This is something I wrote a couple of years ago, when I started to understand that the financial market had gone wildly astray. I’ve been tinkering at it since and I’m still not happy with it but I need to post it as a stepping stone for what I’m going to publish next.
Money appeared, at first, as a trade facilitator: instead of changing five measures of grain for one of oil one started to use as an intermediary step of the process whatever the local civilization called “money”, from shells to beads to holed pebbles or whatever else.
Then some people wanted to delay consumption, stock for “black days”, or wanted to trade further apart so they “invented” gold.
It was not only generally accepted, relatively easy to divide without sizable loses but also practically indestructible. This was fine from the monetary point of view but created the illusion that gold (and later money) is the supreme value per-se and not only as long as we humans invest it with value (functionality).
Do you remember the alchemists trying to transform everything into gold? What if they succeeded? Probably we would have roofed our houses with some very cheap and everlasting gold shingles.
Since it was indestructible it created another illusion: that its role/value will last forever. And so, for some two thousand years, until let’s say 1100 AD, gold, as money, played its role as trade facilitator and hoarding device.
Until then resources available to the society had been allocated at the discretion (whim?) of the local ruler (the “strongest” guy around), maybe pretending to have divine blessing for deciding this or that. For example the feudal system consecrated that the king ruled who had the use of what piece of land or of whatever other natural resource.
An old habit had resurfaced at the same time, civilizations restarted to trade goods and ideas between them. (Christian and Islamic around the Mediterranean Sea, for example). The advent of new transportation technologies created new opportunities for travel and trading. This is why a quantity of gold (money) became itself a resource, albeit not a natural one.
You could use it to start a trading cycle yourself or you could “rent” it to somebody else, for a fee – the interest – so that someone could do the actual buying, transporting/transforming and reselling.
Money, and interest, took on a new role. The amount of interest asked was specific to each occurrence – if I trust you are a capable (of doing whatever you are trying to do) person then I’m going to ask a smaller interest from you. In the end a lender gets paid for assessing risk – at the end of the day some deals get sour, some get through, and if the risks were correctly measured – and the corresponding interests asked – the investor/lender ends up with some profit. Meanwhile the same lender does another thing: he is distributing resources among the competing entrepreneurs and so the ones that are more creditworthy can start their businesses a little easier.
This way resources are no longer allocated at the whim of a single person – the feudal lord – but by the business acumen and experience of a multitude of operators, the “free market” – theoretically a more natural, and thus more efficient, process.
As a consequence money was no longer a mere trade facilitator and a humble hoarding device but also a resources allocating tool. In a way, money (and interest) started to measure not only value but also trust, which became by itself a kind of resource.
Remember this is roughly the same time when “paper/fiat money” started to appear, at first having a gold equivalent and dispensing with it later. And ‘paper’ money have value (and are accepted as tender) only as long as people have reasons to trust the country that printed it.
But this whole line of reckoning presumes that the “efficient market hypothesis” is true – this would translate into the assumption that the risks are measured rationally and as a consequence the resources are appropriated reasonably. Not entirely true, is it? Elliot’s Wave Principle says it’s not, Nicholas Nassim Taleb says it’s not, George Soros (The New Paradigm for Financial Markets – The Credit Crisis of 2008 and What it Means) concurs and so on.
A symptom of this lack of reason is the financial effervescence that is, only now, starting to ebb out. People “foregot” that money is a second class resource (only as long as people think it is and that it has any value) and started to treat it as a first class/real one. As a consequence inflation is perceived as inherently bad and not as a normal mechanism for economic adjustment and, more importantly, people now want to obtain “money”, and lots of it, directly from “money”.
No transformation whatsoever, the cycle “money traded for resources transformed into merchandise and traded back into money” is replaced by money conned from one hand to another. Until very recent days quite a lot of people were convinced they could retire with no (little) public pensions and that they’ll be able to live of the revenue (and not the capital itself) received from investing whatever small fortune they had saved (delayed consumption), or inherited.
This meant that these people had to enter the “resources (trust) allocating” game, the ‘financial market. Since most of them didn’t have the necessary skills they relied on others: bank or fund managers or even the CEO-s of the companies whose stock they had bought. And all these managers, under pressure, started to (mis)use a lot of instruments, originally designed as insurance/hedging, in order to make money out of thin air (speculation).
That’s how the derivative markets became bigger than the spot market. Making an analogy we can consider speculators as some kind of carnivores whose very important role is to keep the herds in top condition by culling the misfits. The benefit of the ‘landlord’, the one who from time to time hunts himself (buys or sells stock), is that the herds (companies) are OK, don’t get degenerated and don’t overgraze. But no sane landlord, not until now at least, would consider lions’ meat (or whatever else might be obtained from them) as a desirable food but only hunts (gets involved with paper issued by highly speculative investment funds) them for sport or when they threaten the well being of the herds. So why am I not surprised by the last moves in the world of investment banking? Or even banking in general?