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!
Showing posts with label Quants. Show all posts
Showing posts with label Quants. Show all posts
Friday, February 25, 2011
Thursday, February 17, 2011
The Future of Finance is Getting Closer
I know that not all of these facts that I present below are new, but reading about the following five in the morning papers just reconfirmed my position on the future of the financial markets.
First and second, stock exchanges have become dominated by high-frequency trading and index funds.
Third, the combination of the Deutsche Bȍrse and the NYSE Euronext will continue the trend for exchanges to turn to derivatives and technology business. The model here seems to be the CME Group, “the world's leading and most diverse derivatives marketplace” which has a market capitalization that is larger than either of the two combining institutions.
Fourth, the Shanghai Stock Exchange and the BM&F Bovespa, Latin Americas largest exchange is going to announce an agreement which will include the fact that stocks will be cross-listed on both exchanges. This will put Brazilian and Chinese interests together, world-wide.
Fifth, the IBM computer named Watson beat the two “greatest” players on the TV program “Jeopardy!” This, of course, comes only a few years after an IBM computer beat the world champion of chess at his own game. And, this most recent battle of “wits” has set off a plethora of articles on the state of artificial intelligence. The advances are mind-boggling!
A sixth fact could be the unrest in the Middle East where a very serious challenge in being raised against local autocratic leaders. Part of the cause, information technology.
Why are these “facts” important to me?
They are all just another indication the spread of information and information technology continues and cannot be stopped. Not only are things happening faster, they are becoming more ubiquitous.
Once again, for those that have not yet read the book titled “The Quants”, you should because it gives us a glimpse of what the future is going to be like. (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.)
And, this is the world that Congress (and other bodies around the world) is trying to regulate?
But, regulating to prevent 2007 and beyond from happening again is not going to protect usin the future.
It is the world that Mr. Gary Gensler, the chairman of the CFTC is trying to get his arms around and control.
But, how do you grab hold of a “whiff of smoke”?
The above facts are dramatically showing that finance is information and that the storing, processing, analysis, use and dissemination of information is going to become more and more technologically advanced as time passes. In fact, it is going to happen faster and faster.
In the future, more and more finance is going to be “quantified”; trades are going to occur at even greater speeds; and information is going to be stored…somewhere…and transactions are going to happen…well, someplace.
Regulation cannot just focus on “outcomes”. Regulation cannot eliminate “systematic” risk.
Furthermore, regulation of the kind we are used to in the United States only takes place “after-the-fact.”
The only way to really gain some insight into what is going on in financial markets is to observe what the market is saying. That is, the only way to get some kind of “advance warning” about market trouble is to watch market information.
Such systems have been suggested. One such suggestion has been given for an “early warning” methodology for the banking system. I have discussed this methodology in several posts over the past year. I will refer to just one of these posts (http://seekingalpha.com/article/242467-america-must-start-again-on-financial-regulation) that references the work of Oliver Hart and Luigi Zingales. The system proposed by Hart and Zingales is a market-based system that can raise “red flags” that regulators can respond to. In this way their system is “anticipatory” and not “reactive.”
Still, this world of the future must avoid some of the problems of the past. No regulatory system is going to be able to survive a regime of undisciplined governmental policy like we have seen in the United States over the past fifty years. Credit inflation undermines an economy and destroys discipline. (See my post http://seekingalpha.com/article/253145-deficits-credit-inflation-and-the-dollar.)
This must be considered within a world that is going through a period of transition that is monumental. Major shifts are taking place everywhere and we really don’t know what the ultimate result is going to be. However, we are moving away from a “labor”-based, manufacturing system to a “knowledge”-based society embedded within whatever the current information technology allows. The government cannot continue to base macro-economic policy on the assumption that the structure of the world still rests on the old, labor-based manufacturing system. It will just perpetuate the errors of the past.
As advancing technology allows us to do “finance” faster and in more ubiquitous ways, the techniques and tools of finance will just be used to take advantage of the credit inflation created by governments. Remember it is the wealthiest, the most trained, and the best positioned that will be able to take full advantage of the incentives created by further credit inflation.
What proof do I have for this?
Take a look at the last fifty years of credit inflation. What have been two of the fastest growing sectors in the economy?
The answer is: information technology and finance. And, these two sectors have complemented each other very well. Computer-based financial innovation has thrived in this environment of credit inflation. In fact, no other environment is so conducive to financial innovation than is an environment based on credit inflation.
And, the results of the past fifty years?
The purchasing power of the dollar has declined by about 85%. Under-employment of the working force is somewhere in excess twenty percent. And, the income distribution has become radically skewed toward the wealthier end of the scale. Need I say more?
First and second, stock exchanges have become dominated by high-frequency trading and index funds.
Third, the combination of the Deutsche Bȍrse and the NYSE Euronext will continue the trend for exchanges to turn to derivatives and technology business. The model here seems to be the CME Group, “the world's leading and most diverse derivatives marketplace” which has a market capitalization that is larger than either of the two combining institutions.
Fourth, the Shanghai Stock Exchange and the BM&F Bovespa, Latin Americas largest exchange is going to announce an agreement which will include the fact that stocks will be cross-listed on both exchanges. This will put Brazilian and Chinese interests together, world-wide.
Fifth, the IBM computer named Watson beat the two “greatest” players on the TV program “Jeopardy!” This, of course, comes only a few years after an IBM computer beat the world champion of chess at his own game. And, this most recent battle of “wits” has set off a plethora of articles on the state of artificial intelligence. The advances are mind-boggling!
A sixth fact could be the unrest in the Middle East where a very serious challenge in being raised against local autocratic leaders. Part of the cause, information technology.
Why are these “facts” important to me?
They are all just another indication the spread of information and information technology continues and cannot be stopped. Not only are things happening faster, they are becoming more ubiquitous.
Once again, for those that have not yet read the book titled “The Quants”, you should because it gives us a glimpse of what the future is going to be like. (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.)
And, this is the world that Congress (and other bodies around the world) is trying to regulate?
But, regulating to prevent 2007 and beyond from happening again is not going to protect usin the future.
It is the world that Mr. Gary Gensler, the chairman of the CFTC is trying to get his arms around and control.
But, how do you grab hold of a “whiff of smoke”?
The above facts are dramatically showing that finance is information and that the storing, processing, analysis, use and dissemination of information is going to become more and more technologically advanced as time passes. In fact, it is going to happen faster and faster.
In the future, more and more finance is going to be “quantified”; trades are going to occur at even greater speeds; and information is going to be stored…somewhere…and transactions are going to happen…well, someplace.
Regulation cannot just focus on “outcomes”. Regulation cannot eliminate “systematic” risk.
Furthermore, regulation of the kind we are used to in the United States only takes place “after-the-fact.”
The only way to really gain some insight into what is going on in financial markets is to observe what the market is saying. That is, the only way to get some kind of “advance warning” about market trouble is to watch market information.
Such systems have been suggested. One such suggestion has been given for an “early warning” methodology for the banking system. I have discussed this methodology in several posts over the past year. I will refer to just one of these posts (http://seekingalpha.com/article/242467-america-must-start-again-on-financial-regulation) that references the work of Oliver Hart and Luigi Zingales. The system proposed by Hart and Zingales is a market-based system that can raise “red flags” that regulators can respond to. In this way their system is “anticipatory” and not “reactive.”
Still, this world of the future must avoid some of the problems of the past. No regulatory system is going to be able to survive a regime of undisciplined governmental policy like we have seen in the United States over the past fifty years. Credit inflation undermines an economy and destroys discipline. (See my post http://seekingalpha.com/article/253145-deficits-credit-inflation-and-the-dollar.)
This must be considered within a world that is going through a period of transition that is monumental. Major shifts are taking place everywhere and we really don’t know what the ultimate result is going to be. However, we are moving away from a “labor”-based, manufacturing system to a “knowledge”-based society embedded within whatever the current information technology allows. The government cannot continue to base macro-economic policy on the assumption that the structure of the world still rests on the old, labor-based manufacturing system. It will just perpetuate the errors of the past.
As advancing technology allows us to do “finance” faster and in more ubiquitous ways, the techniques and tools of finance will just be used to take advantage of the credit inflation created by governments. Remember it is the wealthiest, the most trained, and the best positioned that will be able to take full advantage of the incentives created by further credit inflation.
What proof do I have for this?
Take a look at the last fifty years of credit inflation. What have been two of the fastest growing sectors in the economy?
The answer is: information technology and finance. And, these two sectors have complemented each other very well. Computer-based financial innovation has thrived in this environment of credit inflation. In fact, no other environment is so conducive to financial innovation than is an environment based on credit inflation.
And, the results of the past fifty years?
The purchasing power of the dollar has declined by about 85%. Under-employment of the working force is somewhere in excess twenty percent. And, the income distribution has become radically skewed toward the wealthier end of the scale. Need I say more?
Tuesday, August 31, 2010
The World Continues to Move to Smaller and Faster
Given all the headlines about double-dip recessions, consumer and business de-leveraging, and unemployment it is good to get back to some basic trends that, in my mind, are not going to change.
On the front page of the New York Times we read “Advances Offer Path to Shrink Computer Chips Again” (http://www.nytimes.com/2010/08/31/science/31compute.html?ref=todayspaper). “Scientists at Rice University and Hewlett-Packard are reporting this week that they can overcome a fundamental barrier to the continued rapid miniaturization of computer memory that has been the basis for the consumer electronics revolution.” And to the revolution in the waging of war and keeping of secrets, on advances in finance and business technology and so on and so on.
The problem had been that “the limits of physics and finance faced by chip makers had loomed so large that experts feared a slowdown in the pace of miniaturization that would act like a brake on the ability to pack ever more power into ever smaller devices…”
The new method, discovered at Rice University “involves filaments as thin as five nanometers in width…”
“Separately, H. P. is to announce on Tuesday that it will enter into a commercial partnership with a major semiconductor company to produce a related technology that also has the potential of pushing computer data storage to astronomical densities in the next decade.”
These discoveries, if they prove successful, will help to maintain Moore’s Law, the idea that industry can roughly double the computing power of chips every 18 months, and the Storage Law, the idea that industry can roughly double the amount of data that can be stored every two years. These capabilities have been the back-bone of computing power for the past fifty years or so.
Trends like these are going to continue because there is too much to be lost if they do not. For one, governments cannot allow their countries to fall behind in the development of computing power. There are two reasons for this: first, governments need to keep secrets and so must be able to keep others from breaking codes; second, powerful governments must continue to be able to kill people better than other governments in order to maintain their position in the world. Thus the United States government must continue to finance the development of these capabilities. This is why one can continue to expect the development of a fully operational quantum computer in the next decade.
As with the Eniac computer that was developed in the 1940s to improve the accuracy of firing
shells into the enemy, military needs come first, business benefits follow.
It is my belief in the continuation of such trends that lead me to suggest such things as the ineffectiveness of the newly minted financial regulations even before they become operational. Finance is information. This became apparent in the 1960s when the new computer technology produced faster and faster computers and also produced computers that had the ability to store massive amounts of data from the stock markets. This led to a new industry…quantitative finance. The boom in finance Ph. D.’s got its start with the portfolio theory and CAP-M models developed in these years as it became evident that lots and lots of dissertations could be written given all the data that were now available to researchers.
This industry only grew as computers got faster and data storage capacities continued to increase. And, since we were only dealing in information and the manipulation of information, it became apparent that people in this field really did not need to know much finance because the crucial talent became mathematical model building and data mining. Consequently, backgrounds in physics and mathematics became very useful and the application of Information Theory to data streams provided a source for understanding signals that otherwise appeared to be “white noise.” (A readable source for all these developments can be found in the book “The Quants”: 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.)
This financial engineering continues. This is why I believe that the financial reform package has been legacy from the start. The organizations that the financial reform package are supposed to regulate are, in many cases, already beyond the current legislation, and if they are not yet beyond it, the technology is such that they will be soon.
Is financial innovation going to continue to take place? Yes, and, in fact the pace at which it occurs will accelerate. And, this financial innovation is serving as a model for other markets, even for goods and services. This development is related to what is called “Information Markets” and, with the growth in computing power and the expansion of data bases, these markets are going to become more and more a part of how people transact in the future. (Note for example the new commodity ETF called U. S. Commodity Index Fund (trading symbol USCI). http://professional.wsj.com/article/SB10001424052748703418004575456221354231844.html.The economist Robert Shiller (author of Irrational Exuberance) has written path-breaking work in this area.)
Such developments have led to a boom in employment in the finance industry over the last forty years. This relative shift in employment will continue well into the future because it is information based and the use of information technology is going to spread and prosper.
This is why one person, Andy Kessler, a former hedge fund manager, has suggested (tongue-in-cheek) that one way turn the economy around is to import people that would buy homes. He writes: “I would wager there is a backlog of high-paying jobs for educated foreigners well beyond what H1-B visas allow to trickle in. In the name of financial stability, create a million visas for qualified immigrants, say, those with a masters or Ph. D., and watch home prices start to rise.” (http://professional.wsj.com/article/SB10001424052748704147804575455951017059416.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)
The important distinction here is that Kessler is writing about “educated foreigners” and not unemployed Americans. This seems to be an issue that many analysts are bringing up these days. The jobs that are available for workers are not the jobs that many of the unemployed or underemployed in the United States are able to fill. And, I don’t perceive that there will be a slowdown in the advancement of computing power and other technologies in the future which leads one to conclude that unless something is done about education and training, the United States workforce is going to bifurcate even further between those that can work productively in the 21st century and those that cannot perform at this level. Programs of fiscal stimulus that puts people back into the jobs they formerly held will not succeed only attempt to re-create the past.
Technology will evolve to produce “things” that are smaller and faster and these “things” will be used more and more in the creation and production of “information goods”. Furthermore, the speed at which these advancements take place will continue to accelerate. Organizations set up to operate within the past, like labor unions, are going to have to change and adapt to this environment. Otherwise, they are more of a dis-service to their constituents than a help. But, that is the future.
On the front page of the New York Times we read “Advances Offer Path to Shrink Computer Chips Again” (http://www.nytimes.com/2010/08/31/science/31compute.html?ref=todayspaper). “Scientists at Rice University and Hewlett-Packard are reporting this week that they can overcome a fundamental barrier to the continued rapid miniaturization of computer memory that has been the basis for the consumer electronics revolution.” And to the revolution in the waging of war and keeping of secrets, on advances in finance and business technology and so on and so on.
The problem had been that “the limits of physics and finance faced by chip makers had loomed so large that experts feared a slowdown in the pace of miniaturization that would act like a brake on the ability to pack ever more power into ever smaller devices…”
The new method, discovered at Rice University “involves filaments as thin as five nanometers in width…”
“Separately, H. P. is to announce on Tuesday that it will enter into a commercial partnership with a major semiconductor company to produce a related technology that also has the potential of pushing computer data storage to astronomical densities in the next decade.”
These discoveries, if they prove successful, will help to maintain Moore’s Law, the idea that industry can roughly double the computing power of chips every 18 months, and the Storage Law, the idea that industry can roughly double the amount of data that can be stored every two years. These capabilities have been the back-bone of computing power for the past fifty years or so.
Trends like these are going to continue because there is too much to be lost if they do not. For one, governments cannot allow their countries to fall behind in the development of computing power. There are two reasons for this: first, governments need to keep secrets and so must be able to keep others from breaking codes; second, powerful governments must continue to be able to kill people better than other governments in order to maintain their position in the world. Thus the United States government must continue to finance the development of these capabilities. This is why one can continue to expect the development of a fully operational quantum computer in the next decade.
As with the Eniac computer that was developed in the 1940s to improve the accuracy of firing
shells into the enemy, military needs come first, business benefits follow.
It is my belief in the continuation of such trends that lead me to suggest such things as the ineffectiveness of the newly minted financial regulations even before they become operational. Finance is information. This became apparent in the 1960s when the new computer technology produced faster and faster computers and also produced computers that had the ability to store massive amounts of data from the stock markets. This led to a new industry…quantitative finance. The boom in finance Ph. D.’s got its start with the portfolio theory and CAP-M models developed in these years as it became evident that lots and lots of dissertations could be written given all the data that were now available to researchers.
This industry only grew as computers got faster and data storage capacities continued to increase. And, since we were only dealing in information and the manipulation of information, it became apparent that people in this field really did not need to know much finance because the crucial talent became mathematical model building and data mining. Consequently, backgrounds in physics and mathematics became very useful and the application of Information Theory to data streams provided a source for understanding signals that otherwise appeared to be “white noise.” (A readable source for all these developments can be found in the book “The Quants”: 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.)
This financial engineering continues. This is why I believe that the financial reform package has been legacy from the start. The organizations that the financial reform package are supposed to regulate are, in many cases, already beyond the current legislation, and if they are not yet beyond it, the technology is such that they will be soon.
Is financial innovation going to continue to take place? Yes, and, in fact the pace at which it occurs will accelerate. And, this financial innovation is serving as a model for other markets, even for goods and services. This development is related to what is called “Information Markets” and, with the growth in computing power and the expansion of data bases, these markets are going to become more and more a part of how people transact in the future. (Note for example the new commodity ETF called U. S. Commodity Index Fund (trading symbol USCI). http://professional.wsj.com/article/SB10001424052748703418004575456221354231844.html.The economist Robert Shiller (author of Irrational Exuberance) has written path-breaking work in this area.)
Such developments have led to a boom in employment in the finance industry over the last forty years. This relative shift in employment will continue well into the future because it is information based and the use of information technology is going to spread and prosper.
This is why one person, Andy Kessler, a former hedge fund manager, has suggested (tongue-in-cheek) that one way turn the economy around is to import people that would buy homes. He writes: “I would wager there is a backlog of high-paying jobs for educated foreigners well beyond what H1-B visas allow to trickle in. In the name of financial stability, create a million visas for qualified immigrants, say, those with a masters or Ph. D., and watch home prices start to rise.” (http://professional.wsj.com/article/SB10001424052748704147804575455951017059416.html?mod=WSJ_Opinion_LEFTTopOpinion&mg=reno-wsj)
The important distinction here is that Kessler is writing about “educated foreigners” and not unemployed Americans. This seems to be an issue that many analysts are bringing up these days. The jobs that are available for workers are not the jobs that many of the unemployed or underemployed in the United States are able to fill. And, I don’t perceive that there will be a slowdown in the advancement of computing power and other technologies in the future which leads one to conclude that unless something is done about education and training, the United States workforce is going to bifurcate even further between those that can work productively in the 21st century and those that cannot perform at this level. Programs of fiscal stimulus that puts people back into the jobs they formerly held will not succeed only attempt to re-create the past.
Technology will evolve to produce “things” that are smaller and faster and these “things” will be used more and more in the creation and production of “information goods”. Furthermore, the speed at which these advancements take place will continue to accelerate. Organizations set up to operate within the past, like labor unions, are going to have to change and adapt to this environment. Otherwise, they are more of a dis-service to their constituents than a help. But, that is the future.
Wednesday, June 23, 2010
Follow the Dimon!
For months I have been arguing in my blog posts that the larger banks have already moved beyond the regulators although they have always been far in advance of the politicians. These latter two groups of people are attempting to create a regulatory system that will prevent the events of 2007 through 2009 from happening again.
Would somebody tell them that the big banks are somewhere else.
JPMorgan Chase announced some major changes in their top management structure yesterday. These changes, to me, are just the most visible sign that the banking of the future is going to be significantly different from the banking of the past. But, we’ll come back to this later on.
The management changes also confirm, to me, that Jamie Dimon is the pre-eminent banker in today’s world.
Why?
A long time ago I stopped looking at the “glow” of the person running things, the Chairman, President, or CEO, and I started concentrating on the people around the glorious leader. I found that the fact that the leader of an organization had very, very capable and experienced people around them was a better indicator of the quality of the person in charge than was his or her own sparkling image.
Top people have top people around them. In addition, winners help to make everyone around them perform better.
Jamie Dimon has these qualities.
I believe that Jack Welch also had them.
One person I had contacts with at one time who, I felt, didn’t have these qualities and was a disaster waiting to happen, was Donald Rumsfeld.
Jamie Dimon has a top notch team around him and is positioning them to take on the world. In my estimate, more than one of the individuals that are on this team will be a Chief Executive Officer of a major bank in the United States…or, the world.
Many people that Jack Welch had around him went on to lead major companies around the world.
But, back to the banking changes: JPMorgan is going off-shore!
The New York Times has it right, “JPMorgan Sets Sights Overseas,” (http://www.nytimes.com/2010/06/23/business/23bank.html?ref=business). Dimon has given out the mandate to his closest lieutenants “to start a global corporate banking business and scout out opportunities in Europe, Latin America and Asia.” Mr. Dimon, himself, has recently been in China, India, and Russia and wants to especially focus on these three BRIC countries as well as Brazil and also Vietnam, Indonesia, Malaysia, the Philippines and parts of Africa.
My suggestion: Watch what Mr. Dimon and JPMorgan do. My guess is that they will point the way to the future and will do a good job along the way!
But, what about American and Europe?
In terms of banking and finance, I am not sure the political and governmental leaders in these areas of the world know what they are doing. For one, as I have said over and over again, in terms of financial regulation…they are fighting the last war!
Politically, both areas are split and looking for direction. No one can tell at this time where “direction” will come from.
So, what better time than this to move to where the action is going to be!
If anything, the fiasco going on in Washington, D. C. is going to drive business and finance further off shore. The BRIC nations are becoming wealthier and more savvy in the world. They are also accumulating more power as will be in evidence in the upcoming G-20 meetings. But, as Mr. Dimon indicates, there is a lot more going on if one looks to the other countries he has highlighted in his recent statements.
Moving in this direction will involve acquisitions, something that JPMorgan has already started doing. To build itself into a larger presence in these markets in a timely fashion, the company will have to acquire significant other properties. JPMorgan Chase is going to get bigger.
And, Washington was concerned with the size of the banks in the United States that were “too big to fail” in 2008?
Furthermore, this doesn’t even get into one of my favorite subjects, the “quantification” of finance. What is going on with respect to the “quants” in JPMorgan? My guess is that there has been significant movement in this area as well over the past two years.
The future of banking?
Keep your eyes on the Dimon. I think you will find that it will be time well spent!
Would somebody tell them that the big banks are somewhere else.
JPMorgan Chase announced some major changes in their top management structure yesterday. These changes, to me, are just the most visible sign that the banking of the future is going to be significantly different from the banking of the past. But, we’ll come back to this later on.
The management changes also confirm, to me, that Jamie Dimon is the pre-eminent banker in today’s world.
Why?
A long time ago I stopped looking at the “glow” of the person running things, the Chairman, President, or CEO, and I started concentrating on the people around the glorious leader. I found that the fact that the leader of an organization had very, very capable and experienced people around them was a better indicator of the quality of the person in charge than was his or her own sparkling image.
Top people have top people around them. In addition, winners help to make everyone around them perform better.
Jamie Dimon has these qualities.
I believe that Jack Welch also had them.
One person I had contacts with at one time who, I felt, didn’t have these qualities and was a disaster waiting to happen, was Donald Rumsfeld.
Jamie Dimon has a top notch team around him and is positioning them to take on the world. In my estimate, more than one of the individuals that are on this team will be a Chief Executive Officer of a major bank in the United States…or, the world.
Many people that Jack Welch had around him went on to lead major companies around the world.
But, back to the banking changes: JPMorgan is going off-shore!
The New York Times has it right, “JPMorgan Sets Sights Overseas,” (http://www.nytimes.com/2010/06/23/business/23bank.html?ref=business). Dimon has given out the mandate to his closest lieutenants “to start a global corporate banking business and scout out opportunities in Europe, Latin America and Asia.” Mr. Dimon, himself, has recently been in China, India, and Russia and wants to especially focus on these three BRIC countries as well as Brazil and also Vietnam, Indonesia, Malaysia, the Philippines and parts of Africa.
My suggestion: Watch what Mr. Dimon and JPMorgan do. My guess is that they will point the way to the future and will do a good job along the way!
But, what about American and Europe?
In terms of banking and finance, I am not sure the political and governmental leaders in these areas of the world know what they are doing. For one, as I have said over and over again, in terms of financial regulation…they are fighting the last war!
Politically, both areas are split and looking for direction. No one can tell at this time where “direction” will come from.
So, what better time than this to move to where the action is going to be!
If anything, the fiasco going on in Washington, D. C. is going to drive business and finance further off shore. The BRIC nations are becoming wealthier and more savvy in the world. They are also accumulating more power as will be in evidence in the upcoming G-20 meetings. But, as Mr. Dimon indicates, there is a lot more going on if one looks to the other countries he has highlighted in his recent statements.
Moving in this direction will involve acquisitions, something that JPMorgan has already started doing. To build itself into a larger presence in these markets in a timely fashion, the company will have to acquire significant other properties. JPMorgan Chase is going to get bigger.
And, Washington was concerned with the size of the banks in the United States that were “too big to fail” in 2008?
Furthermore, this doesn’t even get into one of my favorite subjects, the “quantification” of finance. What is going on with respect to the “quants” in JPMorgan? My guess is that there has been significant movement in this area as well over the past two years.
The future of banking?
Keep your eyes on the Dimon. I think you will find that it will be time well spent!
Friday, June 4, 2010
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?
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?
Thursday, June 3, 2010
Hotshot Traders Leave Street
Jenny Strasburg captures the mood on Wall Street in her article in the Wall Street Journal this morning: http://online.wsj.com/article/SB20001424052748704515704575282982462922628.html#mod=todays_us_money_and_investing.
“The competition is on to scoop up Wall Street traders and portfolio managers increasingly unnerved by the likelihood of sweeping new financial regulation.
Since political momentum began building earlier this year to limit trading for profit at Wall Street firms, traders have been exploring their options, and some have already left. Outside the banks, private investment funds looking for traders have been gearing up for a hot talent market.”
Economics works!
You change the incentives and people change…people move.
With the situation being more mobile than ever, with the technology more available and adaptable than ever, with the future more uncertain than ever…people…and the system…can change more rapidly and in more different directions than ever before.
And, that is what is happening!
This is one thing that Congress (and others) can’t seem to understand. Even after observing fifty years of the most dramatic financial innovation that has ever taken place in the world, the members of Congress seem to believe that they can “freeze” things, return to the past, and prevent the recent financial crisis from ever occurring again.
They also seem to think that the government is blameless from creating any incentives that might have a derogatory impact on the future that they want to create.
People in the Obama administration, as well as members of Congress, seem oblivious to the fact that over the last fifty years the United States government, Republicans and Democrats alike, produced a fiscal environment that created the incentives that led to a burst of innovative activity in the financial sector that produced massive changes in the way people did business and in the composition of the American economy. A brief picture of the environment.
From January 1961 through January 2009, the Gross Federal Debt of the United States rose at a compound annual rate of 7.7%. The monetized portion of the federal debt, the monetary base, rose at a compound rate of about 6.5% from January 1961 through August 2008, just before the Federal Reserve’s balance sheet exploded in response to the financial crisis that took place in the fall of 2008. The M2 money stock grew by more than a compound rate of 7.0% during the time period under review.
Thus, money and credit variables grew relatively in line with one another. Real GDP growth during this time was about a 3.4% compound rate of increase every year.
Prices, as measured by the Consumer Price Index and the GDP implicit price deflator, increased at a compound rate of about 4% during this time period resulting in a decline in the purchasing power of the dollar by around 85%. A 1961 dollar bill could only buy 15 cents worth of goods in 2008!
Inflation breeds financial innovation and the late 20th century with its relatively moderate, yet steady increase in prices, was a perfect environment for financial innovation!
The leader in financial innovation was the federal government itself, confirming what Niall Ferguson argues in his wonderful book, “The Ascent of Money: A Financial History of the World.” Ferguson claims that governments, historically, have been the primary financial innovator because of the need to fight wars. This, he continues, spilled over into the 20th century as governments needed to expand deficit financing to incorporate spending on social programs.
My guess is that in the next five to ten years we will see the biggest change in finance that we have ever seen and this change will be worldwide. I have written a little on this in a recent blog: “Changes Continue to Shakeup the Banking System”. See http://seekingalpha.com/article/200475-changes-continue-to-shake-up-the-banking-system.
The largest twenty-five banks in the United States, who control about two-thirds of U. S. banking assets in the country, are already changing their business. Again, they have already moved beyond what Congress and the administration are doing to regulate the banking system.
More important, foreign banks are changing the banking picture in the United States. Currently, foreign branches control about 11% of the total banking assets in the country. I have already stated that this will increase to 15% to 20% over the next five years or so. We see this expansion taking place before our eyes. Yesterday “China Finds a New Market for Loans: U. S.” (See http://online.wsj.com/article/SB10001424052748703957604575273011917977450.html#mod=todays_us_money_and_investing.) Today, “China Bank IPO, Possibly Biggest Ever, Set for July.” (See http://online.wsj.com/article/SB20001424052748704875604575281690877047522.html#mod=todays_us_money_and_investing.) And, don’t forget the sovereign wealth funds, huge accumulators of money.
The world of finance is changing because the incentives affecting finance are changing all over the world. I can’t even imagine what this world will look like with instantaneous trading, further ‘slicing and dicing’ of cash flows and other financial information, greater use of information theory to detect trading patterns (see my book review of “The Quants”, 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), and more and more information markets popping up around the world (see Robert Shiller’s book “The New Financial Order: Risk in the 21st Century”)!
In the field of Complexity Theory, researchers speak of times like this when systems go through the process they call “Emergence” and “Self-Organization.” It is during times like these that one structural system is transitioning into another structural system. The problem is that no one, before-the-fact, can predict how existing information systems combine with other information to produce the resulting system. Systems just “self-organize” and a new system “emerges” from what was formerly un-organized.
This appears to be what is happening now. The movement of “hotshot” traders is one piece of evidence of this. The restructuring of the big banks is another piece of evidence. The response of hedge funds to the Congressional threat to change how partners are paid is evidence of this. The changes in financial regulations around the world is evidence of this. The growth and increased aggressiveness of Chinese banks is evidence of this. And, so on and so forth.
Congress is just speeding this change along. However, they better be careful about what they wish for because my best guess is that what they get will be nothing like what they are planning for.
“The competition is on to scoop up Wall Street traders and portfolio managers increasingly unnerved by the likelihood of sweeping new financial regulation.
Since political momentum began building earlier this year to limit trading for profit at Wall Street firms, traders have been exploring their options, and some have already left. Outside the banks, private investment funds looking for traders have been gearing up for a hot talent market.”
Economics works!
You change the incentives and people change…people move.
With the situation being more mobile than ever, with the technology more available and adaptable than ever, with the future more uncertain than ever…people…and the system…can change more rapidly and in more different directions than ever before.
And, that is what is happening!
This is one thing that Congress (and others) can’t seem to understand. Even after observing fifty years of the most dramatic financial innovation that has ever taken place in the world, the members of Congress seem to believe that they can “freeze” things, return to the past, and prevent the recent financial crisis from ever occurring again.
They also seem to think that the government is blameless from creating any incentives that might have a derogatory impact on the future that they want to create.
People in the Obama administration, as well as members of Congress, seem oblivious to the fact that over the last fifty years the United States government, Republicans and Democrats alike, produced a fiscal environment that created the incentives that led to a burst of innovative activity in the financial sector that produced massive changes in the way people did business and in the composition of the American economy. A brief picture of the environment.
From January 1961 through January 2009, the Gross Federal Debt of the United States rose at a compound annual rate of 7.7%. The monetized portion of the federal debt, the monetary base, rose at a compound rate of about 6.5% from January 1961 through August 2008, just before the Federal Reserve’s balance sheet exploded in response to the financial crisis that took place in the fall of 2008. The M2 money stock grew by more than a compound rate of 7.0% during the time period under review.
Thus, money and credit variables grew relatively in line with one another. Real GDP growth during this time was about a 3.4% compound rate of increase every year.
Prices, as measured by the Consumer Price Index and the GDP implicit price deflator, increased at a compound rate of about 4% during this time period resulting in a decline in the purchasing power of the dollar by around 85%. A 1961 dollar bill could only buy 15 cents worth of goods in 2008!
Inflation breeds financial innovation and the late 20th century with its relatively moderate, yet steady increase in prices, was a perfect environment for financial innovation!
The leader in financial innovation was the federal government itself, confirming what Niall Ferguson argues in his wonderful book, “The Ascent of Money: A Financial History of the World.” Ferguson claims that governments, historically, have been the primary financial innovator because of the need to fight wars. This, he continues, spilled over into the 20th century as governments needed to expand deficit financing to incorporate spending on social programs.
My guess is that in the next five to ten years we will see the biggest change in finance that we have ever seen and this change will be worldwide. I have written a little on this in a recent blog: “Changes Continue to Shakeup the Banking System”. See http://seekingalpha.com/article/200475-changes-continue-to-shake-up-the-banking-system.
The largest twenty-five banks in the United States, who control about two-thirds of U. S. banking assets in the country, are already changing their business. Again, they have already moved beyond what Congress and the administration are doing to regulate the banking system.
More important, foreign banks are changing the banking picture in the United States. Currently, foreign branches control about 11% of the total banking assets in the country. I have already stated that this will increase to 15% to 20% over the next five years or so. We see this expansion taking place before our eyes. Yesterday “China Finds a New Market for Loans: U. S.” (See http://online.wsj.com/article/SB10001424052748703957604575273011917977450.html#mod=todays_us_money_and_investing.) Today, “China Bank IPO, Possibly Biggest Ever, Set for July.” (See http://online.wsj.com/article/SB20001424052748704875604575281690877047522.html#mod=todays_us_money_and_investing.) And, don’t forget the sovereign wealth funds, huge accumulators of money.
The world of finance is changing because the incentives affecting finance are changing all over the world. I can’t even imagine what this world will look like with instantaneous trading, further ‘slicing and dicing’ of cash flows and other financial information, greater use of information theory to detect trading patterns (see my book review of “The Quants”, 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), and more and more information markets popping up around the world (see Robert Shiller’s book “The New Financial Order: Risk in the 21st Century”)!
In the field of Complexity Theory, researchers speak of times like this when systems go through the process they call “Emergence” and “Self-Organization.” It is during times like these that one structural system is transitioning into another structural system. The problem is that no one, before-the-fact, can predict how existing information systems combine with other information to produce the resulting system. Systems just “self-organize” and a new system “emerges” from what was formerly un-organized.
This appears to be what is happening now. The movement of “hotshot” traders is one piece of evidence of this. The restructuring of the big banks is another piece of evidence. The response of hedge funds to the Congressional threat to change how partners are paid is evidence of this. The changes in financial regulations around the world is evidence of this. The growth and increased aggressiveness of Chinese banks is evidence of this. And, so on and so forth.
Congress is just speeding this change along. However, they better be careful about what they wish for because my best guess is that what they get will be nothing like what they are planning for.
Friday, February 12, 2010
Inflation is Just Not Understood!
Funny time to be talking about inflation, but the top economist at the International Monetary Fund brought it up.
Oliver Blanchard, now serving at the IMF while on leave from MIT, has co-authored a new paper and has publically presented the results which have been reported in the Wall Street Journal: http://online.wsj.com/article/SB20001424052748704337004575059542325748142.html#mod=todays_us_page_one. Mr. Blanchard is now saying that central banks that were shooting for a 2% rate of inflation in their deliberations concerning monetary policy should shoot for something more in the neighborhood of 4% “in normal times.”
Economists of Mr. Blanchard’s philosophical bent just don’t seem to understand!
Inflation IS NOT the solution!!!
But, Inflation could very well be the problem!!!
As I keep saying, the post-World War II policy favoring an inflationary economic policy gained power on January 20, 1961. The basic format for such a program was followed, almost religiously, by Republicans as well as Democrats, into the 2000s. As a consequence, a United States dollar that could purchase one dollar worth of goods on January 20, 1961 could only purchase about seventeen cents world of goods in the summer of 2008.
Furthermore, inflation could not keep unemployment, or even more important, underemployment, down, as was originally believed and it could not keep industry working near capacity throughout the last 47 years or so. In fact, if anything, inflation forced manufacturing to focus on rising prices rather than productivity and this contributed to rising underemployment and declining capacity utilization. For more on this see my post, “The US Economy: Not Back to Business as Usual,” of January 8, 2010: http://seekingalpha.com/article/181621-the-u-s-economy-not-back-to-business-as-usual.
Inflation did create a “boom-time” for finance. Finance loves inflation because inflation that runs ahead of inflationary expectations reduces the burden of any debt outstanding. And what did we see between 1961 and 2008? We saw the greatest blooming of financial innovation in the history of the world and a rapid expansion of the finance industry relative to the rest of the economy that was even condemned by the people most responsible for the creation of the inflationary environment.
I have labeled this type of environment one of credit inflation (as opposed to debt deflation). It is referred to as credit inflation because it can incorporate price inflation, as in the case of the consumer price index) and asset inflation, as in the case of housing prices, dot.com boom, stock market boom, and so forth. Credit inflation relates to any time credit in the economy or in subsectors of the economy increases at a faster rate than the normal growth rate of that particular economy or that part of the economy.
And, this was a perfect time for financial innovation. I have just reviewed the new book titled “The Quants” by Scott Patterson, and he mentions many times in the book that the period from the 1960s into the 2000s, the period of the Quant-boom, as a period of “money ease”. In essence, monetary ease “lubricated” the Quant revolution helping to underwrite the massive growth in the financial industry and the development of the “shadow banking system.”
Of course, as Patterson describes, there were some consequences to pay for this expansion. But, I will let you read his book, or, at least, my review of his book, to gather his “take” on the subsequent financial collapse.
This gets me to the main point of this post. Blanchard, and other economists who think along similar lines, work with macroeconomic models that do not really include debt or the changing burden of debt in their models. Thus, the inflation in their models cannot provide an incentive for economic units to increase their use of debt and the subsequent buildup of debt can have no negative implications for the future performance of the economy. Inflation that causes an increased use of leverage and additional risk-taking cannot be explained in their models.
Thus, inflation remains the best solution to this brand of economist for the achievement of economic growth and lower rates of employment. The earlier debates about the Phillips curve seem to be irrelevant to them, let alone earlier discussions about debt deflation.
We are currently in a very precarious situation. Even with unemployment remaining so high and the economy staying so sluggish, more and more people are expressing concern about credit bubbles in the economy. China, who has recovered from the world economic collapse as fast as anyone, is showing tremendous concern about the possibility that bubbles may be forming in its economy and has taken measures with respect to its banking system to prevent such bubbles from occurring.
Still, our banking system contains $1.1 trillion in excess reserves and the Federal Reserve is faced with the problem of “undoing” this injection of reserves into the financial system. See my “Tightening at the Fed”: http://seekingalpha.com/article/187292-tightening-at-the-fed-get-ready-for-the-undoing.
Some economists still believe that re-flation is the only real solution to the current situation of a stagnant economy and massive federal deficits.
To me, Oliver Blanchard and these other economists that think like him just don’t get it! Yet they stick with the models that they have used over and over again and claim, if anything, that the reason why their solutions to the problem have not worked is because they either have not been tried or that they have not been implemented in a large enough size.
To my mind, their models and the solutions they have presented, have been tried and they have been found wanting. To me, to come up with a call for accepting higher rates of inflation in the future is, at a minimum, absurd. In fact, it scares me!
Oliver Blanchard, now serving at the IMF while on leave from MIT, has co-authored a new paper and has publically presented the results which have been reported in the Wall Street Journal: http://online.wsj.com/article/SB20001424052748704337004575059542325748142.html#mod=todays_us_page_one. Mr. Blanchard is now saying that central banks that were shooting for a 2% rate of inflation in their deliberations concerning monetary policy should shoot for something more in the neighborhood of 4% “in normal times.”
Economists of Mr. Blanchard’s philosophical bent just don’t seem to understand!
Inflation IS NOT the solution!!!
But, Inflation could very well be the problem!!!
As I keep saying, the post-World War II policy favoring an inflationary economic policy gained power on January 20, 1961. The basic format for such a program was followed, almost religiously, by Republicans as well as Democrats, into the 2000s. As a consequence, a United States dollar that could purchase one dollar worth of goods on January 20, 1961 could only purchase about seventeen cents world of goods in the summer of 2008.
Furthermore, inflation could not keep unemployment, or even more important, underemployment, down, as was originally believed and it could not keep industry working near capacity throughout the last 47 years or so. In fact, if anything, inflation forced manufacturing to focus on rising prices rather than productivity and this contributed to rising underemployment and declining capacity utilization. For more on this see my post, “The US Economy: Not Back to Business as Usual,” of January 8, 2010: http://seekingalpha.com/article/181621-the-u-s-economy-not-back-to-business-as-usual.
Inflation did create a “boom-time” for finance. Finance loves inflation because inflation that runs ahead of inflationary expectations reduces the burden of any debt outstanding. And what did we see between 1961 and 2008? We saw the greatest blooming of financial innovation in the history of the world and a rapid expansion of the finance industry relative to the rest of the economy that was even condemned by the people most responsible for the creation of the inflationary environment.
I have labeled this type of environment one of credit inflation (as opposed to debt deflation). It is referred to as credit inflation because it can incorporate price inflation, as in the case of the consumer price index) and asset inflation, as in the case of housing prices, dot.com boom, stock market boom, and so forth. Credit inflation relates to any time credit in the economy or in subsectors of the economy increases at a faster rate than the normal growth rate of that particular economy or that part of the economy.
And, this was a perfect time for financial innovation. I have just reviewed the new book titled “The Quants” by Scott Patterson, and he mentions many times in the book that the period from the 1960s into the 2000s, the period of the Quant-boom, as a period of “money ease”. In essence, monetary ease “lubricated” the Quant revolution helping to underwrite the massive growth in the financial industry and the development of the “shadow banking system.”
Of course, as Patterson describes, there were some consequences to pay for this expansion. But, I will let you read his book, or, at least, my review of his book, to gather his “take” on the subsequent financial collapse.
This gets me to the main point of this post. Blanchard, and other economists who think along similar lines, work with macroeconomic models that do not really include debt or the changing burden of debt in their models. Thus, the inflation in their models cannot provide an incentive for economic units to increase their use of debt and the subsequent buildup of debt can have no negative implications for the future performance of the economy. Inflation that causes an increased use of leverage and additional risk-taking cannot be explained in their models.
Thus, inflation remains the best solution to this brand of economist for the achievement of economic growth and lower rates of employment. The earlier debates about the Phillips curve seem to be irrelevant to them, let alone earlier discussions about debt deflation.
We are currently in a very precarious situation. Even with unemployment remaining so high and the economy staying so sluggish, more and more people are expressing concern about credit bubbles in the economy. China, who has recovered from the world economic collapse as fast as anyone, is showing tremendous concern about the possibility that bubbles may be forming in its economy and has taken measures with respect to its banking system to prevent such bubbles from occurring.
Still, our banking system contains $1.1 trillion in excess reserves and the Federal Reserve is faced with the problem of “undoing” this injection of reserves into the financial system. See my “Tightening at the Fed”: http://seekingalpha.com/article/187292-tightening-at-the-fed-get-ready-for-the-undoing.
Some economists still believe that re-flation is the only real solution to the current situation of a stagnant economy and massive federal deficits.
To me, Oliver Blanchard and these other economists that think like him just don’t get it! Yet they stick with the models that they have used over and over again and claim, if anything, that the reason why their solutions to the problem have not worked is because they either have not been tried or that they have not been implemented in a large enough size.
To my mind, their models and the solutions they have presented, have been tried and they have been found wanting. To me, to come up with a call for accepting higher rates of inflation in the future is, at a minimum, absurd. In fact, it scares me!
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