Another classic article from James Tyler, brought forward
Trader: One whose business is trade or commerce.
Trade and commerce is the lifeblood of wealth creation. Without specialisation and exchange, we would all starve. You have oranges, I have apples. Individually we are bored, together we have a fruit salad.
For specialisation, exchange and commerce to work its magic, firstly we need some common ground: a market. Now, mention that word to a Socialist, and he starts to froth and foam at the mouth. The evil of markets, how the market forces this and exploits that, blah blah.
Unfortunately, they are confused. You see a market is just a bit of space, physical or virtual, where people who want to buy meet those willing to sell. That’s it. It has no power of its own. No influence. No horns and a pointy tail.
However, badly aimed as their invective is, they do have a fair grievance lurking in those passionately beating breasts. What they are trying to say is that they object to those who have power in a market. Who wields the power in a market, and where does it come from? That is a fair question to ask.
I contend that power always comes, ultimately, from Government. They hold the monopoly on power, they set the rules, and their arbitrary decisions can mean life or death for any businessman taking a risk. They get the keys to the gun cabinet.
Markets and traders
Only loons attack commerce between good old wholesome types looking to exchange the hard earned fruits of their labour for other stuff they need: I exchange my apples for your oranges.
Unless, that is, you want pears. The free interaction of people that is the market decided on a clever mechanism to get around this problem. It created an intermediate commodity called money.
Money is just a commodity like any other. The free market chose something that was durable, portable, respected, and consistent. The free market originally chose gold and silver as money, and gold remained money until governments came along and nationalised then destroyed it. Money now is a fraud – the greater fool theory of acceptance only because somebody else will too.
The creation of money was a fantastic innovation – a neat solution to the problem of the double coincidence of wants… or rather what to do when there wasn’t a coincidence.
But what happens if an orange farmer wants to sell next year’s crop now? Maybe there is a great demand for oranges and the farmer has cultivated trees to meet the demand, but does not want to take the risk of a craze for plums depressing the demand for oranges. A consumer of oranges may only want to buy what he can pick up and select. A grocer may not want to tie up his cash in something so far off into the future.
What is needed is someone in the middle. Someone willing to guarantee a price for those oranges now, take them in the future and then sell them on when they are needed. This is where the speculator steps in and provides a vital service.
Ahh… the evil speculator, now there is a ripe target!
How can somebody who produces nothing, does not employ physical labour, and does not reorganise the factors of production, be in any way productive in society? Off with their heads!
Speculator: one who speculates on abstruse or uncertain matters
The key is uncertainty. The future is not known; if it was, then the central planners might stand a better chance. But the future peculiarities of individual desires and wants can never be known, so there are always highly uncertain outcomes inherent in planning for the future. The world is too complicated to simplify into maths or bureaucratic diktats. The risks are too great and the mistakes too expensive. What we need is a mechanism to attempt to put a price on future outcomes. We need to “crowd-source” the answer to the problem of resource allocation. And, that’s what speculation is…
I risk my own shirt to take on risks that others do not want. I’m proud to say I speculate. I speculate that I will be able to find another buyer for those risks at a future point in time, and then I charge a fee for my services.
Some say that this is making money from nothing, but I say I provide a service to the world in smoothing out the jagged pointy edges. If things go wrong, I will have to pay the price personally.
The act of speculation is important in the signals it sends out. If prices rise, it signals a shortage which stimulates extra production to satiate demand. Or if the speculator successfully sells short some shares, the falling price will send out a signal that not all is well with that company.
Let me quickly clear a couple of things up …
Markets are not efficient
This is a stupid, indefensible idea peddled by neo-classicist eggheads. Information is often wrong and therefore people err. Mistakes are made, but I contend that the mistakes made by crowds are much smaller than when Government gets its grubby hands on a ‘problem’.
Markets work in waves and ripples and patterns, not aggregates, averages and efficiencies
Early adopters get rewarded the most; late arrivers are penalised. The crowd sometimes gets carried away, and prices rise too much or fall in an unwarranted way, but by and large, when not unduly influenced by power, markets are a remarkably efficient way of making a myriad mind-numbing decisions that all hang together. Markets are smart in the way a regulator can never be.
Secondly, I want to sing the praises of those great unsung heroes of stock markets: the short sellers.
Selling short is the process of selling something you do not own, in order to profit from a fall in prices, then buying it back at a lower price.
Short selling is a dangerous game. You are hated by all and sundry. Governments, regulators, corporate bosses, and fat cats. Everyone, it seems. You are always at risk of being targeted for a ‘short squeeze’. But short selling is vital for two reasons:
1) Buyers need a seller to buy from.
If you want to buy some shares – who do you think it is that will sell them to you?
It’s not usually an investment fund, or a pensioner, or your mate. It’s the ‘market’, and it is more than likely that the person you bought them from will not own them, but will scrabble around for the rest of the day trying to find them a penny cheaper. Can you be bothered to do that?
The stupidity of banning short selling is that it stops the market working – meaning that movements are likely to be bigger, and the falls greater.
2) Short sellers are the policemen of the markets – a much better (and more fearsome) regulator than the FSA.
Without short sellers, Enron and WorldCom would have got away with their fraud for a lot longer. It is a tragedy that the short sellers of banks were not bigger and better armed during the run up to the sub-prime crisis.
Don’t get me wrong, short sellers were there, playing their lonely game, but they were just too small in face of the great money/banking juggernaut carelessly careening away. Stronger short selling might have seen off the sub-prime fiasco earlier and with less pain.
As a society, we should desperately be encouraging short sellers in situations like this. Big business needs to respect the short seller – it keeps them honest. When prices are rising in a rampant fashion, usually no good comes of this. This is when we need the short seller to tame the wild beast.
Speculators do a much better job of sifting through the morass of conflicting signals to fish out the price for the best allocation of resources in a way that Sir Humphrey, sitting in an ivory tower in Whitehall, could only dream about.
So, traders and speculators are vital for a productive and fully-functioning capitalist economy. In a pure and free economy, they are a force for efficiency and part of the crowd-sourced resource allocation system.
But unfortunately, we do not have free markets
The sub-prime fiasco has shown us that markets, especially financial markets, are anything but pure. Markets are distorted by power, and it’s important to turn your swivel gun onto the source of that power….
The one thing you should always know about busts is that you can’t stop the pain at that point: it’s too late, the damage has already been done. The boom may have felt good at the time, but those tequila slammers at 2am always seem like fun. Remember the feeling in the morning. Trying to alleviate the hangover by more of the same is the action of an alcoholic. It’s the boom when assets are wildly misallocated, and that’s where we should focus.
The sub-prime crisis started with government, was promoted by government agencies, and was taken to the dizzying heights of stupidity by a banking system fuelled with masses of cheap money, produced by central banks that panicked after the previous cheap money bubble went pop in 2001.
The bankers perceived an inexhaustible supply of cash that could be lent at a profit to people who had no chance of paying back. The Mexican strawberry picker given a $750,000 loan to buy a house he could never afford to repay. A cleaner running a buy-to-let portfolio of 4 houses, with zero down payment.
What’s the problem with banks, after all, it’s a free world?
Banks are not run by kindly old bespectacled men, carefully lending money to young families to give them their first break. Remember It’s a Wonderful Life with Jimmy Stewart – the friendly banker looking after good ol’ townsfolk? Scrub it from your mind.
Banks are vast hedge funds, with vast trading floors of speculators, all doing “God’s” work, as some idiot once said.
One UK clearing bank has been described as a huge smart hedge fund, with a mediocre provincial bank bolted onto its underside. That’s probably true for all of them.
A few starters on banks:
1) They are licensed by the government. I cannot start up a bank – neither can you, unless you go through the various hoops, fires, and barriers erected in front of you. You need mountains of capital. They make it difficult to join their club.
2) They operate under a specially loosened set of accounting rules.
Normally, companies are required by accounting rules and law to make sure they provide for their liabilities as they fall due. If you order a load of gear on credit, you have to show that you have the ability to pay for it – and pretty rapidly. Companies are expected to make their creditors ‘whole’
Look at the accounts of Vodafone and in their balance sheet they have to provide for ‘current liabilities’ and ‘long term liabilities’, but not so for a bank. Banks get away with a broad ‘liabilities’ section, with no attempt at sorting near term risks from long terms assets. It doesn’t matter whether they owe money tomorrow and are due to cover it in 5 years time.
3) Banks thrive on red tape, loopholes, fuzzy wording and obfuscation
For instance, 75% of people in this country believe that when they place their hard-earned money in a current account, it remains their money. It most emphatically is not. You hand your money over, and you get a promise. Well, I say promise, but the bank goes to great lengths to hide this fact. You are given a statement, which shows your money proudly sitting there, waiting for you – all safe and sound.
Except it’s not.
It is being lent out to Dubai World! Or passed onto the trading floor, and being pushed into Alphabetti Spaghetti Derivative Hooplas, funnelled into their massive casino operation.
Even though you might spend it tomorrow, the bank will not have your money. If you want it, they have to get it from somebody else’s account, or go onto the money markets and borrow it.
4) A bank is an operation designed to make profits from money that is not their own.
When you put your Tesco’s money into a bank, you are investing in a hedge fund, except you don’t get any of the profits. If it all goes wrong, as it did in 2008, then the taxpayer pays for all the losses.
Even in the good times, the taxpayer insures deposits (explicitly or implicitly), leaving the banks free to gamble away. Does this seem like free market capitalism to you?
What is the problem with this, after all, it’s a free world?
Well, it’s not. As I said before, banks operate with privilege and monopoly rights, with taxpayer backing. And we can add a final potion into the mix: incentive and liability
The sub-prime crisis cost Wall Street and the City trillions, or rather it is costing taxpayers that much. If I lose money, I remortgage my house; otherwise I don’t come back.
When Goldman Sachs put all its eggs in the AIG basket, they should have received a bloody nose – at the very least. Yet uncle Sam paid them out 100c on the $ and Goldman scored a slam dunk. God’s work, eh? A miracle indeed.
A trader called Howie Huber recorded the single biggest loss ever at a bank. He cost Morgan Stanley over 10 billion dollars, but he got to keep the 24 million dollar bonus he earned the year before.
Dick Fuld at Lehmans faced some devastatingly hard questions from some horrible congressmen, but retired a very rich man.
It was the taxpayer who paid the price. Private profits and socialised losses – emphatically NOT what I’d call free market competition.
Now I don’t mean that we should round these guys up and shoot them, or even take their bonuses back – they signed contracts, and we respect the rule of law, and contracts. It’s the basis of our freedom and we risk tyranny if we selectively choose to violate these rights.
We have to recognise that bank traders get a free option. You can bet it all on red or black: win, you get a bonus. Lose, you may lose your job – but then probably use your ‘reputation’ to walk into another one.
The system is wrong, and something must be done about it.
In terms of dealing with the crisis we have to understand that damage is done before we are aware of it. In the sub-prime crisis, it was done in those happy days of 110% mortgages, up front discounted rates, and more freshly printed money than you know what to do with. We were killing our economy with cheap money love.
When gravity asserted itself, and the inevitable bust came we faced a simple choice: take the pain, or hide it.
In 1982, 100 Keynesian economists wrote a letter to the times saying that the government’s economic policies were suicide. It’s a bit of a coincidence, then, that that was the exact moment the real economy started to grow. Time and again, history shows us that if we take our medicine early, we get through the illness quicker.
Or we could take the Japanese/Keynesian approach, and hide it with fiscal aggregate kabalah nonsense. And lose twenty years in the process
But banks.. what should we do with them?
1. Firstly, banks should not speculate with your beer money – unless you understand this, and you explicitly sign it off.
2. Banks should be audited as strictly and as thoroughly as normal companies are – no favours.
3. Banks should legally have to provide for liabilities as they fall due – as every other company should.
4. Banks should offer accounts that are 100% reserved. That is where your money is kept safe, not used to speculate – and it remains your property.
5. Speculation should be undertaken by hedge funds and specialist trading groups, not by deposit-taking institutions, or by the likes of Barclays, that can borrow money from the Bank of England at 0.5% and walk over to the craps table.
6. Anybody, or company, that offers fiduciary advice should face 100% liability in case it goes wrong.
And most importantly,
7. Any person paid more than a certain amount by a bank, should be liable when things go wrong.
The contract that Dick Fuld signed should have meant he lost his house when he crashed Lehman’s. Howie Huber should now be serving Big Macs. And Lloyd Blankfein should be a little more circumspect when talking rubbish about doing God’s work.
God is watching you mate… be careful.