Thursday, August 1, 2013

Praise to the Cult of Speculation - at whose expense?

A Brief History of Predicting the Unpredictable,
by James Owen Weatherall, Scribe, 286pp. 

Reviewed: 27 July 2013

The genius of the capitalist system is that it provides an orderly, large-scale means for individuals and groups to pool their savings and direct them to new investment on a scale beyond the scope of any individual investor.  It also provides the means by which the risks of investment can be spread across a wide range of individuals, balanced against the opportunity for profit.

But for this beneficial process to continue, there must be a general trust that it works for mutual benefit. If individuals, or investment managers representing them, lose faith that the opportunity for profit is in reasonable balance with the risk of loss, they will not put their hard-earned savings into the pool, but instead seek lower risks in cash or perhaps bricks and mortar real estate.  With these choices, they reduce the pool of capital available for investment in risky but genuinely productive activity.

When the $60million-salaried head of Goldman Sachs investment house travels the world complaining that investors have "lost their appetite for risk", who does he hold responsible?

Nobody who reads The Physics of Wall Street could continue to believe that the risk and reward of equities and financial instrument investments are in balance for the passive investor. Clever speculation techniques, supported by massive technological advantage and availability of massively liquid financial resources, ensure that the superior speculators will always do better in creaming the profit and evading the risk. Where else would the $60million salaries and bonuses be coming from?

The daily value of your superannuation or other financial investments is now determined by algorithms and strategies that arise from studies of casino gambling, chaos theory, the survival of migrating salmon and earthquake prediction. 

Any factual economic news about interest rates, employment figures or exchange rates is no more than the latest roll of the dice in a game where the accumulated savings of people and enterprises are predated by traders whose sole art is in predicting where prices might move, and trying to get there before their competitors.  Financial markets are an ecology in which long-term investors are the herbivores, and short-term speculators are the carnivores.

This book notes how Nobel Prize-winning economists have lost millions in the stock markets, while several of the most successful fund managers have never studied economics but had backgrounds in physics or higher mathematics.  With no interest in social or economic causes and effects, they have developed sophisticated methods to analyze price movements as a means of predicting opportunities for profit.  It tells you how they did it and why you can't beat them..

Richard Thwaites is a helpless dependant on the chaos of financial markets.