Recent Posts

'Disgusting': A Workplace Conversation

Thursday, November 17, 2016

Like most, I usually avoid religion and politics at work.  But today a co-worker and I were waiting for a computer system to be scanned for cyber-security risks and got to talking about the economy.  He mentioned that he had watched the movie "The Big Short" (which I highly recommend) but got caught up in trying to grasp the underlying explanations - which seemed too arcane to get his head wrapped around.

As I tried to explain them, he shook his head and used the word "disgusting" - which is exactly how people feel after they see the movie.  I used that as an opportunity to explain Donald Trump's win: People held him up in front of the status quo so they could see themselves in all of their disgusting glory.

My friend said he planned to watch the movie again, but this time not worry about understanding the underlying economics.  So I tried to explain the dynamics the movie tries to expose. I'll try here as well.  And once you do understand, maybe - just maybe - you'll understand why people like me are tickled pink watching the status quo establishment retching over "President Trump."

When you buy a share of a company's stock you are buying an ownership stake in the company.  This means you will enjoy a share in the appreciation of the company's value as it competes successfully in its market.  It also means you are exposed to the company's liabilities, and can end up losing money if the company fails to compete successfully.  That success is supposed to be based on the ability to make a better product at a lower cost than its competition.  Part of those costs is the cost of money.  If money comes at a cost (interest rates), then the higher those rates are, the more important it is that the company have a genuinely better product than its competitors.

But what happens when money is free?  Or all but free?

A whole raft of companies emerge who base revenues on financial engineering rather than actually "making a better mousetrap" (as my parents would say) or by "brewing a better beer" (my preferred metaphor here in San Diego).

That financial engineering uses Big Data in much the same way as hurricane forecasters do.  Data is brought into context with other data to create 'information'.  This information is then run through statistical models validated against past data to predict the future.  With hurricanes this means the path and intensity of the center of the storm predicted out about five to seven days.  With financial engineering it means the movement of prices in things like real estate and commodities.

When the models show prices increasing, a company might sign futures contracts.  When the price rises, they sell the contract at a profit.  They are not actually interested in taking delivery of the underlying commodity and turning it into useful products.  So their revenue is based on making winning "bets" - and using Big Data for something that is essentially the same as "card counting."

Now imagine someone decides to set up a company to invest in companies whose revenue is based on winning bets like these.  That company issues stock.  Again, that stock reflects a share in revenue - but that revenue is just an aggregation of winning bets made by other companies.  Theoretically, there is no limit to the number of "links" in a "chain" like this.  So if one company makes a $10,000 bet, and a second company makes a bet on that bet, and so on and so forth, that $10,000 bet can balloon exponentially into a multi-billion dollar exposure.

When get your head wrapped around this, there really are only two options.  You either deny what is actually right in front of you because you think "that can't possibly be legal" (it is - but wasn't in the past) or "that sounds like a conspiracy theory" (this is what Wall Street wants you think).  Or you come to terms with it and are left utterly disgusted and outraged.  It is that disgust and outrage that has propelled Trump into the White House.

But it is not enough to be disgusted and outraged because if that is all there is, then we have no idea of what to expect of what our government and economy should like after the "draining of the swamp."  This is where understanding the math of all of this is essential.

When placing bets on things like commodities or real estate, it is crucial that we understand how the cost of money affects the odds.  Imagine the chips are free at the Blackjack table.  The odds in Blackjack are well-understood.  The only question is long you can remain at the table.  The cheaper the chips, the longer you can play.  It is the same with money in the financial sector.  Cheap - or free - money allows those who understand the math and have Big Data resources to do the math to gamble more and longer.  With essentially free money it is almost impossible not to be lured in by that math - it seems you cannot possibly lose.

Until you do.

And when your bets are chained together in a hierarchy of derivatives, a $10,000 bet gone bad can collapse an entire bank.  And when an entire sector of banks are making these kinds of bets, an entire economy is at risk.

The answer is a properly restrained money supply and an eventual elimination of derivatives as a legal financial product.  What this will do is end the "financialization" of the economy where this kind of completely unproductive economic activity competes with the Main Street economy for capital which it (Main Street) could actually deploy toward brewing that better beer, creating wealth, and with it decent, middle class jobs.

Draining the swamp thus needs to start with the Federal Reserve.  Returning Wall Street to the simplicity of Glass-Steagall and making securitization of futures contracts illegal will end the gambling and allow capital to flow back to Main Street wealth creators.

No comments

Post a Comment

Don't Miss