Facts, relations, linked data, and the US shadow economy

The KUOW Speakers’ Forum continues to deliver the most consistently valuable talks I listen to these days. The latest is Hernando de Soto on Shadow Economies. It’s about facts, relationships, linked data, identity, property rights, the rule of law, derivatives, toxic assets, and permanent credit crunch. Bottom line: We need to get the facts about those assets, link them together, and bring them out of the shadows. So far as I can tell, the current crop of financial reform bills aren’t saying that. The following excerpts from de Soto’s talk explain why they should, and also why they probably won’t.

Facts were the subject of all the reformers who made the market economy come into being, between 1850 and 1950. We’re all clear about the ideology of the people who talked about the market, and the capitalist system, from 1750 to 1850: Adam Smith, Marx. They all talked about division of labor. What they didn’t say is that once labor is divided, and you have many sources of production, how do you coordinate them?

That crisis actually came. The whole system faltered in the 19th century because feudalism had collapsed, patrimony had collapsed, there was freedom, but freedom without law and structure. So different people, who wrote very little — you find the details in things that stopped being published a hundred years ago — said, We are in front of swarms of facts. They have nothing to do with our immediate vicinity, our village, our feudal lots, it’s about the world as a whole, and we can’t digest it.

So, property rights had to become universal. We had to make them explicit as facts. And we had to make sure that everybody had access to a new business instrument, the corporation. Before, even in the US, you needed an act of Congress to make a corporation. That changed. It was a big battle, but finally the argument that won was, they’re doing it anyway, and if we don’t get them on the books they’ll stay in the shadows. So gradually textiles, and cotton, and machinery started recording facts, and it all started coming under property law.

Facts isn’t just information. Here we have an apple, it’s mine, it looks just like a stolen apple, but it has a property right associated with it. That apple can be bought, sold, rented, used as a mortgage, there are a hundred things I can do with the apple. Those are its relations to the rest of society. For that you need something that describes those relations.

Charles Sanders Peirce, when asked to describe the universe, said: “Things in relation to one another.” The wonderful thing about the rule of law, especially as developed in the United States, is that you’ve been able to put together things and relationships in organized documents that are accessible and actionable. When that happens, the shadow economy goes away and you’re in control. You know who you’re dealing with, and you know what their assets are.

Now, here’s my concern about what’s happening with the recession. I’m watching TV, October 2008, and I see your Mr. Paulson, secretary of the Treasury, say, “We’re in trouble. We have troubled assets. So I’m going to buy them up, and then we’ll see what’s what.” Basically, he was saying: “We don’t have the facts, so I’ve got to produce them so we know who’s solvent and who isn’t.”

Later, I turn on the TV and he says, “We’ve thought about it, and we’ve decided we’re not going to buy the toxic assets, these derivatives, and sort them out. Instead we’ll just give enough money to the banks so that everybody knows they’re not going to break.” In other words, I’m not going to find out where the assets are, or record property rights.

Why that change? I asked. The reply was: “Well, he couldn’t find the toxic assets.” I thought that was really interesting. In the United States, everything is recorded: every house, every car, every boat. You know where things are. You’ve got facts. It is a factual economy, not like my economy which is a shadow economy where there are no facts.

I asked Chris Cox: “How many of these assets that are called derivatives are not on record?” And he said, “Well, we think there’s 600 trillion dollars of them.” That violates the crucial law of property as you have developed it over 150 years. No wonder nobody feels safe. You have created the world’s largest shadow economy.

As long as you don’t know who owns the greatest amount of your assets, there’s no info as to who owns what, who is related to what, you have a shadow economy. We live in one, and it has as a characteristic a permanent credit crunch. We know more about it than you do. Credit crunch is where you don’t know who you’d be lending to, so you don’t lend. It’s permanent, we live with it, and now you’re going to have to learn to live with it too, because until you know who is solvent how can you give anybody credit? You’re flying blind.

Einstein used to say: “What does the fish know about the water in which it swims?” That was his way of saying you have to be outside the aquarium to understand what’s going on inside the aquarium. Well, as an outsider looking in, I’m a great admirer of the United States, of your rule of law, which says that everything has to be identified because you are a nation of facts. As opposed to us, a nation of rumors and shadows. But you’ve slipped up really badly. You’ve got to get your banks to put these things on the record.

Back in the 1930s, Roosevelt saw that it was important to find out how much liquidity there was. To do that he needed to know where the gold was. He made a law, you had to record your holdings of gold or go to jail for ten years. Very soon he knew where all the gold was. That’s where you’re at. The problem is, what happens if when you do it, you find out that most of your top banks are insolvent? So you’ll need to involve the FDIC. But you’ve got to get the facts.

It’s very easy to get there, but it will mean that a sector of your society that is today in power will not be in power a month later, because they’ll be broke. Peter Munk, who owns gold mines in Canada, is building a marina in Montenegro for the biggest yachts in the world. When he was thinking that the U.S. administration was going to clean up the mess, and find out where the derivatives were, he said “You see all those yachts?” (He was looking at Sardinia.) “Well, in 2011, 4/10 of them will belong to somebody else.” Those 4/10 are holding out, obviously, because they don’t want that to be known. But they’re really screwing the rest of us.

Update: From Crain’s:

The Senate legislation would push most of the $615 trillion in over-the-counter derivatives onto regulated exchanges or similar electronic systems, a measure that would make it easier for the market and regulators to track the trades.

Really? Well OK then! Fingers crossed.

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9 thoughts on “Facts, relations, linked data, and the US shadow economy

  1. I’m thinking of that line from the Eagles “Hotel California”:

    We are all just prisoners here,Of our own device…

    de Soto seems to be saying that economies are arbitrary constructions, and in order to make sense of them (especially in times of trouble!) we must make them explicit. And, that these explicit constructions are entirely arbitrary.

    It is critically important to separate the data (and relationships) from the processes that generate that data. Economies are complex adaptive systems; we might squint our eyes and imagine that the data has been created by orderly, predictable processes, but we are merely fooling ourselves.

    We are destined to cycles of collapse when we hang our fortunes on such devices…

  2. Jon,

    Key comment I would add:

    By not having a virtualized conceptual view over heterogeneously shaped and disparately located data, investors, regulators, and managers all ended up being in the dark. In a sense, nobody had the ability to “infer” / “entail” what a “derivative” was i.e., identify things that weren’t literally named “…Derivative..” but possessed all the properties of said Entity of type (directly or by inheritance within a class hierarchy) and/or via narrower or broader locations in a taxonomic concept scheme.

    The economic crisis will go down as the ultimate manifestation of opportunity costs associated with: conceptual level data virtualization incomprehension, at the IT infrastructure levels across government departments and enterprises in general.

    Nobody seemed to be wearing or seeking “Context Lenses”
    when looking at vital data :-(


  3. Thanks for those pointers to de Soto’s work.

    As for XBRL, I began as a skeptic:


    But I reconsidered:


    And a long conversation with Charlie Hoffman won me over:


    I learned that he’s wasn’t, originally, any kind of elite XML standards geek. He was a pragmatic accountant.

  4. Truly no matter if someone doesn’t understand then its up to other viewers that they will help, so here it takes place.

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