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Wednesday 28 July 2010

The Hungry Spirit

Today’s post is a very short and concise post, yet these are some inspirational quotes and extracts from two chapter’s of Charles Handy’s 1997 book entitled: “The Hungry Spirit“:

A Life of our own

Capitalism, efficiency and markets have their flaws, but also their uses.  They are neither the complete answer to our dilemmas nor the only cause of the.  They provide some of the context of our lives but not the purpose.  For that we need a philosophy not an economic system.

A better capitalism

Left to themselves, things do not necessarily work out for the best. Laissez faire is value free. No one is responsible for anyone else.  That is improper selfishness and can self-destruct.  We need something better.  Capitalism as an idea includes social capital as well as economic capitalism.  One without the other will not work for long. 

theMarketSoul © 2010

Monday 26 July 2010

Capricious Markets

The market is capricious.  We are paraphrasing a line from one of Bernard Cornwell’s series of historic novels on 9th century England, where he referred to the ‘old gods’ (pagan gods) of the Danes and Vikings as capricious.

So if the impulsive nature of markets is to be appreciated for what they are, then why are we trying so hard to manage risk completely out of existence? 

We will focus on two specific factors today in what we refer to as the ‘dumbing down of risk’.

A strict or narrow definition (old financial language) of risk is possibly that it is a quantifiable number with a probability ranking and we can therefore attach a statistical inference to the occurrence of the risk event.

Yet in The Health & Safety Executives language a risk and “Risk management involves you, the employer, looking at the risks that arise in the workplace and then putting sensible health and safety measures in place to control them”.  So in the common language in the work place the HSE has managed to destroy the proper use of the work risk and risk management with this dumbed-down version.

In our mind, if the risk cannot be quantified and expresses on a scale of probabilities, then it is not a risk, but an uncertainty.  And we can manage both risks and uncertainties, but the emphasis is different.

Maybe any situation or health and safety ‘risk’ can eventually be codified on a risk probability matrix, but the cost involved in getting to this situation is prohibitive, so we shall stick to our guns and call a health and safety issue a ‘Health & Safety Uncertainty’.

Let’s recap briefly the difference between what risk is (supposed to be) and what uncertainty is:
Risk in investment and market participation is the likelihood of a quantifiable measurable outcome either occurring or not occurring.

Frank Knight In his seminal work Risk, Uncertainty, and Profit, Frank Knight (1921) established the distinction between risk and uncertainty.
… Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The term “risk,” as loosely used in everyday speech and in economic discussion, really covers two things which, functionally at least, in their causal relations to the phenomena of economic organization, are categorically different. … The essential fact is that “risk” means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomenon depending on which of the two is really present and operating. … It will appear that a measurable uncertainty, or “risk” proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all. We … accordingly restrict the term “uncertainty” to cases of the non-quantitive type.”
Too summarise therefore, risk should be a measurable and quantifiable occurrence, whereas uncertainty is what the HSE addresses, but misinforms as risk, namely the likelihood of something occurring, but that likelihood is not quantifiable.

So where does this detour into the use of language leave us as far as the Capricious Market is concerned?

We suppose that because market participants are both humans and mechanical systems (eg. ETS – Electronic Trading Systems), one of these participant groups, namely the humans have a level of sophistication and complexity (irrationality) that leaves the best construed risk models in tatters, once the uncertainty element of human emotion and the perception factor unleashed.

Therefore, to construct models of rational behaviours, the outcome and predictability of non-human mechanical systems (in other words more models) should be able to predict the behaviours of other models.  But to extend this to human actors clearly moves us more firmly into the domain of uncertainty and not risk.

Therefore, we conclude that the markets will always be capricious as long as irrational beings are willing and able participants.  Until this ceases to be, let us ensure that we get the use of our risks sorted out from our uncertainties.

theMarketSoul ©2010

Saturday 24 July 2010

The Morass of Mediocrity

We link today’s article to one of our main themes on our home page, namely the ‘Battle against the Status Quo’, or as per the title of this posting, ‘The Morass of Mediocrity’.

The underlying intent and theme is that of competition and competitive behaviours and the difference between rules based and principles based standards.

It is our opinion that a rules based culture encourages more insular and introspective behaviours, where the rush is for the middle ground of mediocrity, rather than as the opposite principles based culture would be the encouragement for the search for innovation and competitiveness at the margins and extremes of the ‘functional envelope’.  By this we mean the parameters and frameworks set-out in the principles based environment, to ensure that a well-defined playing field (not necessarily level), is established and market participants understand their boundaries and culture norms they have to adhere by as part of the participation process.

Yet, apparently, a more principles based regulatory framework is exactly what is being blamed for the Credit Quake of 2008 – 2010.

And if we analyse the circumstances that led to the regulatory failure and debt driven imbalance we currently experience, we would discover that it is because we operate in a hybrid world with symbiotic elements in the relationships between the private, public and third sectors.

Some of these factors include, but are not limited to:
  1. Market structure – free market versus socialist structures
  2. Regulatory framework – the disjointed regulatory frameworks and mixed agendas and the sense of urgency in the global regulatory framework
  3. Cultural setting – Anglo-Saxon, European, Middle Eastern, Far East, etc.
  4. Reliance on macro-economic tools including monetary and fiscal policies
  5. Skewed nature of national performance measurement
  6. Balance between equilibrium and disequilibrium clearance mechanisms in the economy
  7. Erosion of moral hazard and other distorting signals

However, as a mainly libertarian focussed publication, it would be remiss of us not to endorse the principles of minimal interference (small government in other words), yet we also realise that this has to be tempered with personal responsibility.  However, because the symbiotic (hybrid) relationships have become so skewed and dysfunctional over the last few decades, was it any surprise that the uncertainty this created led to opportunist behaviours?  Because a ‘moral compass’ is a very relative term, is it no surprise that depending on your own individual position and point of view, that the direction it indicates will be different from others?

The G20 are meeting again this weekend and the global regulatory framework will again be in more detailed focus, yet other priorities are again distracting the main thrust and issues on the agenda.

Therefore to conclude this brief interlude into the ‘morass of mediocrity’, the real question is:

If we all run and work hard for the centre ground, who will remain at the margins, pushing the envelope and ensuring that we break the tyranny of the status quo by exploring new unchartered territories and responsible risk taking behaviours?

theMarketSoul ©2010