REFORMING WORLD FINANCE.


MAKING WORLD FINANCE SANE, EFFICIENT, AND DEMOCRATIC.

The new US government of Barack Obama should push to reform the world financial system. Clearly the old order was not just unsatisfactory, but it outright collapsed. It has also collapsed in a highly unfair way, with some of the richest even profiting from the crash. If the old system is not reformed now, it never will be, because the need to do so will never be as strong (see P/S).

What should the reform of the world financial system be made of? I suggest:

1) Regulate the market of any derivative so that it can act as a damper, not an amplifier of the fluctuations of the market function it is a derivative of (favor commercial operators, limit leverage, etc.). In other words, make sure that the tails do not wag the dogs, as they do now (see P/S).

2) Create MARKET EFFICIENCY and MARKET DEMOCRACY. As long as some operators have full information, and their computers are acting on it in the next microsecond, while most non professional market participants are doing other things, like working, sleeping or day dreaming, not all operators can take action in a fully informed way. In other words, one cannot have an efficient market as long as only a few are informed in a timely manner. We need time to allow most market participants to have equal access to information. In the age of individuals having a lot of their retirement in market equity, we need to make sure that MOST PEOPLE ARE INFORMED BEFORE PRICES MOVE SIGNIFICANTLY.

To do this: get inspiration from the foundations of physics, or from traffic safety. In both cases, there is a SPEED LIMIT (in physics the speed of light). So put a speed limit on any traded security (bond, stocks, currencies, commodities, etc.) by regulating a limit of say 3% a DAY on any security, up or down.

Another way to slow down the frenzy of transactions (which favors manipulators and speculators, and other similar parasites) is to put a not so tiny tax on each financial transaction. Such a Financial Transaction Tax would be most positive on government deficit too. Or one could try a combination of both speed limit and significant transaction cost.

Rich financial types will scream that this would kill “liquidity” (probably thinking allegorically about all the money they need to fill the moats around their castles). They will scream that trading could not occur, etc. But they can be answered, point by point. And the first answer is this: finance as the exclusive wealth making haven of the plutocrats would be over. Finance would now be first in the service of the real economy, and everybody, not the province of plutocracy. Limiting moves per day, or making them costly will limit excessive speculation. Small investors, that is, most investors, would welcome this.

3) The dangerous and abusive non sense of having people in non democratic regimes (China, Middle East, etc.) forcefully save so that their government and plutocrats can lend money to the USA, because Americans do not save enough, should be discouraged. Americans should be incited to save, like everybody else, so they can invest in their own country with their own money. So put high energy taxes in the USA and an Added Value Tax. The AVT recenters the economic activity towards saving, and away from frantic consumption. (In the European Union, the AVT is a minimum of 15%. By law. The British government just momentarily lowered its AVT from 17.5% to 15%, in the hope it will help with the UK recession… But other European countries did not touch theirs.)

4) In the USA, a CEO CLASS has appeared. These people sit on each other’s boards and give each others’ riches and perks. They have helped to transform the USA into a plutocracy: not only do they control Wall Street, but also industry. That allows them in turn to rig the work of politicians, by buying them off with the prospect of future riches. Then they tweak(ed) the tax code to their advantage. Look at the spectacle of ex president Clinton, now an immensely rich man, but not thanks to his past salaries or personal investments from said salaries. Clinton is now reaping the fruits of years of friendliness towards the hyper rich when he was president. The rise of a worldwide plutocracy is an extension of this. Ultimately, just as happened previously in the Imperium Francorum, the empire of the Franks, a feudal regime with lords will replace all democratic pretense. Fighting the plutocracy starts with breaking the CEO class. Putting representatives of unions on the boards (as done in Germany) could be a first step. Of course, for nationalized companies, civil servants should be disseminated in management and boards.

5) Raise taxes on the hyper rich, worldwide, and regulate fiscal paradises. (The largest fiscal paradise, many argue, is the USA itself! If the USA cooperates with the EU, there will be no more fiscal paradises.) Reestablish the financial reforms made to prevent a return of the Great Bubble and Great Depression that followed it (i.e. re-regulate banks stringently, reestablish the up tick rule, etc…).
***

Patrice Ayme

***

P/S 1: The list of proposed changes is not exhaustive: there will be other bits to tidy up. Bretton-Woods anchored currencies on gold. Nixon yanked the dollar out of its gold connection, anchoring currencies on the dollar thereafter. This needs to be looked at.

P/S 2:  In parallel to the financial reform, there should be a reform of the world economy, a reform of globalization, taking into account strategic goods (i.e., the world location of all high tech products, starting with… cars), agricultural subsidies (bad, except in starving areas), carbon emissions, and carefully maintaining strategic imbalances insuring the military domination of the powers that have imposed a rough approximation of peace in the last 63 years. And, of course, and first of all, making sure that the creation of new jobs somewhere does not mean the sheer disappearance of the corresponding, preexisting jobs somewhere else, but, instead the mutation of the later to comparable socioeconomic situations (that conservation law was not formally imposed so far, and would necessitate some new governmental machinery). 

P/S 3: If the world financial system is not changed now, people will get used to being abused by it. Their indignation will fade, they would adapt, and be profusely thankful for the first slightest improvement. We would move towards a return of greater plutocracy, or, in other words, the feudal system. 

P/S 4: In our interpretation of what caused the decline and fall of Rome, the original cause is the unsustainable rise of the Roman plutocracy.

Globalization the wrong way, plus various financial tactics, the most prominent being world wide tax evasion and huge leverage, have allowed the recent apparition of a plutocracy manipulating countries and populations against each other for its own benefit. This is a bit, but on a grander scale, what is going on presently in Russia, where tremendously rich oligarchs float above a miserable population distracted by fun and games like invading Georgia. Thus world financial reform should try to diminish the influence of world plutocracy (Russian plutocrats have a foot, or more, safely in the West, thus escaping the full might of the Russian government, a general tactic of plutocrats everywhere). The Gracchi brothers tried to pass wealth reform in Rome, to break the unbearable ascent of the plutocracy. They were assassinated, with thousands of their supporters.  Rome marched firmly into plutocracy, dictatorship and civil war, for the next six centuries.

P/S 5: To buy and sell with little liquidity would be child’s play in the computer age (it would have been very difficult before it, that is why it did not occur in history). A complex set of rules could allow trades, depending on who wants to do what. When a security is limit down (say) for the day, up-tick trades could be allowed (so investors could buy at limit down; for selling they would have to wait until next day in their place in the queue, considering their trading history; that would severely handicap extremely frequent traders (like “quant” hedge funds), but not the most sedate ones (like the most thoughtful mutual funds)). If the volume of trading is too huge, automatic lotteries could determine who gets in or out. 

P/S 6: Some people (Nobel Laureate Krugman, for example) have clung to the belief that speculation of the futures’ market cannot influence the price of the underlying commodity. That is completely wrong. They tried to hold to that argument as the price of oil futures shot up. Now they have fallen silent. Why? Because something even more grotesque happened. The price of oil in dollars collapsed from $147.5 to $50 in three months without any change in demand or supply (staying stuck around 86 million barrels/day). Two-third down: it was all a question of the futures collapsing, as hedge funds had to de-leverage (under the polite pretext that they anticipated a severe worldwide recession). The oily tail waged the oil dog.

P/S 7: The housing bubble collapse and its associated foreclosures should not have been a big deal for the banks (by themselves they would have just dented profits). Problems, such as the disappearance of some banks’ entire capital, came from the banks’ massive investments in derivatives, some of them unknown not only to regulators, but to the banks themselves. Pluto hides below the ground, in the Dark, indeed.

P/S 8: One of the master ideas of world financial reform is to make finance a slave to the People, and cut off the evil pathways plutocrats have been using to make themselves ever richer, on the back of the People.

Still another possible example of such an evil pathway is the “Carry Trade” where financial operators borrow in a country with low interest rates, just to transfer the capital to a high interest rate country. This has made some plutocrats very rich. It should be looked at very carefully to see if there is enough good in it, or if it should be mitigated, or outright outlawed. At first sight, it defeats the purpose of providing “liquidity” (i.e., money) to the low interest country (the fundamental reason why the interest rates are low there). Such an inquest would not be a wild attack against riches and capital a la Marx: legitimate pathways to get richer who profit the People by motivating exceptional individuals should be encouraged (and would be encouraged even more, since the evil pathways would have been closed, thus funneling more activity and creativity towards what profits to all, and not just a few parasites).

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10 Responses to “REFORMING WORLD FINANCE.”

  1. Stephen Says:

    I’m sure you have good intentions, but the even current system is far superior and more equitable than the disjointed, fantastical changes proposed here. Before being able to recommend good reforms, you must first have an accurate understanding of the problem.

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    • Patrice Ayme Says:

      The critique is easy, especially without any specifics, but the art is difficult. I would be most gratified if any particular point of mine could be exhibited as condemnable, and why, specifically. That would allow to progress, mentally speaking. I know very well that one could view, at first sight, my proposed changes as “disjointed, fantastical”. They are not meant as small and inconsequent. But I doubt that it would be as obvious to everybody that “even the current system is far superior and more equitable”.

      It is not a question of being “superior” or inferior. There is nothing superior in a system that has completely failed. For several weeks, banks could not lend anything to anybody because there was no more money, and no more trust. The capitalist system, as it existed before, had thoroughly failed. So it has to be changed to a much superior form. It would not be the first time.

      As far as being “equitable” my proposed changes would allow the “efficient market” to become a reality.

      Another subject I addressed was the derivative market. As it is, it’s mathematically insane. One could mathematically prove that such a DERIVATIVE MARKET CANNOT EXIST. Indeed the total value of all the world’s properties is around 100 trillion US dollars, at most. The nominal value of the derivatives is around 600 trillions US dollars. But the part cannot be superior to the whole. Therefore the part cannot exist. QED.

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  2. Jeff Says:

    Re: derivatives market

    In the case of credit default swaps, at least, there have been a lot of redundant trades in the total outstanding swaps discussed in the media. Nonetheless, without addressing it point by point, I tend to agree more with your remarks than with Stephen’s quoted here. The nature of the problem is well understood. These guys were fooling around with billions and trillions on paper with total disregard for reality and finally got a reality check much to their collective disbelief. Should this kind of nonsense be allowed to continue? Of course not, reforms are needed such as transparency, a central clearinghouse and responsible regulation of derivatives by central banks and other appropriate regulatory agencies. The regulatory oversight of derivatives markets was, in retrospect, grossly inadequate in some respects. Maybe Warrne Buffett would say that in business you always have 20:20 hindsight in the rearview mirror. No matter.

    Look at the job the regulators did using another point of reference: the size of the financial impacts of the collapse of LTCM, then the dot.com bubble at the beginning of the decade and then the subprime crisis. Each was progressively larger and needlessly so. Is it necessary for the disasters to grow proportionally larger in each subsequent iteration of excess? Of course not. The regulators were not doing their job properly, and we are still waiting for mea culpas from some of those responsible. The media decided to focus on the pay of banking executives and that the CEO’s of auto manufacturers flew private jets to Washington D.C. instead of driving cars. Sound bites do not go far enough to fully inform an ignorant public or speak truth to power. While the television media is congratulating itself on getting auto company CEO’s to drive a car to Washington, the causes of the subprime crisis continue to get too little press.

    Stephen says “you do not have an accurate understanding of the problem.” Well, the causes are not rocket science. The causes had a lot to do with with the regulators’ failure to take common sense steps to regulate commercial banks, their subprime lenders and investment banks adequately. This cannot be overstated.

    Jeff

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  3. Jason Spalding Says:

    Patrice,

    A couple a comments and a closing remark on the Madoff Ponzi scheme and its relation to regulation.

    SNIP
    “1) Regulate the market of any derivative so that it can act as a damper, not an amplifier of the fluctuations of the market function it is a derivative of…”

    Establishing by law a requirement that all trades in a given derivative be reported electronically, immediately to a central clearinghouse and that those prices be immediately published would go a long way toward creating price transparency that would eliminate much of the uncertainty created by the way in which some unregulated derivatives have been traded. This should eliminate the “tail wagging the dog” phenomenon seen recently in credit default swaps, for instance and is both in theory and in practice a much more efficient way of expressing market participants’ and observers’ sentiments about the underlying security. This would also eliminate many duplicate trades which created uncertainty about the stated size of the market and the value of outstanding contracts.

    SNIP
    “2… …make sure that MOST PEOPLE ARE INFORMED BEFORE PRICES MOVE SIGNIFICANTLY.
    To do this: get inspiration from the foundations of physics, or from traffic safety. In both cases, there is a SPEED LIMIT (in physics the speed of light). So put a speed limit on any traded security (bond, stocks, currencies, commodities, etc.) by regulating a limit of say 3% a DAY on any security, up or down…”

    Regulations already exist requiring information material to the value of securities such as stocks and bonds, etc. issued by companies be disclosed without delay to the public. In other words, formerly it was the case that financial analysts received information from companies that was not made public immediately, but under current law great efforts are supposed to be made by a company when issuing non-public information to do so in such a manner that all market participants receive it simultaneously. In the case of Enron the company deliberately concealed its massive off-balance sheet financial arrangements which, when they finally became known brought down the company. Unfortunately, there is no magic bullet for stopping deliberately deliberate deceptions from occurring, although there are penalties for doing so and more stringent requirements for corporate officers to sign or attest to audited financial statements than pre-Enron, Worldcom, etc. One can ask rhetorically whether existing penalties are sufficient to adequately discourage deception and fraud, but one cannot know which kinds of deception and fraud will occur in the future.

    Secondly, how do you determine when “MOST PEOPLE ARE INFORMED”? What is your litmus test for this compared to the present standard? Should trading in a market be halted until regulators are confident that every or nearly every market participant has been informed? In theory this has some appeal but in practice it is impractical because in practice there is simply no way to know whether all market participants are paying attention or if in fact they want to be informed of the day-to-day information which securities trade on. Some simply do not want to know it because it is a distraction from their long-term strategy to hold a security for a period of time while ignoring the day-to-day fluctuations. This does not mean that they should not have the right to be informed should they wish to search for the information where it has been properly disclosed. I am not a securities lawyer so I don’t want to engage in a discussion about what constitutes proper disclosure.

    ” 3) The dangerous and abusive non sense of having people in non democratic regimes (China, Middle East, etc.) forcefully save so that their government and plutocrats can lend money to the USA, because Americans do not save enough, should be discouraged. Americans should be incited to save, like everybody else, so they can invest in their own country with their own money. So put high energy taxes in the USA and an Added Value Tax…”

    Responding to accusations in a Sunday, Dec. 21, 2008 NY Times article, President Bush has defended his administration’s track record at regulation of the financial markets during his tenure (which also means implicitly how well his appointees at various regulatory agencies performed their duties) and during the recent housing boom and bust and financial collapse by suggesting that inflows of foreign capital were largely or significantly responsible for the size of the boom and bust that occurred and that the blame should not be laid at his feet, so to speak. In theory it makes good sense and a nice ideal as well that democratic regimes should not turn to undemocratic ones to finance their private markets and government spending. But in fact this is one of the chief ways in which un or non-democratic regimes are encouraged to become more capitalistic by the Western world. Whether this can or does eventually lead to said regimes becoming democratic or less repressive toward their citizens is open to great debate, but I do not intend to address the question here because I cannot do it justice. It is easy to see that one can argue on both sides of the question depending upon one’s inclination or point of view.

    To elaborate further, some countries’ currencies are pegged to the dollar while others are free-floating. Both choices have downsides. Those that are pegged can experience devaluations as has been the case in recent years with Mexico and Russia. Those that are free-floating can be subject to greater uncertainty as to their current value, making it more difficult to attract capital inflows from foreigners. It seems to be the consensus view that to discourage the flows of capital over borders would in turn discourage economic activity, thus leading overall to a smaller amount of trade. This is regarded by most as not a good outcome, although those rail against the negative externalities (i.e. pollution, global warming, waste, excess consumption, loss of biological diversity and habitat destruction to name a few) created in a global economy in which market participants seek to avoid paying for the externalities their transactions create might be content with smaller markets subject to greater regulation. Unfortunately, governments have demonstrated much difficulty agreeing on such regulations and enforcing them.

    You make some other points here that I do not have time to address. The worship of wealth creation is responsible for what you refer to as a “CEO class.” When something besides wealth is held in highest esteem another leader class might emerge. Until then, I remain a skeptic. As for fiscal paradises, I believe some governments will continue to respond to what is believed by citizens of some regimes to be excessive taxation by creating tax havens or attractively lower tax rates, particularly when said governments have no other available means to attract sufficient capital inflows to increase commerce and potentially raise standards of living. Luxembourg is an example of a country without a large enough industrial base to be competitive with larger European rivals so it chose to do so instead in banking, albeit with tax treaties between itself and the EU and the US rather that merely trying to attract tax dodgers. Will the hyper rich seek tax havens in greater numbers if taxes are raised? Perhaps so, perhaps not in as great a number as some would predict. It depends upon how intelligently tax legislation is conceived, a difficult subject to say the least.

    Finally, one could create a proxy for how much more graft and deception occurred in weakly regulated financial markets under Bush’s tenure than in an administration that put in place and enforced more stringently regulation of the financial markets by using the amounts lost through fraud and deception from Enron, Bear Stearns, Lehman, AIG, Citi, WaMu, Countrywide, etc. as well as what is eventually known about how Bernard Madoff created his super-Ponzi scheme (some have already speculated the it may have begun when his Payments for Order Flow gold mine from the NASDAQ stock market began to dry up in the late 80’s) as data points or second derivatives (in the calculus sense) and then do a summation (political scientists have done so in the past so it is not a novel idea).

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  4. Patrice Ayme Says:

    To answer your comments, and you seem in agreement with this drift, all that one can do is to mitigate. One cannot completely forbid some behaviors, just make them less desirable, and less probable.

    For example if Enron like frauds were repressed more severely, both in discovering them and in punishing them, they would tend to occur less.

    You also say that things will change “When something besides wealth is held in highest esteem another leader class [besides CEO class] might emerge. Until then, I remain a skeptic.” I agree, and that was one of my points.

    Higher esteem will come from higher pay. And that is especially true for engineers. The quadzillions in payments to money manipulators are as much money that did not go to engineers.

    Also money manipulations (“liquidity”) are too extreme, they should come with more cost, and that would also be an occasion to record them, worldwide. That was also precisely the meaning, and main interest, of putting a deliberately low speed limit on transaction, like in the universe.

    A speed limit would prevent to do everything at the same time, which could only mean, pushed to the extreme of foreseeable technology, doing nothing. It would also make knowledge reasonably likely to reach the working public (a few percents change in value a day insures that everybody can be informed, with verified, government certified (why not?), information, before prices can move significantly).

    Patrice Ayme

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  5. Jim Welke Says:

    I appreciate your thoughtful and thorough propositions. I would be inclined to support them. Our economic framework (U.S.) is not serving even a large majority of our citizens. It is serving to create an oligarchy and to eviscerate our potential for broad prosperity.

    Cheers,

    Jim

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  6. MrPitchfork Says:

    …OR we could just not have “CENTRALIZED” anything including banks, energy companies, etc… AND also throw people in jail that rip people off instead of bailing them out. The most effect regulation that I can think of is jail time with maybe a life sentence. Maybe bring back some old western style justice. We should also be putting the Federal Reserve under a microscope and see just what their hand in this economic mess was. Apparently, they operate outside of the law and are constantly manipulating the money supply and the economy. They are a private bank and not part of the government and do not have members on the board that are elected by the people. They and their counterparts are the root of this tree.

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    • Patrice Ayme Says:

      Indeed, all seems to indicate that, far from behaving as independent civil servants, some employees of the Federal Reserve behave as private individuals keen to advance their private search for riches through their stint at the helm. Alan Greenspan’s career seems a case in point.
      PA

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  7. Swiss Fight Pluto! | Some of Patrice Ayme's Thoughts Says:

    […] By creating what I long called the CEO class (See the essay of November 2008 on Reforming World Finance), the entanglement of corporate boards […]

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  8. Depression’s Causes: Righteousness & Viciousness | Patrice Ayme's Thoughts Says:

    […] is a solution I have advocated since 2008. See “Reforming World Finance”, from November 2008, when I naively still hoped my friend Obama would grab the bull by the […]

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