Yves here. I had come across the speech mentioned in this post, “The Race to Zero” by Andrew Haldane of the Bank of England and decided not to write it up because I had come across it a bit late. This post will probably persuade readers that that was a bad call.
By Sell on News, a macro equities analyst. Cross posted from MacroBusiness
Exactly how did we get into this mess with the capital markets? A situation where the global stock of derivatives is over $US600 trillion, which is about twice the capital stock of the world. A situation where high frequency trading is over two thirds of the transactions on the NYSE and about the same in the stock markets of the UK and Europe. Likewise they are over half the action in foreign exchange markets and they are rapidly becoming dominant in the futures market. Andrew Haldane from the Bank of England is arguing against allowing high frequency trading — algorithms chasing algorithms chasing algorithms — from being allowed to proliferate pointing at volatility as the problem:
Speed increases the risk of feasts and famines in market liquidity. HFT [high-frequency traders] contribute to the feast through lower bid-ask spreads. But they also contribute to the famine if their liquidity provision is fickle in situations of stress.
Haldane noted that relative to gross domestic product, the equity market capitalisation of the US, Europe and Asia had not grown since 2000, suggesting that “the contribution of equity markets to economic growth … has been static”.
Little wonder, when you consider that companies are putting themselves in the hands of algorithms.
I think this conclusion, which many come to, is to some extent a blind alley. Because the volume of transactions is higher — when it is claimed that it adds liquidity this is a circular argument, like saying “the more we trade the more we trade” — it should mean that “volatility” at least on basic measures, is lower. The trades are made around normative models so they will tend to re-inforce those norms. Right up until the moment when the market does not behave with regard to norms, and then they suddenly start doing weird things, such as the so called “Flash Crash”. So it is probably correct to say that there is less volatility. It is also beside the point.
A better question is: Why do we think liquidity is a good thing?” Answer, because it facilitates trade around the exchange of information. “Information about what?” one might then ask. “The company in which the investment is being made,” is the answer. Does algorithmic trading exchange information about the performance of the company? No, it is only working off information about trading behaviour. Ergo, it may increase “liquidity” but it is not fulfilling the purpose of liquidity.
That kind of shift to traders working mostly off what traders do, rather than assessing the value of what is being traded, has become an absolute plague. It has taken over most Western financial markets. Hedging, for example, used to be all about hedging bets to protect the underling exchanges (usually wheat, or pork bellies or physical things). Now, hedging is all about reading behaviour, which then leads to other hedging strategies that are based on reading the hedging behaviour, and so on.
So the disappearing point is part of the problem. In our “anthrosphere” we are increasingly staring at each other’s navels in the financial markets, trying to make money and sustainable wealth out of ether. That is part of the problem. Regulators forgetting what the PURPOSE of financial markets is and instead just trying to stay faithful to the technical explications of that purpose, or utility. A colossal abrogation of responsibility, in other words, fuelled by thoughtlessness or intellectual laziness (Haldane is a notable exception).
But I think there is another problem. A growing mismatch in TIME between financial markets and commerce or economic activity. I can remember in the currency meltdowns of the last 20 years how the explanations in retrospect for why Russia or Thailand or Mexico or Indonesia “deserved” what they got. They were always plausible enough, if usually circular arguments.
But then you looked at what happened to those economies that had experienced crises and the impact was completely out of alignment. In a matter of weeks, there would be a massive re-rating of the currencies. No economy changes that fast. The problems, if there were problems and sometimes it was just a trading fiction, had usually accumulated for years. After the crises, the economies would take years to recover from the shock. It seemed to me that the misalignment in time is what is fundamentally wrong with this kind of financial behaviour.
The misalignment is even more extreme with high frequency trading, where micro-seconds are the basic unit. How can the exchange of information about a stock occur in such small periods? Obviously they can’t. There is a mismatch. Money should be aligned with what it is supposed to be representing, and that includes aligned in its temporal structure. For at least two decades, that alignment has been progressively picked apart, and now it is reaching endemic proportions.
In terms of its intellectual origins, this has a lot to do with the quasi-scientific methods used by economists and financiers. In science, time is just a dimension of space. The point of creating scientific “rules” is to say that every TIME the rule applies. Time, in other words, has to be eliminated as a problem.
Which is why science applies so poorly to human behaviour, because humans are always changing in time. It is why scientific models have extremely limited application to markets, because every time things are different — at least in their timing. For instance, I may reasonably conclude that the $A will fall, and be right because it will probably revert back t a norm. But what I need to know to make money is the time it will happen.
What one notices about all the fundamental analyses is that, while persuasive, they are extremely limited because they don’t tell you when the predicted events will occur. Those traders who sniff “the times” often do much better.
Time, in other words, cannot be eliminated from human behaviour, it is front and centre.
Which is why I would submit that the misalignment in time between financial market instruments and that which they are supposed to represent is not just extremely dangerous, it is fundamentally inhuman.
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Which is why I would submit that the misalignment in time between financial market instruments and that which they are supposed to represent is not just extremely dangerous, it is fundamentally inhuman.
We know how all technocracy works, and especially that which is dedicated directly to serving greed.
Wherever there’s a fundamental contradiction between the pseudo-science and humanity (which is every time), the implication is always, not that the theory will be discarded, but that humanity must be tortured into the correct contortion.
Hitler said it for every elite, once and for all: “The task isn’t to adapt ideology to reality, but to adapt reality to ideology.”
Or in Hayek’s version (paraphrasing): “If my idea is put into practice and doesn’t work, that’s not because my idea is wrong, but because it wasn’t applied rigorously and severely enough.”
That’s, for example, the IMF’s party line on why its every action throughout its existence has done nothing but increase poverty and suffering and demolish productivity and democracy.
And here we have this example:
Why do we think liquidity is a good thing?” Answer, because it facilitates trade around the exchange of information. “Information about what?” one might then ask. “The company in which the investment is being made,” is the answer. Does algorithmic trading exchange information about the performance of the company? No, it is only working off information about trading behaviour. Ergo, it may increase “liquidity” but it is not fulfilling the purpose of liquidity.
That kind of shift to traders working mostly off what traders do, rather than assessing the value of what is being traded, has become an absolute plague. It has taken over most Western financial markets. Hedging, for example, used to be all about hedging bets to protect the underling exchanges (usually wheat, or pork bellies or physical things). Now, hedging is all about reading behaviour, which then leads to other hedging strategies that are based on reading the hedging behaviour, and so on.
Does this prove that trading doesn’t do what was theoretically claimed for it, and should therefore be outlawed (since its destructive effects are proven)? Of course not! That merely means we haven’t given the traders enough license. Failure and destruction always mean double down, in the blackjack charts the elites show us.
This applies on a broader scale than just economics. We see it everywhere in politics as well. No matter how many times various processes and forms are proven not to accomplish what theory claims they can accomplish, their devotees remain devoted to them.
The biggest and most important example is faith in representative government itself (representation fundamentalism).
On a more picayune level, there’s the way much of liberalism has become a slavish fetishizing of “process” with zero concern for outcomes or the substance of principle. “Getting a seat at the table” is literally a primary goal.
Exactly.
Well… to distill what you’re saying further: what we need is economics based in use value.
But in such an economy (an “economy of solidarity” such as that advocated by the 200-million member Via Campesina, whose claim to food sovereignty is now enshrined in several countries’ constitutions and part-recognized by the UN) I’m not sure there’s much place for stock trading at all.
Personally, it seems what we are seeing is the taking of the world economy by “financial sector”, product be damned..
..paper debt…trading of, leveraging of, borrowing based on, to collude with others manipulating mostly emerging markets through micro-second trading, not only unavailable to others=all, information regarding unavailable to others=all…(as Yves noted in “ECONned”..)
But in such an economy I’m not sure there’s much place for stock trading at all.
None at all. It would be a productive, human economy. Purged of parasites.
“…it is fundamentally inhuman.”
And they said the Technological Singularity would be unpredictable.
Amazing post Yves, thanks.
yes, very, very important post imo..
A very nice point.
One wonders what would be against executing all trades simultaneously once every second or few seconds. The stock exchanges wouldn’t like it, obviously, as they could no longer earn money by selling colocated server space, and neither would the banks, but it seems nice to fantasize about stuff like that sometimes.
“Andrew Haldane from the Bank of England is arguing against allowing high frequency trading … from being allowed to proliferate pointing at volatility as the problem.”
Well, sure, HFT has meant volatility problems, and it allows trading absolutely detached from market fundamentals — and if that’s true, what’s the point of such a stock market?
Most perniciously, however, HFT has allowed the creation of a Potemkin stock market over the last three years, which has in turn enabled many MSM business outlets to continually sell a ‘recovering’ U.S. economy where very large numbers of Americans aren’t going to the wall, though in reality the wall is exactly where those Americans are going.
http://en.wikipedia.org/wiki/Potemkin_village
Washington and Wall Street have colluded happily on what would be recognized — if this iteration of the technologies and techniques involved weren’t ahead of the grasp of most folks and of the regulators’ brief — as market manipulation on a massive scale. The Zero Hedge crowd may be wacked out about many things, but on this particular score they are right. They are right. They are right.
And it’s very telling that this administration in DC seems perfectly okay with the fact that, in return for helping to provide a (relatively) happy-face Potemkin market, the financial industry gets to use HFT as, effectively, another financial industry tax on real trading, skimming millions every day from regular pension fund and mom-and-pop investors, etc.
As the article above notes, the main argument HFT defenders offer is that it brings vastly greater liquidity to the market.
But what kind of liquidity? The article has vague complaints about HFT creating ‘structural mismatches’ and being ‘fundamentally inhuman.’ No, it’s worse than that. The liquidity HFT provides is the kind that, if it were healthcare insurance, would be healthcare insurance set up so that just when you suffer an illness or injury and need it is precisely when it disappears.
Here’s an interview with as an establishment figure as you can get, a former Nasdaq Stock Market president and thirty-year veteran of the industry called Alfred R. Berkeley III: –
http://www.tradersmagazine.com/news/pipeline-blocks-high-frequency-trading-al-berkeley-104059-1.html?zkPrintable=true
Berkeley: A recent TABB Group report said that 73 percent of trading is attributed to high-frequency traders.… We have optimized our market for hedge funds to make money. How do they make money? They front-run institutional trades. Traditional long-only traders have had to go into defensive mode.’
Interviewer: ‘Does high-frequency trading have an impact on the quality of liquidity in the market?’
Berkeley: ‘Of course it does. The best way to see that is to look at the size at the inside and see how many orders are canceled when it looks like momentum is going from the buyer to the seller. And the average trade size is just lousy.…’
Got that? The money quote is ‘see how many orders are canceled when it looks like momentum is going from the buyer to the seller.’
Better to think of this so-called liquidity as churn.
What sort of churn is it, though? Clearly, much of the ‘liquidity’ high frequency traders are adding to the mix is simply to match trades created by other HFT traders.
Furthermore, there’s no way that Goldman Sachs’s Sigma X, or any of the other HFT players can absolutely ensure that their algorithms are not trading with themselves.
Really, how can GS ensure it’s not trading with itself — for example, either a different arm of GS or another batch of computers running another algorithm?
In fact, insider esimates are internal order matching happens all the time in dark pools. With Sigma X estimates being around 50 percent when I looked in 2009.
And this is legal —
Rule 17A-7: “Exemption of Certain Purchase or Sale Transactions Between an Investment Company and Certain Affiliated Persons Thereof.”.
http://www.law.uc.edu/CCL/InvCoRls/rule17a-7.html
Effectively, then, HFT players could just split their prop. desks into two or more groups and then trade a single stock back and forth. As long as the desired result is achieved — that is, off-loading the artificially ramped-up shares onto third parties at the end of the day — they don’t need to care. It’s the ultimate churn machine.
I once had a 1950 Dodge that exhibited a fascinating steering characteristic. If one turned the steering wheel sharply to the left and then quickly turned loose, it would a larger over-correct to the right, which would then cause greater over-correction to the left, etc. (continually greater correction back and forth leading to a total loss of control.) I know little about HFT, but I wonder if a set of algorithms could generate that sort of parasitic oscillation in the stock market.
It would be a great way to bring down the country if one had a mind to do so.
Best way to look at HFT is they’re the new marketmakers.
The specialist used to have first look, and in return was not supposed to front-run and was supposed to step in to some degree to keep orderly flow.
HFTs now have first look, and are quicker and smarter and can do instant stat-arb calculations based on what’s going on in many related markets.
But… they have a lot more freedom to game the system, and they step away when the markets start trading outside normal historical patterns that the algorithms understand. I’m sure they provide a lot of liquidity when things are normal, it’s what happens when things get weird that’s the problem.
Maybe the answer is to say you can keep having first look, but always have to provide a two way market in some spread and size.
“When things get wierd, the wierd turn pro”..
There is so much not to like about this that anyone with an ounce of platinum for brains would ask the trillion dollar question – what do we need this for and is it ANOTHER financial WMD?
For one thing I don’t know why they use these geeky names like Sigma X for these systems. It would be more fun to thumb your nose at the SEC and name it something like “I, Nelson Bunker Hunt Robot”. Let ’em know who’s in charge.
Then I am truly dumbfounded about where all the money comes from to do this. The global stock market cap is around $50 Trillion. Say the lion’s share of that is US and Euro stock. Take 70% of that and call it $20 trillion, give or take, in assets they are trading with?????? I don’t think they can all sell at market close like day traders did it in the old days. You would think that would make markets crash at 3:59 ET everyday. I really don’t get it.
hmmmnnn…it doesn’t matter if GS is trading with itself, so long as this raised prices…
this is even better than the oil futures collusion described by Gretchen Morgenson, 2004…between several “investment banks”..selling back and forth to one another to inflate prices at each trade..
Mark P:
“As the article above notes, the main argument HFT defenders offer is that it brings vastly greater liquidity to the market.
But what kind of liquidity? The article has vague complaints about HFT creating ‘structural mismatches’ and being ‘fundamentally inhuman.’ No, it’s worse than that. The liquidity HFT provides is the kind that, if it were healthcare insurance, would be healthcare insurance set up so that just when you suffer an illness or injury and need it is precisely when it disappears.’
Terrific analogy!!!
..terrific analogy, except that’s exactly what health insurance companies attempt to do, while leveraging the “time” factor..to death.
«As the article above notes, the main argument HFT defenders offer is that it brings vastly greater liquidity to the market.»
But how is that valuable? Liquidity is a purpose to an end, and the end is not enriching traders by enabling frontrunning of client trades (eheheheh) but boosting the real economy.
If advanced finance innovations (from HFT to derivatives) does have a net positive impact on the real economy it should be easy for their advocates to materially prove that, otherwise why bother with them? The burden of proof on untried, potentially dangerous stuff should be on proponents.
@Mark P.: “The liquidity HFT provides is the kind that, if it were healthcare insurance, would be healthcare insurance set up so that just when you suffer an illness or injury and need it is precisely when it disappears.”
So THAT’s how our healthcare system was set up. Exactly that has happened to millions of Americans. THANKS for explaining!
This is really just late stage cancer. The problem starts with interest rates set lower than market appreciation that creates speculative feedback loops pumping up the amount of money borrowed into existence in order to gamble, rather than invest. Now it’s just the tail wagging the dog, as this enormous amount of leverage overwhelms all other political and economic functions.
«The problem starts with interest rates set lower than market appreciation that creates speculative feedback loops pumping up the amount of money borrowed into existence in order to gamble, rather than invest.»
Excellent observation, but interest rates lower than investment returns are a deliberate policy goal as they result in ever increasing low or no tax capital gains.
Capital gains (and low wages) have been the main political demand of the middle and upper classes in the past 2-3 decades, to redistribute income from the exploitative working classes to the productive middle and upper classes, and politicians (including those running the Fed) are frantic in delivering them.
Exploitative lower classes? Are you joking? If not, try living at the bottom of the income for a while and see how it feels.
well said, John; that’s how it appears..
There are two deep factors at work.
1) The advances in data processing and communication have made this kind of hyper-speed trading possible. It is also in its nature very desirable for those involved. Profits over time are a function of how much you make doing something divided by how long it takes you. If you can make money in microseconds, even tiny amounts multiply out to huge amounts because they can be repeated so many times. There is no way to make that much money doing anything practical in the real world, so capital will tend to flow to this hyper-speed trading.
2) The elites in the most advanced economies have disintegrated in place over the past few decades. They are still there, but they no longer act in a coherent manner as elites as a whole. The different fragments act on their own, for their own.
This also means that they are defaulting on any and all social contracts (explicit or implicit) because there is no one there to hold up there end of the bargain.
I believe that the root cause of this is that the economy has long needed to transition to centering on knowledge production (in a very broad sense), but we do not yet know how to organize a society for that purpose*. And much of the “social technology” that we have that did work in the industrial phase just gets in the way now. The challenge we face is so fundamental and demands qualities so different from those our societies developed during the industrial era that we do not even realize that we are stuck in a cul-de-sac.
* To run a knowledge-centered economy, we must do two things simultaneously: turn the knowledge loose and appropriately motivate (compensate) those who produce, maintain, and distribute it. We can do one at a time, but not both.
From this perspective, much of what we now have of intellectual production is dependent on the creation of artificial knowledge scarcity, ie ignorance.
For any Tolkien geeks, we live in an era run by orcs. What I am pointing is the world of elves that our orcs are the poor, twisted imitation of. There is no Sauron. It is orcs all the way to the top. We just need to re-elf.
Super post!
To use another movie analogy orcs all want to be and envision themselves as Goldfinger or Blofeld when in reality they are the nameless lackeys who get shot in walk on roles.
“To run a knowledge-centered economy, we must do two things simultaneously: turn the knowledge loose and appropriately motivate (compensate) those who produce, maintain, and distribute it. We can do one at a time, but not both.”
We could pay people to educate themselves as much as they wanted. Start with the unemployed. Pay them slightly more if they go to an appropriate school. Let them study whatever they want. Pay the parents of children according to the grades they get. As they get older give the students an increasing portion of the pay. By college they get 100%.And by college the amount paid should be enough to provide for human necessities. Pay them more and more the farther they go and later according to what they produce in terms of scientific papers, musical compositions, novels, plays, movies, engineering designs, physical productions, crops grown, etc. Thus there would be near universal employment way better than 5% unemployment now counted as “full employment” The pay structure could transition into a market system as these knowledge workers begin producing. Manipulation of money to make money would not be seen as contributing to the group welfare and would not be paid as it is now. We could easily transition to such a system. But first most people would have to realize that the present system is seriously disfunctional, fast deteriorating, and probably doomed, as most Naked Capitalism readers already realize. Maybe the present system will colapse first.
When all else fails get out the Christian carrot n’ stick.
No one buys that shit anymore, zip it.
OK, let it be asome other kind of carrot and stick. Or, Let’s have no carrot and stick. Just pay people enough to have the human necessities of enough food, clothes, shelter, health care, education, etc. even if they don’t contribute anything. There will be enough people who do so that that won’t matter. Let human knowledge just evolve. Don’t encourage it. It will still evolve and increase, just not as fast. And zip it to you too.
Paying students on a scale loses sight of the fact (I’ve taught in states, and Europe) that U.S. capitalism=economics
cannot employ fully educated workforce:
In states Washington, Oregon, Idaho, circa 2001, stats show
average necessary wage for family of 4 to be $45,000.00 per year gross. But in these states, total number of jobs PAYING this “average” was only 20% of jobs, which correlates
to the 20% of Americans (and receding) graduating from 4 year university or vocational equivalent.
That number in Germany, for example, is over 70%.
Knowledge (like money) is a tool. Ultimately it only matters if it comes back into the world in some way that benefits people. An economy in which people accumulated knowledge but didn’t do anything worthwhile with it would be no better than what we have now — a few people accumulating vast sums of money while important work goes undone.
I am assuming as Jessica said, we “turn knowledge loose”, it should be as free as possible and available to everybody. This will accelerate the production of new knowledge. Knowledge builds upon knowledge. The benefits can easily come around to everybody.
hmm. I liked the elf chick, but you do realize the elf king was really Mr. Smith from the Matrix?
Oh, and we live under a vile enchantment that makes many of us wonder why our elites seem to act like orcs not elves and somehow not be able to see that it is because they _are_ orcs.
I get to use my 2 favorite quotes.
Today’s scientists have substituted mathematics for experiments, and they wander off through equation after equation, and eventually build a structure which has no relation to reality.
– Nikola Tesla
The problems are solved, not by giving new information, but by arranging what we have already known. Philosophy is a battle against the bewitchment of our intelligence by means of language.
– Ludwig Wittgenstein PHILOSOPHICAL INVESTIGATIONS Part I, Aphorism 109, 3rd Edition, G.E.M. Anscombe Translation.
Needless to say, algorithms are a unnatural language, but language none the less, which has now, through technological instrumentation, not only bewitched our intelligence, but our economic productivity. We have confused the ink on the page with meaning and truth.
Technology has already saved all of us, daily. Algorithms can be used as weapons if we’ve allow it, that’s what we should see here – not overwhelming complexity, but a high speed shell game. Goldman Fuchs is on the phone to the FBI to keep their proprietary tool hidden in the corporate coffer. Consider DRM, consider all the other information hoarding aggression from Wall Street, look at the laws they want to keep their control, ’tis yet another sign o’ the times.
“if you focus on the finger rather than what it is pointing at, you miss all that heavenly beauty…”
“And much of the “social technology” that we have that did work in the industrial phase just gets in the way now. The challenge we face is so fundamental and demands qualities so different from those our societies developed during the industrial era that we do not even realize that we are stuck in a cul-de-sac”
I agree with your analysis. As for the social technology, the advancement of the social movements in the 60’s & 70’s created enormous leaps in a more equitable distribution of wealth. But, these organizations were co-opted to prevent any further change and created contrived divisions amongst the citizens, all for the continuation of the hereditary wealth of the financiers and industry. Since then the “they” have been undermining advancements, laying on the tracks demanding we reverse the train of advancement of mankind. Dragging us backwards into the southern plantation model of slaves and masters with their regressive self serving agenda of dismantling of FDR’s humanitarian New Deal.
However, FDR continued his Uncle Teddy Roosevelt’s agenda that was based on the platform of the Populists Movement; The People’s Party of 1896. Teddy Roosevelt was a Progressive Republican who resurrected many Populist planks; expanded federal regulations of business corporations including the anti-trust laws. The Progressive Party, which Roosevelt headed in the “Bull Moose campaign” of 1912, echoed many People’s Party concerns. By constitutional amendment, direct election of U.S. Senators became law in 1912. The National Parks Act of 1916 as he stopped privateering, destruction for profit, enforced preservation and conservation of lands secured into the public hands. FDR’s tenure continued the Populist planks of his Uncle–particularly those calling for aid to farmers and employment on public works in time of depression, more restrictions of corporations, and banks via Glass Steagall Act.
Imagine, Teddy Roosevelt was a Republican and Franklin Roosevelt a Democrat whose primary agendas were to buoy the citizens upwards and the USA as a beacon of Enlightenment. Today, both parties are a distant memory as the Profiteers Gone Wild with Greed try their damndest to roll us backwards.
So, as to the idiots who’ve laid down on the train tracks to prevent future egalitarian social movements and technological advancement with a colluded knee-deep congress of aiding and abetting the scheme of “Rolling the USA backwards,” I’d say blow the whistle, full steam ahead.
People’s Party Platform of 1896
http://projects.vassar.edu/1896/peoplesplatform.html
Correction, national parks act was signed under Woodrow Wilson. “Roosevelt established the United States Forest Service, signed into law the creation of five National Parks, and signed the 1906 Antiquities Act, under which he proclaimed 18 new U.S. National Monuments. He also established the first 51 Bird Reserves, four Game Preserves, and 150 National Forests, including Shoshone National Forest, the nation’s first. The area of the United States that he placed under public protection totals approximately 230,000,000 acres”wiki
«advancement of the social movements in the 60′s & 70′s created enormous leaps in a more equitable distribution of wealth.»
For you perhaps, but for a lot of Usian voters those where the years were the craven exploitative (dark skinned mostly) poor started to steal and steal and steal from the deserving productive rich (light skinned mostly).
For a lots of Usian voters social justice means preventing the exploiters (the unproductive poor) from stealing the wealth generated by the producers (the exploited rich).
Consider for example a capital example of this “gun to their heads” exploitation, the minimum wage: if someone is now paid $6/h and would be paid $3/h without the minimum wage, it is as if they were stealing from the till $3 every hour, and exploiting their employer for $24/day. With the complicity of the jackbooted fascist oppressors of Big Government.
This is a view of the world that feels right to many Usian voters, and therefore they are fighting for social justice when the want to exploitation of the deserving rich, from middle class people hiring maids to Angelo Mozilo, to end.
The “deserving rich” used their access to the government backed usury and counterfeiting cartel to leverage their energy and talent while the only leverage a lot of the darker population had was the handle of a hoe.
And so the rich got richer.
You weren’t joking. Amazing. Again, I recommend living at the bottom for a a while and see how it feels. I assure, you will not feel exploitative. Especially if you wind up begging on the streets.
Somebody give Greg a satire detector.
Well, the article is not really too suprising but I wonder if the relatively narrow range that the stock market has traded in 1,000 to 1,200 points or there abouts is due to the HFT skimming the profits from the market. After all if we are to believe the the averages the market overall should grow by some 8% per year. (And really folks let’s not let the 8% be a sticking point it could be 2% or 5% or some other number.) And since the market has a relatively narrow trading range the money has to go somewhere.
The article is spot on. The “wisdom of crowds” works when each individual is out independently gathering their own information. When the information comes not from independent research, but only from gathering the opinions of others (or inferring opinion from behavior), feedback distortion takes over and information becomes increasingly unreliable.
This more or less describes the markets today (Thanks, internet!). Worse, we’ve automated the process of feedback distortion with computer algorithms. The stock market, for example, no longer represents underlying value of companies in any meaningful sense of the word.
Awful crap:
“Which is why science applies so poorly to human behaviour, because humans are always changing in time.”
Management consultants call it art or something?
Great post and comments.
@ casadecampanas,
My tie rod broke the day after I pulled off the road.
Also;”parasitic oscillation in the stock market.”
Mid 70’s I designed a sail for down wind (spinnaker)racing called “the oscillation damper”. Good results.
But, what’s a poor boy to do, call for an HFT tax or petition the lord?
Just once it would be gratifying to have a U.S. economic functionary or politician utter something thoughtful or intelligent. Seriously, when was the last time (E Warren aside) that any body of consequence in U.S. economic/money policy said something one tenth as intelligent as Mr. Haldane? The brits, aussies and yes even the french have literate, thoughtful and sophisticated folks at the helm. What do we have? Why is this acceptable? Why do so few people notice?
“But Mr. Rick, Casablanca is in a desert”..
Bogey: “I was misinformed….”
Good article. Reminds me of Soros’s Reflexivity in which “Oh look the loan leverage we’ve managed to whip up has increased the asset values on our books. Better loan out even more moolah!”
Very powerful Post. Thanks Yves.
The power of common sense!
Bottom line, this transformation has been fed by the provision of EZ credit whose increase’s rationalization would have been rejected out of hand in the ’50s, ’60s and ’70s. Yet with the insertion of a smooth-talking sophist in the Federal Reserve in 1987 — a role greased in a way by Mr. Greenspan’s predecessor, Mr. Volcker, who effectively separated the effects of monetary policy from underlying physical processes driving the economy — a back door hijacking elevating monetary policy as master of physical economy (come what may) was achieved. I think you hit on this transformation in scoring “quasi-scientific methods used by economists and financiers.”
I somewhat disagree with your characterizing the problem as one involving a misalignment of time. Rather, wild, disproportionate swings in financial dealings seen in relation to physical processes (economies) is thought strictly a function of whatever adhered-to sophistry is deemed convenient at the moment: sophistry in support given by finance in good times and sophistry in revulsion.
Were a reversal of primacy causing processes affecting physical economy to hold supreme priority over financial process, then finance would be less so a sophistry-driven master and more so a creativity-facilitating slave. That’s why I am such a big proponent of Glass-Steagall.
You say, too, that “humans are always changing in time,” but is this really fundamentally true? Are there not more or less fixed principles driving human will? I think King Solomon got it right when he said, “There is nothing new under the sun.”
I quite agree with your conclusion. That is why, again, concern for physical processes affecting humankind should be the dominant priority of any sane deliberation among social institutions like governments. To hear these hacks quake in fear of “the markets” simply is repulsive.
Good post, and very interesting.
However, I would not call these algorithms here “science”.
Science is a process by which to achieve knowledge. What is done is a process irrespective of knowledge, or perhaps that even buries it.
DWN
All this will certainly not end well.
The simplest solution to HFT is to simply slap a tax on the value of all security transactions: i.e. if you purchase $1,000,000 of a security, you pay x% in tax, just like the sales tax. In this case, even if this tax is 0.001%, it will render HFT unprofitable. I believe this is what the Tobin tax is.
My question, is it better to keep the sin and tax it or eliminate the sin activity altogether?
I vote for taxation. It worked for cigarettes!
Interestingly Quants in Quantum particle physics sometimes refer to particles that seemingly can be in two places at once. Theories about space travel by threading through worm holes in folded space could make time travel possible some day. In fact, many physicists believe that there is no time, just space, and matters interaction.
The market will fall hard fall all the reasons being discussed related to overleveraged capitalism.
The daily interaction of the various participants including quants, just warp the time factor by creating volataility. The market wants and needs to go down. Market participation just drags the time factor along.
Black swans are worm holes in the folds of cycles.
I recall learning about technical analysis of securities in my finance classes in college. At the time, I couldn’t understand why it was even done in the first place, because according to all the efficient markets stuff they were teaching us, you couldn’t beat the market by studying past data and finding patterns like you were John Forbes Nash. “Surely, fundamental analysis is the only way to go,” I thought.
It turns out I had been terribly misinformed by my professors and my textbooks. You CAN determine which way price movements are going to go, and even help spur them along. Of course, the past data we’re dealing with happened only a tenth of a second ago.
Maxwell’s Demons have been unleashed!
What a great post.
The inhumanity, however, comes from Greenspan Puts, Helicopter Ben and the rampant immorality of the moral hazard…
The irony of it all is that maybe volatility and the harsh punishment from flash crashes will bring the humanity back.
DD,
“Not till we’ve destroyed every church on the planet..”
(“Magic Christian”-Peter Sellers, to Ringo Starr)
Apropos fixed ideology and the variance inherent in reality its hard to miss the fact that for a rich man his objective is pretty static – make more money. Hence his fealty to a right wing ideology which never changes and which should never be allowed to change.
The top 1% own 50.9% of US stock, bond, and mutual funds. The bottom 50% own 0.5% of them. The top 10% own 90.3%.
http://www.businessinsider.com/facts-about-inequality-in-america-2011-11#half-of-america-owns-25-of-countrys-wealth-the-top-1-owns-a-third-of-it-2
Market averages are the most common and widely used stand-ins for how the economy is performing, and how the economy is doing is itself used as a stand-in for how the country and we the people, are doing. But ordinary Americans have almost no financial stake in these markets. Although their lives and livelihoods can be crushed by a falling market, the reverse is not true. A rising market can have little or no positive effect upon them.
High frequency trading adds an extra dimension to the analysis. By dominating trading, HFT controls market pricing, but it also acts as a highly regressive tax on markets, passing wealth from the rubier, slower moving segments, like pension funds, to the richer, savvier ones.
What I find extraordinary about all this is that the rich own and manipulate the measure which is supposed to show how ordinary Americans are doing. I don’t know which strikes me more, the complete intellectual disconnect or its blatant dishonesty.
Perhaps it extraordinary because 40% of the population (the ones who vote) don’t realize they only own 9% of the market and are being played. Same as it ever was.
That 40% of strivers are constantly flattered and cajoled, and ultimately abused. They just don’t believe it’s really happening to them. After all, Fox and friends seems to have their best interests at heart, and Sara P lives among the 40,just like the TPartiers. so their concerns are being heard and remediated. Right??
Sorry Hugh,
I meant to preface my comment with ” Blatant dishonesty- Hands Down (or “Full stop” as our friends across the pond like to say.).
Not to put too fine a point on it, but since you’ve brought it up:
The top 10% don’t watch too much tv.
The bottom 50% don’t watch (or read the financial pages) too much financial news.
Yet the maintstream press (TV and newspapers) (CNBC et al) confidently assumes that the 40% who own only 9% tune in to their spin. And they’re right. It’s a good business model built on BS so long as their viewers buy the spin.
The moment Matt Lauer opens the TODAT show with the headline that his core viewership only controls 9% of market cap, his key demographic has nowhere to go. Then the middle class revolution begins. Not till then, because that 40 is too polite, and too reasnable to call for heads on spikes but perhaps will instead call for Judges to step up to the plate to avoid middle class anarchy.
The 40% beleive they, and their elected leaders really do run this country. Until they are convinved 9% is not a majority, nothing will change.
“By dominating trading, HFT controls market pricing, but … also acts as a highly regressive tax on markets, passing wealth from the rubier, slower moving segments, like pension funds, to the richer, savvier ones.”
Exactly.
“…ordinary Americans have almost no financial stake in these markets. Although their lives and livelihoods can be crushed by a falling market, the reverse is not true. A rising market can have little or no positive effect upon them.”
Correct, again. This is the other big take away here. The phenomenon of a Dow Jones now almost completely unconnected to — and unconstrained by — ordinary Americans’ hardships and struggles is what makes it possible in 2011 for Washington, Wall Street and the MSM to largely ignore what’s going on in much of the rest of the country.
I’m surprised that anyone is surprised. Given adequate technology, HFT is a logical consequence of profit motivated economic system. System stability and fairness are of little or no direct concern when your objective is profit maximization and HFT is profitable.
Who cares that HFT is a purely parasitic activity. Markets are not supposed to have a moral dimension. Is anyone really surprised by pitchfork deflecting corporate propaganda justifying HFT as mechanism to increase liquidity, whatever it means in this case?
I’m going to count to three and snap my fingers now. When I’m done, please wake up and stop believing in the nonsense of financial institutions being wise and responsible guardians of capital markets.
they don’t have a neutral effect, they drain capital from the market.
I fully agree, that’s why I wrote “purely parasitic activity”.
Alas, due to the corruption of the political classes by Wall Street, absolutely nothing is going to be done about this until after something truly horrible happens — where “truly horrible” might mean the effective devaluing of our Bananamerican pensions/401Ks, wiping out the FIRE industry, etc. — without any sort of reasonable justification, just as he says.
What safe harbors can an individual retreat to? Martian bonds, I guess. Everything else is tainted by the HFT disease.
This will all be resolved when the world economic system collapses.
Question: “Exactly how did we get into this mess with the capital markets? A situation where the global stock of derivatives is over $US600 trillion, which is about twice the capital stock of the world.”
Answer: Financial engineers like Salih Neftci who created, taught and promoted the creation of FWMD’s. aka CRAPOLA!
Salih has since passed on, however, there are still many disciples of his school of though, obviously. All you have to do is read the rave reviews of his text “Principles of Financial Engineering”, which, I am sure is still heavily read to this day.
http://fora.tv/2008/02/12/Credit_Crises_of_Central_Banks_Future_Risks
btw: If the front end of the lecture is too elementary, catch the back half sec’s. 11, 12, 13 and Q&A.
gs_
I have read this entire section of responses to see if anyone was going to ask about “how we got to the $600 Trillion…
Here’s the answer-Mortgages were made securities..which led to subprime; markets endrun to oblivion..believing they wouldn’t be standing when the music stopped. The REASON banksters desired more and more (any such) “securitized mortgages”, was to use them as COLLATERAL=LEVERAGE, to BORROW AGAINST..to monopolize, collude with other “investment banks”, and manipulate now “deregulated” markets.
By so manipulating commodities and DERIVATIVES, some “investment banks” colluding drove the market bull, then profited driving it bear=more derivatives..Yves has described this process in “ECONned”. Here’s designated Senate Banking Committee Chairman Robert Johnson describing
it to combined Congress, at their request-his testimony stopped after a few minutes-too volatile for Americans to hear:
http://www.newdeal20.org/wp-content/uploads/2009/10/raj-revised-testimony1.pdf
Note that “6 U.S. investment banks control 95% of total world derivatives”…
“Time to Take Stock”
Ironically, without the government backed usury and counterfeiting cartel, common stock might be widely used as a private money form.
I love the color charts on page 23 of Haldane’s otherwise uninformed & doltish report.
Imo Dave Cummings, the founder of the BATs exchange, is a hero, the proverbial “little guy” who created a much better product than the Big Boys (NYSE & Nasdaq) had long forced upon traders — and in the process tipped the balance of power away from the established broker-dealers by providing a means for smaller, smarter & more nimble prop-shops to compete in that space.
Those are good things — or would y’all feel safer if stock trading reverted back to being controlled by a small select group of firms too big to fail?
http://www.bizjournals.com/kansascity/stories/2006/12/18/story14.html
http://members.forbes.com/forbes/2007/0521/090.html
When can we expect your next book? I’ve read everybody’s from the last three years and Econned is by far the best. This post is more proof that you see reality. Pre-order?
Ditto…
I am wondering, however, if those “6 U.S. investment banks”
are currently colluding against European banks to destruction, to keep U.S. $$$$ appearing relevant?
From What I could see over the past few years is that it is complete bs that HFT give more liquidity to the market. This is s total scam. Have you ever tried to execute a trade on a mega moving stock over the short term, for example double or triple etf inversee or try to sell short a double or triple etf that is being traded by HF traders? they monopolize the stock and if you are trading with TD ameritrade you will get burned. You will not get your trade executed in time to make a profit on short term trade.
And as we had seen with the flash crash what liquidity did that reveal? That everyone could dump stocks in seconds and have half the populuation get burned on margin calls and the other half that cried enough got to be credited….
The HFT is the perfect way to redistribute wealth and take the power to day trade away from the little guy. All of the talk about it makes me want to vomit. Especially since I had half my portfolio sold out automatically during the flash crash as margin call and then the stocks bounced right back but mine were sold at a loss.
Hi Yves
Thanks, this is an incredibly lucid and thorough piece, and I hadn’t seen the Race to Zero paper until just now.
I spoke about some of these topics recently at TED, and I’m not promoting it here, but I would be interested in your feedback and thoughts.
http://www.ted.com/talks/kevin_slavin_how_algorithms_shape_our_world.html
I’m still plowing through some of the points you make here, thanks again for putting this all together.
Regards
Kevin
I suppose I’m impossibly naive, but wouldn’t it work better to eliminate stocks as they are, and incorporate businesses as non-profits? Start-up companies can get the funding they need through a beefed-up government grant program, traditional bank loans, issuing small-scale bonds, etc.
Retire the obligation to keep paying rentiers unless they are directly providing cash for an business expansion.