The Market, The State and Money Flow

This is a direct continuation of my previous entry, and precedes subsequent, directly related ponderings, now in the mental pipeline.

Money circulation is what keeps an economy functioning. That money tends to collect at certain nodes, and once it has collected there is unlikely to leave, is a block in the smooth flow of economic activity. The problem is nicely characterised as hoarding, which occurs simply because being rich is better than being poor. (That there will always be ‘rich’ and ‘poor’ is accepted, the only question, as we take this forward, is: rich and poor in what?) So the challenge is to keep the flow going, despite the pressure scarce money systemically creates to be richer than the next guy, and keep it that way.

In our current dominant myth The Market circulates money well, whereas The State does not. This is, if one peers under the bonnet, something of a circular (no pun intended) argument, in which: “black = bad (because it does)”, “white = good (because is does)” where “Market is white” and “State is black.” “Good” is the flow of money from place to place, from person to person. Trade is good. Strangely, as a ‘happy’ – though unintended – spin-off of this, some succeed to riches, while others fail to poverty, where many will be poor and few will be rich. I say this is strange, because these quite fixed and stubborn outcomes are logically contrary to The Market's primary function of promoting smooth money-flow. Poor people neither have nor can circulate money, rich people have but don’t want to circulate all their money. They want to possess more money. This is a systemic issue with money, though not the only one.

Again, smooth money flow is necessary to keep an economy functioning well. And yet as money flows around it ends up unevenly distributed. This uneven distribution inhibits maximum money flow, which means it inhibits maximum economic activity. What to do?

To answer this, I believe an analysis of The Market and The State is vital. An impartial, unbiased analysis. My efforts are those of an amateur of course, and yet I see very little work being done out there to look at this issue dispassionately. Ideology rules almost every roost.

The myth we all know so well relates that markets are efficient distributors of goods and services, and thereby serve society well. Economists call this myth the Efficient Markets Hypothesis (EMH). Markets are blind mechanisms powered by self-interest yet guided by an Invisible Hand, which, over time, ensures maximum possible societal good. Leave them be, let them alone to work their strange magic, and all will be well. Interfere, tinker, regulate, and The Market doesn’t work as it should. It is a force of nature, and best respected as such. Hence the correlation of ‘free’ markets with ‘freedom’. ‘Freedom’ is a social good ensured by ‘free’ markets. Also, selfishness is the inbuilt and unshakable human trait which, counter-intuitively, ensures maximum societal freedom and health.

To find out how we have come to ‘know’ that ‘free’ markets work this way, we must look to economics, and in particular the long journey economic thought took from Adam Smith, through Keynes, and into the neoclassical school. Economics is a strange discipline shot through with bizarre and impossible assumptions, and is seemingly incapable of making accurate or reliable predictions. It has been torn to shreds repeatedly by mighty thinkers, and yet soldiers resolutely on, convinced the nirvana of perfectly free markets it seeks is out there somewhere. Amazingly, despite its perpetual swagger (and I urge the reader to buy and read “Debunking Economics” and “Econned” for further information) orthodox economics has not proved anything, and most of all, has not proved there ever was, nor that there ever can be, a perfect (or ‘free’) market. They have likewise failed to prove that as-close-as-possible-to-free delivers social good.

To refresh, the conditions for a perfectly free market are:

1. forever rational market participants
2. perfectly informed market participants (knowledge of all prices of all goods and services for all time)
3. ease of entry and exit
4. total transparency

These conditions are of course impossible to meet. And yet only these conditions can prevent cartels/monopolies from forming. Cartels and monopolies do not serve the public good, distorting the market’s functioning. Some even become Too Big To Fail. Because the market cannot be perfectly free, it cannot, with or without the Invisible Hand, prevent these distortions from arising. Indeed, its necessary imperfection guarantees that settled imbalances occur.

Enter The State. How we hate The State. It is corrupt, nannying, bullying, dissembling, greedy, and to cap it all off, takes our money and wastes it on useless projects that no one wants. And yet, how could there be a market without a state? Can the infrastructure that enables markets to exist, such as roads and other transportation components, trade laws, criminal laws, courts, police, education etc., be established and maintained without The State? Can even one of these necessary components be run well by market processes? I believe not. If it were possible it would already be so.

The problem with maintaining societal infrastructure is money flow, how to effect it without ruffling too many feathers. We do not charge for education, and yet schools must be built and run, teachers and other staff paid. Money goes into the process, but does not generate money-profit. This is true of establishing laws; running courts; paying the police, armies, navies; road building and maintenance, and so on. Money flows out from The State into the state sector, but not arrive back as private spending from the private sector. In terms of The State making a profit, it has but one revenue stream; taxes. Or, in fantasy land, it plays the markets and charges citizens for all its services at point of use, thereby becoming a business. This cannot be. So, because The State relies on taxes to draw existing money to it, making a 'profit' would mean taxing back more than it spent. Is such a thing possible? Can such a business demand on The State make sense in any circumstances? (Absolutely, it's called interest and paying off the bill, should you choose to create government money that way.)

Remember, we are talking about money as a created tool. Isn’t it unrealistic to expect the same monetary performance/behaviour of an entity whose function is to spend money, as that of another entity whose function is to circulate money (while profiting from that circulation where possible)? As discussed in my previous post, for some to save or make profits, others have to spend or make losses. For this to be otherwise, there would have to be an abundance of money, and everyone would have to be rich. This is of course logically impossible. Money works as an incentive precisely because it is scarce. Money exists to deal with scarcity, and has to stay scarce in order to ensure competition and productivity.

In my view we have, therefore, a false dichotomy. Comparing The Market with The State is worse than comparing apples and oranges. It is in fact like comparing the right hand with the left. You may be right handed, but that doesn’t mean you’d be more efficient, or benefit, if you chopped your left arm off! The entire debate around this false dichotomy is a manifestation of a power struggle to control money, because money is the best tool humans have for controlling and shaping society. People in positions of power are there because they like it. Control is what they enjoy. The Market/State battle is in some ways a smokescreen, a pantomime in which the actors and actresses are sincerely convinced the right wing/left wing battle lines are helpful and genuine. Ideology rules the roost.

But there are systemic reasons why it must stay this way (for a while yet). Experimenting with entire societies is not easy, so what is done, what is determined to be the ‘best’ way, is the result of battle, propaganda, consensus, and contrived argumentation, not by scientific methods. This means that arguments such as those laid out here are almost bread and circuses for the masses. I can make any claim I want, show any assumption I find to be false, show the entire socioeconomic apparatus to be flawed and doomed, and it makes no difference whatsoever. The show must go on.

Except, except, except... I am part of the process of understanding ‘Life, the Universe and everything’, just as everyone else is. As our understanding changes, so, in time, will our societies also change. Change is the only constant. Sadly, Great Big Global Change is likely to be very bumpy indeed.

More on this in due course.

'Free' Markets = Corrupt Markets?

An economy — whether local, national or global — is just a system, as are all other multi-component, cohesive processes we know of. As such economies are subject to internal and external forces acting upon them, affecting their behaviours, shaping the manner of their operations. The discipline of economics studies economic systems, but, sadly, comes to the task with a raft of core assumptions about the ground rules governing economic operations — such as rational buyers and sellers, unlimited wants and scarce resources (though, strangely, energy is assumed to be infinite in some regards!) — all of which are, at least in the mainstream, out of bounds when it comes to what may be discussed. These assumptions shape socioeconomic policy generally, which shapes our lives. I refer the reader to Steve Keen’s “Debunking Economics” for a forensic analysis of the internal inconsistencies and logical contradictions of the dismal science (it really is not a science), my focus here is on the discipline’s blinkered attitude to corruption, an observation I first heard made by William K Black. Generally speaking, according to the professor, economics fails to consider corruption at all.

For me the best sentence I have read so far highlighting the systemic pressure to corruption inherent in economic systems was written by Jacque Fresco (from “The Best That Money Can’t Buy”):

“In a monetary system there is an inherent reason for corruption and that is to gain a competitive advantage over someone else.”

A core assumption that arises from the perception of unlimited desires having to deal with limited resources is eternal competition. In economic theory rational market participants are also “law-abiding” market participants (though laws are not really considered), so this endless competition should produce efficiency everywhere it is allowed full scope. The real world, that messy, recalcitrant thing, makes this assumption laughable. Here some quotes from a recent discussion at Financial Armageddon:

“Don’t forget the Dow is fake also. They took out GM and Citibank from the Dow. Those are two zeros and they put in Travelers and Cisco…that’s 640 Dow points that were added because they swapped GM and Citi for Travelers and Cisco.”

and

“Those trades [in Citi, Bank of America, AIG and Wells Fargo] are 80% of all trades in the market and the total market volume is less than half of what it was back then [2007]. In other words, you’ve got half the market participation of what it was and of that half, 80% of it is concentrated in less than half a dozen financial firms.”

Some observers are resolutely opposed to the idea that the markets are manipulated by powerful market players, but we need only recall that economic systems have built in to them a constant and unending pressure to corruption, for the idea of corruption to become more than predictable. We then see corruption as inevitable. There is crime (of which some 90% is economic), humans are capable of a great variety of behaviours — that is, they are not the robotic, homogenous, mechanical components of economic engines economics theory needs them to be — consequently it is silly to assume all who are motivated to become ever richer are nice human beings. If they were we would need no laws in this scarcity-based system. That we have laws, and that laws cannot be perfect, says enough.

And of course the world is vastly more complex than a ragtag of markets efficiently distributing scarce goods and services via the price mechanism. We poor saps watch the voodoo of stock markets in hushed awe, feeling good when it rises, and concerned when it drops. In Ellen Brown’s “The Web of Debt” I came across a wonderful analogy for the importance of stock market performance; the Dow is a dead military dictator propped up in the castle window, his arm moved reassuringly up and down by some mechanical device to pacify the troubled crowds outside. So not only do we have internal, get-rich-quick motivations to corruption, we have external, socioeconomic and political pressures to corruption. Economic systems experience constant internal and external pressure towards corruption, and yet in the mainstream the idea that markets are even manipulatable is a virtual heresy. ‘Free’ markets are the panacea for all ills. Just leave markets alone to work their magic and all will be fine.

But at last there are the beginnings of a serious attempt to address this woeful shortcoming of economic theory, and the fallout of this on socioeconomic practices. From the abstract of a recent paper at www.voxeu.org (hat tip nakedcapitalism):

“How does economic theory need to adjust in light of the global financial crisis? This column presents a new insight on how innovation leads to rent capture, which in turn is a sign of a potential crisis. This stems from asymmetric information in the financial sector. To avoid a repeat of the crisis, policymakers need to increase transparency.”

Asymmetric information is anathema to perfect (and free) markets, in which all participants need to be perfectly informed about what’s going on, for price to be fair and distribution to be efficient. Of course, to the untrained eye, such a market is impossible right from the get-go, but here, in the rarefied air of economics academia, we must look at particular instances of a particular sector of the economy (finance), rather than at the very foundations. Such is change of established institutions; a painfully slow nibbling at the edges.

The article looks at the arcane complexities of CDSs, asserting the sellers are privy to more information than the buyers, and as such possess too much power in the transaction, favouring them greatly over the buyer. The authors extrapolate from CDSs to the financial market as a whole, arguing that the entire sector benefits the sellers with asymmetric information advantages that destabilise the entire economy over time.

What is important about this is that the holders of the keys of current orthodoxy, that elite shouting loudest about the beauties of ‘free’ markets, are suddenly under the microscope being exposed as the least ‘free’ sector. A small beginning it may be, but it has the potential to weaken considerably the paradigm-controlling power of financial institutions. Hopefully the debate about the ongoing crisis will widen as a consequence of this, and other, research.

Meanwhile, it must still be only at the extreme fringes that scarcity itself is viewed as an outdated assumption. Once momentum builds around open and unbiased discussions of scarcity and its fallout, then the idea of a resource-based economy might take hold in the public’s imagination. So much of what we ‘know’ about life on Earth arises from this key assumption. Tackling it will prove, I feel, to be humanity's greatest challenge to date.

Free market, perfect market

“So contrast that to the crash of ’29, when, suddenly, the US got involved in a lot of programs, like Barrack Obama’s getting involved in a lot of programs now ... and so ... the recession/depression we can look forward to lasting a lot longer in America, than if Obama just sat back and let the market, you know, be a market.” Max Keiser

Max Keiser, that very entertaining online econo-show host and ex trader, is advocating here the kind of laissez faire, non-interventionist economics that quickly turned the 1920-21 stock market crash into the roaring twenties. I enjoy much of what Max Keiser says and support his efforts to bring important information to the attention of as many people as possible, but this is an argument I do not agree with. However, because it is a good example of the circular “freedom = free markets = democracy” meme so virally ensconced in the public’s imagination, and spreading worldwide since the collapse of “communism,” it presents me with an opportunity too nice to ignore.

The roaring twenties was a speculation-led bubble that directly created the 1929 crash, which itself gave us the Great Depression, so to see that period as somehow economically healthy is somewhat specious. Furthermore, there is a lot of debate about whether intervention or non-intervention turned what might otherwise have been merely a mini-recession into a multi-year depression, but neither of these objections is what I want to tackle here. What troubles me is this idea of the free market. What does that actually mean, in detail?

To my mind it would mean, in pure form at least, no rules whatsoever, which would mean all synthetic derivatives and any trading of anything — including kiddy-porn, snuff movies, cocaine, heroin — would be okay, as would Wild West style gangsterism and true, hard-man, survival of the fittest punch-ups by any means imaginable. If only the fittest survive, in terms of ruthlessness, brawn, intelligence, cunning etc., that can only be good, right? Children working in factories, slavery, genocide of unneeded human excess, the whole nine yards. Those who survive that kind of a market place really would be deserving of their precious existence. But no one in their right mind advocates such a world. So what are free markets?

A free market is one in which the settled rule of law operates in the interest of effective and honest trading. So free markets need laws, which are tricky, complex things full of devilish details and convenient loopholes at the best of times, and subject to revision and interpretation — change is the only constant. The Market therefore needs the help of a legislature and executive that properly understand it (very problematic because politicians don’t work in the markets), the legislature and executive themselves needing money to operate at all. This money must of course come from the business activity of the market via taxation and donation.

So we necessarily have a State-Market partnership which exists in a system whose principal quality is the pursual of success as denoted by material acquisition and wealth. Ever-present in this system as an ongoing pressure towards corruption is money, and, by definition, that being rich is better than being poor. Out of this bizarrely supposed separation of Market and State there is, to my mind, simply no way a free market can exist. There has never been one, and will never be one; intervention is essential, corruption inevitable.

As I have argued before, markets are monopoly/oligopoly/cartel creating processes. They are predicated on competition, which means winners and losers, and the winners slowly gain sufficient power to control the market to their advantage. Nice guys finish last. Greed is good. Greed cuts through. Being rich is better than being poor. The system is stimulated by its very nature to render perfect competition impossible, regardless of its intrinsic theoretical failings. Only perfect competition could produce a free market. A perfectly competitive market is composed of perfectly informed and rational market actors, both as buyers and sellers. This is not possible. If it were, markets probably wouldn’t need any laws.

Perfect competition and free markets are economics’ Utopia condition that can never be reached. Until they occur (and they never do), distribution of goods and services will not be efficient (i.e. built-in obsolescence), will be unfair, and we will get poverty, war, and the many other unsavoury aspects of all monetary socioeconomic models. Even Adam Smith, a passionate advocate of free markets, recognised this:

“To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or Utopia should ever be established in it. Not only the prejudices of the public, but, what is much more unconquerable, the private interests of many individuals, irresistibly oppose it.”

And:

“People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”

There is no way to prevent conspiracy, fraud, or any other type of corruption that the human imagination can conceive of, except through intervention by the State in the Market, such intervention always being, of course, very imperfect. And because the State must intervene, there is necessarily a close relationship between it and the Market (to my mind they are two sides of the same coin and share many characteristics). It is in the Market’s interest — because the name of the game is to acquire wealth — to pressure government to enact law in its favour. This dynamic is inescapable.

Unless we pursue true abundance globally and establish an economics without price. In the same way that Open Source Software and Wikipedia are self-organising and non-monetary in their internal operations, so resource distribution can be too. Now that we can technically produce abundance, the only way to distribute goods and services fairly is by transcending the price system. We just have to learn how to want this, culturally, voluntarily, and then go for it.

Of shorting, naked and otherwise

“You mean just like those wonderful "CDOs" that Goldman (and others) created that were in fact fully synthetic instruments and which came into being ONLY because someone wanted to SHORT your house?” Karl Denninger

Shorting (from Wikipedia):

“In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to the lender. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as he will pay less to buy the assets than he received on selling them”

Ellen Brown discusses naked short selling – short selling's ugly sister – in her very informative and eye-opening book “Web of Debt”, relating the following story, which she trawled from the SEC's online archives. In 2005 a gentlemen by the name of Robert Simpson purchased all remaining 1,000,000 shares of a small company and put them in the proverbial sock drawer at home. He watched in astonishment as the self-same shares traded 60 times each over the next 2 days. 60,000,000 transactions of those shares he had about his person, so to speak. To quote Brown:

“The incident substantiated allegations that a staggering number of “phantom” shares are being traded around by brokers in naked short sales.”

While in shorting there is at least the sense of borrowing in the transaction, there is something distastefully opportunistic about it, and done in great mass can shift the market down. Naked short selling is still more nefarious, with trades of shares the broker neither owns nor has use of taking place. But the legality, criminality, immorality or otherwise of such actions is, to me, of secondary importance to the obvious weighty blow such trades and market activities deal to the cherished idea of the perfect market, and to the idea that unregulated and unrestricted buying and selling, via the mythical “invisible hand,” ends up benefiting everyone, young and old, rich and poor, black and white. That tired old argument of market efficiency, trotted out by free marketeers of every stripe in a bewildering variety of forms, is not only fallacious on the face of it, it is also destroyed by the very greed which is supposed to lead to such benign efficiency.

The perfect market, only possible when every participant is perfectly rational and informed, cannot exist. The speed, complexity and enormity of market activity today makes perfectly informed market participants even more of a laughable idea than it was in days of yore. Add to that the skill and power of advertising, the increasing division of labour and automation that makes it almost impossible to judge knowledgeably the actual value (all definitions of value aside for the moment) of things like iPods and laptops, and you have an even greater gap between theoretical and actual. Consumers and buyers are adrift on a sea of shimmering manipulations while, in the background, price, value, wealth, and ultimately social integrity are the play things of the sociopathically greedy in pursuit of ever more power.

Ideally the perfect market prevents the formation of monopolistic power, which distorts the proper (or wished for) functioning of that market. Since there can be no such thing as a perfect market, we have monopolies. We always have, and always will. Unless, that is, we transcend money and its now overwhelmingly negative effects, by rendering it an unnecessary tool via abundance.

Even Adam Smith, father of The Invisible Hand, though he had no idea of the state we would be in today, nor of alternatives such as a resource-based economy, knew well the importance of human wisdom over 200 years ago:

“The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy: but the mean rapacity, the monopolizing spirit, of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot, perhaps, be corrected, may very easily be prevented from disturbing the tranquility of anybody but themselves.”

Smith's warm views on intervention aside, to my mind the regulation/deregulation debate is a distraction, as are others of its ilk (such as fiat or gold backed currency). We live in a mesh of assumptions and myths about money, value, labour, efficiency, scarcity and our very natures which is strangling us to death. Applying the study and research required to break out of this mesh, and then begin the hard work of forging a new paradigm, is an obligation we all share, if the better future we are technically so capable of is to be realized. That, or more of the same tending to worse, and very possibly to collapse. It's up to us.