Moral monetary theory

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.

20110831 High Frequency Trading


  1. Very good post SoN.

    Another view of this – “Money ‘is’ a moral item of trust”; it was and we trusted our government/system to honour the value, but over time through inflation, it’s value is being eroded. It’s a reality, but is it moral? The “is” becomes a “was”.

    Also, many analysts now say that the market is a traders market due to HFT, and other financial tools …mostly algo based so I agree with your premise.

    Governments have failed their citizens, and we’ve become sheeple to tax and regulate. There is no morality if you look deeply.

  2. “moral behaviour is that it can adapt to circumstances, to different views, to disputes. Machines cannot”

    Ah, have you not seen Terminator ?

  3. In a sense markets are a continual war between known and unknown forces. You cannot fight the war by setting a series of rules when the opposition is using algorithyms to game the rules. The rules assist the gamers. The war needs to be fought with maths and disclosure. It can be done!
    Money is not neceassirily trust, I’d say its accountability which is perhaps the reciprical

  4. I agree that money is a form of trust and that is how it is seen as a store of value. However what I don’t agree with is the premise that deregulation completely breaks this down.

    Eah one of us helps to regulate money through the many monetary decisions we make in our daily lives. Do we decide to trust it? What do we expect from a certain quantity of money? We all through our daily decisions set the rules by what we believe is fair to ourselves and others.

    When you have one fixed person controlling the rules rather than the community or market ; or when a few large people control the worth of money far more the. the community that’s when you get problems that are more long term in nature rather than short crashes and resets. Governments, banks etc unfortunately in this system through the sheer amount of influence they have on the monetary rules including the quantity of the money supply undermine the assumptions made by the community causing a distortion in value over time. The biggest example would be inflation – as long as the community does not act to your behaviour due to information assymmetry you can effectively rob from them.

    And thats why the free market to me is the ideal. Where there isn’t one player making the rules the information that most people have about the money they using and the assumptions that most people have about money become more realistic. Moneys perceived wealth is based upon these assumptions – should people wise up as a community and gain the information that the current rulemakers have and act on the new information money would lose a lot of value to the average person.

    The problem with one rulemaker is that eventually there is one person in power that will have the temptation to break the assumptions that the community has about their money for some benefit.

    I will ask you this; if there was no government involvement do you think hft would be such an issue? If there was no federal reserve banks do you think large banks would have the money to undermine and manipulate the system and how it prices things?

    Maybe they would in the short term. But in the long term if it was a free market once the community became aware of what a bank or whoever was doing they would often take steps to cause a correction of the situation rather than bailing out the banks.

    What do you want? The people setting the rules collectively – a social contract based upon the social standards of the people? Or do you want it to be centrally managed? That’s the question. I know which way I would prefer.

  5. Mark, I think you got my “premise” precisely wrong. I view it pretty much as you describe it (I am simply pointing out the circularity of the argument about deregulation). Although I would add that, as we have seen in the GFC, you can get very long term problems from deregulated markets. But that is not what I am pointing to: I am pointing to the use of computers to exploit the human systems of trust, which creates a new level of “meta money” based on maths.

    • The deregulation wasn’t really deregulation at all, rather it seems like it was just leaving the laws that benefited the banks and destroying the laws that curbed its behaviour.

      Creating meta money based on maths isn’t the issue to me rather its the asymmetry of information between the traders running the machines and people. That’s how machines profit – with probability most of the time showing their guesses about the market and participants behaviour to be correct. Dark pools to be are of a particular concern; their main purpose is to stop the public from learning economic information that would help determine the assets value.

      I do believe in deregulation in the long run; regulation only works in the short run until the people in power can reverse it again.Administrative controls on peoples behaviour are usually the least effective way of mitigating any systems risks. better to design the system in the first place so its actors through their moral decisions passively ensure a fair and stable economic system.

  6. Mark has underlined the problem…

    HFT is only allowed in its present form because of the incest between wall street and govt.

    Look at the amount of human discretionary traders leaving the industry. Though I have no real issue with this trend if ‘bot’ trading was fair and transparent.

    Regarding liquidity, just watch a futures ladder(DOM) for some time and see how many real orders there are (orders that want to get hit), markets have become a mutant version of their former selves.

  7. Thanks for this post. I now see HFT as anti-social and beyond regulation. Therefore it should be discouraged through taxation, like other other social problems (eg. excessive alcohol consumption).

    • Good point Oliver. The CME raises margins for the COMEX trades, so let’s do something similar to the HFT dark side.

  8. The way I basically understand this issue, from a purely mercenary point of view, is that fundamental analysis is becoming more and more important and the view that charts represent the sum of actions of both smart and not so smart money may no longer hold because of a new player – machine money – which has a disproportional effect on the market.
    Doesn’t this just given the smart players more leverage/opportunity?

  9. Thanks to Sell on News. Money is indeed trust, or an expression of trust. The three commonly quoted properties of money are derived from this fundamental property. The reason people in the past chose gold as money was that people could trust that a number expressed in gold cannot be easily falsified. Too many of today’s economic policy treat money as a commodity which the government has a monopoly to create at zero cost. This led to moral corruption, reduction in incentives for real economic activity and a steady decline of the economy as a result.

    We will painfully find out that much of our current economy is not sustainable. Many financial assets will turn out to be mere mirages, because trust had been abused and what is so-called money doesn’t exist when debts cannot be repaid. The lie that is economic policy is neatly summarized by the recommendation that “near-term fiscal policy should be very expansionary while strongly committing to long-term fiscal sustainability”. It really means “we should borrow today as if there is no tomorrow while promising all debts will be repaid in the future”. Yeah, that works, if we are all fools. The reckoning to such a recipe will be terrible.

    Let us man up! If we want our government to spend, then please pay our taxes! If we don’t want to pay taxes, then don’t expect the government do all these things we’d like to have. Anything else is a lie.

  10. DE or UE

    Can you look at this world bank loan book for Australia and tell me why we’re borrowing at such high rates when there are other cheaper methods.

    I stumbled on this after a info request to them and I was told Australia had no loans. They are dated 31/7/2011 so could have been QLD flood related, but is there a transparency issue here? The loans are paid back, but I’d like it if someone could explain. If you don’t know just say as I’m contacting them on another request, and I’ll ask again.

  11. The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it. John Kenneth Galbraith
    “Financial operations do not lend themselves to innovation. What is recurrently so described and celebrated is, without exception, a small variation on an established design . . . The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” John Kenneth Galbraith, A Short History of Financial Euphoria
    Paul Volcker, ex Fed Chairman, said recently that the only social value created by the banking (and fin.) industry in the last 20+ years was the ATM.

    China executes derivative dealers. They know what this is all about.

    “In economics, hope and faith coexist with great scientific pretension.” John Kenneth Galbraith

    Calculus . . . [gives] speculation the deceptive guise of investment. Benjamin Graham.
    In the vernacular this is called “bullshit baffles brains.”

    Fiduciary media is debt organized into currency. There can be nothing more unreal in its pretensions than debt currency itself. Charles Holt Carrol

    When plunder becomes a way of life for a group of men living together in society, they create for themselves in the course of time a legal system that authorizes it and a moral code that glorifies it. Frederic Bastiat

    Sometimes the law defends plunder and participates in it. Thus the beneficiaries are spared the shame and danger that their acts would otherwise involve… But how is this legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them and gives it to the other persons to whom it doesn’t belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime. Then abolish that law without delay … No legal plunder; this is the principle of justice, peace, order, stability, harmony and logic. Frederic Bastiat

    When law and morality contradict each other, the citizen has the cruel alternative of either losing his moral sense or losing his respect for the law. Frederic Bastiat

    There is in all of us a strong disposition to believe that anything lawful is also legitimate. This belief is so widespread that many persons have erroneously held that things are “just” because the law makes them so. Frederic

    The purpose of Fiat money is to tax surreptitiously through inflation. Ludwig von Mises.

    Those who can make you believe absurdities can make you commit atrocities. Voltaire

    Journalism is unreadable and literature is unread. Oscar Wilde.

    Nice try but no cigar.

  12. Fortunately I thoroughly dislike cigars and do not feel deprived in the slightest. (Also, I read literature, Mr Wilde, including some of yours …). I quite like Phillip Bobbitt’s definition of law as legitimised violence, and I toyed with using it the above discussion. There is certainly an element of violence with money, as your above quotes imply. But there is inevitably an element of social violence with mores, too.

  13. I’ve said this before, no doubt I’ll say it again… The mechanisms of trading may change, but market behaviour doesn’t, because markets are traded by humans, and human crowd/mob/herd behaviour doesn’t change. HFT algorithms reflect human nature. Those algorithms were written by humans. Present day charts of financial markets look much the same as charts from 20 years ago, 40 years ago, 80 years ago, 120 years ago. The same patterns are present. The same human behaviours are reflected.

  14. Interesting article, thanks. As somewhat of an insider I enjoy reading about HFT articles. I am not a trader, although I necessarily deal closely with them. I think SoN has a big bone to pick and I also think that a lot of information available publicly on HFT is misleading or inaccurate. Often it’s because they come from the buy side perspective and they are interested in optimising their execution but think a big bad machine got in the way. For example in the article it mentions a cost of $35m against executions of $30b, sounds big, but complaining about at an 0.12% extra cost on extremely large order executions sounds like winging, they could easily loose much more by executing the trade without hiding the volume and letting the entire market react to the subsequent massive volume inbalance that would have occurred. And if someone is sniffing their orders out then they should develop better execution algorithms.

    Anyway, I think that the role of the computer is massively overstated. The computer is only acting upon pre-programmed conditions that are set by a human. A human who has codified the rules into a machine. A good trader who knows the rules would be making the same calculations. Only slower.

    The HFT trades are ultimately governed by a trader. The trader in charge of the machine is identifiable by the exchange, their orders are tagged with an identifier to do this. It’s not necessarily public information but the exchange sees and logs it. There are regulations in place that ensure any trade conducted by a machine can be attributed to a human who will be able to explain why the machine made the decision. Seriously.

    It’s in this way that the mechanical trades are still subject to the mores of the market, they can be and are voluntarily and forcibly reversed by the participants in control of the machines or the exchange itself, eg, when mistakes are made by human operators the machines will trade against the mistake very quickly (if it’s profitable). However these mistakes can be appealed and a negotiation to reverse the trade can be made with the operator of the machine. It happens all the time.

    Also, the current ASX system allows the identification of the participant firm for all options trades, but not equities trades.

  15. While we are at it, why not discuss the formation of “Dark Pools” – markets accessible to only the big players where transactions are not publicly disclosed. More and more of the big block trades are facilitated in this way.

    In this case real humans may actually be behind the trading, and there is an argument that dark pools allow transactions that may otherwise distort market liquidity, but once again there is an incessant distortion of publicly available prices away from fundamental values and price discovery.

    Between these two trends (HFT introducing noise not based on economic reality, and real trades based on fundamentals occuring out of public site), there are increasing reasons not to trust market valuations.

    I consider money as a responsibility to maintain moral (and economic) values. As individuals, what we do with money plays a role in setting the value of whatever transaction it is we participate in. Be it as consumers favouring ‘organic’ produce, ethical investors choosing not to buy gambling stocks, or as ‘evil’ speculators betting on a sovereign default – all monetary transactions involve responsibility. I think all market participants (and consumers) need to understand and recognise this moral responsibility.

    The onus is on the financial world to actually take on the responsibility they purport to represent. They caused this crisis, they should pay for it. As for the rest of us, it is up to us to transact as if we are the setters of value. We must think carefully about what we do with our money. No one else will do this for us. I see this as the only way to take the power away from the world of Meta-Money. While top-down regulation will play a role later on, I see this as a bottom-up process.

    Too long we were deceived by the financiers. We were convinced that because all markets are efficient, transactions have no responsibility – there was no need to think about our choices, and their consequences anymore. Once we were convinced, they then got us to believe that money grows on trees – the longer term value of money was discarded, and with it our perception of value.

    If people are willing to accept this moral responsibility once again – that all transactions (even relatively small ones) represent moral (value determining) choices, I believe we can take the power back.