The Coming End of Right Wing Economics? We Can Only Hope

The new column today out from Paul Krugman, about Tom Piketty’s new book got me to thinking.

It must have been very, very difficult to be a Keynesian economist in the late 1970s in America, Europe, and England. Unemployment was high, inflation was staggering, and growth was stagnant. The ideas on the left edge of the economic spectrum seemed to have run out of gas. Taxes on the wealthy? High. Welfare programs? There were a lot. Economic stimulus? We did it, yet inflation was still high.

So, those right wing ideas of tax cuts were certainly worth a try. Hell, nothing else was working. Why not try all those wacky economic ideas out of the Chicago school being espoused by Martin Friedman’s disciples?

So we did.

Now, the idea that it was Keynesian economic ideas that were failing in the 70s was a bit silly in retrospect. The entire world was still massively dependent upon the strength of the US economy, and US economic policy was a mess due to the Vietnam war. We fought it on the credit card, and like all bills, it was time to pay. Had we not had the Vietnam war, it is entirely possible that the malaise that existed in the mid to late 70s wouldn’t have existed.

But… whatever. We tried right wing policies, and while we also simultaneously doing some left wing things (like Volker radically increasing interest rates to curb demand and thus break inflation’s back), and then the Soviet Union fell apart, and hello there, peace dividend.

In any event, changing from a left-ish style economics to a right-ish style of economics was really only possible because it appeared, right or wrong, that left-ish economics wasn’t working.

I keep hoping, sometimes beyond hope, that we are finally reaching that point with right-ish economics. It is one thing to talk about cutting taxes when the top tax rate is 70%. But when it is 35% for income, and 20% for investment income, that idea seems silly. It’s one thing to talk about cutting spending when the cost of borrowing money is 10%, it’s another thing to talk about cutting spending when the cost of borrowing is less than the rate of inflation, which means the money is basically free.

It does seem like the pendulum is finally, after 30+ years of doing things the right wing way, swinging back to the center. We did actually implement a form of health care that could eventually lead to everybody having insurance, even if it is kind of a mess due to the desires to keep the fantasy of “market based competition” alive. We are pulling back on military spending, even if we still spend way more than the next several countries (most of whom are allies) combined. And the Justice Department is finally looking at our crazy minimum sentencing laws around drug offenses, asking prisoners to apply for clemency, and adding staff to handle the claims. And, as Krugman points out, the rhetoric from the right seems especially hyperbolic and nonsensical.

So, are things turning around? I can only hope. On days like today (Friday), I’m hopeful. I’ll probably be cynical next Monday when I see yet more gobs of money being poured into politics thanks to the Roberts Court.

Review of Michael Lewis Book “Flash Boys”

UnknownThe book “Flash Boys” (Amazon, Apple) by Michael Lewis tells the story of how our current stock market works, how it is being manipulated, and what a group of guys who figured it out are trying to do about it. Like all good Michael Lewis books, it focuses on one central character to provide the narrative structure as he teaches you about what is going on. In this case, the character is Brad Katsuyama, a trader at the Royal Bank of Canada (RBC). By focusing on one character, Lewis’ books become page-turners, though it does tend to leave some of the technical details out in the interest of advancing the story. I find this perfectly acceptable, because it gives you enough of a window into how things work that you can then dive into the deeper, and let’s face it, drier, technical details of the subject if you are so interested. Lewis himself mentions these books in his notes, so you have get a good heads up on where to go for further reading.

While the book focuses on Brad and his colleagues, it gives a fascinating insight to how our modern stock market actually works, and really made me not want to be a part of it at all. As an example, I think we all have an idea that there are these limited quantity of hard, fixed pieces of real estate, called the NYSE or Nasdaq, and there are people running around on the floor shouting at each other as trades get made. If you wanted to trade Apple stock, you went to the NYSE (as that is where it was listed). If you wanted to trade Intel, you went to Nasdaq (because that is where it was listed). Yes, there are computers, and maybe some of this “people yelling at each other” is antiquated, but the NYSE is still a place where this stuff happened. If you turn on CNBC, you see the floor of the NYSE and you see people walking around.

However, this is not how things work anymore. That trading floor you see on CNBC, and the celebrities or CEOs doing an IPO that ring the opening bell? That’s just a set piece, nothing goes on there. And there aren’t 2 or 3 exchanges (Amex being another). There are 12 or 13… and you can trade any stock on any one of them… and those are just the public exchanges. Banks like Goldmann Sachs have their own, private exchanges, called “dark pools”, where their clients can trade. And these new public and private exchanges aren’t loaded with people, but rather are just large arrays of computer servers running algorithms. And you don’t just have trades like “buy” or “sell”, or even things as simple as “limit orders” (buy/sell if the stock hits such and such a price). You have dozens of order types that are complex and hard to describe, because the types are really meant as triggers for the computer algorithms running on the servers in these multiple exchanges.

OK, wait… what?


The world is a much different place, not only from the Wall Street immortalized in the Oliver Stone movie of the same name, but even from the market of the late 90s that you or a friend of yours participated in when they quit their job to be a “day trader”, and even from the market that existed when the financial crisis hit.

Why are things so different, and how come we didn’t know about it? That, basically, is the crux of the book. This change in the market was all transparent to you and me when we go onto our Fidelity web page to trade a stock, because these changes weren’t about you and me. They were about a group of people called “high frequency traders” or HFT. These changes were made to turn the stock market into a complex Rube Goldberg machine, because the more complex the machine is, the easier it is to find inefficiencies in it to exploit. Much like how the financial crisis occurred because people who traded in mortgage backed securities were trading in an opaque market of strange, hard to decipher rules, the new stock market is complex, opaque, and confusing, which allows the people who know how to spot a fissure in the rules to swoop in, unbeknownst to the rest of us, and take some money.

In the olden days, stock trades did happen based upon speed, but it was a regulated speed. You might have a really good stockbroker who has a stacked Rolodex or excellent memory, and when he (or she, but let’s face it, it is mostly he) trades a stock on your behalf, he can get you the best deal because of this. He can find the seller willing to sell for less than he really wanted (so as to get you the best buy price) or find the buyer willing to buy something for more than he wanted to buy (so as to get you the best price) or, perhaps, do great horse trading so that you split the difference.

For example, say you want to buy a stock and make a bid at $10. And somebody else wants to sell the same stock and makes a sale offer for $10.02. A good broker might be able to get you that $10 price because of whom he knows and how fast he works, such that you don’t have to pay $10.02. Conversely, if you were the seller, your broker was so good he could get you the $10.02 price so you don’t have to sell at $10. Or, he works it out such that the stock trades for $10.01. The better the broker, the more you are likely to get your price.

Now, in this old-timey Bud Fox market of guys in rolled up white buttoned shirts and ties yelling on the phone, if your broker instead interjected himself, such that he bought the stock for $10 that you asked for, but turned around and sold it for $10.02 back to you, that would be illegal. He was using his knowledge to make the seller think the only offer for his $10.02 sales price was $10, and to make the buyer think the only stock available for his $10 ask was $10.02. He pocketed the difference. That’s a no-no and a quick ride to jail (well, fines… maybe… depending on how crappy the government feels like operating)

But in the new world order of computer based algorithmic trading, this is not illegal, as long as it is the computer doing it. A computer can make this trade, independently. And the way it works is like this. Your Bud Fox-type broker isn’t getting a phone call… what he is doing instead is taking a bunch of money from an HFT (through fees), which lets the HFT see what the incoming stock price bids/asks are ($10 and $10.02). The HFT sees this information, and has his computer sit closer physically (as in, with shorter wires) to these stock exchanges “matching engines” where the trades occur. Because he is closer, just by rules of physics, he gets to the matching engine before you, and can do the trade with you opposite of the way you hoped. To you, it looks like you didn’t get your price. But the thing is… neither the buyer nor the seller got their price. The seller thinks he had to sell for $10, and the buyer thinks he had to buy for $10.02. The HFT made a 2-cent profit (some of which he paid to the Bud Fox brokerage firm in fees).

Now, that sounds simple and all, and it is. Because, couldn’t the HFT equally “lose” as well as win here? He could, in theory, end up buying at the wrong price and selling at the wrong price, and lose just as easily as he could win. And this would be true, but that gets us back to all those complicated order types. You don’t just have “buy” and “sell” or “limit” orders. You have orders you can make that you can cancel unless certain, wild and crazy and difficult to explain in English conditions are met. And since these orders can be cancelled, they allow you as the maker of the order to tease out what the real buy and sell prices are, which you can use to then cancel the main order, and come in right after it with a “better” order that you do complete. You are thus, in essence, making free money.

Keep in mind, this is all legal. And this legality is not an accident. The people who have made it legal? They made it legal explicitly so they could do this. The “it’s illegal if it is a human but legal if it is a computer” thing is not a mistake – it is part of the plan.

The crux of the story, once you learn this, is what Brad and his colleagues did with the information – they created yet another exchange that can combat these HFT algorithms. Their exchange slows down the orders such that an HFT can’t sneak in. Their exchange has much simpler order types. And finally, they got clients to demand from their banks doing trades (such as Goldmann Sachs) to use Brad’s new exchange when they placed their orders. Like every other exchange, they make money when trades happen on their exchange. They might make less than other exchanges as they aren’t selling access to HFT, but the hope is that by being the “fair” exchange, they will get more volume over time and thus do just fine.

One other fun note… as with the mortgage based financial crisis, Brad didn’t just set out to create his exchange as soon as he figured it out. He went to the SEC to let them know what was going on, with the hopes that maybe this would stop on its own with some rule changes. He was a happy, and rather wealthy man, doing trades at RBC. He wasn’t an entrepreneur with dreams of starting his own exchange. But, just like with what happened in the financial crisis, he found deaf ears at the SEC. They didn’t seem interested in stopping what was going on. Brad’s team did some analysis of this, and as it turns out, the sheer number of SEC employees who later quit the SEC to go work for HFT firms was astounding. In other words, the SEC knows what is going on, but just didn’t care. I know… my head slammed on the desk reading that, too.

As with all Michael Lewis books I have read, this book was very good. Lewis doesn’t feel it is his role to provide answers about how to make Wall Street change, any more than he felt it was his role to make Wall Street change when he wrote “The Big Short”, about the mortgage backed securities fiasco. Lewis instead writes a book that is entertaining as well as educational. It has heroes you root for, and villians you cannot believe exist outside of fiction. As with The Big Short, he succeeds.



The (Hopefully) Salvageable Technology Behind BitCoin


As you all know, I think BitCoin is a horribly stupid idea.  It is thriving in the community of male libertarian internet nerds.  I have been very vocally against it, as I consider the rise in its price to be nothing short of the kind of scams that were the dot-com bubble in the late 90s and the mortgage security bubble of the late aughts that destroyed the world economy.  I feel it will collapse, the early adopter hedge fund type people will walk away with all the money, and normal people will be hurt.

However, that doesn’t mean that the technology behind BitCoin is bad.  In fact, the technology behind it has absolutely nothing to do with trying to create an alternative currency.  And I had a perfect example on how the core technology behind BitCoin – the “decentralized ledger” – is great even though BitCoin is stupid.  This decentralized ledger is the amazing technology behind BitCoin – a problem that computer science has been trying to solve for years.  Banks, Paypal, eBay, etc. have a “centralized” ledger.  The ledger is like a spreadsheet – it says who owns what.

This morning, my company attorney sends out a power of attorney document for 3 inventors (I was one of them) to sign. Even though it is 2014, and we all want “paperless office”, the document has to be printed out, signed by all of us, scanned in, and e-mailed. We actually did this by one person signing it, and walking down the aisle to the next guy with a yellow sticky on it saying to sign it and give to the next person, etc. (We could all have printed our own copies and signed them and then scanned them all in separately and e-mailed back – but you get the idea on how “ancient” this is).

With the decentralized ledger, a document like this can be tagged in the ledger as belonging to the attorney. She sends it to inventor #1 so the ledger indicates inventor #1 has it.  (In BitCoin, this is how BitCoins are transferred – the ledger indicates user #1 had one, and now user #2 has it).  They send to inventor #2, again, with an update to the ledger, they send to inventor #3, and then finally back to the attorney.

The ledger knows who has it, and the “block chain” shows how it transferred through the 4 people. Thus, a full record of a transfer of ownership, with a clear intent to send to the next person (thus power of attorney granted). This all happens electronically – no printing, signing with pen, scanning, e-mailing. (Obviously, I’m skipping a step here, which is that from a legal standpoint, something like this ledger/transfer mechanism is recognized as legally binding).

That is the future. That is the technology that BitCoin uses that should be celebrated. That is the technology that *needs* to live on long after all these stupid crypto-currencies die the death that needs to happen. My fear is that this technology will get stunted, much like peer-to-peer file sharing technology is somewhat stunted because of the first (and still prevailing) usage model – media piracy.  Peer-to-peer networking and file sharing has nothing to do with trading Beyonce songs, but since that is all people really think of when they think of peer-to-peer, it keeps the technology from being more widely distributed.

BitCoin is a Scam

gbnsz5sc-1393331470I know I’m a broken record on how stupid I think BitCoin (BTC) is, but I just can’t help it. I’m taking such perverse joy as Mt. Gox, one of the BTC exchanges, implodes because they were inept at handling financial transactions.

The reason you may have heard about BTC being accepted at things like Starbucks or is because it looked like the price of the “currency” was stable, and doing a transaction in BTC was very cheap for a vendor. If you were to use Visa or Mastercard to buy something online, Visa may charge the online vendors, say 5% of the transaction. This is money you as the consumer don’t see, but it does come out of the vendor’s pocket as a cost to use Visa (this is why, for example, you couldn’t use American Express at a lot of vendors – AmEx charged higher fees).

BTC charges ridiculously low fees – in some cases free. So, to a vendor like, if you charge $10 for something that cost $9, with a Visa fee of 5%, Overstock gets $9.50 and Visa gets 50 cents, where using BITC you might get all $10.

However, the reason these BitCoin exchanges charge such low fees is because they have no… friggin’… idea… just how to keep these transactions secure (Mt. Gox implosion is because of this). In order to keep transactions secure, you have to spend, let me think, um…, a lot of money. Also, Visa has to follow silly little things called “laws” and “regulations”, which make them liable for fraud. Since they have to pay out when somebody steals Billy-Joe’s credit card and rings ups fraudulent transaction, they *are* going to pass that onto their other users, through fees.

Seeing how utterly inept BTC vendors are with transactions reminds me of an episode of The Office – where Michael and Ryan build a competing paper company that implodes because they used a “fixed cost model” instead of a “variable cost model” for shipping paper. Here is a transcript from that exchange (I wanted to find a video, but I guess NBC has made sure The Office clips can’t be on YouTube):

Michael: How much can we afford to pay a delivery guy?
Financial Guy: Well, if these numbers you gave me are correct–
Michael: They are correct, sir.
Financial Guy: Then you can’t afford to pay him anything.
Michael: Okay. A lame attempt at humor. Swing and a miss.
Financial Guy: Your prices are too low.
Michael: Lowest in town.
Financial Guy: Why do you think Staples and Dunder Mifflin can’t match your prices?
Pam: Corporate greed?
Ryan: Look, our price model is fine. I reviewed the numbers myself. Over time with enough volume, we become profitable.
Financial Guy: Yeah, with a fixed cost pricing model that’s correct.
Ryan: Yeah.
Financial Guy: But you need to use a variable cost pricing model.
Michael: Okay, sure. Right, so– why don’t you explain what that is to– so that they can under– just explain what that is.
Ryan: Explain what you think that is.
Financial Guy: Okay.
Michael: Explain that.
Financial Guy: As you sell more paper and your company grows, so will your costs. For example, delivery man, health care…
Michael: Well, we don’t–
Financial Guy: …business expansion–
Michael: Whatever, yeah.
Financial Guy: At these prices, the more paper you sell, the less money you’ll make.
Michael: Our prices are the only thing keeping us in business.
Financial Guy: They’re actually putting you out of business.
Michael: Okay, okay. Hold on, hold on. Ty, I would like you to crunch those numbers again.
Ty: It’s a program. There’s no such thing–
Michael: Just crunch ’em. Just crunch ’em please.
Ty: [presses key on computer] Crunch.
Pam: Did it help?

BitCoin is a complete joke.  Just like Michael trying to undercut Dunder Mifflin by using incorrect rules of finance, BTC is using incorrect math to justify why it is good.  Their transaction fees aren’t because it is an “internet currency”.  The transaction fees are low because the people running these exchanges are inept, or criminal, or both.

Now, this isn’t to completely dismiss BTC having any possible benefit to us as consumers.  While mostly Visa and Mastercard charge what they charge for fees is because of laws and regulations, there is a very good chance that lack of competition and complacency is causing them to charge more fees than they reasonably should be allowed to get away with.  If BTC’s low fees prove to be a good thing for vendors, despite the fluctuation in the value of the “currency” (seriously, I cannot help putting the word currency in quotes, because BTC is not a currency), then Visa and Mastercard will have to lower fees.  At which point, we all win.

But until that happens, I will continue to enjoy watching BTC flail about.  The libertarian ideologues who love it are endlessly entertaining.  I’m waiting for the time one of these goofballs starts railing against the government, claiming the government is behind BTC’s collapses, and then veering off into complaining about fluoride in the water supply.