Home > Uncategorized > How Wall Street discredited Capitalism #OWS

How Wall Street discredited Capitalism #OWS


Capitalism, not without its flaws, combined with democracy and free trade, has produced unprecedented prosperity and personal freedoms for more people than any other system in recorded history. We often take all three for granted, somehow assuming that the system will continue even as we rail against it when things go wrong. However, history shows that these benign conditions have prevailed but briefly. Much of our time was spent struggling under other dogmas and systems of organising economic and social activities that were sub-optimal if not exploitative and oppressive. We are at the cusp of another crisis caused by several flaws in the system. It is important to be specific in nailing these flaws, even as those responsible do their utmost to obfuscate.
Value creation is central to our notion of economic and social progress. Most of us have an intuitive notion of what value is. Like most other fundamental concepts, it is something intuitive and hard to define but we know it when we see it. So long as an individual, or an institution, adds value its utility increases and we all share the created value in varying measures. Much philosophical argument has centred on how value is created and how the process of value creation is best organised, chief among these being Adam Smith. Others like Karl Marx focused on equitable sharing of the value so created among different actors. In doing so, they largely ignored the fact that creating value is a conscious effort that needs to be incentivised because it is randomly dispersed in the population. Neither argument fully captures the dilemma inherent in the problem. While value creation is at the heart of the crisis we now face, none of the flaws rise to a level that warrants a complete rejection of what has worked so far.
Consider two traders, a bull and a bear, who disagree on the value of an iPad created by Steve Jobs at Apple. The bull bets that the iPad is a revolutionary product that will sell like hot cakes. The bear argues that you are better off with an inexpensive Windows Netbook. How do the two resolve the argument? In our system, the bull buys Apple stock from the bear. If Apple profits, the value of its stock goes up. The bull profits by the number of stocks bought from the bear. The bull’s profit is equal to the bear’s loss. Neither the bull’s profit, nor the bear’s loss, has anything to do with value created by Steve Jobs and his Apple. This is the key confusion in the current crisis.
Value creation by Apple will proceed whether or not the bull and the bear bet on the success of Apple’s effort. Neither the bull nor the bear create any value apart from offsetting each other’s profit and loss. However, investment bankers, who are really the bulls and bears in our system, would have you believe that but for them, there would be no Apple or Steve Jobs! Ergo, the value created by Apple is the same as value created by them. Nothing could be more erroneous but there is simply tonnes of ‘literature’ produced by friendly mathematically inclined economists that is keen to obfuscate the distinction between values created by Apple and that created by simply betting on the success or failure of Apple in doing so. The former adds to the sum total of society’s economic well being while the latter is a zero-sum game among traders and bankers.
Financial markets through their trading activities reflect value created by other economic entities in our system and therefore help measure it. But they do not by themselves create that value. A stock exchange is a poor substitute for a power plant in generating electricity. This is not to argue that there is no value created by liquid and efficient markets of which the bulls and bears are an irreplaceable part. But this value creation is much like that created by any other economic entity in the system and needs to be measured accordingly. One cannot impute all value creation to a mythical market. Yet that is precisely the dogma subtly preached by the clutch of investment bankers that so dominated Wall Street. How and why did this hype rise above the marketing literature of investment banks is a subject for study.
Third world governments, including that in India, are neither known for financial integrity nor fairness. Many have spawned corrupt banking systems. Over and above that, such governments have designed many ways to tax and pre-empt public savings in banks to finance foolhardy welfare schemes. All these practices led to huge capital flight to banking systems abroad that were seen to be better at preserving value for depositors. Often such capital flight was just to escape extortionate hidden taxes by themselves and not so much to earn better returns abroad. International banks mushroomed to capture such flows. These flows formed the nucleus around which private baking began to command a humongous deposit base that could be deployed around the world in financial markets.
Meanwhile, commodity markets were dominated by a few oligarchies based in the former colonial powers. They were partnered by trading desks at the investment banks in Wall Street to gain more pricing power. The whole commodity chain from mining to warehouses to metal exchanges was a closed loop dominated by the Wall Street investment banks that indirectly controlled huge stakes in each of the links in the chain. The commodity boom that began in the 1990s provided the supernormal profits to fuel this conglomeration of interests. The US saw the investment banking interests as one way to consolidate its soft power in world markets in much the same fashion as the British did through London before World War II. From interest rates set by the Federal Reserve System (Fed), to commodity financial asset prices, the whole chain came to be dominated by a clutch of investment bankers that were fully backed by the world’s only superpower.
When the bubble burst in 2008, it turned out that one part of Wall Street — the investment banks — had simply been feeding off another part of the same establishment — the insurance industry. The latter was found owing about $ 100 billion to a clutch of investment bankers. The US was forced to bailout the firms in full because letting the firms go under would have destroyed its domination of the world’s financial markets. Every key player in the system, including the rating agencies that wilfully slept through the crisis, was allowed to continue in US strategic interest rather than go under as capitalism demanded. To finance these system-wide bailouts, the US government had no option but to raid the financial savings of the middle class through zero interest rates. Those savings are now showing up as bank profits while the middle class cries hoarse that it has been robbed blind without being able to articulate just how.
To hide the sins of a few rotten apples on Wall Street, the US government has wrongly chosen to tax middle class savings. The harm that has been done may be difficult to acknowledge, much less reverse. Now there is a bigger danger of capitalism based on free markets itself being called into question. It is high time to for some plain old-fashioned truth telling before people throw the baby out with the bathwater.

The writer is a trader. She can be reached at
sonali.ranade@hotmail.com or @SonaliRanade on Twitter

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