Thank You for Being Late

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by Thomas L. Friedman


  When the Big Shift Hits Financial Flows

  Globalization was always driven by financial flows, but thanks to the supernova, these now digitized financial flows are happening at almost unfathomable rates. As a result, the interdependence of markets—particularly major markets—is becoming tighter and tighter every day. When China’s government took some very questionable financial steps in the summer of 2015 and rattled its own markets, Americans immediately felt it in their retirement accounts and stock portfolios. On August 26, 2015, CNN.com reported:

  The American stock market has surrendered a stunning $2.1 trillion of value in just the last six days of market chaos.

  The enormous losses reflect the deep fears gripping markets about how the world economy will fare amid a deepening economic slowdown in China.

  The Dow, S&P 500 and Nasdaq have all tumbled into correction territory, their first such 10% decline from a recent high since 2011.

  The S&P 500—the best barometer for the biggest U.S. companies—has lost trillions of market value in the six-day selloff through Tuesday, according to S&P Dow Jones Indices …

  It’s like erasing almost the entire value of the British version of the S&P 500. Known as the S&P BMI U.K.…

  The dramatic retreat on Wall Street has been fueled by serious concerns about the fallout of China’s economic slowdown.

  With more ways being created every month to digitize money—loans, deposits, withdrawals, checking, trading, and bill-paying—this interdependence will only tighten faster. That subject is worth a book on its own, so I can only give a taste of it here, and the best time and place to take a nibble is May 6, 2010, at 9:30 a.m.

  The Dow Jones Industrial Average had just opened that morning and stood at 10,862. It seemed like a nondescript day. But five hours later, it would make history. Starting at 2:32 p.m. the Dow began to tumble. By 2:47 p.m., it had fallen by 9 percent—the largest intraday point drop from the opening ever, declining 998.5 points to 9,880. One hour and thirteen minutes later, at 4:00 p.m., it closed the day at 10,517, recovering most of its losses. Depending on whether you bought or sold within those ninety minutes you could have either made or lost the gross national product of a good-sized country: the sudden drop created more than $1 trillion in losses in the space of thirty minutes.

  How could market sentiment have changed so much, so fast? What were people thinking?

  People weren’t thinking—machines were. This was computer-driven algorithms misfiring in the age of accelerations and interdependence.

  It took a while to figure out what happened, but on April 21, 2015, British authorities arrested Navinder Singh Sarao, age thirty-six, on the request of U.S. prosecutors, who alleged that he’d helped cause the crash and profited from it to the tune of $875,000. What’s amazing is that Sarao operated with a computer and network connection out of his parents’ home in Hounslow, West London. But in a hyperconnected world, he managed to use computer algorithms to manipulate the market by creating fictitious orders that “spoofed” the Chicago Mercantile Exchange and, authorities maintain, set off a chain reaction.

  “Spoofing,” explained Bloomberg.com on June 9, 2015, is “an illegal technique that involves flooding the market with bogus buy or sell orders to drive prices one way or another. The idea is to fool other traders, both humans and computers, to enable the perpetrator to buy low or sell high … Authorities say Sarao developed his computer algorithms in June 2009, to alter how his orders would be perceived by other computers … [He created] an algorithm that gave a misleading impression of the volume of sell orders.”

  His methods were different from those used by high-frequency trading firms, but the outcome he allegedly helped produce was amplified by the presence of so many such firms in the market, as well as by the advances in computer-driven, high-speed global trading. Spurred by Moore’s law, these firms have created an arms race for who can execute more trades faster. Indeed, the speeds being sought now are so fast that in researching this aspect of globalization, I found some of the most helpful background materials not in financial journals, but in a science/physics journal.

  For instance, Nature, the international weekly journal of science, published a piece on February 11, 2015, entitled “Physics in Finance: Trading at the Speed of Light,” in which it observed:

  [Financial traders] are in a race to make transactions ever faster. In today’s high-tech exchanges, firms can execute more than 100,000 trades in a second for a single customer. This summer, London and New York’s financial centers will become able to communicate 2.6 milliseconds (about 10 percent) faster after the opening of a transatlantic fiber-optic line dubbed the Hibernia Express, costing $300 million. As technology advances, trading speed is increasingly limited only by fundamental physics, and the ultimate barrier—the speed of light …

  High-frequency trading relies on fast computers, algorithms for deciding what and when to buy or sell, and live feeds of financial data from exchanges. Every microsecond of advantage counts. Faster data links between exchanges minimize the time it takes to make a trade; firms fight over whose computer can be placed closest; traders jockey to sit closer to the pipe. It all costs money—renting fast links costs around $10,000 per month.

  The jockeying is so intense, Nature reported, that traders figured out that “fiber-optic cables carry the most data, but do not give the speed required. The fastest links carry information over a geodesic arc—the shortest path on Earth’s surface between two points. So line-of-sight microwaves are a better option; millimeter waves and lasers are better yet, because they have higher data densities.” Fast trading does keep markets liquid, Nature noted, which can “benefit trade in the same way that free-flowing traffic helps transport. Such markets tend to have low ‘spreads’—the difference between the prices at which one can buy or sell a stock, which reflects the fee that dealers demand and thus transaction costs for investors.”

  But there are real downsides, it added: “The algorithms they use to trade profitably make more errors and are programmed to get out of the market altogether when markets get too volatile. The problem is exacerbated by the similarity of the algorithms used by many high-frequency trading firms—they all bail out at the same time. That is what happened in the 2010 flash crash.” Humans can do the same but machines can do it bigger and faster and, arguably, can be more easily spoofed into huge losses. “In 2012, a flaw in the algorithms of one of the largest US high-frequency trading firms, Knight Capital, caused losses of $440 million in forty-five minutes as its system bought at higher prices than it sold.”

  But my favorite line in the Nature article was still to come. The story pointed out that “in the United States, some large trading firms have set up private trading spaces to eliminate the timing edge for high-frequency traders. For example, the alternative trading system IEX, launched in 2013 … has introduced a trading ‘speed bump’—an automatic delay of 350 microseconds—which makes it impossible for traders to benefit from the faster feeds.”

  Really? So 350 microseconds in today’s market constitutes a “speed bump.” I was immediately reminded of the Walmart engineer telling me that once I pressed “buy,” their computers had all kinds of time to figure out how to deliver my television—they had under a second.

  No wonder Nature concluded that “finance research suggests that there may be an optimal speed for trading that today’s markets have already far surpassed.” Either way, there is little sign that “speed bumps” can reverse the fact that global markets have never been more interdependent. Moore’s law just keeps driving innovations to weave buyers and sellers, savers and investors, into a tighter web, explained Michael L. Corbat, Citigroup’s chief executive officer, who offered one of my favorite examples.

  If you were a U.K. pensioner living in Australia, he told me, the Treasury used to cut you a check and put it on a mail truck to Heathrow Airport, where it got sorted, put on a flight to Sydney, dumped into a sorting bin, and distributed by the Post Office in Australia
, eventually arriving in your mailbox somewhere between the seventh and tenth of the month. You would then deposit it and ask that it be converted to Aussie dollars. On the twentieth or so of the month, those Aussie dollars would show up in your account, minus a fee.

  Citibank came along, though, said Corbat, and said: “We can put good money in their account the next day and do it cheaper—transferring it electronically in local currency.” So the U.K. entrusted Citibank with that task, and then others in Europe and Asia did the same. But then one day, recalled Corbat, “Italy said to us: ‘We have some pensioners who are over one hundred years old’”—living in some really remote places. “‘How do we wire them funds?’ To serve them electronically we needed to have proof of life. This used to be done with forms and notaries. Now we are going paperless.” Fortunately, there was a solution. Elderly pensioners can now confirm their identity through Web portals and claim their pension, and the money gets deposited in their accounts. How? It turns out, Corbat explained, that a person’s voiceprint is actually more accurate than their fingerprint, iris scan, or any other means of identification. And as more consumers use their smartphones to pay for things, access data, and check on their accounts, passwords and PINs are less workable. So your unique voice now becomes the key that opens all doors. “Now when a credit card customer calls a service center, you have the option of no longer entering a code, a PIN, or a Social Security number,” said Corbat. “You just say, ‘Hi, this is Tom Friedman,’ and we know from your voice that it is you. So the system says, ‘Hi, Tom, would you also like to check your balance?’ And it knows it is you and it starts to learn what you like to do.” All that traffic got digitized and automated, and some of it has now become voice-activated, said Corbat, “and that gives us the time and resources to really deal with the stuff that creates dissatisfaction.”

  One of the most important drivers of the digitization of finance today is PayPal, the digital payments platform that got its start as part of eBay and specializes in the secure, high-speed digital transmission of all kinds of financial transactions, involving everyone from the most remote buyers and sellers to the most connected.

  Dan Schulman, PayPal’s CEO, explained that the company’s goal “is democratizing financial services and making the opportunity to move and manage money a right and possibility for every citizen—not just for the affluent.” Banks, he explained, “were established in an era dominated by physical presence, not digital flows, and the physical world had expensive infrastructure. A branch needs thirty million dollars of deposits to be profitable. And so where are banks closing? In all the neighborhoods where the average income level is below the national median.” They cannot attract enough deposits.

  “What happened with the explosion of mobile and smartphones,” said Schulman, “is that all the power of a bank branch is now in the palm of a consumer’s hand. And the incremental cost to add a customer when software is at scale approaches zero. All of a sudden the transaction of cashing a check or paying a bill or getting a loan or sending money to someone you love—which were simple and easy things for us in America already—becomes simple and easy”—and nearly free—for the three billion people around the world who have been underserved. These are people who for decades have been “standing in line for three hours to get their currency changed and then go to another line to pay a bill and then get charged ten percent [in fees]. The technology is shifting the possibilities for them dramatically.”

  For instance, PayPal created a global loan platform called Working Capital that can underwrite loans for PayPal users in a matter of minutes, instead of the weeks that banks might take. This makes a huge difference to a small business that needs to purchase inventory or has a growth opportunity. The product has already extended $2 billion in loans in less than three years. How can they do that?

  Big data.

  Schulman explained:

  The key is the amount of data you can now analyze. I can take all the data exhaust from our platform—six billion transactions a year and rising exponentially—and it allows us to make better decisions. You want a loan? If you are a regular PayPal customer, we know you. And we know everyone else like you. And we know that you have not changed—but [maybe] your circumstances changed because you lost your job or there was a natural disaster, and we know you will find another [job]. In a second, using our algorithms, we can compare you to anyone else like you around the world, because we have all this data and modeling capabilities and we can give you a loan based on those models.

  PayPal Working Capital does not rely on FICO scores, the traditional credit scoring system used by banks and credit card companies representing a person’s creditworthiness and likelihood they will pay back a loan. That’s because someone once may have declared bankruptcy—and therefore has a permanent stain on their FICO record, said Schulman. PayPal has found that its own big data analytics based on your actual financial transactions on their site give them a much more reliable picture of your creditworthiness than FICO. This approach allows them to give instant loans to more people around the world with a higher rate of payback.

  Using the same big data analytics, PayPal is also able to guarantee every transaction on its platform. So if a small merchant in India opens a website selling Indian saris and a customer in Europe buys two saris from that Indian merchant paying through PayPal, that customer “is either going to get the sari they ordered or we will refund the money,” said Schulman. “And we can make that guarantee work because, again, we know you, and we have all the data … We have one hundred ninety million customers worldwide and are adding fifteen to twenty million new ones a year.” These guarantees are also driving more globalization.

  Slowly but surely people are using PayPal to do away with cash.

  Like all big financial players, PayPal is experimenting with the emerging technology known as “blockchain” for validating and relaying global transactions through multiple computers. Blockchain, which is most famously used by the virtual currency Bitcoin, “is a way of enabling absolute trust between two parties making a financial transaction,” explained Schulman. “It uses Internet protocols to make the transaction go around any nation-state in a way that is visible to all the participants and goes beyond all middlemen and regulatory bodies—and therefore has the promise of lower costs.” At the speed that the digitization of money is happening, I am sure I will be writing about blockchain in the paperback edition of this book.

  When the Big Shift Hits Strangers

  On February 24, 2016, Facebook announced that as part of its “A World of Friends” initiative, it was tracking the number of relationships forged on its site by longtime foes. Facebook said that on just that one day it had connected 2,031,779 people from India and Pakistan, 154,260 from Israel and Palestine, and 137,182 from Ukraine and Russia. How many strong friendships emerged from those exchanges, how long-lasting they will be, and whether they will contribute to overcoming deep historical enmities—these are different matters. But you would have to be a total curmudgeon to look at those numbers and not think that they represent some pretty impressive contact between strangers and enemies.

  The acceleration of flows is clearly accelerating all forms of human contact, particularly contact between strangers. Almost no matter where you are on the planet, except the most remote locations, you are likely being exposed, directly or indirectly, to more contact with more different ideas and people than ever before in human history. It’s one reason that I have found myself reading the work of the late historian William H. McNeill, author of the classic history The Rise of the West. On the twenty-fifth anniversary of that book, in May 1995, McNeill wrote an essay for the Journal of History and Theory, “The Changing Shape of World History,” re-asking and answering one of the most profound questions for historians that animated his original work: What is the engine of history? What drives more history forward than any other factor or factors?

  Is it what he described as “the sporadic but ineluctable advance
of Freedom,” which “allowed nationalistic historians to erect a magnificently Eurocentric vision of the human past, since Freedom (defined largely in terms of political institutions) was uniquely at home among the states of Europe, both in ancient and in modern times”? In this view, “the rest of the world, accordingly, joined the mainstream of history when discovered, settled or conquered by Europeans.”

  No, McNeill decided, that was not the engine of history—World War I put paid to that thought, since “freedom to live and die in the trenches was not what nineteenth century historians expected liberal political institutions to result in.”

  So he offered up another popular alternative: “Spengler and Toynbee were the two most significant historians who responded to … the strange disembowelment that Freedom suffered in World War I,” McNeill wrote. Their view was that

  human history could best be understood as a more or less foreordained rise and fall of separate civilizations, each recapitulating in essentials the career of its predecessors and contemporaries …

  To many thoughtful persons, their books gave a new and somber meaning to such unexpected and distressing events as World War I, Germany’s collapse in 1918, the onset of World War II, and the breakup of the victorious Grand Alliances after both wars … Spengler and Toynbee put European and non-European civilizations on the same plane.

  McNeill then offered a third answer—his own theory of what drives history in The Rise of the West, a theory that he felt even more strongly about with the passage of time: “The principal factor promoting historically significant social change is contact with strangers possessing new and unfamiliar skills.” The corollary of that proposition, he argued,

  is that centers of high skill (i.e., civilizations) tend to upset their neighbors by exposing them to attractive novelties. Less-skilled peoples round about are then impelled to try to make those novelties their own so as to attain for themselves the wealth, power, truth, and beauty that civilized skills confer on their possessors. Yet such efforts provoke a painful ambivalence between the drive to imitate and an equally fervent desire to preserve the customs and institutions that distinguish the would-be borrowers from the corruptions and injustices that also inhere in civilized life.

 

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