Tuesday, July 03, 2012

Money markets

I've generally tried to avoid reading too much about the financial crisis. I don't have much of a head for figures, and I know what I read will just make me even angrier than I already am.

A sort of morbid fascination, coupled with a vague sense of civic duty, often induces me to go and read up on the latest scandal. I'm not generally that interested in the reportage on the scandals themselves, but more on the peculiar world that these scandals shed light on. In order, for example, for a newspaper to discuss ethical violations by a company involved in the millisecond-turnaround automatic trade they have to first explain what that business is.

Each time I'm struck by just how amazingly abstract the business models of these companies are. They don't create anything, nor do they really do anything. Most of them conjure their wealth seemingly from nowhere by simultaneously jiggling thousands of sets of numbers. They're not investors in the traditional sense – putting their money behind businesses to help them expand or improve, with the expectation that they'll reap some of the subsequent profits – they're just taking advantage of strange quirks in the modern financial system. 

The best analogy I can think of for these businesses comes from the world of computer games. Amongst gamers there is a class of cheat known as an exploit. These are not intentionally programmed codes, nor are they bugs, exactly. An exploit is simply a trick that takes advantage of a careless bit of programming, a loophole in the game’s internal logic.

A good example of an exploit comes from the Elder Scrolls series (Morrowind, I think, was the last one where this was possible). In these games you could create a magical amulet that increased the potency of potions you brewed. You could then put on this amulet and brew a potion that increased the potency of amulets you made. It was possible to repeat this process until you were able to make absurd items that the developers never intended for players to have – like invisibility potions that never wore off, or amulets of protection that rendered your character functionally invincible. 

Most of these traders seem, to my eyes, to be people taking advantage of an exploit – cheating, essentially. They're bypassing the route to prosperity that society’s fundamental code is designed around – hard work, innovation, skill – and are replacing it with a cynical and repetitive manipulation of an overlooked loophole.


On a related note. A while ago I found myself looking at the wikpedia pages for facebook and Rolls Royce in quick succession (I don't remember why). The difference between the market values of the two companies says a lot about the confused state of the modern stock market.

Facebook is a relatively small company. It employs a few thousand people, owns a few million dollars worth of tangible assets (servers, offices, etc.), and has a revenue of about 3.7 billion dollars a year. It has a business model that’s based on people continuing in the mistaken belief that advertising with them is a good idea (many senior ad-men are pretty convinced it isn't) and that it will one day figure out a way of making money directly from its users (which is like someone saying that they've got a lovely pork dinner ready and waiting when what they really have is an angry boar living somewhere in the forest near their house). A while ago facebook spent one billion dollars buying instagram – a company with about a dozen employees and a business model that, as far as anyone can tell, was based around waiting for someone stupid to buy them out.

Rolls Royce, by comparison, employs more than 40,000 people worldwide and has an annual revenue of 17 billion dollars. It makes jet engines and turboprops for just about everyone, along with squillions of other aerospace and high-tech engineering products. A few years ago it bought the Allison Engine Company, a large and highly profitable company which makes the engines for most US military helicopters and transport aircraft, for $525 million.

According to the stock market, facebook is worth 104 billion dollars, while Rolls Royce is worth only 20.

The only reason I can think of for this is that facebook is an entertaining football for the short-term gambler types, while steady, boring Rolls Royce is only of interest to people with an attention span of more than five minutes. The boring people have a more pragmatic approach to valuing companies, which at no point involves the word ‘zeitgeist’.