Sunday, 3 May 2009

Thoughts on a bottom up financial architecture

A question that is being asked with increasing earnestness in the United States is - why do we need the Federal Reserve? This same question can easily be extended to any nation state - why is it vital to have a central bank? In even more general terms why do we need centralized top-down authority structures in the world of finance?

These are Big Questions and the fact that many are beginning to ask them is, I believe, a good omen for the future of our financial architecture. There are some not so constructive and ultimately destructive strands to the debate, and some of the tone of the discussion, in some ways perfectly understandable, may be nothing more than an angry resurgence of libertarianism in reaction to the horrendous stupidity of the financial technocracy and the blatant examples of Wall Street/Washington cronyism.

For those who have something else to do today after browsing the web for an hour or so they can take relief from the fact that I do not want to tackle the issue of replacing the Fed or other central banks head on in this article – I shall leave that for another occasion. However I will simply declare my hand by pointing out that with interest rates effectively at zero around the globe and with the main strategy advocated by the financial technocracy for "solving" almost every financial miscalculation or "accident" being to shovel ever more generous sums from our - apparently - limitless inter-generational future wealth at them, it does seem hard to find a rationale for all of the elaborate Fed machinery. Day to day open market operations are one thing but in terms of the FOMC the default mode for policy making with regard to the financial sector seems to be - If in doubt bail them out.

The question that I want to touch on - and at this stage it really is no more than like a butterfly touching down for a few seconds - is the possibility that de-centralized network dynamics might be expected to emerge that could provide for a far more versatile and less fragile risk management capability than we have today.

Bottom-up, self-organizing forces within distributed networks as a new way to organize the financial world and political system are memes that are still in their infancy. But there are some instances that one can point to of this emergence, including the manner in which Barack Obama was able to mobilize grassroots support via the internet and social networking paradigm and defeat the old style political machinery-big interest group model of the Clintons. I would suggest that this simple case study lends plausibility to the notion that it may not be too distant in our future that a replacement model could start to emerge that would reveal just how outmoded our current highly centralized and oligarchical financial structures are.

A distributed architecture with much less power at the center, and a looser association of the nodes of the network without over-optimization would provide, in the opinion of this author, the foundations for a framework and topology for a financial system which would be more transparent, less fragile and more equitable.

Turning to another dimension enables us to examine some of the cultural and personality issues that can arise in the debate about centralized versus de-centralized modes of organization. To put things rather crudely, some personalities are authoritarian and sometimes described as “control freaks” – these tend to be people who have a low tolerance for risk – and there are others who are more culturally adventurous who are willing to live with less “certainty” and have more confidence and belief that order will emerge from the apparent chaos of multifarious social and economic interactions.

On this topic there is an interesting and thoughtful piece by John Naughton in the London Observer newspaper for Sunday May 3, 2009.

The author of the column contrasts the two mindsets that I have touched upon and makes the following very illuminating comparison

The cultural agoraphobia from which most of us suffer leads us always to over-emphasize the downsides of openness and lack of central control, and to overvalue the virtues of order and authority. And that is what is rendering us incapable of harnessing the potential benefits of networked technology. Industries and governments are wasting incalculable amounts of money and energy in Canute-like resistance to the oncoming wave when what they should be doing is figuring out ways to ride it.

To further demonstrate the point being made above the writer contrasts the manner in which the French government created the Minitel network in the 1990’s – a predecessor to the World Wide Web. Most homes in France had a terminal connected to the Minitel network which was organized by the French government with centrally selected content and channels of information. This would represent the top down form of network organization par excellence .

On the contrary the DARPA system which was used as the basis for the much more loosely connected – from an organizational point of view- internet and the World Wide Web which also came to prominence during the 1990’s became the bottom up publishing platform upon which – to quote from Naughton – “anybody can publish anything - including lies, propaganda and pornography - with no prior approval”.

In a related context it is also possible to make the contrast between the way that the Encyclopaedia Brittanica is published with rigid editorial and source-checking protocols as opposed to the more anarchistic way in which the Wikipedia is evolving.
While “the control freaks” would prefer to use Brittanica rather than Wikipedia there can surely be little dispute as to which is becoming the de facto standard for a new generation of information consumers used to viral networking, collaborative and constantly evolving documents as well as an innate distrust of top down authority figures.

What some are looking for to replace the corrupt Washington/Wall Street consensus and the power of the financial oligarchs at the center, is something which is much more like the World Wide Web than the French government's Minitel. It is taking the technological and open source model that was primarily innovated within what might loosely be called the Anglo-Saxon cultural tradition but, at the same time, resisting the tendencies within that same cultural mindset to seek to dominate and control. If the financial elite fail to recognize the fallacy of seeking such control they will ultimately come to the same realization as King Canute.

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