In his monumental A Study of History, Arnold Toynbee, the great British historian, finds some common elements in the rise and fall of civilisations. These are:
- There is a creative minority which takes a far larger share of society's output than the average member;
- Civilisations continue to grow so long as society accepts that what the minority is contributing is larger than what is takes;
- In course of time, the creative minority becomes a dominant minority; it continues to take more, but its contribution falls;
- When this happens, the 'proletariat' revolts, led by a new creative minority.
This cycle was seen in the rise and fall of socialism. Are we witnessing history repeating itself in terms of the domination of finance capital, in particular, that of speculative capital?
While many religions, Islam and Christianity in particular, have proscribed the making of money from money -- whether through interest or speculation -- by far the biggest profits are being made by the latter activity, whether by hedge funds or by the trading desks of banks. It has, of course, become a cliché in recent years to refer to successful speculators as 'investors': George Soros, for example. (To be sure, in some ways, he has become so.)
But there is a major difference in the manner in which money is made in the two activities: Speculation involves buying or selling an asset for making money without adding any value to it; investment looks to the returns from the investment for earning profit.
The immediate provocation for these thoughts has been the release of Goldman Sachs' Q2 numbers (a record profit of $3.4 billion) -- the erstwhile investment bank, which converted itself into a commercial bank not so long ago, in order to gain access to public funds during the banking crisis.
It not only got $10 billion of public money directly, but also benefited hugely from the bail-out of AIG, the giant insurance company, by the US government. The largest segment of these funds went directly from AIG to Goldman Sachs which was the counterparty to the credit default swaps on securitised mortgage debt sold by AIG -- as big a mismanagement of counterparty credit risk as any.
(It is purely incidental, of course, that at the material time, the Treasury Secretary happened to be an ex-Goldman chairman.) But for the direct and indirect support on a gigantic scale from public money, it is questionable whether the 'Masters of the Universe' would have survived the crisis, let alone earned record profits and payed an average of a million dollars to each employee: Even The Economist, that arch supporter of the virtues of unfettered free markets, seems slightly embarrassed at the humongous profit reported by Goldman, describing it as 'obscene'.
The Economist has also criticised the huge bonuses distributed by Goldman Sachs, but seems to have swallowed uncritically the claim of Goldman management that 'most of its profit came from acting as a middleman, making markets for clients', not through 'proprietary' trading. In the best of circumstances, the distinction between proprietary trading and making markets is thin.
If a bank is making a market in a particular asset, it quotes the bid and offers rates, and has obviously to be prepared to go long or short in that asset class -- which is what proprietary trading does more directly.
Unfortunately, the numbers released by Goldman do not support the thesis that, as its chairman claimed, its 'role as an intermediary
. helped drive our performance'.
This does seem to be something of a 'terminological inexactitude' since the average daily Value at Risk in the quarter has actually gone up very sharply (from $184 million to $245 million) as compared to the corresponding quarter in the previous year.
Surely, if the focus were on market-making than on proprietary trading (that is, speculation), the average VaR would have gone down? The other interesting feature of the Q2 numbers is that the net revenues under trading and principal (that is, proprietary) investments was much higher at $9.3 billion, compared to $5.7 billion in the previous quarter and $5.2 billion in the corresponding quarter in the last year. The net interest income, at $2 billion, is practically unchanged from the previous quarter.
Yes, speculators do provide a needed input to markets -- namely liquidity. On the other hand, considering the volatility of exchange rates, commodity prices etc, arising from speculative activity, prices to which the real economy is forced to adjust, the question is whether the speculating class has not become the new dominant minority -- taking far more from society than it puts back in. But more on this in a later article.
Tailpiece: The newest airline in the US is Pet Airways, meant exclusively for the transportation of the cats and dogs of the super-rich in luxurious comfort. There is no truth however in the rumour that the entire business class has been booked for the next six months for the pets of bank traders and hedge fund managers.