The Flinchum File
Thoughtful Economic Analysis and Existential Opinions

Buggy-Whip Regulators

02/07/2018

While I am often called an economist, I have never been called a technologist or computer engineer.  Technology is a “black box” that absorbs power, perogatives, and flexibility from people, especially the regulators.   

The stock market gyrated wildly yesterday.  The Dow spent the day in a roughly thousand point range, from down 500 points to up 500 points.  While that alone is highly unusual, it doesn’t the tell the whole story.  The Dow traveled an amazing record 5,000 points in one day, gyrating both up and then down and then up again.  What does this tell us?

Did that stock market action reflect gyrations in the economy?  No, the economy is huge and changes slowly.  FYI – The latest ISM is at a record high. 

Did the market reflect gyrations in the profitability of American businesses?  No, earnings have been steadily improving.  FYI – So far, better than 70% of companies have beaten their forecast Q4 earnings!

Over half of all stocks traded are not sold by people.  They are traded by machines — computerized programs that buy/sell automatically based on some secret algorithm.  This huge market share of machine-based trading did not happen overnight.  But, it has been increasing faster – faster than the regulators can regulate it.  Now, some managers are deploying artificial intelligence (AI) to out-race their own algorithms.  I’m afraid the hidebound regulators are falling behind, putting the American financial system at risk.  It is not a question of additional regulations but of faster and more flexible regulations.  Regulators tend to be accountants or lawyers, not technologists. 

Do these poorly-regulated computerized trading programs pose a systemic threat to the stock market?  Not yet!  It is more likely to cause another “flash crash,” which terrifies the retail investor, but then quickly recovers.  However, at some point, a flash crash could trigger a systemic problem, if the counter-parties get thrown into default, but I don’t see that for several years at least.   

We don’t need economists as specialized regulators.  We certainly don’t need computerized-regulators, as some have suggested — computer programs regulating computer programs.  We do need technologists as regulators . . . and soon!

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