Exponential finance


A talk by the futurist Ray Kurzweil was recently played on the ABC in which he talked about the accelerating rate of innovation when it becomes part of what is broadly termed the information technology industry. He argues that in the future medicine, biology, economy and social relationships will be subject to information technology and the law of exponential return. His contention is that whereas in other sectors innovation tends to be advance in a linear fashion, information technology behaves quite differently. For instance, he predicted that the human genome project would succeed within the desired time frame. When it was halfway through and only 1% of the genome had been mapped, he was told that he was going to be proved wrong. He replied that on the contrary it was right on track, exactly in line with the exponential growth curve. It came in one year ahead of schedule. Using the same logic, he says, solar power will dominate world energy supply in about 16 years. Medicine will be transformed in about the same time frame. We have already seen the phenomena in areas like the internet and social media.

My first thought listening to it is how difficult it makes investment, because it simultaneously creates great uncertainty in industry structures — see, for example, how social media has changed conventional media, or file sharing has changed the conventional music industry — while making timing excruciatingly important. It is not enough just to pick the new sectors, on exponential curves investment timing has to be just right. For most of us, it will be wrong. The dot.com boom is a case in point in going too early.

My second thought is that this exponential IT curve has already hit finance, and it explains an awful lot of the problems now being witnessed. The explosion of derivatives, now a startling $700 trillion, well over half the capital stock of the world, has been driven by IT geeks and rocket scientists. The explosion of high frequency trading, which is similarly startling, is also a geek domain. Finance is no longer a discrete industry, it is now part of the IT juggernaut. And it is not going back.


This creates, in my view, far more problems than it solves. In fact, it is downright dangerous, because it leads to self referring, feedback loops that do not occur in other industries. If the energy industry starts to become an IT industry, as Kurzweil predicts is occurring with solar power, then the outcome will be more energy capacity at a lower cost. If the medical industry becomes an IT industry, then the outcome will be much cheaper and new medical treatments. The music industry has been transformed by IT, reducing the cost of recorded music to levels that are negligible, and, in many cases, removing the cost completely.

Now how are these innovations measured, in terms of their impact? By price, or the amount of money required to get a certain outcome. So if the same thing occurs in the financial system, which it has, then how do we measure its effects? We measure the change in the volume and range of monetary instruments by price, or an amount of money. In other words, we measure it by itself. And because something cannot be measured by itself, then we have lost the most important role of money — its function as a store of value. To measure the value of something effectively, by definition you have to have something else with which to measure it. You cannot measure the value of something with itself. Grab your shoelaces as hard as you like and you will still not be able to lift yourself off the ground.

Such self referentiality is, I suppose, a characteristic of the post-modern, post industrial world. But no one is in any doubt about how dangerous financial “innovation” is to the architecture of the global economy. Innovation is entirely different in the finance sector to other industry sectors (I am even sceptical about calling finance an industry, although I suppose it is). Innovation in this area results in tampering with the rules on which everything depends, money being in the first instance rules about value and obligation. In 2008, we saw what that means.


The IT revolution cannot be unwound; finance is now an IT industry. But it MUST be seen as a special case, requiring much more intense governance and sensible thinking about risk control, as opposed to the circularities of models like value at risk, or the Ayn Rand inspired nonsense prosecuted by Greenspan, in which pure self interest was always and in every case beneficial. More specifically, you have to measure the effect of monetary innovation with something other than money. That means looking at things outside money, such as, perish the thought, morality, or, if that is all too hard, at least social utility.