Financial crises, ethics and academics: A bit more Mea Culpa would help

Joris Luyendijk, the anthropologist who interviews finance professionals for The Guardian has recently published an interview with an London based academic who  is a quant "of sorts".  Joris, as an anthropologist, has been trained to interview people and distinguish the wheat from the chaff, and appreciate when they are constructing myths to protect their psyche from unpalatable truths.

One unpalatable truth that (primarily Anglo-Saxon) academics have to face up to is their role in the current financial crises that have ravaged first the Atlantic nations and now the Mediterranean ones, but not much elsewhere.  The first myth in relation to the crisis is that it was all "evil bankers". This was created not by academics but governments whose hands were covered in the blood of Mortgage Backed Securities, sub-prime lending (and borrowing)  and Private Finance Initiative securitisation.

However, possibly more guilty, but less exposed, are academics in finance and economics.  If it wasn't so worrying it would be hilarious that in 2008 UK Economics was judged to be the jewel in the crown of British academia which lead the monarch to ask the obvious question, why did none of the brilliant economists (advising her government at least) see the crisis coming?

Eugene Fama has recently explained that (his) economics never failed.  The didactic joke is "A psychotic builds castles in the skies, a neurotic lives in them and a psychiatrist collects the rent", on this basis Fama seems to be both psychotic and neurotic, though I don't think he's paying any rent, suggesting his psyche is already shot and doesn't need any protection.

More rational economists look to the large slow moving targets, in this case mathematics.  One of the most influential making this case was the Adair Turner, trained in economics and history and the Financial Services Authority's Chairman.  Lord Turner put the blame on "a  mis-paced reliance in sophisticated mathematics"

The increasing scale and complexity of the securitised credit market was obvious to individual participants, to regulators and to academic observers. But the predominant assumption was that increased complexity had been matched by the evolution of mathematically sophisticated and effective techniques for measuring and managing the resulting risks. Central to many of the techniques was the concept of Value--at--Risk (VAR), enabling inferences about forward-looking risk to be drawn from the observation of past patterns of price movement. This technique, developed in the early 1990s, was not only accepted as standard across the industry, but adopted by regulators as the basis for calculating trading risk and required capital, (being incorporated for instance within the European Capital Adequacy Directive)

This is good rhetoric:  start with a statement that no one would quibble with, follow this with something that slips into conjecture and then conclude with something that is base opinion, but carries the weight of deduction.  I would suggest an over reliance on lax thinking, like this, has been more of a problem.  The Financial Times was not impressed.

The  lecturer seems to be following this line, it is the "mathmos" with vaguely Aspergers like qualities who could not communicate in banks that caused the problems.  Does he mean  Ed Thorp? James Simons? Antony Ledford?   In my experience, I worked in industry before taking my PhD, it is the students who have social skills that leave the cloistered world of universities and go into the more corporate, collegiate atmosphere of the work place.  Is the criticism of quants in the work place a case of projection?

Having identified the problem personalities we move on to the philosophical

I do research and I teach. When I see my students go off on careers in the City I do wonder: can't society make better use of all that talent?

What would be a better use of their talent?  Working for British Aerospace building weapons and bribing governments?  Maybe working for Novartis developing drugs and suing health boards for using cheaper alternatives. There is a tendency amongst academics to be unable to recognise that their students may not want to imitate their teachers, and don't want to ensconce themselves in academic ivory towers.  The exaggerated difference between the salary rates is the protective myth: I if it were not for filthy lucre, my students would follow in my footsteps.

Commenting on both these issues, of social skills and use of talents, go back and read about Newton at the Mint.  A grumpy academic but a personable financier, and in the opinion of Maynard Keynes, as important as a financier as a physicist.

The University of London is very difficult for students to get into, probably harder than Oxbridge for flagship degrees.  Investment Banks usually recruit BScs/MScs at £32k-£40k and have around 40% attrition after 3 years, English universities, charging £27k for a BSc or £20k+ for an MSc, don't like to highlight these unpalatable facts to students trying to get onto their courses.  Rather, they attract students with the promise of stellar salaries if you make the grade and get a place.  Academics are responsible for accepting students onto their degrees and are responsible for what they teach and how they teach it.  The "the recruitment circus that banks and financial firms roll out" is not that different from the hoops the elite universities make applicants jump through.

If you get AAB at A-level with an A in mathematics you can come and study Actuarial Science at Heriot-Watt.  If you get an average grade above around 65% in your degree you will graduate with a full set of exemptions from the basic actuarial exams, you graduate "part-qualified".  A part-qualified actuary earns between £25k-£32k.  Around 92% of our students go into graduate employment, the same rate as the LSE (according to the Sunday Times rankings), though only about 60% will be working as part-qualified actuaries.

When I talk to prospective students they ask about their "personal statement" , which, along with the interview is a big part of the UL application that they will make to us alongside Warwick.  At Heriot-Watt there is a tradition of taking anyone who meets the grade, we don't read personal statements ( a student from the local Currie High School is unlikely to have had the opportunities to pad out their statement that a student from Heriot's or Fettes would) and the "interview" is an opportunity for the students to learn about us, not for us to judge the student.

English students are the customers, they are paying the universities.  The government has no cap on universities taking students with AAB, that means an AAB student is "pure profit" for a university and the universities should be competing for them, not AAB students competing for the university (or this is what neo-classical economics would posit).

Our London academic argues

There is a generation gap between students and professors, clearly. Many of my colleagues conceive of a university education at least partly as Bildung, an opportunity for young people to discover, develop and realise themselves, and we believe society will benefit from that.

Most of our students could not care less about all this. They conceive of us as a hurdle; a selection station to get through. They aren't here to learn, they are here to pass

If this is really the case, the academic should make this clear to applicants, you are paying us lots of money "to discover, develop and realise" yourself, rather than you are paying us lots of money to buy a lottery ticket for a position at a bulge bracket bank.  At Heriot-Watt we are honest; come here and become an actuary.

The interview begins where I shall end: ethics.  Academics decide what to teach, and it is generally academics who have decided not to teach ethics.

There are two ways to look at money, as a 'convenient' commodity to facilitate exchange, or as a representation of a 'social relation'.  Money is gold or money is credit.  If money is nothing more than a commodity then its key feature is scarcity, if money is credit the critical variable is trust.  For centuries the 'City of London' has been associated with   the concept that "my word is my bond'', giving a clear indication as to where the City's financiers thought the emphasis should be.

The breakdown of this ethos did not begin, as many imagine, with Thatcherite policies or Reaganomics of the 1980s.  In 1950  a case was heard in the British courts,  Buttle v Saunders.  Saunders managed a trust for Buttle, and had agreed to sell a piece of land owned by the trust for £6,142 to a Mrs Simpson.  Before the transaction had become legally binding, another person offered the trust £6,400 for the land.  However, Saunders believed ``my word is my bond'' and declined the higher offer in favour of the original agreement with Mrs Simpson.  The beneficiary of the trust, Buttle,  took Saunders to court, and the court ruled in favour of Buttle

 The only consideration which was present to [the trustees] minds was that they had gone so far in the negotiations with Mrs Simpson that they could not properly, from the point of view of commercial morality, resile from those negotiations.

'Commercial morality' was not a valid consideration  and the sale to Mrs Simpson was declared null and English home-buyers could never again be certain that a purchase would be completed, 'gazumping' had arrived.

Three years after Buttle v Saunders Milton Friedman published  The Methodology of Positive Economics that begins with a reference to Neville Keynes's The scope and method of political economy.  The implication that Friedman offers the reader is  that ``Keynes called for'' the ``construction of a distinct positive science'' is somewhat mischievous.  Neville Keynes distinguished the `positive' economics from the `normative' economics ``an ethical, realistic, and inductive science'', principally advocated by the German Historical School

The school explicitly calls itself ethical; it regards political economy as having a high ethical task, and as concerned with the most important problems of human life. The science is not merely to classify the motives that prompt to economic activity; it must also weigh and compare their moral merit. It must determine a standard of the right production and distribution of wealth, such that the demands of justice and morality may be satisfied. It must set forth an ideal of economic development, having in view the intellectual and moral, as well as the merely material, life; and it must discuss the ways and means such as the strengthening of right motives, and the spread of sound customs and habits in industrial life, as well as the direct intervention of the State by which that ideal is to be sought after. ...

However, unlike Friedman, Neville Keynes sees the two approaches as, at least, complementary

The method of political economy cannot adequately be de-scribed by any single phrase; and accordingly no one method will be advocated to the entire exclusion of other methods. It will, on the contrary, be shewn that, according to the special department or aspect of the science under investigation, the appropriate method may be either abstract or realistic, deductive or inductive, mathematical or statistical, hypothetical or historical.

Positivism, the idea that science is an "impersonal way of arriving at the objective truth about natural phenomena'',with its associations with 'Baconian science', 'knowledge is power', and empiricism, became a doctrine attached to many branches of science by the mid-1960s.  This doctrine was taught in universities, particularly in the English speaking world}, and it is hardly surprising that if educators are removing ethics from university science, then there will be a breakdown of ethics in society.

Our academic argues its difficult to teach ethics to the Asperger's types that he has to deal with, because it involves complex issues and debates.  I disagree.  Virtue ethics, as promoted by Deidre McCloskey, with its blending of the seven virtues in an alchemical manner is easy for Asperger's types (like myself) to deal with. The problems come with consequentialism, which again is popular with academics because it allows them to blather for ages without coming to a definite answer. 

There is an alternative view of ethics and quants, and that was written by the mathematician with a background in the humanities, Steven Shreve.  Shreve, a leading financial mathematician who is behind Carnigie-Mellon's prestigious Masters in Financial Engineering writes

 we need people with integrity managing our financial systems. Teaching ethics is difficult, and guaranteeing that listeners will implement those teachings is impossible. It is not easy for a quant to sound the alarm that his models are being stretched beyond their limits, knowing that if he is taken seriously it will result in the loss of business to competing firms and may result in the loss of his job. We cannot instil in sixteen short months behaviour that properly requires years of nurturing and mentoring. We do what we can, leading by example, penalizing students for academic dishonesty, setting and enforcing rules for ethical conduct when interacting with potential employers, posing ethical dilemmas for classroom discussion, and encouraging our graduates to consult with fellow graduates when facing tough ethical decisions.

This is the response of a quant, the problem is difficult, but we do what we can, recognising the limitations.

On the Shoulders of Merchants: Gresham, Stevin and science

When the short lived Edward VI became king of England in 1547, the nation’s wealth was based on the export of one commodity, wool, out of London and into Antwerp [Stone, 1947, p 104]. Edward was succeeded by his Catholic sister Mary, who married Philip of Spain but died young and was followed by her Protestant sister, Elizabeth, in 1559. During the turbulent times of Elizabeth’s reign, security, and not prosperity, became the main object of Tudor economics.

Central to managing the economy was Thomas Gresham. Born in London around 1519 into a prominent merchant family, Gresham was appointed the ‘Royal Factor’ at Antwerp in 1551. The role of the Factor was to arrange for Antwerp speculators to lend money to the English crown, mainly to cover the costs of war. The loans were typically short term, lasting six or twelve months, and so the Factor had to continually re-negotiate the agreements. Gresham realised that key to the process was ensuring that the exchange rate was favourable, and to this end he managed the trade in English Bills of Exchange, making sure they were in short supply, and so more valuable, in Antwerp, when he wanted to borrow money. This was no mean feat and, despite falling out of favour with Mary, Gresham became an influential member of the Elizabeth’s court.[Burgon, 2004, [pp9-12], [Johnson, 1940, pp 594-600]

Gresham moved in the circle of Elizabeth’s Secretary of State, William Cecil, Lord Burghley, advising him to develop the English armaments industry in preparation for war [Burgon, 2004, [pp9-12]. Apart from the likes of the spy Francis Walsingham, and the writers Christopher Marlowe and Philip Sydney, others in the group were the mathematicians Robert Recorde and John Dee. Recorde, one time Controller of the Royal Mint, is famous for introducing the “=” sign into mathematics, in the book The Whetstone of Witte dedicated to the Governors of the Muscovy Trading Company that had created to develop English the wool trade with Russia. John Dee is notorious today for being a ‘magician’, but during his lifetime his fame was based principally on his mathematical knowledge, which included the ability to cast horoscopes, Dee had worked with Cardano when the Italian was in London. Dee was also an adviser to the Muscovy Company and worked with Gresham on commercial ‘projects’ to “make this kingdome flourishing triumphant, famous and blessed” [Hadden, 1994, p 109]. This system, where the economy was run to ensure a nation controlled its own armaments industry and accumulated gold or silver, became known as ‘mercantilism’ and would dominate Europe until the Enlightenment.

In 1565 Gresham established the Royal Exchange, modelled on Antwerp’s Bourse, to trade commodities and currencies. He returned to London in 1567, as the Dutch Revolt became inevitable, and in 1579 he died of a stroke. In his will, Gresham left all the revenues from the buildings that made up the Royal Exchange along with his mansion on Bishopsgate to the Company of Mercers and the City of London. In return, these two bodies were to support seven academics, in Law, Rhetoric, Divinity, Music, Physics, Geometry and Astronomy, to be housed in his mansion. The properties were held by Gresham’s widow until she died in 1596, and Gresham’s College opened in 1598. According to the historian, Francis Johnson

The opening of Gresham College was the culmination of a long effort in Elizabethan England to bring about the establishment of a permanent, endowed foundation which would offer instruction and further research in the mathematical sciences and provide a convenient rallying point for all who were concerned with promoting progress in the practical application of these sciences to useful works. [Johnson, 1940, p 424]

Remarkably, the mathematical chairs at Gresham College preceded those at Oxford, where the Savilian chair was established in 1619, and Cambridge would wait until 1663 to create the Lucasian chair in mathematics. [Johnson, 1940, pp 423–424]

Across the Channel, one of the most significant characters emerging out of the turmoil of the Dutch Revolt was Simon Stevin. Born in 1548 in Bruges, like Gresham, Stevin had originally trained in the abbaco tradition and worked as a merchant’s clerk in Antwerp then as a tax official back in Bruges, where he wrote his first book Tafelen van Interest (‘Tables of interest’) which he published in 1582, before moving to the University of Leiden in 1583. He taught mathematics at the University, one of his students being Prince Mauritz of Nassau, who had succeeded his assassinated father William the Silent as leader of the Dutch Revolt. Stevin was involved in the the Dutch Republic’s government, becoming Inspector of Dyke’s, an important post in the low countries, in 1592, and Quartermaster-General in 1604, advising Mauritz on tactics including how to breach dikes in order to flood the land and hinder the Spanish. [Sarton, 1934]

One of Stevin’s most influential posts was as the director of the Dutch Mathematical School, established in 1600 by Mauritz to train military engineers. In 1605 Stevin published a textbook for the School, the ‘Mathematical Tradition’, which was a comprehensive overview of mathematics and included a whole section on ‘Accounting for Princes in the Italian manner’. In a very short period, the Dutch Mathematical School became the centre for merchant’s training in north western Europe. This in turn forced the authorities at the University of Leiden, which provided the School with its facilities, to take practical sciences, in particular mathematics, a bit more seriously [Poitras, 2000, pp131–132].

The significance of the School was that, up to this point, universities had maintained the Aristotelian view of mathematics as being only concerned with the quadrivium, abstract arithmetic and geometry or astronomy applied to calculating dates, and music [Dear, 2001, p 17]. These were not very prestigious in the scholastic world and mathematicians were generally poorly paid [Dear, 2001, p 104]. The incorporation of the practical mathematics curriculum into the University of Leiden can be seen as a conclusion of the integration of the abbaco and scholastic traditions that had begun with Pacioli a century earlier.

Stevin was particularly remarkable in that he wrote almost exclusively in Dutch or French, but rarely in Latin. This meant that his books were read widely and a consequence of the popularity of his writing has had a lasting effect on the Dutch language; it is one of the few European languages that has its own, rather than using Latin or Greek, words for many mathematical terms. For example the Dutch for mathematics is wiskunde, which literally means ‘the art of certain knowledge’. In writing in the vernacular Stevin was disassociating himself with both the scholastic and humanist traditions, which were so enamoured with Greek and Roman ideas, and emphasising the practical usefulness of science in everyday life.

As well as being active in government and administration, Stevin was also a prolific scientist, addressing both theoretical and practical problems and the economic historian Philip Mirowski has suggested that Stevin’s bookkeeping inspired his physics [Mirowski, 1989, p 121]. Practically he designed a new, more efficient, windmill, based on mathematics, to drain the land and power Dutch industry, creating a wind powered industrial revolution. Theoretically, he showed that Aristotle’s science was fundamentally flawed. 

One revolutionary step Stevin took was in regard to the fundamental nature of numbers. The Hellenistic mathematicians had taken the number ‘1’, unity, to be the generator of numbers; ‘3’ is made up of three unities, and so on which related to Aristotle’s theory of measuring using the minimum unit of the thing being measured. Stevin explicitly states that ‘1’ is a number like any other number, because mathematical operations can be performed on it, just as on other numbers. He then makes a startling observation for the time, numbers are continuous, there are no gaps in them as there are gaps between 1 and 2 of a half and a quarter, or a quarter and an eighth, and so on [Katz, 1993, p 347].

Another example, is concerned with the nature of motion.  In his Physics Aristotle starts by discussing the concept of motion and then, having pinned down the idea through reasoning, or logic, goes on to deduce the properties of moving bodies, including the belief that heavier objects fall faster than lighter objects [Hall, 1962, p 161]. In an experiment that is usually attributed to Galileo dropping things from the Tower at Pisa some years later [Hall, 1962, p 78], Stevin disproved this core belief of Aristotle. The Dutch bookeeper was less interested in what ought to happen, but rather what actually happened.

Another result usually associated with Galileo was concerning the tides. Galileo’s original title for the the ‘Two World Systems’, the book that got him into trouble with the Catholic Church, was Dialogue on the Ebb and Flow of the Sea, because, as a consequence of the Copernican theory and mathematics, Galileo argued that there would be one tide a day. When he sent the book to the Church for approval, he was told to change the title because every European sailor knew that there were two tides a day. For the Church of the time, built on Aristotle, Galileo’s use of mathematics to describe reality was not just philosophically wrong, it also resulted in absurd conclusions. The historian, Harold Brown puts a modern slant on the issue

Galileo’s attempt to account for the tides as a result of the combined daily and annual motion of the earth, and his belief that this argument provided a physical proof that the earth moves, stands as something of an embarrassment.Brown [1976]

Galileo was often preceded by Stevin, and it is ironic that Stevin had more successfully addressed the theory of tides in 1608 based on the Moon’s influence [Sarton, 1934, p 280]. Galileo’s error was in ignoring the Moon and attempting to explain the tides by the Earth’s movement around the Sun – a little too Heliocentric.

References

   H. I. Brown. Galileo, The Elements and the Tides. Studies in History and Philosophy of Science, 7(4), 1976.

   J. W. Burgon. The Life and Times of Sir Thomas Gresham: Volume 2. Adamant Media Corporation, 2004.

   P. Dear. Revolutionizing the Sciences. Palgrave, 2001.

   R. W. Hadden. On the Shoulders of Merchants: Exchange and the Mathematical Conception of Nature in Early Modern Europe. State University of New York Press, 1994.

   A. R. Hall. The Scientific Revolution 1500-1800. Longmans, 1962.

   F. R. Johnson. Gresham College: Precursor of the Royal Society. Journal of the History of Ideas, 1(4):413–438, 1940.

   V. J. Katz. A History of Mathematics: an Introduction. Haper Collins, 1993.

   P. Mirowski. More Heat than Light: Economics as Social Physics, Physics as Nature’s Economics. Cambridge University Press, 1989.

   G. Poitras. The Early History of Financial Economics, 1478–1776. Edward Elgar, 2000.

   G. Sarton. Simon Stevin of Bruges (1548-1620). Isis, 21(2):241–303, 1934.

   L. Stone. State control in sixteenth-century England. The Economic History Review, 17 (2):103–120, 1947.

The IMA Conference on Mathematics in Finance

Since John Maynard Keynes rescued a collection of Newton's private papers and declared that "Newton was not the first of the age of reason. He was the last of the magicians" the popular imagination has looked at the influence of esoteric arts on the emergence of Western' science. What is often forgotten is that in almost the same breath, Keynes declared Newton as "one of the greatest and most efficient of our civil servants", in recognition of his work as Master and Warden of the Mint, positions that he held longer than his Chair at Cambridge.

The significance of the relationship between mathematics and finance is often overlooked when considering the development of science. Probability is, to both Poincare and Russell, the foundation of all science, emerged out of the analysis of financial contracts and Bernoulli first identified the number e in the context of interest payments. On a more profound level, historians such as Richard Hadden, Joel Kaye and Alfred Crosby have provided compelling arguments that the uniquely European 'mathematisation' of science came out of a synthesis of commercial practice, following Fibonacci, and scholastic analysis. Copernicus wrote on money before he wrote on planets.

While equity options trading dominated the 1980s, today, the Black-Scholes-Merton pricing formula is used more as a gauge of market volatility than to price traded contracts and the problems of finance have moved on to managing the complex interactions of many agents in the economy. It is in recognition of this evolution that the financial world has changed, not just in the last four years but over the past 25 years, that the Institute of Mathematics and its Applications (the British equivalent of SIAM) is sponsoring its first conference on mathematics in finance, to take place in Edinburgh in  2013.

Algorithmic trading is currently the focus of financial innovation. Investors, such as pension funds, will use algorithms implemented on electronic trading systems to , hopefully, optimise their market transactions. Market makers, and speculators, will use algorithms to search the markets for profit opportunities, often executing transactions in milliseconds in high frequency trading. Algorithmic trading is typically light on mathematics, using simple trend following or mean reverting criteria, and relies more on computational developments.

Since the recent Financial Crises society has realised that financial innovation, like any technological development, is not always a good thing. The Quant and Mammon report of 1998 called for academics to support banks in innovation, today the emphasis has shifted and the consensus is that academics should be trying to understand the financial system and support society's eyes and ears, the Regulators, as much as the Banks. In response to this, the IMA have invited the Bank of England to help organise the conference and provide guidance on what the Regulators' key concerns are.

The Bank of England believes that recent developments in financial mathematics have focused on microeconomic issues, such as pricing derivatives. Their concern is whether there is the mathematics to support macroeconomic risk analysis, how the whole system works. While probability theory has an important role to play in addressing these questions, other mathematical disciplines, not usually associated with finance, could prove useful. For example, the Bank's interest in complexity in networks and dynamical systems has been well documented.

The initial outline of the conference is that it will have three parallel sessions, covering developments in algorithmic trading, the concerns of the Bank of England and contemporary issues in mainstream financial mathematics. For example, in the algorithmic trading stream topics could include data mining, pre-trade analysis, risk management and agent based modelling. As well as the Bank of England’s interest in models of market failure and systemic risk, more esoteric topics such as non-ergodic dynamical systems and models of learning in markets would be interesting. Topics associated with mainstream financial mathematics could include control in the presence of liquidity constraints, Knightian uncertainty and behavioural issues and credit modelling. 


In addition to the main mathematics Conference organised by the IMA, the Scottish Financial Risk Academy is planning to organise an "Industry Day" at the end of the Conference. 

Applied mathematics is developed as a consequence of solving problems. While it is easy to criticise the world's bankers, it is harder to come up with solutions to the complex issues they face. It is always worth remembering that the laws of physics (almost surely) do not change, but finance is constantly transforming itself. Ever since the time that Newton left Cambridge for the City, the UK has built its prosperity on financial innovation, funding the wars with France and the Industrial and Agricultural Revolutions. today financial services account for some 10% of the UK's GDP and it is only fitting that applied mathematicians consider whether they can provide solutions to the difficult problems the sector faces.

The IMA Conference on Mathematics in Finance, scheduled for early April 2013, aims to provide a forum for mathematicians to become more involved in the industry and for industry to become more involved in mathematics, and we would invite any mathematician, academic or practitioner, to attend.


If you would like to register your interest in attending the conference, please contact the IMA.

Creation myths

There is currently a debate being carried out on the internet between Steve Keen  and Paul Krugman on the nature of money. For those (like myself) who do not have a formal training in the discipline, economists will consider money to be either endogenous or exogenous to the economy. Endogenous theories posit that money is created by the economy, exogenous theories place money as a ‘tool’ outside of the ‘real’ economy.

Mainstream, ‘neo-classical’ economics is based on exogenous theories and  describes money emerging as a tool to facilitate exchange. First there was barter,  but then the problem of a “double coincidence of wants” lead the rational caveman to introduce money. This description has no basis in fact. Just as astrophysicists use telescopes to look back in time, anthropologists visit isolated communities to see how society evolved, and the evidence of this research is summarised by Caroline Humphrey

Barter is at once a cornerstone of modern economic theory and
an ancient subject of debate about political justice, from Plato
and Aristotle onwards. In both discourses, which are distinct
though related, barter provides the imagined preconditions for the
emergence of money …[however] No example of a barter economy,
pure and simple, has ever been described, let alone the emergence
from it of money; all available ethnography suggests that there
never has been such a thing.

The barter $\Rightarrow$ money story originates in Plato and Aristotle and, unlike much of Aristotle’s physics, became integrated into modern science.

An earlier Greek writer, Herodotus, the first Greek historian writing some 150 years before Aristotle, recorded that the Lydians, from modern Turkey, invented games and money, implying that they were the first gamblers. The earliest tokens used as ‘money’ were not specific weights of a certain metal but roughly cut pieces of metal with an official stamp on them.

 Coins, tokens with a specific weight of a precious metal, emerged in the  Mediterranean and Near East at around the same time as states started employing mercenary armies. States paid soldiers in gold to conquer some community, the soldiers then spent the gold in the colonised lands and the state  recovered the gold by taxing the colonised merchants and innkeepers that the soldiers had paid for food and lodgings. Greek and Roman citizens never paid tax, only the conquered paid for the privilege and were bound to the conqueror by having to exchange their resources for the Imperial currency. The model would survive, known as the the State Theory of Money, and drive colonialism in the modern age. For example, in the 1920s the British taxed Kenya at a rate of about 75% of wages and forcing the colonised to grow cash-crops to be consumed by the colonisers. The Belgians did not tax the Congo – they relied on forced, rather than ‘free’ wage labour.   These observations are sometimes used to support the theory that markets are created by governments, they are a consequence, not a pre-cursor, of civilisation.

As well as Herodotus’ historical account of the introduction of money, the  Greeks had a mythological account. Athena was the goddess of wisdom, just war, the domestic crafts and agriculture. In summary, the Greeks associated Athena with the skills and characteristics of civilisation, and the image associated with this blog is from a mosaic of Athena (as Minerva) in the Library of Congress. She was born out of the union between the Titans Zeus and Metis, the goddess of prudence and cunning. However, Zeus had been warned that Metis would give birth to children who would challenge him, and so immediately after they had slept together, Zeus swallowed Metis whole, but too late to prevent Athena’s conception, and Metis’s pregnancy took place in Zeus’s belly. Sometime later, Zeus was struck down by a terrible headache and asked Hephaestus, the god of fire, metal working, and technology, if he could do anything about it. Hephaestus split open Zeus’s head and Athena emerged, fully formed and wearing armour.

Athens was named in her honour after she and Poseidon competed to become the city’s patron god by offering gifts to the citizens. Poseidon gave the city a brackish spring, which was the basis of the city’s sea power and prosperity through trade. Athena won the competition by giving the city the olive tree, which gave the city wood, oil and food. She is sometimes known as Athena Parthenos, indicating her virginity, and the Parthenon is her temple on the Acropolis, Athens’ citadel.

Hephaestus, who was the most loyal of the gods, had an arranged marriage with Aphrodite, but the goddess of love and beauty resented being married to the lame and ugly blacksmith and so spent her time with Ares. When Athena visited Hephaestus to have some weapons made, the frustrated blacksmith attempted to rape the virgin. She resisted and was able to escape, but not before Hephaestus ejaculated on her thigh. She wiped the semen of her leg  and onto the ground where it fertilised Gaia, the goddess of the earth. The result of the union was the mortal, Erichthonius, who was raised by Athena in the Parthenon and became King of Athens. The Greek tradition is that this king gave the citizens of Athens, the plough, the four-horse  chariot, he had inherited his father’s lameness and needed transport, and money.

This is a more absorbing story than the standard economic narrative that out of barter emerged money, the medium of exchange. As well as being more interesting it is possibly more meaningful, suggesting money is a consequence of a synthesis of civilisation, technology and agriculture with the influence of the war in the background. Money is central to society.

Athena and Hephaestus play another role in the development of economic theory, as characters in what is considered the first Greek text that addresses economics, written by the poet Hesiodwho probably lived around 750 BCE, an approximate contemporary of Homer.  Archaeologists identify the period around 800 BCE as the transition between the Bronze Age and the Iron Age, and while traditionally this was seen as a time of positive technological progress, the archaeological record paints a more disturbing picture. The transition from the Bronze to Iron Age in North Western Europe took place during a mini-ice-age between 850 and 760 BCE and is now associated with a switch from interconnected communities active in regional trade to isolated communities centred on Iron Age forts. The impact of the change was food shortages, conflict replaced trade and communities moved into the hilltop forts that are still features of the British landscape. The archaeological record for the Aegean at the time also suggests that climate change led to a long running famine and there was migration from the main city-states into new areas for farming. Hesiod’s father had been a farmer and merchant in north-western Anatolia, but the recession had forced him to move to Boeotia, a barren region about 100 kilometres north-west of Athens. When he died he left his estate to his two sons, Hesiod and Perses. The oldest of Hesiod’s poems, that still exists, Works and Days, is essentially the story of how Perses, a lazy good-for-nothing, bribed the local judges and obtained most of the father’s legacy, which he then squandered. Hesiod overcame the loss of his inheritance through hard work and ended up happier and richer than his brother.

Works and Days is split into two parts; the first explains how evil, the source of strife, first came about through the Myth of Pandora’s Box. The story of Pandora starts with the theft from Zeus of the secret of fire and from Hephaestus and Athena the crafts, by the Titan, Prometheus (‘forethought’). Prometheus had created mankind and passed these secrets on to humans. Zeus, not satisfied with punishing Prometheus for the theft by chaining him to a rock and having his liver eaten each day, decided to punish the mortals as well. He asked  Hephaestus to create a the first woman, Pandora, ‘all gifts’ who was given such characteristics as beauty by Aphrodite, cunning by Hermes and the skill to spin thread by Athena. Zeus ensured she was also lazy and
foolish.

Pandora was sent to Earth to seduce Prometheus’s dim-witted brother, Epimetheus (‘afterthought’), with a single possession a jar which had been given to her under the strict instruction never to open it. However, Pandora had been given the gift of curiosity, by Zeus’s long-suffering wife Hera, and so one day she opened the jar, which contained all the evils that afflict mankind; disease, strife, war and the need to work, and these all escaped into the world. Realising her mistake, Pandora put the lid on the jar, trapping the last thing left in there – hope. Hesiod is saying that work is necessary as a consequence of Zeus’s punishment of mankind, and the story bears a remarkable resemblance to that in Genesis.

The second part of the poem then goes on to say that people can free themselves from poverty and misfortune through hard work

Both gods and men are angry with a man who lives idle; but let it
be your care to order your work properly, that in the right season
your barns may be full of victual. Through work, men grow rich
in flocks and substance, and working they are much better loved
by the gods.

The final part of the poem is a practical advice on how to run a household, the word  ‘economics’ comes from the Greek for ‘household management’, and farming. The reason why this poem is considered an early economic work, rather than a straightforward myth, is that it identifies the role that scarcity has in determining  human behaviour. The gods make life a struggle for mankind, and so we have to work hard.

The Greeks recognised the significance of the relationship between Pandora  and Athena and the story of Pandora’s birth was featured on the base of Athena’s statue in the Acropolis. Just as with the myth of the origin of money, the Pandora myth might lack literal truth but it is rich in meaning. It highlights a causal relationship between understanding technology and a greater complexity in life that results in strife.

Today, many scientists, in particular social scientists, regard knowledge as  ‘shared belief’, not necessarily ‘justified belief’, science is less about ‘truth’ and more about ‘consensus’. Deirdre McCloskey, who is simultaneously a professor of economics, history and English at the University of Chicago, recommends an Italian definition of science

the speculative, agreed–upon inquiry which recognizes and distinguishes,
defines and interprets reality and its various aspects and parts, on
the basis of theoretical principles, models and methods rigorously
cohering

Science is speculative, not certain, and agreed–upon, not secret. It is on this basis  that society can begin to understand the value of science.

This definition of science allows economics to base itself on an unjustified myth  that barter evolves into money. However, it could alternatively allow economics to build itself on the Pandora myth, a myth that is remarkably similar to the story of the Fall in the Bible. It might be argued that the barter-money myth is un-scientific, since it is not supported by evidence, just as the Biblical myth is not supported by evidence. However, the barter-money myth endures because it conforms to two key characteristics of mainstream contemporary science. The myth is progressive, it describes a linear process where by the system evolves from a primitive beginning to the complex end we experience, and it is material, its explanations, involving people, goods and metal tokens, do not rely on metaphysical concepts such as society, trust or
belief.

Physicists will argue that, while social sciences can be built on such shaky foundations, the certainty of physics is not. This overlooks the fact that physicists are constantly disregarding old theories and building new ones. Physics is the  ultimate science because it is so eager to evolve. This makes it difficult to contradict, because it will embrace its contradictions, indubitable but not
immutable.

Notes

${}^1$Humphrey [1985, p 48]

${}^2$Ingham [2004, p 98]

${}^3$Ingham [2004, p 76]

${}^4$Gordon [2005]

${}^5$McCloskey [1995, p 6]

References

   B. Gordon. Aristotle and Hesiod: The economic problem in Greek
thought. Review of Social Economy, 63(3), 2005.

   C. Humphrey. Barter and economic disintegration. Man, 20(1), 1985.

   G. Ingham. The Nature of Money. Polity Press, 2004.

   D. McCloskey. The limits of scientific knowledge. In R.F. Goodman
and W. R. Fisher, editors, Rethinking Knowledge, Reflections Across
Disciplines. State University of New York Press, 1995.

Markets, Morality and Mathematics

One of the key critics of Aquinas’ argument that a merchant could charge what heliked, providing the future was uncertain, was Pierre Jean Olivi, who was born near Béziers in Languedoc around 1248. Olivi entered the Franciscan order when he was twelve and was sent to Paris to study theology in 1267, and although he spent four years at the University he did not graduate with a masters degree. When he left Paris he appears to have started working on a theological work that took him over twenty years to complete and addressed a a range of questions, including the nature of free will. During this time he travelled widely in southern France and Italy and came into conflict with the Church hierarchy. 

Franciscans had an oath of poverty, and within a couple of generations of the founding of the order this oath began to be re-interpreted. Some Franciscans took the view that they kept to the oath if they did not own anything, others believed that this was a loop-hole, the oath required that a Franciscan should limit their use of goods. Olivi became a leader of this ‘rigorist’ or ‘spiritual’ wing of the Order. In 1282 he was accused of heresy and his writings destroyed, though he successfully defended himself in 1287 and was able to carry on teaching until his death in 1298. However, his tomb quickly attracted pilgrims and the Church, faced with a growing cult banned his writings in 1299, destroyed his tomb in 1312, and finally, when the Holy Roman Emperor, Louis the Bavarian, used some of Olivi’s arguments to attack the Papacy, he was condemned, again, as a heretic and all his works were obliterated. Umberto Eco’s book, The Name of the Rose, and the subsequent film, have these events in the background. 

Olivi’s fideism, the view that faith and reason are independent of each other and that you cannot rationalise faith, meant that he was sceptical towards Aristotelian empiricism and it was in this context that he made a revolutionary observation with regard to the selling of grain to the starving Rhodeans. He argued that the metaphysical probability of more grain arriving in Rhodes, giving the merchant excessive profits, had a certain reality, which Aquinas was ignoring by focusing on the ‘physical reality’ of the prices being offered in the market. Olivi said

 The judgement of the value of a thing in exchange seldom or never can be made except through conjecture or probable opinion, and not so precisely, or as if understood and measured by one invisible point, but rather as a fitting latitude within which the diverse judgements of men will differ in estimation.

This does not mean Olivi, despite his belief in absolute poverty, felt the merchant should charge a lower price for the grain. While Aquinas felt the market price was justifiable, but it was more moral for the merchant to lower the price, Olivi believed that the market mechanism was important. It was to the common good if prices did rise during a famine as it would encourage an increase in the supply of food.

Olivi applied this approach to the question of loans. As the historian Joel Kaye explains

if someone intends to invest his money in trade or profit, and instead, out of charity, lends the money to a friend in need, can he expect back from his friend not only the sum lent but in addition the profit he lost in not investing in trade? Olivi’s answer to this question was an unqualified yes: the borrower was responsible for indemnifying the lender for his loss of “probable profit”. and for restoring a “probable equivalence”.

 Olivi introduces the idea that market exchange is about equating expectations.

Olivi, despite his position in the Spiritual Franciscan movement, seems to have been a close observer of markets. As well as developing the ideas of Aquinas and Albert the Great, he commented that the market price depended not just on ‘need’ but on three factors; its scarcity, usefulness and desirability. Since desirability is subjective, different people will value the same good differently and based on these ideas, Olivi was able to explain the ‘value paradox’, why water, essential to life, was less valuable than gold, of no use, because gold is scarcer than water.

As a result of his condemnation for heresy, Olivi’s economic thought was retained only by a few Franciscans who secretly read his works, but, of course, could not acknowledge the influence he had on them. As a result has been only recently realised that the writings of another Franciscan, San Bernardino of Siena, were based on Olivi. Bernardino was born into a noble family in Tuscany in 1380 but was orphaned when he was six. Raised by an religious aunt he spent much of his spare time studying law and nursing the sick, remaining in Siena when it was hit by plague in 1400 and miraculously surviving. Bernardino became a strict Franciscan, abstaining from all pleasures, developed a reputation as an inspiring preacher, and now he is he regarded as the most important Italian missionary of the fifteenth century.

Just as it is surprising that Olivi observed markets, it is also surprising that such an ascetic as Bernardino wrote the first book on entrepreneurship, On Contracts and Usury between 1431 and 1433. Bernardino realised that to be successful a merchant had to be well informed; of prices, the qualities of goods and the market, be diligent in keeping accounts; be hard working; and, importantly, be willing to take on risk and he recognised that there were very few people who had all the these qualities. The book was written at a time when the Catholic Church had condensed morality into three ‘Christian’ virtues, Hope (Spes), Faith (Fides) and Charity (Caritas), and four ‘Pagan’ or ‘Cardinal’ virtues, Courage (Fortitudo), Justice (Iustitia), Temperance (Temperantia), and Prudence(Prudentia). An ethical life was one that exhibited all, not just some, of the virtues and within this context a merchant could, just as much as a knight, be seen as being ethical. 

Seven Virtues  c. 1460 Pesellino (Francesco di Stefano) workshop,  Birmingham Museum of Art, Birmingham, AL

The thirteenth century saw a flowering of European science, driven by a flood of classical texts being translated from Arabic. Aristotle became “the Philosopher” and his works came in for particular attention. In Nicomachean Ethics Aristotle considers the justice of economic exchange and argues that reciprocal, fair, exchange in the market as being fundamental to a well functioning society since it binds individuals together. Exchange is not performed in order to generate a profit, for gain, but to correct for inequalities and to establish a social equilibrium. So, for medieval scholars, like Aquinas and Olivi, the virtue of Justice should be central to the actions of a merchant.

Prudence is the ability to judge between different courses of action, it is at the root of reason and rationality and can be seen as the motivation for all science. This virtue is the one most closely associated, in the modern mind at least, with effective merchants. Temperance is the virtue least associated with modern bankers, its corresponding vice being gluttony. However, the modern understanding of temperance as denial is not only how a medieval friar would have understood the virtue. Temperance is at the root of humility, an acceptance that the human is not all-knowing. A good merchant would exhibit the virtue by allowing for the unforeseen, and consequently, diversifying, or at least not betting the house on a single venture. Prudence and Temperance complement each other.

Courage, the remaining Pagan Virtue, is demonstrated by the merchant in being able to commit to a risky venture. However, Courage untempered by the other virtues is rashness, and should be avoided.

Faith is the ability to believe without seeing, and was central to Olivi’s whole philosophy. The Latin root is fides, which gives federal, and captures the concept of trust, the very essence of finance. While Faith is backward looking, you build trust, Hope is its forward-looking complement. When Christian Huygens was translating his ‘On the Reckoning at Games of Chance’ from the Dutch into the more scholarly Latin he had a lot of trouble translating the word kans (‘chance’), which would normally be translated as sors. Eventually, he, or his editor van Schooten, chose expectatio , giving the English term ‘expectation’ (in the mathematical sense). While the English are left expecting, Huygens had also considered using the term spes, or ‘Hope’ and the French have taken this line, using the word espérance when referring to mathematical expectation. Statistics can be seen as the mathematical expression of Faith, while Probability captures Hope. Again, a merchant would need to express these virtues if they wished to be successful in business.

Charity, along with Temperance, is the virtue least likely to be associated with merchants. While we now think of charity in terms of giving to others, in the past it was associated with a love, or care, for others. When business people talk about being ‘customer focused’ they are talking about exhibiting the virtue of Charity. Shakespeare’s play The Merchant of Venice is not about the moneylender Shylock, but ‘Antonio, a merchant of Venice’ who characterises Christian love or agape demonstrated by his sacrifices for his young friend Bassanio. The view that Antonio and Bassanio were physical lovers is a modern misreading based on an ignorance that the medieval mind was much capable of distinguishing storge (famillial love), philia (friendship), eros (physical love) and agape (spitritual love).

In the U.S. the review of the financial crisis of 2007–2009 was not undertaken by the regulator, which was possibly not inclined to give a thorough and independent review of what crippled the economy, but passed to an independent commission, The National Commission on the Causes of the Financial and Economic Crisis in the United States. They concluded that

We conclude there was a systemic breakdown in accountability and ethics. The integrity of our financial markets and the public’s trust in those markets are essential to the economic well–being of our nation. The soundness and the sustained prosperity of the financial system and our economy rely on the notions of fair dealing, responsibility, and transparency. In our economy, we expect businesses and individuals to pursue profits, at the same time that they produce products and services of quality and conduct themselves well.

Unfortunately–as has been the case in past speculative booms and busts–we witnessed an erosion of standards of responsibility and ethics that exacerbated the financial crisis. This was not universal, but these breaches stretched from the ground level to the corporate suites. They resulted not only in significant financial consequences but also in damage to the trust of investors, businesses, and the public in the financial system.

Olivi and Bernardino would be spinning in their graves.

The status of morality and ethics in finance has changed significantly between the seventeenth century, when Huygens and Bernoulli constructed mathematical probability on the basis of commercial ethics, and today when ethics seems to have been expunged from the science of economics. The change point is often associated with the early Victorian period, associated with Romanticism. The ‘liberal’ philosopher John Stuart Mill argued that (political) economics

is concerned with [man] solely as a being who desires to possess wealth, and who is capable of judging the comparative efficacy of means for obtaining that end.

Around the same time, the future poet-laureate, Alfred, Lord Tennyson, wrote about nature “red in tooth and claw”. In 1859 Darwin published the On the Origin of Species by Means of Natural Selection, or the Preservation of Favoured Races in the Struggle for Life which explained evolution in terms of natural selection. In the popular perception, nature became seen as being driven by a bitter struggle for survival, un-regulated by a divine architect. Modern science was demoting man from being created in God’s image to the status of a higher ape, as Darwin wrote in his 1871 book, The Descent of Man

My object in this chapter is to shew that there is no fundamental difference between man and the higher mammals in their mental faculties.

The Descent of Man goes on to argue that “the civilised races of man will almost certainly exterminate, and replace, the savage races throughout the world”, and Adolf Hitler would be the champion of the Romantic triumph of will over reason in the twentieth century.

The reaction to Romantic Fascism was ‘positive science’, and consequence was the abandonment of six of the virtues from economics, and to focus on what Deirdre McCloskey has described as “Prudence Only”, blind rationality. Prof McCloskey is, perhaps, being too extreme, the widespread use of mathematics suggests residual Faith and Hope, but there has definitely been an associated lack of humility (Temperance) The irony is, ethics have been banished from finance, in the main, by academics teaching students to focus on ‘rational expectations’ (Prudent Hope) and ignore Temperance (the counterbalance to Gluttony) and Charity (the counterbalance to Greed), not because the markets are fundamentally unethical and immoral, but because this is seen to be “good science”.

Ian Hislop, the British commentator also discusses how banking changed around the time that Romanticism dominated culture in When Bankers Were Good.

Notes

${}^1$Kaye [1998, p 121]

${}^2$Kaye [1998, p 124]

${}^3$Kaye [1998, p 126]

${}^4$Kaye [1998, p 119], also Franklin [2001, pp 265–267]

${}^5$Rothbard [1996, pp 60–61], Kaye [1998, pp 123–124]

${}^6$Rothbard [1996, pp 81], Kaye [1998, p 118]

${}^7$Rothbard [1996, pp 81–82]

${}^8$Kaye [1998, p 51]

${}^9$Hacking [1984, p 95]

${}^{10}$FCIC [2011] p xxii

${}^{11}$Sylla [2006], Sylla [2003]

${}^{12}$Friedman [1953]

${}^{13}$Persky [1995, quoting Mill, p 223]

${}^{14}$MacCulloch [2009, pp 861–862]

${}^{15}$Darwin [1871, pp 36]

${}^{16}$Darwin [1871, pp 200–201]

${}^{17}$McCloskey [2007]

References

   C. Darwin. The descent of man, and selection in relation to sex. John Murray, 1871. darwin-online.org.uk/contents.html.

   FCIC. The Financial Crisis Inquiry Report. Technical report, The National Commission on the Causes of the Financial and Economic Crisis in the United States, 2011.

   J. Franklin. The Science of Conjecture: Evidence and Probability before Pascal. Johns Hopkins University Press, 2001.

   M. Friedman. The methodology of positive economics. In M. Friedman, editor, Essays In Positive Economics, pages 3–43. Univ. of Chicago Press, 1953.

   I. Hacking. The emergence of probability. Cambridge University Press, 1984.

   J. Kaye. Economy and Nature in the Fourteenth Century. Cambridge University Press, 1998.

   D. MacCulloch. A History of Christianity. Allen Lane, 2009.

   D. N. McCloskey. The Bourgeois Virtues: Ethics for an Age of Commerce. University of Chicago Press, 2007.

   J. Persky. Retrospectives: The ethology of Homo economicus. The Journal of Economic Perspectives, 9(2):221–231, 1995.

   M. N. Rothbard. Economic Thought before Adam Smith. Edward Elgar, 1996.

   E. D. Sylla. Business ethics, commercial mathematics, and the origins of mathematical probability. History of Political Economy, 35:309–337, 2003.

   E. D. Sylla. Commercial arithmetic, theology and the intellectual foundations of Jacob Bernoulli’s Art of Conjecturing. In G. Poitras, editor, Pioneers of Financial Economics: contributions prior to Irving Fisher, pages 11–45. Edward Elgar, 2006.