What went wrong. An anthropologist’s point of view.

Here is the communication I made on March 3rd to the Socialist members of the European Parliament in Brussels as my contribution to the one-day conference entitled “Closing the casino: building a fairer and stronger real economy”

Modern societies of European origin were historically built according to a tripartite structure composed of warriors-raiders, priests and commoners. By the time the new concept of democracy emerged, the land and the wealth buried in it had already been distributed by the warriors-raiders between themselves. Inheritance of property had contributed at strengthening this pattern. Bourgeois revolutions of the eighteen century condoned the addition of the power of money to that of strength only. From then on cash buttressed the power balance that the sword had first put into place. In the twentieth century, colonialism and paradoxically communism, ensured the full globalization of that order of European origin. Current appeals for “leveling the playing field” ignore the lack of evidence that the field was ever level.

Stock options: the holy alliance between investors and company executives

In an infamous quote that Ben Stein had him concede for the New York Times, investor extraordinaire Warren Buffet stated: “There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.” This statement marked the return in common parlance of an outmoded way of speaking. Indeed, with the rise of the Chicago School, the phrase “class warfare” got tabooed and the words “capitalists” (aka “investors”), “bosses” (aka “company executives”) and “workers” (“employees”, “associates”, “team members”, etc.) removed from the economic literature and replaced by the catch-all notion of “monetary mass” as part of a more general process where “physical forces” replaced “people” in explanations of the economy. That didn’t mean though that class warfare was over or had never taken place. The decisive and final move came in the late 1970s when McKinsey devised “stock options” by which the “interests of investors and company executives would henceforth be aligned.” The plan succeeded beyond both parties’ wildest dreams.

The distribution of wealth: what happened to it

Prior to stock options, wage-earners were part of a triangular power game where investors and executives kept each other at bay. With the introduction of stock options, those days were over: a holy alliance was born to which wage-earners were no match. Predictably, their piece of the pie dwindled down. Any attempt they would make to increase their share would be brutally countered by central banks concerned with monetary masses and raising interest rates – that is: raising unemployment – forcing wage-earners to pipe down.

With lower revenues, wage-earners were led to ever borrow more. Commercial banks graciously obliged. Meanwhile, companies had got in the habit of borrowing rather than reinvesting so that by now any money that anyone needed was borrowed. Interest payments were mushrooming, becoming a burdensome component of every price. “Capital” – being money you don’t have but still need – kept concentrating in fewer and deepening pockets. The more capital is concentrated the less likely it is though that it happens to be where it is actually needed.

Speculation: the ascent of the Speculative Society

What do you do then when you don’t have the money you need and you know that working harder won’t make much of a difference ? You buy a lottery ticket. By the end of the twentieth century everyone had come to that same conclusion and “bubbles” and growth had become synonymous notions.

You buy stock but not for dividends which are boringly your share in the surplus the company has made through the stock you purchased, no: you buy stock for capital gains. To insure that this happens the stock exchange needs to be turned into a casino. The price of Total or BP stock needs to change every five seconds. Not that there is anything in the business of Total or BP justifying that the price of its stock changes every five seconds or for that matter even every five days. But it is needed for the stock market to be run as a casino where huge capital gains may materialize. When the scheme stops working, it crashes, which happens indeed every eighty years or so.

Hunger riots stirred by museums and hospitals

If only people who have wheat to deliver or to take delivery of were trading wheat the price of that cereal would be determined by how much of it gets produced and how much is needed: what is commonly called supply and demand. But this is not how things work nowadays: the price of wheat gets determined by bets made by big institutional investors such as pension funds, university endowments, hospitals and museums. A reasonable social expectation is that they would focus on offering pensioners annuities, teaching pupils, curing patients or displaying art, but they are not: they are heavily busy pushing the price of wheat up or down with the goal of protecting their assets and no concern whether anybody would live or die as a consequence of their speculation.

Spot and futures markets allow those exposed to an actual risk (due to the weather, the economic environment, etc.) to cover their positions, hence reducing overall risk. Speculative “naked” positions on the contrary artificially create risk where there was none. Coverage provides an insurance while “naked” positions are risk-generating bets. Insurance protects the economy while bets kill it and measures should be taken accordingly. The means for banning betting on the fluctuation of prices are simple: they are spelled out in FASB 133, a rule issued by the American Financial Association Standards Board that establishes a fiscal differential treatment for coverage and naked positions. FASB 133 should be upgraded to a badly needed and clear-cut prohibition.

Recommendations

1. Break the unholy alliance between investors and company executives: the social fabric is being damaged as we speak. Ban stock options.

2. Free central bankers from monetarism: societies are not made of monetary masses but of people. Central banks have a more crucial role to play than systematically siding with investors and company executives against wage-earners.

3. Apply urgently appropriate fiscal policy so that the chances increase that capital happens to be where it is actually needed.

4. Close down the casino: stop continuous pricing on the spot and future markets.

5. Bar speculators from commodities’ markets: bar “non-commercials.” Let them focus on what they do best: teach pupils, cure patients and display art for the enjoyment and education of the public.

6. Encourage insurance but ban bets on the fluctuation of prices.

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6 thoughts on “What went wrong. An anthropologist’s point of view.”

  1. Boom and bust cycles, wages amputated by hyperinflation, inflation as a hidden tax. These need to repudiated before claiming that central bankers need to be freed from monetarism. Moreover, A widely circulated idea is that a lax monetary policy has, in fact, contributed to the real estate bubble, amongst many causes.

  2. Interesting article and original proposals, though look dangerous in hands of European socialists or even Obama.
    Narrowing down on 4. Not sure whether in any financial market regulators have ever purposedly placed restrictions on continuous time trading, it may exist and make sense in some very illiquid exchanges where stocks trade only a couple of times per month (Eg. some Central American ones).
    It is difficult to conceive why banning continuous trading would necessarily make it unattractive to place bets on stock prices. If prices of a security, futures contract or commodity for which great demand exists (or on the opposite which many market participants are desperate to sell) are alowed to reset say only once a week, the resetting moment itself might become a special event that attracts a lot of speculators (like a highly publicized auction). Bookmakers may start offering the possibility to place off-market bets before the stock price reset date (fostering a thriving over the counter market). The “casino” would move from the exchange to the street corner, the internet and depending on the transferability to other countries that do not want to make it illegal to sell a security at any time during market hours.
    The idea reminds me to restrictions on continuous price changes of consumer goods and State price controls that have existed in the Communsits states and in the ’70s and ’80s in some Latin American countries that were attempting to stabilize inflation (so-called “tablitas”). In the former price controls contributed to black markets and scarcity (and in some way to the implosion of the system), in the latter the price tables propelled the economies from high inflation into hyperiflation, benefitting the speculators and hoarders and pushing large numbers of people well below poverty line.
    It appears even DPRK’s notorious repression cannot enforce totally price controls, so brutal state force would not be an option to enforce official quotes. Perhaps less sanguine would be to take away all Bloomberg and Reuters terminals out of the speculators’ dealing rooms and nationalize all media, banning continuous time news. By taking away continuous news flow there would be less justification for continuous time trading. News would only be released at defined periodicity by the state news agency. Not entirely as news spreads also by means of hear say, informal networks, internet blogs and even animals (the famous Rothshild pigeon brought the news of Napoleon’s Waterloo defeat and contributed to make great profits in the bond market). Nationalizing media, taking financial blogs out of the air and putting constraints on pigeon ownership and bongos might still not be enough. There are still market participants who place buy / sell orders merely based on observed price patterns, impulses and even astrology. In Japan there used to be even a stone toad which at midnight professed stock market predictions to senior bank officials.

    Though in the aftermath of latest bubble it sounds plain stupid to talk of self-stabilizing market mechanisms, i think there is a chance that large stock markets will become less volatile in the near future and less prone to new bubbles. Nowadays in large exchanges a substantial and increasing portion of trading is conducted with help of algorithms and software that allows high frequency trading. There is a high entry barrier to develop such systems and hire the people who can manage them. Such systems have in the past contributed to volatility (Eg. program trading in the crash of ’87, large quant fund losses in 2007) though as a result of the learning curve are becoming much better calibrated than they used to be and in some cases even designed to take early advantadge of bubbles. As a result a handful of professional market participants (hedge funds, some investment banks) appear to be building a substantial advantadge to other market participants who have been traditionally active in speculation (Eg. day trading, margin trading, naked short selling & option writing). Traditional speculators include thousands of less sophisticated financial institutions with equity trading desks (even large commercial banks are sometimes way behind), less sophisticated investment funds and amateur investment clubs, the often cited Japanese housewives and Korean households who used to be quite active day traders in curency and stock & option markets. To the extent that it becomes increasingly a sucker’s game to try to beat the so-called professionals less market participants would remain prepared to place bets. Commercial lenders scaling down equity trading, invesment funds shifting to index tracking and buy & hold investment strategies. At that stage the market would even bear some similarities casinos, in which the house has nearly perfect control of the odds of paying out money to the gamblers. It would never become a genuine casino as securities markets remain subject to highly unexpected events that do not favor the professionals. The appetite for day trading among less sophisticated investors reaches a limit, professionals continue for a while among themselves and finally as profits dry up start focussing on their other money making activities elsewhere.

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