productivity

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Have Financial Markets Gone Post-Human?

So, Thomson-Reuters pays the University of Michigan a million dollars a year to provide selected clients with the results of the latest survey of consumer sentiment 5 minutes before the rest of the world sees them — and to provide higher-paying clients with this information in a machine-readable format ready for algorithmic trading 2 seconds before the rest.

This was not first revealed by the issuers of the consumer confidence survey, or by Thomson-Reuters, but rather by Nanex:

On May 28, 2013, about 1/4 second before the expected release of the Consumer Confidence number, trading exploded in SPY, the e Mini and hundreds of other stocks. Even more interesting, activity exploded just 1 millisecond earlier in the futures (traded in Chicago) than stocks (traded in NYC). The speed of light separates information between Chicago and NYC by at least 4 or 5 milliseconds. Which means this was more likely the result of a timed trading in both futures and stocks, rather than a arbitrage reaction between the two.

We found no other instances of early trading in the 11 previous monthly releases of the same Consumer Confidence data.

Nanex’s data:

screen shot 2013-05-28 at 1.55.25 pm

So, is having a two second jump on the market “insider trading”? Well, yes — but it’s legal insider trading with consent, out in the open. And it likely provides a valuable income stream for the University of Michigan. With or without an early information premium, the algorithmic traders would still have the jump on the wider market. A two second delay in the high-frequency world is an eternity. This kind of early information premium is more like a financial tax on high-frequency traders. If we’re going to have high-frequency trading at all, it may be better for publicly-funded information providers to be able to recoup some or all of their costs by charging the high-frequency traders. In fact, while high-frequency trading continues states might want to look at rolling this out across other datasets, and putting the proceeds toward infrastructure spending or some other public good. After all, while banning high-frequency trading makes for attractive rhetoric, it would probably send an even greater amount of financial activity offshore into a jurisdiction that allowed it. That implies that it would probably be about as effective as prohibiting marijuana and alcohol.

And is this financial markets going post-human? These kinds of barriers to entry cannot be healthy for inclusive, open, transparent markets. If there was anything that might drive retail investors out of the markets — retail investors remain significantly under-invested on where they were before the advent of high-frequency trading, for example — it is massive information asymmetries that render the little guy entirely uncompetitive. Of course, retail investors can still be fundamental value investors, buying and holding. But trying to daytrade against the algorithms seems analogous to a human runner competing against a Ferrari. In fact, given the timeframes (microseconds, in some cases) this analogy is many orders of magnitude too small; it’s closer to a human runner competing against an Alcubierre warp drive. Not so much picking up nickels in front of a steamroller as picking up nickels in front of a Borg cube. If this continues, trading is going post-human.

But in the long run — given how badly traders tend to do against the market — perhaps driving daytraders out of daytrading where they tend to lose money against the market, and into holding diversified index funds is a cloud with a silver lining. Let the robots read the tape (i.e. use regression analyses) and do financial battle. Robots are fast, they don’t get bored or discouraged. Just as in other areas where human endeavour is threatened by robots, it is important to note that while robots can do many things, there are many spheres where humans still have a great advantage. Let humans act in the roles in which they have a natural advantage, and in which robots do not have any skill at all — abstract thought, creativity, social interaction. Robots are still largely confined to drudgery; the word itself is rooted in the Czech word for drudgery, after all. In finance, while robots may some day soon do the overwhelming majority of the trading, humans can still devise the trading strategy, still devise the marketing and sales strategies, and still devise the broader macro strategy.

So perhaps the beginning of the end for human traders is just the end of the beginning for global financial markets. Perhaps that is less of a death sentence, and more of a liberation, allowing talented human labour that in recent years has been channelled into unproductive and obscure projects in big finance to move into more productive domains.

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Explaining Wage Stagnation

Why?

Well, my intuition says one thing — the change in trajectory correlates very precisely with the end of the Bretton Woods system. My intuition says that that event was a seismic shift for wages, for gold, for oil, for trade. The data seems to support that — the end of the Bretton Woods system correlates beautifully to a rise in income inequality, a downward shift in total factor productivity, a huge upward swing in credit creation, the beginning of financialisation, the beginning of a new stage in globalisation, and a myriad of other things.

Some, including Peter Thiel and James Hamilton, have suggested that there is data to suggest that an oil shock may have been the catalyst that put us into a new trajectory.

Oil prices:

And that this spike may be related to a fall in oil prices discoveries:

I certainly think that the drop-off in oil discoveries was a huge psychological factor in the huge oil price spike we saw in 1980. But the reality is that although production did fall, it has recovered:

The point becomes clearer when we take the dollar out of the equation and just look at oil priced in wages:

Oil prices in terms of US wages ended up lower than they had been before the oil shock.

What happened in the late 70s and early 80s was a blip caused by the (very real) drop-off in American reserves, and the (in my view, psychological — considering that global proven oil reserves continue to rise to the present day) drop-off in global production.

But while oil production recovered and prices fell, wages continued to stagnate. This suggests very strongly to me that the long-term issue was not an oil shock, but the fundamental change in the nature of the global trade system and the nature of money that took place in 1971 when Richard Nixon ended Bretton Woods.

UPDATE: Commenters are pointing out that I should probably have concentrated a bit more on the trade and globalisation dimension, which I did mention in passing. However, I see this as an outgrowth of the end Bretton Woods, because it began just after Bretton Woods was ended and there is no way that America could afford to run the kind of trade balance it runs today with the world had America stayed in the Bretton Woods system.

I have covered this issue in quite some depth in the past.

https://azizonomics.com/2012/03/18/global-trade-fragility/
https://azizonomics.com/2012/07/09/the-real-fiscal-cliff/

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Stagnation Nation?

It has long been my view that most of the seeds of the West’s ills were sown in the 1970s: that was the decade when Western consumerism began to be sated by Chinese imports, and Arab oil, and the decade when America cut the link between the dollar and gold sparked the first flames of the great Keynesian debasement bonfire. Richard Nixon and Henry Kissinger were the chief architects, of all three of these innovations, and the internationalisation of the dollar as the global reserve currency.

In the 80’s, the United States’ trade balance flipped over and the U.S. became a net debtor, sending more and more dollars and debt out to the world as the free lunch got bigger and bigger. But something odd happened from the 70s onwards, as demonstrated by our graphic of the day:

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Reindustrialisation

I’ve talked a lot recently about reindustrialisation. Now, I’m fairly certain David Cameron hasn’t been reading what I write. But I’m also fairly certain we have been looking at the same statistics: Manufacturing has shrunk from nearly 40 percent of Britain’s gross domestic product in the late 1950s to not much more than 10 percent now. And while Cameron might not put it this way, that has left Britain as a shrivelled husk of an economy: overly reliant on services, foreign oil, Chinese manufacturing, junk food, corporate handouts, and too-big-to-fail-too-big-not-to-fail financials. So it’s no surprise that Cameron has been talking up manufacturing. From Bloomberg:

Prime Minister David Cameron has latched on to manufacturing as a cure for Britain’s economic hangover and its 7.9 percent jobless rate. U.K. Business Secretary Vince Cable says that for sustainable, long-term growth, “manufacturing is where we need to be.”

“One of the main growth sectors of the economy in recent years has been banking,” Cable said in an interview. “For reasons that are blindingly obvious, that’s not going to be so important in future.”

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