by David Orrell
Consider, for example, the price chart of gold shown on the top in figure 7.1. Pre-1968, under the Bretton Woods agreement, the price was maintained at US$35 per troy ounce. The price was stable, because gold was still used as a money object by central banks and therefore had a defined price. This arrangement first came under stress in 1968, and when it collapsed completely in August 1971 the price of gold began a highly nonlinear, chaotic-looking path. In the first two business days of 1980, the price of an ounce of gold went from $110 to $634, as people lined up to swap dollars for gold. It peaked at $850 on January 21, and fell the next day by $145, as the same people queued to sell.52 This shows the difference between a money object and a metal object: prices for gold were stable under government control, but the invisible hand of the market apparently has a bad case of the shakes.53
Figure 7.1
(Top) The price of gold was stable when gold bars were used by central banks as a money object, with a defined price, but was unstable under the control of the invisible hand; (bottom) the price of a bitcoin shows similarly nonlinear behavior.
The volatility in this case is caused by the feedback loops leading to unstable behavior. If the price of gold is going up, then “momentum buyers” who follow the trend tend to get excited and buy more. That acts as a positive-feedback mechanism that drives the price even higher. The same thing happens in reverse on the way down, as investors dump their holdings. Alternatively, “value investors” may sell their holding if the price gets too high or buy when it goes too low, which acts as negative feedback. If the positive feedback outweighs the negative feedback, then the outcome is boom followed by bust, with the price lifting to extreme heights before suddenly collapsing.
At times when the price of gold is high, it is often debated whether it is in a bubble. But is more accurate to say that gold is always in a bubble, a bubble of human desire, which inflates or deflates in unpredictable ways. Newtonian calculations aside, gold doesn’t have a constant value—it doesn’t come out of the earth with a number stamped into its side. Money objects are designed to have a fixed numerical value, but for other things, including gold, the tether that ties numerical price to fuzzy conceptions of value is highly flexible and influenced by investor psychology. The price of gold therefore has its own dynamic, which depends to a large extent on what is happening with the price of gold. The same is seen in any speculative bubble, be it for tulips in seventeenth-century Holland or bitcoins in the fall of 2013 (see the bottom graph in figure 7.1), when the price increased by a factor of 100 in a matter of weeks. Nout Wellink, the former president of the Dutch central bank, compared media interest in Bitcoin at the time with tulip mania and pointed out that “at least then you got a tulip at the end.”54 If the behavior of money can be described to an extent by mathematics, then it is the mathematics of nonlinear dynamics and chaos rather than stability. And to deny the existence of bubbles—which neoclassical economists such as Fama are wont to do—is to deny the role of money and emotion in the economy.
In general, while markets tend to reduce arbitrage opportunities, this acts more as a consistency check on prices than as a stabilizing force. As discussed in chapter 6, currencies are linked together through the activities of traders, but instead of reducing volatility, this activity just means that currencies are in a kind of synchronized dance, with changes in one place propagating quickly through the system. To borrow a phrase from Jevons, the unstable, bipolar nature of money is “registered in the price lists of the markets,” with their oscillations from peaks to troughs and from optimism to pessimism. The reason market prices—the numbers attached to investments—are hard to predict has nothing to do with efficiency; it is because prices are inherently unstable. Such effects can be simulated using the so-called agent-based models from complexity science, which are designed to capture the nonlinear behavior caused by interactions between individual agents.
In quantum physics, the uncertainty principle, which is related to the wave/particle duality of matter, puts a fundamental limit on our ability to accurately measure both the position and momentum of an object. So, for example, we can put an exact number on a particle’s position, but momentum is known only to within a certain bound. A similar principle could be said to exist for markets—we can measure prices at the instant something is sold but remain uncertain about how it will change. And because markets are part of a closely coupled system, this uncertainty is further magnified through feedback loops. Market volatility is an expression of money’s fragile and uneasy link between objective number and subjective value, reason and emotion, reality and perception, order and chaos, precision and ambiguity; and it is fueled by the same energy—and the same quantum chaos—that binds heads with tails. Note that this wild uncertainty is very different from the tame sort of randomness assumed by traditional economic models, in which the system is treated as being at equilibrium, with price changes being due to small, random perturbations to the steady state.
The Money Moment
The most important market in the economy, of course, is the market for money; and as heterodox economists, including Frederick Soddy and later Hyman Minsky, pointed out, its supply is also affected by destabilizing feedback loops. According to Minsky’s financial instability hypothesis, the desire for money, and therefore credit creation, tends to increase during an expansion.55 This raises asset prices, which provides collateral for further loans, and so on, exaggerating the expansion, as “success breeds a disregard of the possibility of failure.” Much of the investment goes into unproductive assets such as real estate or excess industrial capacity. The last people to join the party are those, such as the famous NINJA borrower with “no income, no job, and no assets” of the U.S. subprime crisis, who can’t service interest payments but relies on the borrowed asset increasing in value. On the surface, everything seems to be going well, but only if you ignore the mounting and destabilizing levels of debt. At some point—since dubbed the Minsky moment—debts become unsustainable, asset prices stop rising, speculative borrowers fail to make payments, and the process reverses, with the economy sliding into a recession whose depth is exaggerated by a rapidly contracting supply of credit.
The role of the central bank is to control this process; however, its power is limited by the fact that most of the money supply is created by private institutions, which it can influence only indirectly. There is also a tendency to ease conditions during a recession (e.g., quantitative easing) rather than to withdraw stimulus during an expansion (let the good times roll!). The result has been a credit boom/bust cycle on top of an upward-trending level of total debt, which finally started to turn over in 2007. As his former student L. Randall Wray put it: “This wasn’t a Minsky moment. It was a Minsky half-century.”56
Minsky was considered something of a maverick in the economics profession; one assessment, published a year after his 1996 death, concluded that his “work has not had a major influence in the macroeconomic discussions of the last thirty years.”57 According to mainstream economics, as summarized by Ben Bernanke, the debt cycle “represent[s] no more than a redistribution from one group (debtors) to another (creditors).”58 Or as Paul Krugman explains: “Think of it this way: when debt is rising, it’s not the economy as a whole borrowing more money. It is, rather, a case of less patient people—people who for whatever reason want to spend sooner rather than later—borrowing from more patient people.”59 In this linear view of the economy, debts and credits cancel each other out in the aggregate, just as the two sides of money are assumed to merge into a neutral chip. However, this ignores the pivotal money creation role of private banks, who act as a kind of amplifier on the system.60 As Steve Keen notes, the main reason central banks were surprised by the crisis was because their DSGE models include “neither money nor banks nor debt.”61 Again, this omission will seem bizarre to noneconomists but is consistent with the assumption that money is just an inert medium of exchange; its consequences are a graphic illustration of how our ideas a
bout the nature of money have influenced economic outcomes.
While subjects such as nonlinear dynamics and complexity are beginning to influence economics, this does not mean that economists are abandoning the equilibrium approach, as epitomized by DSGE models, en masse. As Wolfgang Munchau wrote in the Financial Times in 2015, “The mainstream invested a life’s work in developing their DSGE models. They will not let go easily, but continue to tinker with their models, and hope that no policy maker will ever use them. Unfortunately, many institutions already have. An example is the European Central Bank’s use of a DSGE model that has produced persistently too optimistic forecasts.” He predicts that “the successful challenge will come from outside the discipline, and that it will be brutal.”62 Economics may be about to experience some disequilibrium of its own.
Happy Yet?
Money’s volatility is, of course, not limited to just the markets. One of its most obvious features is that it is a highly emotional subject. Married couples—not to mention countries—have more arguments over money than probably any other topic, and it has been called the leading cause of divorce.63 Words used to describe spending habits include “greed,” “generosity,” “miserliness,” and “extravagance.” As discussed in chapter 2, the dualistic structure of money resonates powerfully with the dualistic structure of our thought processes. We value it both as an idea and as a thing in itself. It is therefore amazing that orthodox theory, by focusing only on the numerical, left-brained side of money, somehow managed to strip economics of all its psychological and societal implications.
The fact that people are prone to make all sorts of irrational judgments about money was demonstrated in a long series of experiments, starting in the 1970s, by the psychologists Daniel Kahneman and Amos Tversky, whose work helped create the field of behavioral economics.64 For example, we tend to underestimate the possibility of extreme events like crashes and overestimate our ability to cope with them. We put more value on things that we can see now, and discount the future.65 It is perhaps not surprising, then, that most people find it hard to get excited about planning for retirement. Marketers and advertisers have always known that reason is only sparingly applied when making buying decisions, which is why they target our emotions through images, music, and so on (one study, for example, showed that gamblers spend more if slot machines smell nice, which doesn’t seem to involve rationality at any level).66
While economists have traditionally modeled people as independent atoms, we are affected by people around us, and emotions are particularly contagious. In markets, this often leads to a herd mentality, with everyone stampeding into or out of positions at the same time—confidence is highest when everyone is doing the same thing, which is exactly when risk is highest. And at its core, money relies for its function on trust and power, which have a complicated relationship (power inspires obedience, which isn’t quite the same thing as trust). As Walter Bagehot (chapter 4) knew, trust is not produced by a purely rational calculation but, again, is also influenced by emotions and the influence of others. Runs on banks, or runs on currencies, occur when trust evaporates.
Money is a source of pleasure, and we associate its pursuit with the pursuit of happiness. This connection was made explicit by neoclassical economists such as Francis Edgeworth, who went so far as to imagine a “psychophysical machine” called a hedonometer that would register “the height of pleasure experienced by an individual.”67 Other economists preferred to assume that utility could be measured by prices. However, happiness can also be measured in other ways—for example, by asking people how happy they are. The results appear to show that in rich countries happiness actually peaked some time back in the 1960s and has been stable or in slight decline ever since—even though per capita GDP has soared in the same time.68 One reason for this discrepancy is that GDP is a purely monetary measure of economic activity and was never intended to be a measure of welfare. Confusing it with well-being is like confusing price with value.
Also, while wealth certainly affects our happiness, we tend to be more concerned with relative wealth, as compared with one’s peers, than with absolute wealth. Because money is based on number, it doesn’t have any inbuilt sense of scale—it doesn’t really make sense to say that a number is big or small, because it’s all relative ($1,000 is just noise to a billionaire). However, numbers can be ranked in order, and we therefore tend to assess our wealth not in absolute terms, but by comparing it with those around us. As John Stuart Mill put it: “Men do not desire to be rich, but to be richer than other men.”69 This was illustrated by a U.S. Gallup poll that asked, “What is the smallest amount of money a family of four needs to get along in this community?” The answer simply tracked the average income. As other people get richer, we feel we must do the same just to maintain the same relative position.70 A survey by Boston College of superwealthy people with net worth in excess of $25 million found that most still reported anxiety about their finances, and to achieve full financial security would require on average 25 percent more than whatever they had.71 Of course, if they got that then they would need another 25 percent, and so on. The hedonic treadmill is an expensive ride.
As Daniel Kahneman points out, there might even be a negative correlation between money and happiness beyond a certain point, since those with a higher income usually spend more time on doing things that evoke negative feelings.72 But the perverse effect is that we just want even more of the stuff. According to Jeffrey Pfeffer from Stanford Graduate School of Business, the more money we are paid, the more we tend to value that money. His research was inspired by a remark from Daniel Vasella, the former CEO of pharmaceutical giant Novartis AG, who turned down a $78 million severance package after a public outcry. “The strange part is, the more I made, the more I got preoccupied with money,” he told Fortune magazine in 2002. “When suddenly I didn’t have to think about money as much, I found myself starting to think increasingly about it.”73
Money has become a way of keeping score, in a game that we no longer play for its own enjoyment. It is what Peter Singer, professor of bioethics at Princeton, calls “an end in itself, a way of measuring one’s status or success, and a goal to fall back on when we can think of no other reason for doing anything, but would be bored doing nothing.”74 We mark our position and display our wealth through what Thorstein Veblen called in 1899 “conspicuous consumption.” In a recent study of American households, University of California, Los Angeles, anthropologists found that a typical family works hard so it can spend hard and even goes into debt in a “vigorous show of consumerism.”75 Working parents are able to spend four hours or less with their kids on a weekday, feel guilty, and are trying to make up for it with bought stuff. The subsequent stress is then treated via so-called shopping therapy, meaning more shopping and bills. The outcome, as the UCLA team noted, could be epitomized by 2,260 visible possessions they found in three bedrooms of one of the researched households along with the admission that these things do not really make their owners happy.
While it makes sense to accumulate some possessions for pleasure or reserves for whatever might come, there is a difference between a sensible purchase and a hamster wheel, with many clearly following the latter path. As Bournemouth University’s Donald Nordberg notes: “Greed incentivized a lot of people to do a lot of good things. However, once it is without context it creates an illusion that the ultimate goal is to scrabble. And there is certainly no virtue in that.”76 Because we tend to compare ourselves with those of our peers who are better off, any increase in social inequality—of the sort seen in most rich countries over the past few decades—can have the effect of decreasing overall happiness.
Cowboy Capitalism
Money has two poles, the abstract mental and the embodied physical. The split between these two is acted out on a global scale in the split between the economy and the planet; just as money contains a bias toward the numerical, so our economy has becoming increasingly virtual and disembodied. When we refer to We
stern materialistic, capitalistic culture, it isn’t really materialism we are talking about: it is the numerical representation of the material world, which is enabled by money. It is a kind of immaterialism, a final realization of the Pythagorean dream of reducing the universe to number. We boost GDP by liquidating the planet (a different measure known as the “genuine progress indicator,” which accounts for resource depletion, apparently peaked some forty years ago, according to a study in the journal Ecological Economics).77 But the environmental ethos that emerged in the late 1960s reminded us that human well-being is linked to that of the biosphere. This point was perhaps best expressed in a 1966 paper by economist Kenneth Boulding, who—inspired by the Apollo missions—compared two versions of what an economy could look like: a cowboy economy and a spaceman economy.78
Boulding’s cowboy economy was driven by a frontier mentality. Like the pioneers who first settled the open plains of America, or sixteenth-century Spanish conquistadors, or an oil worker in what journalist Laura Gottesdiener called the “Wild West” of the U.S. fracking industry, cowboys see the universe as a landscape ready to be plundered.79 There is no need to worry about the availability of resources or pollution sinks, because they are effectively infinite, and with cheap nuclear energy perhaps not even necessary.80 The world is seen as property, and the job of the cowboy is to convert it all into money. As the inventor of the steam engine and the steam-powered screw press, James Watt wrote: “Nature can be conquered, if we can but find her weak side.”81 It is fitting that capitalism, whose name refers by root to heads of cattle (capita), is based on this idea of subduing nature and branding it with number; like a cowboy tackling an unruly calf and sinking a firebrand, or more recently a scannable microchip, into its side.
