Last weekend, the MacroBusiness New York bloggerspondent, Rotten Apple, mounted an interesting critique of the dominance of neo-liberal economics in the face of mounting evidence to the contrary. It details the hypocrisy of our times: how a global debauch by the financial sector — one of the most irresponsible collective acts, or thefts, ever seen — has “mysteriously morphed into a sovereign debt crisis”. And then the so-called financial conservatives (conserving what, exactly?) argue that unless governments cut back spending we will get hyper-inflation. I would argue that we already have hyper-inflation, but of a peculiarly twenty first century variety, and it has nothing to do with governments, and everything to do with out of control financial markets fuelled by the neo-liberal circular arguments. In fact it was only the less developed, very definitely non-neo-liberal China, that probably stopped us from losing the financial system entirely. Because they do not have this problem of hyperinflation.
What do I mean? Consider some of the excesses in the monetary system. About $4 trillion a day is transacted in the global capital markets, according to the Bank for International Settlements. About four days trade equates with US GDP for a year. The US’s various deficits equate with just a few hours trading.
The global stock of derivatives stands at $600 trillion, about three times the financial assets of the world, according to estimates from McKinseys (that does not include land). More than half the trade of stocks on the US share market is high speed, algorithmic trading.
Derivatives, computerised foreign exchange trading and algorithmic stock market trading are all “money” – it is not possible to distinguish between them and other forms of money in any meaningful sense — and they are thoroughly out of control. How is this not hyper-inflation? Almost all the analytic focus, understandably, goes on the conventional measures like credit, money supply (although even the Fed has stopped measuring some aspects of that), equity levels, asset prices and fiscal and trade deficits. But there is a whole level of “meta-money” above that which dwarfs the conventional forms of money and which continually threaten to undermine the very basis of the monetary system. At the very least they create the kind of distortions that we are now seeing, resulting in polices like quantitative easing. Indeed, the irony at the moment is that the hyper-inflation of meta-money has created a dearth of more conventional money. The dangerous trend is that the hyper inflation at the top level is taking over.
Interestingly, Myron Scholes, who was behind the Black and Scholes method of pricing risk that led to the explosion of derivatives thinks some of the meta money should be blown up. As Time reported:
Scholes knows. Not only he is the Nobel Laureate and the father of Black-Scholes, he also ran LTCM that blew up for the very same reason in 1998. Cancelling contracts while things are good seems to be an excellent option. The reason for a complete seizure of the libor market was the market pricing of couterparty risk. It happened before, and it can happen again. The notional size of derivatives market is 10 times the size of the global GDP, and the usual Central bank liquidity fix will only make it bigger.
It is worth asking what money is; start from some basic definitions. Money is rules, it is not a tangible thing (you cannot have a “shortage” of capital, it does not “flow” around the world etc.). More importantly, you cannot deregulate rules. it’s a logical nonsense. Sp when Western financial systems were “de-regulated” in the 1990s what really happened was that there was a shift from government setting the rules to traders setting the rules. The rules exploded: CDOs, CDSs, volatility hedges, etc. etc. It created hyper inflation, too many rules.
The only solution is for government to reign in these lunatics. Re-establish some sanity in the rules of money (that will have to happen anyway if we have another GFC and the whole thing collapses). Forget fiscal austerity. It is time for governments to govern. This hyper-inflation of meta money remains extremely perilous. It is doubtful that the world economy can recover from another crisis. The GFC did not bring down the system last time because there were some government tools available, and China, which does not even have all the more conventional form of money (such as bonds), let alone the meta money excesses, proved to be a circuit breaker. But there will not be a second chance.
Three things should be done:
1. A small tax on cross border capital flows, which would stop the forex casino in its tracks;
2. A small tax on derivatives, which would mean it would return to what it is for — such as hedging wheat contracts or commodity contracts — rather than debt driven gambling;
3. Some kind of minimum trading period on stock markets to stop the rocket scientists spreading their algorithmic poison into the equities market.
Governments, instead of worrying about removing financial support for the weaker in society in the name of balancing their books, should start doing some governing.
And the good news? You can buy inflation linked derivatives. But I don’t think you can buy hyper-inflation linked derivatives.