Debunking the global financial con job


'Money Is Rules' by Chris JohnstonFor at least a quarter of a century, the financial sector has pulled off a confidence trick that in 2008 almost destroyed the monetary system of the world and continues to imperil the world's money system. It is called financial deregulation.

Pro-market politicians, especially US president Ronald Reagan and the British prime minister Margaret Thatcher, business-funded think tanks and conformist university economics departments, established a chorus that mesmerised the world: financial markets are overly controlled by governments; there is a need to remove that control in order for money to roam free and create more efficiency.

Even after the most dangerous financial crises ever seen, the finance industry's lobbyists are still arguing that the sector should not be too heavily regulated on the grounds that it would be counterproductive.

This is nonsense. Money is rules. It is impossible to deregulate rules, as it is impossible to take the wetness out of water.

The rules of money are principally about value and obligation. When a bank lends money for a mortgage, the borrower is obliged to repay the value of the loan within a certain period. When investors buy shares, they purchase ownership of a certain value, which the company is obliged to give to them.

Money is not a commodity with a value in its own right; in the English speaking world, not since Henry VIII diluted the value of coinage in the 16th century. The wooden stocks (sticks) of medieval times that were used to record debts were just sticks, of little value in themselves.

These days, money mostly exists as blips on a computer screen. The amount of physical cash is very small. Such electronic transactions are based on agreement about how the rules operate.

Since finance cannot be 'deregulated', what actually occurred was a shift from government setting the rules, to traders setting the rules. Far from reducing the number of rules, the amount of rules has soared. According to Andrew Haldane, a senior official for the Bank of England, speaking at the economists' talkfest in Jackson Hole:

Since 1978, the Federal Reserve has required quarterly reporting by bank holding companies. In 1986, this covered 547 columns in Excel, by 1999, 1208 columns, by 2011 ... 2271 columns. Fortunately, over this period the column capacity of Excel had expanded sufficiently to capture the increase.

This is only the reporting side. The creation of massive amounts of derivatives (transactions derived from conventional monetary exchanges such as bank debt, shares and currency swapping) is an instance where traders make up rules — money made from money made from money. The total number of derivatives is over $700 trillion — more than twice all the bank debt, shares, land and bonds in the world.

Deregulation has descended into a rule-creation debauch, a financial Tower of Babel. And the Tower is a threat to itself. According to Paul Kanjorski, former chairman of the subcommittee on Capital Markets, on a Thursday in September 2008 $550 billion was drawn out of money market accounts in one morning in the US:

The Treasury ... pumped $105 billion into the system and quickly realised they could not stem the tide. We were having an electronic run on the banks. They decided to close the operation, close down the money accounts, and announce a guarantee of $250,000 per account so there wouldn't be further panic ...

If they had not done that their estimation was that by 2pm, $5.5 trillion would have been drawn out of the money market system of the United States, [collapsing the national economy] and within 24 hours the world economy would have collapsed. It would have been the end of our political and economic systems ...

What Kanjorski describes is the ultimate price of allowing traders to make up their own rules, and of governments failing to notice the logical cul-de-sacs in the arguments proffered for deregulation. The global monetary system was almost destroyed.

Nothing has been learned. There is still a failure to realise that money is rules. The discussion in the wake of the financial crisis centres on how much to regulate banks and financial traders. Derivatives remain the main cause of instability in the global financial system as they amplify crises, such as the Euro crisis in the latest iteration.

The emergence of high frequency trading is another dangerous rule-creation absurdity. This is the application of computer algorithms to financial markets that involves trading at high speed — trades are done in nanoseconds.

High frequency trading can apply to any market and takes no account of the value of the underlying asset or security. Its proliferation — it is growing fast in the Australian stock market and is about 70 per cent of the turnover in the American stock market — results in increasing incidences of volatility and collapses.

The algorithms can only be constructed because there is an underlying set of rules about the markets, whatever they are. So the explosion of rules continues unabated.

So what is needed? First, to recognise that money is rules, and that the question is not how many rules you have but who should set the rules and what kind of rules should they should be.

Second, governments need to govern, not hand things over to mythical market forces. Governments can change the rules to stop the debauch, by returning to only allowing derivatives to apply to physical commodities, or putting a small (Tobin) tax on cross border monetary flows to put the speculators out of business.

But governments have become so supine, and so desperate to save the existing system from the traders' greed and mathematics, that they seem incapable of standing back and asking some basic questions about how the system should be constructed. 

Haldane noted that if a 'once-in-a-lifetime crisis cannot deliver change it is not clear what will'. One of the consequences of governments' abrogation of its responsibility is that the job is passed to regulators. But regulators work from within the system; they cannot stand back and change it.

As Haldane observes: 'To ask today's regulators to save us from tomorrow's crisis using yesterday's toolbox is to ask a border collie to catch a frisbee using Newton's Law of Gravity.'

David JamesDavid James has been a business journalist for 25 years and is the author of Managing for the Twenty First Century and The Business Devil's Dictionary. He has a PhD in English Literature from Monash University.

Topic tags: David James, economics



submit a comment

Existing comments

Economics has "hit the wall" as a credible source of policy insight because its mathematical models are "irrelevant" and/or even "dangerously wrong", crippled by lack of sufficient accurate, complete and timely real life data - professor Varoufakis 2012

Hillan Nzioka | 12 November 2012  

Let's not leave the Hawke-Keating duo of deregulators out of the Reagan-Thatcher set please. And what about Blair-Brown, who wilfully continued with Thatcher's programs? As for the behaviour of the Rudd-Gillard government, they had a chance to force changes here and on the international scene but did nothing at all, preferring to continue running 'the joke' as if the band-aid Rudd provided to the local economy was a genuine fixit. Abbott, of course, will be more of the same too.

janice wallace | 12 November 2012  

Thanks David for reminding us of the elephant in the room - the global financial system itself. Without responsible governments making the hard decisions to regulate these chimeras, we will reel from crisis to crisis over the next decades.

Dr T | 12 November 2012  

Good stuff, David James. When the Melbourne Storm plays another Rugby League team they are subject to the strictest rules imaginable. The enforcers of the rules namely, the referees, are also subject to the greatest scrutiny. There is also transparency to the highest degree - no secret deals !! (video ref).i Yet, yet, yet — it somehow enables the greatest competition that is possible.

Dally Messenger | 12 November 2012  

I'm not an economist. I'm not working in the finance industry. But to me it just seems common sense that where bucketloads of money can be made by so few then those few need to be subjected to regulation and close watching. The examples in the US when the big banks had to be bailed out courtesy of the public purse and the top bankers still wanted to pay themselves bonuses just indicate how out of touch they were/ are and how superior they see themselves to be. Deregulation and self regulation are con jobs alright and work against the public interest.

Joe | 12 November 2012  

++Great article. What concerns me is that a Labor Government, Hawke/Keating started the ball rolling here in Australia calling it "economic rationalism" Treasurer Swan is still committed to this failed economic disaster. Interestingly it was introduced around the world under different names e.g. Thatcherism and Reganism. Our now retired think tank was warning about this collapse - and we're not even economists

John Morris | 12 November 2012  

"the elephant in the room - the global financial system " Isn't the real elephant in the room the environment? We need to move to a more sustainable economy, but despite our scientists constantly reminding us of the danger, we go on with our getting and spending which is destroying the environment we depend on. We need to reform the finance system, as the author suggests, but within the frame of environmental sustainability.

Russell | 12 November 2012  

What I liked so much about the article is that it identified the problem rather than opting for traditional party politics and the usual boring debate that follows. It is clear that the whole of Parliament - all members, all parties - need to consider how our financial system can be changed to deliver a fairer/more equitable outcome for all. The implications of the nanotechnology in transfers, the incredibly fast flow of massive capital, at speeds which far outstrip our capacity to think, must be considered fully. The bail-out of banks was apparently unavoidable this time, but it should not be repeated. I am despairing when I hear of the billions, trillions, etc, which the financial sector is now talking about. Such numbers no longer make sense, and help to confuse us altogether. If we can’t imagine something we certainly can’t deal with it. Maybe as a society Australia can try to do something more effective than lamely take the same road that Europe is presently treading.

Eveline Goy | 12 November 2012  

The problem is deeper than this article suggests. Fractional reserve banking itself is the culprit. Outlaw it, return to the gold standard, and neither greedy governments nor greedy private citizens will have anything like the power to embezzle that they have now. In other words, restore a truly capitalist/honest monetary and banking system (contra "Thatcherism" or "Reaganism") and our current massive problems will wither away. As Ron Paul incisively has argued all these years.

HH | 12 November 2012  

A first solution might be for bailout funds to take the form of equity investment. This will dilute the shareholdings of other investors and will put senior public servants on bank boards. A second solution will include restriction of the bonus culture; a first step might be to make all bonuses payable out of after-tax profits ... but still treated as income for tax purposes in the hands of the bonus recipients. Alternatively, it would be better to pay bonuses not as cash but as equities held in trust, with dividends of those equities paid to the bonus recipient. The equities would be released to the bonus recipient upon their retirement, and would be treated as part of their superannuation payout.

David Arthur | 16 November 2012  

Good article, David! The International Banking and Finance Industry has become the most greedy and irresponsible sector of the economy with a philosophy of speculative borrowing and lending and an aversion to customer service so that huge salaries can be paid to senior executives. Most politicians in Australia, the USA and England do not have the courage to confront the bank's greediness. Everybody should support people such as Angela Merkel and Christine LeGarde who are trying desperately to curb the greediness of the the banks for the social benefit.

Mark Doyle | 17 November 2012  

Yes. There has been a financial crisis. I object to the all inclusive "Global". Was the phrase coined by economists, journalists or the perpetrators wanting to make us all feel responsible? Yes, we were affected by it but were we ever in crises? Same applies to NZ and Canada. I suspect the Chinese were playing games, they still imported iron ore and coal from "small" quantity suppliers at lower prices and Australia has lost market to them. The large quantity suppliers can only control the price while the purchaser wants or needs to buy large quantities. China had a buffer of iron ore stocks, not so much of coal due to limited “shelf” life because of its nasty habit of spontaneous combustion. The Australian government tried slights of hand like road building and repair programs. This didn’t solve problems, simple moved them. The work was slatted for the future anyway, moving it took away future jobs and finance. Then there is the housing industry. The government promoted solar energy and insulation and when it suited cut the legs out from under the newly created sector leaving it struggling. Australia avoided the crises in spit of its politicians, no because of.

fred from Townsville | 04 February 2013  


Subscribe for more stories like this.

Free sign-up