Its not high frequency trading. On both sides of the debate, hearing some in the media respond to Michael Lewis, you would think his new book, Flash Boys, was about creationism, the Vietnam War, Edward Snowden, the message of the last episode of Seinfeld or some other truly controversial and emotionally charged subject, rather than about the status of best price execution in liquid markets.
Both those who attack Lewis as overstating his claims about the insidiousness of HFT and those who support him in mutual righteous outrage seem to have been incited into a strangely emotional reaction over a book about trading technology. I suspect that an altogether different theme of Flash Boys less explicit than trading algorithms, to the point of being nearly unstated is the true culprit behind the feeling of deep unease at the book: the tech-sourcing of white collar jobs.
High frequency trading in and of itself should not provoke mass Mike Wallacelevel public opprobrium. Depending on how you tally them, the profits from the literally trillions of HFT transactions last year were somewhere around $1 billion perhaps enough to cover the landscaping fees at hedge fund firm Bridgewater Associates. HFT, while probably creating additional frictional costs for real money investors mostly institutions has also created benefits that exponentially exceed those losses for those same institutions. Between 2000 and 2010 the total cost per trade dropped by perhaps as much as 90 percent for institutions. And those very institutions were availing themselves of the same algos as the HFT boys, happily supplied to them by all of the largest bulge-bracket banks.
But the hydra-headed implications of HFT for the financial industry do have one particularly minatory face, and it is hardly the one at the conscious forefront of the rancor over Flash Boys.
Prior to the industrial revolution, more than 90 percent of Americans worked in agriculture. Then they were replaced by machines that could do their jobs exponentially faster, exponentially more efficiently and exponentially cheaper per constant dollar. The transition away from agriculture because of mechanization resulted in substantial social tension (including, in many respects, the Civil War, the rise of the labor movement, nationalism and communism), but eventually the majority of Americans were calmed by the awareness that there was another job waiting for them in a brighter technofuture one in which they could work under a roof, as opposed to in the rain or heat or snow, and one that was at least by some measures associated with substantially fewer accidents, injuries and deaths and short life spans than in the world of preindustrial farming.
A middle class emerged and was content within a few decades to view an agrarian America as an anachronism. A halcyon period lasted for nearly a century, straddling two wars, as America became the wealthiest and most powerful nation in the world and the average American was employed in industry. During that period Americans built the first mass-produced automobiles, refrigerators, radios, dishwashers, vacuum cleaners, electric razors and televisions: everything that makes modern life habitable, easier and entertaining. Admittedly a long distance from the time in the fields that many at one point physically fought to keep in their grasp.
But things changed quickly following World War II: Japan and Germany, recently flattened, were able to rebuild their economies tabula rasa, and they picked many of Americas leading industrial goods as targets for further perfection, further automation and, admittedly, government subsidy. Within a mere three decades following the war, the average television was made in Asia, and the average electric razor was a German electrical device. Blue collar opportunities in the centers of American manufacturing crested around the Vietnam War and then began to wane. This trend continued to accelerate for several decades with the growth of China following its liberalization, until the world was divided into countries like Japan and Germany, where industrial staples were made well, and countries like China, where they were made poorly leaving the U.S. as a place that needed to reinvent itself once more.
Luckily, America was good at doing this and had a lot of experience. The white collar, or service, sector shifted into high gear, and industries like financial services, insurance, media and advertising though each in their own right trace back centuries. By about 1986, finance, insurance and real estate collectively were responsible for the largest slice of U.S. GDP. A second major structural shift in less than two centuries had been completed, and America the Start-Up had twice successfully pivoted from agriculture to manufacturing and then from manufacturing to services and as a result its employees once again were never more well off or comfortable.
Finance, especially, grew in prominence. In 1986 the typical financial transaction was made by an American wearing literally a white collar shirt asking another American, whose shirt was also likely recently starched, to buy or sell some amount of some asset, upon which that second white-collared American would call with a physical phone, anchored to a desk by a cord someone else who looked in broad strokes identical to himself. A trade was made.
When electronic trading arose in the 1990s, hundreds of thousands of the second kind of folk the people whose gainful employment it was to pick up the phone and buy or sell something were rendered instantly useless by the tech-sourcing of their jobs.
Like outsourcing, tech-sourcing does not replace a set of tasks; it simply replaces the people who do them with an alternative process that is cheaper, faster and more efficient and often less American, whether the sourcing comes from Bangalore (as it did for the customer service sector) or from bits and bytes, as it did for the financial sector.
Where those hundreds of thousands of people found new employment is unclear. Unlike the two great pivots of the U.S. economy before it, tech-sourcing did not offer up some New Great Next Stage of Wealth and Comfort for those disenfranchised by it to join in.
The Wall Street labor market shrank in size. Though the legions of young Gordon Gekko wannabes picking up physical telephones disappeared with the Soviet Union, at least the people deciding which trades to make (how much to buy, when and for what price) and the people giving the orders could never themselves be replaced by computers the best Wall Streeters consoled themselves. Computers might be more efficient at placing an order or making a trade than was a white-collared worker with his quaint brick telephone, but they could never be better than a human brain, honed by millions of years of resource-maximizing evolution, at discovering investment opportunities in the markets. Traders might be replaced through tech-sourcing, but actual asset managers and asset management itself would be safe. Because if they werent, where would the legions of people employed in all the tall glass towers that punctuate Manhattan like stalagmites from a cave work next?
Their great-grandfathers could at least look forward to industry, their grandfathers to manufacturing, and their fathers to services. The U.S. now generates vastly more wealth than during any of those periods than during all of them combined and once again makes the best products in the world. But the quarter- and half-trillion-dollar companies like Apple and Google now carrying this torch employ near teenagers, and even of those they need ruthlessly few to dominate the global economy.
With honest reflection, it is not the challenge to best price execution that makes us all so uncomfortable with HFT and Michael Lewiss new book. Its time to begin a frank conversation on the tech-sourcing of white collar jobs, and on how the New New Thing has few openings for most Americans.