Risk Management From Markets to Market-Amoebas, and back to MMT

This column was promised to introduction of MMT, or Modern Monetary Theory, since it is the only economic approach that comes close to mapping to the vast literature about known, biological model market systems, i.e. species and ecosystems. The parallels are of paramount utility to investors able to swing between hyper-local and systemic views in the endless pursuit of adequately managing both known risks and uncertainties. My conclusion, up front, is that investors need to invest as much or more time & resources in upgrading operations at the SEC, US Treasury, Federal Reserve and US Congress as they do in choosing winning stocks. Market platforms, like all other systems, must be created and maintained, and the highest cost in all systems is eventually the cost of maintenance, alternately known as the cost of coordination. To broaden perspectives, let's start with a particular biology model, the social amoeba

Dictyostelium discoideum

since it carries so many parallels to human market systems, and proceed from there to MMT. Comparing diverse market models provides quick, powerful methods for seeking consistency and spotting inconstancies. There are far too many useful parallels to mention in one column, but "dicty" will be introduced as a fantastically useful model which future columns will return to consistently. Here's one, useful comparison useful for reducing confusion over the nature of currency, and of currency creation. The USA is a social collection of over 300 million agents now. Every amoeba is a collection of

well over 300 million molecules

. Each market, human and single-cell amoeba, utilizes a currency system to denominate transactions and carry liquid value between delegated transactions. What primary currency system does the amoeba, and all known cells use? A molecule called adenosine. Adenosine can be loaded with energy value by attaching one, two or three phosphate bonds, making adenosine mono-, di- or tri-phosphate, respectively AMP, ADP or ATP. How much adenosine does every cell make? As much as it needs. What's the mystery? Does any cell "borrow" adenosine? What a silly question. No system borrows bookkeeping methodology. What entity in cells manages adenosine production? There are multiple synthesis & degradation paths all capable of recycling adenosine, and they are all kept in dynamic equilibrium by universal feedback. The self-reporting system becomes it's own Federal Reserve. Can a cell ever "run out of" it's adenosine bookkeeping currency? No, as a bookkeeping "issuer", cells are tasked with managing real-goods budgets. Short of absolute death or damage, cells can always synthesize as much adenosine bookkeeping currency as is needed in order to carry resources between transactions waiting to happen. Bookkeeping in any system is infinitely self-generating, as a byproduct of the system itself. How do cells manage the thorny issue of "price stability"? What? The question has no logical base. The cell must survive. No secondary framework for determining price stability has any relevance. The actual relevance of any given internal transaction has no consistent frame of reference other than survival of the aggregate. Local measures of value relevant to that framework are ephemeral, change every picosecond or faster, and are constantly re-established so unpredictably that there is no aggregate purpose in tracking it other than in assuring adequate component maintenance. If forced to consider it, most biologists would presumably say that the majority of what we call human market activity is only random, irrelevant system noise thrown off between those intervals where context demands that we actually tune our aggregate operations. Now you can see why a biologist first addressing economics would ask, "in human economics, what is the equivalent of the adenosine molecule"? Surprisingly, there is no absolute consensus on that definition and the history of human market bookkeeping systems is comically convoluted, understood by few, yet vociferously argued over by many. That's to be expected in still-emerging systems. What's especially comical is the certainty of so many people in claiming permanent definitions for an obviously still-forming operational system. Without consistent, axiom definitions of components, it is very difficult to make a self-consistent system capable of smoothly scaling up markets of any size. A lowly "market-amoeba" such as dictyostelium can routinely scale up from small to large size, aggregate and dis-aggregate "international" markets, and emigrate and colonize - all without EVER having a "depression" caused by currency mismanagement. In contrast, what are we struggling with? To begin to parse currency operations in human markets, let's start digging through it's history, and arrive at MMT, which is not a theory at all, but rather just a description of how monetary operations actually occur in current market systems. It is the only economic data base I've come across that, like cells & adenosine, deals only with operational facts, and can scale up smoothly to handle any contingency, on demand. In short, it is geared to the operations of aggregates, not encumbered by the non-scalable perspectives of components alone, nor the limiting ideology of any market component. To a biologist, that sounds promising, and like something an aggregate can successfully work with and on. There are useful reviews of early decisions on currency matters mentioned in the Constitutional Proceedings of 1776, see

Public initiative and the beginning of US currency

(how a confused electorate can end up pretending to borrow it's own currency, instead of creating it) and

Understanding Modern Money

. Such links make it clear that currencies are initially created, on demand, by aggregate entities, whether nation states or market-amoebas. So far, so good. However, what happened next? Why so much historical confusion over currency creation and management of currency supply? A biologist would simply conclude that we have an incompletely formed aggregate, not coordinated to the degree ensuring coherent actions and guaranteeing national survival. When that state holds, there is mass confusion, and the bulk of relevant feedback is not yet parsed, and hence ignored. That certainly seems to be the case when reviewing current monetary policy. See Robert Eisner, The Misunderstood Economy, p.90;  

Almost everybody talks about budget deficits. Almost everybody seems in principle to be against them. And almost no one, literally, knows what [they are] talking about

. Given this degree of ideological confusion, it is not surprising that so many residents, even financial professionals, know so little about our fiscal history, and possess even less systemic perspective. Here is just a few examples of the many fiscal and financial misbeliefs blatantly muddying our current financial press.

Teaching the Fallacy of Composition: The Federal Budget Deficit

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Taxes for revenue are obsolete

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Fiscal sustainability 101

. One of my favorite exchanges on fiscal policy occurred in 1941, after we'd had to jettison the cumbersome gold-std in order to gain the focussed speed & flexibility needed to successfully wage WWII, an example of a nation acting like a market-amoeba.

"ECCLES: We [the Federal Reserve] created it. PATMAN: Out of what?  ECCLES: Out of the right to issue credit money.  PATMAN: And there is nothing behind it, is there, except our government's credit?  ECCLES: That is what our money system is."    - Federal Reserve Board Governor Marriner Eccles in testimony before the House Committee on Banking and Currency in 1941, during questioning by Congressman Wright Patman about how the Fed got the money to purchase two billion dollars worth of government bonds in 1933

. This exchange drives home points that make consistent sense to a biologist. First, any sovereign currency system is, by definition, always tied to a "public initiative" standard, and nothing else. Second, momentary tactics are not written in stone, only enduring national goals and policies are. If we can direct our Central Bank to arbitrarily create the currency to "buy" bonds, in order to quickly force innovation through outdated methodology, then it's also immediately obvious that we don't even need to "buy" the bonds, and may bypass them as well.   If Treasury-bonds were irrelevant & obsolete in 1941, then there is no reason for US citizens to be limiting their ability to think creatively in 2010! Warren Mosler has a simplified essay driving home many of the diverse inconsistencies in how most people, even banker and economic policy exerts, view modern monetary operations.

The 7 Deadly, Innocent Frauds of Economic Policy

. In summary, will our national market system eventually have to act more like a self-consistent market-amoeba? If we are to survive, that seems to be an inevitable conclusion. How will we continue to evolve successful operations? By exploring, on demand, whatever options present themselves. Certainly not by refusing to go where context is forcing us! Our last great depression was both the result and cause of a complex confluence of factors, yet we traversed it by aggressively exploring entirely new, still emerging options. The rate of bold domestic policy activities explored during the 1930s rivals in scope those explored during the 1940 war years, not to mention the 1860s and 1770s-1780s. See

a calendar of some of the notable events and dates during the 1930s

. How should an investor leverage these sweeping insights in order to shepherd short and long term returns? As every market component is itself one particular market-amoeba, the obvious lesson is to continuously invest in your market platform, not just your isolated trades. The surest way to lose market value is to eradicate the market which allows value creation. Rather than endorsing MMT as an ideology, I've purposely only provided links revealing operational facts. The biological approach is that any and all methodologies are incessant works in progress, and that survival comes ONLY with initially full integration of all approaches, followed by relaxation to the leanest subset fitting a fleeting context. Our only hope, as Ben Franklin cautioned, is for ideologues of all stripes to fully engage, openly share, and honestly compromise views in light of rapidly unfolding operational reality. There is always less time than we believe.

"But while they prate of economic laws, men and women are starving. We must lay hold of the fact that economic laws are not made by nature. They are made by human beings."

For those further interested in MMT, here is an early attempt to enclose most of the operational insights that have come to be loosely described as

Modern Monetary Theory

. It's an unfortunate name. A simpler term like "A List of Current Monetary Operations" would be more accurate, but as usual, mobs and markets come to be ruled by logic after the fact, if ever.

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