As a young financial journalist in the late 1980s, I went to visit the Chicago Board of Trade when it remained an entirely open outcry market. The impact of the noise when trading began after the opening bell, a physical reaction in the pit of the stomach, has stayed with me all these years. In those days, of course, the computer revolution was in its infancy, and all the major markets were open outcry. I don’t think many people outside the financial world appreciate how minor a role humans now play in the financial markets.

Computers do about three-quarters of the trading on US stock markets, a quarter in Europe, and rapidly growing proportions in other asset markets, with this algorithmic trading occurring at intervals of fractions of a second  – so fast that the speed of light is a material barrier to trade, and high frequency traders co-locate their computer servers in the same building as the servers of the exchanges. Asset prices display extreme volatility. The ‘Flash Crash’ was one, but research suggests there are thousands of them, just so fast we don’t notice. The average holding period for shares has dropped from about 4 years in the 1950s to 22 seconds now. The number of companies listing on US stock markets has declined from 530 a year in the 1990s to 126 a year by the late 2000s, and the number of listed companies has fallen from 8,200 in 1997 to about 4,000 by the end of 2010.

[amazon_link id=”1847940978″ target=”_blank” ]Dark Pools[/amazon_link] by Scott Patterson tells the story of the rise of algorithmic trading, and it’s both a fascinating and a completely terrifying tale. The development of computerised trading began as a sort of revenge of the nerds and mavericks against the insiders of the NYSE and Nasdaq, albeit seasoned with the classic greed of the financial markets. The book describes the motivation of Josh Levine, the developer of one of the key early electronic trading systems, as a classic hacker desire for transparency and information. He wanted a fairer, freer market, and the rise of the algorithmic traders was indeed greatly assisted by anti-trust actions against the main markets.

Levine, though, has left finance now. For the titans of the financial markets did what they do when upstarts begin to make headway against them: bought them out. The NYSE and Nasdaq, and major banks like Goldmans and Credit Suisse, acquired the most successful of the computerised traders.

What’s more, as the book explains, successful algorithms trade so well that either they engage in an arms race among themselves for minuscule advantage, or they need to be fed a constant diet of less successful traders from whom they can profit. That would be me and you, either as retail investors or through our pension and mutual funds. The rules of the market enable computers to jump to the head of the queue for trading a particular stock; so if a big investor has placed an order, the algorithmic investor will see it and take advantage of its pre-cognition. The computerised traders are also paid ‘make’ fees by exchanges for providing liquidity, while the ‘takers’ (i.e. you and me again) pay for it. The computers can finally jump around from exchange to exchange, the result of well-intentioned regulation, and use their unique speed to their advantage as well.

In short, this is a rigged market, ineptly regulated, in which the owners of the main electronic trading systems steadily milk money from savers. And algo trading is spreading from stock markets to other assets. There is some evidence (although it is challenged) that the creation of commodity indices traded electronically has contributed to spiking food prices. Today’s FT suggests Goldmans and other mega-banks now want to play an active role in the oil market. I hope the regulators turn them down, but expect they won’t.

There is a fundamental problem of trying to achieve information transparency in an asset market, inherently characterised by at least an asymmetry of perception and probably  often an actual asymmetry of information. It makes the competitive structure of the market all the more important, and [amazon_link id=”1847940978″ target=”_blank” ]Dark Pools[/amazon_link] suggests to me that the anti-trust authorities need to step in again. But that is a slow and uncertain process, and meanwhile the financial system is just not pooling savings to place into productive investments, which will generate a return for savers. On the contrary, it has become a global video game, Final Fantasy Finance, with unfortunate real life side effects. The best bet may be, as Andrew Haldane hinted in one of his recent speeches, to work around the dysfunctional financial ‘markets’ and build new financial institutions such as the peer-to-peer lenders. It will be very important for regulators not to strangle these by throwing up impossible barriers to their growth.

Meanwhile, I highly recommend [amazon_link id=”1847940978″ target=”_blank” ]Dark Pools[/amazon_link]. It is a terrific read, both for a history of high frequency trading well told, and for a different kind of perspective on what’s gone so wrong with finance. If you really want to scare yourself, pair it with Robert Harris’s [amazon_link id=”0099553260″ target=”_blank” ]The Fear Index[/amazon_link], and to think about what to do, turn to the speeches of the Bank of England’s Andrew Haldane and Robert Jenkins.

[amazon_image id=”1847940978″ link=”true” target=”_blank” size=”medium” ]Dark Pools: The rise of A.I. trading machines and the looming threat to Wall Street[/amazon_image]

A cold has turned my brain to cotton wool over the weekend, but I have been paging through a pamphlet that turned up courtesy of Abe Books, [amazon_link id=”B001OVBYXG” target=”_blank” ]National Income and Expenditure[/amazon_link] by J.E.Meade and Richard Stone. (I’ve got the 4th, 1957 edition; it was first published in 1944.) This is research for my next book, which is about GDP – contain your excitement. Modern national accounts manuals run to hundreds of dense pages. This first, crystal clear, description is 44 pages long.

It is startling, too, to be reminded how much the economy has changed. In 1954, personal consumer expenditure on food amounted to 21% of GNP at market prices, spending on communication services 0.45%. The percentages in 2011 were 5.5% and 1.3% respectively. Spending on clothing is down as a share, spending on entertainment up. We are living in difficult times, but these changed patterns are the measure of prosperity since the first systematic work on national accounts. It’s just as well that what might turn out to be a decade of GDP going backward came after a half-century going forward.

Meade and Stone

I’ve been looking through a book that arrived here yesterday, [amazon_link id=”B008AU9LZM” target=”_blank” ]Affluence & Influence: Economic Inequality and Political Power in America[/amazon_link] by Martin Gilens, a Princeton political scientist. Although I haven’t read it at all carefully, paging through makes it clear that there is important evidence here that in the United States public policies have increasingly been shaped in the interests of the top 1% (not even the 10%) of the income distribution. There does not appear to be any ranting at all, not a vampire squid in sight. This is serious, empirical social science and lots of it, careful multivariate regression analysis.

The conclusion: “The patterns of responsiveness found in previous chapters often corresponded more closely to a plutocracy than a democracy.”

The influence of the rich is sometimes tempered a little by a closely divided Congress and legislative gridlock, and by an approaching Presidential election. Otherwise, the very rich have bought policies, literally – campaign donations prove be the main channel of influence. Professor Gilens is not optimistic about the prospects for campaign finance reform. Yet as he warns:

“Further concentration of political influence among the country’s affluent threatens both the perception and the reality of a shared political community so central to the health of even the modestly democratic republic we currently enjoy.”

So this rather dense-looking work of political science has a sobering message for the United States, and for all of us non-Americans who used to greatly admired what was, once, the world’s leading example of democracy and opportunity.

[amazon_image id=”B008AU9LZM” link=”true” target=”_blank” size=”medium” ]Affluence and Influence: Economic Inequality and Political Power in America[/amazon_image]

[amazon_link id=”0230392547″ target=”_blank” ]Going South: Why Britain Will Have A Third World Economy by 2014[/amazon_link], by Larry Elliott and Dan Atkinson, is a rattling good read.

The authors, veteran journalists on the economics and finance beat, are the Statler and Waldorf of the field. This book is a follow-up to 2007’s [amazon_link id=”1845296052″ target=”_blank” ]Fantasy Island[/amazon_link] – the new book has the same gloom about Britain’s economic prospects seasoned with a sense of satisfaction that events seem to have proven these  pessimists right.

[amazon_image id=”0230392547″ link=”true” target=”_blank” size=”medium” ]Going South: Why Britain will have a Third World Economy by 2014[/amazon_image]

The thesis is straightforward: the UK is de-developing. Just as Argentina, which would have been in the G7 in 1945, has dropped down the world economic league table, so is the UK. The roots of the decline date back to at least 1914, although at some points the book seems to trace them to 1815 or even – I thought at one point – 1530. Young workers have inadequate skills, thanks to the failings of the school and training system, there is too little manufacturing industry, the infrastructure is decaying, finance has unbalanced the economy, living standards are declining and will do so for years more.

Interestingly, the authors focus on the malign role of the state in shaping this grim economic future. They describe the proliferation of rules and intrusive petty officialdom (a 600,000 increase in state sector employment between 1997 and 2010) as “enormously wasteful and inefficient” (p97) and speak of the “hostility by practitioners to public choice and involvement” (p112). The result is that “the state’s own enforcers are increasingly treated with the greatest suspicion.” (p117) and most people aim to avoid the attention of officialdom in all its manifestations. This, they argue, is undermining the rule of law in favour of the rule of personal connections. Hmmm, echoes of Good Italy, Bad Italy. Their prescription? Shed our illusions, stop daydreaming of a golden age (Downton Abbey, Call the Midwife), and recognise that the economic policy needed is a development policy.

Now, of course this is overstated – especially the decline of manufacturing –  and the recent books [amazon_link id=”1408703300″ target=”_blank” ]Made in Britain[/amazon_link] by Evan Davis and [amazon_link id=”0300117779″ target=”_blank” ]The New Industrial Revolution[/amazon_link] by Peter Marsh offer useful balance. (Although it should be acknowledged that Elliott and Atkinson are in the distinguished tradition of [amazon_link id=”0333197720″ target=”_blank” ]Britain’s Economic Problem: Too Few Producers[/amazon_link] by Bacon and Eltis, which was big in my student days.)

Still, this is mischievous of me, but reading the book so soon after listening to Niall Ferguson give this year’s BBC Reith Lectures, the areas of agreement seemed striking. Although both contributions to the debate, Ferguson on The Rule of Law and Its Enemies, Elliott and Atkinson in Going South, overstate their case, both make some important points. The economic and political system as a whole is not working. This book exaggerates wildly – and very entertaining it is too – but they’re on to something.

Elliott and Atkinson