How moral is money? OK, I’ll pause while you laugh bitterly. But in this era of computerised meta-money, it is an important question. First it should be said that I am using the word “moral” in the sense of an extension of “mores”, social habits, not as a reflection of larger questions of right and wrong. It came to my mind because of a response from a reader, BurbWatcher, who had this to say:
The more people realise that money is a moral item of trust, the more they will understand its up and downs.
It is true that capital is, in this post-gold standard world, nearly all rules. It is impossible to de-regulate financial systems, because we can’t “de-rules” rules, any more than you can take hydrogen and oxygen out of water. We can only change the character of rules, and, crucially, who gets to set them. Thus the de-regulation of the financial markets over the past two decades has been a shift from governments mostly setting rules to traders setting them. The number of rules has exploded: CDOs, CDSs, futures betting on just about everything, algorithms on just about everything. Money piled on money in the apparent pursuit of infinity.
In such an environment of informal rule setting trust, especially trust in the system, becomes crucial. Because there is no overseeing government — no state has global jurisdiction — then the trust between players becomes the principal way the system is ordered. Disputes over derivatives contracts, for example, are overseen by a group of lawyers and decisions are enforced not with legal punishment, but the threat that traders or firms might be ostracised. An honour system based on trust, in other words.
That means that certain collective norms become crucial to the way the system is made to function. It is why, for instance, the signal value of policies becomes so important. The policies have to appeal to the (usually right wing, neo-liberal) prejudices of the players within the system. That is, reinforce their mores. To that extent, BurbWatcher is correct. Money is a moral item of trust, and watching the mores that underpin it are crucial to understanding what it will do.
But here is where that claim falls down. The mathematicisation of money, and its subsequent computerisation. The rules that are based on these mores can, of course, be turned into mathematical formulae. These can be used to create transactions, and, as we are seeing in derivatives and, especially, in the use of algorithmic trading, that type of trading is taking over. The crucial difference is that this type of trading has no moral dimension, because there is no individual or group thinking. It is just mechanisation.
So as the mathematical formulae takes over, the moral dimension of money is progressively fading. That means the system is becoming more fragile, because a feature of moral behaviour is that it can adapt to circumstances, to different views, to disputes. Machines cannot. This is implicit in the following comment in a Schroders White Paper on algorithmic trading:
Professor Zhang’s seminal study finds that in fact, over the longer term (quarterly periods), “HFT hinders price discovery”; this finding represented the first trend shift away from other studies which confirmed a positive impact on price discovery, for example, Hendershott and Riordan in 2009. To further elaborate, there is a general view that increased trading activity leads to improved bid ask spreads, and thus, improved price discovery. However, this view tends to overlook the impact of noise trading on the market and it was back as early as 1993 that Campbell, Grossman and Wang conducted studies into this area, finding that noise traders lead prices away from fundamentals, agitating prices into temporary swings and reversals which would distort the discovery of a genuine price. The relationship with over and undershooting the price was pre- confirmed by Schwartz and Francioni 2004 who noted “price discovery is inaccurate when new equilibrium values are not instantaneously achieved”. These underpins have transcended to a world today where market volumes are dominated by non fundamental based HFT strategies that derive perceived value of the traded stock through correlations and pattern detection, resulting in a stock price that over (under) shoots its fundamental valuation.
The self-defined HFT technique of market making, deployment of flickering quotes spread across multiple venues, as well as more passive aggressive forms of noise trading, has led to concepts such as “artificial liquidity” and “disappearing liquidity” entering the lexicon of methods to describe HFT and thus raised questions over HFT’s positive role in effecting price discovery.
The “noise” referred to here is transactional activity that not only does not serve the purpose it is supposed to serve — price discovery — it is devoid of mores. An amoral intrusion into, or even take over of, a system based on trust. As in many post-industrial systems, the humans are being pushed to the sidelines, in a system supposed to benefit humans. A kind of social nausea, or self disgust, perhaps.
In any case, BurbWatcher is only half right. Money was a moral item of trust. Until it was hijacked by mathematicians armed with computers.