Is the Future of Finance "Post-Human"?

Thursday, February 17, I put up a post titled “The Future of Finance is Getting Closer” (http://seekingalpha.com/article/253645-the-future-of-finance-is-getting-closer). In this post I discussed the changing world of finance and how it is being impacted by changes in information processing and the spread of information. I write on this subject fairly frequently because I believe that the continued improvement in information processing and the continued spread of information are going to dominate the future of finance…and everything else.

A reader of this post expressed concern over this assessment: derryl, stated that “John seems to be describing, not a post-industrial world, but a post-human world. Disembodied minds trading in information.”

I don’t believe that I am describing a “post-human world.” Information processing and the spread of information has been going on for a long, long time. Let me put this in context. Freeman Dyson, Physics Professor Emeritus at the Institute for Advanced Study in Princeton wrote in review (New York Review of Books, March 10. 2011) of the new book by James Gleick, “The Information: A History, A Theory, A Flood” that “Everywhere around us, wherever we look, we see increasing order and increasing information.” This is true both in the living world as well as the non-living world.

Dyson goes on to qualify this statement. This “unending supply of information is a glorious vision for scientists. Scientists find the vision attractive, since it gives them a purpose for their existence and an unending supply of jobs.” Scientists work with the increasing amount of information to identify and work with the increasing amount of order.

The concern by derryl only becomes real if the amount of information that exists is finite. Then the advancements of information technology can conceivably capture and model all that is and we evolve into “post-human world”.

The world being described by Dyson is a world in which the questions never end because the amount of information in this world is growing and will continue to grow. Thus, there will always need to be humans because there will always be questions to ask and inferences to be made.
This world Dyson sees is continually requires humans to be around to gather the new information being produced and incorporate into new concepts and models.

This is even more true of “human” activities like finance and investing. All the studies of complexity theory argue that the behavior of humans is much more “complex” than the behavior of non-living things. The reason for this is that modeling humans requires more information and more sophisticated models than is required to model non-living things. Thus, building models relating to investment behavior in a world where the total amount of information is increasing is something that cannot become “post-human.”

Dyson captures this reality by writing that “The vision is less attractive to artists and writers and ordinary people…Ordinary people may not welcome a future spent swimming in an unending flood of information.”

We see the problems in modeling human behavior in the book “The Quants” (See review: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) In this book, the author describes what has been called a quant-led collapse: specifically the August 2007 market meltdown. “This meltdown came in what is known as the “shadow banking system” and not the true banking system (for) the Federal Reserve really didn’t seem to know what was going on. The first catastrophe came when the Bear Stearns hedge funds were instructed to file for bankruptcy on July 30, 2007. The melt-down started in earnest on Monday August 6.” Quant firms suffered large losses on “toxic” assets.

But, the “Quants” are still in business. And, the “Quants” are still using sophisticated mathematical models to invest. As with all human problem solving activity, the humans have learned from the 2007 experience. They have modified or re-built their models to take into account the new information that has been gathered and processed. And, they now have more robust models than they did before the financial collapse.

This is a highly quantitative world, yet it is not post-human and in my view will never be post-human. Humans are problem solvers and in playing this role they must build models, test models, modify models and use models to make decisions or explain things. Humans are information users. And, in the world we are moving into will be even more information and information processing driven. It will be “smaller and faster.” (See http://seekingalpha.com/article/225773-the-new-world-order-smaller-and-faster-part-2.)

This world, however, is going to be a more volatile world, it is going to be a world that changes faster, and it is going to be a world that requires people to adapt to the changes that they see going on around them. One cannot “lock” themselves into the world of the past.

History has shown that the spread of information and information technology cannot be stopped. It’s spread may be postponed for a while, but it eventually will succeed in spreading.
Laws and regulations must take account of this. Congresses and regulators must take account of this. Dictators and autocrats must take account of this. Presidents and Prime Ministers must take account of this.

A danger is that this world bifurcates…divides into two…those that can work within the new paradigm and those that adjust, for whatever reason, to the new paradigm. We are seeing some of the consequences of such division. The income distribution is being determined more and more by the amount of education a person has. Jobs are splitting more and more between service jobs and manufacturing jobs. But, even this is not all. Even clerk-like service jobs are being replaced by new technology. Jobs are more plentiful in information technology and finance than in jobs connected with “making things.” Health care is going to be an employment magnet but even there the clerk-like jobs are going to be replaced by new technology.

As a consequence of these developments, under-employment has grown substantially and will not decline much in upcoming years. Capacity utilization in the manufacturing industries will remain at historical lows. A substantial re-structuring is going to have to occur in the economies of the developed nations.

The point I am trying to make is that the world is going through a period of major transitions…economically, politically, and culturally. This is a once-in-a-century thing. As with major transitions in the past, the human element has not been eliminated, but the structure of human involvement in the world has changed dramatically.

Such change can be disturbing. I know that I am feeling the effects of this change in my life…and it is not just because I am getting older!

The New World Order: Smaller and Faster--Part II

Readers of this blog have confessed concern over my focus on computers that are faster and faster (http://seekingalpha.com/article/223127-the-new-world-order-smaller-and-faster) and the blue-sky idea of quantum computers. I stand by this interest.

I focus on these developments because finance and the future of banking are going to be significantly impacted by faster computers, their greater capacity to store data, and to the ubiquitous presence of these things in our lives.

So we read: “A new photonic chip that works on light rather than electricity has been built by an international research team, paving the way for the production of ultra-fast quantum computers with capabilities far beyond today’s devices.” (See “Computers Set for Quantum Leap” in the Financial Times: http://www.ft.com/cms/s/0/8c0a68b0-c1bc-11df-9d90-00144feab49a.html.) The technical results of this research are being published today in the journal Science.

Many people in the field felt that it might be 25 years before we saw a functional quantum computer.

“We can say with real confidence that using our new technique, a quantum computer could, within five years, be performing calculations that are outside the capabilities of conventional computers,” claims Jeremy O’Brien, director of the England’s Centre for Quantum Photonics, who led the project.

Quantum computers are going to happen. Governments cannot afford to miss out being a part of the quantum revolution in computers. Governments must have quantum computers to keep secrets. Governments must also have quantum computers for defense purposes…a country like the United States cannot afford to be second in this field.

Therefore, “Hundreds of millions of dollars” are being spent “in the field.”

Why is this so important in finance?

Finance is information!

To see that this is so take a look at the book “The Quants” (I reviewed this earlier for Seeking Alpha: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) In this book we see how closely the fields of quantitative finance and financial engineering have always been to information science and information theory. For example (I quote from my book review):

“It is interesting to me that the beginning of the story Patterson (the author of ‘The Quants’) tells is how math/physics whiz Ed Thorp, the Godfather of the Quants, started out on the path to ‘Quant-dom.’ Thorp, as a new member of the MIT staff, took some of his early work on how to predict outcomes of roulette wheels to a well-known member of the MIT faculty named Claude Shannon.

Shannon is known as one of the founding fathers of Information Theory, a theory that has to do with the transmittal of information and the ability to receive and discern the message conveyed in the information transmitted.”

Furthermore, “Now let me fast forward to the quant fund group known as Renaissance Technologies and its star fund Medallion. This whole group was created by Jim Simons and it is ‘the most successful hedge fund in history.’

What kind of team did Simons pull together to staff his funds? Cryptographers and people trained in speech recognition; in essence, people trained in Information Theory. They were trained to detect hidden messages in seemingly random strings of code.”

The development of computer technology and data storage in the 1950s resulted in the massive change that took place in the field of finance in the 1960s. Given the availability and greater accessibility of data related to the stock market, researchers on university campuses produced dissertation after dissertation on performance in the stock market.,

The field of finance has never been the same.

The power of quantum computers is hard to imagine. These computers will be able to make calculations that are only dreamed about in “far out” science fiction novels. These computers will be able to access data bases containing information from almost unlimited sources. The possibilities are mind-boggling.

Will these computers be used in finance?

If there is a chance to “make-a-buck” or several billion bucks, they will be used. Finance is always looking for an edge. Faster and more powerful computers are always a potential source for finding an edge.

But, back to one of my fundamental predictions: finance and financial institutions over the next five to ten years will be something substantially different from what we know now. What happened to finance and financial institutions over the past fifty years is only a prelude to what is going to take place.

I Beat You By 200 Milliseconds, So Sue Me!

The future of finance is wrapped up in information technology. First because the technology deals with information and secondly because the technology is rapidly improving, even as I write this sentence.

In lectures I have given around the country on how information technology is going to impact the future I tell my audiences to keep their eyes on two groups of people and what they are doing with computers. First, check out what large governments, like the United States are doing about computers, because in order to keep their position in the world they must continue to be better than anyone else at killing people.

The first modern computer, the Eniac, was funded by the government in order to be able to better track the flight of artillery shells so that the army could be more accurate in hitting their targets. The Quantum Computer is going to be built because the government must be able to keep secrets and Quantum Computers are so fast that current coding systems are inadequate relative to the speed at which these new computers will be able to calculate. Also, these computers will be so fast that the ability to attack targets far away and the ability to simulate battles before they happen will be an overwhelming tool for the military. Obviously, America cannot afford to be second in the race to build the Quantum Computer.

Second, I suggested, watch what the kids are doing. If you want to know what is going to be “ubiquitous” in a few years, check out what that eight year old in your family is doing with electronic gadgets. And, by-the-way, in terms of stimulating battles and what kids are doing, read “Ender’s Game” by Orson Scott Card. In this book, a set of children are being trained to repeal an invasion of earth. The invasion is simulated by computer games with “faster than light” communications. After much practice, another game takes place. However, as we learn, it is an actual invasion and the only thing protecting the earth is these kids!

Great book…you should read it if you haven’t already read it. Actually, put “Ender’s Game” on your bookshelf right there along with “The Quants”! (See my review: http://seekingalpha.com/article/188342-model-misbehavior-the-quants-how-a-new-breed-of-math-whizzes-conquered-wall-street-and-nearly-destroyed-it-by-scott-patterson.) The important thing, however, is that this book is hugely popular, it is what young people are familiar with, and it presents a picture of what they believe the technology of the future will be like. And, the book was written in 1985!

What does this have to do with finance?

The Wall Street Journal this morning contains the article “Fast Traders’ New Edge.” (See http://online.wsj.com/article/SB10001424052748703340904575285002267286386.html#mod=todays_us_money_and_investing.) “Some fast-moving computer driven investment firms are getting an edge by trading on market data before it gets to other investors…The firms gain that advantage by buying data from stock exchanges and feeding it into supercomputers that calculate stock prices a fraction of a second before most other investors see the numbers.” Although these moves may only produce pennies, if one multiplies the pennies by thousands of trades, “big profits” can be made.

“The ability to estimate price moves ahead of the national best bid and offer price can give traders an advantage of about 100 to 200 milliseconds over investors who use standard market tools.”

This practice is called “latency arbitrage” and, of course, those investors that are not into it at the present time are searching for ways to protect themselves. Of course, the first thing you do is see whether or not you can compete electronically. Obviously, if you can’t compete electronically then you ask for regulation.

But, this is the world of the future. This is “Ender’s Game” only it is beyond the simulation exercises, it is the real thing. It is also a part of that netherworld that includes high frequency trading and dark pools.

My point is that advancements in computer technology are not going to slow down. If anything, these advancements will speed up. And, with the possibility that Quantum Computers will become a reality within the next decade or so the ‘speed up’ will tend to be exponential and not linear. Furthermore, the generations that will follow us expect this ‘speed up’ to happen and will look on these capabilities as just another part of their ‘normal’ lives.

If we do not comprehend this future, if our elected officials and regulators do not comprehend this future, then we will not be prepared for the economic and financial systems that are on the horizon. Hence, we will all make mistakes.

The “Quants” made mistakes this last time around. But, they are alive and well, and, I believe that it is a very safe bet to say that they have learned from their mistakes and have already modified their systems to take advantage of the most recent information available to them. Many “Quants” are trained in Information Theory, the study of the messages that are contained in strings of data, even though these strings may seem to be random in nature. Their systems are now more robust than they ever were in the past.

This is how humans become better decision makers. They adapt their models and systems so that they can make better predictions of the future in order to make better decisions or solve more difficult problems. This process is part of being a human and humans will not cease to put it into practice.

The discussion so far has been at the “top of the pyramid,” so to speak. But what about the “bottom of the pyramid”? How is technology playing out there?

This morning there appeared in the Financial Times a description of how banks in the South African Township of Tembisa are using mobile phones to develop their customer base. (See “Banks find potential in mobile phone growth,” http://www.ft.com/cms/s/0/0f6fad92-6f28-11df-9f43-00144feabdc0.html.) Banks have changed over the past decade because “as the spending power of low-income groups increases, more and more banks are competing for the business of the 15m adult South Africans who had previously been excluded from the financial system.” And they are using information technology to do it!

And, the players are not small. “In South Africa, Capitec and African Bank pioneered the drive…” and Vodafone, the British telecoms company, “launched one of the most celebrated mobile banking initiatives.” “Instead of opening an expensive branch network, many of these new operations work with agents such as shops or bars.” Mainstream banks are following suit.

This is not the only technological initiative taking place at the “local level” in the world. Electronic finance is here to stay and it is spreading further and further into previously under-served communities every day. Remember, finance is really nothing more than information and the exchange of information.

So the Obama administration, Congress, and the regulators in Washington (and politicians and regulators in the rest of the world) are attempting to prevent the last financial collapse from happening again.

Should I smile…or giggle…or break out in laughter?