The Cultural Theory of Risk

Financial bubbles and crashes are a form of collective madness: a catataxic moment when suddenly more of the same is different. Perhaps you think there is no more to be said about financial crisis? You might be right from about economists, who failed to see it coming anyway but the most interesting analysis on financial crises, risk and blame, comes from cultural anthropologists.

Though Mary Douglas first developed this framework in a different context, it seems to add much more insight than standard economic models. Douglas suggested we could view societies (all societies) within a framework of four different groups within a society, all acting rationally and consistently from their own perspective.

These groups are: i) self seeking individualists, ii) fatalists, iii) hierarchical bureaucrats and iv) egalitarians. Crises happen when one of these groups becomes too powerful and too popular, which of itself creates instability.

The anthropologists have gone further and use the mathematics of biological ecosystems to model this instability. In the early 20th century, a Ukrainian chemist, Alfred Lotka, and an Italian mathematician, Vito Volterra, built a famous model to describe the volatility created by interactions between predator and prey. Imagine an island populated by foxes and rabbits, as the rabbit population grows, the foxes eat more rabbits: the fox population increases and the rabbit population falls. Yet the growth in fox population means that there is less food available per fox, while surviving rabbits have more food available. The system never settles down, but swings back and forth in favour of foxes, then in favour of rabbits. The ups and downs do not come from an outside source, they are built into the very structure of rabbit and fox populations on the island.

For a while the anthropologists experimented with the two agent version of Lotka-Volterra, but in the end found that their four agents of i) self seeking individualists, ii) fatalists, iii) hierarchical bureaucrats and iv) egalitarians was a more useful framework.

What does this mean for protections ourselves from future crises? Perhaps instead of trying to maintain stability as a goal “no more boom and bust!” we should accept that instability and volatility are the natural state of societies. And instead of looking for specific causes such as “bad lending decisions” or “greedy bankers” which economists, regulators and journalists can only see with the benefit of hindsight; we should instead look for warning signs when one group’s narrative becomes too widespread. And so, despite the financial crisis, perhaps the views of economists are still too popular.


This is a guest post by my good friend Bruce Packard

The tragedy of the commons

grazing cows and the tragedy of the commons“Don’t worry darling, there are plenty more fish in the sea ” said my mother as she comforted me after my girlfriend dumped me in 1983. It was little solace to my heartbreak then: a platitude worn thin by careless usage. It is even less use today, because it is no longer true. Sorry Mum. There aren’t plenty more fish in the sea.

Cefas, the government fisheries laboratory, has announced that  there are only one hundred adult cod left in the North Sea according to their estimates. Yes, that’s right only a hundred. Mature cod can live for up to 25 years and reach lengths of 6 foot. In 2011, a North Sea survey of catches showed not a single fish that was older than 13 years. Cod become more fertile as they get older. Most cod are caught when they have barely reached sexual maturity, on average when they are 4 years old. If there are no older fish, there are no eggs and larvae to perpetuate future generations. In the early 1970s, trawlers were catching 360,000 tons of cod a year in the North Sea. This year the catch is only 32,000, less than one tenth of the previous level but still 50% higher than the sustainable limit according to Cefas.

What makes this even sadder is that it is not a new story. It has happen before. In 1992, the Canadian Government finally banned all cod fishing in the Grand Banks following the complete collapse of the fish stocks. In Newfoundland, 35,000 fishermen became unemployed overnight, devastating the local economy and ending a traditional industry with a 500 year pedigree. The fishing moratorium was intended to last only 2 years to let the fish stocks recover. Sadly, this did not happen. It is only now, 20 years later, that cod stocks are recovering again but they are still at only 10% of previous levels. So the current collapse of the North Sea cod fishery is merely repeating a journey down a well worn tragic path*.

The crisis of the cod fisheries in both Newfoundland and now the North Sea were well flagged many years in advance. So the real question is  “Why didn’t someone do something about it before it was too late?” The short answer is that they couldn’t. The collapse in fish stocks had a ghastly inevitability; a high-sided luge track leading to disaster.  This phenomenon is known as the tragedy of the commons. Individuals acting in self interest deplete a common resource, even though it is in no one’s long term interest for this to happen. It was first observed by Thucydides and Aristotle, then resurfaced in the arguments over the British Enclosure Acts in the 18th Century but was most precisely defined in economic terms in a paper by the ecologist Garrett Hardin in 1968. It is also an excellent example of the reversal of virtue at a catataxic boundary.

In the tragedy of the commons, the word “tragedy” does not imply unhappiness and sorrow but rather the inevitableness of destiny, a remorseless working of logic to its inescapable conclusion. The logic working here is the economic concept of marginal utility. Picture an area of common ground – maybe a village green. Local cattle herdsmen have the right to graze their animals there. Gradually the number of cattle increase until the size of the herd is greater than the amount the grazing land can support. This is the catataxic boundary. The time when more of the same becomes different. Each individual herdsman is faced with a choice: should he put more cows on the pasture or fewer?  At this point the marginal utility equation comes into effect. He gains all the benefits of putting his extra cow on the common, but the negative effects are shared amongst all. He owns the cow but he does not own the commons. So the marginal utility to him as an individual is an overall positive: he gets all the upside, others share the downside. Therefore the logical course is for him is to keep putting more cows on the pasture until it is destroyed.

There are many examples of the tragedy of the commons and it is central to many of the problems of the modern world. Traffic congestion, email spam, the destruction of the rain forest, water shortages, pollution, global warming and overfishing all examples of the abuse of the commons. In each case, a slight gain to a self-interested individual results in a major detrimental effect to the larger community. So, for example, the new car owner gains some mobility but causes traffic congestion for everyone else. The online marketer gets a tiny positive hit rate as he clogs up the internet with spam. A farmer’s borehole to irrigate his parched crops lowers the water table for everyone else. Likewise,illegal logging, factory fishing fleets and toxic waste from chemical plants destroy the environment for every one else.

So what is the solution? In 18th century England the answer was obvious. Put the commons into private ownership. If the same man owns both the cow and the land, there is an economic incentive for effective stewardship. He owns all the upside and all the downside and so will manage both to positive effect. This was the argument behind the hugely unpopular “Inclosure Acts”: acts of parliament that allowed large landowners to expropriate  common land, turfing off peasant farmers and enriching themselves in the process. The Highlands of Scotland were cleared of crofters who then emigrated to the USA and in turn expropriated land from the native indians through similar trickery with title deeds. In England, a landless working class was created to feed the newly emerging “dark satanic mills” depicted in Danny Boyle’s Olympic opening ceremony. Karl Marx, living in London and watching from the sidelines, saw this as the first act in the class struggle that would eventually lead to the triumph of the proletariat. He outlined a different solution to the tragedy of the commons. He believed that the commons should be owned by the state not private individuals; hence, communism.

Since then, more nuanced solutions have emerged. Elinor Ostrom, who sadly died this June, won the Nobel Prize for Economics in 2009 for her work on the tragedy of the commons problem. Her solution was neither private nor state ownership, but local, communal ownership. She call such a solution “common pool resource” (CPR) management.  After years studying pasture management systems in villages in Africa and Nepal, she codified a set of rules which would enable common resources to be exploited in a sustainable way. In essence, these involve clear cut boundaries between entitled locals and outsiders and a strong set of property rights and sanctions administered in a self determined way by the local community. To some, this CPR solution is the holy grail: a temperate middle path between the twin evils of rapacious capitalism and spirit-crushing communism. But others will notice that this solution the problem requires the introduction of a different type of evil: xenophobia.

CPR requires a clear division between locals who have ownership rights and outsiders who don’t. There needs to be a line drawn between “us” and “them”. Through rose tinted spectacles, CPR is the idealised English village community; good neighbours, earnest vicars, friendly grocers, church fetes, a good local school and a cracking village pub. Take off those spectacles and you see small mindedness, nimby attitudes, petty chauvinism, corrupt local councillors, disapproving frowns from behind twitching lace curtain and the all the ghastly wrangling of the local housing committee.

Any system that encourages the demonisation of outsiders and foreigners is surely to be deplored. One headline in the weekend press was more tragic than the story about disappearing cod. It was the killing of the US Ambassador in Libya. J.Christopher Stevens was  a Peace Corps veteran, fluent in arabic with a deep knowledge of the Middle East; surely just the type of of ambassador Libya should welcome. He was killed by militant Islamists enraged by an offensive movie put on YouTube by a US citizen on the West Coast. It seems so unfair that a sympathetic arabist in Libya should be killed in retaliation for the actions of a crazed bigot in California, but to a xenophobe all foreigners are the same.

So the tragedy of the commons has three solutions, all with potentially negative side effects. Is there nothing positive to be said? Yes, there is. Let’s look at the mirror image of the tragedy which we could term the “comedy” of the commons or the “inverse commons”. This is where a small negative to an individual results in a major positive benefit to the community. Those who believe in the economic utility function would classify this self-harming, altruistic behaviour as impossible. But not only does it exist, it is the basis of a lot of successful business models in the new information economy.  The best example is Wikipedia where individuals contribute their knowledge for free for the good of the greater community. The “inverse commons” concept is also at the heart of the “facebook” social networking revolution and open source software movement.

On a lighter note, even cod shortage may have a silver lining. Fewer cod has meant a boom in the population of the crustacea that the cod feed on. It looks like you will be swapping your “cod and chips” for “scampi and chips” in the future…

* For those who are interested in further reading on the subject, I highly recommend Cod by Mark Kurlansky (Vintage, 1999) and The End of The Line by Charles Clover (Ebury Press, 2004).

The hour between dog and wolf

There is an old French aphorism that calls sundown ‘the hour between dog and wolf’.  At dusk,  the familiar domestic pet turns into a rabid hunter.  Dusk is the hour of metamorphosis. This is how Jean Genet puts it in his 1986 memoir “The Prisoner of Love” (Un Captif  Amoureux):

[The hour] between dog and wolf, that is, dusk, when the two cannot be distinguished from each other, suggests a lot of other things besides the time of day … the hour in which … every being becomes his own shadow, and thus something other than himself. The hour of metamorphoses, when the people half hope, half fear that a dog will become a wolf. The hour that comes to us from at least as far back as the Middle Ages, when country people believed that the transformation might happen at any moment.

I spent last weekend at the Hop Farm festival, a three day mini-Glastonbury in Kent. Since it is British Sumer Time, the sun does not go down until 9.30pm so the headline acts are hitting the stage at dusk. We had two grand old men of rock: Peter Gabriel on Friday and Bob Dylan on Saturday. Both of them underwent a metamorphosis at dusk, since neither were presenting their seminal rock tunes in their original form. In both cases, their back catalogue had been radically transformed to such an extent that it was almost unrecognisable.

Dylan first. Listening to his incomprehensible growling and barking interspersed with the occasional yelp,  it was definitely a lupine transformation but I could not tell if it was a dog or a wolf. It was more like a metamorphosis frozen between the two, like a ghastly science experiment gone wrong or the dog monster from John Carpenters The Thing. The creature was clearly in excruciating pain judging from its piteous yowling, as was the audience that had to listen to it. More puzzling was the fact that the big video screens to the side of the stage were stuck on a single long shot showing a tiny figure in a white hat – exactly like the view from where I was standing – which made the whole thing utterly pointless. Technology negated by a man so vain that he had banned all close ups of his 71 year old face.

When he came on he was greeted with a huge cheer befitting his iconic status, but by the fourth song half the audience had drifted away to the other stages (Primal Scream, Gary Numan, New Order). This left a hard core knot of Dylan Fans in the gathering gloom exchanging quizzical glances as they tried to work out what song His Bobness was actually singing – sometimes it took until the second chorus to work it out.

Was I disappointed ? No. I last saw Dylan live 25 years ago when things were pretty much the same but just with a faster tempo. He has been on a never ending tour ever since. There is a PE ratio for live shows. Not the Price/Earnings ration beloved of financial analysts, but a Performance to Expectations ratio. Seasoned concert goers know that that Dylan is always the lowest ranked on this basis (followed by Van Morrison in a close second). The greatness of his artistic halo is repeatedly shattered by the awfulness of his live show.  The concert promoters had crowed in the advance publicity that this was to be Dylan’s “only UK Show in 2012”. Now we know why…

Peter Gabriel, in contrast, was terrific. His metamorphosis was triggered by setting himself an artistic constraint: no drums or guitars. So his rock oeuvre had to be completely reinterpreted for an orchestra to play…with spectacular results. The audience was still playing a game of  “guess the song” but in a good way.  The orchestral versions of his songs brought new resonance and meaning to his work. It is good example of how an artist can take a risk and and reach new heights.

The interesting point is how self-imposed restraint promotes artistic excellence.  Rhyming poetry has more artistic merit than blank verse, and blank verse more so than prose.  Art house movies often use black and white rather than colour. Peter Gabriel’s ‘no drums or guitars’ restriction was in a similar vein. But the best example of “high art through restraint” is calligraphy. Picture the master calligrapher standing in front of a blank sheet of paper with his inked up brush in his hand. The ink is black – no colour is allowed. The character he must paint is pre-defined. Even the very order in which he makes the strokes is set by centuries of historical convention. Yet despite, or maybe because, of all these constraints he produces something of such transcendent beauty that it is seen as the ultimate art form by more than half the world: the true mark of a civilised man.  Artistic endeavour must be honest; a truthful expression of inner conviction. This is pithily summed up in this maxim:  Lies cripple the artist. To this we can add another: a strait jacket sets him free.

Excellence through restraint was also very much on show in the movie I saw as I was recovering from the festival weekend. This was X Men – First Class. The restraint in this case being that there are pre-formed familiar characters – a lot of them – all of which have to be woven into the story.  This summer’s blockbuster Avengers Assemble, which I also enjoyed, carries a similar burden with four strong hero characters (Hulk, Captain America, Thor and Iron Man) all having to be fitted into a single movie. With X-Men – First Class we also know where we have to end up because this is a prequel. So unlike a typical story, we already know the ending and the character ‘development’ is similarly constrained. The fun and skill comes in delivering us (the audience) to that pre-agreed destination through the most enjoyable route. This is the storytelling equivalent to a third option on your satnav that lets you chose not the fastest, nor the shortest route but the most scenic.

The dilemma at the heart of the X Men movies is this: is being a mutant a disease from which you should be cured ? Or is it a beauteous and natural thing that should be celebrated. Should Wolverine be transmuted back into a domestic pet? In the movie the answer is no. So the series can be read as a thinly veiled critique of right wingers who believe that being ‘gay’ or ‘different’ is something that can be cured.

This month also sees the publication of a new book entitled “The Hour Between Dog and Wolf: Risk-taking, Gut Feelings and the Biology of Boom and Bust” by John Coates, a successful Wall Street Trader turned Cambridge neuroscientist. Coates took saliva swabs from 250 traders on the dealing room floor over a two week period. He then plotted testosterone levels against risk taking and trading performance. Those with higher testosterone levels took bigger bets, greater risks and subsequently made the most money.

In the book,  John Coates seeks to explain “irrational exuberance” of the markets through blood biochemistry – testosterone and other hormones coursing through the veins of amped up traders in the dealing room causes them to be overconfident, take unnecessary, irrational risks and so cause financial bubbles. Having found a ‘reductionist’ explanation for financial excess, maybe it can now be ‘cured’ ?

In my view, the error underlying this blood chemistry approach is the idea that financial bubbles are a mistake – something that needs to be eliminated or cured. The X men movies make the same point. Bubbles are not a mistake, they are a naturally occurring phenomenon, part of the fabric of nature. Their existence is not a sign that something has “gone wrong” but that everything is working fine. They may be inconvenient and cause financial damage but this is to misapply a human concern to an entity on a higher level. It’s the same type of error as calling the law of gravity “immoral”

King Canute ordered his throne to be carried in to the shallows of a rising tide. The reason normally ascribed is that he believed he could command the waves. In fact, his intention was to mock his courtiers and to demonstrate he was not all powerful: he could not control the waves. The tides follow their own cycles, dictated by celestial bodies in a higher dimension beyond the control of man. Likewise financial cycles, belong at a higher level.

Set up three levels: blood chemistry, trader, market. We can join the dots with two causal arrows pointing upwards crossing the catataxic boundaries like this: blood chemistry controls the trader, the trader controls the market. Our we could reverse them and have the causal arrows pointing downwards. If we want to control the market (eliminate financial bubbles and crashes) we must control the trader and to control the trader we must control the hormones. This leads to some rather farcical conclusions. This reductionist argument is really a reductio ad absurdum. Maybe the FSA should prescribe testosterone suppressant drugs in order to eliminate boom and bust? Or maybe firms should only employ women on the dealing floor?

Just as it is wrong to view the trader as purely a product of raging hormones  (drunk driving excuse- the booze made me do it). So it is wrong to see the market as purely an amalgam of traders. To do so is to make a catataxic error. Each entity belongs on its own level with its own rules. The point is that you can not control the market. King Canute knew that a thousand years ago. Some of us are still struggling to understand that now.

Death’s upside: the diamond skull

This morning is the first day back at work after the Easter break. Having overindulged on chocolate eggs on the weekend, I decide to get some exercise and walk to my Mayfair office from London Bridge station. As a result, I happen to be passing the Tate Modern as they open and pop in to see the Damian Hirst show on impulse. There is a huge queue for tickets but no queue or tickets required to see the ‘diamond skull’. The whole of the huge turbine hall is given over for the display of this one tiny piece.

But what an astonishing piece. Inside a small completely dark room the platinum skull, studded with diamonds, is the only thing visible. It is brilliantly lit and walking around it you see the scintillating, inner fire of all those diamonds shimmering at you. The effect is quite breathtaking. It is much smaller than I imagined and I was surprised by the strength of my emotional response. In the darkness, you feel torn between a push-back of revulsion and the tug of desire. The middle aged matrons next to me are completely hypnotised by it: rabbits in front of a snake. The only time I have felt a similar feeling is when my aunt took me to see Tutankamun’s golden death mask in the exhibition at the British Museum in 1972.

Both objects seem to be saying the same thing. Exquisitely crafted from priceless materials, they are simultaneously a celebration of death and a bid for immortality. In Hirst’s case there is another angle: the obsession of the art world with money.  The value of the diamonds is reputedly £14m and the asking price when it was displayed at the White Cube gallery was £50m. There is still some confusion about whether it was actually “sold” and it is apparently owned today by an anonymous consortium which includes Hirst himself. So there is catataxic debate about whether the whole is worth more than the sum of its parts. How much value has the artist added? If you were to sell it today in the open market would it be worth more than the value of the diamonds that make it up?

I don’t want to go too far down that path because there is a different catataxic angle that I want to explore. In the train this morning, I read two articles in the newspaper, both of which are obliquely connected to the diamond skull. The first was a warning by the Financial Services Authority (FSA) that thousands of Britons face a “mortgage time bomb”. The second was about Shandong Helon, a Chinese chemical company teetering on the edge of bankruptcy.

Let’s look at the mortgage time bomb first. Banks in the UK have been transferring customers over to “interest only” mortgages and these now make up 35% of the market. Many homeowners have been struggling to meet payments on traditional mortgages. Rather than calling in the loans, the banks have rescheduled them and switched their customers over to “interest only” products where the monthly payments are much less. A £200,000 mortgage would typically cost £1,000 a month if it was a traditional product but only £600 a month if it was “interest only”. They are cheaper because, as the name suggests, you are only repaying the interest and not the capital sum. The problem is that your debt is not reducing, so at the end of the mortgage period you are faced with a huge bill: the whole value of the amount you originally borrowed.

Why are the banks being so helpful? It may be that they have such a poor profile in the media right now that they want to avoid headlines about evicting impoverished homeowners, especially since half of them are now government owned. But the other reason is that if they repossessed the houses of the defaulting customers and sold them off they would drive house prices down thereby damaging their own balance sheets. It’s much better for all concerned for the loans to be classified as “in forbearance” rather than “in default”. Homeowners keep their house, the banks’ assets look better than they really are and house prices are kept artificially high.

There is a downside though. All this ‘benevolent’ activity is just storing up problems for the future. When interest rates finally rise, all hell will break loose. If people are struggling when base rates are 0.5%, what will it be like when they go up fourfold and return to a long term norm of 2%? In America, banks have been much more ruthless about mortgage foreclosures. House prices have halved, causing painful adjustments in the economy. But that is all history now, and the banks, having written off all their bad loans, are lending again driving growth in the economy. In contrast, the UK seems to be following the same path as Japan in the 1990s. Japanese banks hid their bad loans and the resulting drag on the economy meant no growth for more than a decade.

The second article about Shandong Helon has a similar theme. This Chinese chemical company has to repay 400m renmenbi  on April 15th. The market has been assuming that it will default; the first ever default in China’s fledgeling domestic corporate bond market. But a brief statement today confirmed that the bond will be repaid in full. No Default. Strangely, this is not good news at all. The problem with China’s bond market is that it has developed under the assumption that companies will always be bailed out by the state in the end (just like the EU Greek crisis). That means that risk has been badly mispriced.  So plenty of people were secretly hoping that Shandong Helon would default, thereby resetting the market’s sense of risk and allowing the market to function properly for the first time.

One of the five maxims of catataxis is  “virtue reverses at a catataxic boundary”. In other words, what is good for the individual is bad for the collective (and vice versa). Death (or default) is a good example of this. Death, from the individual perspective, is pretty much the worst thing that can happen. But from the collective perspective it is vitally important: a positive thing in that it allows the chemical elements of the life form to be broken down (through bacterial decay) and redistributed more profitably to other parts of the ecosystem. Ashes to ashes, dust to dust; it’s all part of the great circle of life. Similarly, in the economy,  the parallel to death is default, which, after the bad debts have been written off, allows capital to be redistributed to those who deserve it more.

So that’s the message that I take from Damian Hirst’s diamond skull. Death should be celebrated and not feared. It’s an important part of the process. Death has an upside.

Catataxic funds outperform

Recent research from Collins Stewart, a UK stockbroker, shows that investment trusts have comprehensively outperformed open ended funds over the last 10 years. These funds are rarely recommended by financial advisers since they don’t pay commissions (i.e. kickbacks) to the IFA’s who promote them. In major markets, Investment Trusts gave investors a 106% return while unit trusts only returned 36%. In emerging markets, the difference was even greater: 357% vs 230%.

OK. So maybe the last time someone tried to explain the difference between an Investment Trust and a Unit Trust to you, you edged away and went to find the fun guys at  the party. Maybe you would even prefer to be stuck on a long distance flight in the seat next to an overenthusiastic proctologist, than listen to an explanation like that. But here goes anyway, because there is a catataxic twist to the story.

An Investment Trust is a form of collective investment that has been around a long time (since 1868). It is a closed end fund constituted as a public limited company. So unlike a normal unit trust, once the money has been raised no new money comes into the fund ( that’s why it is called “closed end”). Investors buy and sell shares in the company which can trade at a premium or discount (more likely) to the underlying asset value.

For an open ended fund, like a unit trust, OEIC or mutual fund, investors money can flow in and out. When it is performing well, new money floods in. When it is performing badly, investors pull their money out forcing the fund to sell its holdings which further reduces prices and potentially creates a downward spiral. It is this ‘forced selling‘ effect which may explain the difference in performance. The manager of an investment trust can afford to be more long term in outlook. The money he manages is locked up in the trust and can’t be withdrawn. He only has to worry about stock market performance, not about investors pulling their money out. He is therefore less likely to panic, and more likely to outperform in turbulent markets.

In catataxic terms, an investment trust is a level two entity, hermetically sealed off from level 1. In contrast, a unit trust has a permeable membrane between the two levels so is not truly a level 2 entity. An investment trust is a catataxic fund, a unit trust is not. The research proves that the key to outperformance is catataxis.

Stimulation or austerity: the catataxic debate

Gold CoinMost Western countries are having the same economic debate at the moment: austerity or stimulus? Britain’s coalition government, Germany and the Tea Party in the USA want more austerity. The logic is simple. If you have too much debt then you should stop spending. But the counter argument goes like this: government cutbacks depress the economy, recessions mean less tax revenues which mean more cutbacks. The result is an ever decreasing spiral like the one in Greece where the economy is shrinking 5% a year. So governments should be spending to stimulate the economy and worry about balancing the books later when the private sector is booming again. Rubbish, say the fans of austerity, you can’t spend your way out of a debt crisis…

This “stimulus versus austerity” debate can be recast as an example of catataxis. It hinges around the fundamental concept of money which has three main functions: a medium of exchange, a unit of account and a store of value. These three functions form three different “levels” and the stimulus vs. austerity debate is a conflict between these levels. Let’s look at each of the three in turn.

The first function of money is as a medium of exchange. It acts as a physical token that is exchanged when a transaction takes place. In this sense, money can be cowrie shells, gold bullion, coins or notes. In a prison, cigarettes are often a medium of exchange. It also does not need to be that ‘physical’. If you transfer money between two bank accounts through a BACS transfer, then some digital tokens are being exchanged between two computer systems. Likewise, air miles are a form of money which can be exchanged for seats on an airplane.

The second function of money is as a unit of account. It acts as a common yardstick for measuring the value of different things. In a barter economy, you can exchange two sheep for three goats. In a monetized economy, you might say that both were worth six shillings. Money as a unit of account tells you what things are worth. In our example, a sheep is worth three shillings and a goat worth two.

The third function of money is as a store of value. This arises because you don’t spend money the instant you get it (unless you are my daughter, Flora). There is a timing difference between transactions. Having sold your sheep for six shillings, you may not spend the money for a couple of weeks. While it is in your pocket (or under your mattress) it is a store of value. The money is worth something while you hang on to it.

These three different functions give us the three different levels. The first is physical, the second is conceptual at a mathematical or accounting level. The third is at conceptual level one higher than that. The store of value is not about numerical equations but about the crystallization of confidence; the distillation of belief. Catataxis is level confusion: the conflict between these different interpretations of money.

If you view money at level one as a physical medium of exchange, then you want your economy to have as much of it as possible. That means that more physical exchanges can take place. In other words, more trade and more growth in the economy.

If you view money at level three as a store of value, then you want your economy to have as little of it as possible. The less there is, the more valuable it is. By restricting the supply of money you keep its value.

A good illustration of the difference between these two views is the “shopping in Vietnam” example. You can pay for your goods in a shop in Vietnam in US dollars, but you will get your change in Vietnamese dong. The shopkeepers would prefer to hoard the dollars as they see them as a better store of value but the medium of exchange is dong – that’s how you get the change.

Some would argue that the US dollar is not a very good store of value. When Nixon broke the link between the dollar and gold in 1971, gold was worth $35 an ounce. Once the link was broken, the US government was free to create as much money as it liked. This “freeing up” of the physical medium of exchange led to a period of spectacular global economic growth. More money, more exchanges (more trade). But now, 40 years later, gold is worth $1,900 per ounce. In other words, the dollar has declined in value by 98% (many currencies have fared worse) so its role as a store of value has been damaged.

The stimulus vs. austerity argument, in effect a debate about whether the money supply should be expanded or contracted, is a catataxic debate. A conflict between the level one and level three views of money. It is also a debate between creditors and debtors. Creditors (people who are owed money) favour level three. They are concerned with the store of value and want their money to be worth something when they are paid back. Debtors (people who have borrowed money) favour level one. They want a lot of economic activity so they can earn the money to pay back their debts. If the value of money falls in the process so much the better – that means less to pay back in real terms.

Normally, the debtors are many and the creditors few. So the populist position is to be on the side of the debtors and let the money lenders take the punishment. This was true when the economy first began to be monetized in 1190 with the terrible massacre of the Jews at York (see the novel Holy Warrior for a graphic description of this appalling event). It is still true today. Maybe the current trend for “banker bashing” is a reflection of this.

Phillip Coggan in his excellent book Paper Promises points out an interesting irony in US politics this time around. The Tea Party is a populist, grass roots movement that is pro-austerity. They favour level three and are concerned about the store of value. Wall street bankers, who would normally be level three advocates, are the ones calling for stimulus at level one. So the traditional positions of the banker and the populace have recently become inverted in the USA.

Rogue Trader? Rogue Numbers!

SPSS for psychology studentsMy niece is about to go to University to read Psychology. I was surprised to find out that on her required reading list is a book called “Discovering statistics using SPSS”. It’s a monster tome of over 800 pages filled with maths. There are chapters on multivariate analysis of statistical variance, the chi-square test with standardised residuals and a section on factor extraction with eigenvalues….. No? Me neither!

SPSS stands for Statistical Package for Social Sciences. It first appeared in 1968 and has been much updated since. The SPSS manual has been described as one of sociology’s most influential books. Why? Because it turns sociology into a science. Most of the statistical methods used in the program, such as the least squared method, were invented by physicists in the 1800s. SPSS allows sociologists to plunder the wardrobe of physics. By dressing up in their clothes, it makes their discipline look more like a hard science and less of a touchy feely one: it now has numbers and maths.

One of my metaphors for catataxis is a shrink consulting a physics textbook when you are lying on his couch telling him about your father issues. He is analyzing your emotions, which are seated in the brain. And the brain, at the most fundamental level, is made up of subatomic particles. But you can’t analyse emotions by looking at subatomic particles; to do so is a catataxic error. You need to use therapeutic techniques not quantum physics – the right tool for the right level. Hence my surprise on finding out that psychology students have to study statistics.

Don’t get me wrong. Of course, statistics are useful things. They enable you to see a pattern that you might miss if you were too bogged down in the details. Statistics transmute a problem up one level, from messy reality on level one to pristine, summarising numbers on level two. Statistics let you see the wood for the trees. To run a regression on a set of data is to perform a catataxic transformation; one that can save lives with medical trials and the like. The problem is that having reduced the world to a numerical one, the judgements made on those numbers can be flawed. There is a nice warm feeling of security that you feel after you have ‘crunched the numbers’ and shown that they support your case. But your confidence in that numerical data mining may well be misplaced.

Which leads us to the UBS rogue trader who just lost that bank £2.3bn dollars. I must confess to some degree of schadenfreude. UBS took over Phillips and Drew in the 1980s, the partnership that I started work with in the City. They then proceeded to destroy it. So to see this global bank that boasts of its risk management skills humbled by a rogue trader brings a wry smile to my face.

“When will banks learn to control risks properly?“ many commentators ask. Surely the lesson is that it is not possible to control risks, not with a spreadsheet anyway. Most statistical methods rely on the bell curve; they assume a normal distribution of risk in order to make the maths work. The problem is that risk is not normally distributed, so traders keep dropping huge sums unexpectedly. Apples fall to earth, tides go in and out, riots happen in the summer and traders bankrupt banks. It’s the natural order of things. Nothing that really needs explaining.

I imagine that the senior managers at UBS looking at the trading accounts felt comforted by the numbers showing how profitable they were. But just as with psychology students, converting things up one level to the numerical domain does not necessarily make things safe, or even true. Just looking at numbers gives a false sense of confidence. Better to look one level down at the real world, the human world, messy and unstructured as it is. I bet the guy sitting on the desk next to the rogue trader all day for the last three years knew something funny was going on…

The Hop Exchange

The Hop Exchange, Southwark, London
Exterior of the Hop Exchange, Southwark, London 2011

I was working on a local history project in Kent (where I live) when a friend gave me some old photos. They showed men in frock coats handling hops on long trestle tables. These are city workers handling an agricultural product. It took me some time to track down where the photos were taken.  It turns out they were hop factors in the 1920s, working in 15 Southwark Street opposite the Hop Exchange in London.

The hop trade was once a major industry in Southwark. Back when there was only one bridge over the Thames (London Bridge) everyone passed through  Southwark . Its coaching inns and breweries have been famous since Chaucer’s time; this is where the pilgrims gathered before setting off for Canterbury. There was plenty of traffic up the other way too. Kentish hops, grown in the Garden of England, came up the A2 and the Old Kent Road to the market traders in Southwark Street, around the corner from Borough Market.

Hop factors at the exchange
Factors working near the Southwark Hop exchange in 1920s

The hops were dried in oast houses and then tightly compressed into 6 foot sacks called ‘pockets’ and sent up to the middlemen, known as hop factors, in Southwark Street.  Each load was sampled by cutting a foot square brick of pressed hops out of one of the pockets. This cube was wrapped in brown paper and secured with brass chair nails. Samples from a particular grower were all strung together with waxed hemp.

Another set of middlemen, the hop merchants who acted for the brewers, came to inspect the samples. These photos show the merchants (e.g. man in top hat on left) examining the hop samples displayed by the hop factors.  The room is starkly functional. A big glazed roof lets in plenty of natural light to help the inspection and a big clock to measure opening and closing times. Nothing else. No decorations at all.  After all, this is a serious place of business.

Hop production peaked in Kent in 1878 and has been declining ever since.  Kentish hop varieties, such as Fuggles and Goldings,  add bitterness to beer and ales, whereas German hops have low bitterness and strong aroma and are used for lager. So a number of trends conspired in the decline of the Kentish Hop industry. First was the trend towards lager over bitter. Second was the decline in exports as Australia and South Africa began growing their own  hops. The third blow came in 1973 when Britain joined the Common Market and cheaper continental hops wiped out most of the growers in Kent.

Bomb damage in WW2 meant that many warehouses were rebuilt in Paddock Wood in Kent and the hop merchants moved what was left of the industry down there in the 1970s.The last hop merchant, Wolton Biddell  in Borough High Street, closed its doors in 1991.  All the buildings have been redeveloped. The area around London Bridge and Borough has become one of the hottest development areas in London as evidenced by the Shard, Europe’s tallest building to be completed next year.  The old Hop Exchange has become a general purpose office building.

Interior of the Hop exchange
Inside the Hop Exchange, Southwark London, 2011

But what a beautiful building. Opened in 1867 and designed by R.H.Moore it is now Grade II listed. When you step inside you can see the vast open atrium and the three tiers of balconies overlooking it. It is designed to allow ‘open outcry’ ; traders on the floor, merchants on the balconies shouting their orders back and forth to each other.  Its just like the old stock exchange before it became computerised, or the Royal Exchange where futures were once traded but which is now an upmarket shopping mall.  The Lloyds Insurance building has the same “atrium and balcony” design,  letting all the brokers hear the stroke of the Lutine bell to inform them of bad news. In the hop exchange, all the balconies bear the  crest of Kent – a white horse on a red shield – to remind occupants that this is the trading place for Kentish hops.

I live opposite a oast house and travel to London Bridge every day. The oast house across the road from me has been converted to a spectacular county home. My daily journey encompasses the agricultural history of Kent both at the beginning and end; from an oast with no hops to a hop exchange with no brokers. A palace for a product that no longer exists. There are plenty of brokers getting off the train at London Bridge these days, but they are not broking hops any more but financial products instead.

You may be wondering where the catataxis comes in all of this. This tale is not just a personal trip of nostalgia,  because there is one more twist to the story: the hop exchange was never full of brokers.  The Victorian developers built it in a burst of progressive optimism hoping to capture and consolidate the hop trade inside its walls. But the hop factors and merchants already had their own various premises and saw no reason why they should move. So the hop exchange has only ever been a general office building and not a commodity exchange at all. It was an attempt to anchor the level 2 activity of the hop trade inside the level 1 physical shell of a building which failed.

Oast houses in Kent
Oast Houses in Chiddingstone Kent

The Victorians were keen on making the abstract concrete. Think of the statues of “Trade” or “Progress” that adorn Victorian metropolitan buildings. These are industrial versions of the ancient Greek muses; abstract concepts  in female form. The Hop Exchange was an attempt to cast economic activity in architectural form. Sadly, it did not work. This building designed to house speculators was itself a speculative failure. This was a catataxic blunder. Just because a building exists at level 1 does not mean that the trade at level 2 will be captured by it. In this case, the motto is: if you build it, they will not come.

See more photos of the building here:

Warring twins on Wall Strasse

Warring TwinsTwo key concepts of the modern world were born at a similar time. The joint stock company appeared in the early 1600s with the English and the Dutch East India Companies as early examples. Then, in 1648, comes the Treaty of Westphalia which establishes the principles of the nation state . Both are abstract concepts: one economic, one political. Both are catataxic in that they are second level entities . They exist one level above the world of flesh and blood. Despite that, they are destined to fight each other with all the competitiveness of warring twins.

For a long time, country dominates company. Corporations are seen as national entities. In the most extreme cases like the East India Companies they become effectively an arm of their respective governments. As the industrial revolution comes, industrial prowess is seen as a form of nationalism. Steel production is used as measure of national potency for communists and capitalists alike. Breakthroughs in the chemical industries are seen as national secrets to be kept from foreign spies; secret formulas that are the macguffin at the heart of many adventure stories.

Then, starting in the 1950s, things begin to change. The company ceases to be national and becomes multinational. It is no longer contained by national boundaries. The key underlying economic inputs cease to be national too. Raw materials, labour and capital were originally national possessions but this is also in flux.

Raw materials become freely available to the highest bidder as colonialism breaks down and international commodity trading expands dramatically. Remember that the Japanese bombing of Pearl Harbour was all about access to raw materials. Labour frees up next. The shortage of workers in Europe prompts a big influx of immigrants. Multinational companies create openings for executives worldwide. Well educated people can get a job anywhere around the world. Then capital is set free when currencies move off the gold standard and exchange controls are abolished in the 1970s.

As a result, countries no longer control the levers of economic power. The second twin becomes ascendant, company becomes dominant over country. The economy is no longer national but global. The general populace still seems to find this fact hard to grasp. Companies are not national assets. They don’t belong to a country but to shareholders. The takeover of ‘national’ companies by foreigners is still anathema. This confused sentiment is catataxis: an attempt to apply out-of-date national rules to an international creature.

France is notoriously touchy about its ‘national champions’ . When Danone, a dairy products group, is threatened by takeover in 2005 the French Government drafts a special law to protect it. It seems yoghurt is a strategically important product for the French. But feelings in the UK still run on similar lines, hence the public moaning about Kraft’s recent takeover of Cadbury.

A better example of misplaced corporate nationalism is the confused sentiment about the ‘British’ film industry. Star Wars and the Indiana Jones movies were shot in Elstree , lovingly made by British craftsmen. Are they British movies? What about a Wallace and Gromit movie financed by a Hollywood studio? Or Scorsese’s “Gangs of New York” which was financed by a British producer ? Films may have a language but do not really have a nationality. Neither do companies.

The USA, which has gained most from globalisation, seems strangely intolerant when it comes to foreign takeovers. In the 1990s, Congressmen smashed Sony Hi Fis on the steps of the Capitol to protest a wave of Japanese takeovers. These fears have now been shifted to China. A string of proposed takeovers of US assets by Chinese companies have been refused in sectors including steel, mining, media, shipping and telecoms. Don’t feel too sorry for them because the Chinese are equally protectionist back.

The most recent twist in this tale is the proposed takeover of the New York Stock Exchange (NYSE) by the German exchange Deutsche Borse . This is stirring up nationalistic sentiment in the States again. It comes as a surprise to some that stock exchanges are not public institutions but companies that can be bought and sold like any others. So the takeover of the icon of American capitalism by the Germans rankles. But, of course, stock exchanges don’t have any real national identity either. The London stock exchange is merging with the Canadian exchange, and Singapore likewise with Australia. In the end, there is one big pool of capital trading on global exchanges free of national identities.

In Rome’s foundation myth, Romulus slays Remus and then names the city after himself. In a newly merged Wall Strasse we will see the triumph of another twin. The joint stock company slays the nation state to found a catataxic city at the heart of a new financial empire.