Finance and the world

One of the highlights of my career as a  financial journalist was a trip to the Chicago Board of Trade in its open outcry days. It must have been around 1993. I can still remember the physical sensation caused by the explosion of the noise of human voices shouting orders in the huge trading pits as soon as the bell rang. It was an extraordinary experience. But one shouldn’t romanticise open outcry. And as Donald Mackenzie records in Trading at the Speed of Light, one CME trader said to him after the closing bell had rung (this was in 2000): “Look at my glasses. They’re all dirty.” Flecked with spittle from the shouting melee.

I loved this book. I’ve been a keen follower of Prof Mackenzie’s research on high frequency trading since his early articles in the London Review of Books as well as a previous book, An Engine, Not A Camera. Prof Mackenzie describes his research endeavour as ‘material political economy’, and it concerns the interaction between the physics and (literal) construction of financial markets, and specifically HFT, and regulatory or political decisions, or power relations.

HFT is a world which is Einsteinian: the speed of light is the constraint on trade, and what traders (human or algorithmic) know about the market is determined by their physical location and physical connectivity: where are they, to the millimetre; how close to a geodesic curve is their communications connection (and is it fibre optic or wireless or microwave); is it raining (which interferes with certain parts of the radio spectrum more than others); to what extent have they programmed trading activities into hardware (chips and C++) for speed?

I’ve always been deeply fascinated by the physical dependencies and consequences of the online world. For example, I was right to predict in The Weightless World that – rather than the death of distance – digitalisation would enhance the agglomeration effects that concentrated people in certain places (we will see if this changes post-pandemic but I’d still reckon not.) Currently I’m somewhat preoccupied with where the internet is, and with the huge physical investments Big Tech companies have made, the weight of digital activity on climate and minerals.

Trading at the Speed of Light is an amazing, detailed account of why material reality matters for virtual outcomes, and conversely, in the financial markets. Everybody with the slightest interest in modern finance should read it (Prof Mackenzie helpfully flags sections that are technical enough to be readily skipped). The book is based on years’-worth of interviews and attending conferences and visiting remote data centres and masts, snapping photos.

The book describes the arms-race of speed and pushing ever-closer to physical limits. A key interview quotation appears mid-way: “I don’t think there’s any other industry than the finance industry that can pay for it ….It’s mind-numbing to look at this whole industry where you have a lot of people with extended training that spend night and day shaving nanoseconds. Where, if you could put that brainpower to something else, maybe somehthing different……”

Indeed. And yet the HFT we have today is the product of decisions taken by people, politicians persuaded by lobbyists. One of the things I learned from the book is that forex trading remains far more artisanal than share trading, albeit still automated. Alas, this was because of the political power of the banks involved rather than anybody’s deep foresight. Human decisions shape markets shape the world, but the consequences are rarely if ever forseen.

Who knows where it will all end (although, presumably, not well). The book ends by pointing out that ‘material political economy’ is the right lens to turn on both crypto (energy-devouring, CO2-spewing monsters) and the world of Big Tech with its datacentres and algorithmic advertising market. At least in these two cases, regulators are perhaps more aware of the societal challenges than their equivalents were in the early days of algorithmic share and futures trading. But it’s a good while since financial markets served their societies rather than predating on them.

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In August we’re going to have a week’s holiday, and I’ll also be declining all but the most absolutely urgent online meetings, so am looking forward to some reading. The pile of books to read is very satisfying.

Meanwhile, this week I’ve enjoyed the newly-published Boom and Bust: A Global History of Financial Bubbles by William Quinn and John Turner. The book recounts the history of 10 bubbles in history, some well known – the South Sea Bubble, Wall Street in the 20s – others less so – I for one had never heard of the British Bicycle Mania of the late 1890s. It also ranges from 19th century Australia to modern China.

Each episode is set in the context of a framework described in the first chapter, the Bubble Triangle. These are the three necessary conditions for a bubble to take off: good marketability of the assets involved; abundant money & credit; and large numbers of speculators. With these in place, they argue there are two potential sparks: technology (radio in the 1920s, bicycle innovations in the 1890s) or politics (often, governments seeking to engineer higher asset prices to meet a policy goal, such as encourgang home ownership (the early to mid 2000s) or reducing government debt (John Law in France in the 1760s).

This is a very nice framework, and the book is an enjoyable read, its large array of references kept unobtrusive while testimony to the amount of research that has gone into it. There are some interesting points along the way. For example, the authors argue that the form of railway network shaped by the railway mania of 1848 locked in inefficiencies “which have plagued British railways down to the present day.” Other, less laissez faire, countries invested in a better planned and less duplicative network at lower cost. In Britain, they argue, politicians were too accomodating to constituency interests rather than able to plan a national network.

However, they also highlight the distinction between bubbles sparked by technology and those sparked by politics: “Technology bubbles often involve large sums of money flowing into extremely innovative sectors of the economy, which might otherwise have trouble getting off the ground.” During political bubbles, the money flows into sectors where there are few positive externalities.

The book ends by returning to the Bubble Triangle as a means of predicting when a bubble might occur and some discussion of policy choices – to avert the bubble (hard, with the political ones), or clean up afer it? The final chapter includes a discussion of the role of the media, whose role during bubbles has not always been blameless.

All in all, a great read and a great addition to the literature on financial bubbles.

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Finance, the state and innovation

Yesterday brought the launch of a new and revised edition of Doing Capitalism in the Innovation Economy by William Janeway. Anybody who read the first (2012) edition will recall the theme of the ‘three player game’ – market innovators, speculators and the state – informed by Keynes and Minsky as well as Janeway’s own experience combining an economics PhD with his experience shaping the world of venture capital investment.

The term refers to how the complicated interactions between government, providers of finance and capitalists drive technological innovation and economic growth. The overlapping institutions create an inherently fragile system, the book argues – and also a contingent one. Things can easily turn out differently.

The book starts with a more descriptive first half, including Janeway’s “Cash and Control” approach to investing in new technologies, and also an account of how the three players in the US shaped the computer revolution. This is an admirably clear but nuanced history emphasising the important role of the state – through defense spending in particular – but also the equally vital private sector involvement. I find this sense of the complicated and path dependent interplay far more persuasive than simplistic accounts emphasising either the government or the market.

The second half of the book takes an analytical turn, covering financial instability, and the role of state action. It’s fair to say Janeway is not a fan of much of mainstream economic theory (at least macro and financial economics). He includes a good deal of economic history, and Carlota Perez features alongside Minsky in this account.

The years between the two editions of the book, characterised by sluggish growth, flatlining productivity, and also extraordinary changes in the economy and society brought about by technology perhaps underline the reasons for this lack of esteem. After all, there do seem to be some intractable ‘puzzles’, and meanwhile, just in time for publication, Italy looks like it might be kciking off the Euro/banking crisis again. The experience of the past few years also helps explain the rationale for a second edition. That’s quite a lot of economic history and structural change packed into half a decade.

Although I read the first edition, I’m enjoying the second as well. And for those who didn’t read the book first time around, there’s a treat in store.

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The culture of finance

Shelia Kolhatkar’s Black Edge is a cracking good read about how the growth of hedge funds was rocket-fuelled by their extensive reliance on insider trading. The focus of the story is Steve Cohen’s SAC capital. The abuse was enabled by the fact that the regulators were slow to cotton on to the scale and interconnections of the sector, and by the presence at the head of the SEC at the time a Bush-appointed free marketeer who thought the government should keep out of the way of the markets. The book reads like a thriller (leaving just the usual slight uneasiness about how the author knows what people were feeling, and wondering who spilled the beans out of two people in a reported conversation).

It left me reflecting about the culture of financial markets and how quickly and extensively unethical and illegal behaviour spread, like a rampant infection, after the deregulatory turn in the US and UK. Perhaps the obvious conclusion is that a culture of eternal vigilance is necessary in finance, and there was something sensible about the extremely strong cultural prohibitions applying to finance in times past. It is interesting, and sobering, to note how much the main characters in this sorry saga act just like homo economicus.

The authorities did eventually charge Cohen with failing to prevent insider trading; SAC was fined Capital and the fund was closed. Cohen is active again in the markets and a super-wealthy man.

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Wise and foolish finance

I’ve thoroughly enjoyed reading The Wisdom of Finance by Mihir Desai. It aims to humanise finance in two ways. One is by pointing out to non-finance folk that finance is dealing with inescapable aspects of the human condition: risk and uncertainty, asymmetric information, values, stewardship for the future. The other is by pointing out to finance folk how finance can and should serve society.

The approach is to draw examples from literature and history – and films and TV shows – demonstrating the way financial techniques absolutely permeate life. The cultural references range from The Simpsons to Jane Austen, Euripides to Bob Dylan, linked to recent events in business and the financial markets. The book starts with the fundamentals: insurance against risk, opening with The Maltese Falcon. It goes on to discuss options, valuation, leverage, and M&A.These chapters have lots of examples that could prove useful in the classroom, as well as being an enjoyable read.

The latter part of the book takes a more philosophical turn, and rather than explaining finance to the uninitiated reflects more on the character of the financial sector and the motivations of those who work in it. What drives people to lead highly leveraged personal existences rather than opting for simplicity (taking leverage broadly to mean building interdependence with other people in order to benefit from their skills or resources – and correspondingly owe them commitments in return)? Is it always possible to identify the ‘right’ course of action in a context such as financial failure or takeovers? Here the book quotes Martha Nussbaum:

“To be a good human being is to have a kind of openness to the world, an ability to trust uncertain things beyond your own control that can lead you to be shattered in extreme circumstances, in circumstances for which you are not yourself to blame. And I think that says something very important about the condition of the ethical life. That it is based on a trust in the uncertain, a willingness to be exposed.”

Needless to say, this almost existential openness is not what comes to mind when we think of finance, of Enron, Madoff, the sub-prime frauds. So Desai ends by pondering – without reaching a firm conclusion  –  what makes so many people in the financial markets so unethical, or at least driven by selfishness and greed. He also gives us a wonderful model of an ethical financier. It is Alexandra Bergson in Willa Cather’s O Pioneers!, the homesteader who borrows to invest and brings the land to life. What a great example. I devoured Willa Cather’s books some 30 years ago and had forgotten about them. It sin’t finance that’s good or bad, it’s people.

The Wisdom of Finance ends with a nice afterword pleading for inter-disciplinary alertness, citing C.P.Snow’s famous The Two Cultures and E.O.Wilson’s Conscilience, both excellent books.

All in all, highly recommended, for those who already know a lot about finance, and those who don’t.

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