There was a very interesting article in Der Spiegel Online last week titled The Destructive Power of Financial Markets. The article was focused on how financial market players could wreak havoc for profit according to a number of global leaders. Here are a few quotes from the article to consider:
The enemy looks friendly and unpretentious. With his scuffed shoes and thinning gray hair, John Taylor resembles an elderly sociology professor. Books line the dark, floor-to-ceiling wooden shelves in his office in Manhattan, alongside a bust of Theodore Roosevelt and an antique telescope.
Taylor is the chairman and CEO of FX Concepts, a hedge fund that specializes in currency speculation. It's the largest hedge fund of its kind worldwide, which is why Taylor is held partly responsible for the crash of the euro. Critics accuse Taylor and others like him of having exacerbated the government crisis in Greece and accelerated the collapse in Ireland.
People like Taylor are "like a pack of wolves" that seeks to tear entire countries to pieces, said Swedish Finance Minister Anders Borg. For that reason, they should be fought "without mercy," French President Nicolas Sarkozy raged. Andrew Cuomo, the former attorney general and current governor of New York, once likened short-sellers to "looters after a hurricane."
The German tabloid newspaper Bildsharply criticized Taylor on its website, writing: "This man is betting against the euro." If that is what he is doing, he is certainly successful. While Greece is threatened with bankruptcy, Taylor is listed among the world's 25 highest-paid hedge fund managers….
Taylor grimaces and sighs. He was expecting these questions. "The big problem is that in some cases these politicians are looking for the easy way out and want to blame somebody else and say speculators are taking Europe apart, taking the euro down and ruining the prosperity of our country," he says, characterizing such charges against hedge fund managers as "nonsense." "My capital isn't the capital of the Rothschilds," he says, insisting that he is working with the "capital of the people," and that his goal is to protect and increase this capital. Taylor points out that no one from any of the German pension funds that invest their money with him has ever called him on the phone to tell him not to bet against the euro.
Markets Control Politicians
Taylor's arguments echo those of everyone in the financial industry — the executives, the bankers and the big fund managers. They all insist that they are not responsible for the crisis in the euro zone and the turbulence in the financial markets, and that their actions are purely rational and in the interest of their investors.
The truth is that the financial markets are controlling the politicians. If Sarkozy interrupts his vacation, the markets interpret his sudden return as a sign that the situation there is worse than they thought — and promptly set their sights on the country. And if there is an argument between Italian Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti, then the markets target Italy, because they doubt that the Italian government is serious about introducing austerity measures. The markets take advantage of every weakness and every rumor to speculate against one country after the next.
In doing so, they aggravate the crisis. Once a country has become the subject of rumors and speculation, other investors become nervous. Fearing further price declines, pension funds and insurance companies also start selling stocks and bonds. In the end, fear nurtures fear and a panic ensues….
Many things that happen on Wall Street and in London's financial district are "socially useless," says Lord Adair Turner, chairman of Britain's Financial Services Authority (FSA). The values that are created there are often not real or of any use to society, Turner adds. Paul Volcker, the former chairman of the US Federal Reserve, once remarked that the only truly useful financial innovation in the past 20 years is the cash machine….
Two weeks ago, the share price of Société Générale, a major French bank, fell by 14 percent, after the British newspaper Daily Mail had reported the previous day on alleged problems at the bank. Even though the bank promptly denied the veracity of the report, the rumor had been set in motion. Apparently no one cared whether or not it was true. It was later rumored that journalists at the British paper had taken a piece of summer fiction printed in the French newspaper Le Monde, about a breakup of the euro zone and troubles at Société Générale in 2012, to be the truth — which the Daily Mail promptly denied.
Whoever has the fastest connection to the market stands the best chance of taking advantage of a critical millisecond and thus reacting to a price signal ahead of the competition. The computers are far more efficient than any human trader, because they can process hundreds of pieces of information per second. At the same time, such programs can also amplify — or even trigger — a crash.
On May 6, 2010, prices on Wall Street plunged by almost 10 percent within a few minutes. To this day, no one knows exactly what caused the so-called Flash Crash. Because this sort of thing happens with growing frequency, the US Securities and Exchange Commission (SEC) has imposed a waiting period on computers in emergency situations. If the price of a stock has dropped by 10 percent within five minutes, trading is temporarily halted, allowing the human players to consider whether there is in fact a real reason for the sharp decline.
Woolley believes that this regulation is insufficient. He is calling for a strict ban on high-frequency trading, which, in his view, has no social value whatsoever.
Computers have long set the tone in foreign currency trading. The currency markets are now too complex for humans to manage alone. "We realized that you couldn't really manage this with the human thought process, it was too difficult, there were too many variables," says New York hedge fund manager Taylor. Many of his roughly 60 employees are IT experts, mathematicians and engineers. They feed massive volumes of data into the computers, including figures on the gross domestic product of countries, interest rates, commodities prices and inflation rates. "The only thing the computers can't handle are political developments, that is why we have me as Chief Investment Officer," says Taylor, although he points out that the money ultimately follows the instructions that are spat out by the computers.
But even Taylor isn't entirely convinced of the myth of purely rational markets that obey nothing but the logic of numbers.
For example, says Taylor, he is "sure" that legendary speculator George Soros is "plotting against the euro." Although Soros denied such accusations in an interview with SPIEGEL last week, he also said: "Financial markets have a very safe way of predicting the future. They cause it."
The 81-year-old is one of the founders of the hedge fund industry. In the early 1990s, he suddenly became the quintessential unscrupulous speculator, one who takes advantage of even the tiniest weakness in the system without regard to the consequences. He borrowed 10 billion British pounds, then sold them on, triggering a wave of speculation that meant the Bank of England could no longer maintain the pound's fixed exchange rates against the other currencies in the European Exchange Rate Mechanism (ERM). The pound had to be devalued and withdraw from the ERM. Soros was able to buy back the sum of money he had borrowed from the bank at a lower exchange rate. It was a bet that earned him more than $1 billion (€700 million).
Normally individual speculators like Soros and Taylor cannot move the market to such a significant degree on their own. But they can establish a trend that others then follow. Investors adhere to a herd mentality and, like lemmings, they are prepared to rush headlong toward an abyss, provided a few individuals are heading in that direction with sufficient determination.
As a result of the crisis, some of these speculation funds have become even larger and more powerful, with a number of smaller competitors being forced out of the business. Customers tend to prefer investing their money with bigger players, believing this to be the safer choice."
So we see that hedge funds can use existing market opportunities to create profits while wreaking havoc in the real economy. There is an active debate as to whether or not this is harmful in the long run. Pure free market advocates will argue that the imbalances will be self correcting over time. They will point out that any negative imbalances will create opportunity that speculators will exploit in beneficial ways. That may or may not be entirely true but it is a legitimate debate.
The problem, however, is that the same mechanisms that can be used for profit are available to those who have other motivations. The lack of market transparency makes it virtually impossible to trace exactly who is placing the orders and what the motivation behind them might be. This is where a normal market debate becomes a serious issue of national security. The only hope is that terrorists or those wishing to engage in economic warfare lack the resources, access, or knowledge to use these mechanisms to attack. Our research has proven this hope to be naive and foolish. It is imperative that the national security community wake up to reality.
All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved