Tuesday, 28 February 2017

Where do experts come from?

Over the weekend, Brigitte Nerlich published a piece on the origin of the ‘deficit model’.
The ‘deficit model’ is the idea that if the public understood scientific concepts they would accept the judgements of scientists. Or, if scientists shout loud enough eventually people will agree with them. Or, people don’t like GMOs/fracking/climate change science because they are dumb.
This is a hot-topic in the aftermath of the US Presidential Election and theUK’s EU Referendum, when ‘experts’ were widely ignored and her contribution has been well received.
My reaction to Brigitte’s tweet was “Spinoza of course”, but there was no reference of the seventeenth century Dutch philosopher in her piece.
My interest is as part of my remit as the RCUK Academic Fellow for Financial Mathematics between 2006 and 2011 was the ‘publicunderstanding of Financial Mathematics’, or at least the ‘public engagement with Financial Mathematics’. This introduced me to the issue of the ‘deficit model’ over a period in time dominated by the ‘Great Financial Crisis, which started 10 years ago yesterday.
For almost ten years I have been trying to figure out what is the relationship between finance, mathematics and ethics. To me, a significant contributor to the GFC was the belief that ‘science’ had some how tamed financial risk. Therefore to understand the GFC it was necessary to understand where the faith in scientific determinism originated, and I think the source (in European science at any rate) is in Spinoza. The argument is presented in the book I am finishing off for Palgrave
and I have extracted two relevant sections, separated by some 27,000 words and 125 years.
Baruch Spinoza would produce the most influential development of Descartes’ philosophy that incorporated ideas from de Groot and Hobbes during the ‘Dutch Golden Age’. Spinoza’s family were Portuguese Jews, marranos, who had been forcibly converted to Christianity in the sixteenth century. They had immigrated to the United Provinces in 1593, taking advantage of Calvinist toleration and Baruch’s father became a prominent, and wealthy, citizen of Amsterdam. Baruch was born in 1632, his first language was Portuguese and he grew up studying in Spanish and Hebrew and he only studied Latin in his twenties. His understanding of Greek philosophy came primarily through Judaic and Islamic interpretations, rather than from the Scholastics.
Spinoza became involved with the Collegiants, a sect that had emerged as a successor to the Arminians, and was eventually excommunicated by his synagogue in 1656, changing his name to Benedictus. The excommunication did not worry Spinoza too much and he developed a reputation as a teacher, writer and a lens-grinder, a skilled profession closely associated with the important new science of optics. Supported, in part, by a pension from de Witt, he developed his philosophy and in 1670 moved to The Hague where he would witness de Witt’s murder in 1672. He died in 1677, probably of tuberculosis.
Spinoza’s most influential work, his Ethics, was published posthumously in 1677. Spinoza echoed Plato, Augustine and Descartes in arguing that mathematics provided the means of discerning truthi and the text presented a deductive chain that proved propositions having started with definitions and axioms. The key step that Spinoza took in developing Descartes’ work was to collapse the three types of substance: matter, mind and God, into one. This was captured in his phrase Deus sive natura, ‘God or nature’, indicating that there is only a single substance2 that, when viewed from one perspective is nature but from another is God. This solved the problem of how Descartes’ mind interacted with matter at the cost of prohibiting contingency3 because if everything was connected to God, it could not happen by chance. This also meant that emotions were not part of the mind, and so could not be rationalised, but were governed by the laws of nature4, as Hobbes had implied.
Spinoza argued that people believed themselves to possess free-will and had autonomy because they did not see the complete picture, being only finite5. Spinoza believed that the purpose of the individual was to lift themselves out of a mundane perspective in order to comprehend the totality of creation, coming to understand the true nature of God’s will: the laws of nature. The ethical nature of the Ethics was in describing how different actions helped, or hindered, the individual in approaching God6, which would give the correct perspective on everyday phenomena. Spinoza believed that at the most basic level people had direct knowledge of nature through their senses. This could be improved into a scientific knowledge of the world that identified connections between phenomena and so was able to make generalisations. The ultimate aim was to have direct knowledge of the generalisations7, not mediated by ‘finite’ ideas or concepts and this knowledge delivered true freedom8.
Spinoza’s contribution to western philosophy was in suggesting that humans were capable of attaining a complete picture of the universe that provided certain knowledge. This was novel to Europeans rooted in the Scholastic tradition that synthesised Aristotle and Augustine. However, it was reminiscent of Jewish and Islamic mysticism. Jewish mysticism Kabbalah had become prominent in the thirteenth century through Moshe ben Naiman Girondi, from Catalonia, while Sufi thought was legitimised in the eleventh century by the Islamic scholar Muhammad ibn Muhammad al Ghazali. Both these scholars challenged Hellenistic philosophy, with al-Ghazali’s repudiation of Aristotle in The Incoherence of the Philosophers being pivotal in the development of Islamic thought. Associated with al-Ghazali was the doctrine of occasionalism, that effect follows cause not because of a physical law but only because God’s will. Spinoza echoed this attitude when he argued that a law of nature was simply a consequence of God’s or nature’s consistency9. In Sufi metaphysics there is the concept of ‘Unity of Essence’ (wahdat al-wujud, وحدة الوجود) and the idea that people seek ‘annihilation in God’ (fanaa,فناء‎‎)10 just as for Spinoza people sought a God-like perspective. While Islam and Spinoza both denied contingency, they did not deny the ability of the individual to assert their own will, it was just that asserting one’s will against God or nature would be detrimental to the individual11. This idea of determinism was unusual in European thinking. The Calvinists believed in predestination, that the ultimate fate of a person’s soul was destined for heaven or hell, but an individual had will throughout their life. Spinoza’s argument was that individuals don’t really have a choice in correct action; knowledge guides them to the correct course12. If someone makes an immoral choice, it is through ignorance13. This is less bestial than Hobbes but still rejects autonomy.
If Judaism can be characterised by the covenant with God and Christianity by God’s caritas for people, in Islam people can be characterised by having an intellect that can discern God’s will14. In this sense Spinoza was introducing Islamic, specifically Sufi, ideas into western philosophy. This was possible because Spinoza was re-presenting tested Islamic philosophy that opposed Aristotle, just as European thought was rejecting Aristotelian ideas.
The influence of Spinoza on western thought becomes significant at the end of the Enlightenment. Romanticism had appeared in English literature in the 1790s. It incorporated Rousseau’s idealisation of the ‘noble savage’, in a ‘state of nature’, and empiricism, which focused on the individual sensation of nature. In Germany, the movement was broader and more significant with a philosophical basis, idealism, in a problem Kant created in trying to resolve the issue of mind-body dualism. Idealism addressed the problems by dissolving the distinction between observers and observed, an approach that was heavily influenced by Spinoza15. A core concept in idealism was the principle that what was observed was dependent on the thinking ‘I’ that, itself, could only exist in the context of society. This spawned the idea that national identity was fundamental to the individual, fusing Spinoza, Rousseau and Kant.
Johann Wolfgang von Goethe, born in 1749, exemplified the broader Romantic Movement. His fame was established with his 1774 sentimental novel Die Leiden des jungen Werthers (The Sorrows of Young Werther). Today Goethe is known for his interpretation of the Faust story, written in 1808, that describes how Mephistopheles suggests that a ruler solved their financial problems by printing paper money, backed by gold reserves, which were yet to be discovered16. In 1775 had been invited to become a civil servant for the small Duchy of Weimar where he would remain a bureaucrat until his death in 1832. Goethe was responsible for some mines and became interested in geology and the natural sciences generally. As a novelist, Goethe was interested in the ‘narrative’ of science rather than brute, individual facts, an approach that coincided with the idealists’ approach to science, Naturphilosophie.
Naturphilosophie was personified by the Prussian naturalist Alexander von Humboldt. Humboldt travelled to South America between 1799 and 1804 and gathered observations of nature that he then presented in Ansichten der Natur (Aspects on nature) in 1807. Humboldt aimed at Spinoza’s all-encompassing perspective that transformed an apparently capricious nature into a cohesive whole17. However, this implied that science was fundamentally subjective, with the scientist being part of, not an objective observer of, nature18. To ensure that the ideas coming out of the mind of a scientist, often presented as a solitary genius, were true representations of the world, their observations had to be precise and accurate. Johann Carl Friedrich Gauss, the director of the Göttingen observatory from 1807, addressed the fidelity of scientific observations by developing the Central Limit Theorem into a theory of measurement and the Normal distribution, which is often referred to as the Gaussian distribution.
The Romantics regarded nature as a complex, ‘living’ organism and were concerned with how nature changed, rather than focusing on how it was at any single point in time19. This represented a ‘counter-revolution’ in science, reverting to Aristotelian qualities rather than Cartesian quantities. Some Romantics, notably William Blake, were highly critical of the mechanistic natural philosophy founded on Descartes and Newton20 and stressed the need for human imagination in theory construction. With respect to Malthus, the Romantics saw his argument as reducing people to elements of a machine and they preferred more paternalistic policies, associated with the Tories.
Prussia had initially joined the attacks on Revolutionary France in 1792 but became neutral in 1795, content to see the Holy Roman Empire, ruled by the Austrian Hapsburgs, disintegrate. However, in 1806, as Napoleon presented a greater threat, Prussia declared war on the Empire and was swiftly defeated. In the aftermath of the defeat the Prussian’s began a programme of reorganising the state administration, inspired by Kantian ideals, whereby subjects would become citizens21. During this time, Georg W.F. Hegel developed idealism by arguing that the nation was a living organism, with a purpose, will and rationality22. This contrasted with the dominant view of the eighteenth century that saw the state as a machine designed to deliver ‘interests’, a view that Hegel rejected for the same reasons that the Romantics rejected mechanistic science. Hegel argued that the state’s will was defined by ‘public opinion’ which expressed
the genuine needs and correct tendencies of common life, but also, in the form of common sense, of the eternal, substantive principles of justice23.
Hegel argued that the state and people were indistinguishable, because an individual was formed in the context of culture, and so their aims are necessarily compatible. In addition, he rejected the idea that public opinion developed through discourse could be meaningful, since it would only represent the subjective opinions of a narrow section of the public24. Therefore, like Rousseau, Hegel believed the well-constituted state could not be challenged and the role of education was to ensure people’s subjective opinions conformed to the state’s, Spinozian, objectivity. This perspective can be contrasted with that of Thomas Paine, who had argued at the start of Common Sense, an essay of 1776 and a key inspiration of the American Revolution, that
Some writers have so confounded society with government, as to leave little or no distinction between them; whereas they are not only different, but have different origins. Society is produced by our wants, and government by our wickedness; the former promotes our happiness positively by uniting our affections, the latter negatively by restraining our vices. The one encourages intercourse, the other creates distinctions. The first is a patron, the last a punisher.25

I suspect students of Spinoza and Hegel will object to my caricature, but I think the essential point that " Spinoza’s contribution to western philosophy was in suggesting that humans were capable of attaining a complete picture of the universe that provided certain knowledge." is important in understanding why 'science' believes in the 'deficit model'.

1 (Spinoza 2002, 240)
2 (Spinoza 2002, I.P14, 224)
3 (Spinoza 2002, I.P26, 232)
4 (Spinoza 2002, 277-278)
5 (Spinoza 2002, 238-241)
6 (Spinoza 2002, IV.P28, 334)
7 (Spinoza 2002, V.P25, 375)
8 (Spinoza 2002, 378-379)
9 (Spinoza 2002, 239)
10 (Davis 1984, 12)
11 Qu’ran 4:79, (Spinoza 2002, 359-362)
12 (Spinoza 2002, V.P42, 382)
13 (Spinoza 2002, IV.P27,334)
14 (Schuon 1976, 19-22)
15 (Frank 2003, 55-76), (Förster and Melamed 2012),
16 (Wennerlind 2003, 234), (Binswanger 1994)
17 (Daston 2010)
18 (Fara 2009, 215-218)
19 (Brush 1976, 655)
20 (Christensen 1982)
21 (Clark 2006, 327-344)
22 (Hegel 1952, Secs. 257-258), (Clark 2006, 451)
23 (Hegel 1952, Sec. 317), (Habermas 1991, 120)
24 (Habermas 1991, 119)
25 (Paine 1998, 5)

Brush, S. G. 1976. The Kind of motion we call heat: A history of the kinetic theory of gases in the 19th century. North-Holland.
Christensen, B.J. 1982. “The Apple in the Vortex: Newton, Blake and Descartes.” Philosophy and Literature 6 (1&2): 147-161.
Clark, C. 2006. Iron Kingdom: The Rise and Downfall of Prussia, 1600--1947. Penguin.
Daston, L. J. 2010. “The Humboltian Gaze.” In Cultures and Politics of Research from the Early Modern Period to the Age of Extremes, by M. Epple and C. Zittel, 45-60. Walter de Gruyter.
Davis, D. 1984. “Introduction to The Conference of the Birds.” In The Conference of the Birds, by Farid ud Din Attar, 9-26. Penguin Classics.
Fara, P. 2009. Science: a four thousand year history. OUP.
Förster, E., and Y. Y. Melamed, . 2012. Spinoza and German Idealism. Cambridge University Press.
Frank, M. 2003. The Philosophical Foundations of Early German Romanticism. Translated by E. Millán-Zaibert. SUNY Press.
Habermas, J. 1991. The Structural Transformation of the Public Sphere: An Inquiry Into a Category of Bourgeois Society. Translated by T. Burger and F. Lawrence. MIT Press.
Hegel, G.W.F. 1952. “Hegel’s Philosophy of Right.” Edited by T.M. Knox. Clarendon Press. Accessed September 2016. https://www.marxists.org/reference/archive/hegel/works/pr/philosophy-of-right.pdf.
Paine, T. 1998. Rights of Man, Common Sense and other Political Writings. Edited by M. Philip. Oxford University Press.
Schuon, F. 1976. Understanding Islam. Unwin.
Spinoza, B. 2002. “Ethics.” In Spinoza: Complete Works, edited by M. L. Morgan, translated by S. Shirley, 213-382. Hackett Publishing.
Wennerlind, C. 2003. “Credit-Money as the Philosopher's Stone: Alchemy and the Coinage Problem in Seventeenth-Century England.” History of Political Economy 35 (5): 234-261.

Saturday, 7 January 2017

Some implications of the Bank of England comparing itself to the MetOffice

At some point over the Christmas break I was cursing the fact that I was finding  it difficult to find a weather map.  That is a weather map with isobars and fronts marked on it not one with icons of cloud, rain and sun.  My favourite subject as a final year physics student was Atmospheric Physics: I was fascinated by how the differential equations delivered different weather, particularly cloud formations, based on different inputs.  Underpinning this academic interest my father taught me to sail and until I left the oil industry for academia, and lost money and free time as a result, I was a keen sailor.  This has left me with the ability to formulate my own idea of the future weather from pressure charts, and my expertise is such that my wife confidently ignores it.  Though I find pressure charts more useful than the rain icons, which I believe replace the cloud icon with a rain icon when 26 out of the 50 simulations the MetOffice runs return rain.

Meteorology also featured in a discussion of "fog" and "mist", on the BBC Radio 4's Today programme.  The meteorologist distinguished the two identical phenomenon in terms of visibility: fog is less than 1,000 m, mist indicates visibility is 1,000m-2,000m and they said terms like "thick fog" or "dense fog" are meaningless.  I checked my 1998 RYA Weather forecast book, where it said shipping forecasts do distinguish fog (200m-1000m), thick fog (50m-200m) and dense fog (less than 50m).  The distinctions the meteorologist was making come from aviation forecasts and they were ignoring maritime definitions, that describes visibility of 1,000m-2,000m as "Poor visibility", since it can be caused by mist, dust or smoke.

Two things struck me about these experiences.  Firstly the meteorologists definition reflected the relative significance of modern aviation over shipping, the public forecast definitions reflected this change in status, definitions were mutable to social status.  The weather map issue is more significant in that the maps it uses today provide the public with "the answer" (there is a 52% chance of rain tomorrow, here is a rain icon that is interpreted as rain) rather than the information to make a judgement.  I see this is an example of the transformation of the public sphere, where by a state institution inhibits the public's ability to think and criticise.  I think this type of transformation in relation to finance as being core to the lack of faith the public have in finance and the public's inability to knowledgeably criticise finance the root of financial crises.

A key episode in the transformation of finance was the 1844 Bank Charter Act.  This was a consequence of twenty years debate amongst economists on the  merits of fixing the relationship between money and gold. The currency school argued, with the support of statistics, that the easy availability of credit led to inflation and so there should be a link between the, concrete, quantity of gold and the availability of credit. The banking school argued that financial instability was a consequence of fluctuations in demand and supply and had nothing to do with the networks of banks providing credit by issuing their own notes. This argument was supported by the fact that high, not low, interest rates were associated with periods of inflation. The currency school won the argument and  the Bank Charter Act prohibited English banks, other than the Bank of England, from issuing notes and required all banks to hold Bank of England notes as a capital reserve to back up their lending. Banks could still create ‘money’ in bank deposits by lending money, which would be ‘destroyed’ once the loan was repaid but were under the centralised control of the Bank of England.

In the aftermath of the Bank Charter Act the Quaker dominance of banking waned. The Act undermined the network of ‘country’ banks that served local businesses and led to the merger and centralisation of the provincial Quaker institutions. Following this centralisation a number of Quakers became associated with financial malfeasance. The most famous example is the failure of Overend, Gurney & Company in 1866. The firm was connected to the Quaker Gurney banking dynasty and had been able to underwrite other banks during a crisis of 1825. Its failure was a result of speculative investing in the 1850s, exposed by the Panic of 1866, and the refusal of the Bank of England to underwrite it. In the distributed financial network that existed before 1844 the stability of the system rested on inter-personal relationships and trust. Quaker doctrine nurtured this trust and produced financial success. After 1844 this stability rested on the centralised decision making of the ‘lender of last resort’.  

On this basis I was interested to hear that Andy Haldane, Chief Economist at the Bank of England had also drawn connections between finance and weather forecasting in a speech hosted by the Institute of Government (the relevant section is initiated at 15:22 and then developed at 18:45 in this video)

 Dr Haldane compares economists' failures to foresee the Credit Crisis with the the BBC's lunctime weather forecast of 15th October 1987

Note that the forecaster starts by dismissing the prospect of a hurricane hitting the UK raised by a member of the public.  The following day the BBC reported a "hurricane" had struck the UK overnight causing the death of 18 people.  It is ironic that the BoE looks back to the weather event of 15 October 1987, skilfully passing over Black Monday of 19 October 1987.

Dr Haldane observes that the accuracy of weather forecasts has improved dramatically since 1987 through the greater use of data  and economics could similarly improve (19:53-20:10).  I would start of by disputing Dr Haldane's diagnosis and argue it was not greater data (10 weather ships used in the 1970s have been replaced by 18 weather buoys) that lead to the improved forecasts but greater computational power that has allowed finer scale simulations of the differential equations that has delivered the better precision.  Whether or not the improvement in forecast accuracy is down to greater data or greater computational power the underlying assumption is that the economy, like the weather, is a system that can be represented by a set of differential equations that can be used to simulate the evolution of the economy.  This is a massive assumption.

Both Aristotle and Cicero recognised that it was feasible to predict natural phenomena, like the weather but events subject to human agency were impossible to foresee.  Augustine agreed that humans were not able to foresee the future though the Christian God, unlike the pagan gods, had perfect fore-knowledge.  The change in attitude begins with Descartes search for certainty that involved applying the deductive reasoning presented in Euclid's Elements to non-mathematical thinking starting from the ‘common notion’  “I think therefore I am”.  This resulted in Descartes seeking mechanical, logical, explanations for natural phenomenon, rather than the teleological ones of Aristotle. Because different objects had different ends, Aristotle believed there were distinctive sciences to account for different phenomenon. Descartes, in contrast, believed in a unified science and he likened his whole philosophical programme to a tree whose roots were in metaphysics while its trunk was made up of mathematics ‒ “on account of the certitude and evidence of [its] reasoning” ‒ and physics with the branches of the tree being the practical sciences, both natural and moral.  Both Dr Haldane's association of economics and meteorology, a consequence of a belief in unified science, and his search for certainty, revealed (19:41-19:48) by his admiration of precision in weather forecasts,  reflect a commitment to Cartesian science.

The alternative to Descartes has traditionally been Locke who dismissed the Cartesian belief that there are innate ideas, rather people are born with minds that are blank-sheets: tabula rasa.  Locke argued that knowledge came from experience with sense organs first perceiving events in the real world and then the mind interpreting them to form ideas. The validity of an idea did not depend on how it conformed to some authority, theoretical or political, but on the  origins of idea and how had it evolved: its genealogy.  This meant that people needed to investigate the origins of their beliefs, reflecting a Puritan upbringing. For Locke the purpose of philosophy was to show how the tabula rasa was filled with knowledge, which is “the perception of the agreement” of two ideas. In contrast to Descartes  Locke argued that human knowledge could never be certain.  One  might observe the Sun rising every morning of our lives and infer it will do the same tomorrow, but we cannot assume it is true and this motivates us to ask ourselves why the Sun rises. Locke finished the An Essay concerning Human Understanding by dividing knowledge into three types. The first is physica, the nature of things. The second is practica, what people should do as rational and wilful agents. The final type is semeiotika (Greek for ‘signs’), how physica and practica are attained and communicated.
Locke applied these ideas to politics in his Two Treatises of Government.  As a Puritan who had lived through the Civil War, Commonwealth and Restoration, Locke had been concerned with the fundamental tension between an individual’s right to sincerely express their religious beliefs and the need for a well ordered society to mandate the restriction of those rights, such as by a sovereign’s exercise of prerogative powers. Locke argued that a state was made up of autonomous individuals ruled by rationally constituted, abstract and universal laws rather than by subjects enforced to comply with the personal decrees of monarchs.

While Descartes philosophy can be caricatured as being based on doubt, Locke’s can be characterised as focusing on trust with Locke claiming that language was important because it enabled promises to be made , which created the trust that bound a society together.  Since knowledge was fallible reliable knowledge could only be based on trust, faith is only necessary in the presence of doubt, while a stable political system relied on people making and keeping promises and abiding by contracts. Locke opposed atheism because it dissolved trust by undermining individuals’ commitment to truth telling, promise keeping and consideration for others.

Locke's influence was persistent.  The tripartite separation of knowledge into physica, practica and semeiotika was mirrored in  Kant's tripartite Critique of Pure Reason, Critique of Practical Reason and Critique of Judgement.   Laplace’s reputation in mathematics was built on two parallel pairs of books: Mécanique Céleste (1799-1825) and Exposition du système du monde (1796) describing the mathematics of physica to a technical and general audience, while Théorie analytique des probabilités (1812) and Théorie des probabilités (1819) did the same for the mathematics of practica.

Descartes view of a certain, unified science came to dominate during the nineteenth century.   Descartes' ideas had been developed by Spinoza who's Deus sive natura, ‘God or nature’, indicated that there was only a single substance that, when viewed from one perspective is nature but from another is God. This solved the problem of how Descartes’ mind interacted with matter at the cost of prohibiting contingency, because if everything is connected to God, it cannot happen randomly. Spinoza argued that people believe themselves to possess free-will and have autonomy because, being only finite, they do not see the complete picture. The purpose of human rationality was to come to understand the true nature of God, the laws of nature.  Spinoza believed that at the most basic level people have direct knowledge of nature through their senses. This can be improved into a scientific knowledge of the world that could identify connections between phenomena and so was able to make generalisations. The ultimate aim was to have direct knowledge of the generalisations, not mediated by ‘finite’ ideas or concepts and this ‘third type’ of knowledge delivered true freedom. Spinoza saw the purpose of the individual as to lift themselves out of a mundane perspective in order to comprehend the totality of creation.  Spinoza's objective, described in his Ethics, presented in the Euclidean style, was of attaining a 'God-like' perspective was picked up by the German Romantics and resulted in the Idealists assuming a deterministic outlook across a unified science.

Dr Haldane refers to a "methodological mono-culture" in economics (16:29-16:31). I  think that the mono-culture is not a specific to neo- or new-Keynesianism or Marxism etc. etc. but to the fact that they are all based on the Cartesian tradition that results in 'rationality' coming to signify a commitment to deterministic certainty.

I suspect Dr Haldane would regard these points as reading a little too much into what he has said in an informal setting, in much the same way a patient may dismiss a line their psychiatrist takes.  However, I think the distinction between a Lockean and Cartesian approach to economic policy making is fundamental to the issues the BoE is facing up to.  Consider the issue of market liquidity.  For most of the period since 1700 liquidity, the ability to transact at will, had been associated with a person's credit, Defoe discussed it frequently.  A person's credit was based on their trustworthiness and the financial system was founded on believing 'promises to pay'.  Today much of the research on liquidity, some of it funded by the BoE, seems to see 'liquidity' as a utility that is the responsibility of the regulator.  This tends to focus on defining the capital reserves of institutions, based on the assumption that the economy is a deterministic system, and ignores the Lockean issue of trust.  I suspect these points have broader relevance in the whole issue around "post-truth" politics: people who think there is an issue seem to have lost the faith of the public.

Some post-scripts:

  1. Proofs that the economy is not deterministic are fairly straight forward to construct.  Locke and Spinoza would agree that peoples' beliefs are formed by their experiences and inform their decisions.  Hence, whether or not a person has a conversation with another determines the future.  The economy can only be predictable if individual interactions are predictable.  This is only possible if all peoples deaths are predictable, which is not the case since earthquakes and hurricanes are not predictable.  It might be admirable to aspire to identifying the equations that represent the economy and amass the data, but in the meantime I think it would be better to focus on what is important and achievable in an uncertain world, such as restoring public trust in economics.
  2. It might seem odd that a mathematician is sceptical about the Euclidean method.  Most mathematicians appreciate that a proof of a theorem starts at the result and the process of working out what is required to deliver the proof.  This approach to organising science was the great contribution of the ancient Greeks and was rooted in Platonic Forms, which needed to be the foundations of knowledge.  This fact about Euclid was not really appreciated until Frege in the 1880s and resulted in Descartes belief in innate ideas and justified Kant's synthetic a priori truths.  Its a great way of 'proving' the conclusion you want to, with Hobbes being the first great exponent.
  3. An interest.  I submitted a grant application to the BoE in spring 2016 for funds to model, mathematically, the effect that trust might have on the resilience and effectiveness of financial networks.  It was declined. 

Monday, 8 February 2016

Quaker bankers: building trust on the basis of sincerity, reciprocity and charity

This post follows discussions of the norms sincerity, reciprocity and charity in financial markets. It suggests that the success of Quaker finance, that funded the British Industrial Revolution (the Darby's of Coalbrookdale, the Stockton and Darlington Railway) was based on trust built on the norms. A full argument is in a working paper Discourse Ethics for Debt Markets.
Trust is defined as “a firm belief in the reliability, truth or ability of someone”. Accounts of how trust is developed vary, however they involve terms connected to sincerity, such as: honesty, integrity, credibility, predictability, dependability and reliability; terms connected to reciprocity, such as: judgement and fairness; and terms related to charity, such as: benevolence, goodwill and responsibility (Seppänen et al., 2007:255). Essentially, the synthesis of the norms sincerity, reciprocity and charity, can be seen as the basis of trust in commerce and our argument reduces to: finance relies on trust, which is built on the three norms. This might be regarded as naïve and trust a nebulous concept. However Quakerism represented in the names Barclays, Lloyds, Cooper, Waterhouse and Peat in connection with banking and accountancy offer testament to its concrete practicality.
The Quakers emerged as a non-conformist Christian sect during the English Civil War (1642‒1651) and became an important expression of independent (not Anglican/Episcopalian or Presbyterian) faith during the Commonwealth. The sect was ‘comfortably bourgeois in character’ and egalitarian, promoting the rights of women and would lead the Abolitionist movement in the nineteenth century. With the Restoration of Charles II (1660) the Quakers were suppressed and it was during the period of persecution during that the Quakers became the dominant independent church, accounting for around 1% (60,000) of the English population in 1680.
The growth of Quakerism, while other independent sects founded on charismatic leaders disappeared, can be explained by how the sect was organised. Quakerism was distinctive from Anglicanism and Presbyterianism in rejecting a priesthood (appointed or elected) and the particular authority of the Bible. To fill the void of dogma, a system emerged where the central ‘Meeting House’ issued Queries to individual Meetings on a regular basis, enquiring about ‘the state of the society’ and posing specific questions to the congregations. The replies were reviewed and Advices issued defining Quakerism: doctrine, holding the community together, was developed in a discursive manner that was able to react quickly to events (Walvin, 1998:24‒26).
On this basis the “Quaker success story” (Prior and Kirby, 2006; Roberts, 2003) in finance was built. It could be that the financial prominence of the Quakers was a consequence of their ‘Protestant work ethic’ and frugality, which delivered unconsumed surpluses that they were able to re-invest. However, other Protestant sects were equally frugal but did not have the disproportionate influence on finance that the Quakers had.
Being a Quaker meant adhering to the regulations collected in the Advices, in return a Quaker businessmen could rely on the support of the whole community. Quakers were required to account for themselves and to monitor each other, this lead them to rely on written records that testified to individuals’ conformity to the Advices and the development of networks of communities based on letters and libraries (Prior and Kirby (2006:117‒121); Walvin (1998:46‒47)). In business, Quakers were expected to consult with more experienced ‘mentors’ before engaging in activity that required borrowing. Moreover they were scrupulous, like Antonio, in repaying debts during a time characterised by high levels of default (Prior and Kirby (2006:121‒129); Walvin (1998:55‒57)).
The Quaker commitment to the repayment of debts highlights their commitment to reciprocity. Sincerity was a consequence of their doctrine of simplicity. This ranged from simplicity in appearance, which inhibited consumerism, to simplicity ‒ honesty ‒ in speech. Quakers
detested that which is common, to ask for more goods than the market price, or what they may be afforded for; but usually set the price at one word (Walvin, 1998:32)
Quaker’s were renowned for their charity (Cookson (2003); Walvin (1998:81‒90)) and the norms sincerity, reciprocity and charity are captured in their approach to lending, encapsulated in their proverb
“Well, Friend”, said the Quaker Banker, “Tell me the answers to these questions so that I may help you in your projects, for you have opportunities: Firstly, how much do you seek to borrow? For how long? And how will you repay the loan plus its interest?” These are the issues all good bankers must explore.
The Quaker experience suggests that the culture of sincerity (commitment to truthfulness), reciprocity (commitment to fair pricing and repaying debts) and genuine care for others generated a robust financial network that was able to fund the growth of the British economy between 1700 and 1850. Quaker influence waned towards the end of the Industrial Revolution in the mid-nineteenth century. The 1844 Bank Charter Act undermined the network of ‘country’ banks that served local businesses and lead to the merger, and centralisation, of the provincial Quaker institutions. In the aftermath of this centralisation a number of Quakers became associated with financial malfeasance. The most famous example is the failure of Overend, Gurney & Company in 1866. The firm was connected to the Quaker banking dynasty, the Gurneys, and for the first half of the nineteenth century dominated the discounting of Bills and was able to underwrite other banks during the Crisis of 1825. Its failure was a result of speculative investing in the 1850s exposed in the Panic of 1866 and the refusal of the Bank of England to underwrite it. In the distributed financial network before 1844 the stability of the system rested on inter-personal relationships and trust, the Quakers’ doctrine nurtured trust and on it rested their financial success. After 1844 the stability rested on the centralised decision making of the ‘lender of last resort’.
In the pursuit of efficiency, banks, both retail and commercial, have replaced personal relationships with clients by automated systems in the loan approval process. A retail bank will employ dozens of models to convert data on a customer into a loan decision (only a dozen or so models are used in commercial lending). This has seen the emergence of the ‘credit risk modelling’ profession that develops, maintains and interprets the algorithms.
While many models appear to use the same data to make similar decisions they often deliver contradictory results. Lending managers, confronted with a diversity of results, tend to focus on a single model to deliver ‘objective truth’ without investigating why others deliver different answers. Founded on algorithms, the process cannot be sincere (it can be objective/reciprocal) and as a consequence the borrower and lender are alienated. The bank’s task is to optimise the ‘harvesting’ of loans and is devoid of charity.
Financial institutions understand that using data from social media, ‘Big Data’, will enhance the algorithms, but are prevented from doing so by European Union and U.S. legislation. However, ‘the gods punish us by giving what we pray for’ and, in the event that such data could be used it is difficult to see how existing banks would survive in competition with social media platforms that started to offer loans. This suggests that the survival of existing retail banks does not depend on their ability to implement new technologies, but their ability to communicate meaningfully with their clients1.
This account leaves open the problem facing contemporary finance: how to support a financial culture that nurtures trust in a pluralistic society, not centred on Quaker doctrine?


1 Banks cannot employ ‘machine learning’ because they need to justify their lending decisions. Because a machine learning algorithm evolves independent of human interaction, it cannot provide a justification.


   Cookson, G. (2003). Quaker families and business networks in Nineteenth-Century Darlington. Quaker Studies, 8(2):119‒140.
   Prior, A. and Kirby, M. (2006). The Society of Friends and business culture, 1700-1830. In Jeremy, D., editor Religion, Business and Wealth in Modern Britain, pages 115‒136. Routledge.
   Roberts, H. (2003). Friends in business: Researching the history of Quaker involvement in industry and commerce. Quaker Studies, 8(2):172‒193.
   Seppänen, R., Blomqvist, K., and Sundqvist, S. (2007). Measuring inter-organizational trust: a critical review of the empirical research in 1990‒2003. Industrial Marketing Management, 36(2):249 ‒ 265.

    Walvin, J. (1998). The Quakers: Money and Morals. John Murray.  

Friday, 22 January 2016

Sincerity - the subjective rationality of markets

The Vietnamese have a proverb: two women and a duck make a market. This simple saying highlights the inter-subjective nature of markets, there is an asset (the duck) who’s price is determined through the discussion of two subjects.
The foundation of this paper is in the claim that financial markets should be perceived as centres of communicative, as opposed to strategic, action. This claim rests on recognising a distinction between markets based on market-makers (in England, ‘jobbers’) and those based on brokers. A broker, whether an individual or a firm, makes their money by arranging transactions between buyers and sellers for a fee; brokers facilitate the strategic action of those who own property. Most commercial transactions, such as buying groceries, are facilitated by brokers, such as retail supermarkets; in the context of financial markets brokers mediate between ‘investors’. Brokers make a living from the commission they charge for bringing buyers and sellers together. Most general retailers look for a 100% commission (they charge buyers twice the price an item is sold for), auctioneers charge sellers and buyers commissions running 10%-20% each, estate agents charge 0.5%- 3%; commission rates fall as the value of the asset rises. While a broker’s commission rate is proportional to the liquidity of the asset, the absolute commission is lowest on the most liquid assets.
Market-makers, sometimes known as ‘dealers’ in the U.S.1, will quote bid prices, at which they will buy an asset, and offer prices, at which they will sell an asset, without knowing if the counter-party is seeking to buy or sell the asset (though the quantity will affect the quoted prices). The market-maker makes a living through the bid-ask spread: the bid price is always lower than the offer. The bid-offer spread is highest when liquidity is low and and market-makers profit when investors are ill-informed and prices change frequently (Bagehot1971:13)2, (Millo2003:89), (Carruthers and Stinchcombe1999:Note 14), leaving them open to the accusation that they promote uncertainty. The general public encounter market-makers in banking, where banks traditionally make money by lending to and borrowing from customers at differential rates. This final observation justifies the focus on market-making in the context of debt markets.
Stock-jobbing had a dubious reputation as the English financial markets emerged in the late seventeenth century. In 1719 Daniel Defoe wrote The Anatomy of Exchange Alley in which he described stock-jobbing as
a trade founded in fraud, born of deceit, and nourished by trick, cheat, wheedle, forgeries, falsehoods, and all sorts of delusions; coining false news, this way good, this way bad; whispering imaginary terrors, frights hopes, expectations, and then preying upon the weakness of those whose imaginations they have wrought upon (Poitras2000:290)
An observation mentioned by Defoe but more explicitly stated by Thomas Mortimer in 1761 concerned the type of person involved in stock-jobbing. Mortimer makes the point that there are three types of stock-jobber: foreigners; gentry, merchants and tradesmen; and “by far the greatest number”, people
with very little, and often, no property at all in the funds, who job in them on credit, and transact more business in several government securities in one hour, without having a shilling of property in any of them, than the real proprietors of thousand transact in several years. (Poitras2000:291)
These jobbers did not only trade in vanilla products such as stocks or bonds. Murphy (2009:24-30) estimates that around 40% of the trades between 1692 and 1695 were in stock options that were being traded in order to manage the risks of stock trading: ‘hedging’. Evidence of the widespread use of options comes in Colley Cibber’s 1720 play, The Refusal (the term for an option at the time) describing the action in Exchange Alley
There you’ll see a duke dangling after a director; here a peer and ‘prentice haggling for an eighth; there a Jew and a parson making up the differences; there a young woman of quality buying bears of a Quaker; and there an old one selling refusals to a lieutenant of grenadiers (Ackroyd2001:308)
The role of stock-jobbers in the U.K. markets became normalised and an accepted part of the financial system from the late eighteenth century until 1986 when they disappeared with the ‘Big Bang’ reforms. Attard (2000) reports that at the end of the nineteenth century the number of jobbers and brokers on the London Stock Exchange were approximately equal, though the proportion of jobbers increased at times when new markets emerged. Through the twentieth century the proportion of jobbers declined: in 1908, at the height of the market before the collapse of Bretton-Woods there were some 3,300 jobbers to 1,700 brokers; in 1938 there were 1,433 jobbers to 2,491 brokers; in 1961, 697 jobbers to 2,694 brokers. The majority of jobbers worked in small partnerships of one or two members but the most of the business passed through a few large firms, such as Akroyd & Smithers, who ‘made’ the market in British government debt.
Mackenzie and Millo (2001:19-22) present a similar picture of the market-makers of the Chicago exchanges as outsiders with limited reserves while (MacKenzie2008:142) describes how the Chicago market-makers were idle in the late 1960s and a comprehensive account of market-making culture at the Chicago Board of Trade is given in Millo (2003:88-132). This reveals that while a ‘designated market-maker’ is obliged to provide bid and offer quotes to a broker the majority of market-making activity is conducted by market-makers who risk their own capital as ‘traders’.
On this basis we can describe a market made by market-makers as a discursive arena. A market-maker will make an assertion as to the price of an asset by giving the market a bid and offer price. If other traders agree with the bid-offer, they let it pass and do nothing. If, however, another trader feels the market-maker has mis-priced the asset, they will act - challenging the assertion - by executing a trade. Note that the specification of a bid-offer pair by a market-maker is critical: offering to sell air for £1,000/kg would not demonstrate anything, offering to buy air at £999.95/kg would be challenged as a mis-pricing. It is through this process, whereby one market-maker makes a claim as to what is a true price and then the claim being challenged, that the market seeks to reach an understanding as to the price of an asset. The process is one where traders are continually taking yes-no positions to validity claims implicit in quotes. Central to this process is that the market-maker’s and dealer’s “manifest intention is meant as it is expressed” (Habermas1985:99) with the evidence being that they are prepared to act on their utterances by having ‘skin in the game’ (Taleb and Sandis2014).
In what followers we shall use the term ‘jobber’, as distinct from ‘broker’, to refer to an agent acting as a market-market, trader or arbitrageur3: that is they are concerned with asset pricing as distinct from asset valuation, which is the aim of investors. We can contrast the markets mediated by jobbers from the type of markets mediated by brokers, were commodity owners undertake exchange, by considering an extreme example of commodity exchange where a central authority sets the price, such as the Emperor Charlemagne who in the ninth century, at the start of feudalism, set the ‘just price’ of commodities that would apply in Bordeaux, Aachen, Salzburg or Lubeck. When Charlemagne set the price of a good throughout his empire he was setting the rate at which a commodity would settle a tax debt, rather than relating the price to supply and demand. This had the effect that merchants could not move a commodity from an area of abundance to region with a shortage, which would lead to a certain loss since prices were fixed. This is a central problem of economics and a focus of much economic theory is on the allocation of resources across a society. Neo-liberal economic theory has it that the ‘market’ will achieve an optimal distribution while Marxists argue that the institution of private property creates the scarcity and the consequential power-imbalances enable the bourgeois to exploit the proletariat.
The issue of the power of the price setter could be resolved by obliging the price setter to specify not just the price at which a commodity is brought (or sold) but by obliging them to offer both bid and offer prices. This is an obvious practical solution but it points to the central issue: if an authority is only giving a price at which he is willing to buy a commodity, but not at which he is willing to sell it, they is being insincere, in the sense that they are being hypocritical, about the price. By requiring authority to give both bid and offer prices their power to act arbitrarily is curtailed. Kaye (1998:22-25) describes how in France in the first decade of the fourteenth century, after a century of the society’s monetisation, the authority of Philip IV to set economic affairs was challenged by the broad public signalling the end of feudalism.
In a market mediated by jobbers, recorded prices represent, not an implicit agreement in the price quoted by the market-maker but, an explicit disagreement in the market-maker’s valuation. This is because a speculator would only trade with a market-maker if they believed they would profit at the price quoted and this would only be the case if the speculator believed the market-maker had mis-priced. The statement that market prices indicate disagreement appears incoherent with standard economic theory that argues the market price is the true price and is discussed in Bjerg (2014:24). Standard economic theory focuses on exchange undertaken by owners of commodities, in this case it is reasonable to believe that the two parties can come to some agreement as where the equivalence between commodities should rest. This type of exchange is dominated by objective rationality, discussed in the Reciprocity as a Foundationof Financial Economics.
We make sense of the apparent incoherence of jobber-mediated markets delivering prices that are disputed by noting that, unlike investors, jobbers have no commitment to the assets they trade. A jobber gives prices in much the same manner as a good book-maker - by setting prices that balance supply and demand and bringing to mind Ramsey (1931:181-183). Believing that there is an objective value of the asset they are trading can be detrimental. Market-makers should focus on the relative volume of buy and sell orders and traders make a subjective assessment as the veracity of the prices given by market-makers. This attitude is captured in Beunza and Stark (2012:394) where it is recorded that terms like buy and sell suggest a commitment to assets that traders see as a sign of un-professionalism. It was also understood by the Scholastics, who recognised that “the individual’s responsibility in economic activity is effectively eliminated” if finance rests solely on objective valuations (Kaye1998:98-99). The difference between broker and jobber mediated markets is emphasised by the difference between traditional ‘cash-and-carry’ markets, where it is possible to physically hold the asset and valuations can be regarded as objective, and ‘price discovery’ markets associated with financialisation and where the asset is intangible and so prices are subjective (Hirsa and Neftci2013:3).
Financialisation is often presented as a recent phenomenon, alongside neo-liberalism and globalisation (for example, Krippner (2005)), emerging after the collapse of the Bretton-Woods system of fixed exchange rates in 1971. However, finance - the science of money - has eclipsed commodity exchange at a number of times in the history of western Europe. Money appears in pre-Socratic Greece (Seaford2004); comes to dominate trade in the thirteenth century (Hadden1994Kaye1998); and is a significant feature of seventeenth century England and the Netherlands. These episodes of financialisation are also associated with the democratisation of politics and the development of ‘western science’.
An example of seventeenth century financialisation, closely linked to globalisation at the time, is given by Poitras (2000:274-277) who describes the emergence of stock trading in seventeenth century Amsterdam. During this time the trade of ‘duction’ shares was reported in de la Vega’s Confusion de Confusiones4 (1688). Duction shares had a nominal value of one tenth a Dutch East India Company (VOC) share but there was no expectation that holding ten ductions would entitle someone to a VOC share: . Duction shares appeared because it was impossible for the general public to participate in speculation on VOC shares, which were held exclusively by the Dutch elite and their trading incurred significant transaction costs. Duction trading enabled the public to challenge the VOC owners’ assessment of the value of the firm and in 1610 the VOC board petitioned the government to prohibit the sale of shares “in blanco” (short-selling, signifying the public felt the VOC was over-valued). The ban was ineffective, and had to be repeated in 1624, 1630, 1636 and 1677. de Goede (2005) discusses the similar phenomenon of ‘bucket shops’ that appeared in the U.S. in the 1870s and enabled the American working class to speculate on commodity prices without having to incur the cost of trading through CBOT.
While many argue that modern (quantitative) finance starts with Bachelier’s thesis of 1900 (such as Bjerg (2014:19), Appadurai (2015:2-3), Roffe (2015:11)) we would argue that Bachelier’s work, and the subsequent, independent, work of Bronzin (Zimmermann and Hafner2007) that is much closer to current theory than Bachelier, marks the end of an era that had included the railway booms and the globalisation associated with nineteenth century colonisation. Between the closure of the exchanges at the start of the 1914-1918 War and the collapse of Bretton-Woods a form of ‘gold-standard’ defined money as a commodity and after 1945 exchange rates were based on the opinions of American, British and Frech policy makers. Bretton-Woods collapsed because the global power balance changed as the German and Japanese economies grew faster than those of Britain and the U.S. In order to regulate exchange rates in this new world order governments adjusted central bank lending rates. In the 26 years between 1945 and autumn 1971, the Bank of England changed its lending rate 41 times, with 30% of these changes occurring between 1966 and 1971. In the 26 years after 1971, it changed them 216 times. As exchange rates fluctuated so did commodity prices. An exemplar is the oil price whose control passed from the Railroad Commission of Texas to OPEC and ultimately to the Brent crude futures price, where jobbers on the International Petroleum Exchange controlling the price muting the owners of the rights to produce Brent crude. In 1908 and 2008 markets were dominated by jobbers because their role in ‘price-discovery’ was necessary in an uncertain world.
Market-makers gain from investors who are taking strategic decisions of the C -M -C type but lose out to ‘informed traders’ engaged in M - M'' type speculation (Bagehot1971:13). Brenner and Brenner (1990:91) argue that ‘investors’ are preoccupied with future scarcity and so defer income. Because uncertainty exposes the investor to the risk of loss, investors wish to minimise uncertainty at the cost of potential profits, this is the basis of classical investment theory. ‘Gamblers’ will bet on an outcome taking odds that have been agreed on by society, in a discursive manner as in sporting bets, or based on stable statistics, as in roulette. ‘Speculators’ bet on a mis-calculation of the odds quoted by society and the reason why speculators are regarded as socially questionable is that they have opinions that are explicitly at odds with the consensus (Beunza and Stark2012:394).
Gambling is today regarded as profane, but this was not always the case. For the Greeks, the brothers Zeus, Poseidon and Hades cast lots to divide up the universe. The Hindus believe the world was a game of dice played between Shiva and his wife and at the heart of the epic tale Mahabharata is an, unfair, dice game between the Kauravas and the Pandavas ((Sahlins2003:27), (Brenner and Brenner1990:1-5)). Divination by casting lots played an important role in Judaism and the Bible refers to the ‘judgement’ of Urim and Thurim, which were probably two dice (Exodus 28:30, Leviticus 27:20-21, Samuel I 14:41). Gambling was often associated with sacrificial practises that were widespread and are generally known by their Native American name, potlach ((Keynes1936:17-19), (Graeber2011:56)).
The role gambling plays in archaic societies has been studied by Altman (1985) and Mitchell (1988). Altman studied an Australian aboriginal group that had access to social security payments and there was often a surplus left over after essentials had been bought. However, some individuals were excluded from social security payments by the government and there was an “inter-household variability in access to cash”. The community regarded this variability as a subjective discrimination by the Australian government and gambling “acted effectively to both redistribute cash †[and] provided a means for people with no access income to gain cash” (Altman1985:60-61). This was important in non-hierarchical communities because it meant that one arbitrary bestowal of money was not corrected by another subjective distribution, such as redistribution by a chief. Mitchell considered the role that gambling plays in disrupting hierarchical social structures, such as the Indian caste system, by studying the Wape, a Sepik community in New Guinea, and concluded that their non-hierarchical society was maintained through gambling. The pervasive nature of gambling in archaic communities can be explained as it is an objective, ‘fair’, mechanism for the redistribution of wealth (Sahlins2003:27). What needs to be recognised is that this process remains valid only so long as no single entity accumulates enough wealth that it can bankrupt all the others.
Gambling had been outlawed in the medieval period, usually because time spent gambling could be better used (Brenner and Brenner1990:58). However, building on Roman practice, lotteries began to be used as means of raising public-finance in the later Medieval period. The first private lottery appeared in the sixteenth century in Italy and the mechanism spread to France and England (Brenner et al.2008:133-138) culminating in ‘The Million Adventure’ lottery set up by the English government and drawn in November 1694 (Murphy2009:34). In the seventeenth century, William Petty, observed that lotteries were “a tax upon unfortunate, self-conceited fools” and from the start of the eighteenth century gambling became increasingly associated with “the waste of time and money; the neglect of familial and business duties; the erosion of social trust; and the severed link between hard work, talent and gain.” (Daston1998:161).
Brenner et al. (2008:98-104) argue that the de-legitimisation of lotteries, and gambling in general, comes about because during the seventeenth and eighteenth centuries there was significant social and economic change. In this environment gambling and speculation provided the ‘lower classes’ with a means to climb up the social ladder . While the lotteries enabled this disruptive social mobility, they were a necessary tool of public finance that prevented the stagnation and crises suffered by states reliant on taxation (Nash2000). By the start of the nineteenth century, finance had developed to such an extent that governments could tax more effectively, notably the incomes of the middle classes, or to borrow from the middle and upper classes. In 1808 the British Parliament set up a committee to “inquire how the evils attending Lotteries have been remedied by the laws passed”. The parliamentarians concluded that, despite the fact that the British government was still raising money through lotteries, “the foundation of the lottery system ...under no ...regulations ...will it be possible ...[to] divest it of ...evils” (Brenner and Brenner1990:12). The status of lotteries was changing and in 1823 they were outlawed, with the last draw taking place in 1826, the working classes were excluded from the opportunities to get rich that participating in public-finance, by purchasing lottery tickets, provided. .
Daston (1998:172-174) argues that usury prohibitions inhibited the use of mathematics in insurance and for much of the seventeenth and eighteenth century life-insurance provided people with the opportunity to gamble on the lives of others. The first life-insurance fund to be managed on the basis of mathematics was the Scottish Ministers’ Widows Fund established in 1744 (Hare and Scott1992). The model was copied in the Presbyterian’s Ministers Fund of Philadelphia in 1761 and the following year the English Equitable Company was founded. Mathematics and life-tables would enable the emerging middle-classes to provide, responsibly and prudently, for their families in the event of their death. By the end of the century ‘gambling’, in the form of insurance, had become a legitimate practice if based on rational foundations (Zelizer1979Daston1987) and in 1774 the Life Assurance Act distinguished between legitimate insurance and illicit gambling and became known colloquially as the Gambling Act.
The prohibitions on gambling had an important impact on the development of finance. In 1851, following a dispute between two counterparties in a forward contract, English law established that there needed to be ‘intent to deliver’ for a derivative to avoid being classed as an illegitimate gamble (Swan1999:211-213); the only legitimate exchange was of the C - M - C type, M - M'' of the duction trade and ‘bucketshops’ was illegitimate. While English courts generally avoided becoming involved in the derivative markets, U.S. courts were much more active in restricting speculative behaviour and were vigorous in prosecuting “idlers who made profit even while they slept” (de Goede2005:62, quoting Fabian) by speculating in bucketshops rather than the “competent men” of CBOT engaged in “the self-adjustment of society to the probable”, as the U.S. Supreme Court ruled in 1908 (de Goede2005:71). We stress how the Supreme Court ruled that only an elite could speculate on the markets just as they prevented the poor from betting on horse-racing by only allowing on-course betting relate these observations to Levy (2012)’s account of the alienation of the public from financial risk by U.S. corporations at the end of the nineteenth century.
The strict prohibitions persisted into the late twentieth century and in 1968 CBOT consulted lawyers about offering an index future, but had been told it would probably be ruled as illegal. While commodities, including stocks and bonds, could be delivered, the ‘index’ could not (MacKenzie2008:145). The publication of the Black-Scholes equation, where all the variables were ‘known’, removed uncertainty in pricing options and meant derivatives trading was not gambling, it was, like insurance, ‘scientific’. In similar circumstances, in 1997 the International Swaps and Derivatives Association (ISDA) sought the advice of an English barrister as to the regulatory status of Credit Default Swaps (CDS): the ‘Potts Opinion’. The issue was two fold: on the one hand iff CDS were insurance contracts they would be regulated by strict insurance law while if they were wagers, they would be subject to gambling legislation. A CDS is a contract where by a protection buyer pays a regular premium to a protection seller over a fixed period. If the contract underlying the CDS defaults (a strictly defined term that goes beyond fails to pay) then the protection seller pays a specific amount and the contract ceases. Potts argued that, since the amount the protection buyer receives is independent of the loss they incur and the related feature that protection buyers do not need to have an interest in the underlying, the CDS is not an insurance contract. The CDS is not a ‘wager’ since the protection buyer and seller do not hold opposite views of whether the underlying will default or not: there is no winner or loser.
The Bible suggests that humans suffer because they were expelled from the Garden of Eden into a world of scarcity. The thirteenth century rabbi, ben Maimon (Maimonides), argued that God’s punishment was not so much about scarcity but uncertainty. In the Garden of Eden humans had perfect knowledge, which was lost with the Fall and it is the loss of this knowledge which is at the root of suffering: if we know what will happen we can manage scarcity (Perlman1997). Classical economics seems to hold an implicit assumption that the price of a commodity can be known. Sometimes in economics uncertainty comes to dominate and during these periods the central problem facing markets is how to price an asset whose prospects are radically uncertain. Keynes (1921:321-322) recognised this when he observed that the largest class of problems in economics were not reducible to the conventional concept of probability: the problem is one of ontology, numerical probability economic events in the future does not exist. Ramsey (1931:181-183) criticised Keynes’ rejection of mathematical probability by introducing the ‘Dutch Book’ argument (Hájek2008) that argues probabilities (which are proxies for prices) can be ascertained in a market-mechanism: Ramsey argues for a subjective view of probability and that “Having any definite degree of belief implies a certain measure of consistency”, or sincerity.
We offer the conjecture that at times of economic uncertainty, such as when new markets are being established through either globalisation or technology, jobbers become essential in discovering prices through a discursive process that rests on sincerity. At such times we cannot rely on enlightened authority to value assets and must involve speculative traders in setting prices: it is a co-operative process as defined by Gide (1898). This conjecture seems to be aligned to Sotiropoulos et al. (2013) where it is argued that profits made in the presence of uncertainty need not be exploitative.
The pragmatic maxim demands we consider the practical consequences of our assertions. To this end we consider the claim that sincerity is fundamental to successful markets by examining the practice of ‘order stuffing’ on electronic exchanges, the status of Credit Default Swaps (CDS) and the role of Collateralised Debt Obligations (CDO) in the Credit Crisis of 2007-2088.
The two women in the Vietnamese proverb do not require the mediation of a broker but in this situation we can presume, because the owner of the duck is not specified, that the price is a sincere price at which the women would both buy and sell the duck. Modern markets, whether financial or consumer, where technology facilitates the matching of buyers and sellers for a relatively small fee, appear to follow this model. However in the domain of High Frequency Trading the practice of ‘order stuffing’, issuing large numbers of orders to an exchange and then cancelling them within a tenth, often a hundredth, of a second is widely regarded as being an attempt to manipulate the market. While acknowledging this concern, the UK Government Office for Science has not advised that any legislation should be enacted in order to prevent the practice. They argue that there is a competitive market in exchanges, and legislation would discourage trading on the UK exchanges (Foresight2012, Section 8.2). This fails to appreciate lessons of the LIBOR manipulation scandal, that sincerity is foundational to the markets, and submitting and then cancelling orders signifies a lack of sincerity.
The Potts Opinion is not in the public domain and so we cannot be certain of its full purpose but what is apparent is that his argument seeks to legitimise the pricing of credit risk through jobbers rather than brokers, whether ratings agencies or brokers. This means that ‘informed traders’ are able engage in discourse about the liklihood of credit defaults in the future, rather than limit the discussion to investors with vested interests. Some claim that because CDS are so like insurance contracts they should be treated as insurance contracts, in particular that not requiring a CDS protection buyer to have an economic interest in the underlying creates moral hazard. Kimball-Stanley (2009:253-261) gives a number of reasons for re-classifying CDS but none of them is convincing5 and all overlook the negative impact insurance companies, such as AIG, and ratings agencies had in the Credit Crisis of 2007-2009.
With regard to the Credit Crisis in general, MacKenzie (2011:1811) makes the point that the financial instruments at the heart of the crisis were not priced using the jobber mediated “canonical-mechanism market”. Valuations were based on ratings provided by agencies paid by the producer of the financial instruments (a broker mediated model) and mathematical models using parameters based on unrelated markets. Because these parameters meant the models pointed to arbitrage profits, they were widely used with only a few exceptions (Tett2009:148-151). This example leads us to distinguish to cases of financialisation. There is the one discussed in the previous section where by jobbers price in the abstract and apply subjective judgement. There is a second where ‘quants’ abstract and employ algorithms and data, what might be described as objective judgement, in a strategic manner. The second form of abstraction failed, as most experienced traders believed it would (Tett2009Triana2009Haug and Taleb2011Duhon2012). From a mathematical point of view the failure of the models was in their instrumental use; the legitimate use of mathematical models is to develop a clearer understanding of what can be inferred about market sentiment from jobber-mediated market prices so that trading decisions can be taken ((Johnson2011); (Beunza and Stark2012:384-385); (Duhon2012:265-277)).
We can conclude that some form of jobber-mediated market mechanism, based on sincere discourse about prices in an uncertain environment, is essential for markets to perform as they are expected to. The Committee on the Global Financial System (2014) of the Bank for International Settlements has observed a decline in market-making activity that is regarded as problematic. They argue that regulation has reduced the ability of jobbers to provide liquidity - by taking on risk - and this liquidity gap will have broader economic consequences. This raises a question: why does economic theory advocate market liquidity?
Liquidity represents the ease with which an asset can be traded. The economic justification is that it enables investors to trade as and when they wish, it gives them a sense of control, market risk has been tamed (Bernstein1998) by the investors ability to dynamically hedge, which rests on the market being liquid. Furthermore, the investor wants to, simultaneously, be able to exchange, implying a shift in supply and demand, without changing the price. Illiquid financial markets involve wider bid-ask spreads, or higher absolute commissions, representing higher transaction costs and less certainty that the market price is an accurate reflection of the asset’s value. Liquidity is an essential assumption of the Efficient Markets Hypothesis (Fama1970) where it is taken that the “primary role of the capital market is allocation of ownership” and so prices must “provide accurate signals for resource allocation”.
The instrumental, as distinct from the epistemic, use of mathematics in finance to hedge and earn arbitrage profits relies on markets being liquid. Canonical failures in recent finance, such as Metallgesellschaft AG in 1993, the hedge fund Long Term Capital Management (LTCM) in 1997 (MacKenzie2008:233-239) and during the Credit Crisis (Brunnermeier2009) all relate to financial strategies that failed because liquidity disappeared. This is not a modern phenomenon, in 1706 Defoe explained the liquidity problem in the debt markets in this description of ‘Lady Credit’
Money has a younger sister, a very useful and officious Servant in Trade ... Her name in our Language is call’d CREDIT ... 
This is a coy Lass ...a most necessary, useful, industrious creature: ...a World of Good People lose her Favour, before they well know her Name; others are courting her all their days to no purpose and can never come into her books. 
If once she is disoblig’d, she’s the most difficult to be Friends again with us (de Goede2005:28)
The economic role of liquidity can be summarised as in facilitating the strategic action of investors. Before the Enlightenment liquidity risk, and related market risk, seem to have been an accepted feature of finance. The ‘instrumental mindsets’ that came to dominate in the nineteenth century. However, the tools that control market risk rely on liquidity, and, in the aftermath of the Credit Crisis, we see an emphasis in the financial and economic on focusing on ‘liquidity risk’. Under the current regulatory framework liquidity providers are likely to be highly capitalised institutions, global investment banks or hedge-funds employing algorithms, seeking to make a profit. Based on the analysis presented here, noting Attard (2000)’s observation that most English jobbing firms were small partnerships risking their personal capital, this approach has two drawbacks. Firstly, these institutions will not be that heterogeneous and so susceptible to ‘group think’/‘herding’/‘the superportfolio effect’: there would not be the pluralism necessary for the discourse required in price-discovery. Secondly, these institutions have power and so could come to dictate prices: ‘order stuffing’ is a manifestation of this.
In light of this observation we can state the main result of this section as a question: should society see the principle role of markets as either; facilitating the strategic action of investors; or, delivering prices of assets. We note that a market can always deliver prices, with the bid-ask spread acting as a confidence interval, but it frequently fails to deliver liquidity.
These comments suggest regulatory policy should create a clear distinction between firms undertaking brokerage and those involved in ‘jobbing’, making it explicit which institutions are ‘speculating’ and which are ‘investing’. This implies support of the ‘Volker rule’ in the U.S. and reversing some of the regulatory changes associated with the U.K.’s ‘Big Bang’ reforms of 1986. This would address one of the issues that Kimball-Stanley (2009:257-258) identify: the fact that while one part of Goldman-Sachs was manufacturing Mortgage Backed Securities (MBS) and selling them to customers, another part was using the CDS market to speculate on the value of the MBS falling. The speculators were right and were able to signal their beliefs by trading in CDS, yet rather than criticise the process of manufacturing MBS Kimball-Stanley (2009) seeks to silence speculators by banning CDS. What Goldman-Sachs was doing was mis-selling6 MBS to customers because, as an institution, it did not believe the products had the value they were marketing them at: it was being in-sincere.


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1 The New York Stock Exchange employs the ‘specialist’ system that combines the role of broker and dealer. From our perspective this is a degradation of the market-maker’s particular role for the benefit of the monopolistic specialists.
2 W. Bagehot was a pseudonym for Jack Treynor.
3 Arbitrageurs aim to ensure prices of many assets in the market are consistent, a practice described by Fibonacci eight hundred years ago (Fibonacci and Sigler2003:180).
4 While ‘confusion’ has long meant disordered, in metallurgy, a branch of finance in the seventeenth century, it was used to refer to the point at which metals, such as gold and silver, mix as molten liquids - ‘com-fundere’ = ‘with pouring’. Confusion de Confusiones may be a pun implying a disordered mixing.
5 In A, the hedge-funds had an insurable interest; B, ratings agencies had a bigger influence on pricing mortgage default than CDS; C, banks win and lose with CDS - that’s the point of market-making; D, disassociating payout from loss does create moral hazard if there is an insured interest, standardising payout enables price discovery.
6 In January 2016 Goldman-Sachs reached a $5.1bn settlement with the US government and other agencies for mis-selling mortgage-backed securities in the run-up to the financial crisis