Part 10 (1/2)

As discussed above, one's happiness depends on a number of factors. It generally doesn't help if you're stressed out and working incredibly hard to pay off a mountain of debt. At the same time, what counts for happiness is relative rather than absolute salaries. It would therefore make sense to aim for lower debt and lower economic growth, as conventionally defined in terms of GDP. As shown in Chapter 8, economic growth also often subtracts from environmental quality, which itself is important for happiness. This doesn't of course mean that growth or progress should stop, only that they should be redefined.

In unequal societies, though, it is hard for anyone to be satisfied with what they have in material terms. So the first priority is to reduce inequality, which as discussed earlier is also strongly correlated with a range of social problems. The sociologist Robert Putnam observed that: ”Sometime around 1965-70 America ... started becoming both less just economically and less well connected socially and politically.” 34 Free markets, if left to their own devices for long enough, tend to concentrate wealth and power into the hands of a small number of individuals or firms. We therefore need non-market mechanisms, such as those discussed in Chapter 7, to limit this tendency.

Another plank of happiness is freedom from excessive levels of economic stress. So it is desirable that the economy be reasonably stable. Economic shocks such as financial crashes or unemployment have powerful emotional consequences. ”It's probably no accident that the economic term - depression - is the same as the psychiatric one,” notes the psychiatrist David Spiegel. ”People tend to feel bad when what they have planned seems suddenly to come apart, when their ability to be effective in the world is challenged.”35 To restore financial stability is not the same as arguing for continuous growth. A low-debt, low-growth economy with a smaller financial sector may turn out to be inherently more stable because it has less leverage.

As mentioned in Chapter 6, a large amount of labour - including much done by women - is unpaid. This work, which is performed according to social norms, is vitally important for maintaining the happiness of a society. It should therefore be acknowledged and rewarded. One way is to use tools such as local currencies or time banks, which allow one to earn credits for services performed, and offer a balance between social and market norms. The popularity of these schemes has exploded in recent years, with many areas adopting their own local version.36 A shorter working week might lower GDP, but it would allow the informal sector time and s.p.a.ce to expand, with increased involvement by both s.e.xes.37 Finally, we have to acknowledge as a society that money and happiness are completely different quant.i.ties. The reason that GDP has soared in Western economies over the last few decades, but reported happiness levels have remained relatively static, is because they are not the same thing. The economy can't make us happy all by itself. We just need it to work. Happiness is a separate issue that eludes direct pursuit and instead emerges as the indirect result of other activities.

The neocla.s.sical model for economic growth is unsustainable and unsatisfying, not just because it requires infinite resources and harms the environment, but also because it relies on an eternal desire for more, which can by definition never be satisfied. It offers, not happiness, but the eternal promise of happiness, if we can just work harder and upgrade our lifestyles to the next level before everyone else does. We therefore need a new model of a successful society, in which money and material possessions play a subordinate role. Part of that is a new model for what const.i.tutes a full and satisfactory life. Who is to say that maximising individual pleasure is the guide to a good life - or that it is even appropriate, in a world where pain and suffering have yet to be banished? What about values and qualities like wisdom, humility, empathy, graciousness, justice, service, courage, loyalty, honour, spirituality, and love, which cannot be reduced to simple calculations of short-term utility?38 The main obstacle to achieving this switch to a more balanced and pragmatic view of the economy is, I believe, neocla.s.sical ideology. Anyone who takes an introductory economics course is taught that the individualistic pursuit of pleasure will, by a roundabout process involving the invisible hand, free markets, and so on, somehow make life better for all humanity.39 Since many of these students then go on to become leaders in business or government, where they perpetuate the same self-legitimising fiction, it is no surprise that we live in an individualistic, materialistic culture dominated by market norms. As a society, we're all sitting further away from one another.40 It's time we started telling a new story.

What's wrong with this picture?

Economics sees itself as an objective, impartial, detached science; however, as already discussed, theories influence the world they seek to describe, and sometimes in surprising ways. For example, for a theory that emphasises qualities like stability and symmetry and rationality, and downplays the role of the financial sector - the Arrow-Debreu model of the economy doesn't even include one - neocla.s.sical economics seems destined to create a world that is unstable and unfair and run by banks.

This points to perhaps the most puzzling fact about mainstream economic theory. On the one hand, it says that the economy is fair and stable and optimal. On the other hand, companies in the financial sector that actually control much of the world's wealth, and should therefore understand how it works, don't seem to pay any attention. They support all the correct neocla.s.sical think tanks, of course, but they also do everything they can to support inequality and instability. Such companies thrive on volatility, because they make their money by speculating on changing prices. If markets were really efficient, then price changes would be small and completely random, and it would be impossible to make a profit. It would be as exciting as surfing in a puddle.

And for that matter: why do we need central banks? If the economy is efficient and self-stabilising, and markets are all-knowing, what is the point in having a Federal Reserve tweaking interest rates? Wouldn't it be better to just let banks set their own interest rates according to the ”law of supply and demand”?

And finally, if neocla.s.sical ideology is so rigid and widespread, why is it that free markets and small government are OK when the economy is on the up, but as soon as a crisis comes the first companies to get supported by the taxpayer are the banks? Shouldn't they be allowed to fail according to the law of ”survival of the fittest”? Isn't it what their principles would demand? None of it makes sense.

In the final chapter, we therefore ask the inevitable, and entirely reasonable question: is neocla.s.sical economics all part of a giant global conspiracy - an attempt to distract us from the real game that is being played behind the scenes?

CHAPTER 10.

THE GOOD ECONOMY.

The world over, citizens think we are lying to them, that the figures are wrong, that they are manipulated. And they have reasons to think like that. Behind the cult of figures, behind all these statistical and accounting structures, there is also the cult of the market that is always right.

French president Nicolas Sarkozy, speaking on the need for new economic metrics to provide alternatives to GDP (2009).

What's important when you are in that hedge-fund mode is to not do anything remotely truthful because the truth is so against your view, that it's important to create a new truth, to develop a fiction.

Jim Cramer, television personality and former hedge fund manager (2006).

Mainstream economics teaches that the market economy, if left to its own devices, will maximise the utility of each individual and lead to the best of all possible worlds. This concluding chapter discusses how the mistaken a.s.sumptions and myths of economic theory mask our understanding of how the economy actually works. They persist not for scientific reasons, but because they serve a certain agenda. We see how a flood of new ideas is providing us with the tools to shape a better, fairer, and more sustainable economy. These ideas come from diverse sources: new areas of mathematics such as nonlinear dynamics, complexity, and network theory; social movements like environmentalism or feminism; and also the ancient discipline of ethics. Current economic theory is less a science than an ideology peculiar to a certain period of history, which may well be nearing an end.

The Lipstick Building is an elegant 34-storey postmodern office tower in midtown Manhattan. Resting upon an oval array of pillars, the red granite and stainless steel construction tapers to the sky in three layers, like an opened tube of lipstick. The first two floors contain an impressive gla.s.s lobby, adjacent to a pedestrian plaza. The building's largest tenant is a huge law firm, Latham & Watkins. Until 2008, the 18th and 19th floors also played host to a thriving and unusually profitable stock-trading and investment operation known as Bernard L. Madoff Investment Securities.

Madoff started the firm in 1960, at the age of 22, on savings of $5,000. Initially, most of his clients came from family contacts - his father was a stockbroker, his father-in-law an accountant. Madoff was a pioneer at developing fast computer systems to make quotes, thus allowing him to siphon business away from rival companies that were members of the New York Stock Exchange. The technology later formed the basis of the NASDAQ exchange. By 1992, Madoff's trading volume was equivalent to 9 per cent of the NYSE.

Then in the mid-1990s, motivated at first by a desire to cover up an investment loss, this Wall Street insider took something of a left turn.1 He set up what would become the largest investment fraud in history - a $65 billion Ponzi scheme, which sucked in money from private and corporate investors with the sole purpose, it appears, of enriching Bernie Madoff.

The 18th and 19th floors of the Lipstick Building were filled with the usual array of smart, college-educated traders, who gave the impression of urgent efficiency common to those who handle millions of dollars a day. They worked hard and long and were exceptionally well paid. Clients included Bear Stearns, Lehman Brothers, and Fidelity. The office was routinely audited by regulators. All in all, it was what you would expect from a successful financial company. That wasn't the whole story, though. Like a family with a secret in the bas.e.m.e.nt, the whole operation had another level - the 17th floor - that clients, visitors, regulators, and even the other employees rarely got to see.

This floor was staffed with a different type of person - less educated, less experienced, less skilled. They dressed casually, and worked only regular nine-to-five hours. Their jobs were simple and routine, mostly clerical work, but still well paid. They were the ones running the ”hedge fund” that was the heart of Madoff's operation.

The scheme worked as follows. Madoff exploited his network of contacts in the business, philanthropic, and Jewish communities to take in money from wealthy investors, charities, or feeder funds. Advertising was by word-of-mouth, and referrals from the official business on the top two floors. The Madoff funds consistently delivered a high rate of return, and people asked few questions. If anyone wanted to withdraw money, they could at any time - there was always more cash coming in from new investors. But most preferred to allow it to grow. This was especially true of the charitable trusts that Madoff specialised in.

When asked how he managed to consistently beat the market, Madoff explained that his strategy was based on a combination of blue-chip stock investments and derivatives such as futures contracts. As he told the Wall Street Journal in 1992, this allowed investors ”to partic.i.p.ate in an upward market move while having limited downside risk.”2 The story was complicated but plausible enough to convince even major banks like HSBC or Spain's Banco Santander to invest billions. Intermediaries such as feeder funds were awarded high commissions, which discouraged too much a.n.a.lysis.

Madoff's operation came under suspicion from regulators a number of times and was investigated. But whenever they looked over the paperwork, and the reams of numerical data for all the stock transactions, it all looked OK. The only thing that brought it down was the crash in 2008, when too many investors tried to withdraw their funds at the same time, only to find that they had never really existed.

A new truth.

So how did Madoff manage to perpetuate this illusion of growth for so long? Part of it was his skill at creating a compelling story - a ”new truth” - which according to Jim Cramer (host of CNBC's show Mad Money) is essential for any hedge fund, real or not. But technology - or rather the lack of it - also played an important role.

Madoff had built his original business around the innovative use of high-speed computerised trading. People on the top two floors had fast computers and real-time access to prices. But for the ”hedge fund” Madoff preferred to use an antiquated IBM AS/400 machine, which was kept in a special gla.s.s case. Its outdated hardware - the range first came out in 1988 - meant that it was not compatible with the other systems.

That wasn't an accidental drawback; in fact it was the entire point. Madoff, perhaps with help from his closest accomplices, would have to enter the data each day by hand. This procedure allowed Madoff to fabricate a history of stock transactions that would give whatever rate of growth was desired. Trade confirmations for each client were then prepared separately, each showing the fict.i.tious gains calculated by the old IBM. In reality, no trades were taking place at all. There was a risk that clients would check, but it seems they never looked beyond the bottom line.

The key elements of this particular scam, then, were:* A complicated but plausible story. The hedge fund strategy could have worked in principle, and the returns were never so large that they seemed impossible. Its apparent complexity deterred questioning.

* Trust. Madoff was an insider who had built a reputable business.

* Incentives. Intermediaries were kept happy with high commissions. Investors were kept happy, or at least optimistic, with dreams.

* A network of rich and powerful contacts. Madoff had many wealthy friends, including entrepreneur and philanthropist Carl J. Shapiro, who chipped in a quarter of a billion dollars months before the scheme collapsed.

* Influence with regulators. Madoff and his family had extensive ties with regulators. He was a former chairman of NASDAQ and on the board of directors of the Securities Industry a.s.sociation.

* The illusion of growth. Madoff's funds showed consistent returns of around 10 per cent.

* An ageing computer. A machine that adjusts prices to agree with the story.

By 2006, Madoff had acc.u.mulated billions of dollars, which he mostly kept in cash accounts at Chase Bank. They financed a luxurious lifestyle for him and anyone in his gift-giving circle. But there was no investment, no real growth - all of that was a fiction. When the scheme collapsed, lives and inst.i.tutions were destroyed. Madoff was sentenced to 150 years in prison - the judge labelled his crime ”extraordinarily evil.”