If Only Stefan Stern Knew What He Was Talking About

I know, big surprise, columnist in The Guardian in not a clue shocker. But this is more than just the whining of some other entitled haute bourgeoisie complaining about the oiks having something. Stefan Stern thinks he knows how people should be paid – he’s from the High Pay Centre you know – and yet he betrays no understanding of how the City nor business works in the slightest.

Yet in reality the core ethos of financial markets – picking up pennies in front of a steamroller – has not fundamentally changed.

No, that’s a description of a certain sort of arbitrage, that’s not what finance nor the City does.

There is still a relationship between risk and reward, and big winners take bigger risks.

This is to grossly misunderstand the efficient markets hypothesis. An implication of which is that you can only make higher returns if you also accept higher risk. Which means, as risk is symmetrical, that taking higher risks, if those risks come off, produces higher returns, but if they don’t then losses rise. Again, a bit subtle for a Guardian columnist, even one claiming to understand this stuff, but what is really being said is that risk adjusted returns aren’t higher. People who take bigger risks don’t make more that is. It’s that the survivors of taking bigger risks make more, the non-survivors less. This is not the same thing of course.

That’s why the great financial markets gold hunt is to find higher returns without taking bigger risks. Diversified portfolios of junk bonds being the last discovery of this that I know of but that’s just my memory.

OK, so people might not be trading “collateralised debt obligations” (CDOs) any more – the financial weapon of mass destruction that ruined that fun game of bankers’ Jenga.

Yes, they are, it’s a vast market. A CDO is just another name for a tranche of a securitised loan pool. Issued every day, or at least every week, in volume, and traded.

But cryptocurrencies (Bitcoin and the like) have emerged as a new plaything for the financially adventurous.

Not in The City they’ve not, this is very much a private sector hobby and has absolutely no systemic implications at all.

There is still plenty of risk about, as calamitous falls in the Turkish currency have recently reminded us.

Err, yes, that’s what all that speculating does. Those taking those risks are the people taking the risk off you and me and importers and exporters. That’s the point of such speculative markets, to move risk.

So, not knowing a great deal about the financial markets then. But this is the truly joyous part of his argument:

Supposedly legitimate financial practices, such as share buy-backs, still dominate orthodox thinking. A buy-back is carried out by a business when it has surplus capital and can’t think of anything else it wants to do with it. So it simply buys its own shares, pushing up its share price and keeping investors happy for the time being.

OK, and as we and others keep pointing out, those shareholders then go do something with the money and things still happen. But here’s the next part of his thinking:

But buy-backs starve businesses of useful investment in new technology and increased productive capacity. If you want to know why productivity and pay remain so low, start looking here. The orthodoxy of buy-backs is actually killing business, slowly. So yes, we should still be worried.

So pay and productivity would rise faster of the money stayed inside companies where they’ve not a Scoobie over what to do with it? To make the point is to show how vapid it is, isn’t it?

Sure, it’s entirely possible that people who write in The Guardian will disagree with you, me, each other, about the merits of markets and finance. But it would be useful if they knew something about either, no?

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isp001
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isp001

Again, Berkshire Hathaway is a phenomenal example of a company that sometimes purchases slow-growing businesses because of their ability to generate high levels of excess cash flows that can be reinvested in other growth projects. In fact, Warren Buffett once warned about the perils of mindlessly investing money back into the company that generated it: “Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them… Read more »

isp001
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isp001

Again, Berkshire Hathaway is a phenomenal example of a company that sometimes purchases slow-growing businesses because of their ability to generate high levels of excess cash flows that can be reinvested in other growth projects. In fact, Warren Buffett once warned about the perils of mindlessly investing money back into the company that generated it: “Long-term competitive advantage in a stable industry is what we seek in a business. If that comes with rapid organic growth, great. But even without organic growth, such a business is rewarding. We will simply take the lush earnings of the business and use them… Read more »

Spike
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“a business when it has surplus capital and can’t think of anything else it wants to do with it” often means that the business knows exactly what it would like to do with it, but cannot currently do so profitably. Stock buybacks (if not sneakily cancelled with acquisition and employee compensation using shares) make stockholders wealthier, as each is no longer say 1 millionth but 1/900,000 of the firm, and the stock price tends to rise. The factors in an owner’s decision to cash in the shares, pay tax on the gains, and reinvest the remainder, are as they were… Read more »

Southerner
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Southerner

Kill off the dogs, fatten the hogs and milk the cash cows.

Southerner
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Southerner

Kill off the dogs, fatten the hogs and milk the cash cows.