Money, banking & insurance

Financial aftershocks and instability

The financial earthquake of 2007/9 appears to be over and most of the damage has been cleared from view. But no-one really knows what’s going on. Two key trends have emerged from the recent crisis and these are uncertainty and volatility. The perception of markets is that the world has entered a dangerous era of risk. This is partly because national economies are now so tightly connected and partly because there is extra sensitivity to potential triggers. Everyone expects an aftershock, but nobody can say for sure where, or when, it will occur. Hence everyone has the jitters.

It’s possible, of course, that a handful of Eastern and Asian economies will pull the rest of the world out of trouble. It’s also possible that the US will recover sooner than expected or that developed nations will learn to live with less and adjust to a new age of austerity. Alternatively, soaring debt, tax increases and spending cuts may create a new age of bitterness.

We could be in for a period of deflation, high unemployment and competitive currency devaluations. This could lead to the Eurozone falling apart (trust me, it will eventually) and higher levels of protection. On the other hand we may be in for a period of inflation, the likes of which we’ve not seen for decades. But this isn’t necessarily a bad thing. Higher inflation would mean falling real wages, which would create more jobs. It would also, critically, reduce household and government debt. So, to sum up, nobody has the slightest idea what’s going on.

 

Follow the money

If you want to make a great deal of money you have two options. The first is to invent something disruptive that upsets an established order or creates a new category.The bag-less vacuum cleaner created by James Dyson and Apple’s iTunes Music Store are good examples. The second way is much easier. Simply tap into a large flow of money. Twitter co-founder Jack Dorsey has potentially gone down both routes simultaneously with the creation of a new payment system called Square.

The idea is simple enough. Give away a smart phone application that allows people to make credit-card type payments via a mobile. Users sign up, sign in with a fingerprint scan and pay for the item electronically. They then receive a receipt by text message or email. Better still, they can get a photo of the item they’ve purchased and GPS coordinates of where the transaction took place. Square makes money by taking a small percentage of the transaction or a flat fee.

This may sound gimmicky but it’s not. Moreover, even if this idea tanks, someone, somewhere, will eventually create a digital payments system similar to this that does makes billions from micro-payments or other informal transactions over a mobile. This may spell trouble for the big banks and credit card companies. Paypal recently reported it transacted over $US71 billion in e-payments in 2009, while a UK report claims that, by 2015, only 59% of all transactions will be made by cash in the UK, down from 73% a decade ago. To my mind this is an interesting trend. More compelling is that payments may soon be physically separated from fixed payment terminals, which has huge implications for store design.

 

Will they stay or should they go?

The Euro is in crisis and a handful of European countries continue to wobble financially. There are two options: drastically cut economic integration or increase economic integration! Most northern Europeans would probably favour the former, while most southern and eastern Europeans would probably favour the later. Most likely is greater integration for the simple reason this will benefit the Eurocrats sitting in Brussels. This would mean that Brussels will move to approve the spending plans of all member nations but there will be consequences.

One consequence could be mounting public opposition to the European experiment. Another could be that one or more countries will simply pull out. Opting out of the Euro isn’t easy, but pulling out of the EU (and thereby removing oneself from the Euro by default) may prove a more practical idea. The prime candidate to take such action is Germany, Europe’s largest and most productive economy. In a nutshell, Germans are angry that their taxes are being used to support weaker and more profligate member states such as Greece, Spain, Portugal and Italy. Countries that are strongly linked to Germany’s economy, such as Austria, Belgium and Luxembourg and the Netherlands, may follow suit. All one can say will any degree of certainty is that, if they stay there will be trouble but, if they go, it will be double.

When computers run wild

The 6 May 2010 has already been forgotten, but this was the day of the ‘flash crash’, when the Dow Jones lost 998 points in just a few minutes, only to rise 600 points moments later. Volatility is a feature of hyper-connected economies and low liquidity markets, but this time the cause was something altogether more logical. The culprit was a computer – or lots of computers – that traded stocks at lightening speed, thereby compounding the volatility that was already embedded in the system. Computers – or more accurately, perhaps, algorithms – have been used for some time by ‘high frequency traders’ (HFTs) to buy and sell stocks, but the practice is largely unregulated. It’s also hugely complex and tends to be shrouded in secrecy, which is why HFTs have been branded as ‘digital piranhas’ by some commentators and politicians.

Buying and selling a company stock based on market share, price-earnings ratio, net profit, reputation, product quality, innovation or management experience (or even long-term strategy) is no longer the name of the game. These days the easy money is in using algorithms to spot inefficiencies. And things will probably get worse. A few years ago a trade made in a millisecond (one thousandth of a second) was thought to be fast. Nowadays trades are made in microseconds (one millionth of a second).

Given developments in computing, these trades will speed up even more in the future and complexity will increase still further. Unless regulators get a handle on this, there could be more trouble ahead.