There is a disease plaguing the global financial system that can be characterised as a willingness of governments to give up the responsibility to set the rules of money, and hand it over to private traders and the banks that facilitate the trading. In effect the umpire, government, has handed over the rules of the game to the players.
It is reminiscent of the three-person-chess that the eccentric character Sheldon invents in the television show The Big Bang Theory, which, according to the Big Bang Theory Wiki, 'utilises a non-standard, three-sided board with transitional quadrilateral-to-triangular tessellation to solve the balanced centre combat-area problem, additional (or fairy) pieces, and different rules for capture, move order, and game objective'.
Such gobbledegook sounds suspiciously similar to the application of mathematical models to financial securities in derivatives markets: high tech nonsense that can be brought undone at any time by the vagaries of crowd behaviour. The results have been sputtering economic growth, virtually no cost of money in most of the developed world and continual financial crises, mainly in the peripheral countries of the Euro zone.
The 'three-person chess' that financiers were allowed to create is called the derivatives market: transactions derived from more familiar activities such as bond markets, stock markets, currencies and bank debt.
Derivatives are a legitimate form of insurance if they are on the margin, but they have taken over. The global economy — the buying and selling of goods and services — is about $60 trillion. According to the McKinsey Institute global financial assets (shares, bonds, bank debt) are about $250 trillion. The Bank for International Settlements estimates the stock of derivatives is about $700 trillion.
Derivatives markets are driving what is happening in the 'real' economy and 'real' financial markets (the Greek and Italian financial crises, for instance, have a lot to do with the use of derivatives by those governments to cover their real debts). And that is proving extremely hard for economists and regulators to analyse. In effect, they are accustomed to analysing chess moves, not Sheldon's three-person meta-chess.
The International Monetary Fund recently conducted a conference to consider the future of macro economics as a discipline, which is looking distinctly frayed at the edges. IMF economist Olivier Blanchard expressed the widespread confusion:
Five years into the crisis, the contours of the macroeconomic policy of the future are only slowly coming into focus. From macroeconomic to financial stability, policy makers have realised that they have to watch many targets. They have also realised that they have potentially many more instruments at their disposal, from macro prudential tools to unconventional monetary policy.
But how to map instruments to targets remains very much a work in progress.
If regulators and financial analysts are confused, the big banks are not. They know where their interests lie — in protecting the derivatives markets from either scrutiny or change.
Dr Robert Johnson, executive director of the Institute for New Economic Thinking, recently commented that the problems started with the Thatcher era — when financial 'deregulation' was instituted mainly using economist Milton Friedman's 'snake oil' philosophy, the illusion that markets are stable and self correcting.
The attorney general of the US, Eric Holder has said he cannot prosecute crimes in the largest banks because it might undermine confidence. Clear evidence that the umpires cannot umpire because the game has been handed over to the players.
Johnson describes the US as a 'money politics system'. The derivatives system, he estimates, is 97 per cent dominated by six banks, which make about $35 billion a year. If derivatives were properly structured, put on exchanges, made more transparent and properly capitalised, it is estimated that the banks would lose about a fifth of their profit, about $7 billion a year.
'You get a financial bill through Congress about every five years. So the excess profit is about $35 billion,' said Johnson. 'As it turns out the banking lobbies spend about $600 million, which overwhelms American politics. It is the dominant force in American politics given the importance of money and how our society works. For $600 million these guys can protect $35 billion of profit. Fabulous risk return for them. Terrible for society.'
Francesco Musolino, in a paper 'Game Theory for Speculative Derivatives: a Possible Stabilising Regulatory Model', describes how self contained the financial world has become:
The current financial system is based on virtual money, which does not confluence into the real economy, remaining stuck in the finance. Possible solutions? Before arriving to a point of no return (which is actually not so far), it becomes appropriate, and perhaps vital, to establish the 'rules of the game', in order to redistribute the social wealth in a way at least close to the concept of equity.
Establishing better financial rules is what is needed, but the banks will resist it, and with such financial power they are likely to succeed, making another crisis likely.
Bitter battles between the banks and governments are not new; they have occurred for about two centuries in the United States. Franklin D. Roosevelt, for instance, in the 1930s used the word 'banksters' to decry 'the ruthless manipulation of professional gamblers and the corporate system' that allowed 'a few powerful interests to make industrial cannon fodder of the lives of half the population'.
But financial globalisation means that what used to be mainly an American problem is now a danger for the whole world.
David James has been a business journalist for 25 years and is the author of Managing for the Twenty First Century and The Business Devil's Dictionary. He has a PhD in English Literature from Monash University. 
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