By George Friedman
Global markets fell yesterday. I read numerous stories about them falling and the consensus was that the decline is due to concerns of low oil prices and fears of Chinese economic weakness. That seems reasonable until you ask a second question – why yesterday? The Chinese economy has been declining for years and oil for at least a year. So why did the markets take so long to start falling and why did they panic yesterday?
The second question that comes to mind is what difference does it make? It makes a difference to me if I make or lose money, but to be honest I don’t much care about others. But there appears to be a great social significance to the movement of financial markets that transcends the interests of individuals like me. So if the first question is why yesterday, then the second question is so what?
I am not about to try to predict the stock market. But it is useful to consider its role in the general scheme of things and perhaps try to answer the two questions, which, when taken together amount to a third question. What is the stock market? There is no question that it exists, there is no question that its movements transfix many and there is no question that vast amounts of value were lost yesterday and created other days. But to the unaided eye it appears to be a casino. When I go to Vegas, which I do to play blackjack, there is the dealer, the cards and the drunken woman called Fiona sitting next to me. None of this is connected to anything outside of my money and the casino’s balance sheet. To an observer more interested in blackjack than the markets, it appears that the markets are simply a vast casino, with incredibly more complexity than blackjack.
Let’s approach this question from a geopolitical point of view. Geopolitics views human community, these days the nation-state, as the fundamental unit of human life. Humans live within these communities and engage in a large variety of activities, which we might designate as political life, which is the manner in which large numbers of people are managed. Another aspect of geopolitics is war, which is how nations occasionally interact with each other. There is technology, which is how humans manage their relationship to nature. And there is economics, which is the manner in which humans produce, distribute and consume goods and services. There are other things but I think you can fit most of it into one of these categories.
Geopolitics as a discipline would argue that these distinctions are useful ways to organize your thoughts, but that in fact the distinction between these is illusory. Politics, war, technology and economics are simply different aspects of the same thing, communal life, which is the only sort of life that humans can live. Geopolitics takes the view that there is an inherent unity both among people and among the various things they can do. And therefore people live in all of these spheres and carry out all of their activities together.
Economics is that activity that keeps you alive. It provides, in conjunction with the other spheres, food, shelter and clothing. Of course economics, like all human activities becomes enormously more complex than that. There are many ways to organize an economy, and how an economy is organized evolves over an extended period of time and in conjunction with nature and technology, foreigners and warriors, leaders and followers.
Accounting – or in its advanced form, finance – is a subset of economics that is always present. If there are three apples, then someone must have the right to eat them and that question is present in the most congenial of tribes to a fascist state to a commercial republic. There are things that are produced and distributed and consumed and there must be some mechanism that determines allocation. Economics doesn’t determine that but law, a subset of politics, does. Economics studies the process and accounting of the allocation. This was essential because human activity requires a division of labor, and, within large communities, smaller organizations to carry out economic functions.
One of the extraordinary inventions of Europe was the idea that it was possible to organize these lesser organizations into legally recognized entities – companies – that were empowered to carry on economic life. Far more extraordinary was the decision that it was possible for someone to own all or part of this organization, without having any liability greater than what he invested. The invention of money is not essential to this story. The idea of ownership began with three apples. That owners could control an organization, but not be held liable for its debts was a political invention on which our world pivots.
If a person could own a company while limiting his liability, then he could sell part of that company to others at will. They also would have no more at risk than what they spent on their share of the company. And then they could resell the shares and the shares would reflect the value of the company. Some would buy it anticipating growth in value and others would sell anticipating loss. And the people would stand on a street and buy and sell shares.
It was at that moment that corporation’s invention spawned a new dimension. The initial owner managed the company. The various shareholders were familiar with the company and benefitted from prudent management. But the people on the sidewalk trading shares benefitted from the movement in the price of the stock and were ultimately indifferent to the cause of the movement. Someone was building widgets, someone was investing in building widgets and someone was investing not on the value of the company, but on the perception of the company’s value.
The corporation was a politically invented system for managing financial risk and facilitating economic and technological change. All of this had to be accounted for, and a system of internal accounting was created and a system of financial processes was created to provide tools for investing in various companies. The value of the investment was determined by what other people were willing to pay for it. And the financial system spawned its own subsystem that traded shares whose price was related to value, but varied around it and sometimes was only tenuously connected. As corporations became vast, the internal accounting system struggled to determine value and the financial system sought to efficiently move money. But value was set in the markets and the markets were focused on what others might think the value would be seen as tomorrow, not on what the value would be.
To the question of why the markets did what it did yesterday in spite of the fact that China had weakened years ago and oil has been falling for an entire year. The answer is that it is not the weakness of China or the price of oil that moved the markets, but rather the perception of China and oil. The game at this casino is not to predict when China would weaken, but to predict when others would think it weakened. And since perceptions are common and the fear is to miss the moment of perception, the markets are only loosely connected to reality and intimately connected to perception of reality. As to the next question, so what? This is how advanced industrial capitalism manages risk and the movement of capital. In its way, it is an ultimately democratic movement, in which knowing the opinions of others is more important than knowing the truth. Each person’s opinion is as good as the next.
But it is important to note that all societies have economies and financial systems and even markets. But what is radically unnatural, and central to what we do, is the invention of the limited liability corporations, which made the stock market possible. This is an entirely political invention having no natural existence. The trading of shares cannot be a free and natural market because it is built on a political invention, neither fully free nor fully natural.
That said, it works – painfully, brutally and slowly. In the end General Motors goes bankrupt and Digital Equipment disappears. A market driven by perceptions is efficient only in the very long run. In the short run, it starts at fairies and rushes toward mirages. As for me, if I want to bet on perceptions, I will play poker, preferably with a very successful lawyer. And if I want to bet on my ability to remember how many face cards had been dealt, I will play blackjack. There you get the one thing you don’t get playing the market – free liquor.