Global finance, a coda: Continuing to explore why we view economics as both boring and terrifying.

So, we were discussing why economics is viewed as boring, when it's really pretty fascinating stuff -- and we were thinking about how to put the life back in it, how to re-imagine this discipline which has gone stale.

Re-imagining the entire discipline of economics may fall on the shoulders of the media. Alas, there are institutions that have a stake in presenting economic information in a certain way. An ignorant populace is an easily manipulated populace.

I am not claiming a conspiratorial "they" that consciously controls these media images, but the fact remains that the way the subject now is presented (boring, in the realm of "professionals") is very useful to the people presenting it-- the corporate media, etc. Economics news coverage is pretty interesting in that it's alternately presented as some incomprehensible mess of numbers, or it's presented in a way to incite fear: two very different reactions to the economic news. Either it makes your eyes glaze over, or it terrifies you. Isn't it possible to learn about what's going on economically in a way that's measured, yet engaging? Apparently, not when the people hired to inform you have an interest in you being bored or terrified about the economy.

Let's look at the Money section of USA Today.
We've got "'Shocking' slump: Industry pros see Detroit steering into a skid." We've got "Stocks extend losses in bruising volatile week as Dow drops 4.2%". And we've got "German man torches his car to protest high gas prices." Bruising? Metaphorical car crashes? Torching? It's looking violent, and scary. They take the humanity out of economics, conceptually, and insert it back in how they choose: in the language of pain & injury. I mean, really read into this stuff sometime.

But the blame for our bored/fearful state doesn't rest just on the media; we have our own psychic filters when it comes to economics. I mean, we have a way of thinking that kind of glazes over it and tunes it out. If you don't get what I mean (I've phrased it a bit imprecisely), go and observe the reactions of people when economics gets brought up in conversation. If people do get excited about it, they don't usually relate it to their own lives, or look at it as concerning moral issues. This is partially because our ways of thinking have habituated us to a certain kind of economic environment where we take certain things as given.

John Maynard Keynes: "The power to become habituated to his surroundings is a marked chracteristic of mankind. Very few of us realize with conviction that the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half-century. We assume some of the most peculiar and temporary of our late advantages as natural or permanent and to be depending on, and we buy or plan accordingly."

He wrote that in 1919, by the way: uncanny, no?
However, I think this is changing: that economics (and oil) are starting to come to the attention to the middle class, and thus the media. Increasingly, we will see economic matters viewed as public issues (more so than before) now that they are starting to affect people in a measurable way. But how will we see them? I think it will be through the lens of fear, again. It gets scary when the middle-class becomes poor... (to the middle-class anyway, most of the world just deals with it) because they thought they were invincible, a few decades ago. Like the tone of this CNN piece on an older woman who lost her condo and now has to live in her SUV. "'She added, "The way the economy is going, it's just amazing the people that are becoming homeless. It's hit the middle class."" As if the middle-class was some sacred, untouchable thing-- There are psychic markers with gas prices, too-- Then reality shifts, and a new norm is adapted to. It is interesting to watch how reality shifts, because this is where possibility comes in. (This is the psychic premise of economic "shock therapy", but I've always argued that reality shifts can be used to positive ends, if we were as smart as the financiers to take advantage of them).

How did we get so accustomed to a certain way of viewing economics and the world? Charles Derber in Corporation Nation attributes it to what he calls the corporate mystique; "the main recipe for how to think, and live in a corprate world ... an ideology, which for decades has effectively disguised the rising power of corporations in our lives." Pointing out that "the personal identity of today's worker, consumer, and citizen is becoming a corporate construction," he asks where we get our dreams and opinions... in great part, they are subtly given to us by corporations. They have a huge part in manufacturing our very identities. This works at a very subtle level, even for those of us who think we are aware of it.

"It is impossible to underestimate the extent to which one's own moral integrity and sense of self-respect stem for how one is situated in that world, and the extent to which most of us are involved as both agents and targets of corporate power."

So, in great part, we are the ones manufacturing our own limitations. Furthermore, as Derber points out, we see corporations as the source of our creature comforts, so we often view them in a positive light... as benefactors.

We are psychically tied up and invested in this corporate economic system, even when it is working to destroy us, and the planet. (I know that last sentence sounded melodramatic, but I mean it quite matter-of-factly.)

Who makes the information you get on the financial system? All the headlines are manufactured by corporate media conglomerates. This is a huge issue, because so much of what goes on in economics is about mood and confidence. If they manufacture a certain mood, things either glide on when they logically shouldn't, or things fall precipitously. Who controls the mood controls reality: few other fields actually work this way, but economics seems to. Right now the mood is anxious: Derber calls the middle-class "the anxious class."

But consumer confidence fell more than expected in June, hitting another 28-year low as surging prices and mounting job losses contributed to a bleak outlook, according to a survey Friday.

"Moreover, gas prices have risen to an all-time peak, food prices posted the largest increases in decades, home prices have fallen faster than any time since the Great Depression, and there has been widespread distress associated with foreclosures," the report added.

Distress. Falling confidence. Bleak outlook. Mood. The phrases above are from a USA Today article on the economic stimulus checks, but I could manufacture an article just as easily off the top of my head & convince people it was true. All you have to do is use words like "worried", "turbulent", etc. a bunch of times. At this point I sound like I'm just bitching, but really: there are implications to constantly being exposed to fear-formula news.

How will this anxiety be eased?

There's a very powerful psychological mechanism at work to simply trust in the corporate world, in the world of global finance, that everything will be sorted out.

But why trust them? It doesn't even seem like these guys are very smart. If you look at what they are doing, it is not very smart. In fact, it is like children. In deregulating the futures system in the way that they have, and running up the national debt like teenagers with credit cards, and failing to invest in alternatives to oil, both our politicians and economic experts have displayed an extreme lack of discipline and maturity.

Childhood is when you think about the short-term; you have your mother to step in and regulate your candy consumption because she knows in the long term it will be bad for you. Maturity is when you are able to plan for the long-term, and disciplined enough to follow your plans. As a society, we are quite immature, and we will be forced to grow up fast. It's looking like a painful adolescence.



The Final, Short List.


What does one do, in 2008, when faced with global economic difficulty ahead?

the most important thing -- is to truly assess your needs -- find worth, value, in meaning in things that are free -- break the mental shackles.

We control our moods; we don't have to accept the mood given to us by the media.

I think the individual psychic work to be done is just as challenging as the practical work. It will help immensely to have other people around you who are thinking as you do: only through group shifts in thinking can we really re-imagine economics on a scale large enough to do something about it.

smart things to work toward, practically:

-- figure out a way to make your voice heard on financial policy
-- get out of debt
-- put yourself in a situation where you don't rely on auto transport
-- put yourself in a situation where you can produce your own energy needs and grow a portion of your own food
-- become part of a community that shares expensive items, like cars or lawnmowers or kitchen appliances or whatever

Maybe it is a good idea to move towards this now, or at least continue to educate yourself on what's really going economically, so you can face these weird news reports without the fear they're intended to produce: information is, to some degree, confidence.

Granted, most of the ideas above are just common-sense provisions for damage control once the whole economic system is already really screwed up. As far as being able to influence the policy decisions to keep things from being totally screwed up... I honestly don't know the best way to do this. I've been basically arguing this whole time for greater citizen involvement, but I suspect it won't come quickly or easily, given that the people profiting from the status quo don't want citizen involvement. Persistence and ingenuity, I guess: if you have any ideas on this problem, comment.

Adventures in Global Finance [Part V]

What the Future Holds

the future a cradle, holding / the future soil, holding . . . life? / the future a used mine, holding nothing? / the future a hand, holding . . .


...actually, everything written in the posts prior to this was just a prelude to the really interesting questions ahead.

But first, an important note: none of this is trying to be prophetic. I'm someone who looks at the evidence I can find-- from the best sources available-- and extrapolates conclusions from it. I encourage you not to believe anything I say, but to do your own research & extrapolate your own conclusions, so you can make the best decisions for your life-- decisions which take into realistic consideration the future facing you, your family, your country, your planet. My main argument to this whole piece, if there is one, is that we should think about and understand global finance. We should make educated financial decisions on a personal level, and elect people who actually have economic intelligence and solutions.

I think there has been a semi-deliberate attempt to obscure understanding of our financial system.

It's surprising that we consider ourselves educated people, yet we don't understand the basic workings of finance. We can have advanced degrees and explain deconstruction, and do fancy stuff with computer programming, yet most of us don't know that the financial system was deregulated, and couldn't give the definition of a futures contract. But which of these things affects our ability to buy food?

Why do we view a system that's so vital to our very lives as something peripheral and boring; why do we pay it little attention? This is, at first glance, very strange.

Part of this economic ignorance can be attributed to how we think about economics: we think of it as existing within the realm of experts who somehow know what they're doing.

I would like to re-imagine how we think of economics. These "experts" we let handle the whole thing are not experts, but experimenters, who are playing a vast game with our entire society (often much to their own benefit). And there are moral consequences to that. When people in Haiti are scouring garbage dumps for food, that's a moral issue.

There's an example in The Shock Doctrine that I think back to, when Margaret Thatcher goes to Thailand and comments on the sad, immoral situation of child prostitution... yet it was economic shock therapy contrived by economic policies, where the Thai baht fell and the IMF intervened, that resulted in the child prostitution. It didn't exist on that scale before.

We need to see economic decisions in context, linked with morality. And, as many have called for, a different way of measuring economic figures which takes into account environmental and social costs [see the Genuine Progress Indicator, etc.]


So, that's a brief look at how we think about global finance: boring, mathematical, disconnected to us, with little awareness of the moral implications of policies. But the question remains: why do we think about it this way?

To a great extent, why we pay so little mind to finance has to do with the way the information is presented to us. The public school experience does little to get us excited about economics, and the current media presentation of it is terrible in many regards. What's your reaction, when you think about the business section of the newspaper? What's your reaction when the business news comes on the TV? Think about it; now think about why you have that reaction.

Economics takes place in a whole other discourse community that not everyone is allowed to access. The language used is specialised, and most people aren't initiated to what the words even mean. And the imagery is equally exclusive: look at any business media, and you'll see a lot of men in suits. If you're not a man in a suit, you learn that this is the province of men in suits. Furthermore, it happens in the "business" section. I'm looking at the cover article in the business section of the Globe and Mail, which is on "The Cost of the Next Barrel." But the subject matter covers an issue that affects everyone in innumerable ways-- it's not just about "business".

We have this image of economics and finance being boring -- but really, what is boring about this stuff? Figuring out how we are going to move and eat this century is fascinating. Figuring out how people around the world can live in a healthy, sane way is the most interesting challenge our species has faced. These things are basically about economics: its finance that determines so much of the changes in our societies, in our environments, etc. And yet we've left these fascinating challenges up to a few not-that-smart guys, because they sold us the image of it being boring.

Finance is boring because it has had the life drained out of it. As living beings, we are much more attracted to things that have life and color and energy than we are to things that have the life sucked out of them.

Of course, it was draining the life out of economics that enabled the system to be the way it is. Reducing matters to numbers, instead of human issues. We don't say, people in country X are suffering and they slave away in factories to produce our cheap goods. We say, the average annual income in country X is $1261. If you go to these guys and put it to them like -- your social security policies are ensuring that your children will have worked their whole lives and not see a dime of the money, and you are spending the credit of your children -- even if they're evil schmucks, they won't say -- Oh, that's okay. But we don't put it in those terms, even though those terms are true. We put it in numbers and specialized language that the average person doesn't understand. In this way, finance is separated from life. What we need to do is put the life back in it; reconnect it to the whole. Economics should not be some distant branch of knowledge: economics comes from eco, as does ecology, from home. It is truly at the heart of things.

[To be continued...]

Adventures in Global Finance [Part IV]

Coming towards Conclusions


Basically, my only real aim with all this financial writing is to point out that...

-- the economy is not a scientific, rational, proven thing run by experts who know what they are doing... but a wild, human experiment
-- the ways global finance operates now are quite different from even a decade ago, and nobody knows what effect the changes will have: this is all new
-- there is a great amount of public ignorance or misunderstanding, which (whether intentionally encouraged or not) works to the advantage of the people manipulating/profiting off the system-- and to your disadvantage.

There are four obvious factors that will make times ahead tougher, economically, than what the last two generations have known. In this piece, we'll look at each in turn, and then in in a final part (I know I said there would be 4, but I lied) we'll wrap things up with a picture of the future... and how to make it rosier despite some challenges.



The Four Horsemen of Economic Gloom

-- Bad financial policies
-- Debt
-- Shifting demographics
-- Oil


the horseman on a stupid horse: Financial mismanagement

Even if these policies weren't enough to force us into a crisis, they will certainly make it harder to deal with the other factors in the crisis: the shifting demographics, for example, could have been forseen and planned for with smart financial policies.

We've already began to look into bad financial policy (that's so vague-- "irresponsible policy", maybe?) in the last post, where we examined the role of speculation in the food crisis.

Let's briefly attempt to understand another example-- the subprime loan lending mess. (If you already grasp what happened and are sick of hearing about it, please skip ahead, but if you're wondering what that was all about, here's another chance for a readable explanation.)

Basically, lenders got borrowers to take out mortgages without taking into consideration whether or not they could pay it back -- sometimes hoping, in fact, they wouldn't pay it back, but that they would have to refinance into mortgages that would generate even more money for the lenders. These customers were called "subprime" because they were in more difficult financial situations, but at this time, lenders loved them because they could charge them more than "prime" customers.

Credit comes from the latin creder -- "to trust, believe". (Like "creer" in Spanish; like "credible.") Credibility costs-- the price of credit (the interest rate) -- is based on alender's belief in the borrower's willingness or ability to repay the debt.

(It is worth noting that 61 percent of subprime loan customers could have qualified for less expensive conventional loans -- they just didn't know it, which is another reason we need better education & understanding of finance.) (See this Washington Post article, which I will paraphrase below.)

How did this irresponsible practice how did this turn into a major upset in the global economy?

It was caught up in another irresponsible practice: that of selling these shaky subprime mortgages to other transglobal investors. From the Post article:

Mortgage finance giants Fannie Mae and Freddie Mac -- companies chartered by Congress to finance home lending -- bought home loans from banks, then bundled hundreds of them together to secure a bond, called a mortgage-backed security. Wall Street investment bankers bought the securities, which then traded freely in the bond market. For a fee, Fannie and Freddie guaranteed the mortgages behind every security against default, so they required lenders to assess each borrower's ability to repay a loan -- a prudent practice known as underwriting.

Fannie and Freddie's underwriting rules are the gold standard by which lenders evaluate the creditworthiness of "prime" borrowers, people whose strong credit histories make them a low risk and therefore eligible for the lowest borrowing charges.

Fannie and Freddie competed fiercely with each other to create these bonds at the best price, paying less and less for the loans they bought from banks. Securitization became so efficient that it shaved profits in the prime market paper-thin. In response, by 2000, a market had sprouted to lend to "subprime," or higher-risk, borrowers, who could be charged more for loans.

...

The private-label, subprime bond market grew from $18 billion in 1995 to nearly $500 billion in 2005. Wall Street sold subprime everywhere: to public and private pension funds, foreign governments and financial conglomerates, even fishing villages in the Arctic Circle.

(How did this happen? Well, it wasn't just commodity trading that was recently deregulated--
in 1999, the Clinton administration repealed the depression-era Glass-Steagall Act. The act had made sure that banks wouldn't use the money of depositors for investments other than loans, but after the repealing of the act, banks could form superconglomerates and diversify into other investments (see this PBS article about how the act was dismantled, with Citicorp playing a lead role in this.)

What happened, of course, is that the housing boom (which had in many ways driven this whole thing) slowed. Home appreciation and refinances of mortgages slowed, and eventually people who took out these loans couldn't pay them back, and the investment funds and banks who had bought their risk lost lots of money.

And what happens when a bank loses a phenomenal amount of money?

This topic is an article in itself, so let's be brief: British bank Northern Rock lost big on the crisis, and got nationalized by the British government. Swiss bank UBS saw its shares drop by half. In the case of New York investment bank Bear Stearns, it got bailed out for 30 billion dollars in a transfer to J.P Morgan Chase, arranged by the federal government. It wasn't that Bear Stearns was a super-important bank, but its collapse would have had reverberations throughout the infrastructure... however, we can't count on the Fed to step in and save all the banks. Let's talk about the Fed for awhile...


the horseman on a lame horse: Debt

Let's examine for a moment how the federal government handles its money.
Or, your money, our money -- we should seriously start thinking of this as our money, and take an interest in what's done with it.

You probably know that the government is in debt.
Do you know how much debt?

About $9.4 trillion dollars.

Aside from being a really big number, this signifies two notable things:

-- We have to pay interest on this debt. Yes, people have been investing in America because they get interest payments on the Treasury bonds they're buying. This year, the interest we owe comes to an estimated $459 billion, $244 billion of that which has to be paid out this year. (For comparison, we spent $583 billion on defense, $68 billion on education, $23 billion on energy, $52 billion on housing and urban development, $7 billion to the Environmental Protection Agency. So just the interest on this debt was far more than education, energy, housing, and the environment combined.) Plus, when the economy slips, we still have to pay our interest... so all the other stuff is what gets cut.

-- If confidence in America's economy falls (it is right now), investors might stop wanting to hold our debt and our dollars. (So much seems to depend on mood... & our brand name isn't the hottest this year.)

Who are these investors, and what happens if they don't think it's a good idea to finance our debt anymore?

About half of the debt is owned by our own government, bought with money that's supposed to be used for Social Security (which is a situation too weird for my limited powers of explanation; apparently there is $2.2 trillion dollars in a Social Security Trust Fund, but debate exists over whether or not this money is fact or fiction).

However, lots of people besides our own government own our debt-- foreign governments, foreign corporations, foreign individuals; also U.S. citizens who have bought treasury bonds, etc. (See the Treasury Statistics).

(MSN, not my favorite media outlet, but... has a very readable article on this topic. Also see the Debt Clock. Also, there's a funny (fake? real? legit government or pseudogovernment) government FAQ about the debt that tells you where you can send a "gift" to reduce the public debt [shady, no?])

How do we deal with this debt? Well, we could print more money.
Here I'm going be dubious and quote wikipedia's entry on the U.S. public debt, because it's quite well-done:

United States Dollars are essentially a commodity on the world market and the value of the dollar at any given time is subject to the law of supply and demand. In recent years, the debt has soared and inflation has stayed relatively low in part because China has been willing to accumulate reserves denominated in U.S. Dollars. Currently, China holds over $1 trillion in dollar denominated assets (of which $330 billion are U.S. Treasury notes). In comparison, $1.4 trillion represents M1 or the "tight money supply" of U.S. Dollars which suggests that the value of the U.S. Dollar could change dramatically should China ever choose to divest itself of a large portion of those reserves.

So, if investors did decide to stop financing our debt, all of a sudden the dollar could drop. (They probably won't do this, because they have a lot to lose when the dollar drops, too).

But what happens when the value of the dollar drops? It results in more than you having to cancel your European vacation, because your dollars don't mean anything over there... Though people who have lived their whole lives in this country have no experience of rapid currency devaluation, one can look at the experience of Russians or Argentinians to see what it's like when your money sharply declines in value. Not only can you not buy much at the store, but all the savings you've worked your life to earn are suddenly worthless.

As we read above, dollars are a commodity which is driven by the rules of supply-and-demand. We just briefly considered what a demand-dropoff would do to our economic situation. Who controls the money supply? That would be the Fed, or the Federal Reserve System, which you've probably heard a lot about. It was created in 1913 and serves as our central bank, tasked with monitoring the money supply and maintaining financial stability.

The Fed has this monolithic building at 33 Liberty Street, NY.
Apparently, 26m beneath it there is a vault
that bears the largest gold repository in the world,
with 500 metric tons of gold bullion.
It rests on the bedrock of Manhattan Island
(as the Fed says, "one of the few foundations considered
adequate enough to support the weight of the vault, its door,
and the gold inside." -- "To protect their feet from dropped bars, the stackers
wear strong, yet lightweight, magnesium shoe covers.")

On the building you can also read a nice story
about the farm of Mr. Jan Jansen Damen that used to be there.

There are basically two ways the Fed influences the economy: by manipulating the federal interest rate, and by printing money.

Through these actions, it influences the rate of inflation-- it has a legal mandate, by the way, to maintain stable prices. Not an easy job!

Congressman Ron Paul discusses what's going on with the dollar:

This decline in the value of the dollar is simple to explain. The dollar loses value as the direct result of the Federal Reserve and U.S. Treasury increasing the money supply. Inflation, as the late Milton Friedman explained, is always a monetary phenomenon. The federal government consistently wants to spend more than it can tax and borrow, so Congress turns to the Fed for help in covering the difference. The result is more dollars, both real and electronic-- which means the value of every existing dollar goes down...when the Fed sets interest rates artificially low, the cost of borrowing becomes cheap.

Individuals incur greater amounts of debt, while businesses overextend themselves and grow without real gains in productivity. The bubble bursts quickly once the credit dries up and the bills cannot be paid...the Fed steadily increased the monetary supply throughout the 1990s by printing money. Recent Fed numbers show double-digit annual increases in the M2 money supply. These new dollars may make Americans feel richer, but the net result of monetary inflation has to be the devaluation of savings and purchasing power.



But there's also other things influencing inflation and the worth of the dollar right now besides the actions of the Fed, such as supply/demand issues over oil, which we'll discuss later...



the horseman on an aging horse: Demographics

How much is the debt, really?
I just told you it was $9.4 trillion dollars.
But, in another way of thinking, it is actually $55 trillion. [See this article]

... the true national debt figure: $55,146,513,890,000.00.

This calculation of the national debt includes all the "off balance sheet" liabilities of the government, such as its promises to pay benefits to Social Security and Medicare recipients far into the future, as well as military and civilian government workers' pensions.

In other words, the true liability of the United States of America is not only the Treasury bills, notes and bonds we sell to finance our annual deficit and past deficits. To get to the true liability, you must include all the promises we've made to make payments in the future.

What happens when those payments come due? The demographic situation is the only economic factor that no-one really disagrees that we're facing: we know that the baby boomers will get older. When they do, we will have way more people retiring and needing health care-- making demands on the system-- that we will have people working and contributing to the system. This is a huge issue, and to give it a cursory treatment doesn't do it justice, but because I'm getting mired in this whole essay, I'm going to keep moving on.

horseman on a black steed: Oil

We're all pretty clear on the relationship between the cost of a barrel of oil and the cost of filling up a gas tank.
But besides driving... in what ways can oil really effect the entire economy?

-- The "green revolution" which enabled modern mass agriculture was born on oil: not just the huge agricultural machinery, but the fertilizers & chemicals used to produce the increase in crop yields, depend on oil. Higher oil prices = higher food prices.

-- Not just fertilizers, but all kinds of chemical products are made from petroleum derivatives: medicines, plastics, tires, and more. Higher oil prices = higher prices for plastic chairs, carpets, paint, etc.

-- Most of our goods -- not just food -- are moved around by ships and trucks and planes that run on oil. Higher oil prices = higher prices for everything that gets moved around.

-- A lot of our electric power comes from oil. Higher oil prices = more expensive to heat your home in the winter.

So far, merchants have been eating the cost of these increased expenses, but eventually they will have to pass them on to consumers. [Look to this NY Times article for more.] But basically, we will no longer have access to the cheap goods we are accustomed to.

For the small percentage of Westerners that currently are in the grips of a throwaway society, this will have good elements. We will owner fewer goods, of higher quality, and value them more: nothing wrong with that. Life could be enhanced. But for most of the world's population, the shock of dramatically higher prices for food, transportation, electricity, and goods will be impossible to absorb. Already, there are riots in many less-developed countries, and they could get much worse once countries like China, Egypt, and southeast Asian nations can no longer afford to subsidize gasoline costs. This situation will only grow more grave as the supply of oil declines (I'm not going to get into peak oil too much since I already wrote about it in 2005: suffice it to say that the situation's only become more evident). Can we transfer our infrastructure to something non-oil-dependent before oil gets scarce enough to be completely unaffordable? These are the great questions in life...

If you're concerned that all this is the wacky hallucinations of some girl on the Internet (I wonder from time to time myself), I would refer you to the updated UN report, "World Economic Situation and Prospects 2008". You can download the whole pdf, and it is quite readable for a governmental report. Here are the first two paragraphs:

In the wake of numerous challenges, the world economy is teetering on the brink of a severe global economic downturn. The deepening credit crisis in major developed market economies, triggered by the continuing housing slump, the declining value of the United States dollar vis-à-vis other major currencies, persisting global imbalances, and soaring oil and non-oil commodity prices all pose considerable risks to economic growth in both developed and developing economies. Additionally, the unfolding food crisis, which is not only a grave humanitarian issue, but also a serious threat to social and political stability in some developing economies, endangers the achievement of the millennium development goals (MDGs) by reversing some of the progress towards those goals made so far.

As with climate change, the poor & relatively "unseen" will get screwed the worst. While any of the things I've mentioned in these pieces could trigger a global economic crisis -- a stock market crash, a burst of the derivatives bubble, a loss of confidence & unwillingness to finance the American debt, etc. -- it is the oil-dependence situation that will be the hardest to recover from. I think we could mitigate the other things, even the demographic situation, with smart financial policy and open discussion... but to get our society off oil will require intense effort in all sectors.

At talks in Jeddah yesterday, Gordon Brown called the oil crisis "the biggest crisis facing the world" [The Guardian].

Coming next... looking at the future.

Adventures in Global Finance [Part III]

From Derivatives to Rice Riots

To understand why the price of rice can double virtually overnight, we need to understand what kind of weird financial mechanisms have sprouted up in the past couple of decades.

The world is full of many complex, new "financial instruments."

(Could one say that as a musical instrument is used to play music, a financial instrument is used to finance something? It may or may not be analogous -- I can tell you simply that a financial instrument is "any funding medium".)

There are two main categories of financial instruments:
-- cash (like in loans, deposits, stocks) and
-- derivatives (which derive value from some other financial instrument or variable).



What's the biggest market in the world?

It's not the bond market (selling of debt/credit) -- that's worth about $45 trillion.
It's not the stock market -- that's worth about $51 trillion.
And it's not actual goods & services -- the world gross domestic product is about $50 trillion.

The biggest market in the world is in derivatives: at least $681 trillion & growing.


Derivatives are financial instruments or contracts with values that are linked to, or derived from, the performance of underlying financial instruments, interest rates, currency exchange rates, or indexes. In a simplified sense, a derivative links its holder to the risks and rewards of owning an underlying financial instrument without actually owning the financial instrument. -- FDIC web site


The main types of derivatives are futures and options. These are contracts to buy a certain good on a certain date for a certain price -- or for the option to buy that good on a certain date for a certain price.

from Wikipedia: A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract, but both parties of a "futures contract" must fulfill the contract on the settlement date.



Futures and options are commonly traded on commodities like wheat, oil, metals, pork, orange juice, etc. This kind of trading began in the US during the 19th century to help out wheat farmers -- it helped them ensure that they would get a certain price even if things went unexpectedly with the harvest. But futures trading on non-commodity things, like the interest rate, didn't begin until the 1970s; the rapid growth derivatives trading is even more recent.

Where are derivatives traded? On futures exchanges like the Chicago Mercantile Exchange, and also the NYMEX -- the New York Mercantile Exchange -- where every minute 1200 contracts are bought and sold.



The NYMEX went public in 2006 -- before then, it cost $6 million for a membership to trade there. It's electronic now, but also open outcry; traders have a special sign language they use to trade with. The human hand still has a part in all this.






But it's not just commodities that are traded-- derivatives have grown far beyond that. Futures & options can be traded on interest rates, stock market indexes, foreign currencies, etc. For example, people even trade in weather derivatives (an instrument pioneered by Enron); you can make money by betting on the temperature of a certain number of days. There's a $60 billion a year market in weather derivatives; one can imagine the unpredictability of global warming will increase this gambling market. It seems that many things that have an element of unpredictability or risk can be traded upon-- for these derivatives are basically a trade in risk.

Options, for example, come in flavors of "vanilla options" (the standard kind) and "exotic options", like rainbow options. You can, for example, put an option on an option. I am adding this extraneous information because I find it gruesomely amusing, at the risk of losing my readers, I am sure. But the points I want to make are:

-- Most of the financial activity going on in the world is in this kind of betting; nothing of value is created with these derivatives. For every $1 floating around the productive wold economy of real goods and services, there is an estimated $20 to $50 circulating in the world of pure finance, producing or creating nothing (Charles Derber, qtng. David Korten, Corporate Nation).

-- This is a new situation: it is only in the last decade that futures trading was deregulated, and that vital commodities really became speculative investments.



OK: believe it or not, that was just the beginning: the background necessary for this story.


Some questions to delve into:

What are the implications of these "exotic global speculative instruments" on our financial system?

As Charles Derber explains in his book Corporate Nation, we have moved into a state of 'finance capitalism', which is "dominated by financial rather than nonfinanical corporations and reifies the pursuit of money gains over the making of useful products ... Capital becomes a paper commodity increasingly unrelated to production, and the profitability of stock markets and finanical corporations becomes increasingly disconnected from the real economy." Still, the eventual implications of this are yet unknown -- experts are unsure of how it will play out, since it is after all an uncontrolled, improvisational experiment. So let's move to another question...


How will financial speculators somewhere affect our ability to eat?

This second question is more answerable. Let's look at the role of derivatives trading in the current food price crisis. For this, I'll refer you to an excellent Globe & Mail article published on 31 May, "The Byzantine World of Food Pricing" (cover page, business section), which I'll summarize and quote from below:

In the past few decades, pension funds became a common way for people to save for retirement. They produce a massive influx of cash into stuff like commodities-- you can invest in a fund that either tracks the commodity index as a whole, or funds that buy a specific "basket" of commodities. People like you & me wouldn't normally want to buy oil or orange juice in these quantities, but under this system, it seems like a good way to diversify your portfolio-- especially if the stock market is uncertain.

But it was only in very recent years that the amount of fund money in commodity indexes shot up-- from 13 billion in 2003 to 260 billion in 2008.

Why? Because until recently, there were restrictions on how commodity trading was regulated.

(For a miniature review...)

In a forward contract, the buyer and seller agree to the price of a commodity and a fixed date for delivery. A farmer enters into a forward contract with a food company by promising to deliver a certain amount of grain on a certain date at a certain price. ... A futures contract is the same basic agreement, but it trades on exchange, and the buyer rarely -- if ever -- takes delivery of the commodities. Instead, futures contracts are used mainly by farmers for hedging and by investors for speculating. These contracts have historically been regulated.

However . . .

Beginning with the energy market, regulators made a series of far-reaching decisions that gradually loosened oversight of complex commodity derivatives and created loopholes for large speculators, allowing them to trade virtually unlimited amounts of corn, wheat, and other food futures. Only now, nearly two decades later, are the full consequences of those decisions being felt.

Basically, there was a legal case in 1990 that decided that some kinds of futures contracts should be classified as "forward contracts" and thus be outside of regulation by the Commodity Futures Trading Commission. (Wendy Gramm, wife of Republican senator Phil Gramm, was the chairmon of the CFTC and made this policy). Rewriting the rules on how these contracts were policed gave birth to a "new frontier of commodity trading, enabling financial speculators to buy and sell complex derivatives away from the prying eyes of regulators and exchanges."

So, first financial speculators -- and then investment banks, armed with your retirement money -- swooped into the province of farmers. As Manitoba farmer Ian Wishart said: "The commodity market was designed to provide a forward pricing tool to protect ourselves ... not to provide an opportunity for someone else to make profits."

In 1991, after the rules were altered, a bank requested exemption from speculative trading limits (because it was using a middleman to get around the rules). It was granted, which allowed all kinds of funds to enter commodities trading. Later, in 2000, more exemptions from the commodity trading limits were introduced (including one for the electronic trading of energy contracts, "the Enron loophole.")

Why might it be a bad idea (not for you per se, but for the world) for you to have some of your retirement savings in a commodity fund?

Many in the food industry compalined that these index funds don't behave like traditional speculators in commodity markets. Unlike hedge funds, which actively buy and sell contracts, and make bets on price increases and decreases, index funds are passive investors. They take positions in various commodities and hang on for extended periods, betting that prices will continue to go up. Critics claim that this has resulted in a kind of hoarding, and that the market no longer reacts the way it should to supply and demand factors.

Are there benefits to speculation in the commodity markets? Many say yes: speculators increase liquidity in the market, and as trader Mack Frankfurter explains, "the function of speculators is required to facilitate the hedging utility and price discovery mechanisms" [citation]. However, many of those who support speculation believe that it should be regulated.



Will a revamping of the derivatives-trading system solve the food crisis?

It may help, though rising oil costs have played a part in rising food prices. (But not that big a part-- yet). So have rising population levels, ethanol, increased wealth in China & India, etc-- still, none of those factors explain how the price of wheat doubles in a year. Recently, we have seen riots over food prices in scores of countries, and rationing in Russia and Pakistan. Reconsidering how commodity speculation is handled could make the markets more stable. There is still enough food to go around-- the problem is that many poor people can't afford it.


What can you and I do?

For one, cut back on meat (animals consume grain people could eat), and eat locally.

Many people are coming to a common answer: grow your own food. Backyard gardens will probably come back into fashion, and supply a greater part of our food source again.

And, we should probably not invest in commodities, and take political action to get these derivatives regulated again. It's a humanitarian issue.



I'll close with an excerpt from a blog entry in the RGE Finance and Markets Monitor:

Two or three generations ago, most of us would have been directly involved in food production as a hedge against food insecurity. My parents’ generation kept a garden in the back yard, putting to me to work each summer to raise corn, tomatoes, cucumbers and other fresh foods for the table, sending me to pick berries and fruits in season from our own and the neighbours’ bushes and trees. My grandparents’ generation kept chickens as well as a garden behind their house in the middle of a large industrial city. The garden and chickens helped my mother survive the Great Depression at a time when my father suffered stunted growth from rickets. My great-grandparents’ generation were almost entirely farmers working the land.

Today global agriculture is dominated by eight multi-national corporations. The policies promoted by successive governments and international institutions including the IMF, World Bank and WTO have aimed at undermining local production, distributed commercial networks, and diverse local markets in favour of mass production, streamlined supply chains and concentrated global market pricing.

As with other areas of our lives, the policies of “free market fundamentalism”, as George Soros styles it, have not diminished risks but increased them. My children are hostages to food insecurity, as are yours and billions of others. A disruption in global food supplies or surge in prices that puts food staples beyond the reach of many low income or middle-class families cannot be offset from the back garden. The exposure of food to pricing in markets open to manipulation and excess speculation puts the lives of millions at risk.

*

In the final episode in this series, we'll look at derivatives trading in the housing market, as well as inflation, and put all of this information together into best guesses on what we can expect in the future of global finance (and, therefore, our economic lives).

*

footnote: If you're not convinced that some gardening is for you, check out this great piece in The Guardian, "Don't Give Up". It has to do with gardening and climate change... which reminds me that I haven't even gone into oil derivatives trading and energy prices. There are only so many hours in a day. Let it be known that the commodity market in oil suffers from similar problems as with food commodities-- though with oil, there is definitely a supply-and-demand issue at work.

Adventures in Global Finance [Part II]

The Stock Market

Of Trees and Origins

New York has long been a home of speculation & intense trading.
In 1791 and 1792, there was so much speculation that the state cracked down & banned auctions of securities [citation]. To deal with this, twenty-four traders met one day in May, beneath a tree where they regularly met. (A buttonwood, or sycamore, tree). They signed an agreement to form a private club, where they could trade stocks with each other, with a set rate of commission. (The "Buttonwood Agreeement.")

After that, they didn't hang out under the tree, but met regularly at the Tontine coffee house to gossip and trade stocks. In 1817, this exclusive club became the New York Stock Exchange & Board, and rented a room to do business in. Over the years it grew, but maintained exclusivity: and until 2005, only those with one of the 1,366 seats could trade directly on it (the price for a seat peaked at $4 million). In 2005, the NYSE became a for-profit, publicly traded company, which sells 1-year licenses to people who wish to trade on it. Now the largest stock exchange in the world (in dollar volume -- the Tokyo exchange is larger by other measurements) it meets in this well-guarded building at 11 Wall Street.



It is interesting to note that the stock exchange began as an illicit attempt to avoid a law, by taking business into the private room... also that it has such a simple, narrative beginning. The sycamore tree, the coffeehouse, the twenty-four guys: it all began so simply, convivially, so classically & charmingly human.


Stock Crashes: What caused the stock market crash of 1929?

Surprisingly, there is really no consensus on this. (What does it signify that 70-80 years later, we have no explanation for what happened? Have we made a real effort to understand it, or are the causes still obscure because the practices involved are still at work today?)

Basically, the famous stock market crash preceding/causing the Great Depression had either one cause or many; either domestic or foreign causes; it may have been an inevitable result of business practices, or it may have been caused by governmental actions -- your interpretation of the origins of this crash will be determined by your economic philosophy.

Here are some of the oft-cited causes:

-- a decline in consumer spending/investment
-- the size of the money supply (too small, according to some experts)
-- the amount of personal debt citizens carried (they had just began to use payment-in-installment credit schemes, then)
-- corporate mergers / consolidation of wealth into the hands of a few
-- the fact that the economy was too dependent on just a few industries (autos, for example)
-- a wide gap between rich & poor; the polarization of incomes
-- deregulation actions
-- stock speculation

There was a speculative boom in stocks, which led to the market being overvalued; people were living with the anticipation of future riches rather than in economic reality.

Because of the practice of "buying on margin", people only needed 10% of a stock's price as a down-payment to buy stock: they would borrow the rest from their broker. In Sept. 1929, for example, there was 8.5 billion in outstanding broker loans.

Once people realised this was a bad idea, there was a lot of panic selling... and then, the famous stock market "crash" (which actually was a rolling slide that stretched for several weeks, in the autumn of 1929).

the ticker tape from the NYSE which tracked the crash of 1929,
on display at Wall Street's Museum of Finance

The crash followed a period of genuine optimism, fueled by the industrial boom during this time. The industrial boom gave people the idea that they were in a glorious era of something-for-nothing, and this confidence fueled all kind of schemes, like a real-estate bubble in Florida.


Could the stock market crash again, like in 1929?

To begin somewhat tangentially, we should consider the role of mood in the stock market. The 1929 crash was as much a crash of confidence as it was of stocks. Why do you think "consumer confidence" is constantly "measured" by economists? Because the mood is important, somehow. Whether there is an all-out panic or a mild sell-off depends on mood.

"Irrational Exuberance" was a phrase coined by Greenspan, to describe the mood of the markets (back in 1996)-- the phrase seems to echo the mood of the Roaring Twenties.

So, will the irrational exuberance of the 1990s result in a crash? Consider this paragraph from a dated (2002) but interesting article by economist Ellen Frank:

In 1999 alone, the market value of U.S. equities swelled by an astounding $4 trillion. During that same year, U.S. output, on which stocks represent a claim, rose by a mere $500 billion. What would have happened if stockholders in 1999 had all tried to sell their stock and convert their $4 trillion into actual goods and services? The answer is that most would have failed. In a scramble to turn $4 trillion of paper gains into $500 billion worth of real goods and services, the paper wealth was bound to dissolve, because it never existed, save as a kind of mass delusion.

I suggest that a stock market crash happens when reality crashes delusion. But as long as confidence is high, the delusion can be sustained.

Can't it be good to get rid of your delusions?

As Andrew Mellon told President Herbert Hoover, regarding the crash & Depression: "...it will purge the rottenness out of the system. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people."

Cold, no? The truth lies in the part about "values being adjusted"; this could be quite positive.

It's worth nothing that a stock crash today would be quite different than in 1929, because today, most middle-class people own some stock (only a small percentage of the population did in 1929). Your retirement money, or your parents' retirement money, likely involves a 401(k) or a mutual fund plan, etc. If the market crashes, and the baby boomers lose their retirement savings overnight, it will not be a good situation. (I know how weak that sentence reads, but I'm pressing on...)

I think that we will have a crash of confidence again, in the next decade -- for many reasons, some of which I will go into later (the two main reasons being energy & demographics). But basically, there is a gulf between image and reality that needs to be corrected; a gap that will correct itself eventually. A stock market crash, or at least a downturn, will likely be part of this.

The foundation of the whole system, whose shape I am beginning to discern, lies with responsibility -- the cracks in the foundation lie with irresponsibility. People in the 1920s who bought stocks on margin were acting irresponsibly, as are people who run up credit card debt today, as are the recent mortgage lenders who urged poor people into unreasonable sub-prime loans, as are the banks which bought these loans, as is a national government who runs up its debt into the trillions: all of it childish & irresponsible.

But why should you care if some people act irresponsibly? ... because we will all fall together.

In the next part of this series, we'll look deeper at speculation -- if you've ever wanted to know about futures, options (vanilla and exotic) -- or if you just wonder why it costs so much to buy a bag of flour this year -- well, we will try to understand it together. Stay tuned!

me posing with legendary financier J.P. Morgan
In 1907 there was a financial panic
in which stocks fell 50% (due to speculation, that evil spectre)
J.P. Morgan stepped in and saved the economy,
bailing out the market with a team of bankers he organised.
Who can play J.P. Morgan today?