The ring of finance

Doubts are growing about the efficacy of quantitative easing. Maccanomics  is asking whether monetary easing is a Ponzi scheme, a trap that central banks won’t be able to get out of. The Economist explores the possibility that there is a problem of diminishing returns:

For economies that have already used QE, the problem is one of diminishing returns. The Fed’s first round of asset purchases between late 2008 and 2010 reduced corporate-borrowing rates by nearly a percentage point; its QE2 programme of $600 billion in Treasury purchases, rolled out in late 2010, succeeded in bringing down corporate rates by 13 basis points. In Britain, banks still face high borrowing costs and remain nervous about lending more to small and medium-sized enterprises: a new credit-easing programme about to be introduced by the BoE and the Treasury is long overdue.
My immediate thought is that if monetary tools prove impotent, and fiscal policy is caught in this bear trap of a simultaneous need to stimulate and balance the books, then what exactly is left? The greatest theft of modern times — the rape and pillage of financiers that led up to the GFC — may be leading to a kind of slow motion destruction of the whole system. Especially when the real culprit, the “metamoney” of derivatives and HFT etc, is not being stopped.
But, in the interim, it is worth exploring some of the errors that continue to be committed. I think a key to what is incorrect about the analysis can be found in the word “quantitative”. This is the myth that capital is a quantity of stuff, that “flows”, can be “scarce”, can be “abundant” and can even get “contagion”. It is not a quantity of stuff, it is transactions, social interchanges based on agreed rules about value and obligation. Pricing is not a symptom of physical forces interacting (i.e. supply and demand as two forces of nature). It is, to be more precise, intersubjective. A shared sense of value.
That is crucial when it comes to understanding the inflationary consequences of QE, for instance. If you think QE is potentially pushing too much “stuff” into the system (capital), so that eventually there will be too much stuff relative to the output of the goods and services, resulting in price rises, then you would be concerned about QE. But if you think capital is transactions around an agreed set of rules, not “stuff” at all, you might arrive at a different conclusion. What is the signal value of QE? Because what it signals to the human participants is what will determine pricing. It is the difference between trying to assess something objectively, and trying to assess something intersubjectively (in an intersubjective approach, you, the observer, are necessarily part of the calculation).
Now, this would just be an academic point, if it were not for the massive volume of Metamoney, the $700 trillion that sits on top of the conventional world of money: bank debt, bonds, equity, property etc. That has rendered the whole question of the supply of money vexed indeed. What, exactly, is money supply, now? Is it M1, M2 etc? Or do we include the daily transactions of meta money, the $2 trillion + that spins around the world each day, dwarfing conventional money supply? These figures dwarf other money supply figures. Are they money, or are they not money (bearing in mind that all money is just transactions?). If we include them as money, then money supply has exploded globally over the last decade. And it has not resulted in inflation. Well, except for inflation of financial salaries and bonuses.
It seems to me that what is needed is a way of looking at price behaviour that assumes its primarily intersubjective nature. That is, ditch the pretence that the system is a physical system that can be analysed scientifically, empirically. It is full of self aware actors, and their collective perception is the primary subject being examined. And what I think is happening is that Metamoney is creating huge swings in prices, both in the inflationary direction (asset prices, bankers’ salaries) and in the deflationary direction. It is creating a massive volatility because of the debauch with money creation. It is somewhat reminiscent of what happened in Japan since 2000, when a debauch in transactions around assets in the 1990s resulted in zero interest rates that failed to get the private sector to start transacting again.  Richard Koo is making that point.
But it is worse than that. The Japanese money explosion was at least around something conventional: property. This time it is Metamoney: money made out of money made out of money. Money supply has been exploding globally for a decade. And it means that the “laws” of supply and demand, or equilibrium or any other principle borrowed from the physical sciences, simply do not apply in the financial system as it is currently constructed. As is pointed out in this excellent column that details the circularity of modern finance:

“1. The laws of supply and demand do not apply. When food producers compete to supply a supermarket, the retailer has the luxury of selecting the lowest bidder. But when it comes to investment banking, wages are very high even though the number of applicants is vastly greater than the number of posts. If the same was true of, say, hospital cleaning, wages would be slashed. An investment bank, like a supermarket, demands a certain quality standard: it will not hire just anybody. But whereas it may be easy to identify a rotten banana, it is harder to be sure which trainee will be the next Nick Leeson and which the potential George Soros. That gives executives an excuse when things go wrong.”


  1. What you have proposed leads me to wonder if the physical scientific rules of microeconomics are (or should be) the foundations of macroeconomics.

    What we have had is ‘finance’ attempting to reverse engineer these concepts.

    Until recently it worked insofar as it did not cause collapse and they made a pile of money in the process.

    Deflation Inflation Gold

  2. Top post thanks.

    A question to ask is how much are the assets which the various central banks purchased worth now? When those assets are sold what will they be worth? Can they even be sold? I’d like to hear view on this by “people familiar with central bank asset sales”.

    The banks have done well, but who else, and in the case of the US just look at the excessive reserves so banks are happy to derivative trade and not lend.

    This post has some nice charts of the QE problem.

  3. There’s been quite a lot of discussion recently of how the financial economy has become detached from the real economy, concomitant with the rise of subjective economics emanating from the Chicago School of Economics, beginning with Friedman and reaching its creschendo with Richard Posner, Gary Becker, and others.

    Robert Heilbroner defined economics as “the process by which society marshalls and coordinates the activities required for its provisioning.”

    With such a definition, it is possible to avoid the pitfalls of both an “objective” and a “subjective” definition of economics. These pitfalls are explained by Heilbroner in Behind the Veil of Economics:

    Economics has been caught between two respectively unsatisfactory definitions: an “objective” interpretation tied to the idea of wealth, and a “subjective” one focused on decision making. Both approaches run into trouble, the first because “objective” wealth cannot be described without reverting to the subjective criterion of utility; the second because the central placement of subjectivity widens economics to the point at which it becomes applicable to everything, and therefore empty of specific “economic” content. Recently, for example, Richard Posner has called for a “functional,” not a “definitional” approach to economics: economics becomes identified with a certain “density” of analytic concepts, such as perfect competition, utility maximization, equilibrium, and the like. “When economics is ‘defined’ in this way,” he writes, “there is nothing that makes the study of marriage and divorce less suitable a priori for economics than the study of the automobile industry or the inflation rate.” This approach strikes me as containing one vitiating weakness: it leaves completely unbounded the domain of the “economy.” I presume there is such a domain, distinguishable from, say, the domain of “marriage.” If so, its decisive criteria must surely be included in the definition of that which describes or studies it—-namely, economics.
    **end of quote**

  4. “..which trainee will be the next Nick Leeson and which the potential George Soros.”Perhaps, tongue in cheek, one should ask, what is real the difference between these two individuals? Perhaps it’s as simple as ‘one got caught’ or that the other could ‘tough it out longer’ than the other. Regardless, each supports the notion that money has become an identity unto itself, rather than the mechanism for the transaction of goods and service; the point of this good article.

  5. I would also point out that Cartesian science, such as that proseltyzed by the Chicago School of Economics, came under attack almost immediately upon its conception. As Michael Allen Gillespie writes in Nihilism Before Nietzsche:

    Hobbes spoke for nearly every empiricist when he argued that Descartes had established his system upon a faulty foundation by positing the I as fundamental…. Empiricists such as Hume thus argue that what seemed to Descartes to be causal connections were only regularities of experience. For empiricism, science can only describe such regularities. Its results are thus not certain or a priori but probable and a posteriori….

    Hume’s skepticism was a frontal attack on rationalism. His demonstration that causality could not be logically deduced or derived from experience dealt an especially grievous blow to rationalist science.

    **end of quote**

  6. “My immediate thought is that if monetary tools prove impotent, and fiscal policy is caught in this bear trap of a simultaneous need to stimulate and balance the books, then what exactly is left?”

    What’s left is what Ludwig Von Mises called ‘creative destruction’. Get the interfering politicians and dunderhead central bankers out of the way and let the market take care of the problem. Anyone who knows the Austrian school will tell you that all this meddling will only exacerbate the problem and cause a slow motion train wreck of developed economies. Much better to take the bad medicine, get over the undoubted global depression and then build new economies free from debt and free of inefficient zombie banks and businesses.

    • The “logic” of the Austrians always reminded me of a popular Mexican saying, primero matamos luego veriguamos, which translates to something like “first we kill them, and later we find out whether they’re guilty or not.”

      Besides being completely unrealistic from a political perspective—-no democratically elected government could survive if perceived to be sitting back and doing nothing in times of extreme economic hardship—-the collateral damage to such a shotgun approach would be monumental. Far more innocent people and businesses would get wiped out with such a solution than “inefficient zombie banks and businesses.”

      The government has to be more selective in singling out and punishing the true perpetrators of the financial crimes.

      The whole intent of Austrian economics, however, seems to be more about protecting the true perpetrators of financial crimes. It’s the defense that Adolf Eichman argued: if everyone is guilty, then no one is guilty.

      • There is a tendency for people to resort to extreme hyperbole the moment there is any suggestion that a process of creative destruction is both inevitable and should start now.

        By reducing the amount of easing and moving interest rates to a less stimulatory level you can gradually lower the tide and reveal the swimmers in flesh tones.

        Measures can be taken to keep people affected fed and sheltered if necessary but weaning the debt fix now by raising the price of credit is critical.

      • So let me get this straight.

        J.P. Bankster is luxuriating on his private beach in his custom Prada bathing wear, millions stashed in various accounts scattered about the world, all proceeds of highly unethical and totally unproductive banking practices that left millions of people without the shirts on their backs, and now you want to “gradually lower the tide and reveal the swimmers in flesh tones”?

        Meanwhile, above us coastybloke is clamoring to bring on “the undoubted global depression” and below us Jumping jack flash is getting swept away in an orgy of schadenfreude talking about “entire countries going bankrupt here, not the least of which is the good old US of A,” and yet you speak of me “resorting to extreme hyperbole”?

        For Christ’s sake, who can argue with “logic” like that?

      • Well I am all ears for a better plan but your approach appears to be limited to a dose of good intentions.

        I not sure how you think JP Bankster will enjoy my suggestion which involves dismantling the Merchant of Debt industries.

        Unfortunately, and this is the bit you have missed, the Merchant of Debt industries were built on the back of interest rates manipulated by the behaviour of central banks and the financial repression of the developing world.

        If you are serious about cutting out the tumour that is modern banking/finance you need to start by ending the manipulation of the cost of credit.

      • If a rerun of the first half of the twentieth century is the best plan we can come up with to weed out a handful of free-riders and rent-seekers, then we indeed learned nothing from the events of that period.

        The idea of subjecting entire nations and peoples to the ravages of depression, just so we can hopefully, but more than likely not, punish a small minority of wrongdoers, has to be one of the most far-fetched and grotesque follies ever conceived by the human mind.

      • Always eager to learn something new Glen5875!

        Keep us posted on any suggestions you come up with other than suggesting there must be a better solution.

        As for there being only a small minority of wrong doers.

        Keep in mind that ANYONE who has taken on debt they cannot afford to service at a reasonable rate of interest is part of the problem.

        Unfortunately, the solution to the problem involves debtors who cannot pay defaulting.

        Trying to keep them all afloat is exactly what is happening now.

    • Jumping jack flash

      +1 let the market correct itself.

      The problem is that the major players have too much at stake and will never let it correct.

      Come on, we’re talking entire countries going bankrupt here, not the least of which is the good old US of A. They’re not going to go down without taking out everyone else. It is their nature.

      ” if everyone is guilty, then no one is guilty”

      Glen that is also correct, if everyone acts the same way at the same time, are we really acting, or creating a “new normal”?

  7. Interesting discussion. In practice all financial services exist in a pretty competitive and contested space that is actually very well colonised.

    However, the process of making big money fast always seems to involve the following:

    1. Develop a new product that hides the true risk (in a temporal sense). This is often quite clever and usually involves a time-honoured slight of hand applied in a modern context and;

    2. (This is really tricky bit). Be able to sell the product (and the mis-priced risk) to someone silly enough to buy it. This usually involves a great deal of skill and an amoral/immoral character – in recent times this has obviously been lined up with using a previously trusted brand to add to the sale. People that can do this are paid handsomely because this is the hard part.

    3. Fees are realised and locked away before the risk materialises.

    As far as i can tell this always plays out the same, and so meta-money, whilst complex on the face of it, is really just the same model being played out on a massive scale because it has proven to be so successful in the past.

    Be it a weird derivative product, a new tax structure or something as simple as a home equity loan for shares, it’s all about grabbing the fees before the risk materialises.

    Perhaps the solution lies in finding a way to disincentivise the mis-pricing of risk. At the moment we only really punish this behaviour where there is grossly obvious fraud and this has opened up the grey area to open slather.

    In the end however, this all ultimately relies on finding a buyer that doesn’t understand the risk – buyer beware as they say.

    • @ aj.

      Great comment.

      To me it all seems to boil down to trust, something which is without a doubt both objective and subjective in nature.

      Whatever its nature, however, once trust is destroyed, the schemes you describe being the quickest and surest way to destroy it, and the failure of government and society to punish those who engage in such schemes being an even greater annihilator of trust, when preservation of capital becomes more important than return on capital; when the U.S. or Swiss or Australian governments are perceived to be the only safe counter-parties in the world; when people prefer to stash their dollars and francs under their mattresses and banks refuse to loan; when credit-worthy borrowers refuse to borrow because of the dense fog of uncertainty and lack of transparency that obscures both the present and the future, then the effectiveness of monetary manipulation has reached the end of its rope.

    • @ aj.

      I would also argue that the U.S. government not only fails to disincentivise the mis-pricing of risk, it acutally rewards the mis-pricing of risk.

      This is the phenomenon that Kevin Phillips so thoroughly documents in Bad Money with the serial bailouts of the financial sector the U.S. government has engaged in starting in 1982.

      • I’m inclined to agree. This is yet another of those situations where the solution is actually reasonably easy but the politics of dealing with the rent seeker interests is hard.

        If we are sticking with the finance rules we currently have then capital has to be allowed to fail early and often, and competition policy has to prevent organizations reaching a scale where the effect of an idividual collapse is systemic. That is, risk impacts directly those allocating capital in a timely and honest way.

        As the above is not likely to happen in a hurry, and given the extent to which previously respected organizations have been abused by individuals for personal gain (especially in the finance space), it may be time for some laws that put individual windfall gains into escro pending the visibility of the true risk to the capital providers, and systemically to the community.

  8. ….and to suggest that the laws of supply and demand don’t apply to investment bank hiring is appalling garbage.