Devastation by High Frequency Trading

From time to time important challenges emerge from the most unlikely sources. Like the Investor’s Chronicle’s dogged 1970s uncovering of Denys Lowson’s criminality, Lowson being a former Lord Mayor of the City of London. Or Computer Weekly’s ultimately successful campaigning against the bureaucracy’s claim of gross negligence on the part of the pilots of Chinook ZD576 which crashed in 1994 on the Mull of Kintyre killing all 29 occupants.

Thanks in large part to Computer Weekly the real cause was revealed as software error in the helicopter’s computer system. Now the magazine PCPlus, whose prime focus is on the latest computer hardware and software, devotes 11 full pages of its current issue to what it refers to as the ‘virtual money crash’, and the role of High Frequency Trading (HFT) in producing what it describes as the ‘unpredictable and unstable world economy’.

HFT is of recurrent interest on this site (see, for example http://www.gordonpearson.co.uk/05/ultra-fast-exploitation-of-real-economy-firms/#more-553 ). The majority of trading in equities, currencies, commodities, bonds and even purely imaginary products, is now done by computers without human intervention other than in designing the program or algorithm by which the trades are made. And the factors which influence such trades have nothing to do with the underlying value of the security being traded, and everything to do with some guestimate of its future value, the future being measured in fractions of a second. A prime factor affecting this guestimate is the current price movement of the security in question. Thus contagion is inherent, bubbles inevitable and bursts essential.

HFT is the cheapest and fastest way for investment banking to conduct business. It is therefore also the most profitable as well as offering the opportunity to make super profits investing in bubbles or by shorting them before they burst. These trouble free returns are difficult to resist (see http://www.gordonpearson.co.uk/06/pity-the-poor-banker/#more-630 ). Lending to a successful firm in the real economy that needs to cover its working capital requirements as it grows, is far less profitable and much more hassle. No wonder the banks show little interest in the real economy.

From the perspective of the small and medium enterprise, the banks lack of interest is shown by their slowness to reach decisions: weeks or months rather than nanoseconds; by their demand for detailed, fundamental information, rather than reliance on unknown data fed by a computer into an almost certainly unknown algorithm; and by their demand for collateral to cover the risk of failure, rather than blind faith that black swans won’t appear.

Pouring more public money into the banking system won’t alter any of these factors, merely feed more money into speculative markets.

So what is the answer? As the PCPlus article concludes, ‘when it comes to finance, computers have detached us from the reality of how much a buck is actually worth. Computers are responsible for our debt, and for allowing us to take uncalculated risks with our hard earned income.’ In the end HFT will have to be outlawed and targeted taxation or regulation will have to make speculative investment less attractive than investment in real economy activities. Despite the focused power of vested interests, international progress in that direction is starting to be made, in response to mounting objections from many electorates,. But it is too slow to stop further real economy devastation.

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