Monday, 2 February 2009

Silly Money

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I start this series on economics with a sense of urgency. I know that talking about money with the constant media bombardments on credit crunch, cash strapped, global recession looks for sure like another tedious text. Be patient. There might be some clues on what you are about to read as I share with most of you, this sense of uneasiness when glancing at the bad shape of the world economy. There is no way back for decades. The repercussions in human relations are already present with social unrest in China, United Kingdom, France and Russia. Ultimately only a catastrophe will put things back on track.
Please note that the use of dollars and Microsoft as a corporate example on the pages below is almost coincidental. I could have used Coca-Cola or Shell and euros or British pounds. However I am certain that if it wasn't for Microsoft drive allied with new technologies and the Internet, the stage we reached today would have taken at least an extra 25 years. The credit crunch postponed to 2033, how lovely would that be? What we are confronting at present is worse than the understated "credit crunch" would lead us to believe. We are, as it is commonly said in banking, facing an unavoidable loss.
So... here it goes...
The news of a $825 billion dollar stimulus package that new USA President Barack Obama is trying to approve in Congress might not be the measure that the USA economy, and by proxy the world economy, is in need now. President Obama is in an intellectual conundrum; as the New Kid In The Block he needs all the help he can get but he is also the only man in this planet that has the power to help and make a genuine difference. He has only arrived 10 days ago and in my view, which I will try to explain here, he is already running out of time.
The title of this story is SUM0. It is a very simple concept that has been used in accounts, basic and not so basic, for centuries. It started in the Renaissance, with double-entry accounting invented by Luca Pacioli in Venice in... 1494. The principle is simple and every company in the world uses it. It means that debits equal credits, income equals expenditure, profits equal losses. As debits, expenditure and losses are negative, red, bracketed, it also means that you can say that debit+credit=0, income+expenditure=0, profit+loss=0, SUM0. This is the basis of all economy models; anything and everything should comply with the SUM0 environment.

Some basic concepts:

If someone makes a profit, someone else has a loss.
Money does not grow on trees.
A bank posting a $20 billion profit means that someone is out of pocket by $20 billion somewhere. Or is he/she?
The thing is... he/she isn't. For the past 40 years the Western World has been making basic accounting mistakes that are now showing their marks with dire consequences to our future. So what are these mistakes?

Basic Mistake n. 1 or "money for nothing"
Tom, Dick and Harry are the main characters in this story. Tom sells Dick 50 Microsoft shares for $1000 ($20 each). In this simple process I shall skip the mediation of the NYSE, the payment of stamp duty and other brokerage charges. So far the transaction between Tom and Dick is a SUM0 one as $1000 dollars went from Dick's bank account to Tom's bank account. Now this is the time when things start going a little bit pear shaped. Tom is happy and Dick is also happy as, on the following day, he notices that his Microsoft shares are now quoted at $24 each. So now he has $1200... and with glee he goes into his Microsoft Money file and puts there, on the top of his bank money (let us assume $5000 for practical purposes), the 50 shares. The software/books now show that he has $6200 in "assets". And Dick thinks "Great! I have made a $200 profit overnight." This is wrong because suddenly we are out of the SUM0 environment as originally Tom had no money in the bank and Dick had $6000. Now Tom has $1000 and Dick has $6200 which, if you add both amounts, makes a total of $7200. As if by magic $1200 have been generated, money for nothing surfaced. The good news is that this will revert to a SUM0 process when Harry arrives and buys Dick's Microsoft shares for $1200. However this event could occur between 5 minutes and 15 years. Then all accounts will be reconciled. In the meantime for all practical purposes the economy will be better off/increased/profited by $1200 by the simple touch of a button. And on a cascading process after Dick's sale, nothing impedes Harry to err into the same misconception and state that his "assets" include now 50 Microsoft shares. This is a basic mistake on a simple product as shares are. Worse, banks are willing to take shares as collateral for loans and other more convoluted financial products, therefore validating the mistake in their own books. So lets be clear... shares can (should) only be accountable in a SUM0 environment AFTER being sold, exchanged for cash. At best only its nominal value ($0.20?) should enter anyone books at any time. The thing is no one likes to digest the concept that, until the shares are sold, they are effectively having a loss. Harry does not want it, neither does Tom or Dick. Oh by the way, neither do the financial institutions, governments, IRS, etc. And this triple-entry just gets accounted every second of our modern lives and it is worth what... $4 trillion?
I tend to smile with the sensational news that the Stock Exchange had assets of $100 billion wiped out on a single day as if the cash went down the toilet. Don't worry and don't run to put your money back into it out of pity. The cash just went somewhere else. In trading and on SUM0 the profit of one is always somebody else loss. So that $100 billion is almost certainly in someone bank account somewhere.
The only time there is a SUM0 environment for a share trade is on transaction number 1 when effectively cash goes from someone pocket into the corporation (e.g. Microsoft) that floated on that particular day. People and corporations that make the first transaction and give money to Microsoft, will file in their books the value of their shares as "real" money (as Tom, Dick and Harry did) effectively doubling the cash as it "shows" in their accounts AND in Microsoft's bank. However only Microsoft has indeed real money. What should you call the "other" money? Well... the best description should be fantasy money but I will leave a vox populi name for it. When discussing house prices with my builder Chris, a couple of years ago, plus mortgages and remortgages he said "There's too much money given away and most of it is silly money!". He had the gut feeling that something was not right. So I shall describe the "Money for Nothing" as Silly Money... and how silly? My estimate is around $300 trillion!!! worldwide. As silliness goes, this one must be pretty close to the top.

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