Slaughter of bulls, bears, sacred cows

Doug Henwood has written an extremely interesting and provocative book about Wall Street in particular and financial markets more generally. He makes no secret of his critical opinions, so much so that a former executive editor of the Wall Street Journal was sufficiently outraged by his work to write to him and say: "You are scum ... It's tragic that you exist." A particularly enjoyable aspect of the style of the book is that Henwood is not reluctant to retaliate in kind.

Henwood operates at a level far removed from the simplistic world of far left or do-gooder liberal critiques of financial markets. He is enormously well read in the often arcane and complex world of academic work on financial markets, with the bibliography containing the best part of 1,000 references. And he displays an impressive knowledge of the intricate detail of financial statistics and flow of funds.

The book is packed with ideas that, combined with the inherent difficulty of some of the arguments, leads to a density of text that at times might deter the non-economist. But anyone with a serious interest in financial markets, how they operate and what their impact is on the rest of the economy should persevere.

Indeed, this book can be recommended to a wide range of readers. Non-economists will learn a great deal about the workings of the markets, and be exposed to some important ideas in economics. Economists and finance specialists in business schools, particularly those of a more conventional bent, will find their minds stretched by the arguments Henwood puts forward.

The first two chapters contain very thorough descriptions of the mechanics of the markets, the various assets involved, such as currencies and derivatives, and of what Henwood terms "the players": banks, companies, hedge funds and so on.

But even in these opening descriptive chapters, Henwood's opinions keep breaking through. He is quite willing to accept orthodoxy where he believes it is correct, even though the implications may seem brutal to some. For example, he is scathing of the populist claim that futures markets in commodities in some way rig prices against the producers. On the contrary, such markets help to undermine cartels or, as Henwood puts it, "Third World commodity exporters face chronic problems of oversupply that aren't caused by the gnomes of Chicago".

For economists, perhaps the most challenging and interesting part of the book is the long chapter in which Henwood discusses three theories that lie at the heart of much of financial economics - Tobin's q, the Modigliani-Miller theorem and the efficient markets hypothesis. The discussion is introduced in a way that is typical of the book: "Like all models, they tried to simplify the world in order to explain it. All are wrong."

It will be tempting for academic economists to dismiss or ignore Henwood's arguments, simply because they appear in a book intended to sell, rather than in the pages of a learned journal that few people will read. But this would be a mistake, for he assembles some cogent evidence to support his opinions. For example, Tobin's q (defined as the market value of a firm's shares and long-term debt divided by its real capital) implies that firms should invest more when q is above the value of one and less when it is below. When Nobel prize-winner James Tobin introduced the concept in 1970, the postwar American data were consistent with this hypothesis. But since 1970, a high q has been associated with low investment and vice versa. Of course, this problem is known in the literature, and Henwood deals with not only the basic evidence, but the subsequent discussions of this issue.

Henwood's challenge is not restricted to the world of theory. For example, he attacks the fashionable view of the so-called wonders of the Chilean pension system. The administrative costs, for example, are almost 30 per cent of revenues, compared with under 1 per cent for the American social security system.

Inevitably in a book of this kind, not all the arguments are convincing. The chapter on Keynes and Marx in particular falls short of the general standard. And the final chapter, engagingly entitled "What is (not) to be done?", is not particularly strong on practical policies, in part because Henwood recognises very clearly the enormous benefits the capitalist mode of production has brought.

But overall this book offers a serious analysis and critique not only of the role of financial markets but of academic financial economic theory and deserves to be read widely.

Paul Ormerod is chairman, Post-Orthodox Economics.