17 July 2006

Tired and emotional finance

Dick Bryan, The University of Sydney

Jocelyn Pixley Emotions in Finance: Distrust and Uncertainty in Global Markets, Cambridge, Cambridge University Press, 2004 (244 pp). ISBN 0-52153-508-5 (paperback) RRP $49.95.

For Australian money market operatives, there is a changing of the guard. But will it be enough to address some underlying contradictions within the monetary system?

Earlier this year, head of the US Federal Reserve Alan Greenspan—the patriarch of central bankers—retired. US money markets have been somewhat more fragile since then, with direct ramifications for Australia. Soon the head of Australia’s Reserve Bank, Ian Macfarlane, will retire and someone else will have to take over the position.

It’s not an easy job. Not only will the new bosses be under the spotlight, but no-one is sure what they actually do. Consider their plight. Being CEO of a car company or a telco may be a tough job, but people know that you produce cars or telecommunications facilities. What does a central bank produce? Not notes and coins—they are made at the mint. A central bank produces monetary stability—something much harder to define than cars or text messaging.

Two problems face a central banker responsible for monetary stability. One is money. The other is stability. Money is hard to define—it’s a case of knowing it when you see it. But where you draw a line around ‘money’ is difficult to say. We think instantly of notes and coins. We might also think of bank deposits. But when we get to more complex monetary roles, like forms of money which store value across different currencies, or forms of money which generate interest rates determined by an index of share prices (generally, money in financial derivative markets), it is hard to say where the category of ‘money’ stops and other kinds of assets start.

So money is a nebulous category, but we rely on it daily, and we depend on it holding its credibility and its value. Little surprise, then, that a huge amount of energy goes into mounting and defending the credibility of a money system. History points to close links between royalty and money. The king’s head was supposed to establish the credibility of coinage; credible coinage, conversely, was the sign of an effective monarch.

Credibility is still important today, albeit more subtly portrayed. On one hand, the money units are, of themselves, less credible—they are not chunks of gold, but bits of paper (or are they plastic?) and electronic balance sheet entries. On the other hand, our social order is well disposed to accept on trust these tokens as bearers of value.

The idea that money is based in social relations of trust is not new.

The idea that money is based in social relations of trust is not new—the seminal work on the topic by Georg Simmel was published almost exactly a century ago. But it is interesting that the social foundations of money are re-emerging as an object of research. Two relatively recent books—one by Cambridge sociologist Geoffrey Ingham (2004), the other by London University’s Costas Lapavitsas (2003)—are on precisely on this topic. They disagree, and have been arguing it out in the pages of the journal Economy and Society. For Ingham, the basis of money is the promise to pay—what we call credit. For Lapavitsas, the issue is the balance between power relations and relations of trust: trust that valueless paper money will be received as payment, and trust that data entries in bank accounts will be honoured.

The fact that Ingham is a Keynesian and Lapavitsas a Marxist no doubt drives their positions. But both, despite their disagreements, emphasise the role of the nation state as guarantor of the money system. (This point of consensus is perhaps a bit surprising, because in the global economy, money is losing attachment to nations and is increasingly beyond the regulatory capacity of national central banks.)

To be sure, trust is important, and a lot of effort goes into creating and re-creating it. In part, trust in the money system is just one aspect of the wider problem of social stability. But the importance of monetary credibility means that it cannot be taken for granted, even within a stable society. It is not, as it once was, about the credibility of the sovereign—it is about the credibility of financial institutions, and especially those who superintend them. Today, we have central banks and central bankers.

Central bank buildings are notoriously mysterious places. They tend to lack windows and some of the more famous are built to look like forts. Central bankers are just as mysterious. It is part of their mystique that inside these buildings sit inaccessible people of science—or perhaps alchemists—who know the formula for making the money system work. We want to think of them as all seeing and all knowing.

A vast range of social processes generate this image. Think, for example, of the way interest rate policy gets reported in the media. The central bank is the oracle. Private bank economists, financial journalists, and other punters conjecture on what the central bank might do to interest rates. The central bank doesn’t conjecture—it decides. The Board meets. It makes a decision. This decision is the final word. The truth.

The authority of the central bank is reproduced in other ways. In Australia, and many other countries, the central bank has been given legal independence from government—to ensure that it is seen to be politically impartial. The central bank is elevated above the political world, even though its activities are have intensely political impacts.

Central bank buildings are notoriously mysterious places.

And think of central bankers themselves. Their signature is on every bank note, but at the local supermarket they would go unrecognised. They are as inscrutable as a political figure can be. Like royalty, their role is to be seen (sparingly), but not known. They make speeches, but try to avoid controversy (notable exceptions being Paul Volker and Prince Phillip). They don’t crack jokes (no notable exceptions). They avoid fashion—Alan Greenspan had the one set of spectacle frames for 30 years; Bernie Frazer the one suit for about the same time. It is all part of the image of being extra-ordinary. To be ordinary is to be as vulnerable as the rest of us—susceptible to bad judgment, rashness, uncertainty, perhaps even open to manipulation. There can be none of that for our central bankers—we have to trust them.

Something is at odds here. On the one hand, money is really hard to understand (we aren’t even really sure what it is). On the other hand, the people who manage the money system have to be all-knowing. The two are hard to reconcile. It shows through, occasionally. Type into your search engine the words ‘central bank’, ‘science’, and ‘art’. Up will come a long list of official speeches of central bankers from around the world, on the theme of whether central banking is an art or a science. They all say pretty much the same thing and it’s not hard to imagine why. Econometric predictions are not enough: central banking is an art as well as a science.

This standard speech is usually presented by central bankers as if it were a confession—as close as any of them will ever get to a candid disclosure that running a stable monetary system is guesswork. Regrettably, the ‘art or science’ speech is never so revealing. So it is really interesting when someone actually talks emotions with central bankers.

University of New South Wales sociologist Jocelyn Pixley takes up these sorts of questions in her book Emotions in Finance: Distrust and Uncertainty in Global Markets. In terms of the ‘art or science’ speech so favoured by central bankers, one gets the impression from reading Pixley’s book that the art they have in mind is more likely to be Edvard Munch’s ‘The Scream’ rather than a John Constable landscape.

The critical point Pixley engages is that, while the money system depends on trust, the financial system engenders deep uncertainty and that opens up a much broader range of emotions—not all of them so positive. The central bankers’ binary is not really ‘art or science’ but ‘certainty or uncertainty’. We look to central bankers for certainty, and on that basis we trust them. But we find that financial markets are awash with mistrust and deception on the one hand and naïveté on the other, expressed in the belief that market forces will actually lead to efficiency and effective policy. (A recent report by PricewaterhouseCoopers (2006) reinforces this strange combination—bankers report that they see their greatest risk is too much regulation, but their leading fears also include rogue traders, derivatives, hedge funds, and money laundering—which are surely products of a lack of regulation!)

The great strength of Pixley’s book is that her extensive interviews get the central bankers, market actors and journalists engaging directly with these issues. We hear them in their own words. They are somewhat cautious and mild in their apprehensions, but it is not a comforting sound. As a reader, the emotion one is left with after reading Pixley’s book is alarm and concern—and a dark sense of assurance that our fears are being confirmed.

The current global financial system has survived more than three decades.

How stable is this financial system that is driven by uncertainty and so different from its idealised version? There are merchants of gloom who describe it all as an irrational casino. Yet the current global financial system has survived more than three decades, and any number of ‘hiccups’. Predictions of a catastrophic crash may create headlines, but the column inches that follow are usually thin on substance. A more considered diagnosis is needed.

The task, surely, is to build explanations of the contradictions within the current system of global finance. We cannot expect central bankers or other players in the markets to offer such explanations—their day-to-day enmeshment and locked-in theoretical predispositions inevitably narrow their perspectives.

Nor does the academic discipline of ‘finance’ seem to be particularly fertile ground. Although researchers in this area have more recently developed an interest in what is called ‘behavioural finance’, analysis generally remains limited to propositions about traders’ strategies. This focus involves simply attributing behavioural motives to individuals who are presumed rational but, in the context of market instability, appear to act ‘irrationally’. Hence we see, for example, propositions that market participants may have ‘over-reacted’ or ‘under-reacted’ to market information. Such developments might show that financial theory is not trapped into beliefs that markets are always in stable equilibrium, but they are a long way short of framing contradictory tendencies evident in global financial developments. It is a job for the wider community of social scientists to come to grips with these concerns.

Re-opening debates about the nature of money is a creative path, because it causes us to question our premises. This debate must be historically-specific, for the development of global financial instruments has surely changed what money is and what it does. Moreover, the global reach and operation of finance must diminish the connection of money to the nation state, as corporations (or individuals) seek to hold assets in multiple currencies to reduce the impact of exchange rate volatility. So, for example, we see the emergence of financial derivatives (futures and options and ‘swaps’ contracts) designed precisely to hedge the risks that come from doing business with exposure to many currencies and many interest rate alternatives. We should see these sorts of products as new forms of money, appropriate to the requirements of a global money system.

It is a big project. Jocelyn Pixley’s work has made an important contribution because it shows emphatically that the answer lies not in alternative econometric models, but in the way society grapples with its aspiration towards a dependable, unchanging unit of measure (money) in a world of uncertainty.

Pixley’s work leads us to conclude that the next Governor of the Reserve Bank, whether or not he takes up the project of re-thinking global finance, is in for a deeply emotional experience.

REFERENCES

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

Lapavitsas, C. 2003, Social Foundations of Markets Money and Credit, London, Routledge.

Pricewaterhouse Coopers 2006, ‘Too much regulation tops banana skins poll—28 June 2006’ [Online], Available: http://www.pwc.com/extweb/ncpressrelease.nsf/docid/BEA0D14A59758FEFCA25719B0028306D [2006, Jul 14].

Simmel, G. 1978 (1907), The Philosophy of Money, London, Routledge.

Dick Bryan teaches Political Economy at The University of Sydney. He is co-author, with Michael Rafferty of Capitalism with Derivatives: A Political Economy of Financial Derivatives, Capital and Class (Palgrave Macmillan 2006).