The VOX economics blog ran an good piece by Biagio Bosone on Jan 23 where he makes the case to slow down the current rush into robotic finance  (http://www.voxeu.org/article/putting-time-and-space-back-finance).

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Bosone asks some existential questions at the start of his essay:

  • What room is left in today’s finance for real people in flesh and blood?
  • What room is there left for real enterprises of the kind finance should be supporting?
  • What room is left for development finance, expected to provide access to greater opportunities and freedoms for the largest lot?
  • What room is left for the real geography of local economies and producers, which are overlooked by a financial culture that only sees them as anonymous nodes of ubiquitous networks?

Bosone’s argument might be summarized in this quote:

Yes, many of us are now connected through instantaneous and unbounded network links, and this has eased access to financial services, but in the process we have become parts of impersonal relations, framed as entities into grids of statistics and stochastic parameters, managed by artificial intelligence.

When space-time shrinks, this is what takes place in economic contexts where critical phenomena rapidly grow global in scale. The room for decision-making subsides, especially when policy responses require international coordination. Market opinions become unanimous verdicts based on fleeting conventional beliefs, more than on underlying fundamentals. Market operators find it convenient to join the herds and follow the leaders, instead of taking the chance to run countertrend. Expectations align and strengthen market ‘sentiments’. Euphoria, uncertainty, and panic mount in sequence, with unprecedented speed and breadth. Information abounds, and yet there is no time to digest it, and its quality runs down if those producing it have an interest in matching market expectations. With compact space-time, short-term delocalised speculative activities prevail over longer-term, locally established productive undertakings.

Bosone’s point is an important one, and it reminded me of an excellent piece in a recent issue of Wired that described the phenomenon of high-frequency trading (HFT). The piece, called “Raging Bulls” (http://www.wired.com/business/2012/08/ff_wallstreet_trading/all/), writted by Jerry Adler, does a fine job of explaining what HFT is and all the efforts being made to push the boundaries of physics-based finance.

After laying out the fascinating arms race taking place between providers of HFT networks, Adler takes a step back and asks where all this is going:

High-frequency trading raises an existential question for capitalism, one that most traders try to avoid confronting: Why do we have stock markets? To promote business investment, is the textbook answer, by assuring investors that they can always sell their shares at a published price—the guarantee of liquidity. From 1792 until 2006, the New York Stock Exchange was a nonprofit quasi utility owned by its members, the brokers who traded there. Today it is an arm of NYSE Euronext, whose own profits and stock price depend on getting high-frequency traders in the door. Trading increasingly is an end in itself, operating at a remove from the goods-and-services-producing part of the economy and taking a growing share of GDP—twice what it did a century ago, when Wall Street was financing the enormous industrial expansion of the economy. “This is counterintuitive, to say the least,” wrote New York University economist Thomas Philippon in an article for the Russell Sage Foundation. “How is it possible for today’s finance industry not to be significantly more efficient than the finance industry of John Pierpont Morgan?”

Both Basone and Adler raise questions about the very nature of finance and its role in society. While it would be tempting to dismiss the topic with a “you cant put the genie back in the bottle) comment, this is not the correct response. Finance, like medicine or education, is too critical a social function to let it become robotized without some sort of discussion about how and when this evolution should proceed. I make this argument, because I have often noted that a key to an effective democracy is that its citizens understand how the most basic processes of society work. In other words, the average citizen needs to understand basic aspects about society, i.e., how a law is made, how is health care provided, how a good citizen is educated, how to rise from poverty to wealth, what is the role of money in society. After all, what can be more fundamental to a capitalist society than the role and function of capital, the essence of commercial finance?

A problem in the US and Europe these days is that ordinary people simply no longer understand how these basic processes work. Who understands how laws are made in the age of PAC’s and Super-PAC’s? Who understands the logic of healthcare in the of HMO’s and PPO’s? And who understands finance in the age of trades that take place in micro-seconds across fiber-optic cables with zero human intervention?

The answer, of course, is almost no one — not even the people that build these systems as frustrated lawmakers, doctors and traders will tell you. This matters because when ordinary citizens cease to understand how society works, they become frustrated and open to consider alternate explanations for reality that may have nothing to do with reality: think Germany in the 30’s, the US in the 50’s or Latin America in the 70’s. Confusion breeds anxiety and anxiety is the soil in which the seed of a dictator often takes root.

Bosone’s cogent plea that we need to take a step back and consider the social implications of this avalanche of technology in finance is an important one, and something important not just to regulators but to anyone who cares about democracy in the 21st century.

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Posted by Carlos Alvarenga

Carlos Alvarenga is the Executive Director of World 50 ThinkLabs and an Adjunct Professor at the University of Maryland's Smith School of Business.

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