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Debunking the Global Financial Con Job

World's money system continues to be imperiled by financial deregulation

By David James Created: November 19, 2012 Last Updated: November 22, 2012
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A trader works on the floor of the New York Stock Exchange, on Nov. 7, 2012. The emergence of high-frequency trading, computer controlled and performed within nanoseconds, is dangerous and can result in increasing incidences of volatility and collapses, writes David James. (Allison Joyce/Getty Images)

A trader works on the floor of the New York Stock Exchange, on Nov. 7, 2012. The emergence of high-frequency trading, computer controlled and performed within nanoseconds, is dangerous and can result in increasing incidences of volatility and collapses, writes David James. (Allison Joyce/Getty Images)

 For 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 U.S. President Ronald Reagan and the British Prime Minister Margaret Thatcher, business-funded think tanks and conformist university economics departments, established a chorus that mesmerized 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 number 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, 1,208 columns, by 2011 … 2,271 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.

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.

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 United States:

“The Treasury … pumped $105 billion into the system and quickly realized 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 2 p.m., $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 realize that money is rules. The discussion in the wake of the financial crisis centers 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 percent 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 recognize 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 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 their 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 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 doctorate in English literature from Monash University. This article was originally published on Eureka Street, www.eurekastreet.com.au.

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