Professional analysts scrutinised the contents of these regulatory announcements and advised their clients on their implications. They wined and dined farmers; but once the farmers were required to be careful about the information they disclosed, these lunches became less useful. Some smarter analysts realised that understanding the nutrition and health of the ox wasn’t that useful anyway. Since the ox was no longer being weighed - what mattered were the guesses of the bystanders - the key to success lay not in correctly assessing the weight of the ox but in correctly assessing what others would guess. Or what other people would guess others would guess. And so on.
Some people - such as old Farmer Buffett - claimed that the results of this process were more and more divorced from the realities of ox-rearing. But he was ignored. True, Farmer Buffett’s beasts did appear healthy and well fed, and his finances ever more prosperous; but he was a countryman who didn’t really understand how markets work.
International bodies were established to define the rules for assessing the weight of the ox. There were two competing standards - generally accepted ox-weighing principles, and international ox-weighing standards. But both agreed on one fundamental principle, which followed from the need to eliminate the role of subjective assessment by any individual. The weight of the ox was officially defined as the average of everyone’s guesses.
One difficulty was that sometimes there were few, or even no, guesses of the weight of the ox. But that problem was soon overcome. Mathematicians from the University of Chicago developed models from which it was possible to estimate what, if there had actually been many guesses as to the weight of the ox, the average of these guesses would have been. No knowledge of animal husbandry was required, only a powerful computer.
By this time, there was a large industry of professional weight-guessers, organizers of weight-guessing competitions and advisers helping people to refine their guesses. Some people suggested that it might be cheaper to repair the scales, but they were derided: why go back to relying on the judgement of a single auctioneer when you could benefit from the aggregated wisdom of so many clever people?
And then the ox died. Amid all this activity, no one had remembered to feed it.
The assets of British banks are five times the liabilities of the British government. But the assets of these banks mostly consist of claims on other banks. Their liabilities are mainly obligations to other financial institutions. Lending to firms and individuals engaged in the production of goods and services - which most people would imagine was the principal business of a bank - amounts to about 3 per cent of that total.
Modern banks - and most other financial institutions - trade in securities, and the growth of such trade is the main explanation of the growth of the finance sector. The finance sector establishes claims against assets - the operating assets and future profits of a company, or the physical property and prospective earnings of an individual - and almost any such claim can be turned into a tradable security. ‘High-frequency trading’ is undertaken by computers which are constantly offering to buy and sell securities. The interval for which these securities are held by their owner may - literally - be shorter than the blink of an eye.
If securities are claims on assets, derivative securities are claims on other securities, and their value depends on the price, and ultimately on the value, of these underlying securities. Once you have created derivative securities, you can create further layers of derivative securities whose values are dependent on the values of other derivative securities - and so on. The value of the assets underlying such derivative contracts is three times the value of all the physical assets in the world.
What is it all for? What is the purpose of this activity? And why is it so profitable? Common sense suggests that if a closed circle of people continuously exchange bits of paper with each other, the total value of these bits of paper will not change much, if at all. If some members of that closed circle make extraordinary profits, these profits can only be made at the expense of other members of the same circle. Common sense suggests that this activity leaves the value of the traded assets little changed, and cannot, taken as a whole, make money. What, exactly, is wrong with this commonsense perspective?
Not much, I will conclude.