In addition to revolutionizing the banking system and accelerating the international movement of money, it was the power of computing that made possible the explosive development of a whole new wave of sophisticated "products" called "financial derivatives" in the nineties. Since 2008, we have all heard about them, and they are usually hard to understand.
The essence of these "products" is supposed to be the opportunity to tease apart the different elements of risk, and market them separately. For example, if one buys the yen denominated bonds of a Japanese company, there are at least three separate risks involved. There is the risk that the value of the yen will change relative to one's own money. There is the risk that Japanese interest rates will change (at the discretion of the Japanese central bank. Remember that the value of one's bond, which pays a certain interest rate, will fall if the general interest rates in the community move up) There is the risk that the company itself is poorly managed, and defaults on its agreement to pay interest on its bonds. As an investor, you may be comfortable with your ability to judge the management of the company, but not so sure of your ability to assess the forces at work moving the Japanese central bank's position on interest rates, and not so sure you understand the forces operating on the value of the yen.
Bernard Lietaer compares this with a technology that would allow you (instead of just going to a concert) to choose your favorite tenor, your favorite violinist, your favorite conductor, and have them interpret your favorite opera. If you knew what you were doing, you might come up with a fantastic performance. Similarly, you might create a stupendous investment portfolio- you could buy shares in the company and shelter yourself against the volatility in the currency and interest rates. However, when it comes to separating the elements of risk for your personal investment portfolio, it seems that most people are really not up to this level of complexity.
In fact, it seems to me that we have all now heard way too much about financial derivatives. It seems to me that even most of the so-called professionals (in AIG, and Lehman brothers, etc.etc. etc/) didn't know what they were selling. Those who end up holding the most risk are usually the least capable of managing it, but in our recent financial melt-down, even those who were supposed to be sophisticates didn't know what they were doing. "Financial engineers" developed complex mathematical formulas about risk, and in the end, they choose to live in a world that has very little contact with ordinary human life. So they missed the big picture and we all went down the financial drain.
Once upon a time, a local bank offered local mortgages to people in the community who were thought to be a good bet to repay their loan. In those far off days, people had to come up with a sizable down payment as well, for the purpose of demonstrating their competence in the world of money. During the recent real estate bubble, banks "packaged" large numbers of mortgages ("pooled" them) and sold them off in "sections". A very small percentage of mortgage holders traditionally defaulted, and the "sections" could be sold for different prices depending on whether the buyers were willing to take a higher risk or wanted a lower one. The buyers who were willing to take a higher risk got higher interest. And so forth. But as we have seen, the end result was often that nobody knew who owned one particular mortgage (since they had all been pooled)
Bernard Lietaer wrote that these financial derivatives have come to stay, because used correctly, they are highly profitable. That part rings true for what I see as the shark pool of the professional financial world, whose interest appears to be profit no matter what the cost. He also says that used correctly financial derivatives are a benefit to society. I must say, the benefit is not clear to me, but I will keep reading. We are not going to put the computer genie back in the box, and there has always been more complexity than any of us can manage.
Sunday, January 30, 2011
Monday, January 10, 2011
Why are we seeing all this speculation?
The extraordinary growth of speculation began in 1971, when Richard Nixon removed the link between the dollar and gold. Bernard Lietaer was one of the few to originally understand and profit mightily from the newly unregulated market, as he recounts in "Credentials of a Flying Fish"
In the eighties Margaret Thatcher and Ronald Reagan deregulated the financial markets, and the Baker Plan extended this deregulation to sixteen developing countries. The deregulation permitted a much wider group of players to trade in the currency markets.
Michael Durbin, author of “All About High-Frequency Trading," is quoted in the New York Times (Jan 2011) as saying that most of the industry is legitimate and benefits investors, but " the rules need to be strengthened to curb some disturbing practices....markets are there for capital formation and long-term investment, not for gaming.” In fact, gaming has long since overtaken the markets, with great increases in volatility. This is contrary to what was expected and hoped for by the original deregulators, who really did believe that "the invisible hand of the market" would encourage stability. Stability is the enemy of traders, whose profits come from fluctuations.
On one hand, technological change (computers and the internet) has led in some ways to a fairer market. To-day, broker's commissions are often negligible, one can execute a trade from a mobile anywhere on the planet, and much more information is available about companies to anyone who cares to read.
On the other hand, no one, including the regulators, knows how to manage the unparalleled speed, volume and volatility of these markets. Speaking in December 2010, Bart Chilton, a member of the futures trading commission, addressed the advent of what he called "Star Trek gee-whiz high frequency trading. technology.... one of the most game-changing and tumultuous shifts we have ever seen in financial markets.”
The Welsh economist Glyn Davies researched 5000 years of monetary history for his 1994 book, A History Of Money From Ancient Times To The Present Day. He concluded that there had been only two truly "game-changing" developments. At the end of the Middle Ages, the printing of paper money superceded the minting of coin, and banks took over the privilege of issuing money from monarchs. Today, with the development of electronic transfer of funds, a great battle is underway to control these new forms of money. Banks have become computerized telecoms, while telecoms, credit card processors, and internet merchants have discovered they can offer the same services as banks. Nobody knows what the consequences will be.
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Wednesday, January 5, 2011
Your treasure will be safe
"Sell what you have and give to those in need. This will store up treasure for you in heaven! And the purses of heaven have no holes in them. Your treasure will be safe--no thief can steal it and no moth can destroy it."-Luke 12:33
My parents considered debt a fearful state- always to be avoided. Their families had been administrators, military adventurers, farmers and merchants in England, Africa, and America. They were part of that remarkable historical anomaly, the "middle class". In Ontario, in the 1950s, we learned that the rise of the middle class had provided an unusual and valuable stability to society. As a child, I thought that class distinctions were a matter of history. It wasn't until I went to McGill University in 1960 that I discovered the continued existence of an actual "upper class" whose fathers went on golfing holidays to Scotland, and whose siblings all attended a certain few schools.They seemed irrelevant to me.
My parent's families both had another stream, though: a stream of priests, nuns, and monastics, who followed Luke's advice, and whose attitude to the accumulation of wealth lay like a shadow across our acquisitive natures. When I entered medical school it was a kind of compromise with the call to the convent. I just wasn't willing to have a life without men, although it never occurred to me that medicine was an avenue for creating wealth. It was the opportunity to be of service without the requirement to relinquish all the pleasures of life!
Now that Bernard Lietaer's own website makes his remarkable contribution directly available to my friends, this blog is going to shift away from whatever constraint I felt about translating "The Future of Money". I am still following the book, because I want to really understand it. Some version of it ought to be an elementary school textbook about money. However, I am knitting up my own version as I go along. For the moment, the question is what to do about the accumulation of wealth. By sticking to my family's ideas of avoiding debt, I have accumulated some wealth: now I confront that perennial problem of the wealthy-what to do with it?
It is time we taught everyone money basics. There is a middle class mindset, and a lower class mindset, and both are steeped in ignorance of our money system. My college friends, the children of the wealthy, had some knowledge about real estate, bonds, trust funds, investing, and so forth. The girls had studied such things as interior decorating, and required husbands who could finance periodic skiing trips to Switzerland. They were generous and unworried. They lived with plenty, and imagined a life of plenty. In spite of my own accumulation of wealth, I do not think that way.
A review of the means available for storing up one's earthly treasures creates an excellent background for understanding what is going on while our financial system does its endless alarming contortions.
In my lifetime cash has been a very poor way to store value. Between 1971 and 1996 the US dollar fell to 25 cents in value. This was not a particularly bad performance by the US.... it came17th out of 108 currencies- during that period the winner was Germany (100-42) and the loser Brazil (100-0) There have been some periods when money held value, but it's basically not a good plan to put cash under your mattress. Land was the traditional store of value ever since the hunter gatherers settled down to farming. With the arrival of the Industrial Era major wealth came to be associated with shareholding in enterprise-stocks and bonds. In recent times, both property ownership and stock-holding have led people to enormous losses.
Who seems left to be winning? Those would be the winners in the global casino created by deregulation and computerization in the past 30 years. Huge winners, huge losers, there is no safety here. If we desire some safety, we may need to rediscover our care for one another. This will likely be very interesting (there is an old saying "May you not live in interesting times") We live in interesting times.
My parents considered debt a fearful state- always to be avoided. Their families had been administrators, military adventurers, farmers and merchants in England, Africa, and America. They were part of that remarkable historical anomaly, the "middle class". In Ontario, in the 1950s, we learned that the rise of the middle class had provided an unusual and valuable stability to society. As a child, I thought that class distinctions were a matter of history. It wasn't until I went to McGill University in 1960 that I discovered the continued existence of an actual "upper class" whose fathers went on golfing holidays to Scotland, and whose siblings all attended a certain few schools.They seemed irrelevant to me.
My parent's families both had another stream, though: a stream of priests, nuns, and monastics, who followed Luke's advice, and whose attitude to the accumulation of wealth lay like a shadow across our acquisitive natures. When I entered medical school it was a kind of compromise with the call to the convent. I just wasn't willing to have a life without men, although it never occurred to me that medicine was an avenue for creating wealth. It was the opportunity to be of service without the requirement to relinquish all the pleasures of life!
Now that Bernard Lietaer's own website makes his remarkable contribution directly available to my friends, this blog is going to shift away from whatever constraint I felt about translating "The Future of Money". I am still following the book, because I want to really understand it. Some version of it ought to be an elementary school textbook about money. However, I am knitting up my own version as I go along. For the moment, the question is what to do about the accumulation of wealth. By sticking to my family's ideas of avoiding debt, I have accumulated some wealth: now I confront that perennial problem of the wealthy-what to do with it?
It is time we taught everyone money basics. There is a middle class mindset, and a lower class mindset, and both are steeped in ignorance of our money system. My college friends, the children of the wealthy, had some knowledge about real estate, bonds, trust funds, investing, and so forth. The girls had studied such things as interior decorating, and required husbands who could finance periodic skiing trips to Switzerland. They were generous and unworried. They lived with plenty, and imagined a life of plenty. In spite of my own accumulation of wealth, I do not think that way.
A review of the means available for storing up one's earthly treasures creates an excellent background for understanding what is going on while our financial system does its endless alarming contortions.
In my lifetime cash has been a very poor way to store value. Between 1971 and 1996 the US dollar fell to 25 cents in value. This was not a particularly bad performance by the US.... it came17th out of 108 currencies- during that period the winner was Germany (100-42) and the loser Brazil (100-0) There have been some periods when money held value, but it's basically not a good plan to put cash under your mattress. Land was the traditional store of value ever since the hunter gatherers settled down to farming. With the arrival of the Industrial Era major wealth came to be associated with shareholding in enterprise-stocks and bonds. In recent times, both property ownership and stock-holding have led people to enormous losses.
Who seems left to be winning? Those would be the winners in the global casino created by deregulation and computerization in the past 30 years. Huge winners, huge losers, there is no safety here. If we desire some safety, we may need to rediscover our care for one another. This will likely be very interesting (there is an old saying "May you not live in interesting times") We live in interesting times.
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