Capitalism's Fundamental Flaw

http://www.forbes.com/2009/11/05/innovation-ayn-rand-intelligent-technology-capitalism.html

by acangiano • 17 years ago

49 92 17 years ago

Antonio - good find. I read this article earlier this morning and it spoke directly to the disconnect I've noticed as well. Logistically, what do you think leaders on the Street and in business can do to curb these short-termist, corrupted practices?

jamesbressi2• 17 years ago

If you don't mind me chiming in, I think the lesson is that there really is nothing that can be done to curb it.

Why? Two reasons.

First, every time we create legislation, laws and other governing to something, the problem either gets worse or creates a whole new set of issues. The problem becomes a snowball -- you can look at the examples there to see some of this.

Second, the saying that goes something like "locks keep out the curious, not thieves" is very true. Those who want to scam will always find a way and there is nothing to stop them, only try and catch them and prosecute them.

I could go on with a very lengthy post about this and sound very studious, but I think those two points in their simpler form make a lot of sense. What do you think?

AndrewDucker2• 17 years ago

I disagree strongly.

1) Legislation can change things significantly and effectively. It can also merely shovel things around. Both are possible and doggedly asserting that only one effect ever happens is just ridiculous.

2) Locks keep out thieves very well a lot of the time. They may not keep out every thief, but it keeps out most of them, most of the time.

fnid2• 17 years ago

I would suggest that it was an elimination of a lot of laws regarding financial transactions and regulation that enabled the recent decline. The removal of these laws enacted to prevent a recurrence of an historical collapse, did in fact bring another collapse, so pragmatically, I would say laws help.

pjkundert2• 17 years ago

Perhaps a better title would be "Mercantilism's fundamental flaw". Rand makes few assumptions regarding the inherent integrity of "leaders"; in fact, she assumes no such integrity, and argues for liberty.

While we trip over ourselves (as a society) to give up our freedoms and grant ever more sweeping power to "leaders" to save us, we will reap what we deserve -- ever greater examples of waste, bungling, abuse, malinvestment and looting, on scales simply unimaginable just a few years ago.

We gave up our ability to directly monetize wealth 2 or 3 generations ago -- what features of our present financial system makes you believe that it is "Capitalism"? Government giveth, and government taketh away. Sounds like good, old-time kingly Mercantilism to me...

Xichekolas4• 17 years ago

We gave up our ability to directly monetize wealth 2 or 3 generations ago

pjkundert2• 17 years ago

Central bank money, created and debased at will, vs. Wealth-backed money, intrinsically valued by the wealth that backs it. Freedom to choose money that doesn't inflate allows multigenerational wealth transfer, etc.

yafujifide2• 17 years ago

I hate to bring this to a general discussion of capitalism/Rand etc., but I have a question:

How is Rand's "liberty" supposed to be provided?

It seems to me we already live in a universe where people have as much free will as we ever will. Some people use this free will to restrict the free will of others. Sometimes this is a government, sometimes it's a corporation, or sometimes it's a kidnapper.

But what hypothetical external agent could ever ensure that no one's free will will be restricted? To have such a system would necessitate restricting people's free will so that they couldn't restrict each other's free will; it would be a self-defeating situation.

This is analogous to the set of all sets in mathematics, or other paradoxes that arise by having "all powerful" objects. Humans are so free, that we are free to kill ourselves (for instance), and remove our freedom. Likewise, we are free to disable our own free will.

How could Rand change things so that this is not the case?

In my view, governments are the result of the utter freedom we have as humans. It is simply absurd to think of getting rid of the systems that restrict freedom; if we did, the freedoms granted would simply create new systems, like corporations, or another government, that would replace all the functions of the system we got rid of.

Let me put it another way: It seems we already have maximal liberty. How are things ever going to be better in that respect?

unalone2• 17 years ago

I was going to submit this a few days ago, but I don't like Rand-only discussions. However, I'd like to contribute to the thread with this recent Slate article, which abruptly reversed almost all my remaining positive feelings about Rand:

http://www.slate.com/id/2233966/

Not only was she a hypocrite who ignored her own teachings when things got personal, she worshipped a serial killer who raped and dismembered a 12-year-old girl, because she saw him as a hero defying society.

danteembermage5• 17 years ago

I think this whole argument implies an interesting normative method for evaluating government policy. Your implication seems to be that restricting some freedoms for some people ends up producing an overall increase in freedom relative to no restriction. The obvious crimes come to mind first but the framework could be applied elsewhere. Take copyright for example, do I have the freedom the control my own creative work however I like, or does the freedom not to have to constantly worry about the source of media outweigh the freedom to control my creations. More succinctly, in a world without copyright are we more or less free? It's not obvious to me.

Singapore is a case in point, freedom not to be caned for minor infractions vs. freedom to walk around relatively safely in a high density metropolis. Again who is more free is not clear.

I think you are wise to suggest there might be "maximal" achievable liberty. Does the culture of society affect the attainable liberty opportunity set? It seems like it must.

dantheman5• 17 years ago

I'll say we haven't reached maximal liberty, all one has to do is look at the drug war, education, and medicine. You'll quickly see limitation on your liberty.

The way things are better is when people are free to choose what they want through voluntary interaction without force. If I want certain standards for a school or a doctor, I seek those out -- If I want to go to witch doctor that's ok too.

I'd highly recommend Nozick's Anarchy, State, and Utopia if you're interested in this question.

danteembermage5• 17 years ago

I think the appeal of finance is the intellectual leverage one gets there. If I am really bright and I can develop a profitable arbitrage trade in the marketplace I can turn it near instantly into millions of dollars (if I'm right, obviously the market does not give points for effort).

If I'm in a start up, which we would probably consider to be very high cleverness to reward leverage, it can take a long time and have lots of randomness to get the big payoff, e.g. Kiko.

Now, compare that to being an employee, where to get enormous payoff you have to climb the ladder into stock options land.

The article's point is that this is not how the world should be, but markets cause this by construction: If I'm stranded on an island with a bunch of Robinson Crusoes I'm going to try swapping coconuts for mangoes across the island before I start experimenting with cross breeding them.

From a welfare perspective it even makes sense to do the easy things first (trade) and the hard stuff next (R&D) because effort is more likely to be rewarded in the former than the latter.

One could also complain about how all the socially well connected are lobbyists instead of high school teachers and the beautiful are in pharmaceutical sales rather than portrait modeling. Sure it's sad, but also mostly inevitable.

yafujifide2• 17 years ago

> if I'm right, obviously the market does not give points for effort

But the market does give points for effort. How else do you explain the bonuses awarded to bankers who damaged the economy? They were rewarded despite their antisuccess.

mseebach2• 17 years ago

It's a very perverted market, where banks that would have been bankrupt if not for billions in taxpayer funds, even gets to pay their employees salary.

On the other hand, bankers in the banks that actually lived through the crisis because they didn't jump on all the fancy derivatives, actually deserves a bit fat bonus.

bdr• 17 years ago

You're blatantly taking that out of context. GP's idea was to "develop a profitable arbitrage trade" using one's intelligence, not to go work for a bank.

sethg4• 17 years ago

If the government imposed a small tax on stock purchases and other financial transactions, with the tax level rising according to the number of intermediaries and the amount of leverage, then working in an organization through which lots of money passes would not be such a lucrative career.

(And if it remained lucrative, at least the government would be able to participate in the bounty that comes from skimming a few parts-per-thousand off the top of a very large cash flow.)

gaius4• 17 years ago

working in an organization through which lots of money passes would not be such a lucrative career

No, those people would just go work for the government.

mseebach2• 17 years ago

The reason speculators can make tons of money on Wall Street, is because they can get people to play along.

You don't make money because an asset you own rises. You make money because someone buys it at that price. (That's the same, I know, but it's an important point to understand - it's NOT just numbers going up and down in a computer, at the end of the chain there's actual liquid money changing hands).

Now we've lived through two financial bubbles right after each other, and one can hope that people will learn that sharp rises in the value of an asset are often inflated, and stop putting their money into the game. After all, those who bet and then hedged their bets on real estate (this time) and .coms (last time) were also (generally!) the ones who lost the most.

pbhjpbhj• 17 years ago

at the end of the chain there's actual liquid money changing hands

Naked short selling doesn't require one to have any money to invest nor any shares. You can still make a lot of money and destroy a company's shares if well connected enough. The price falling on the shares is only produced by the apparent glut of shares offered for sale, they don't need to sell initially to produce a price fall, the offer is enough. Once the naked sale has iterated through a couple of loops and many other offers appear as the stock falls then the price plummets, not because of sales but because of lack of sales.

You make money because no one buys. Traders can make money any way the market moves and if sufficiently skilled and backed can make the market move - it _is_ just numbers going up and down.

ibsulon• 17 years ago

Are you kidding? Most people are just looking to find the next bubble and get out before "the suckers" get in!

jriddycuz2• 17 years ago

There's a fundamental flaw in the logic that concludes that "government must intervene to stop the shameless looting of taxpayer money." Taxation itself is government intervention.

Abuse of money received from a government that shamelessly loots its people for the "common good" and through manipulation of a highly regulated system is no more an indictment of Capitalism than failure to run is an indictment of a man tied to a chair.

larryfreeman3• 17 years ago

There's a fundamental flaw in your reasoning too. You can't have capitalism without some form of government and you can't have government without some form of taxation.

darjen5• 17 years ago

you can have voluntary, free trade without government. whether it's called "capitalism" or something else can be a matter of discussion...

jriddycuz2• 17 years ago

Maybe the term capitalism has a different meaning to you than it does to me, but I use almost synonymously with "free markets." And I would actually make the case that you can only have "pure" free-markets without government.

What I was suggesting in my comment above is that the failures of a bound and adulterated form of free markets do not indicate that free market principles are themselves flawed. The notion that banks' or other firms' abuse of bailout money is a problem with capitalism neglects that an extremely important (and often ignored) freedom in capitalism is the freedom to fail.

btilly• 17 years ago

A sobering read about the problems our system faces is http://www.theatlantic.com/doc/200905/imf-advice.

During the last boom a full 40% of all of the profits in the system came from the non-productive activity of people manipulating cash flows. This is simply not a sustainable financial structure. History shows that economies that are based on financial manipulation rather than production don't last. The USA isn't the first to combine of financial manipulation along with the export of production and the knowledge that previous lead to persistent economic advantage. In the last several hundred years Spain, Holland and England did this. In all previous cases it was a big factor leading to financial collapse and the loss of empire.

Is there any reason to believe it will work any better for us?

frig• 17 years ago

In hindsight the present situation is pretty predictable: as the # of goods produced increases and the amount of specialization increases the value supplied by the intermediary network ("the financial system") increases.

The way the financial system is currently "architected" (a strange term, but I'll use it) it has as a class an inordinate amount of negotiating power vis-a-vis everyone else (!), and thus is able to capture much of what ought to be consumer and producer surplus.

As much of the value it adds is due to network effects just going to a gold standard (which is a popular cure-all on the internet) wouldn't change much, even if you thought that was a good idea; there's still the same tremendous problem of coordinating trade in the same complex, highly-specialized economy and the central switchboard is still ideally placed to extract most of that value.

The easiest-to-envision solution is to forcibly unbundle the basic storage-and-transmission of credits between accounts (full-reserve checking accounts, basically) and run that infrastructure as a public utility (a handful of mainframes in the fort knox). Let the private sector sell value-added services on top of this, but don't leave the basic infrastructure of value-exchange in the hands of the private sector, who will retain the ability to hold the country up for ransom.

It's an easy solution to envision but it's hard to see much happening; it is too radical a shift to go down easily (and all that surplus value captured funds a lot of lobbying) and it too closely resembles socialism and other bugaboos to be an easy sell to the public at large.

(!) Where we are now is pretty analogous to having the local power company -- which provides necessary services to its area of operation -- also involved in speculative ventures that backfired enough that its continual operation is threatened; having the ability to turn the lights off would naturally give the local power company a lot of leverage negotiating for a bailout.

Suppose that the "too big to fail" banks were allowed to fail, and there was temporarily a severe disruption in the banking system. How would you propose that federal, state, and local law enforcement and other "essential services" get paid? With cash -- dangerous and risky? With checks -- while the banking system isn't reliably working? Would you trust them to work without pay for very long?

richcollins2• 17 years ago

"Integrity, justice, fairness, work-ethic, excellence--all have fallen prey to greed."

Greed is tempered by risk when the government can't save you.

viggity• 17 years ago

Greed would be tempered a lot more by risk if the government didn't save anyone.

megamark162• 17 years ago

I think that is what richcollins is saying. What I took away from that article, although I don't think it is quite what the author had in mind, is that Capitalism is flaw by the fact that our government does not allow/force us be purely capitalistic. The safety nets open the doors for greater risk, which require bigger safety nets.

richcollins2• 17 years ago

Yes I should have worded it "when you can't rely on the government to save you"

danteembermage5• 17 years ago

Counterpoint: flash trading. If I can peek at the orders the little guys put in through scott trade and execute a trade before theirs clears, then I can benefit from the upward price pressure that their orders induce. Little risk, no government, hardly "fair".

In an ideal world new stock markets would pop up without flash trading and the little guys would flock to those instead but there are huge network effects to get over. In this case regulation, or at least shaming the exchanges into doing something, seems appropriate.

I'm totally with you on the bailout moral hazard, there are just definitely some zero-work-ethic, unfair, risk-less behaviors that are quite profitable even (especially?) under anarcho-capitalism.

yummyfajitas3• 17 years ago

You are confusing front running with flash trading. What you describe is front running, and is illegal.

Flash trading is simply trades based on receiving market data with lower than normal latency (usually by having colocated servers).

http://en.wikipedia.org/wiki/Front_running

http://en.wikipedia.org/wiki/Flash_trading

lutorm• 17 years ago

It seems the trouble with this idea is roughly the same reason that it makes economic sense for poor people to not have car insurance. You're playing with other people's money, and it's an asymmetric risk situation: when your bet doesn't pay off you do not have to pay the entire price, because you don't have it. So it makes economic sense to subject yourself to long-term risk for short-term profit because if/when the crash happens you're not able to pay for the damage you did even if you were liable for it. (As opposed to now when money made is safe, at worst you can be fired.)

darjen5• 17 years ago

A fundamental flaw in the article:

"The banks, however, are another matter altogether, and this is where I think capitalism has hit a roadblock. The government has intervened to save many of them, and now, these bailed out banks want to hand out billions in bonuses to their non-performing employees. Capitalism gave way to welfare economics, and now the government has to intervene further to limit these looters from behaving badly by imposing taxes and regulations."

If the government hadn't intervened in the first place, and instead let these irresponsible banks fail, then the transfer of taxpayer money in the form of bonuses never would have happened.

What she's describing here is, in actuality, yet another flaw of government intervention.

AndrewDucker2• 17 years ago

Do you have any idea what the current financial situation would have looked like if the government had just let the banks collapse?

Hint: a lot like a jenga tower does just after you take away a vital piece.

Letting the entire financial system collapse might _possibly_ have led to better behaving banks in the long term(although I doubt it, people don't learn). But in the short term it would have cascaded through the entire economy and left the economy entirely non-functional.

billswift• 17 years ago

It could have, but I have seen no evidence to support this. In fact, that is why the econo-blogger Megan McArdle at The Atlantic supported the bank bailouts, because she feared that would happen. But despite reading her blog regularly, she has presented evidence only her (and others) fears about what could have happened.

condor2• 17 years ago

"Do you have any idea what the current financial situation would have looked like if the government had just let the banks collapse?"

No, and neither do you. That's why its called a free-market. It's free to do anything. It's not a free-market thats only free to take the form of what our expectations are.

kansando• 17 years ago

Right. And allow the economy to go into a long-term depression with 25%+ unemployment. A government "for the people" does not have a choice in this matter. The real problem is that bankers/speculators have so much power on the outcome for people who are not at all related to the industry.

moron4hire6• 17 years ago

You write like you have a crystal ball and can see the future. There is no telling what "letting the banks fail" will do for the long term. However, we do know that increasing national debt to the degree that has been done is not good.

darjen5• 17 years ago

strangely enough, that's not what happened when harding kept his hands off the market during the major crash of 1920-21.

and why did the bankers get so much power in the first place? there is a LONG history of government centralizing, cartelizing, supporting, and regulating the market's major financial players.

megamark162• 17 years ago

The point isn't whether or not the government should have intervened, the point is that because they did we can't blame Capitalism for the outcome of that specific action. A purely capitalist market would have let the financial crisis run is course, right or wrong. At least, that's how I see it.

gaius4• 17 years ago

these bailed out banks want to hand out billions in bonuses to their non-performing employees

If I worked for a bank, and I had nothing whatsoever to do with its subprime business, and had made a trading profit (or was in an unrelated function like IT and had fulfilled all my targets) then damn right I'd expect a bonus, and I'd deserve it too.

It's interesting to note here in the UK that the 70% taxpayer-owned RBS has just posted record losses, where as Goldman Sachs who repaid their TARP money to the US government, plus interest, as soon as they could is doing good business and paying their employees decent bonuses this year.

dantheman5• 17 years ago

Goldman may have repaid their TARP payment, but they received a crazy amount of money through the AIG bailout. The amount of government flowing into these institutions is astronomical, and almost all of them should have entered bankruptcy -- had their assets sold to firms that were responsible.

condor2• 17 years ago

Goldman's business was subsidized by the Government, in the form of funding Goldman's transaction partners, so that they could pay Goldman what was owed.

In normal business if my customer goes bankrupt, even if I made the sale and was owed money, I would take a loss on that transaction., and if the loss was large enough it would affect all of my employees, who in turn took the risk of working for me. I took the risk of selling to that customer, I was in the best position to judge their stability, and so would have to deal with the consequences. Goldman didn't have to deal with the consequences of transacting with unstable partners, the Government (in the form of the taxpayers) stepped in to deal with those consequences, and that is why in large part Goldman is able to exist, earn a profit, and pay bonuses.

KirinDave5• 17 years ago

I wouldn't say that was the main thrust of the article, by any means. You take one sub-point amongst a set of much larger and more important points and mine it out and claim that yet again, government intervention has proven useless.

Her main points, for those who will tl;dr the article and take your post for granted:

1. People do not always act in ways that are inherently good, either in an ethical sense or in a sense of what is "financially good." Rand does seem to suggest that this will be an inherent property of people who are capable of rising to positions of power.

2. The current system rewards people who can amass capital and take risks with it more than people who actually create that capital in the first place. She points out scientists and engineers who make the world a better place and invent new technology that can revolutionize markets are not proportionally rewarded for this change, while speculators who can take big chances with money are rewarded disproportionately. This creates a strong draw away from the allure math, science, and medicine towards the better paying jobs in the world of finance, thus weakening our ability to innovate and generate new capital for capitalism to draw upon.

Your complaint addresses neither of these, and I can't help but feel like you were being a bit disingenuous and dodging the actual issues she raised by hiding behind a straw man outside the crux of the article. Please address her substantive complaints if you're going to argue with the article.

steveplace2• 17 years ago

The current system rewards people who can amass capital and take risks with it more than people who actually create that capital in the first place.

The origin of this system was not created through free-market-capitalist methods.

scientists and engineers who make the world a better place and invent new technology that can revolutionize markets are not proportionally rewarded for this change,

But the men and women who take on risk to pay them are rewarded.

dantheman5• 17 years ago

Inventing something by itself does not create value, to create value it must solve a problem. If you invent something,self funded it, and then take it to market you will be incredibly rich.

yummyfajitas3• 17 years ago

Regarding 1, that's nonsense. There are many unethical people in positions of power in both Atlas Shrugged and the Fountainhead.

Near as I can tell, the most she ever suggests is that people who compete within the market (e.g., by inventing a better metal or making better loans) are more ethical than those who use the government to gain an advantage.

sethg4• 17 years ago

Banks, more so than most enterprises, are stepchildren of the state. You can't charter a bank without "government intervention", because a bank's stability, and hence its ability to attract depositors, depends on things like access to credit from the government (the Federal Reserve, in the US). The question is not "government intervention" vs. "no government intervention", but rather what kind of intervention is in the best interest of the public.

darjen5• 17 years ago

you're right, our banking system isn't even remotely close to being based on voluntary trade and "free market". so I'm not sure how we can even discuss this supposed failure of the free market.

bensummers• 17 years ago

This article suggests, twice, that "most intelligent people" agree with the author. Surely there is a better way of proving these facts, than just using such an assertion?

moron4hire6• 17 years ago

"The government has intervened to save many of them, and now, these bailed out banks want to hand out billions in bonuses to their non-performing employees"

So presumes the author that the people who are ostensibly receiving "billions" in bonuses are the same people who pushed this over-leveraging scam. All bankers are equal, none managed wisely.

"And thus, we lose Berkeley Ph.Ds in nuclear physics to hedge funds and MIT computer scientists capable of delivering computing to 6 billion people to derivative manipulation on Wall Street."

So presumes the author that nuclear physics and democratization of computing are more noble pursuits than finance. What he forgets is that mortgage-backed derivatives really did reduce risk for really bad mortgages. This was a phenomenal development, we could get more people into houses while not losing our shirts in the deals. Unfortunately, those same mathematicians weren't the ones employing this great tool that they created. "When the only tool you have is a hammer, every problem looks like a nail." It's not that mortgage-backed derivatives were wrong or evil or bad, it's that they were grossly overused. They reduce risk, they don't eliminate it, so when the scenario in which that risk turned to losses came true, the losses were too much to handle.

But, few people saw the risk for what it was because the Fed suppressed the price of money to lower-than-market rates, explicitly encouraging this sort of speculation. Price floors lead to shortages, this is a basic tenet of Capitalism. Is it any wonder that the entire nation is over-leveraged? Without the manipulation of the Fed, the price of money (interest rates) would have been much higher and this sort of speculation would not have happened.

KirinDave5• 17 years ago

So you're arguing that an accounting trick to statistically suppress risk and get a few more million people into homes that they ended up having taken away from them is fundamentally the same level of contribution to society as people inventing the Internet, the Telephone, Chemotherapy, Relativity, etc.?

You, sir, have an interesting outlook on life. But hey I guess a few high-risk buyers got to hang out in someone else's house for awhile, and that's good right?

danteembermage5• 17 years ago

I think his point is that, traditionally lending was a very local matter with local banks and local capital issues. If Norwegian pension funds want to fund a mortgage for a home in Paducah, KY, without some kind of securitization they're stuck earnings treasury rates and the home loan is charging the interest rate demanded by Paducah capitalists whether its higher than the Norwegian's rate are not.

The point is, there are gains from trade to be had from securitizing mortgages, the trick is to design them so that the information asymmetry costs don't outweigh the benefits. Maybe that's impossible and mortgage derivatives will always be value destroying but I doubt it.

steveplace2• 17 years ago

The banks, however, are another matter altogether, and this is where I think capitalism has hit a roadblock. The government has intervened to save many of them, [...]

That's not capitalism.

TrevorJ• 17 years ago

"[O]nly a virtuous people are capable of freedom. As nations become corrupt and vicious, they have more need of masters."

-Ben Franklin

The flaw in capitalism is us.

chrischen3• 17 years ago

I though it was quite obvious captialism provides only incentive to increase profits, and that it does not necessarily correspond with an incentive to make better profits.

Consider communism, ideally no one will worry about financial gain and everyone focuses on self actualization and innovation (because there's no monetary incentive, so only the truly altruistic thrive). However there's yet to be an implementation this ideal.

It's probably impossible to achieve a perfect system, so I think the answer lies in a more perfect balance of capitalism and communism.

bh23ha• 17 years ago

That's not the flaw of capitalism.

It is a hopefully temporary result of a world wide obsession with financial speculation.

Part of that is specific government policy resulting in financial speculation being more profitable then brick and mortar and bits and bytes businesses. I'm not just talking about the fed, and printing money, but also about trade policy.

The other part is lack of supply. When people can charge 2 and 20 and the 2 even if they suck, that means either there are a lot of people deliberately looking to lose money, or there is a shortage of hedge funds. And while those have exploded in number in recent years, that is not enough.

The government, through Ph.D. programs encourages education, some say this supply side intervention has the uninteded consequence of depressing wages for Ph.Ds. But what if the government strongly encouraged everyone to go into wall street? Politically it would be crazy to try and explain why we're paying for people to become bankers or fund managers. But a flood of talent is perhaps exactly what we need, to even out supply and demand.

hugothefrog• 17 years ago

From the article:

"She assumed integrity is implicit in the characters of the "leaders.""

I haven't read much Ayn Rand (i.e., none), but I've read a lot about what she has said and written. Is the quote from the article above dramatic license on the case of the author, or did Rand actually state that integrity is a required characteristic in the 'leaders'?

rms• 17 years ago

The fundamental flaw of capitalism is the tendency for wealth to concentrate in the hands of those that already own the capital. There's nothing to be done about it because the fundamental flaw is more like a fundamental feature.

Capitalism's Fundamental Flaw

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