A few weeks ago, Stephen Hawking opened the world’s eyes to the dangers of Artificial Intelligence (AI), warning that it has the potential of outsmarting humans in the financial markets. But few people realize that we are already in imminent danger of this happening.
The stock market is a system for assigning value to companies through the buying and selling of stock. It’s a human-based system, assigning human value, to corporations owned and operated by humans. Well, at least that is how it was supposed to work until the machines started taking over.
In the 1960's, an average share of stock was held 4 years. By 2000, average ownership dropped to 8 months, and in 2008 it dropped even further to 2 months.
Today the average share is held a scant 20 seconds and within a few months, it will drop to less than 10 seconds.
At the center of this rapid buying and selling of stock are a series of high-frequency trading machines run by the quants, the math-whiz kids who are a type of hackers only on Wall Street.
Without having people at the center of these trades, we have lost the core ingredient, our ability to accurately assess value.
The invasion of high-frequency trading machines is now forcing capitalism far away from anything either Adam Smith or the founders of the NYSE could possibly find virtuous.
We’re not about to let robots compete in the Olympics, driverless cars race in the Indianapolis 500, or automated machines play sports like football, basketball, or baseball. So why is it we allow them to play a role in the most valuable contest of all, the world wide stock exchange?
With crude forms of AI now entering the quant manipulator’s toolbox, we are now teetering dangerously close to a total collapse of the stock market, one that will leave many corporations and individuals financially destitute.
Here is why this should be ringing alarm bells all over the world.
The Flash Crash of 2010
Few things explain the dangers of AI manipulations of the stock market quite like the Flash Crash of 2010. Here’s a quick overview:
The date was May 6, 2010 and by all outward appearances, everything on the markets appeared to be normal. Yes, people in Greece were protesting austerity but there were no other indicators of what was about to happen.
Cheap credit had been pushing stocks higher for months, but the mood was changing. Every time disgruntled workers in Athens hits the TV screen, the Dow Jones would drop a bit more. By 2:30 p.m., it was down 2.5%, a moderately bad day, but that’s when everything was about to go crazy.
It began as a ripple in the price of E-mini futures contracts, traded on the Chicago Mercantile Exchange, but almost nobody noticed. This tiny ripple quickly morphed in a major ripple, and with very little forewarning, the tail quickly started wagging the dog to pieces.
Within seconds, the Dow has lost 100 points, then 200, 300, 400, and 500.
It’s important to know that the internal self-limiting mechanisms designed to halt trading after unnatural price swings only works until 2:30 p.m. EST.
At 600 points down, the Dow had fallen further than it did on news of Lehman Brothers' collapse in 2008. But that crash took a full day, this was killing the market in a matter of seconds.
When the market goes into a freefall, traders start to panic, vomiting into trashcans and mentally preparing themselves to leap off tall buildings. Even the 9/11 disaster hadn’t rocked the market like this.
Those close to the action started demanding that someone “break the glass and hit the emergency stop button on the wall,” but this button doesn’t exist.
At 2:47 pm, with the Dow racing towards an unprecedented 1,000-point loss and almost $1 trillion being wiped from the balance sheets, an even bigger surprise happened. The market switched directions and began to rise.
The 600-point loss suddenly became 400, then 300, and 200.
The craziest part of all was that this entire episode, the most dramatic in stock market history, had occurred in just 10 minutes.
After a short period, rumors began pointing fingers at the supposed culprit - Waddell & Reed, an asset management firm based in Kansas. But this was later disproven.
In the background were the quant-hackers managing the strings for some other puppet-master. These people are also experts in blame-shifting and deception so we will probably never know what actually happened.
(Here’s a more detailed account of the Flash Crash of 2010.)
Killing the Goose that Laid the Golden Eggs
Even the most egregious abusers of the stock market have no interest in killing the system that has become their central playground, the goose that continually lays the golden eggs. But they have no problem with extracting wealth from it at every turn, often harming individual companies quite severely in the process.
The tactics used in the flash crash of 2010 are similar to a denial of service (DoS) attack. On this day servers became so overloaded that quotes for some shares experienced as much as a 36 second delay.
This is a black-hat technique known as “quote stuffing” where machines begin placing and canceling unrealistic orders 10,000 times in a second, or stepping from one share all the way to 100, one at a time, and then marching back down again in milliseconds, over and over and over.
Keep in mind this is a very crude form of artificial intelligence. Imagine the type of exploitations that will be possible when higher forms of AI begin entering the system.
Manipulations like this are only a problem if we continue to let the puppet-masters guard the marionette stage. Much of this problem quickly goes away if we return to a system where human “authority” is used to curb abusive practices.
The Need for Human Authority
Many of our free-market thinkers have long advocated automating human authority out of the equation.
Trades can happen faster and in greater volume if we remove the gatekeepers from the system. However, we still need humans to oversee the system. It may be automated human, but still humans.
As an example, Google’s largest computer data centers are built around thousands and thousands of flawed machines that individually fail time and again. With systems for circumventing failures when they occur, the overall machine, in its entirety is more than a little impressive.
People are very similar. We are all flawed individuals, mired in an ocean of personal chaos. But the same imperfections we see on the micro scale change dramatically when we transcend to look at humanity on a macro scale.
In much the same way that Google operates a massively complex machine by changing out individual units on the fly, we will eventually be able to create superhuman intelligence by connecting our own individually flawed brains with a massively coupled super brain.
No, this would not be a 24/7 link that limits our individuality or free will, but the human equivalent of a moral machine that we can choose to be part of. I’ll save the details of this for a later discussion.
We are currently walking on dangerously thin ice. Artificial intelligence is already creeping into our lives on a daily basis, but even with its current Neanderthal-level intellect, it can do incalculable levels of damage.
I would compare the current stock market to The Borg on Star Trek, but it’s even more sinister than that. The deeper we probe, the more we appear to be pawns on someone else’s financial chessboard.
I’d like to extend an open invitation for you to weigh in on this topic. Am I being too alarmist in my assumptions? Are there protective measures in place to prevent this type of abuse from happening? What am I missing?
Author of “Communicating with the Future” – the book that changes everything