How the financial meta-regime drives self-perpetuating status quo dependency
Today’s capital markets are operating under a set of axioms that severely inhibit their transformative capacity. Axioms are propositions seen as widely accepted and self-evident, much like first principles in science.
One important axiom currently operative in the financial industry is that everything of value must be measurable in monetary terms. So capital markets cannot relate to—or engage with—sources of value outside our narrow definition of money. Another important axiom is an epistemological one, namely, that the future can be predicted. Investors engage with probabilistic models to forecast the evolution of the economy and of individual financial assets, neglecting that the world at large behaves as a complex adaptive system and thus, by definition, possesses non-deterministic characteristics.
There are other axioms worth highlighting: Nation-states as the guarantors of the rule of law, financial statements as the principal accountability ledger in the economy, the acceptance of the efficient market hypothesis and the rational economic agent theory, and the existence of markets operating on the principles of open access, supply/demand balancing and anti-trust protection.
All of these axioms are social constructs and thus contingent and fragile, yet investors take them for granted and assume that they will exist into perpetuity. As a consequence, these axioms set rigid boundaries around the inner workings of capital markets and strip them of the capacity to adapt in the face of exogenous pressures and discontinuous change.
From these axioms flow a set of financial mathematics which underpin the financial industry’s decision-making frameworks. One of the defining mathematical propositions is that the value of an asset is defined as the sum of the cash flows occurring in perpetuity, discounted at a rate that reflects the risk of these cash flows. This and other mathematical relationships endow the activity of investing with self-referentiality. Just consider how the financial performance of an investment is calculated: As the change in the value of such an investment over time. Based on this definition, stock (investment) and flow (change) relate to each other—and to nothing outside of this frame of reference.
To uphold its axioms and ensure conformity with its mathematics, the financial industry embraces and self-enforces a set of idiosyncratic structures and practices. Finance professionals are educated and socialised through highly homogeneous courses offered by universities and professional education providers. Many of the industry’s recruitment practices are geared toward maximising cultural and educational fit, which drives conformism and tribalism. Its incentive systems are geared toward short-term profits, which double as determinants of self-worth and social status.
In combination, these axiomatic, mathematical and structural idiosyncrasies create a dependency for the finance industry on retaining the systemic status quo. For today’s capital markets, systemic stability is beneficial, systemic volatility is detrimental. This status quo dependency is so large that it is self-perpetuating—capital markets prefer assets that conform to its axioms, mathematics and structures because anything else is simply not investable. And herein lies the problem: If capital markets depend on—and indeed nurture—the perpetuation of the status quo, they are unlikely to fuel the type of profound transitions the world needs to cope with the gravest challenges of the 21st century.