The lighter side of the financial crisis

Although I cannot vouch for its authenticity, there is some grave news coming out of Japan as the repercussions of the US financial crisis hit that country.

In the last 7 hours Origami Bank has folded, Sumo Bank has gone belly up and Bonsai Bank announced plans to cut some of its branches. Yesterday, it was announced that Karaoke Bank is up for sale and will likely go for a song, while today shares in Kamikaze Bank were suspended after they nose-dived. Samurai Bank is soldiering on despite sharp cutbacks, Ninja Bank is reported to have taken a hit, but they remain in the black. Furthermore, 500 staff at Karate Bank got the chop and analysts report that there is something fishy going on at Sushi Bank where it is feared that staff may get a raw deal.

[Update 25/08/2012: This is my own - Sudoku Bank has been unable to make the numbers.]

And in earlier news from Wall St:

Helium was up, feathers were down. Paper was stationary.
Fluorescent tubing was dimmed in light trading.
Knives were up sharply.
Cows steered into a bull market.
Pencils lost a few points.
Hiking equipment was trailing.
Elevators rose, while escalators continued their slow decline.
Weights were up in heavy trading.
Light switches were off.
Mining equipment hit rock bottom.
Diapers remain unchanged.
Shipping lines stayed at an even keel.
The market for raisins dried up.
Coca Cola fizzled.
Caterpillar stock inched up a bit.
Sun peaked at midday.
Balloon prices were inflated.
Scott Tissue touched a new bottom.
And batteries exploded in an attempt to recharge the market.

The Current Financial Crisis - My Biggest Fear

So Congress rejected the bailout plan, the markets reacted by (what else?) crashing, and now the world is waiting with bated breath to see what happens next.

This being an election year when the contest is particularly close, truth can safely be expected to be the first casualty. The name-calling and one-upmanship between the candidates and their parties has already begun.

There is great temptation on the part of everyone involved in the debate to take the path of maximum populist appeal. The unanimously agreed villain of the piece? Deregulation. The solution? Lots of regulation.

Aaarrrrgh!

So now the answer is to control, stifle, smother and shackle the economy so it can't collapse? You poor sods, now you've really done it!

No one can recommend the free market in the current climate without being booed, it appears. The free market (taken in the sense of an unregulated market) has now been blamed for all the world's ills. Yes, the lack of controls has been a major culprit, but it wouldn't have been such a killer if the market had been truly competitive. The collapse of a few players wouldn't have developed into the market-threatening crisis that it has now become.

In the process of blaming the free market, I fear we may be walking away from the one thing that can get us out (and forever keep us out) of this kind of mess - a free market! And my regular readers know that when I say "free market", I mean a liquid market. A market with plenty of competition. Because freedom for me does not carry the petty meaning of a freedom without restrictions. It means a freedom that cannot be taken away. Only liquidity (the inability of any single player or small group of them to influence the rest of the market) can protect the freedom of all players in the market. To enjoy freedom, we need to (paradoxically) accept the constraints demanded by freedom, i.e., the guaranteed powerlessness to unduly influence others.

I think we should start using the phrase "liquid market" or "competitive market" instead of "free market" from now on. The term "free market" has been tainted, ironically because the financial markets weren't really free but highly illiquid and oligopolistic with a few very large and powerful players who operated without the checks on their behaviour that a competitive environment would have naturally provided. It's no use trying to educate people about what the term "free market" should really mean. In the aftermath of a systemic collapse, no one wants to hear what would appear to be hair-splitting or intellectual sophistry. People cannot now be convinced that a free market is the solution we need and not the problem.

I think we need to start characterising the problems of the last few years as an "oligopoly", an "illiquid market" or as "cronyism". Any and all of these terms would be an accurate description. And we should then point to "liquid markets", "competition", "transparency" and "accountability" as the answers, rather than "regulation".

Competition provides most of the regulation we really need. All we need to do is ensure that our markets stay competitive.

Regulation by government bodies is important and has its place, but knee-jerk legislation mandating more regulation will exacerbate the problem. Complexity hinders transparency.

Will the wisdom of crowds see through the current round of election-sozzled name-calling and understand what the economy really needs?

I'm hopeful, but not optimistic.

My Economic Philosophy - 8 (Beyond Socialism and Capitalism)

(This is the eighth of n pieces on my emerging economic philosophy called Liquidism.)

I came across this hilarious illustration today:

While funny, it's also sad that both systems have come to represent a zero-sum game in the eyes of many people, a belief that one person's gain must always result in another person's loss. I don't believe this is true. I believe that wealth is potentially infinite, and human civilisation is constantly improving the incentive systems that cause us to apply our ingenuity and industry to increase our collective wealth, with everybody being better off as a result. I believe in the capitalist ideal based on competition and liquid markets (not the cronyism and oligopolistic markets that pass for capitalism nowadays). At the risk of appearing trite, I can sum up my economic philosophy with another illustration:

It could be argued that what I call Liquidism is just "capitalism done right", but it does involve some non-intuitive aspects. I arrived at this economic philosophy in stages, and it's the fortuitous result of many coincidental experiences in my life.

My journey began when I realised that "freedom" could mean two very different things, and that one kind of freedom is higher than the other. A freedom that cannot be taken away is superior to a freedom without restrictions. I thank the Free Software / Open Source software communities for sensitising me to this difference.

Then I discovered the beauty of Ayn Rand's philosophy (and its limitations). Ayn Rand opened my eyes to the fact that capitalism was not just an economic system but a political philosophy grounded in the notion of individual freedom. The economic aspects of capitalism flow out of the political philosophy.

With that insight, I tried to derive (from first principles) an economic system from a philosophy of freedom, but using the higher of the two kinds of freedom I talked about earlier. In essence, I was trying to redefine a "free market". In the process, I realised that a truly free market had to be a guaranteeably liquid market, not a market without controls. That meant that there was a legitimate role for government (in the absence of any self-correcting behaviour on the part of the market) to step in and enforce liquidity whenever required. In other words, antitrust is not an enemy of the capitalist system (as libertarians make it out to be), but its saviour. That's where Ayn Rand is wrong.

From there, it was only a short step to realising that Liquidism is the next logical step in prudent economic policy, taking the "Australian model" of prudent fiscal policy (avoiding budget deficits) and prudent monetary policy (keeping inflation low through alert interest rate manipulation) to its natural conclusion by ensuring high market liquidity as well. I have been privileged to be part of the Australian economy for over a decade now, and I marvel at the simple yet effective way in which the Australian government and central bank have together kept the economy consistently booming in the face of worldwide boom-bust cycles. The Australian model has many aspects of a welfare state, but that welfare state operates within the discipline of a balanced budget. Australia has shown the world how to reconcile capitalism and socialism. However, many segments of even the advanced Australian economy are held to ransom by oligopolies.

It's unfortunate that nowhere on earth can an example be found of the perfect economic system. Worse, very few people have shown an interest in getting there. Until now.

I have finally seen the vindication of my philosophy in the market failures of 2008, and I realised (as did an eminent economist and old classmate of mine), that capitalism has to be saved from the capitalists. In a truly liquid market, the effect of a single player (or even a few players) has no perceptible impact on the market as a whole, so bailouts using taxpayers' money are never required. But in our imperfect world, large players always act to preserve their oligopoly, by making it harder for themselves to fail (governments are forced to prop them up using taxpayer's money in the larger interests of market stability, making a mockery of the free market in the process) and by erecting scale barriers to newer entrants. I'm sure the downsides of having extremely large players in the market has become apparent to others as well. We just need to join the dots and go where the logic leads us, i.e., to a guaranteeably liquid market, where no player can ever become large enough to unduly influence the market.

However, entrusting the role of market "liquefier" to governments is fraught with danger. Governments are corruptible, as we all know. The timidity of competition watchdogs in our economies is testament to the power of incumbent market players to protect their interests. Governments and legislative bodies are influenced more by market incumbents than by companies yet to be formed. Therefore, liquidity-seeking behaviour needs to be driven into the DNA of the basic unit of capitalism itself - the corporation. Corporations need to have an "amoeba gene" that causes them to grow and split ad infinitum, rather than grow and merge. This is the only way that the market can inherently (i.e., without external intervention) be prevented from consolidating into an oligopoly or monopoly. Such a solution would satisfy Ayn Rand as well. In this context, it must be pointed out that divestitures do not reduce shareholder wealth. On the contrary, new wealth can be released when diseconomies of scale are eliminated and competitive energies are unleashed. The few examples we have of corporate breakups (such as AT&T in 1984) bear out this optimism.

I think it's time the world innovated a new kind of corporation that contributes to market liquidity instead of opposing it. This may need to be defined and enshrined in law, just as the notions of "joint stock company" and "limited liability" were previously formalised through acts of legislative bodies. The capitalist system can then be relied on to generate wealth in a sustainable way, without needing constant government oversight and intervention, and without suffering the periodic system-wide collapses it is prone to in its current suboptimal form.

My concept of Liquidism has been a gradual awakening rather than an epiphany. I still read semi-informed (yet heated) debates in many forums about the merits of different ideologies and varied reasons for our recent financial crises. Although I don't want to sound overconfident, I'm increasingly convinced that I have found the answer to these questions. I think Liquidism is the key to future financial stability and world prosperity.

Three Palindromes and a Spoonerism

We've all heard palindromes that make no sense, such as

Mad Zeus, no live Devil, lived evil on Suez dam.

HUH?

I much prefer palindromes that make sense in a plausible context, not contrived ones like "Step on no pets" or "Draw pupil's lip upward".

My favourite ones are these three:

An ad for Toyota:

A Toyota. Race fast, safe car. A Toyota.

A sports-hater's plaintive plea to be left alone:

Golf? No Sir, prefer prison flog!

(I can identify with that!)

An anti-smoking slogan:

Cigar? Toss it in a can. It is so tragic.

And a good spoonerism I read yesterday in MX fits in neatly with the story of the Knave of Hearts:

The Queen of Hearts, she made some tarts,
All on a summer day:
The Knave of Hearts, he stole those tarts,
And took them quite away!

Q: How did the knave respond when questioned about the lack of pies?
A: With a pack of lies.

My Economic Philosophy - 7 (The Place of a Welfare State in a Capitalist Economy)

(This is the seventh of n pieces on my emerging economic philosophy called Liquidism.)

The Welfare State has always been synonymous with Socialism and generally viewed as incompatible with Capitalism. This belief has polarised opinion along rather simplistic lines, between those who favour government support for the needy, and those who believe that all economic decisions should be made by "market forces" (a term that implicitly excludes the government). And then there are the pragmatists who believe in a mixture of the two, unencumbered by any ideology.

I have evolved a different view, and my philosophy not only provides an ideological basis for the pragmatic approach but also lays down clear guidelines for how big the Welfare State can be.

I have written about what is known as the "Australian model". From a social perspective, the Australian model is a wonder of the modern age because it manages to reconcile a capitalist economy with elements of a Welfare State, such as state-subsidised healthcare and social security. From a purely economic perspective too, the Australian model is a wonder because it has managed to deliver 17 straight years of growth while the rest of the world reconciled itself to the "inevitability" of periodic recessions.

What's the secret?

The economic model is no big secret. It lies in responsible government spending that yields a (growing) budget surplus and thereby refrains from provoking the inflation that unfailingly follows deficit financing. As a bonus, the budget surplus delivers flexibility in investing for the future (the Future Fund) and acts as a cushion against economic shocks. The secret also lies in an alert central bank that promptly raises interest rates as inflation rises and lowers them when the economy slows. These two levers of the economy, when prudently applied, maintain conditions of low inflation, low unemployment and uninterrupted growth.

Of course, the Australian economy could do with even greater efficiency, and this can only occur when the oligopolies in its various markets are broken, but that is not the topic of this post.

Returning to the social perspective, how does Australia manage to be a successful capitalist economy while also supporting aspects of a Welfare State? Even if it works (as it clearly does), isn't there at least a theoretical contradiction between the two?

My answer is no, there's no contradiction, because the perceived dichotomy between a Welfare State and a capitalist economy is false.

It leads back to the fundamental definition of "freedom". If freedom is taken to mean the untrammelled freedom of individuals to act, only constrained by the rights of other individuals and with no "controls" by external authorities, then every act of government (as a player in the market) is seen as a violation of freedom. The model of a "free market" by this definition of freedom is a laissez-faire system where government does not interfere with the functioning of the market, either as a regulator or as a bulk consumer.

If, however, freedom is seen as something that must be guaranteed never to be taken away, then some controls are inevitable. The model of a "free market" by this definition of freedom is a liquid market with a large number of buyers and sellers, where no single buyer or seller (or a small group of them) can significantly influence prices or the stability of the market as a whole. Actions by government violate no principles as long as the market stays liquid.

And this explains the seeming paradox of a Welfare State within a capitalist society. By itself, government action in a market is neither good nor evil. The crucial question is whether such action breaks one of what I would call the three pillars of the economy (a balanced budget, the right level of money supply and healthy levels of competition in the market).

The Welfare State is an example of government spending. Is this a legitimate activity in a market economy? In a democracy, government is an agent of the people in a legal sense, and so government spending on behalf of the people is really no different from individuals spending their own money. The various mechanisms of democracy ensure that the agency of government spends the money of its principal (the people) in a way that serves the interests of the principal. I believe that government spending in a functioning democracy is legitimate, as long as it does not lead to a budget deficit.

(One could argue that government spending that leads to a deficit budget is also legitimate because in a democracy, it reflects the will of the people. I disagree, because deficit budgets in effect borrow from the future. They are inflationary, and they rob our descendents of wealth. Our children, grandchildren and unborn descendants do not have a vote, even in a democracy. We have no right to rob them of their wealth without their consent. And so government spending has legitimacy only as long as the budget stays balanced.)

The constant demand by "free-market" advocates to privatise social security seems pointless to me. I can't see any economic reasoning behind it, merely an ideological one stemming from the dubious definition of freedom as an absence of external controls.

So how large should the Welfare State be? As large as the budget allows. The government is a consumer on behalf of the people, and like any consumer, should live within its means. "Free-market" advocates tend to criticise "big government", but to my mind, the problem is not "big government" but "irresponsible government". I say, if the government has the revenue to sustain a large Welfare State without running into deficit, then go for your life! There are no absolute limits (in dollar terms) to the size of a Welfare State. The only limit is the size of the budget.

So in my opinion, there is no contradiction between a capitalist economy and a Welfare State. Those who start off with an inferior definition of freedom ("no controls on individual freedom") exhibit a knee-jerk opposition to any action by government, which seems a bit silly to me. To those who define freedom as something that cannot be taken away, it is obvious that there are clear-cut principles that determine what governments can and cannot do. As long as the Welfare State abides by those principles, its proponents need not be apologetic or defensive about its existence.

We can have our cake and eat it too.

US bailout bad, Australian bailout good

I've been a vocal critic of the Fed's bailout of Bear Stearns, Fannie Mae, Freddie Mac and Lehmann Bros. And so I should be expected to similarly disapprove of the Australian government's recent bailout of players in the non-bank lending market.

Ah, but there is a difference. More than one difference, as a matter of fact.

The US bailout was primarily aimed at preventing a market collapse, which is a symptom of a larger problem - a highly illiquid, oligopolistic market. The Australian bailout of second-tier lenders, in contrast, is aimed at preventing the collapse of competition in the market. There is no fear of a market collapse in Australia. There has just been a tightening of credit, which hurts smaller players more than it does the larger ones.

The US bailout shores up market leaders in an oligopolistic market. The Australian bailout shores up second-tier players in a market that threatens to become oligopolistic if they go under.

The US bailout props up entire companies, regardless of their dodgy asset base. The sub-par quality of these assets stems from the subprime crisis that originated in that country. The Australian bailout is more discriminating. The government is making $4 billion available to buy up not dodgy securities but AAA-rated (secured) mortgages from second-tier lenders. These assets are Australia-based with no links to the US subprime market.

The US bailout deepens the government's budget deficit. The Australian bailout still leaves the budget in surplus.

The US has lost the plot where competition is concerned. Their "free market" is about as free as Sukarno's "guided democracy" was a democracy. In contrast, it appears that the adults are still in charge of Australia.

So there is a world of difference between the US model of capitalism and the Australian one after all, and I'm not just waving the Australian flag because I'm a citizen. The leaders Down Under just seem to have a fundamentally more sensible approach to the economy than those at the helm of "the greatest country in the world" - keep markets competitive, don't run up budget deficits, invest taxpayers' money in sound assets.

Labor keeps my vote.

Two Quotes from Henry Ford (or When to Second-Guess the Customer)

Henry Ford's most famous quote is probably this:

"They can have it in any color as long as it is black."

But Ford is also known to have said this:

"If I'd asked my customers what they wanted, they'd all have said they wanted a faster horse."

I think he was right on the money with the latter statement, but the former was just arrogance.

Ford lost out to General Motors mainly because of his failure to meet the legitimate demands of the market. In 1921, Ford had 60% of the market for new car sales. But Ford doggedly insisted on selling a single model (the Model T), while GM began to offer a full line (Cadillacs, Chevrolets and Buicks) at different price points. Obviously customers preferred GM.

The lesson this holds for me is, you can ignore your customers' demands as long as you give them something even better (a car instead of a faster horse). If you merely ignore their demands, you do so at your peril.

I've seen a lot of timidity in the area of software design, where software makers go to great lengths to ensure a good "user experience". They do this by running focus groups and testing various user interfaces to see which ones users like best. This is a valuable approach, but it virtually rules out developing bold and innovative products that create new markets.

After all, no computer user could have asked for the mouse in an age when the only interface to computers was a keyboard. The invention of the mouse surely required a leap of imagination, and its inclusion with the first mass-market computers must have taken prodigious courage on the part of their makers, because every user has struggled to master its use on their first encounter with it. Yet the mouse is nothing less than a marvel of user interface engineering.

The lesson here is that intuitiveness is a function of learning. What seems unfriendly and unusable initially becomes indispensable over time.

We must be bold enough to look beyond customers' stated wants and their current mindsets and instead visualise what can be. Entrepreneurs owe their success not only to their responsiveness to customers' needs but also to their vision of a future that may not exist at the time.