Friday, July 1, 2016

Capital Flow Only for the Sake of More Capital Flow

This post concerns an article in Nautilus by Bob Henderson about the intricacies of, and dangers inherent in, the networks that handle Credit Default Swaps; something that involves already confusing layers of abstraction in CDS instruments, with even more confusing considerations of how the way the parties involved in these interactions are actually linked with each other; referred to as network topologies. The design of such interactive systems is important because not only can there be significant inefficiencies, but also because bad design can make the system as a whole a great deal more subject to catastrophic failure.

This sort of thing is even more important (with a capital I) because of the unbelievable amounts of capital that are now wrapped up in CDS instruments; as in about $493 Trillion. Whereas total global GDP for 2015 was only $77.9 Trillion.

The issues that Mr. Henderson brings up here are interesting, as well as more than little difficult to follow, because they do point to the complexities of this process, even with new arrangements with "hub and spoke" designs to limit the risk of failures. All of that, however, is not what really concerns me. No... What really gets me shaking my head is why so little discussion is proffered on why such transactions are allowed in the first place.

Money chasing money via various forms of speculation is hardly new of course. Certainly currency speculation has been around for a long time. And then you have futures trading on stocks, which themselves, once money as been received by the issuing institution, are just abstractions of ownership where, unless dividends are issued more than rarely, are also instruments that exist to be speculated on (where the ongoing profits thereof benefit only the speculators directly).

With Credit Default Swaps, however, we have entered a whole new realm of abstracted profit generation, and to appreciate that you have to take a step back and remember how Capitalism first justified itself.

Initially, people who had accumulated capital accepted the risk of putting some portion of it into an entity that would either provide a service, or create a product that the rest of us could purchase; and to to complete the virtuous circle, people were employed in making that service, or product happen, thus providing the spending power to keep the whole thing going.

More and more, however, holders of capital want to lessen risk, and in an ever more competitive, not to mention more volatile financial world, risk becomes a great deal more complicated to assess. As Kevin Phillips has written in "Wealth and Democracy" there has always been an historical tendency of great economic powers to eventually fall into the trap where established wealth no longer desires the taking on of risk with actual productive ventures, and instead turn to paper instruments with which to support itself with. With the advent of electrified experience retrieval, however, and the technological change that has been a part of that, "disruption," as well as uncertainty, are a way of life now far more than they ever were in the past.

Even more confounding, though, is the fact that, through both the insane avoidance of all costs possible, as well as ever increasing automation related to that, a viable middle class is disappearing; providing fewer and fewer consumers able to buy any part of the ever increasing capability to produce that global Capitalism has created now.  Which, of course, adds more instability and uncertainty so why wouldn't a holder of Capital turn to abstracted instruments that don't actually produce anything? And also want to take out insurance policies on those instruments so as to make sure their ass is covered not matter what (supposedly).

And thus do we have the makings of a not so virtuous circle where the only thing that keeps increasing is the counters profiting from the movement of debt instruments from one holder to another, and the fail safe, side bets placed just to make sure. If that isn't insanity for the rest of us I certainly don't know what is.

Can Topology Prevent Another Financial Crash?

New regulations are applying network science to restructure global finance.