accompanying and being fueled by the developing bubble, explanations, appealing to rational reasoning, are offered to justify the increasing prices. The most famous one is the concept of a “new economy,” which are surfaced many times, including during the bubbles in the 1920s, during the 1960s “tronic” boom and during the recent bubble on the Internet and information technology ending in the crash of March 2000. See  for a recent survey of the macroeconomic issues that have developed as a result of the surprising economic performance of the 1990s expansion, including some sense of what is known and not known about accelerated productivity growth, the key driver of the new economy.

How can one go beyond this storytelling? A large literature has addressed the empirical detectability of bubbles (and in particular of “rational expectation bubbles”) in financial data (see  for surveys of this literature). Empirical research has largely concentrated on testing for exponential trends in the time series of asset prices and foreign exchange rates . However, it has been shown that tests for exponential roots are quite unreliable in the presence of the more realistic variant of periodically collapsing rational expectation bubbles . In fact, certain variants of bubble dynamics might look like the outcome of a stationary process . They would, therefore, fool the testing strategy recommended by Hamilton and Whiteman  of comparing the stationarity properties of both asset prices and observable fundamentals. In a nutshell, the problem is that it is hard if not impossible to distinguish an exponential explosive bubble from an exponentially growing fundamental price. The following quote from Federal Reserve Chairman A. Greenspan illustrates a now famous view : “ We, at the Federal Reserve, recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact, that is, when its bursting confirmed its existence. Moreover, it was far from obvious that bubbles, even if identified early, could be preempted short of the Central Bank inducing a substantial contraction in economic activity, the very outcome we would be seeking to avoid.”

A different line of attack has been suggested, based on an analogy with so-called critical phenomena in the statistical physics sense of critical phase transitions (see  and references therein). Two hallmarks of speculative bubbles have been documented: (i) super-exponential power law acceleration of the price towards a “critical” time $`t_c`$ corresponding to the end of the speculative bubble and (ii) log-periodic modulations accelerating according to a geometric series signaling a discrete hierarchy of time scales. Out-of-sample tests  have shown that, over many analyzed world markets in which 49 drawdown outliers were identified, the log-periodic power law (LPPL) precursors are present in 25 cases, qualifying these bubbles as endogenously generated. Restricting to the world market indices, 31 drawdown outliers have been identified of which 19 are preceded with clear LPPL precursors. Systematic non-parametric tests have also confirmed the relevance of LPPL structures for the detection of crashes or severe changes of regimes .

All these studies have been focused on financial time series taken one at a time, to test whether past market anomalies could be associated with incoming market instability. But, of course, the world is multi-dimensional and especially the financial world is multi-variate: interest rates, implied volatility, volumes, exchange rates, cross-sectional dependencies between equity and commodity time series should in principle all be integrated in a global analysis of speculative bubbles. One step in this direction was performed for the analysis the bearish market trends unraveling since the summer of 2000 , which showed that the majority of European and Western stock market indices as well as other stock indices exhibit practically the same LPPL “anti-bubble” 222An “anti-bubble” is defined as a self-reinforcing generally severely declining price trajectory with self-similar expanding log-periodic oscillations, which are the symmetric to LPPL bubbles under a time reversal. structure as found for the USA S&P500 index.

Here, we present new evidence in favor of the LPPL theory of speculative bubbles by testing quantitatively one of the predictions of the scenario $`15`$ presented above, which underlies financial bubbles and crashes. This prediction concerns the role of foreign investors in providing increasing amounts of funds, therefore driving up the stock market of the target country as the bubble develops. Many researchers have indeed stressed the impact of foreign investments in the fueling of bubbles, preparing the stage of financial instabilities and crashes . Albuquerque et al. have analyzed the unparalleled increase in foreign direct investment to emerging market economies of the last 25 years . Kim and Wei have shown that foreign investors outside Korea before and during the Korean currency crisis were more likely to engage in positive feedback trading strategies and were more likely to engage in herding than the branches/subsidiaries of foreign institutions in Korea or foreign individuals living in Korea . Foreign investors’ strategies on future and option contracts have been found to have a destabilizing role . Dahlquist and Robertsson found a strong link between foreigners’ trading and local market returns . They also found that foreigners act like non-informed feedback traders as they increase their net holding in firms that have recently performed well. On the other hand, analyzing the effects of the 1987 stock market crash on the London markets, the bursting of the Japanese stock market and real estate market bubble in 1989-1990, the short term and long term consequences of the turbulence in the European exchange rate system in 1992 and 1993, the short term and long term effects of the Mexican devaluation in 1995 for Mexico and other emerging stock markets and the developments in South-East Asia in 1994-1997, Tesar and Werner purport that, while foreign investors at times set a financial market crisis in motion (especially currency crises), they have not been the underlying cause of the crises nor have they exacerbated these crises . Dooley and Walsh survey the large literature on capital flows and discuss several possible origins of induced destabilization .

We propose to add on this literature by analyzing the relationship between the stock market in the late 1990s and the net foreign capital inflows in the USA, available from the Federal Reserve’s web site333FRED II: http://research.stlouisfed.org/fred2/. The source is the U.S. Department of Commerce, Bureau of Economic Analysis. The data correspond to the net flux of US international transactions: investments of foreigners in the US are counted positive and US investments outside are deducted. The net flux corresponds to a given quarter and is seasonally adjusted. The time evolution of the US foreign assets net capital inflow $`I(t)`$ per quarter since 1975 is shown in Fig. 1. The net inflow increased over the years, accelerating to very large values before crashing in the first quarter of 2001.

## 2 Testing for a LPPL signature in the foreign capital inflow

### 2.1 Log-periodic power law accelerating structure

We follow the methodology explained in our previous papers . Specifically, we use the generalization of the LPPL formula in terms of the truncated second-order Weierstrass-type function

$$I(t)=A+Bx^m+\mathrm{}\left(\underset{n=1}{\overset{2}{}}C_n\mathrm{e}^{i\psi _n}x^{s_n}\right),$$
(1)
where $`x=t_ct`$ with $`t_c`$ the end of the bubble and $`\mathrm{}()`$ stands for the real part. The phases $`\psi _1`$ and $`\psi _2`$ are determined from the fit to the data. The exponent $`s_n`$ is defined as $`s_n=m+in\omega `$. Its real part is the exponent $`m`$ which controls the overall power law dependence of the price trajectory. Its imaginary part $`\omega `$ is the angular log-frequency of the log-periodicity. The component $`n=2`$ allows for the existence of an harmonics.

This second-order Weierstrass-type function (1) proved to outperform our former specification in terms of a first-order LPPL function for modelling of the worldwide 2000-2002 anti-bubbles that started in mid-2000 . The special case $`C_n=C/n^{m+0.5}`$ recovers the zero-phase Weierstrass-type function, which captures well the five successive crashes within the 2000-2002 anti-bubble in the US S&P 500 index  and models well the ongoing UK real estate bubble .

We fit the seasonally adjusted quarterly net capital foreign inflow to the USA $`I(t)`$ of foreign assets (transactions over a given quarter) from 1975 to the first quarter of 2001. We use the algorithm and the fitting procedure described in . The optimization search was performed for a critical time $`t_c`$ in a wide range of $`t_{\mathrm{last}}\pm 1000`$ trading days by replacing $`t_ct`$ by $`|t_ct|`$ in fitting , where $`t_{\mathrm{last}}`$ is the date of the last point used in the fitting analysis.

Figure 2 shows the fit of the net inflow $`I(t)`$ to Eq. (1). The predicted critical time is $`t_c=2001/03/12`$, which is consistent with the real date of the inflow crash that occurred in the first quarter of 2001. Four well-developed log-periodic oscillations can be observed in Fig. 2. We can also identify their second-order harmonics, which we analyze further below. We have constrained the formula to have a non-negative exponent $`m`$, to ensure that $`I(t)`$ remains finite at $`t_c`$. With this constraint, the fit chooses the lowest $`m=0.01`$ that we allow. Slightly better but not significantly better fits are obtained by freeing $`m`$, which then adjusts to values around $`0.5`$, while $`t_c`$ is moved to 2002-2003. A negative exponent would lead to an unrealistic divergence of the flow and we thus reject this family of solution. This appears to be justified by the also unrealistic values of $`t_c`$ obtained with negative $`m`$ values. Such a small value of the exponent $`m`$ means that the power law is equivalent to a logarithmic law $`\mathrm{ln}(t_ct)`$, as proposed in . The other parameters of the fit are $`\omega =4.9`$, $`A=7355`$, $`B=6719`$, $`C_1=21.5`$ and $`C_2=16.2`$. The r.m.s. of the fit residuals is $`22.810`$. Note that the comparable amplitudes of $`C_1`$ and $`C_2`$ imply the existence of a significant second-order harmonic in the log-periodic structures of the net inflow bubble.

We test for the robustness of this fit by studying the impact of inflation on the extracted log-periodic structures. We have deflated $`I(t)`$ for inflation by the seasonally adjusted US consumer price index (CPI), also available at the database FRED II. The original monthly CPI were converted to quarterly CPI by averaging the three monthly CPIs in each relevant quarter. Figure 3 shows the time evolution of the deflated US foreign assets net capital inflow $`I(t)`$ from 1975 to the first quarter of 2001 and its fit to the second-order Weierstrass-type function (1). Again, four significant log-periodic oscillations are observed in the figure, as well as their second-harmonic oscillations, which exhibit very similar characteristics as in Fig. 2. The predicted critical time is $`t_c=2001/03/14`$, the power-law exponent is $`m=0.01`$ constrained by the positivity condition, and the angular log-frequency is $`\omega =5.0`$, which is essentially undistinguishable from the value obtained without deflating the price. The linear parameters are $`A=3963`$, $`B=3609`$, $`C_1=15.3`$ and $`C_2=12.0`$. The r.m.s. residual of the fit is 16.114. We conclude that inflation has a minor impact on the LPPL structure as both $`I(t)`$ and the deflated $`I(t)`$ exhibit the same accelerating oscillatory pattern, with the key parameters, $`\omega `$ and $`t_c`$, which are very close.

### 2.2 Robustness of the critical time $`t_c`$

The determination of $`t_c`$ is particularly important as it gives the estimated termination time of the speculative bubble as well as the most probable time for a crash or a change of regimes. Since the time evolution of a bubble is contaminated with noise and the sparseness of the data close to the critical point, it can be expected that the estimated $`t_c`$ may be quite sensitive to the length and end-point $`t_{\mathrm{last}}`$ of the time series used for its determination, as well as to the properties of the noise . In our previous studies, we often find that $`t_c`$ increases with $`t_{\mathrm{last}}`$, which makes the prediction of $`t_c`$ unreliable. When the determination of $`t_c`$ is stable, this gives in general a reliable estimation of the end of the bubble. In the present case, we find a remarkable strong robustness of the prediction of $`t_c`$ when changing $`t_{\mathrm{last}}`$ both on the un-deflated $`I(t)`$ and the deflated $`I(t)`$.

The results of the test on un-deflated $`I(t)`$ are presented in Table 1 with seven different values of $`t_{\mathrm{last}}`$. For $`t_{\mathrm{last}}`$ varying from 1999/10/01 to 2001/01/01, the six fits give almost the same solution with practically unchanging values for the seven parameters: $`t_c`$, $`m`$, $`\omega `$, $`A`$, $`B`$, $`|C_1|`$, and $`|C_2|`$. The predicted $`t_c`$ is found consistently in the first quarter of 2001. When data after 1999/07/01 are excluded ( $`t_{\mathrm{last}}`$ 1999/07/01), the solution changes suddenly, with a new family of estimated $`t_c=`$ 1999/04/27 and a much smaller value for the angular log-frequency $`\omega =1.8`$. Such low value of $`\omega `$ can be interpreted as an artificial log-frequency stemming from the most probable noise decorating a power law .

Table 1 thus shows that one could have predicted precisely the crash date of the bubble on the net foreign inflow 1.5 year before the crash happened!

Similar results for the deflated $`I(t)`$ are presented in Table 2 for eight different values of $`t_{\mathrm{last}}`$. For $`t_{\mathrm{last}}`$ varying from 1999/07/01 to 2001/01/01, the seven fits give again almost the same solution with very close values of the seven parameters. One can observe that the values of $`t_c`$ and $`\omega `$ for the deflated $`I(t)`$ in Table 2 are almost the same as for the un-deflated $`I(t)`$ in Table 1. Notice, however, the predicted $`t_c`$ using the un-deflated $`I(t)`$ are closer to the actual time of the crash (in the foreign capital inflow), compared with those using the deflated $`I(t)`$. This suggests that the un-deflated $`I(t)`$ is a better measure for the bubble as herding investors are more sensitive to the actual price than their deflated value. The difference in values of the linear parameters $`A`$, $`B`$, $`|C_1|`$ and $`|C_2|`$ in Table 2 and in Table 1 simply reflect an affine transformation between the two fitted second-order Weierstrass-type functions. For $`t_{\mathrm{last}}=1999/04/01`$ and for smaller values, the solution branches to another family with incorrect critical times $`t_c`$. These results show a rather amazing prediction power of (1) with respect to the determination of the critical time.

Additional tests on the goodness of the fits and on a non-parametric analysis of the log-periodicity are offered in the Appendix. In particular, we identify a rather strong periodicity in the residuals with a period of exactly one year. Since the formula (1) is describing a scale invariance pattern unfolding as a function of the time $`t_ct`$ towards a critical time, regular periodicities are just additional structures, not relevant here. Our non-parametric analysis of the log-periodicity gives a strong confirmation to our parametric fit (1) and shows that even higher harmonics of the fundamental angular log-periodic frequency $`\omega _15`$ are present in the data. The possible importance of harmonics in order to qualify log-periodicity is made also more credible by recent analyses of log-periodicity in hydrodynamic turbulence data  which have demonstrated the important role of higher harmonics in the detection of log-periodicity.

### 2.3 Comparison between the LPPL patterns in the NASDAQ 100 index and the foreign capital inflow

From the all-time high on the NASDAQ 100 Composite index of 5133 on March 10, 2000 to the low at 3321 on April 14, 2000, the NASDAQ 100 lost over 35%. Johansen and Sornette have shown  that this crash was preceded by a speculative bubble passing all LPPL tests, as defined in Refs. . The analogy with the infamous crash of October 1929 was found to be striking: the belief in what was coined a “New Economy” both in 1929 and in the late 1990s made share-prices of companies with three digits price-earning ratios soar.

Table 3 presents a test of the robustness of the fits with the second-order approximation of the Weierstrass-type function (1) of the NASDAQ 100 index, obtained by varying the time interval of the analysis. We vary the start time of the window of analysis, keeping the ending time fixed at the date of March 10, 2000 (the date the all-time high was reached), as in . The fits and predictions of $`t_c`$ are very robust with respect to $`t_{\mathrm{first}}`$, confirming the conclusions obtained previously .

In view of the joint detection of LPPL patterns in the NASDAQ 100 Composite index and in the net foreign capital inflow to the USA, it is natural to ask whether the two are in any way related. If we compare the three key parameters $`m,\omega `$ and $`t_c`$, we find respectively: $`m=0.010.18,\omega =7.0\pm 1`$ and $`t_c=`$ May 2000 for the NASDAQ 100 index and $`m=0.01,\omega =5.0`$ and $`t_c=`$ March 2001 for the foreign capital inflow. A smaller exponent $`m`$ implies a slower initial acceleration finishing more abruptly close to $`t_c`$, hence suggests that the foreign capital inflow was lagging behind the NASDAQ 100 index with respect to the unfolding of the speculative bubble. The later date for $`t_c`$ found for the foreign capital inflow suggests a confirmation of this lag.

In order to attempt to capture further the existence of a possible synchronization between the two time series, we compare the pure log-periodic structures within the two time series. For this, we construct the log-periodic residues defined by $`[I(t)AB(t_ct)^m]/(t_ct)^m`$ for the two time series, in order to extract what should be pure log-periodic oscillations (if no other pattern and noise were present). We then standardized these residues to have unit variance, which provides us with the standardized residues $`R_{Nasdaq}(t)`$ and $`R_I(t)`$. Fig. 4 shows $`R_{Nasdaq}(t)`$ and $`R_I(t)`$, plotted as a function of their respective $`\mathrm{ln}(t_ct)`$ (recall that the two time series have different critical times $`t_c`$). The thick (resp. thin) line and upper (resp. lower) horizontal scale correspond to the NASDAQ 100 index (resp. foreign capital inflow). We note that the last two log-periodic oscillations in the two time series before the crash seem to exhibit a synchronization, when taking into account a log-periodic lag. Indeed, the local peak in early 1999 in the NASDAQ 100 index residue $`R_{Nasdaq}(t)`$ corresponds approximately to the local peak in the foreign capital inflow residue $`R_I(t)`$ in early 2000. Similarly, the local peak in early 2000 in the NASDAQ 100 index residue $`R_{Nasdaq}(t)`$ corresponds to the local peak in the foreign capital inflow residue $`R_I(t)`$ in mid 2001. Notice the two logarithmic scales in terms of their respective $`\mathrm{ln}(t_ct)`$ with different critical times $`t_c`$ for each time series. This synchronization with a log-periodic lag suggests that the foreign capital inflow has been following a LPPL trajectory similar to that of the NASDAQ 100 index, indicating a speculative bubble. However, this signal on the foreign capital inflow has been lagging in a self-similar way behind the NASDAQ 100 index bubble. The reference to a log-periodic lag stresses that this lag was not constant in time but has been shrinking as the bubble approached its termination. The synchronization is however only approximate as the angular log-frequencies are different, indicating a transient effect present only at the end of the bubble. The fact that parallel log-periodicities can culminate at different critical times is made possible by the extended description in terms of a hierarchy of singularities offered by the quasi-Weierstrass functions .

## 3 “Egg-and-Chicken” source of the NASDAQ 100 bubble and of the net capital foreign inflow bubble to the USA

The evidence presented in the previous section suggests that foreign investors have been attracted by the capital gains offered by the bubble on the US stock market. They have followed the bubble rather than having been at its origin. The synchronization of the log-periodic patterns of the NASDAQ 100 index and of the foreign capital inflow however indicates that the foreign capital inflow may have amplified the bubble, in line with the standard scenario $`15`$ of a bubble described in the introduction.

We now attempt to elaborate a bigger picture embodying what could be the major elements linking foreign capital inflows and the stock market bubble. We also try to understand the positive feedbacks between the two processes and how they may be linked with other macroeconomic processes.

We start from the premise that the main mechanism behind the development of speculative bubbles is the strengthening of herding and over-confidence among investors, providing positive feedback which further enhances the expectation of future capital gains . In the case of the internet and information bubble that ended in 2000, the flowchart shown in Fig. 5 summarizes the main processes involved and illustrate the cause and effects of the foreign capital inflow.

* Box 1 in Fig. 5: It is a well-documented fact that the private disposable income over expenditure has gone from its long-term average surplus of about 3% GDP per year in the early 1990s to a deficit approaching 6% GDP in 2000 . By “private”, we refer to the aggregate of households and corporation.
* By accounting balance, the surplus of private disposable income over expenditure is equal to the government balance (written as deficit) plus the current balance of payment (income from exports minus expenditure to pay for imports): Private surplus $`=`$ Government deficit $`+`$ balance of payment.
* Boxes 2 and 3 in Fig. 5: By (ii), the large private deficit has fostered a growing deficit of the balance of payment and a diminishing deficit of the Government turning to surplus in 2000. The larger spending of the private sector has profited to foreign manufacturers who have been increasingly successful in invading U.S. markets. The strengthening of the US dollar has also helped foreigners exports to the US. The growing deficit of the balance of payment has also resulted from the increased outsourcing of intermediate products.
* Box 4 in Fig. 5: The annual deficit of the balance of payment has been growing and reached $500 billion (2% GDP). This deficit corresponds mechanically to a surplus for foreign exporting nations, which have accumulated trillions of dollars in reserves since the early 1970s. In 2001, the United States’ net debt to the rest of the world jumped to $2.3 trillion (this amounts to about 25% of GDP), a level double that recorded in 1999 . Much of the increase reflects new borrowing undertaken by the country to finance its mounting current account deficit. A third of the change, however, could result from a simple accounting effect, the impact of a rising dollar on the decreasing value of U.S. assets held abroad.
* Box 5 in Fig. 5: To avoid pushing up their own currencies in order to keep their competitive hedge and because of the large interest rates enjoyed until 2000 on US treasury bonds, foreign central banks reinvested a significant part of their reserve denominated in US$ back in the US, leading to a large inflow of capital (see Figs.1 and 2). Thus, the spent US$ fueling the deficit of the balance of payment have been coming back as a boomerang in the form of investments by foreign countries .
* Boxes 6 and 7 in Fig. 5: However, due to the decreasing deficit of the Federal government, a decreasing quantify of treasury bonds are been issued, letting the stock and real-estate markets (Fannie Mae, corporate bonds, NASDAQ 100) as the main siphoning tanks of the foreign capital inflows.
* Boxes 1 and 8 in Fig. 5: This inflow of foreign capital together with an exhuberant herding mood on the part of investors  has fueled the bubble in the later part of the 1990s.
* Boxes 9 and 1 in Fig. 5: As a result of the impressive appreciation of the stock market, investors and households have felt richer, spending and consuming wantonly, further fueling the bubble by the feedback of this spending on economic activity, leading to a positive feedback amplification. This is the so-called wealth effect such that an increase in wealth directly causes households to increase their consumption and decrease their saving (see for instance  and references therein).

This implies that the 1990s expansion was powered in large part by a large increase in net spending by the private sector, which itself was fueled by the exhuberance and optimism resulting from the feedback of the growing stock market via the wealth effect on spending. This also suggests a mechanism for the observed synchronization of the foreign capital inflow documented in this paper and the stock market LPPL pattern. First, the LPPL pattern of the foreign capital inflow documented here shows that foreign investors were following a herding behavior similar to that of national investors. Second, the feedback loops between market-appreciation / increased-spending / increased-deficit-of-balance-of-payment / larger-foreign-surplus / increased-foreign-capital-inflows rationalize our finding in Fig. 4 of a synchronization of the LPPL pattern taken as the qualifying signature of a speculative herding bubble.

Another interesting question is the following (we are indebted to J. Spanos for these remarks): why did it take so long (well into 2001) for the foreign capital to stop flowing into the US, while the US markets have crashed almost a year earlier? It seems that foreigners did not acknowledge the coming bear market in stocks until it was well under way. This implies that the foreigners did not cause the crash of the stock market. Their actions simply confirmed it after the fact, with a considerable lag. This confirmation came well before the 2001 attacks on the world trade center on 911. This is a strong evidence in proving that the attacks had nothing to do with the bear market which was already on its way and confirmed by foreign inflows. We also note that both the NASDAQ crash time and the foreign inflows crash time could have been forecasted as early as 1999.

## 4 Implications for the following years

Let us examine the implications of our findings and reasoning for the next years.

Two main variables have changed since 2000, when compared with the situation in the late 1990s described in the previous section 3.

First, the stock markets have declined substantially since their all-time highs in the first quarter of 2000. The NASDAQ 100 has lost close to 75% of its value at its dip in October 2002, and remains at a loss of close to 70% at the time of writing. The S&P500 has lost about 47% at its dip in October 2002 and remains negative by about 35%. The Dow Jones Industrial Average lost about 38% at its minimum in October 2002 and remains off by about 23%. The wealth effect has thus vanished.

Second, the Federal budget surplus of the last years of the 1990s has transformed again into a growing deficit. The private sector spending fury has abated but the private disposable income over expenditure remains in deficit and several percent of GDP below its long term average . A radical change of attitude to budget deficits has also occurred, which suddenly became respectable as a way to fight fears of recession . In addition, after 911, private spending of households were encouraged at the highest level of the executive hierarchy as being patriotic.

Our own analysis for the period from 2000 to 2002 strongly suggest that the US stock markets has declined as a consequence of another herding process characteristic of bearish “anti-bubbles” .

The overheating of the speculative bubble led to a crash on the NASDAQ 100 in March-April 2000. As a consequence of vanishing of the wealth effect and of the self-reinforcing negative sentiments, the stock markets have gone down. As a result of the increasing Federal budget deficit, foreign capital have flowed again to buy the debts issued by the treasury, disrupting a part of the flow that was previously directed to the stock markets. As Fig. 1 and our analysis show, the crash on the foreign capital inflow coincide with the transition from surplus to deficit in the Federal budget.

There are several drastically different scenarios, proposed by various analysts and commentators, for the future evolution of the stock market and of the economy. Standard measures of valuations suggest that the market has not yet bottomed as it still appears significantly over-valued; currently, the price-to-earnings ratio is over 34, the dividend yield is 1.74%, and the price-to-book value is over three times. Compare this to the bottom in 1982, for which the price-to-earnings ratio of the S&P 500 was 7, the dividend yield was 6.3%, and the index was selling at book value.

However, there are strong forces willing to push up the confidence of investors, to foster the economy and by the same token the stock market, since the later is a confidence/sentiment thermometer. A first force is the increase in money supply. Since early 2001, the money supply M1, which is basically cash and checking accounts, has been rising at a 30% annual rate, with a deceleration in 2002 and then resuming an acceleration in the first part of 2003, as seen in Fig. 6. The size and growth of money supply is influenced (controlled?) by the Federal Reserve System through its direct control over the reserves of member banks, the discount rate and through open market operations. This increasing money supply, which is supposed to foster economic development, also finds its way in the stock market, because companies are not spending the money to boost capacity, as some industries like semiconductors are working at only 65% capacity utilization, and the overall capacity utilization rates are around 75% (compared to +90% in the late 1990s). Companies are also using this cheap money to re-leverage their balance sheets, similar to consumers switching their credit card debts to different cards with lower rates.

A second force is found in the behavior of foreign capital inflows. With the growing availability of treasury debts, the enormous surplus of foreign central banks have found again a natural depository, which avoids the risk of inflating their own currency. However, the interests paid have now plummeted from above 6% to slightly above 1% per year. The bonds are attractive only on the basis of a speculative capital appreciation, no more by the paid interests. Therefore, naturally, foreign capital is attracted to the US stock markets. And here comes into play a confidence and herding game. Notwithstanding the stock market over-value, foreign capital (as well as national investors) would like to see the stock market re-appreciate since they have not many other choices to invest their surplus dollars. There is thus a growing availability of capital to hold prices from falling, at least for a while.

This may constitute a part of the explanation for the appreciation of the US stock market since the uncertainties with the war with Iraq in March 2003 fadded out. Will this continue? At this stage, since we view investors confidence and herding as an important and integral part of the self-organization of stock markets and of the economy, it is interesting to dwell more on quantitative measures of confidence. So-called market sentiment ratings are obtained through polls where responses are bullish, bearish or neutral on the market, which are regularly available . During the entire time when the NASDAQ 100 dropped by more than 75% since March 2000, there was not one weekly reading showing more bears than bulls. It took the greatest terrorist act in U.S. history to finally register a week during which there were more bears than bulls, for the first time in 153 weeks. The plurality of bears over bulls was minuscule considering the magnitude of the events. The 911 catastrophe could only produce three consecutive weeks where bears outnumbered bulls, after which the bulls dominated the sentiment readings again. The study reported in Barron’s study on May 5th, 2003 gave the following categories and responses: Very Bullish (9%); Bullish (51.1%); Neutral (28.6%); Bearish (10.5%); and Very Bearish (0.8%). This is not the type of sentiment (60.1% bulls versus 11.3% bears) after three years of a nasty bear market! This overwhelming reading, already impressive in a bull market, is unheard of for a bear market.

Our reading of this surprising pervasive bullish sentiment is that it confirms that the private and foreign investors want the market to go up, but that there is so much uncertainty that “wishing” is different from “acting,” that is, investing. Investors are waiting for signs of confirmation of their bullish sentiment to drive the price up. They have already be burned severely by the crash in 2000 and the two years that followed. In particular, foreign investors have strong incentive to buy the US stock market as well as corporate bonds and the debts in US real estate market  in order to get a return on their surplus dollars above the ridiculous discount rate offered on treasury bonds. But such action would be warranted only if the market risk is not too high, hence the conflicted observations of a strong bullish sentiment in a depreciating stock market. The contradictory conclusions on the economic outlook and these polls suggest that the natural herding behavior of investors will be even more predominant in the future and lead to highly volatile and unstable market behavior in the near future.

As the US stock market and economy were heating up in the late 1990s, the higher interest rates and stronger dollar were the natural instruments to attempt to avoid inflation and to try to stabilize growth but also resulted from the economic and stock market growth . Actually, as we explained above, both led to the rather perverse effect of fueling further the bubble by (1) increasing the deficit of the balance of payment through the deterioration of competitiveness accompanying a strong dollar and (2) by the attractiveness of investing in the US for foreign capital in part obtained through the surplus of foreign countries on their balance of payment.

Now, the situation is different. The economy has been flirting with stagnation and depression several times in the last two years and the stock markets have been falling down; hence, the massive cuts in interest rates. Since May 2002, the strong dollar has been steadily losing ground against the major currencies, with an acceleration of this loss since November 2002, showing a cumulative loss of about 28%. As a consequence, investments in the US by foreigners is becoming less attractive due to the increasing exchange risk and the lowest interest payment.

Weighting these different ingredients, our prefered scenario for the future is the following.

* The private sector will continue spending more than its long-term average, as it is psychologically difficult to abandon habit acquired in good times (the glorious 1990s) and it is in addition almost considered as a patriotic act.
* The debt of the Federal Government as well as the private, municipal, corporate and local government debts will continue to rise, reinforcing further the US as the major deficit nation.
* As a consequence, interests will remain low to allow servicing of the payment of the interests of the debts, both of private sector and the government. This will continue to have the effect of further fueling the growth of liquidity by the mechanism of fostering loans refinancing on lower interest rates (mostly from residential real estate)

This consequence will also continue to be a source of the two first bullets, acting as a positive feedback loop. The central bank of the US is now compelled to peg short-term interest rates, promise to forewarn the marketplace of any intention to adjust the peg. and to guarantee continuous marketplace liquidity. Federal Reserve operations will continue to work by aggressively manipulating rates, yield spreads (by repurchasing long-term debts) and, increasingly, market perceptions to ensure these goals. This is further reinforced by the perception that the proposed tax cuts and current low interest rate environment will further increase liquidity and turn the US economy around which will power the stock market even further ahead.
* The dollar will continue its descent as a mechanism to fight against the deficit of the current balance by boosting exports (which translate into cheaper imports for foreigners). A decrease of the dollar also provides a mechanical device to decrease the absolute value of the debt. This will accentuate the incentive for foreign central banks to sell progressively their dollars, but they cannot do it too fast to avoid losing the competitiveness of their currencies. There is thus a subtle balance between the economic competition giving rise to surplus in dollars, the corresponding importance of not having a strong currency and the present lack of attractiveness of the dollar. We thus envision a slow sell out of the US dollar, but only on a limited scale since the world is overflowed by dollars, which has replaced gold at the international reserve currency, since the breakdown of Bretton Woods (about 80% of the world’s free capital is invested in dollars, even though the US makes up only about 30% of the world’s economy).
* In view of these negative factors, foreign capital will be less attracted to the stock market.

From the point of view of detecting large scale cooperative behavior, Fig. 7 presents a long term view of the evolution of the US market proxied by the DJIA and its extrapolation in the past as explained in . The continuous line shows the fit with our LPPL formula, a second-order Landau expansion described in , which is an extension of the formula (1) to describe such long time intervals. Fig. 8 shows the residual or difference between the realized DJIA and the fitted formula. The previous value of the residuals and the characteristic time scales before recovery suggest that one may wait for a year or two before the stock market recovers its long-term trend. This appears to be in line with the prediction that the US stock market will bottom during or at the end of the first semester of 2004, according to our previous analysis of the LPPL anti-bubble which started in 2000 .

The residuals plotted in Figure 8 show that the current bear market has been almost as severe as all other bear markets since 1950 but far less severe than the 1932 bear market. One scenario is that the market may have in fact bottomed out in October of 2002. However, if this is a deflationary bear market as the US was in 1932, then a huge decline is still ahead. The interest rate data so far point to a “deflationary” environment but this is far from conclusive as the Federal Reserve is currently waging war with deflation and is prepared to drive short term rates to zero to avoid this scenario. But doing so, it is fueling the credit bubble to unprecedented levels, developing another dimension of instability.

A very interesting additional information is provided by the behavior of the main currencies against the US dollar. We have found unmistakable LPPL signatures of a speculative bubble which is presently developing on the EURO. Specifically, Figure 9 shows the EURO in US$ and a typical accelerating LPPL bubble pattern, which is suggestive of a speculative herding buying of EURO’s using US$. Figure 10 shows the EURO in Yen and again a significant accelerating LPPL pattern. In contrast, the Yen in US$ does not have any acceleration (nor has the US$ in Yen), even if a marginally significant log-periodicity may be observed, as shown in Figure 11. These three figures provide a remarkable message: the depreciation of the US$ is not just the undirected flight-for-safety of a herd fleeing from a looming catastrophe; it seems to be associated with a speculative bubble directed to what is felt (at least on the short- and medium-term) to be the new haven currency, the EURO.

## 5 Conclusion

Our main conclusions are the following.

1. The “sacrifice” of the US$ and the stock market is the cost for a lower sustainable debt burden on the global US debt structure and for allowing the slow rebuilding of an internationally competitive economy. This is reinforced by the evidence for a speculative bubble developing on the EURO. We thus envision a continuation of the depreciation of the US$ that may reach unprecedented low levels.
2. On the medium term, the stock market is not going to recover a strong bullish trend as the growing Federal deficit is consuming a large part of the foreign surplus dollars and the stock market is remaining a very risky and unattractive investment. In addition, the huge credit bubble, that the US has developed in the last decade and is increasingly fueled in the hope “to avoid deflation,” may be expected to burst and have severe consequences for the recovery of the economy.
3. On the short term, the stock market may hold for a while as one of the main sink of a strong surge of liquidity and of the credit bubble, justified in the mind of investors by their sentiment and hopes.

The US has been growing as the major deficit nation in the world, attracting huge amounts of foreign capital. In parallel, it is also growing steadily by immigration, powered by a variety of factors. Studying the relationship between immigration and capital flows, Groznik has shown that, surprisingly, labor not only moves in the same direction as capital, but it also leads capital . This finding is also found for various countries, periods and migration flow specifications. Thus, an important predictive variable for international capital flows is immigration flows. One strength of the USA has been its ability to attract people and capital. To what degree this inflow will continue to justify its unsustainable deficits (at all levels) is linked with its potential for development of new riches and remain to be seen.

Acknowledgments

We are grateful to Gary Dostourian who has attracted our attention to the foreign capital inflows, and to Didier Darcet, Garrett Jones, David Nichols and John T. Spanos for stimulating discussions. This work was supported in part by the James S. Mc Donnell Foundation 21st century scientist award/studying complex system.

## 6 Appendix: goodness of fit and non-parametric analysis of log-periodicity

### 6.1 Testing the goodness of the fits

We present two tests assessing the goodness-of-fit of the seasonally adjusted quarterly US net capital inflow $`I(t)`$ of foreign assets with formula (1). They are based on the analysis of the fit residuals with the autocorrelation method  and the sign test . Based on a rigorous mathematical proof , these two tests are complementary in their detection of possible remaining patterns in the residuals. The autocorrelation method is often considered to provide an estimate of the model error. The sign test is based on an intuition that the changes of sign of the residuals should be random for a good fit.

Assume that $`\{y_i:i=1,\mathrm{},n\}`$ are $`n`$ observations of the true values $`\varphi _i`$ at $`n`$ evenly spaced successive times $`t_i`$ and $`f(t;\mathrm{\Theta })`$ is a proposed model with $`p`$ parameters $`\mathrm{\Theta }`$. If $`\widehat{\mathrm{\Theta }}`$ is an estimate of $`\mathrm{\Theta }`$, then the residuals of the fit are

$$e_i=y_if(t_i;\widehat{\mathrm{\Theta }}).$$
(2)
The one-lag covariance of the residuals is then defined

$$a=\frac{1}{n1}\underset{i=1}{\overset{n1}{}}e_i\times e_{i+1},$$
(3)
where the mean of $`e_i`$ is zero (this has been verified to be true in our residuals with extremely good accuracy $`10^{11}`$). The unbiased estimate of the variance of the residuals is computed as

$$s^2=\frac{1}{np}\underset{i=1}{\overset{n}{}}e_i^2.$$
(4)
By assuming that (1) the fit is made using least-squares, (2) the measurement errors $`ϵ_i=y_i\varphi _i`$ are centered random variables with the same variance, and (3) the data are uncorrelated, one can deduce the first order estimates for the model error $`\sigma _\delta `$ or model bias, defined as the standard deviation of $`\varphi _if(t_i;\widehat{\mathrm{\Theta }})`$, and the measurement error $`\sigma `$, defined as the standard deviation of $`ϵ_i`$:

$$\begin{array}{ccc}\sigma ^2\hfill & \hfill & \mathrm{Var}[y_i\varphi _i](1\frac{p}{n})s^2a,\hfill \\ \sigma _\delta ^2\hfill & \hfill & \mathrm{Var}[\varphi _if(t_i;\widehat{\mathrm{\Theta }})]\frac{p}{n}s^2+(1\frac{p}{n})a.\hfill \end{array}$$
(5)
For $`p/n=0`$, Eq. (5) recovers the standard zero order estimations. The key statistics of the sign test is the frequency $`f`$ of changes of signs of the residuals $`e(t_i)`$ given by

$$f\frac{1}{2}\frac{a}{\pi s^2}.$$
(6)
The residuals of our fit are shown in Fig. 12. We have $`p=5`$ free parameters since the four linear parameters are slaved . We find $`a=86`$ and $`s^2=546`$, which gives a one-lag correlation coefficient $`a/s^2=0.16`$. This yields $`\sigma ^2=602`$, $`\sigma _\delta ^2=56`$. The negative value of $`\sigma _\delta ^2`$ reflects some anti-persistence in the residuals. The frequency of changes of signs given by (6) is $`f=0.550`$, which is not too far from the value $`0.5`$ for completely random residuals. We cannot however negate the existence of a significant residual structure, whose prominent characteristic is a strong yearly periodicity, as shown from the spectrum of the residuals presented Fig. 13.

### 6.2 Generalized $`q`$-analysis of the log-periodic structure

We check the the significance level of the extracted log-periodic pattern using a non-parametric analysis, called the $`(H,q)`$-analysis which we have already explained and used in our previous works . It consists in a generalization of the $`q`$-analysis . The $`(H,q)`$-derivative is defined by the following formula

$$D_q^Hf(x)\stackrel{\mathrm{}}{=}\frac{f(x)f(qx)}{(xqx)^H},$$
(7)
such that $`D_q^{H=1}f(x)`$ recovers the standard $`q`$-derivative $`D_qf(x)`$. For a power law function $`f(x)=Bx^m`$, $`D_q^{H=m}[Bx^m]=B(1q^m)/(1q)^m`$ is constant. In a nutshell, the $`(H,q)`$-analysis performs a kind of fractal derivative which is particularly sensitive to the presence of log-periodicity. The index $`q`$ refers to the discrete scaling ratio used in the definition of the fractal $`q`$-derivative and $`H`$ is an exponent used to rescale the $`q`$-derivative. Scanning $`q`$ and $`H`$ provides an important test of the robustness of the log-periodic structure. A Lomb periodogram analysis  of the $`(H,q)`$-derivative allows one to detect the presence of log-periodicity and assess its significance level.

The analysis was performed on a $`19\times 19`$ grid with $`H`$ ranging from $`0.9`$ to $`0.9`$ evenly and $`q`$ varying from $`0.05`$ to $`0.95`$ evenly. Each node $`(i,j)`$ in the grid corresponds to a pair $`(H(i),q(j))`$, which is converted to a single number through the one-to-one map: $`(i,j)19\times (i1)+j`$. Figure 14 uses this number as the abscissa to show the corresponding angular log-frequency $`\omega `$ of the most significant Lomb peak in each Lomb periodogram for each of the scanned $`(H,q)`$ pairs of the $`(H,q)`$-derivative of the net foreign capital inflow $`I(t)`$ into the USA. Each cross corresponds to a pair of $`(H,q)`$.

The majority of the $`\omega `$’s cluster around $`\omega _1=5`$, which is consistent with the fundamental log-frequency extracted from the fit with equation (1). Furthermore, one can observe clusters of $`\omega `$’s at integer multiples $`\omega _2=10`$ and $`\omega _3=15`$ of this fundamental angular log-frequency. Some higher-order multiples $`\omega _525`$, $`\omega _735`$ and $`\omega _{10}50`$ (not shown) are also clearly visible. The deviations from the exact integer multiples are mostly due to small $`q`$’s which are most sensitive to finite-size effects.

The $`(H,q)`$-analysis confirms the presence of a very significant log-periodic structure in the bubble of the US net capital inflow of foreign assets.