It’s a Different World out There.
I have learnt so much in recent years about all sorts of things. It makes one wonder how little we still know.
International finance and banking is an area that has taken my interest since the 2007-08 global financial crisis. This topic really is rocket science. On steroids. No one really understands much of what goes on and how it works it seems. All that matters is that “profits” can be created. By using exotic systems created by mathematical geniuses, super computers and no little amount of deception and hubris.
One tiny part of international finance I do understand a tiny bit now is called “Short Selling”, or “shorting” or being “short”.
Most people would think that conventional investment strategies involve buying something, and hoping it goes up in value after much hard work had been done to improve its value. The asset in question could be property, a currency, company shares or bonds. No doubt, most of us have followed this normal asset investment strategy at some point in our lives, even without knowing it. By buying a family house and slowly improving it over time, its value will grow automatically.
This stratedy is based upon the expectation of positive growth in asset values. But the asset value growth doesn’t have to be positive in order to profit from the change.
Welcome to Short Selling – where investors profit when an asset goes down in value. When an asset becomes less valuable over time.
Seems a bit weird right? How it worked seemed quite odd to me too when I first heard of it. But then, much of the modern “financialization” of the western global economies, particularly in the United States, is weird, and unethical in my view.
Looking at the flow diagram above. An investor, Mr Moneybags decides he wants to short sell shares in an airline for example to the tune of say 10,000 shares. He doesn’t need to currently have any shares in the airline. He simply contacts his stock broker and tells the broker he wants to short himself on the airline stock for 10,000 shares.
So, step 1 begins with the broker looking through the portfolio of his existing customers who already own the airline stock in question and they take out the 10,000 shares from one or more conventional stock market investors’ accounts. Essentially, the broker borrows the airline stock from its owner for a set period of time, and hands the “borrowed” stock onto Mr Moneybags, in a contract lasting for say 2 years.
In 2 years time, Mr Moneybags has to give back the borrowed stock to the broker to restore the original investors asset.
Once the IOU contract is signed for 10,000 shares, straight away Mr Moneybags sells the airline stock at market value, say $10 a share and banks the money, amounting to $100,000 in this case. This is transaction 2 above.
Mr Moneybags’s is sure that the airline shares that he has borrowed for 2 years will go down in value, so all he has to do is wait. In the meantime, the money he gets from selling the borrowed shares can be invested somewhere else entirely, perhaps in a more conventional way, and for more profit, perhaps growing to $125,000 in two years time.
As it turns out, Mr Moneybags was lucky. A new type of virus soon hits the world and all borders are shut to international travel. One of the hardest hit are airlines due to the big drop in global travel. Planes are stored. Airports are empty. Airline share prices plummet. This is step 3.
Mr Moneybags is very happy as this is what he thought might happen. After 2 years, he buys back 10,000 airline shares from the market and gives them back to the broker in Step 4. Except at this time, the airline shares might only be worth $4 a share, not $10 as when he sold them 2 years ago. Therefore, it only costs Mr Moneybags $40,000 to buy back the same 10,000 shares that he initially borrowed and then sold for $100,000.
After paying the broker a fee for the 2 years contract, Mr Moneybags still comes out with a profit of almost $60,000 from the transaction, and perhaps more, if he invested the original $100,000 wisely. Step 5 – make profit!
With his new found profits, Mr Moneybags is now free to look at other investment opportunities.
Short selling doesn’t profit from creating anything. In fact, it profits from other people’s difficulties and loss in their equity. Even the problems of entire nations can be taken advantage of if you know how. But it is clearly problematic that people can make money not only from negative value growth, but can do it without actually owning anything.
Any asset can be shorted, not just company shares. For example, a nation’s currency. Billionaire investor George Soros was famous for making one billion pounds profit by betting against the value of the British currency in 1992 when the newly formed EU was facing financial stress. He was right and his speculation upon the difficulties of the British taxpayer made him a handsome profit from it. A handsome profit made from the backs of British taxpayers, whose government then had less money to spend on health and education after paying Mr Soros.
In some circumstances, short selling speculators can even initiate the drop in value of an asset, and then, by constant further short selling attacks, they can perpetuate and enhance the fall in value of a currency or share. It is always easier to destroy than to create. You can profit from both now.
Short selling is a speculative and damaging activity, but it is legal all the same.
Does this seem an ethical way to make money? Our opinions do not matter.
Even if it does pass your personal “sniff” test, there is another angle that bears consideration.
How could potential, or even clear, conflicts of interest be handled with respect to profiteering from events surrounding the normal administration of a country?
Is it possible that inside the Washington and London elites, there are select groups of people who have inside knowledge of an imminent foreign intervention, or imposition of crippling sanctions thereby allowing them to take advantage of that knowledge, by say, short selling a currency like the Iraqi dinar, Venezeulan Bolivar or the Iranian rial?
There are in fact, huge opportunities to profit from other people’s misery. Many nations have been targeted by these “vultures.” They are “slam dunk” investment opportunities for the skillful. If you have good inside information. And if you don’t care about making huge profits by destroying something.