Two problems plague the analysis of the financial system, problems that are related. Let’s call them the twin delusions. One is the persistent use of metaphors to characterise what is happening in the markets by people who do not seem to understand what a metaphor is, so they are seduced by them. The second is the mathematicisation of transactions, which creates the illusion that “the system” can be analysed as if it is like a physical system subject to scientific laws.
Let’s go to some basic definitions — to quote Marcus Aurelius: “What is it, what does it do?” Financial and economic markets are TRANSACTIONS. GDP, for instance, is not an indicator of wealth, or consumption, or growth. It is a recording of transactions. If there is a property bubble, for instance, consumption and wealth might actually fall, as people transact more aggressively over an existing stock of dwellings. I can remember an economist was asked by the Nebraska state government how to raise the state’s GDP. His response was: “Well, you could burn down the Capitol building.” He was right, of course. That is why, for instance, GDP in Japan rose after their tsunami. As people cleaned up the mess, they transacted more.
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This is where the twin delusions hit. To characterise transactions metaphors are created, or the transactions are turned into a metaphor. So, we talk of national GDP as if it is a metaphor for the nation.
“Australia’s GDP went up 3%” = “Australia is doing well.”
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This sounds very different from “Australians transacted 3% more” and allows the army of economic pundits to acquire an authority about their analysis of Australian GDP, analyses which become self reinforcing. Australia’s GDP is rising, therefore Australians are doing well therefore Australians are more confident therefore Australians do well.
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The second of the twin delusions is to mathematicise the recording of the transactions. So, for instance, economic transactions such as GDP, which is a number, can be cross referenced with other numbers in the financial sphere, such as interest rates, or currency transactions.
“Interest rates fell and GDP went up so that must be an indication of XYZ ratio., especially when we look at the $A cross-rate ….”
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Such correlations may be correct – mathematicisation is nor necessarily wrong, it can be right. But the illusion is created that these correlations are necessary, like physical laws. That is far from inevitable. Except for the purely computer driven activity (admittedly becoming increasingly dominant) transactions are created by people. People have to decide that there is some shared value system and minimum level of trust to engage in a transact. I often think that the word is interesting: trans (across) act (an act). I wonder “across what?” The answer must be some shared belief about value. So when that belief starts to come apart, such as during the GFC, the artifice starts to fall to bits, the “system” starts to disintegrate.
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The point about the twin delusions is that they take us a step away from the fact. The fact is that transactional systems are a human artifice conducted by humans. Humans are at its centre. And humans produce that wonderfully unpredictable thing: HUMAN BEHAVIOUR. They are self conscious, unpredictable, they feel more strongly about losing money than gaining it and so on, as an Economist article points out.
“To take one example, the “people” in economic models have fixed preferences, which are taken as given. Yet a large body of research from cognitive psychology shows that preferences are in fact rather fluid. People value mundane things much more highly when they think of them as somehow “their own”: they insist on a much higher price for a coffee cup they think of as theirs, for instance, than for an identical one that isn’t.”People are also capable of understanding metaphors and mathematics, which produces a kind of infinite regress in the twin delusions of metaphors and mathematical analyses. That is one reason why conventional analyses of markets are so often wrong.
Columbia University economist Jeffrey Sachs recently commented that the financial system is plagued by large scale fraud . He blamed it on a docile president, a docile Whote House and docile regulators;
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“We have a corrupt politics to the core, I am afraid to say, and . . . both parties are up to their neck in this. This has nothing to do with Democrats or Republicans,” Sachs told the Philadelphia conference, “Fixing the Banking System for Good.”Sachs described an environment of Wall Street buying off politicians with their huge campaign contributions. In the 2012 election cycle, political contributions by the securities and investment sector totaled some $271.5 million, compared with $176 million in 2008, according to the Center for Responsive Politics.“I meet a lot of these people on Wall Street on a regular basis right now,” Sachs told the conference, hosted earlier this month by the nonprofit Global Interdependence Center. “I am going to put it very bluntly: I regard the moral environment as pathological. And I am talking about the human interactions . . . I’ve not seen anything like this, not felt it so palpably.”
Sachs is right in his observations, of course. But I am not sure he is right to imply that it is new. I think Greed and Wall Street have been bedfellows as long as Wall Street has existed.
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What, I think, is new is the way the “pathology” is concealed. It is easy to cover up greed and its immorality by either deploying a metaphor – “these are the way the capital “flows” are going and we have to invest accordingly – or by creating a mathematical equation. In both cases the activity is pushed one step away from what it is – an activity between humans – and so decoupled from anything human such as morality, or ethics or what is good for society. By being denuded of its human element, scientised, as it were, the question of personal responsibility is removed. In other words, the greed is not new. It is the sophistication of the cover up that is new.
That is what the twin delusions enable:
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“Sachs said these same people on Wall Street are out to make billions of dollars, and believe nothing should stop them from doing that. “They have no responsibility to pay taxes; they have no responsibility to their clients; they have no responsibility to people, to counterparties in transactions,” he said. “They are tough, greedy, aggressive and feel absolutely out of control in a quite literal sense, and they have gamed the system to a remarkable extent.”Sachs’ outburst stunned the crowd. “There was an initial shudder, is how I would describe it, because they could feel the passion that was in the discussion,” said attendee Dennis Peacocke, head of Strategic Christian Services, a religious group that advocates on topics of economic and social justice. “Jeffery Sachs’ comments were full of conviction. I was applauding him for bringing values and ethics into the discussion.”