During the past few days, I’ve had the pleasure to discover the works and explore the wisdom of one of the greatest economists of our time, Antal Fekete. This mathematician and economist is, as far as I know, the most knowledgeable person on matters of monetary policy and financial markets. I hope that in the following weeks, I will be able to distill this knowledge into my posts on subjects such as monetary policy, the gold standard, interest rate theory and much, much more.
For today, I will content myself with developing a simple idea. An issue, which I hadn’t considered of much importance. The subject at hand, today, will be speculation and gambling.
Speculation, is often given a bad rep in the media. People think that it is simply a matter of bankers and brokers gambling and enriching themselves with our money.
Free-market advocate, on the other hand, will defend speculation, saying that it has a relevant role in the market, that it prevents markets from deviating too much from their equilibrium.
But the truth is, that today the world does suffer from excessive gambling by the financial sector. The derivatives markets, triples every year, and its growth outpaces that of any other market, having reached recently a total estimated value of 100 trillion dollars.
To appreciate why this is a problem, and how it came about, we must appreciate first the subtle difference between speculation and gambling.
Speculation, is trying to predict future outcomes, based on forces of nature which may or may not push things one way or another. This means that we try to guess and insure ourselves against the risks created by nature.
Gambling, on the other hand, means betting on risks created by man. When you go to a casino and you spin a wheel and try to guess on which number the ball will land, that is gambling. It is a game of chance and the uncertainty in it is a human creation.
In those two simple definitions, we can find the hidden truth behind derivatives markets. We can understand why derivatives have grown to over 100 trillion, having been virtually inexistent before the 1930s.
The way in which monetary policy has evolved in the last century, has given place to what we have today. Through this dogma of “money supply” manipulation, we have created, us humans, a world of uncertainty in terms of interest rates, exchange rates, and the gold price.
Back in the age of the gold standard, interest rates were stable, and also, notably low. Exchange rates, were fixed, and of course, their value in terms of gold was stable since gold was money.
The demise of gold, is what brought about the rise in financial gambling. When markets are volatile, speculators jump at the opportunity. It becomes profitable, not to own bonds, or currency, but rather to trade them, if you know when. And financial markets do know when. Though it is not openly discussed, it is clear where the Central Banks, the Fed and ECB, stand when it comes to the bond and gold market.
In terms of bonds, we know the Central Banks will always have a bias in favor of lower interest rates. All that regular banks need to do is anticipate what the Central Bank will do. They will buy bonds, not because of their return, but because of the expected surge in price that will occur after the Central Bank conducts its Open Market Operations.
When it comes to gold, the opposite is true. The Central Banks will act to stop the price from rising beyond a certain point. When street banks have an idea that this is coming, they can preemptively sell their gold options and futures, again, contributing to set in motion the decline of the price, which is precisely what the Central Banks want.
In this way, the financial sector enriches itself yes, purely by gambling. Worst of all, this is not a matter of one bank loosing against another, but rather, it constitutes a transfer of wealth from the productive sector to the financial sector. The process of how this happens, is incredibly complex, and we will explore it more in depth in the future. For now, just keep in mind what I said before:
Speculation on exchange rates and interest rates is literally inexistent under a gold standard. The de-linking of gold from our monetary system, is what has allowed this massive amount of gambling and debt accumulation which will eventually bring the Western world as we know it to a sudden end.