Lisa Simpson
Aug 31,2009
In: Finance

There Is No Logic in the Behaviour of Financial Markets

no logic finance

We are taught that there is balance in the world with the good cancelling evil that assets are the same as liabilities and in short life is a ball. But in reality that is not. There are imbalances in the financial world and it is finances that determine the social picture. There is no logic in the behaviour of financial markets.

George Soros recently pointed to a simple truth. Financial markets are dangerous because of the risks involved in going long (only buying and not selling) is not the same or equal to going short (selling or taking loans for what you do not possess.) If anything is bought and the price falls to zero then the asset is lost. But if one borrows and then something happens to the price not only is the product gone but debt is incurred.

This simple truth AIG, the American insurance giant, did not understand. While insuring for cars or human life one is up against the law relating to large numbers. So long as the premium covers the predicted losses then the company continues to make money. But if one insures leveraged institutions like banks or borrowers the losses are magnified by the inherent derivatives. This is exactly what AIG was doing in London.

It needs a lot to imagine any effort to insure the current global bank losses amounting to $3 trillion. The losses of the banks were astronomical because they were extremely leveraged entities. The lower the price of the assets in their hands the more bankrupt do they become. Thus AIG required over $180 billion to be bailed out. This is in contrast to the initial request of $10 billion made for funding.

This brings into focus the issue of usage of domestic currency as reserve international currency. When a currency is circulated within the confines of its own country it tantamounts to citizens borrowing and lending from each other – the left hand taking from the right. If debts remained unpaid there are legal protections for the lender even if the corporate group borrowed excessively and fell flat. The state can step in by either nationalizing the debt or taxing the other citizens to compensate for the loss. But in the case of foreign debts the picture is different. The central bank of a country cannot print foreign notes.

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