What’s the Big Deal with High-Frequency Trading?
One of the fundamental laws of economics is that prices display information. When goods and services are sold, the price reflects the intersection of supply and demand. As Ludwig von Mises showed in his groundbreaking article “Economic Calculation in the Socialist Commonwealth,” without an objective measurement of individual, subjective desire, there is no rational way to distribute goods. This is why socialism never fails to fail while capitalism is the bedrock of material wealth.
The peaceful cooperation fostered by laissez faire is also why deference should be given to the marketplace when disagreements erupt. But often, it’s the opposite approach taken. In the past few years, Wall Street has seen its share of demonization in the media. Leftist politicians decry the get-rich-quick culture of major banks (while being on their payroll in some cases). An anti-Wall Street populist movement arose in the shadow of Washington bailing out the banksters in the financial crisis of 2008. Overall, there continues to be suspicion over the efficacy of stock trading.
One of the scapegoats of this anger has been the practice of high-frequency trading (HFT). The buying and selling of stocks is given enough grief. Now that computer-generated algorithms encompass about half of all stock trades, it makes sense the marker of blame is put onto this new device of proletariat exploitation.
In a recent article for The Atlantic, economic dunce Matthew O’Brien pulls no punches and calls high-speed trading “cheating.” He denounces it as “Wall Street at its most socially useless.” While normal market transactions succeed to allocating resources where they are most needed, HFT does nothing of the sort. According to O’Brien, these millisecond trades “aren’t allocating capital” where it’s most productive, but where traders “think other people will put it 50 milliseconds from now.” This dubious practice acts as a “tax on everybody else” for reasons unspecified.
Like most of what passes for economic commentary in The Atlantic, O’Brien’s reasoning makes no sense. First off, stock trading is not taxation – no matter what speed it occurs. Taxation is only ever implemented by governments. By definition, they are forced payments. Anything else is a voluntary exchange.
Now, O’Brien may be implying that everyone is forced to pay for the misallocations caused by high-speed trading. His criticism is filled with the charge that HFT is a good-for-nothing practice that makes a mockery out of the marketplace. He is, in a word, mistaken. Not only is HFT a basic market transaction, it also doesn’t allocate capital in an irrational manner.
Carl Menger was one of the first economists to observe how the process of bargaining occurs. In his Principles of Economics, he wrote that in each economic transaction “the two bargainers will attempt to acquire as large a portion as possible.” These respective attempts to subvert each other will be “mutually paralyzing.” That means any and all attempts to rip off an unsuspecting dupe will be met with the same strategy. There is little choice left but to bargain for an agreeable price.
This dance between asking prices is exactly what occurs in today’s high-frequency trading market. As Politt & Co. researcher John Paul Koning writes, the algorithms designed by HFT programs attempt to “make quick feints up into the spread by issuing a sudden stream of new bid quotes.” The hope is that the computer program will “goad other buying algorithms into following them” or “instigate algorithms on the sell side to respond.” It’s not a meaningless activity. There is competition in trying to uncover who wants what, and what price they are willing to pay.
O’Brien won’t have any of it. High-frequency trading is still “cheating” even if the transaction is mutual. Admittedly, some of his animus is driven by the selling of information collected by public institutions like the University of Michigan. The University’s survey data, which reflects desire on the part of broad swaths of consumers, is sold to private companies who in turn make it available to traders minutes (or even seconds) before the rest of the public. Because the University of Michigan is a government institution, O’Brien sniffs out something corrupt about the whole process.
He is certainly correct in that there is something amiss about the whole arrangement. But his solution – a relatively small financial tax to eliminate HFT altogether – does not get to the heart of the problem. If the University of Michigan were private, there would be no dispute over the rights to pertinent information. Data would be sold to the highest bidder; winner take all. This would be a much more amicable solution than stomping out a free process.
I suspect O’Brien won’t be satisfied with a miniscule penance stripped from computer-savvy traders. His tirade is filled with both envy and a concern for promoting government’s role in society. He sees HFT as an unfair mechanism used to rig the marketplace in favor of the big players. Therefore, only the state can step in to remedy this injustice.
In the market, there is not overriding exploitation as long as the process remains voluntary. For every buyer there’s a seller; including high-frequency trading. The argument that there is something fraudulent about millisecond-speed transactions is undermined by the fact that no one unwillingly engages in the practice. That isn’t to say fraud is absent from Wall Street. But the day a Keynesian statist like O’Brien comes out against fractional reserve banking is the day I will eat my keyboard.
Likewise, the charge of “unfairness” is often loaded with a plea for immature rationalization. What O’Brien doesn’t get, or refuses to acknowledge is that the marketplace is like life: it isn’t fair. Those with the know-how or the foresight into human desire are better at profiting.
If Matthew O’Brien wants to levy the charge of unfairness on the financial system, he is better off looking at the lordship: the Federal Reserve. No other organization has the monopoly privilege of the Fed. Large banking institutions are always the first receivers of the central bank’s newly-created “wealth.” And anyone who attempts to create an alternative legal tender is thrown in a jail cell. The whole institution screams of cronyism.
So does O’Brien utter a word about the unfairness of central banking? Not a chance. He worships at the throne of monopolized money creation. He does not question it. Instead, he attacks a practice no one is forced into and that attempts to locate price preference at a given point in time. It’s quackery in the form of economic analysis. In other words, it’s typical fare for The Atlantic.
James E. Miller is editor-in-chief of the Ludwig von Mises Institute of Canada, where this article was originally published.
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