The Computer Code Algorithms in Your Life That Will Determine Your Financial Future . . . and Much, Much More

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An article in Wired reports on the computer programs that buy and sell capital. A programmer understands his program, but no one understands how all of them interact. They are autonomous. And they are now in control of price movements: buying and selling. These are the algorithems in our lives.

Algorithms have become so ingrained in our financial system that the markets could not operate without them. At the most basic level, computers help prospective buyers and sellers of stocks find one another — without the bother of screaming middlemen or their commissions. High-frequency traders, sometimes called flash traders, buy and sell thousands of shares every second, executing deals so quickly, and on such a massive scale, that they can win or lose a fortune if the price of a stock fluctuates by even a few cents. Other algorithms are slower but more sophisticated, analyzing earning statements, stock performance, and newsfeeds to find attractive investments that others may have missed. The result is a system that is more efficient, faster, and smarter than any human.

It is also harder to understand, predict, and regulate. Algorithms, like most human traders, tend to follow a fairly simple set of rules. But they also respond instantly to ever-shifting market conditions, taking into account thousands or millions of data points every second. And each trade produces new data points, creating a kind of conversation in which machines respond in rapid-fire succession to one another’s actions. At its best, this system represents an efficient and intelligent capital allocation machine, a market ruled by precision and mathematics rather than emotion and fallible judgment.

But at its worst, it is an inscrutable and uncontrollable feedback loop. Individually, these algorithms may be easy to control but when they interact they can create unexpected behaviors — a conversation that can overwhelm the system it was built to navigate. On May 6, 2010, the Dow Jones Industrial Average inexplicably experienced a series of drops that came to be known as the flash crash, at one point shedding some 573 points in five minutes. Less than five months later, Progress Energy, a North Carolina utility, watched helplessly as its share price fell 90 percent. Also in late September, Apple shares dropped nearly 4 percent in just 30 seconds, before recovering a few minutes later.

These sudden drops are now routine, and it’s often impossible to determine what caused them. But most observers pin the blame on the legions of powerful, superfast trading algorithms — simple instructions that interact to create a market that is incomprehensible to the human mind and impossible to predict.

This will spread. As computers get more powerful, programmers will rely on them to do more of the actual coding.

Will computers get more powerful? Oh, yes. Every year, they double their capacity per dollar. This is Moore’s law. It is explained by the editor of Wired, Kevin Kelly. Kelly is probably the most thoughtful magazine editor on earth. He used to edit and publish The Whole Earth Catalog.

In an article on his site (www.kk.org), he surveys the implications of Moore’s law, the law of doubling. It turns out that it applies to numerous areas of the digital world, not just computers.

Here is what he concludes. Pay close attention. This is very, very important.

The unbending trajectories uncovered by Moore, Kryder, Gilder, and Kurzweil spin through the technium forming a long thread. The thrust of the thread is inevitable, its course destined by the nature of matter and discovery. Once untied, the thread of Moore’s Law will unravel steadily, inexorably towards its anchor at the bottom of physics. Along the way it unleashes other threads of technology we might wish to pull. Each of those threads, of Communication, Bandwidth, Storage, will unravel in its predetermined manner as well. We choose how fast to unzip them, and which ones to unloosen next. Collectively we push and pull with exceeding energy to wrench the threads from their place, but our efforts only serve to unravel it as it would anyway. . . .

Listen to the technology, Carver Mead says. What do the curves say? Imagine it is 1965. You’ve seen the curves Gordon Moore discovered. What if you believed the story they were trying to tell us: that each year, as sure as winter follows summer, and day follows night, computers would get half again better, and half again smaller, and half again cheaper, year after year, and that in 5 decades they would be 30 million times more powerful than they were then, and cheap. If you were sure of that back then, or even mostly persuaded, and if a lot of others were as well, what good fortune you could have harvested. You would have needed no other prophecies, no other predictions, no other details. Just knowing that single trajectory of Moore’s, and none other, we would have educated differently, invested differently, prepared more wisely to grasp the amazing powers it would sprout.

A few years ago, a friend of mine put one of these laws to work: the one on wireless. He started with two premises.

Bandwidth will get cheaper.People don’t like to read.

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January 13, 2011

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2011 Gary North