We are developing the social individualist meta-context for the future. From the very serious to the extremely frivolous... lets see what is on the mind of the Samizdata people.

Samizdata, derived from Samizdat /n. - a system of clandestine publication of banned literature in the USSR [Russ.,= self-publishing house]

Alternative Samizdata quote of the day

I don’t think earning about the same as Kenwyne Jones of Stoke City is cause for apoplectic outrage.

- Mark Littlewood of the IEA on the UK political storm about the head of the world’s sixth largest bank getting a bonus of something under one… meelion… pounds. (US readers may wish to read that again. A million, not a billion.)

Stoke City is currently the 8th best soccer team in England. It has 44 players in its squad.

57 comments to Alternative Samizdata quote of the day

  • Joshua

    The last link in this post is broken (referring to “It has 44 players in its squad”) — “a herf” isn’t a correct HTML tag.

  • APL

    ” Kenwyne Jones of Stoke City ”

    When Kenwyne Jones starts to falter as a footballer ( I’ve never heard of him, btw, then I don’t care much for football either), he’ll be relegated to the third division P.D.Q, and obscurity ninety days after.

    Wen the Royal Bank of Scotland fails on the other hand, it is bailed out when it should have been dismantled and anything worth anything sold off.

    In Capitalism, the price for failure is oblivion. Not life support.

    This is no longer a Capitalist economy.

  • Joshua (and everybody): link now fixed.

  • William Newman

    Paul Graham on something similar (and also arguably related to APL’s point): “Unfortunately the only industry they care enough about so far is soccer. But that is at least a precedent.”

    (from http://www.paulgraham.com/america.html)

  • JohnB

    Yes. So many stupid things.

    The veneration (the money bestowed on them indicates the veneration) of soccer stars, or any ‘stars’ for that matter, indicates the priorities of this society.
    Things obviously have to get worse before they get better.

    As APL says, a failing bank should have been allowed to fail, not bailed.

    And what is it with banking that it should be so complicated and mysterious to justify such select people to run them?
    The fact that financial institutions (which do not make or build anything, just play around with the media of exchange) are of such importance, itself, indicates that the system is false, distorted, untrue and out of balance.

    When the way of life becomes a variation on a Ponzi scheme, the end cannot but be nigh!

  • William Newman

    JohnB writes “And what is it with banking that it should be so complicated and mysterious to justify such select people to run them?”

    Trying to figure out the expected value and expected default rate of a typical financial arrangement involving a big organization in a real market is fundamentally tricky. Being able to do it 15% more accurately than your competition is worth tons of money when the arranged sum is dozens of tons of money.

    Most of what I know about it is in math-heavy skills, so I will talk almost entirely about those. But other skills like contract law or organizational behavior, and less quantifiable skills like judging how reliable people are, can also be very valuable in banking for the same “15% of a whole lot is still a lot” reason.

    Have you ever audited a course in pricing derivative securities? I have. It’s hard to summarize the difficulty in a blog comment, but it was sort of a cross between the stuff that actuaries do and the stuff that chemical engineers do (partial differential equations vaguely like those that describe diffusion). Most of the class was from the business school, and they seemed to consider the exercises very difficult. And even those of us from more math-y departments who had less trouble with the exercises could see that trying to move on from the exercises to an accurate analysis of a real-world problem would become very difficult.

    Admittedly a lot of the big money in finance is in stuff that is largely unrelated to any sort of skill that promotes economic efficiency. E.g., a lot of money can be made by schmoozing with municipal officials to convince them to pay big underwriting fees to your institution when they issue bonds. Nonetheless a lot of the big money is in pure better-estimation-of-price, and being smart really does seem to help there, even up to being very smart indeed. The physics student who most impressed me in my classes at Caltech ended up in securities, and seems to’ve done rather well, presumably at the pricing rather than schmoozing end. Charlie Munger also famously did well for himself with his rather math-y resume. Of course clever math is not a magic bullet: LTCM and others have managed to blow themselves up in math-y ways. But just as in e.g. aircraft design, instances of people getting things wrong in math-y ways don’t demonstrate that math isn’t important and valuable.

    If you have something tricky that’s very expensive — e.g., lending money for megaprojects, or scheduling logistics for a military invasion, or building an airframe that will carry many tons of passengers for many thousands of hours — it can be well worthwhile hiring very smart people to think very hard about wringing a few percent of efficiency out of the problem. (Indeed, in practice, it may sometimes require very smart people thinking very hard to wring the last 50% of efficiency out of the problem…)

    This is already awfully long for a blog comment, so enough from me, but: _My Life as a Quant_ and _The Poker Face of Wall Street_ are nontechnical books that convey more of the flavor of why this might be.

  • Johnnydub

    The aspect of this that has got my goat is how the BBC has gone to town on the bonus…

    This being the same BBC that pays Alan Hansen £1.5M p/a to sit on a sofa and talk about football…

  • One meelion pounds? Wow, that’s about 0.3 percent of the Solyndra bailout. (Pound = roughly 1.5 USD)

  • JohnB

    WM, I agree the situation is quite complex. In large part because it has been made so.

    However.

    The chemical engineer figuring out difussion rates is working towards a product or a service that will be of tangible benefit.
    Likewise designing a cost-effective airframe. Or even logistics for a military exercise.

    When it comes to dealing with money as a thing in its own right rather than as a medium of exchange, and getting an income out of its manipulation beyond the simple service of storing it, transmitting it, investing it in businesses that produce stuff or services, and other such activities, it is tending ever more into the land of the unreality.

    I realise Britain makes a substantial portion of its money in this way (having shipped substantial parts of its steel production, oil refining, car and train manufacture to people of other lands and interest groups) which is cause for concern.
    Money manipulation, derivatives, short selling, the whole game is unreal, in many ways parasitic.

    Sure, as long as there is ‘money to be made’ that way then people should be free to make it. But the the fact that there is is indicative of a problem that will turn into a bubble at some stage because the endeavour is not based in reality but in manipulating the represenation of reality.

  • Alisa

    Not true, John. Money is not just a medium of exchange, it has other functions, such as store of value, gauge of value, and possibly more. In a truly free market money is as real as the goods and services it represents. Consequently, the banking industry is a real industry in the sense that it facilitates the use of money in all its practical capacities (such as the ones mentioned above), and helps make that use more effective for everyone involved. Money is a product like any other. When you buy a car, the money with which you buy it is no less a real product than the car itself. To understand this, it may help to think of the car itself not as an end in and of itself, but as a means for moving around long distances (as well as other purposes for which cars may be used).

  • Alisa

    Hit ‘post’ too soon…

    Anything that is useful to a human – i.e. has subjective value – is a product like any other, and money is absolutely no different. What makes it different is that by its nature it is much more submissive to government control and monopolization than any other product. Also, all markets are quite complex. Some are more complex than others due to the particular nature of the product. Money happens to be such a product – still, the complexity itself does not make the market of money any different than any other market. OTOH, central control, forced monopolization and regulations etc. add unnecessary complexity to this market, but that is also the case in other markets where governments tend to meddle – I’m sure anyone here can come up with examples.

  • JohnB

    You don’t own the money for its own sake.

    Unlike food or cars it is relatively unuseful paper. Or numbers in a computer’s memory.
    You own it for what it can get. Bread, cars, holidays, medical treatment.

    It is stored as a medium of exchange.
    Other than that it is almost worthless. It can do nothing more than, as bank notes, paper a wall, or whatever.

    A car journey is a real event.

    Okay, Scrooge McDuck would call basking in his bank notes a real event. But he’s actually revelling in what it can get him.

  • Alisa

    You missed my point about cars, John: you don’t own a car for its own sake, either – you own it for the sake of the journeys it can facilitate. And, some people do not value journeys for their own sake, either – rather, they value the ability to meet friends and family, or to take in new sights, or to do business in faraway places, etc., etc., etc. See? You can play this mind exercise with any real or “unreal” product or service you can think of, because value is subjective, and also because values are interdependent and inter-derivative.

  • Alisa

    …and helps make that use more effective for everyone involved

    Meant to say ‘more efficient‘.

  • JohnB

    A car is expensive to produce.
    Bank notes cost almost nothing.

    A car does something you want.
    Bank notes only do what you want insofar as they can get you something else that can do what you want.

    But if you want to mindgame the second point, then I refer you back to the first. :)

    I will stop on this because it is a bit off topic. I did think it was relevant to how we value things.

  • Alisa

    Bank notes cost almost nothing.

    Banknotes are not the same as money, and in a free market even banknotes do cost quite a bit – in fact, they cost just as much as the products and services they represent.

    Bank notes only do what you want insofar as they can get you something else that can do what you want.

    The same goes for cars, a point you keep ignoring. And no, you cannot refer me to the first point, since it has been refuted. But sure, I’ll stop if you like:-)

  • Laird

    JohnB, I agree with Alisa. A car can do only certain limited things. Money, however, can be used to do anything; it’s like a wild card. But to work properly it has to be widely accepted (in its “medium of exchange” function) and it has to remain un-debased (in its “storehouse of value” function). The first condition applies to dollars and euros (and some other currencies) today, but it’s not clear how much longer that will last. The second condition is routinely and massively abused by every government on the planet (which is why the first condition has now become problematic).

    As to your original post, you’re merely demonstrating that you know very little about either money or banking. That’s OK; very few people do. But “short selling” serves a valuable market-clearing function, helping to maintain liquidity and minimizing massive price volatility, and the term “derivatives” is so broad as to be essentially meaningless. True, there are certain species of derivative created at the height of the bubble which have no true economic purpose, but there are many other, older, forms (futures contracts, interest rate swaps, etc.) which do serve valuable and legitimate purposes. Most people who cavalierly throw around the word “derivatives” as something inherently evil don’t have a clue what they’re talking about, but are simply parroting something they’re heard from a politician or a TV newsreader (neither of whom has any real knowledge of the subject, either).

    You haven’t refuted anything William Newman said. The analysis of large, complex credits is extremely difficult, and the stakes are very high. Unfortunately, the people actually performing those analyses are rarely the same ones making the million-dollar bonuses, but that’s another matter entirely.

  • William Newman

    JohnB, deciding how to route trains and manage maintenance and so forth so that a rail network carries a collection of things efficiently is a totally intangible thing. But optimizing that intangible thing makes a big difference in how well various tangible things work. Similarly, deciding which enterprise to lend a chunk of resources to is an intangible thing. And participating in a market for bonds is a slightly more intangible thing. But optimizing those intangible things, so that capital tends to flow to enterprises that can make particularly good use of the capital, makes a big difference in how well various tangible things work.

    There is a long tradition of claiming that markets and middlemen, and especially markets and middlemen for capital, are inherently parasitic and/or waste. It can works marvellously well as a rhetorical appeal to us-vs.-them impulses in the audience. But it doesn’t make a lot of logical sense on its own, and the usual advocacy ignoring the alternative of classical economic analysis makes even less logical sense. Given economic history since the Industrial Revolution (and to a lesser extent, even economic history of capital-intensive stuff like ships before that) there should be a heavy burden of proof on the person who makes that claim. Proof by assertion or by appeal to rhetorical tradition is not sufficient, nor proof by unwillingness to make counterarguments to (or even acknowledge) the classical economic analysis of how free markets in goods including capital tend to work.

    It is true that a rather significant fraction of finance activity today is parasitic and wasteful, forced on customers by government decree. And even in the absence of government intervention, customers buy unnecessary stuff, including finance services, for various reasons. But that’s not inherent to finance. Consider that significant amounts of construction activity and medical activity and education activity today are also parasitic and wasteful, and also forced on customers by government decree; and that even in the absence of government decree, customers sometimes buy these services unnecessarily. It doesn’t follow that construction and medicine and education are inherently parasitic or wasteful.

  • JohnB

    No wonder Keynesians have been able to get away with it for so long.

  • Paul Marks

    Most “money” is not notes or coins – it is credit. Even the stuff the Bank of England (and the ECB and the Amercian Federal Reserve) produce is often not notes – yet stuff produced by Central Banks is still counted as “monetary base” (it hardly matters – as even the notes represent NOTHING).

    This system is too absurd to waste much time on, I look forward to the day when it finally collapses – even though I will be starving to death at the time.

    As for “RBS” (what used to be the Royal Bank of Scotland – operating from a nice old building, before it moved to what appeas to be alien space station….), even by the standard of credit bubble banking, it was demented.

    It should no longer exist – “period” as Americans say.

    This man should not be getting a million Pound bonus because he is in a job that should not exist – the “CEO” of a bank that should not exist (even by the debased rules of credit bubble banking).

    So the post (and the discussion) misses the point. Stoke City Association Football Club is a legitmate enterprise – “RBS” is NOT.

    By the way – even legitmate enterprises should not have “remuneration comittees” – the pay of top staff should be decided by the OWNERS of enterprises.

    The “seperation of ownership and control” (so celebrated by Financial Times writers, and other vermin) is one of the worst features of modern big business.

    However, this feature will also soon pass away.

  • Grant Freedom

    I have a lot of sympathy for what Paul says above, but…
    Fred the Shred bet the house on RBS becoming the biggest bank in the world. It was a stupid fragile expansion that was never going to end well. He calculated they would be Too Big To Fail, and that he’d be outta there anyway.
    It would have been a very brave chancellor who didn’t do what Darling did, but regardless of that decision, what’s done is done, and we have to make the best of it. That means we do whatever it takes to patch it together and get the best price for it. We need to pay whatever it takes to retain the best, most cunning hard-nosed bastard in charge so that our children don’t have to live in penury due to past mistakes.

  • Laird

    A small nit to pick with Paul’s post (with which I mostly agree): Academics do not celebrate the “separation of ownership and control“, but rather the separation of ownership and management. There’s an important difference. In theory, at least, shareholders retain “control” even though they have delegated day-to-day management to professionals. In many cases control has been subsumed by management, which I agree is a problem, but as far as I know it’s not “celebrated” by anyone outside the boardroom.

  • Midwesterner

    I think I get John B.’s point and if I do, then I’m in agreement with it. I thought he was doing a poor job of saying what he wanted to say until I tried to say it better and realized it is a very non-obvious point. For lack of a better approach, I’ll give an example and let you work it over.

    As a farmer in a time fairly long past, I have a strong appreciation for futures markets in commodities (although I never used them). When I was planning my operations, I had to project my expenses and incomes far into the future for things that floated with the market. How do I know what fuel will cost for harvesting and drying corn and how do I know what corn will be selling for, all before I make the decision to of what and how to plant? Easy. Farmers can hedge either directly or indirectly in the commodities futures markets.

    Some people are trying to turn the term “speculators” into a pejorative for people who buy and sell futures contracts with the intent to make a profit. But what speculators are in actual practice doing, is underwriting forward price and cost insurance contracts. By hedging, I would happily have let speculators take some of my farming profits in exchange for insuring my costs and prices. These “speculators” are engaged in a very useful and productive ‘real world’ service.

    But I don’t think this is the kind of activity that John B is talking about. I see a world of difference between the activities of commodities futures speculators (cost/price underwriters) and foreign exchange futures speculators.

    Like the commodity speculators, the FX futures speculators provide a necessary service to businesses required to deal in the underlying product, in this case international currencies.

    Commodities futures contracts, which are protection against weather (crops), refinery fires (energy), unanticipated demand or lack of it (all commodities), are all insuring against vagaries in the prices of real stuff; the real stuff that is exchanged using media of exchange.

    But FX futures contracts are protection not against vagaries in the prices of real stuff, they are protection against vagaries in media of exchange.

    A perfect medium of exchange is a terrible investment. Ideally, media of exchange hold their value and do not fluctuate. If they are functioning in an ideal form, they are useful solely as exchange media.

    While I am not certain it is John’s point ( but I think it is), all market activity that occurs exclusively among and within the various media of exchange is intrinsically ‘unreal’. That is to say that it does not contribute to wealth aka ‘more stuff’. Yes, media of exchange are essential, but if they are functioning optimally, they will only interact with real stuff. Any profits made exchanging money for money do not generate new stuff. In fact, since profits made exclusively within the category ‘media of exchange’ cannot be from the generation of real stuff, simple extrapolation says that those profits (since they can be exchanged for real stuff) come out of the interaction that some (but not all) monetary transactions have with real stuff.

    To the extent that there are multiple competing currencies (a concept I heartily support) these money to money transactions and profit skimming must occur. But they should be viewed much as one would view the roof on a factory; as a necessity that contributes nothing to production and should only consume as much resources as are essential to keeping the production line running. We are living in a financial markets world where (metaphor alert) assembly lines are being underinvested while the roofs over them are getting copper sheeting and ornamental tiles. It is the financial equivalent of the edifice complex. Media of exchange are to the exchange of real stuff what the headquarters edifice is to the company’s raison d’etre.

    I hope this rather tangled up comment conveys the point that I think John was trying to make, and that I know I am trying to make.

    In summary, ideal media of exchange do not confound the exchange process by fluctuating in value. Ergo, media of exchange being winning (or losing) investments are a sign of systemic failure in the medium. ‘Media of exchange’ are not the same as ‘real stuff to be exchanged’, ergo, any profits taken from inter m-of-e transactions is of necessity taken out of the profits that would have otherwise gone to the people dealing in real stuff via the media of exchange. This is also why, when currencies break down, barter reasserts itself.

    Maybe some of the regulars who are used to sorting out my circumlocutions can explain my point better than I have.

  • Laird

    Mid, I disagree. All you are saying is that the purveyors of these media of exchange (i.e., governments) are doing a poor job of maintaining the integrity of their product. No argument there. But given that fact, it makes absolutely no sense to deride people who (a) attempt to profit from idiotic governmental actions, or (b) make markets for those who would seek to minimize the effect of (insure against, in your term) those value fluctuations. Rain exists. You don’t complain about the existence of roofing companies, or people who pay others to install and maintain roofs for them. And if it rains a lot, coupled with high winds, we expect the roofs to be very stoutly constructed. Expensive, but necessary. Guess what? We’re in a monetary monsoon.

    If we have to suffer with perfidious governments asserting an absolute monopoly over the issuance of currency (which we obviously do), finding ways to protect against the vagaries of their actions is entirely rational and expected, and those who seize the business opportunity thereby presented are to be celebrated, not denigrated. (Unless, of course, those persons also happen to control the levers of government, in which case they should be strung up from the nearest lamppost.)

  • JohnB

    Midwesterner, yes, more or less.
    And the more one exchanges the representation for the reality the worse things get.
    It is an indication that something is wrong with a system that can be so manipulated into making wealth from nothing.

    Bastiat:

    I.11.9
    All this is sheer rigmarole, and not science. The truth, reduced to its simplest terms, is this: Whether men destroy cloth and wheat by burning them or by using them, the effect on prices is the same, but not on wealth; for it is precisely the potentiality of using things that constitutes wealth or well-being.

    I also agree with Paul that this was not the issue that should have been addressed. Apologies.

  • ThePresentOccupier

    “Making wealth from nothing”… Hmm, interesting one. My day job involves creating product, effectively from my imagination.

    It has no mass. It has no physical presence. You can’t see it, touch it, taste it or smell it – but without it, you’ll soon recognise its absence. It is ephemera, represented by nothing more than a collection of 1s and 0s (in some semblance of order). It can kill, it can save lives, it can help interpret data or it can entertain….

    Footballers – arguably – only entertain. Ergo, software engineers should be paid more than footballers (and maybe footballers’ parents should be paid for pproduct?). Quod erat demonstrandum.

  • Johnathan Pearce

    I suppose the boss of a football team might reply that his players are not ultimately subsidized or bailed out by the taxpayer. (And actually, quite a lot of fans are fearful that spiralling wage bills are hurting the sport and that there will be a correction).

    However, I doubt that many of the people now screaming about bank bonuses are worried about such nuances about bailouts, “too big to fail”, the dangers of fractional reserve banking, legal tender, deposit insurance, moral hazard, or the other issues that we free market zealots care about. Alas, all too much of the debate is about “rich bankers” vs spending money on “schoolsandhospitals”, our brave lads in the Mideast. Some of it has a core of rationality, but a lot of its is just aggressive venting.

    Oh well, at least at my football club, Ipswich Town, we don’t have this problem, given the high risk of relegation.

  • APL

    Alisa: “Money is not just a medium of exchange, it has other functions, such as store of value, gauge of value,”

    That worked out well then didn’t it?

    The statistics imply a near 99% devaluation in the value of Sterling over the last century. Same for the dollar in the US.

    Money as a gauge of value has utility in so far as it has a provided an index of how valueless it has become..

    Paul Marks: ” Stoke City Association Football Club is a legitmate enterprise – “RBS” is NOT.”

    Agreed.

  • Midwesterner

    In the USA and presumably in the UK as well, football is subsidized by tax revenue in the form of stadiums to play in. If teams were required to provide their own stadiums or bear the full market cost of the ones that they rent (but that couldn’t survive without taxpayer funding) then perhaps player salaries would drop a lot. So footballers are in fact getting subsidized incomes.

    What I think the public outrage over bankers salaries captures (but that I think Mark Littlewood probably missed) is an incoherent, but more instinctively accurate understanding of Bastiat’s broken windows. At the end of the day, the soccer players have created entertainment for their income. Bankers, being in the value conveyance business, have created nothing but only facilitated the payment of the soccer players.

    But first, Laird, perhaps we speak different Englishes. You’ll have to explain to me how me saying “Like the commodity speculators, the FX futures speculators provide a necessary service to businesses …” means “to deride people who (a) attempt to profit from idiotic governmental actions, or (b) make markets for those who would seek to minimize the effect of (insure against, in your term) those value fluctuations.” Very different meanings we have for words, I guess.

    And, you entirely missed my point. But in that case, probably a lot of other people did as well. You said:

    All you are saying is that the purveyors of these media of exchange (i.e., governments) are doing a poor job of maintaining the integrity of their product.

    Absolutely not. That is the same as saying that factory managers are doing a poor job of maintaining their roof. I am not commenting on the quality of roofs; I am stating that the roof is not the product of the car factory.

    This is Bastiat’s broken windows, plain and simple. If the car maker can produce twice as many cars with the same inputs, net wealth increases. But if the roofer replaces the roof on the car maker’s factory twice as many times, net wealth decreases.

    Let’s say that Bastiat’s shopkeeper was a shoe maker. Transactions that occur entirely with the market category “media of exchange” are not the equivalent of making shoes. They are the equivalent of mending windows.

    Financial activity is not like manufacturing, it is like distribution. Increases in manufacturing output equal more stuff. Increases in distribution activity equal less stuff. While a car manufacturing company will reasonably measure productivity in cars produced, a freight handling company will reasonably measure their productivity in ton/miles and may be delighted to load and offload cargo and maximize handling and distance traveled if it can be added to the freight bill the customer receives. But that increase in freight handling is pure broken windows. Yes some window mending will always be necessary, but the larger the share of profits lost to window menders/freight haulers/financial transactions, the more it is indicative of “that which is unseen” being diminished.

    The same with financial transactions. Media of exchange are nothing more than vessels for delivering value. The greater the burden of delivering value, the more “that which is unseen” is diminished.

    At no time do I think Bastiat proposes that window mending can be eliminated. Some windows will always break and need fixing. Never do I propose that inter-media financial activity can be eliminated. Financial activity will always be needed. But it is a fundamental error to mistake activity for production.

    At some level, I think the public outrage directed at the financial sector is an intuitive understanding that an overweight financial sector is feeding at the expense of “that which is unseen“.

  • Mid – actually, I think you’ll probably most football stadiums in England are built largely with private finance.

    Your elucidation of the point about m-of-e transactions was clear enough toward the end of your first comment: if the currencies held their value in the first place, some of the people now engaging in m-of-e transactions would then be working elsewhere to produce real wealth and since they are not this is an “unseen” cost.

  • Laird

    Mid, I agree with you that financial transactions are more akin to maintenance or repair than to manufacturing*. And that repairing broken windows is a net cost. But, to stick with your metaphor, the situation we’re dealing with is (a) windows [read: currency] are essential (you can’t operate the business without it; (b) they’re manufactured by a monopolist (the government); (c) they’re of very poor quality and are constantly deterioriating and breaking (inflation); and (d) the firm which manufactures the windows is also the one breaking them (debasing the currency). With all that said, it isn’t particularly helpful to assert that the window repair shops aren’t adding value to the economy. In a better world we’d need very few of them, it is true, but we have to deal with the world we actually live in. Blaming them for the actions of others, over whom they have no control, makes no sense.

    I don’t think we’re really disagreeing that, in a perfect world, with currencies which maintained their value, the financial sector would be much smaller than it is today. But we don’t live in that world, and for the most part the players in the financial markets aren’t responsible for its condition. They’re simply operating in the environment in which they find themselves.

    *Although I disagree with your characterization of shipping: if the product isn’t where your customers can buy it it’s not worth anything, so I would include transporting the product to a useful place as a part of the value-creation process.

  • Midwesterner

    I’m glad to hear that about UK sports stadiums. In the US, local governments compete to see who can offer the best taxpayer assisted sports facilities to draw teams and add prestige to their cities.

    Yes, when activity in the financial sector is in excess of what would occur in a market with unfettered freedom of exchange, those people who would be working elsewhere producing real wealth are part of the unseen cost, but it is a double dip. In addition to not themselves creating value, they are actually impairing the value-creation activities of others. Instead of buying more leather, the shoemaker is paying the window mending monopoly to mend the same windows it is enticing politicians to break. Instead of buying more steel for cars, the car maker is paying the financial services industry to overcome transactional obstacles that it has paid politicians like Chris Dodd and Barney Frank to put in place.

    There is legitimate debate about whether big business has captured government or government has captured big business. At this point I don’t think it matters anymore who was holding the shotgun at their wedding. They are busy making big time whoopee and spawning new forms of rent seeking.

  • Midwesterner

    Laird, I cannot repeat any more clearly than I already have many times over. Some window mending/shipping cost/roof repair/financial services are necessary.

    I am not seeking to assign blame. I am assigning activities to categories. There are many desirable activities that do not add anything to wealth. At best, they prevent its dissolution. A factory is no better at building cars because it has a new roof. It is only as good as it was before the previous roof failed. If somebody could invent a comparably priced roof that never needed replacing, only the roofing industry would be distressed. Roofs are an ancillary support function. Simple arithmetic here. The more of your resources dedicated to ancillary support functions, the less dedicated to primary functions.

    You are either in excitement or inattentiveness repeatedly asserting that I am attacking the activities themselves (window mending/shipping costs/roof repairing/financial services). I am not and I have made that repeatedly, repetitively, redundantly clear.

    What I am talking about is how these activities effect net wealth, how things have improved at the end of the day and how the activity’s overall significance should be assessed when weighing the health of an economy. These are things that, the greater the share of the economy they comprise, the less is left for real goods at the end of the day. – And I include a game/concert/cruise etc in “real goods“. I still very fondly remember my two childhood pilgrimages to Wrigley Field to watch the Chicago Cubs. They were goods delivered. – The healthiest economy is not the one with the biggest share of its workforce and resources dedicated to shipping. It is the one with the smallest share. The healthiest economy is not the one that has the biggest share of its workforce and resources dedicated to dealing with financial services. It is the one with the smallest share.

    When having difficulty understanding the hidden consequences of an activity, project it to the infinite. In closed community small enough to do everything by direct barter, if 100% of the workforce is making stuff, then people are drowning in cheap goods. But if 100% of that workforce is dealing with financial matters and nobody is making anything . . . ? No matter how important it is, media of exchange can never be more than an ancillary support for the actual stuff being exchanged.

    Again, for the umpteenth time, this is about how to categorize activities, not who’s to blame for them.

  • Alisa

    Mid, the biggest single problem I have with your series of comments is that I cannot identify any point at which you make a clear distinction between ‘is’ and ‘ought’ – IOW, how things would work in a truly free market, and how things are working (or not working, as the case often is) in reality (note that this is also quite tangential to Laird’s point). Can you clarify where you and your comments stand on this particular distinction?

    In a free market neither shipping, nor roof making, nor any other “ancillary” activity is anything like Bastiat’s broken windows (this is also a point Laird touched on, I’m just trying to expand it). Bastiat specifically created that parable to signify artificial activity created by governments (it sounds like he specifically meant wars, but I could be wrong). Roof making and shipping are nothing like that, and neither is the financial industry, provided they all operate in a totally free market.

    A factory is no better at building cars because it has a new roof. It is only as good as it was before the previous roof failed. If somebody could invent a comparably priced roof that never needed replacing, only the roofing industry would be distressed.

    A factory is no better at building cars because it has a new machine. It is only as good as it was before the previous machine failed. If somebody could invent a comparably priced machine that never needed replacing, only the machine-making industry would be distressed.

    A factory is no better at building cars because it has a new manager. It is only as good as it was before the previous manager died. If somebody could invent a comparably priced manager that never needed replacing, only the engineering schools would be distressed.

    I don’t mean to be flippant: of course this is a matter of degree (managers and machines are more important to factories than roofs, shipping and maybe even financing), but your point was putting them in separate categories – they are not, they are in the same category, and only differ in the degree of their importance.

  • Laird

    I’m not entirely sure what we’re arguing about, Mid. I think perhaps we’re talking at cross purposes. You started out by supporting JohnB’s comment, which I read (perhaps unfairly) to be an attack on the banking industry per se (“money manipulating”), so I assumed that you were agreeing with his point. Now you’re only “categorizing”, not “blaming”. Frankly, I don’t see much purpose to that. Categorization is completely sterile. If you’ve identified a problem, categorization doesn’t do anything toward solving it. You need to identify the responsible cause (blame) and then devise a solution.

    As I read your posts, the “problem” you have identified is a bloated financial services sector sucking up resourses which could be put to more productive use elsewhere. Fine. We’re in agreement that much activity in that sector would be unnecessary in a rational monetary environment. Unfortunately, we’re not in a rational monetary environment, but rather one which is completely dominated and manipulated by politicians. So who is responsible for this sorry state of affairs, and how can we fix it? Not by blaming bankers (JohnB’s approach), or by “categorizing” them (yours), but by identifying the culprits (assigning blame) and working to thwart their evil machinations. We all know who those culprits are. And they’re not bankers.

    You’re struggling to find a definition of “real goods”, but you keep stumbling on services. I don’t buy the distinction. If a baseball game or other entertainment is a “real good”, then so is anything else which someone voluntarily chooses to expend resources on. Services are as “real” as anything else, and I don’t think you can draw a principled distinction between those which are economically rational and those which are not. There’s an immense gray area between the two. The only meaningful distinction I can see is whether the purchase is voluntary or coerced.

  • Alisa

    You’re struggling to find a definition of “real goods”, but you keep stumbling on services. I don’t buy the distinction.

    Amen brother. I’m not sure Mid is in fact making this distinction, but a lot of people do, and it bears to keep refuting it.

  • Midwesterner

    Bitcoins. I have no idea if they work as anticipated, but for the sake of discussion, let’s accept that they do as a starting premise.

    Bitcoin is pure media of exchange. It is not something you can stuff a pillow with. It is not something you can listen to on your Ipod. It is not something you can put in your fuel tank. You can use it for nothing except exchange. As such, it is a pure media of exchange with none of the confusion that is introduced when the media of exchange has non-monetary value.

    Let’s posit two or more competing bitcoin networks. Let’s call them bitcoin-α, bitcoin-β, bitcoin-γ, etc.

    Bitcoin is clearly a service, a media of exchange is a service. Bitcoin is not a good being exchanged. Under the argument that means-to-acquire something are structurally/consequentially indistinguishable from things-to-be-acquired, somebody making money arbitraging differences in the various bitcoin systems is generating wealth. Before I try to argue against this assertion I need you (either of you) to give me a hypothetical example of this occurring. How can arbitraging bitcoins, how can arbitraging pure media of exchange, generate wealth? Not how can it reassign wealth created by someone else, but how can it generate wealth itself? How can it create food or music or shelter or transport or any other consumer end-good?

    Because if it can, then JohnB’s statement about “making wealth from nothing” stands solid. If the arbitrager spends his profits on end goods, then what end goods did he exchange for them? None. The transaction represents the exchange of real goods for some medium of exchange created from thin air.

    In fairness, I am making a distinction between ‘services’ that are in fact consumer goods (hearing a live concert) and services that are means to an end (the parking place at the concert hall) but that does not change the points I am making about means versus ends and the proportions of each in an economy.

    My distinction that I am making is between things that somebody wants, and ancillary things that are necessary to get it. My distinction is that sitting in the mezzanine at the concert and parking your car in the lot outside are two fundamentally different things even though they are materially pretty much the same.

    The more the parking space costs, the less you have available to spend for good seats for the performance. It is incomprehensible to me that people believe that there is no difference between means-to-ends and the ends themselves. If this belief is widespread (as it appears to be) that could explain the utter incapacity of our governing class to understand the economy.

    I really don’t know how to explain this any better so I’ll wait for your explanations of how arbitraging bitcoins can generate wealth to see if it points the way to possible communication problems.

    My position, stripped to its essence, is that in any economy, ancillary functions (means to ends) compete with end goods and the proportions between them in the economy directly control the ‘wealth’ of the economy. Money and finance are ancillary to end goods, therefore they cannot contribute to wealth, only minimize their own negative impact on it through efficient operation. I am confused as to how this can possibly be a controversial statement. I think we are working from different economic meta-contexts.

  • Alisa

    Mid, I don’t think that you need to try and explain it any better. Rather, what you possibly need to do is try to understand the counterarguments presented above, and if you already did that, try to address them.

  • JohnB

    Money is purely and simply a medium of exchange. As such it represents wealth in that it can be converted back into something you want. So it is also a convenient store of wealth in a complex market of exchange.

    You can’t eat it. Listen to it. Ride on it. Use it to do anything other than convert it back into something that you can use.

    If you want to say that indicates it is a ‘good’ in its own right, then you are just playing with words, not the meaning.

    Yes, some folk can get a real buzz out of money which comes from what it can get them (what they can buy).

    But absent other goods on which to spend it, it is worthless. As Crusoe would have discovered if he wound up on a barren island with a treasure chest full of bank notes (even gold), but nothing else.

  • Alisa

    You are just reiterating what has already been said, John, and not adding anything new to the discussion. Just saying.

  • Midwesterner

    Alisa,

    You are calling JohnB and me wrong. I have explained to the best of my ability that your arguments above are not counter arguments. Your “counter arguments” are, at best, discussing another topic entirely. I can find nothing in them to support your (and others) claim that purely financial activity generates wealth. I laid out my statements that you claim to be countering in my last comment.

    Your ‘counter argument’ as best I can identify it comes down to an assertion that it is possible to generate wealth through purely financial activity. I’ve have countered that assertion with every analysis I can muster. And yet your assertion continues that it is possible to generate wealth purely from financial activity.

    All financial activity is ancillary to productive activity. Unless you can prove that financial activity can, in fact, generate wealth in its own course is not simply an overhead cost burden ancillary to productive activity, then I’ve got nothing of yours to work with. I cannot “understand the counterarguments” when they are nothing more than assertions.

    Financial activity is overhead cost. Overhead costs should always be minimized. The greater the amount of financial activity in an economy, the greater its contribution to overhead costs. Financial activity can never generate wealth. It can only consume it. Until you can find a counter example, you have no arguments for me to counter. Only assertions.

    And before you take the line that everything that leads to a finished product is, by my measure, ancillary, yes. Everything that goes into generating an end product that somebody wants is ancillary. If one carpenter can build a house in 1/10 the time of another one, then the ratio between ancillary activity and primary activity (delivering product) is shifted favorably towards the faster carpenter. At one end of the scale is endless work and nothing to show for it and at the other end of the scale is endless stuff for no effort. This is why one of the soundest measures of the wealth of a society is recreational activity.

    The financial industry is perhaps the most clearly, definitively ancillary activities there can be. Everybody without exception engages in financial activity for the purpose not of having more dollars or bitcoin as an end goal, but rather to use them to ultimately gain ‘stuff’. This does not mean that finance is without use and merit. But if finance is to be equated with producing wealth, rather than just facilitating its rearrangement, then the ‘stuff’ it generates must be demonstrated. Nobody in this thread has been able to.

    Put farmers, cooks and carpenters (but no financial professionals) on an island and you will soon have a flourishing barter economy. Put bank officers, forex arbitragers and certified public accountants (but no end product generators) on an island and the last one will have nobody to bury him. Unless they change careers, that is. Yes, the farmers, cooks and carpenters may soon reach a level of affluence where they can afford to sub out the barter process to professionals (the finance industry) but that does not transmogrify barter into production. It remains barter. And without somebody producing ‘stuff’ to be bartered, barter is nothing.

    The ball is in your court. I can’t hit it back until you first get it over the net. If you can’t offer at least one example of how purely financial activity can generate wealth then please drop that claim.

  • Paul Marks

    Sadly Midwesterner – the “financial economy” (the credit bubble) is now vastly bigger than the “real economy”.

    For example, when people say “manufacturing is only a few percent of the economy” what they are actually saying (although they know it not) is that the economy is vastly smaller than people think it is – and that all most people’s hopes and plans are based upon an illusion.

    It is true that the manufacturing is NOT all of the real economy – but it is most of it. So if manufacturing is only a “few per cent of the economy”.

    RBS alone is (ON PAPER) a matter of hundreds of billions of “assets” (in the Madhatter world of banking – a loan is an “asset”, and a bank does NOT have to have actual MONEY [notes and coins] in order to lend”money” out).

    In theory the alien space colony created by “Fred the Shred” (thanks for that Grant Freedom) is more important than all the manufacturing (and farming) enterprises in Britain – PUT TOGETHER.

    There is no way that an economy that has gone this far into insanity can be saved.

    Sorry people – but very hard times are comming.

  • Alisa

    Your ‘counter argument’ as best I can identify it comes down to an assertion that it is possible to generate wealth through purely financial activity.

    Say what??? There is no such thing as ‘purely financial activity’ in a free market – that’s the whole point, just as there’s no such thing as ‘purely roofing activity’ or ‘purely-anything activity’. In a free market financial activity is just like any other: services (in this case financial ones) given in exchange for other services or goods.

    I’ll now read the rest of your comment, just wanted to get this out of the way.

  • Alisa

    I now did, but am none the wiser.

    You seem to have missed my comment at January 30, 2012 10:09 PM, and never answered my question. You don’t have to call it a ‘counterargument’, just points that I tried to raise to reach better understanding.

  • Alisa

    You forget that your carpenters and your cooks on your island do not have any equipment with which to do their carpentry or their cooking (everything has been sunk with the ship). So you need your iron-smiths, and your tool-makers, and your potters, and what not. Of course bankers are not anywhere close to being in that second tier, but neither are roofers, let alone rock stars or football players.

  • Alisa

    I thought it might be a good idea to go back to John’s original comment to which I responded, to recap, and to take a closer look:

    The chemical engineer figuring out difussion rates is working towards a product or a service that will be of tangible benefit. Likewise designing a cost-effective airframe. Or even logistics for a military exercise.

    Here John seems to be implying that financial services in general cannot produce ‘tangible benefit’. This is obviously not true, as others have explained above.

    When it comes to dealing with money as a thing in its own right rather than as a medium of exchange, and getting an income out of its manipulation beyond the simple service of storing it, transmitting it, investing it in businesses that produce stuff or services, and other such activities, it is tending ever more into the land of the unreality.

    This is the bit to which I replied to the effect that money is not just a medium of exchange, but also serves in other capacities – but, to be fair to John, he admitted that much in that same sentence, perhaps without even giving a second thought.

    I realise Britain makes a substantial portion of its money in this way (having shipped substantial parts of its steel production, oil refining, car and train manufacture to people of other lands and interest groups) which is cause for concern.

    It is a cause of concern only because it did not happen “naturally”, but as a result of government meddling. Otherwise, there’s nothing inherently wrong with division of labor, even if it is divided between different countries.

    Money manipulation, derivatives, short selling, the whole game is unreal, in many ways parasitic.

    Again, only to the extent that it is the result of government intervention. Others (including Mid) have shown why some of these activities are highly beneficial to the production of “real” stuff.

  • Laird

    Mid, Alisa is carrying the ball quite nicely, but I want to answer your question about how financial engineering can generate wealth.

    Suppose you have some excess capital which you would like to put to productive use. And suppose that Alisa has a wonderful idea for a new widget manufacturing company but needs capital to build it. If I, as a financial intermediary, introduce the two of you (for a fee) and you invest in her new widget plant, I have most definitely contributed to the creation of wealth. If I hadn’t done so (and assuming that the two of you didn’t otherwise know each other) no widgets would have been made and you would have received no yield on your capital. I have provided a valuable service, to the two of you as well as to society as a whole (which now has access to more, and cheaper or better, widgets). QED.

  • Midwesterner

    Laird, you are not dealing purely in finance in your example. In your example, I am buying a widget plant. Real stuff is changing hands. Easily achieved by barter, I could even pay your finder’s fee with a few shares of stock and pay Alisa with shares of my company. The only thing financial about your hypothetical is that we used money in place of barter. You have no more identified a “purely financial transaction” than if I paid you to find my lost dog. I paid you to find something that I want to buy. Your fee was deducted from the amount I have to spend. Finding (real) things that other people want to buy is a useful service, but it is not unique to the financial industry. You are renting out your finding skills to locate a factory that I can buy. The only financial element is when I pay you for finding it and Alisa for selling it. But if every item sold and paycheck cashed makes that person a part of the financial industry, particularly when the use of money is optional to the transaction, I think we are having a problem with definitions.

    Knowing that what constitutes a “purely financial” transaction would be non-obvious to some people, I created the purest hypothetical that I could. I’ll repeat it with the specific question in bold face.

    Let’s posit two or more competing bitcoin networks. Let’s call them bitcoin-α, bitcoin-β, bitcoin-γ, etc.

    Bitcoin is clearly a service, a media of exchange is a service. Bitcoin is not a good being exchanged. Under the argument that means-to-acquire something are structurally/consequentially indistinguishable from things-to-be-acquired, somebody making money arbitraging differences in the various bitcoin systems is generating wealth. Before I try to argue against this assertion I need you (either of you) to give me a hypothetical example of this occurring. How can arbitraging bitcoins, how can arbitraging pure media of exchange, generate wealth? Not how can it reassign wealth created by someone else, but how can it generate wealth itself? How can it create food or music or shelter or transport or any other consumer end-good?

    Just for clarity, this is an example of a major activity of financial markets around the world. It has no contact with real stuff until arbitrageurs spend their profits to buy some real stuff. I would happily make money in arbitrage, I don’t have a problem with arbitrage or arbitrageurs. But neither would I think I was making the net wealth of the economy greater.

  • Alisa

    Sorry Mid, I could be wrong, but I feel like you are ignoring everything I’m saying. I am going to put on a frown, fold my arms and go do some useful stuff, until my words of wisdom are given the proper attention they deserve.

  • Alisa

    …yes, I am going to have to unfold my arms to do the useful stuff, you geniuses…But the frown stays!

  • Laird

    Mid, first, in my hypothetical you did not “buy” a widget plant, you merely provided capital for Alisa to build one. Your capital could have been in the form of partial ownership (as an investor in her company), which permits you to share in the profits (and risks), or as simple debt which gives you a guaranteed yield but no share in the upside (or downside). Either way, it’s still Alisa’s widget plant, and your capital helped to create it where none existed before. No “real stuff” changed hands. My involvement in the arrangement is indeed purely financial, and it did indeed contribute to the creation of wealth. That’s true whether my fee is paid in cash or in shares in the company.

    As to your specific question, postulating that there are several “brands” of Bitcoin competing in the market (for simplicity let’s focus on just two), and that for some reason the market values each of them differently, my arbitrage position in that market only makes me a profit if (a) the relationship between the two values changes (if it stays constant there is no arbitrage to be had, any more than there is if I change two nickels for a dime), and (b) I accurately predict the direction of that change (if I guess wrong I lose money). The relative values of the two competing Bitcoins would change only if there is some driving factor (i.e., one of the two Bitcoin issuers is inflating his coins, which would drive down their value in terms of what they can buy, or for some reason the market is coming to have more confidence in one than the other). My recognition of that differential, and my actions in the market (buying one and selling the other) help to impart knowledge to the market and drive the prices of the two into the proper relationship vis-a-vis each other, taking into account the new information. True, this doesn’t create any tangible products. But it does help the market function in a more orderly manner and conveys to its participants valuable information. If my study of the financials of one Bitcoin issuer convinces me (correctly) that he is inflating his coins relative to the other, my participation in the market both alerts others to his actions (via the price signal) and serves to prevent him from gaining from them, thus helping to ensure that his coins aren’t debased in the future. Whether or not you consider that to be “creating wealth”, it clearly adds value to the rest of the market.

  • Midwesterner

    No matter whether I lend and hold a lien on her factory or own shares in her factory, I have a piece of both the risk and profit. I own some sort of a claim against the real stuff that is the widgit factory.

    I just about choked when you said that lending money as simple debt gives me “a guaranteed yield but no share in the [...] downside).” Wow! With that statement I am beginning to understand how you can say “no real stuff changed hands“.

    Since no sane person would enter into such an arrangement with a stranger without adequate security, it is most decidedly not “still Alisa’s widget plant“. In the absence of a bill of sale, something was put up as collateral. A collateralized loan is best viewed by the lender as a purchase made, that they can get out of if the borrower is good for the money.

    In summary, you either brokered a gift to a stranger in the form of an unsecured loan (in which case you would need to find some other counterparty than me), or else an interest of some sort in Alisa’s widgit company has changed hands. The only remaining question is whether Alisa will be able to buy back that interest under the terms of the loan.

    I’m still stunned by your flippant conflation of promises made with promises kept. That is precisely the presumption that opened the path to the repo crisis. You and I truly are in different economic meta-contexts. I am beginning to see how we differ when you can see that transaction as potentially occurring entirely unsecured through a third party. I have a name for an unsecured loan to a stranger (which is what Alisa is in this example otherwise you wouldn’t be involved). It is more accurately called a “gift”.

    In your example, my capital did indeed help to create wealth, but your participation was not purely financial. You arranged the exchange of my capital for an agreed upon claim against very real assets and the hope to profit in some way from widgit sales.

    You stated with respect to currency arbitrage -

    My recognition of that differential, and my actions in the market (buying one and selling the other) help to impart knowledge to the market and drive the prices of the two into the proper relationship vis-a-vis each other, taking into account the new information. True, this doesn’t create any tangible products. But it does help the market function in a more orderly manner and conveys to its participants valuable information. If my study of the financials of one Bitcoin issuer convinces me (correctly) that he is inflating his coins relative to the other, my participation in the market both alerts others to his actions (via the price signal) and serves to prevent him from gaining from them, thus helping to ensure that his coins aren’t debased in the future. Whether or not you consider that to be “creating wealth”, it clearly adds value to the rest of the market.

    Just to be clear, are we talking about you and bitcoins or George Soros and pounds sterling? Because I for one am having a heck of a time figuring how anybody but George benefited. The record clearly shows that he did successfully prevent the BofE from profiting. But even if we set aside as a given that he created exactly zero wealth (and perhaps destroyed much for pennies on the pound), what exactly was the value that he added to the rest of the market? How did that value serve to generate wealth? When you helped Alisa get a secured loan, you did provide a valuable service that lead directly to the creation of wealth. How exactly did Soros’ profits lead directly to the creation of wealth? If he educated other participants in the market, who did he educate, what did they learn, and how are they material better off for it? Was there more or less real stuff extant after that whole Soros/Black Wednesday farce?

    And Alisa, I am not discussing blame and the opportunities to profit from it. Anybody who can make a profit by estimating the form political stupidity will take, is being perfectly ethical in my opinion (provided of course that they aren’t engineering the stupidity). What I am discussing is the market/wealth, creation/destruction aspects of profit taking from arbitraging fiat currencies. It was JohnB’s statement “The fact that financial institutions (which do not make or build anything, just play around with the media of exchange) are of such importance, itself, indicates that the system is false, distorted, untrue and out of balance“, that started this debate. The question is whether ‘playing with the media of exchange’ can ‘make or build anything’. Please note that JohnB did not say “using the media of exchange for exchanging stuff”. I presume from the structure or his statements that understands the usefulness of having media of exchange, it is specifically the manipulation of them independent of their purported use for exchange of real goods and services that he is faulting. It is precisely when other functions are added onto a media of exchange, functions like investment commodity, tool for goosing the economy, etc, that its primary purpose is compromised.

    There is a generally accepted belief, even by some here, that when commercial banks create multiplier money, or central banks create ‘stimulus’ money and lend it to businesses, home buyers, or other acquirers of real goods, that they are creating wealth. This is a dangerous fallacy that springs from the notion that manipulating the media of exchange can create wealth. It cannot. There is always some other activity that is unseen that is being deprived by the financial manipulations. But that belief in the power of money permeates our ruling classes. I am trying to attack it at its roots. It is not a matter of beneficial or detrimental media of exchange manipulation. All any of it can do is displace wealth, not create it.

    Laird, I was just getting ready to hit send and this statement by you with respect to currency arbitrage jumped out at me.

    my participation in the market both alerts others to his actions (via the price signal) and serves to prevent him from gaining from them,

    If that adds value to media of exchange, then yelling “Stop! Thief!” at a pickpocket adds money to pockets. I really think we do have a very different way of looking at things.

    I look forward to continuing this conversation but tomorrow will be very full so I may or may not be able to comment before Thursday.

  • Laird

    Mid, stop being silly. I know perfectly well that if you made a loan you would take collateral as security, and there is always the risk of loss. I didn’t think I really needed to go into that level of detail, with you of all people. Can’t I use a little “verbal shorthand”? The point is that a lender expects to receive nothing more than the return of his principal with the contracted interest, whereas an investor hopes to enjoy a large gain on his capital but isn’t overly surprised at a loss.

    And (in that hypothetical) my participation was indeed “purely financial”. I didn’t “arrange [for] the exchange of [your] capital for an agreed upon claim against very real assets”, but rather for a stipulated financial return on that capital. The security interest you took was merely protection in the event of unexpectedly poor results of Alisa’s operations. You had no expectation (or desire) to take over the property; you simply wanted the yield. It’s purely financial by any reasonable definition of that term.

    As to the Bitcoins issue (or George Soros, as you prefer), if there is a discrepancy between the values of two competing brands of Bitcoin (or between pounds sterling and whatever other currency Soros employed for his undoubtedly evil machinations), by his actions the arbitrageur helps to eliminate that discrepancy and move the market back toward equilibrium. Buying one and selling the other pushes up the price of the former and down the price of the latter, restoring the proper balance. Any action which removes an inefficiency from the market (which is what that price discrepancy was) adds value to that market. One can create new wealth (as with Alisa’s widget plant) or prevent the destruction of existing wealth (as with currency arbitrage); in either case value has been added. (Unless, of course, Soros somehow manipulated the market, in which case he merely engaged in a clever theft. But that’s not what I’m talking about, and in any event is not the usual case; few people have that sort of market power.)

  • Midwesterner

    But without taking those statements literally, your conclusion that “No “real stuff” changed hands” is utterly wrong.

    The whole point of your argument is that a purely financial activity creates wealth and that the transaction was not dealing with “real stuff” only money. Don’t lose track of the fact that the transaction here is my capital transfer to Alisa’s widgit endeavor. We’ve already established (I hope) that your paycheck is not a purely financial transaction or every person to ever cash a paycheck would be employed in the finance industry. The transaction that is under discussion is mine with Alisa.

    You made a string of logic statements. Let’s take them in reverse order.

    My involvement in the arrangement is indeed purely financial, and it did indeed contribute to the creation of wealth.

    First, unless we accept that all paychecks qualify somebody as an employee in the finance industry, we must assume your involvement includes my transaction with Alisa.

    Either way, it’s still Alisa’s widget plant

    Not so unless it is an uncollateralized loan. Ergo, you were serious, not oversimplifying, not ‘avoiding unnecessary detail’. Collateral is by definition something of intrinsic value. Whatever words or legal structures you use to describe it, I have a claim on real stuff. Real stuff changed ownership. This cannot be a purely financial transaction unless the loan is unsecured. If it is not a purely financial transaction, then it is just an appropriate use of a medium of exchange and not relevent to whether purely financial transactions can create wealth.

    And (in that hypothetical) my participation was indeed “purely financial”. I didn’t “arrange [for] the exchange of [your] capital for an agreed upon claim against very real assets”, but rather for a stipulated financial return on that capital. The security interest you took was merely protection in the event of unexpectedly poor results of Alisa’s operations. You had no expectation (or desire) to take over the property; you simply wanted the yield. It’s purely financial by any reasonable definition of that term.

    Not even close. Clearly I had some small expectation of taking over the property or there would have been no need for collateral. What you arranged was a multiply optioned contract that no matter how it was named, amounts in actual consequence to a sale and buy back, which is what a mortgage is. Arguing about the buy back pricing methodology doesn’t change that essential nature of the transaction. If we went before an ethical judicial process, the court would look at her failure to give me money and determine that an appropriate part of the plant was mine. No matter what complicated names it is given, the transaction, and all collateralized mortgages, are in their essential, structural consequence, sale and buy back contracts. All the butter in the world cannot change what kind of bread is underneath it.

    One can create new wealth (as with Alisa’s widget plant) or prevent the destruction of existing wealth (as with currency arbitrage); in either case value has been added.

    Finally, you have conceded your agreement with what I have been saying all along. Purely financial transactions cannot create wealth. At best they can prevent its destruction, at worst they can be parasitic destroyers. The entire premise that wealth can be created by a financial industry is false.

    Your foray into “value” is symptomatic of the underlying problem in the entire financial meta-context of our time. “End goals” and “means to achieve end goals” are two entirely different things. A “means” is a value, but it is not an “end“. The unthoughtful conflation of means and ends under the heading of “value” is at the root of most of the problems plaguing our society, from Marxist socialism to central bank stimuli, and it is at the root of the broken window fallacy. Breaking a window increases the need for “means” and moves the pointer on the dial away from the “ends” end of the scale.

    I’ll repeat that scale that places these “ends” and “means” at opposite ends. At one end of the scale is endless work and nothing to show for it and at the other end of the scale is endless stuff for no effort.

    Now I really do have to get to work. A great deal of means to be dealt with today or I will have none of those ends I occasionally enjoy.

  • Laird

    Mid, you don’t understand collateral. A security interest is not “ownership”; Alisa very much owns the widget plant, subject to your lien. If she defaults on the debt you can’t simply take the plant; you have to go through a legal process. You don’t “own” it in any sense of the word. And no lender ever expects to have to take ownership of the collateral; that’s a last resort if there is no other means of getting repaid. You can call it a “multiply optioned contract” or any other fancy term you like, but that doesn’t reflect either the legal structure or economic reality. Your security interest is an inchoate potential claim in the event of a future contingency (over which you have no control). It’s not only not “ownership”, it doesn’t even rise to the level of an “expectancy”.

  • Midwesterner

    Laird,

    With due respect, you are the one who does not understand collateral.

    I have been to many, perhaps dozens, of auctions over the years that were administered by new owners who took possession of property that they loaned money against. Too many times I have seen shell-shocked former owners watching their life’s work sorted into piles and sold by the lot. There are many former farmers and other small business owners who would take great exception to not just your statements, but to your seemingly cavalier attitude towards mortgage debt.

    When, at the end of the day, the sheriff and his deputies are standing around with guns on their belts telling you in polite legalese to GTF out, you most certainly do not own the property and for you to claim that a collateralized loan is a purely financial transaction that doesn’t involve anything real is utterly, spectacular preposterous. Unfortunately I believe it is also ubiquitous in the banking industry. Nothing else could explain reckless writing, bundling, sale and purchases of mortgages and mortgage securities. At the end of the day, everybody forgot that there was real stuff behind it all.

    We’ll have to agree to disagree on this matter, lord knows there is plenty of things that we do agree on, but in the mean time I recommend you attend some farm bankruptcy auctions. Usually the defaulters stay away, but sometimes they will be there and watch as generations of farming assets are sold to the highest bidders. I don’t know why, but some do. You might try explaining to them that it isn’t really real.