
Capitalism's Fundamental Flaw - acangiano
http://www.forbes.com/2009/11/05/innovation-ayn-rand-intelligent-technology-capitalism.html
======
darjen
A fundamental flaw in the article:

"The banks, however, are another matter altogether, and this is where I think
capitalism has hit a roadblock. The government has intervened to save many of
them, and now, these bailed out banks want to hand out billions in bonuses to
their non-performing employees. Capitalism gave way to welfare economics, and
now the government has to intervene further to limit these looters from
behaving badly by imposing taxes and regulations."

If the government hadn't intervened in the first place, and instead let these
irresponsible banks fail, then the transfer of taxpayer money in the form of
bonuses never would have happened.

What she's describing here is, in actuality, yet another flaw of government
intervention.

~~~
kansando
Right. And allow the economy to go into a long-term depression with 25%+
unemployment. A government "for the people" does not have a choice in this
matter. The real problem is that bankers/speculators have so much power on the
outcome for people who are not at all related to the industry.

~~~
megamark16
The point isn't whether or not the government should have intervened, the
point is that because they did we can't blame Capitalism for the outcome of
that specific action. A purely capitalist market would have let the financial
crisis run is course, right or wrong. At least, that's how I see it.

~~~
chrischen
The thing is the US isn't purely capitalist.

------
danteembermage
I think the appeal of finance is the intellectual leverage one gets there. If
I am really bright and I can develop a profitable arbitrage trade in the
marketplace I can turn it near instantly into millions of dollars (if I'm
right, obviously the market does not give points for effort).

If I'm in a start up, which we would probably consider to be very high
cleverness to reward leverage, it can take a long time and have lots of
randomness to get the big payoff, e.g. Kiko.

Now, compare that to being an employee, where to get enormous payoff you have
to climb the ladder into stock options land.

The article's point is that this is not how the world should be, but markets
cause this by construction: If I'm stranded on an island with a bunch of
Robinson Crusoes I'm going to try swapping coconuts for mangoes across the
island before I start experimenting with cross breeding them.

From a welfare perspective it even makes sense to do the easy things first
(trade) and the hard stuff next (R&D) because effort is more likely to be
rewarded in the former than the latter.

One could also complain about how all the socially well connected are
lobbyists instead of high school teachers and the beautiful are in
pharmaceutical sales rather than portrait modeling. Sure it's sad, but also
mostly inevitable.

~~~
yafujifide
> if I'm right, obviously the market does not give points for effort

But the market does give points for effort. How else do you explain the
bonuses awarded to bankers who damaged the economy? They were rewarded despite
their antisuccess.

~~~
bdr
You're blatantly taking that out of context. GP's idea was to "develop a
profitable arbitrage trade" using one's intelligence, not to go work for a
bank.

------
mseebach
The reason speculators can make tons of money on Wall Street, is because they
can get people to play along.

You don't make money because an asset you own rises. You make money because
someone buys it at that price. (That's the same, I know, but it's an important
point to understand - it's NOT just numbers going up and down in a computer,
at the end of the chain there's actual liquid money changing hands).

Now we've lived through two financial bubbles right after each other, and one
can hope that people will learn that sharp rises in the value of an asset are
often inflated, and stop putting their money into the game. After all, those
who bet and then hedged their bets on real estate (this time) and .coms (last
time) were also (generally!) the ones who lost the most.

~~~
pbhjpbhj
_at the end of the chain there's actual liquid money changing hands_

Naked short selling doesn't require one to have any money to invest nor any
shares. You can still make a lot of money and destroy a company's shares if
well connected enough. The price falling on the shares is only produced by the
apparent glut of shares offered for sale, they don't need to sell initially to
produce a price fall, the offer is enough. Once the naked sale has iterated
through a couple of loops and many other offers appear as the stock falls then
the price plummets, not because of sales but because of lack of sales.

You make money because no one buys. Traders can make money any way the market
moves and if sufficiently skilled and backed can make the market move - it
_is_ just numbers going up and down.

------
pjkundert
Perhaps a better title would be "Mercantilism's fundamental flaw". Rand makes
few assumptions regarding the inherent integrity of "leaders"; in fact, she
assumes no such integrity, and argues for liberty.

While we trip over ourselves (as a society) to give up our freedoms and grant
ever more sweeping power to "leaders" to save us, we will reap what we deserve
-- ever greater examples of waste, bungling, abuse, malinvestment and looting,
on scales simply unimaginable just a few years ago.

We gave up our ability to directly monetize wealth 2 or 3 generations ago --
what features of our present financial system makes you believe that it is
"Capitalism"? Government giveth, and government taketh away. Sounds like good,
old-time kingly Mercantilism to me...

~~~
yafujifide
I hate to bring this to a general discussion of capitalism/Rand etc., but I
have a question:

How is Rand's "liberty" supposed to be provided?

It seems to me we already live in a universe where people have as much free
will as we ever will. Some people use this free will to restrict the free will
of others. Sometimes this is a government, sometimes it's a corporation, or
sometimes it's a kidnapper.

But what hypothetical external agent could ever ensure that no one's free will
will be restricted? To have such a system would necessitate restricting
people's free will so that they couldn't restrict each other's free will; it
would be a self-defeating situation.

This is analogous to the set of all sets in mathematics, or other paradoxes
that arise by having "all powerful" objects. Humans are so free, that we are
free to kill ourselves (for instance), and remove our freedom. Likewise, we
are free to disable our own free will.

How could Rand change things so that this is not the case?

In my view, governments are the result of the utter freedom we have as humans.
It is simply absurd to think of getting rid of the systems that restrict
freedom; if we did, the freedoms granted would simply create new systems, like
corporations, or another government, that would replace all the functions of
the system we got rid of.

Let me put it another way: It seems we already have maximal liberty. How are
things ever going to be better in that respect?

~~~
unalone
I was going to submit this a few days ago, but I don't like Rand-only
discussions. However, I'd like to contribute to the thread with this recent
Slate article, which abruptly reversed almost all my remaining positive
feelings about Rand:

<http://www.slate.com/id/2233966/>

Not only was she a hypocrite who ignored her own teachings when things got
personal, she worshipped a serial killer who raped and dismembered a 12-year-
old girl, because she saw him as a hero defying society.

~~~
dgordon
Considering how much just about every other quote in that article was taken
out of context, I would expect that was too.

~~~
unalone
The Branden quotes weren't taken out of context. It was the Branden affair
that first led me to doubt her words, and that's pretty much as it happened.

Back-up of the mass murdering psychopath bits:
<http://michaelprescott.net/hickman.htm> FTA:

 _According to Rand scholar Chris Matthew Sciabarra, she deliberately modeled
Renahan - intended to be her first sketch of her ideal man - after this same
William Edward Hickman. Renahan, she enthuses in another journal entry, "is
born with a wonderful, free, light consciousness -- [resulting from] the
absolute lack of social instinct or herd feeling. He does not understand,
because he has no organ for understanding, the necessity, meaning, or
importance of other people ... Other people do not exist for him and he does
not understand why they should."_

So she modeled her initial Randian Hero after the psychopath.

 _In the original version of her first novel We the Living: "What are your
masses [of humanity] but mud to be ground underfoot, fuel to be burned for
those who deserve it?"_

Sounds Jokereqsue, no?

 _Of The Fountainhead's hero, Howard Roark: He "has learned long ago, with his
first consciousness, two things which dominate his entire attitude toward
life: his own superiority and the utter worthlessness of the world."_

And:

 _The editor also provides the briefest and most detail-free synopsis of
Hickman's crime possible: "He was accused of kidnapping and murdering a young
girl. He was found guilty and sentenced to death in February of 1928; he was
hanged on October 20, 1928."_

 _As far as I can tell, this is the one and only reference to Hickman's victim
to be found anywhere in the book. Ayn Rand never mentions the victim at all in
any of her journal entries. The closest she comes is a sneering reference to
another girl, "who wrote a letter to Hickman [in jail], asking him 'to get
religion so that little girls everywhere would stop being afraid of him.'"_

Pretty damning. And there's much, much more.

------
btilly
A sobering read about the problems our system faces is
<http://www.theatlantic.com/doc/200905/imf-advice>.

During the last boom a full 40% of all of the profits in the system came from
the non-productive activity of people manipulating cash flows. This is simply
not a sustainable financial structure. History shows that economies that are
based on financial manipulation rather than production don't last. The USA
isn't the first to combine of financial manipulation along with the export of
production and the knowledge that previous lead to persistent economic
advantage. In the last several hundred years Spain, Holland and England did
this. In all previous cases it was a big factor leading to financial collapse
and the loss of empire.

Is there any reason to believe it will work any better for us?

------
richcollins
"Integrity, justice, fairness, work-ethic, excellence--all have fallen prey to
greed."

Greed is tempered by risk when the government can't save you.

~~~
viggity
Greed would be tempered a lot more by risk if the government didn't save
anyone.

~~~
megamark16
I think that is what richcollins is saying. What I took away from that
article, although I don't think it is quite what the author had in mind, is
that Capitalism is flaw by the fact that our government does not allow/force
us be purely capitalistic. The safety nets open the doors for greater risk,
which require bigger safety nets.

~~~
chrischen
Humans aren't angels. Just as we need laws to protect us from killing each
other or stealing we need laws to protect us from ourselves in the economy.

Whatever system we have, however much it naturally encourages innovation,
_someone_ will try to manipulate it.

~~~
danek
Agreed. I think people spend too much time arguing about "capitalism the
ideal" when what we should be talking about is "capitalism the
implementation."

------
frig
In hindsight the present situation is pretty predictable: as the # of goods
produced increases and the amount of specialization increases the value
supplied by the intermediary network ("the financial system") increases.

The way the financial system is currently "architected" (a strange term, but
I'll use it) it has as a class an inordinate amount of negotiating power vis-
a-vis everyone else (!), and thus is able to capture much of what ought to be
consumer and producer surplus.

As much of the value it adds is due to network effects just going to a gold
standard (which is a popular cure-all on the internet) wouldn't change much,
even if you thought that was a good idea; there's still the same tremendous
problem of coordinating trade in the same complex, highly-specialized economy
and the central switchboard is still ideally placed to extract most of that
value.

The easiest-to-envision solution is to forcibly unbundle the basic storage-
and-transmission of credits between accounts (full-reserve checking accounts,
basically) and run that infrastructure as a public utility (a handful of
mainframes in the fort knox). Let the private sector sell value-added services
on top of this, but don't leave the basic infrastructure of value-exchange in
the hands of the private sector, who will retain the ability to hold the
country up for ransom.

It's an easy solution to envision but it's hard to see much happening; it is
too radical a shift to go down easily (and all that surplus value captured
funds a lot of lobbying) and it too closely resembles socialism and other
bugaboos to be an easy sell to the public at large.

(!) Where we are now is pretty analogous to having the local power company --
which provides necessary services to its area of operation -- also involved in
speculative ventures that backfired enough that its continual operation is
threatened; having the ability to turn the lights off would naturally give the
local power company a lot of leverage negotiating for a bailout.

Suppose that the "too big to fail" banks were allowed to fail, and there was
temporarily a severe disruption in the banking system. How would you propose
that federal, state, and local law enforcement and other "essential services"
get paid? With cash -- dangerous and risky? With checks -- while the banking
system isn't reliably working? Would you trust them to work without pay for
very long?

------
sethg
If the government imposed a small tax on stock purchases and other financial
transactions, with the tax level rising according to the number of
intermediaries and the amount of leverage, then working in an organization
through which lots of money passes would not be such a lucrative career.

(And if it remained lucrative, at least the government would be able to
participate in the bounty that comes from skimming a few parts-per-thousand
off the top of a very large cash flow.)

~~~
gaius
_working in an organization through which lots of money passes would not be
such a lucrative career_

No, those people would just go work for the government.

------
bensummers
This article suggests, twice, that "most intelligent people" agree with the
author. Surely there is a better way of proving these facts, than just using
such an assertion?

------
bh23ha
That's not the flaw of capitalism.

It is a hopefully temporary result of a world wide obsession with financial
speculation.

Part of that is specific government policy resulting in financial speculation
being more profitable then brick and mortar and bits and bytes businesses. I'm
not just talking about the fed, and printing money, but also about trade
policy.

The other part is lack of supply. When people can charge 2 and 20 and the 2
even if they suck, that means either there are a lot of people deliberately
looking to lose money, or there is a shortage of hedge funds. And while those
have exploded in number in recent years, that is not enough.

The government, through Ph.D. programs encourages education, some say this
supply side intervention has the uninteded consequence of depressing wages for
Ph.Ds. But what if the government strongly encouraged everyone to go into wall
street? Politically it would be crazy to try and explain why we're paying for
people to become bankers or fund managers. But a flood of talent is perhaps
exactly what we need, to even out supply and demand.

------
PatrickMorrell
Antonio - good find. I read this article earlier this morning and it spoke
directly to the disconnect I've noticed as well. Logistically, what do you
think leaders on the Street and in business can do to curb these short-
termist, corrupted practices?

~~~
jamesbressi
If you don't mind me chiming in, I think the lesson is that there really is
nothing that can be done to curb it.

Why? Two reasons.

First, every time we create legislation, laws and other governing to
something, the problem either gets worse or creates a whole new set of issues.
The problem becomes a snowball -- you can look at the examples there to see
some of this.

Second, the saying that goes something like "locks keep out the curious, not
thieves" is very true. Those who want to scam will always find a way and there
is nothing to stop them, only try and catch them and prosecute them.

I could go on with a very lengthy post about this and sound very studious, but
I think those two points in their simpler form make a lot of sense. What do
you think?

~~~
AndrewDucker
I disagree strongly.

1) Legislation can change things significantly and effectively. It can also
merely shovel things around. Both are possible and doggedly asserting that
only one effect ever happens is just ridiculous.

2) Locks keep out thieves very well a lot of the time. They may not keep out
every thief, but it keeps out most of them, most of the time.

~~~
jamesbressi
Very glad you engaged, now on to my rebuttal...

Really?

Show me a piece of legislation that hasn't shoveled things around? And show
legislation that actually changed things significantly and effectively without
already having legislation in place that it enhanced? Drugs? Education?
Prostitution? None of those for sure. I know, gun laws? Nope, not there
either.

And in regards to your response to my use of the saying "locks keep out the
curious, but not thieves", you have to understand the underlying principle to
completely get it. No "locks" (and we aren't talking just physical) keep out
thieves, only the curious. Bernie Madoff anyone? The underlying principle to
that saying ties with the really corny saying "where there is a will, there is
a way". When someone really wants to do something, locks are not a deterrent,
they will find a way.

Cheers to you for debating with me, really enjoy it.

------
rms
The fundamental flaw of capitalism is the tendency for wealth to concentrate
in the hands of those that already own the capital. There's nothing to be done
about it because the fundamental flaw is more like a fundamental feature.

------
chrischen
I though it was quite obvious captialism provides only incentive to increase
profits, and that it does not necessarily correspond with an incentive to make
better profits.

Consider communism, ideally no one will worry about financial gain and
everyone focuses on self actualization and innovation (because there's no
monetary incentive, so only the truly altruistic thrive). However there's yet
to be an implementation this ideal.

It's probably impossible to achieve a perfect system, so I think the answer
lies in a more perfect balance of capitalism and communism.

------
steveplace
_The banks, however, are another matter altogether, and this is where I think
capitalism has hit a roadblock. The government has intervened to save many of
them, [...]_

That's not capitalism.

------
jriddycuz
There's a fundamental flaw in the logic that concludes that "government must
intervene to stop the shameless looting of taxpayer money." Taxation itself is
government intervention.

Abuse of money received from a government that shamelessly loots its people
for the "common good" and through manipulation of a highly regulated system is
no more an indictment of Capitalism than failure to run is an indictment of a
man tied to a chair.

~~~
larryfreeman
There's a fundamental flaw in your reasoning too. You can't have capitalism
without some form of government and you can't have government without some
form of taxation.

~~~
jriddycuz
Maybe the term capitalism has a different meaning to you than it does to me,
but I use almost synonymously with "free markets." And I would actually make
the case that you can _only_ have "pure" free-markets _without_ government.

What I was suggesting in my comment above is that the failures of a bound and
adulterated form of free markets do not indicate that free market principles
are themselves flawed. The notion that banks' or other firms' abuse of bailout
money is a problem with capitalism neglects that an extremely important (and
often ignored) freedom in capitalism is the freedom to fail.

~~~
sramana
I agree that free market capitalism ended when the government bailed out the
banks. I think, the issue on that is what would have happened if the banks
were not bailed out? Many believe, the western financial system would have
collapsed and we would have been sitting amidst 25-30% unemployment right now.
Most economists agree that bailing out the banks was the right thing to do
under the circumstances, and faced with the consequences.

But now that we do have a financial system that has not collapsed, we need to
rethink how we recover from 10% unemployment and a gaping deficit wound that
has been created.

For that to happen, we need more people like Kao, fewer like Soros. Those,
after all, just examples. My point is, the system has created incentives for
people to be attracted to the Soros-like professions, not the Kao-like
professions.

And what we need right now are more the Kao-like innovators (and the Jobs like
entrepreneurs, who, to your point, is very wealthy).

But entrepreneurship and innovation are not short-term money-making
propositions the way speculation-oriented professions are. And my point is
we're diverting the youth in two directions as a result: (a) an entitlement
path, where they expect the government to come to their rescue (b) the
speculator path, where they are attracted by easy money.

The path that is longer, harder, riskier - the path of building, creating,
innovating - is losing out in the process.

------
TrevorJ
"[O]nly a virtuous people are capable of freedom. As nations become corrupt
and vicious, they have more need of masters."

-Ben Franklin

The flaw in capitalism is us.

------
hugothefrog
From the article:

"She assumed integrity is implicit in the characters of the "leaders.""

I haven't read much Ayn Rand (i.e., none), but I've read a lot about what she
has said and written. Is the quote from the article above dramatic license on
the case of the author, or did Rand actually state that integrity is a
required characteristic in the 'leaders'?

------
moron4hire
"The government has intervened to save many of them, and now, these bailed out
banks want to hand out billions in bonuses to their non-performing employees"

So presumes the author that the people who are ostensibly receiving "billions"
in bonuses are the same people who pushed this over-leveraging scam. All
bankers are equal, none managed wisely.

"And thus, we lose Berkeley Ph.Ds in nuclear physics to hedge funds and MIT
computer scientists capable of delivering computing to 6 billion people to
derivative manipulation on Wall Street."

So presumes the author that nuclear physics and democratization of computing
are more noble pursuits than finance. What he forgets is that mortgage-backed
derivatives really did reduce risk for really bad mortgages. This was a
phenomenal development, we could get more people into houses while not losing
our shirts in the deals. Unfortunately, those same mathematicians weren't the
ones employing this great tool that they created. "When the only tool you have
is a hammer, every problem looks like a nail." It's not that mortgage-backed
derivatives were wrong or evil or bad, it's that they were grossly overused.
They _reduce_ risk, they don't eliminate it, so when the scenario in which
that risk turned to losses came true, the losses were too much to handle.

But, few people saw the risk for what it was because the Fed suppressed the
price of money to lower-than-market rates, explicitly encouraging this sort of
speculation. Price floors lead to shortages, this is a basic tenet of
Capitalism. Is it any wonder that the entire nation is over-leveraged? Without
the manipulation of the Fed, the price of money (interest rates) would have
been much higher and this sort of speculation would not have happened.

~~~
KirinDave
So you're arguing that an accounting trick to statistically suppress risk and
get a few more million people into homes that they ended up having taken away
from them is fundamentally the same level of contribution to society as people
inventing the Internet, the Telephone, Chemotherapy, Relativity, etc.?

You, sir, have an interesting outlook on life. But hey I guess a few high-risk
buyers got to hang out in someone else's house for awhile, and that's good
right?

~~~
danteembermage
I think his point is that, traditionally lending was a very local matter with
local banks and local capital issues. If Norwegian pension funds want to fund
a mortgage for a home in Paducah, KY, without some kind of securitization
they're stuck earnings treasury rates and the home loan is charging the
interest rate demanded by Paducah capitalists whether its higher than the
Norwegian's rate are not.

The point is, there are gains from trade to be had from securitizing
mortgages, the trick is to design them so that the information asymmetry costs
don't outweigh the benefits. Maybe that's impossible and mortgage derivatives
will always be value destroying but I doubt it.

~~~
KirinDave
Sure, but that doesn't change the fact that he's implicitly equating an
accounting technique with the Theory of Relativity, the invention of the
Internet, etc.

This worldview seems shocking to me. It's hard to imagine that someone can
equate a vaccine for polio and a statistical method as equally beneficial to
society, especially when one caused such woe and the other eradicated a
crippling disease.

~~~
moron4hire
I never made that valuation, you made it for me. I said that the author
implied finance was a lesser career choice than nuclear physics, then provided
an example where statistical analysis can be used in finance to provide a
social good.

Not all bad-credit people are bums looking to default on their loans, skirting
the credit collectors as long as they can, living on the underbelly of
society. But people who were hit hard by a disaster, made a few mistakes in
the past, or are just getting started out are lumped in with the deadbeats.
Unfortunately, there is no way to tell them apart, based on financial numbers.
By minimizing risk in dealing with these types of loans, the people who are
legitimately trying to improve their lives are given an avenue to show they
are responsible enough to own a home.

There is still risk involved, but the construct is not inherently deceiving
about its risk level. The problem was over-leveraging on this type of
activity. Even over-leveraging on mutual funds and money market funds can make
you lose your shirt.

"an accounting trick to statistically suppress risk" Mortgage-backed
securities as a construct unto themselves are no more an "accounting trick"
anymore than accident, life, or health insurance policies are "account
tricks". Regardless, "risk" is nothing but a probability factor anyway. Risk
is the probability of losing money on an investment, not the certainty of it.
To organize assets together in vehicles that allow the earnings of the winners
offset the losses of the losers, you're not performing accounting legerdemain,
you are reducing actual risk.

