McQueen on ‘How to lose a trillion’ and ‘McValue’

How to lose a trillion. (2 October)

When the radio news reported that the New York Stock market had “lost” a trillion dollars, my eyes glazed over.

A trillion is what Douglas Hofstader calls a Very Big Number, meaning that we have no way of coping with so many zeros after the one ($1,000,000,000,000). Those Arabic symbols might as well be in Roman numerals for all the use they are. According to Hofstader, the newsreader might as well have said “zillions”, for all the information that “trillion” conveys.

Those noughts add up to a sense of hopelessness. Therefore, the development of the class struggle, or a retirement plan, requires that we deflate the Very Big Numbers. The way of doing so is to puncture that non-doing word, “lost”.

We understand what it means to lose a wallet or a purse. We also know that those objects almost certainly still exist somewhere. It’s just that we cannot put our hands on them for the moment. One little difference is that the trillion dollars no longer exist because – and this is the key – they never did.

The “value” put on each company’s stock is determined by the latest bid price for one of its shares, multiplied by the number of shares issued. The “value” of the entire stock market, in turn, is calculated by multiplying the prices paid for the fraction of shares traded each day by the total number of shares of all listed firms.

Take a homely contrast. In the first case, you have paid $300,000 of your earnings into your industry super fund. The market plummets and you have to retire on $200,000. You have indeed lost at least $100,000. Now, consider this alternative. While you were buying $300,000 worth of super, its realisable value went up to $600,000. Had you cashed it in, you would have made $300,000. But, alack, the market collapsed before you go grey-nomading so that you have to live off only $500,000. You feel as if you have lost $100,000, although that is money you never paid out. (OK, OK, there were also opportunity costs.)
For many traders, the trillion dollar loss was also on paper. Of course, there are some real losers, those who did not find a Greater Fool to buy them out in time.

On Monday, New York went down by a trillion, then, on Tuesday, it went back up by $600bn. That bounce was not from the influx of $600bn of capital. After all, the justification for the $700 billion bailout is that those sums are not available.

All that happened was that enough bargain-hunters bought just enough shares at a marginally greater price than the day’s before so that when those handful of bids were multiplied by all the shares, they added up to $600bn.

Had everyone offered to sell all of their shares on either day, all the stocks would be worthless. The bailout and nationalisations are to deter investors from fleeing into bonds or gold. Should that happen, the aged pension will be cut by $30.

McValue

McBankers justify their $200m. bonuses as rewards for “adding value”. That phrase has gone feral among private equity merchants.

But what kind of value? To answer “the share price” makes a $90bn takeover sound cheap, at least, aesthetically. Yet it seems that some public affairs consultant has succeeded in re-branding “price” as “value”, and vice versa.

That prestidigitation is replete with paradox. Three instances can be tracked across economic theory to accountancy and then stock-broking.

From the 1870s, jettisoning “value” as metaphysical was the launching point for the Neo-Classical economists, the progenitors of today’s orthodoxy. What mattered to them was not some intrinsic value in a commodity, but its price as determined by supply and demand. To reach this position, they turned their backs on Adam Smith.

Then, in 1926, Piero Sraffa showed that the Neo-Classicals had been calculating capital and profit in terms of each other. For the next fifty years, the brightest and the best of them tried to rescue their premises. Failure led them to pretend that the circularity in their algebra was merely “technical”.
(The above will surprise most economics graduates since the history of their discipline is eschewed as subversive in many Australian universities.)

Meanwhile, accountants had no “technical” bolt hole. Their scholarly literature was blotted with worries about which number to inscribe against capital goods. Should they be entered at their historic cost? Or at the cost of replacement? The oldest swindle for adding value was to switch between these two criteria for pricing stock and plant.

Because McBankers claim to “add” value, their accountants need some measure to quantify the performance bonuses. In the old days, one basis would have been an increase in the price of a share in some toll road; the alternative might have been the growth in the capitalised value of that business.

But the value-adders at McBank are no longer bound to either the past or the present. Values at McBank are neither “historic” nor “replacement”, but “futurist”. Executives who can not put a number on their current debt know with certainty what the earnings from that leverage will be several years hence.

In promising bonuses for all, the McBankers have learnt from the mistakes of the dot.com boomers whose share prices went stratospheric without ever turning a cent of profit. Today’s value-adders operate a new law of value: dividends first, profits later.

20 July 2007

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