Monday, 25 January 2010

The Driver of Social Change – (Epilogue)

Why did I choose an obscure dispute over the regulation of derivatives to expound on the macro themes of social change and public alienation?

The reason is that the dispute goes to the heart of the matter. It is the heart of the matter – the definition of finance, the dialectics inherent in a dispute (that is pregnant with new developments), the abstract nature of the argument (that goes over the collective head of the hoi polloi) and the uncompromising position of the parties (who know what the stakes are) – are all there.

Let us begin with the definition, which is a highlighting of relations. The definition sets the direction of the investigation by establishing the investigator's point of view, his angle of vision to reality. If it is set right, things will fall into place.

Here is a finance professor writing to the editor of the Financial Times to volunteer his unsolicited 2 cents about the crisis :

First, “finance” must not be considered as one homogeneous discipline. The traditional finance (asset management, corporate and international finance) did not create the crisis, but the mathematical finance/economics that invented the structured products certainly played a part because they feed the financial markets’ appetite for generating excess profits based on non-existing assets.
Finance not a homogeneous discipline!

Finance concerned with asset management and corporate finance. (Thanks, Paul Samuelson!)

Mathematical finance “inventing” structured products!

With this appalling insubstantiality as the starting point, our professor could not go far – or at all.

Finance is the discipline of studying finance capital. Finance capital is capital in circulation that is evolved to the point of subjugating the industrial capital, the capital in the realm of production.

Capital in circulation – historically its two dominant forms were merchants’ capital and bank capital – is necessary for the realization of the value of products; a product must be sold for the profit in it to be realized, hence the critical role of say, merchants’ capital, that delivers the products from the producer to consumers. In that regard, while it logically plays a subordinate role to the industrial capital, its existence is nevertheless necessary, because without the conversion of commodities into money, the production cycle would cease.

From this historical position of being a “humble servant” of the industrial capital, capital in circulation evolves to the point of dominating the tempo of the entire production process, including that of industrial capital.

In the previous volumes of Speculative Capital, I touched upon the nature of this transformation. In the upcoming Vols. 4 and 5, I will delve into the subject in further detail. But two words that I just used need elaborating.

One is “subjugate”. What does the word mean when applied to the relation of two forms of capital?

For the answer, consider the car market in the West, especially in the U.S. Whilst previously cars were purchased, they are now leased, typically with 3-5 year terms. The change was brought about, driven and dictated by the funding exigencies of the finance capital that resides, among other places, in the financial subsidiaries of auto manufacturers.

The design engineers, the marketing executives, the raw material producers and the parts suppliers are then forced to react to the fact that the average life of the car on the road is reduced to the terms of the lease. That is the dominance of production by finance capital.

Or take a case from the aviation. Two recent events, the test flight of Airbus A380 and Boeing 787 made the news. While the A380 is a totally new plane with new concepts, the 787 is a rehash of the existing lines. Still, the plane was more than 2 years behind in the delivery schedule and experienced considerable design difficulties. Why did Boeing engineers who invented the mass production of the commercial aircraft have such a hard time with the latest model? From The Financial Times of February 27, 2004:
Boeing has left it too late to catch up with Airbus in modernizing its commercial aircraft range because shareholder “short-termism” would not allow the scale of investment needed, the head of BAE Systems claimed yesterday … The failure to renew its product range resulted in Boeing being overtaken by Airbus in terms of deliveries for the first time in 2003 … Sir Richard Evans, the outgoing chairman of BAE … estimated Boeing would need to spend between $40bn and $50bn over the next 10 to 15 years to “match” Airbus’s product range.
Note that the culprit is not financing, in the sense of the availability of capital, but the speed of the turnover of finance capital that has a tendency to increase, leading to the “short-termism” of the executives.

The other word is “evolve”, as in “capital in circulation evolves to the point of dominating the tempo of the entire production process”. The word has a historical connotation. It includes expansion and growth – both, quantitatively in size, and qualitatively in form.

For the size, it will suffice to quote from the finance professors who regularly cite that the size of “finance" as a percentage of the GDP has doubled from about 4% in the mid 1970s to about 8%. In terms of form, there is of course the rise of speculative capital, the latest and most aggressive form of finance capital which reaps profit from volatility. From Vol. 2:
Derivatives are the functional form that speculative capital assumes in the market. This form is fundamentally a bet. But like the bodies of the damned in the Inferno whose deformity corresponds to the sort of sin they have committed, the particular composition of each derivative corresponds to the sort of arbitrage opportunity that speculative capital intends to exploit. Arbitrage opportunities are many and varied; hence the confusing array of derivatives.
It was the expansion of speculative capital, being pushed by one side and resisted by the other, that took the form of the fight over the regulation of derivatives.

The U.S. side demanded constant marking-to-market, a practice that presupposes trading. That is the realm of finance capital.

The “end users”, all industrial companies representing industrial capital, wanted to prevent finance capital from getting a foothold within their accounting system, and eventually, their production cycle.

For the time being, the two sides being approximately equal in political power, the matter ended in a draw. The two sides agreed to disagree. But we have not heard the last of this dispute.

What I discovered theoretically about speculative capital, speculative capital and its agent know instinctively. From the New York Times of April 27, '08, describing a meeting in which then Treasury secretary Rubin got uncharacteristically angry in a meeting in which he was trying to block the regulation of derivatives.

But on at least one occasion, Mr. Rubin lined up with Mr. Summers and Mr. Greenspan to block a 1998 proposal by the Commodity Futures Trading Commission that would have effectively moved many derivatives out of the shadows and made them subject to regulation ... At an April 21, 1998, meeting with Brooksley Born, the chairwoman of the commodities commission, Mr. Rubin made no secret of his feelings about her proposal. “It was controlled anger. He was very tough,” Mr. Greenberger [then director of trading and markets at the CFTC] recalls. “I was at several meetings with him, and I’ve never seen him like that before or after”.
From the Nice Jewish Boy to a bully in a few seconds! One more word from Brooksley Born and Bob Rubin would have pulled a knife on her!

Why this uncharacteristic anger? Why the Treasury secretary of the U.S. who, by all accounts is a mild mannered, almost shy, individual, gets all worked up over something like the regulation of derivatives?

The answer is that he is not the Treasury secretary in the institutional sense of the word, with all the duties and obligations of the office that go with it, but an ex-Goldman FX arb trader occupying the office. He gets angry because he instinctively knows that the proposed regulation would get in the way of arbs making money.

Look at this unbelievable passage, unbelievable because what a single individual is allowed to do under the auspices of the U.S. government, from a laudatory article in the New York Times that I quoted in Vol. 1:
Then, when the dollar had fallen off the front pages and the market’s attention was elsewhere, they [Rubin and Summers] ambushed the currency speculators, ordering the Treasury to buy dollars. The idea was to sow so much uncertainty about the Treasury’s tactics that no big speculators or hedge funds would risk being caught with a huge position in yen.
I commented there:
So the Treasury Secretary of the United States fixes the exchange rate of the dollar against the yen by sowing uncertainty about their exchange rate!
A palan dooz is allowed to run the U.S. Treasury Department like a hedge fund – and then go further still:
His [Rubin’s] first move was to impose an ironclad rule that he would be the only one in the Administration even to talk about the dollar, the loquacious president included … Mr. Rubin had a free hand in fighting the dollar war; the President almost never got involved.
The president of the U.S. is forbidden by his Treasury secretary from talking about the U.S. currency.

We now see the larger issue behind the regulation of the derivatives. To facilitate its movement, finance capital changes the laws to its favor. If the laws, including those of the sovereign nations, stand in its way, they have to go. Hence, the “globalization”, a term that is void of national and political connotation precisely because speculative capital deems them irrelevant.

Because the laws enabling, empowering and propelling speculative capital are enacted at a macro, almost abstract level, they appear as a “given”, like the laws of nature, with the result that they remain outside the political discussions and agenda; think of the Fed’s “independence”. In this way, policy making become removed from the hands of policy makers. Policy is removed from politics.

Under these conditions, the difference between one politician and the next becomes the color of their skin, and not the content of their policy – or even character.

Such changes are far from natural. In fact, they are the elements of the most extreme and disruptive form of social engineering. But because the dynamics of the process is hidden from the people, they feel powerless to bring about any change. They become passive, alienated, superstitious and angry.

All the while, Prof. Becker, who dislikes social engineering very much, will have nary a word on these subjects.