Finance raised to the power of infinity

The below article is an excerpt from one of the newsletters I send to my subscribers every Sunday. You can subscribe and read the rest of these newsletters in the archive section here - reallyonlyharmessaboutnothing.

This week I write on finance and economy. And before you choose to skip over this email in case finance and economics bores you, does not interest you, or maybe you find it daunting - I have a few words of caution. No matter what you do, what choice you make (or choose to not make), everything has / will have either an economic reason behind it or an economic impact due to it. We are a nation where financial literacy is remarkable low, even in the age-bracket of 20s-40s that's the youngest, most aware workforce and quite well-versed with technology and the times we live in, where less than 2% of the population invests in mutual funds and the stock market. And if you think finance does not impact you, chances are that you are acutely unaware of how much it actually does, and how much you might be held back in your life because of not being cognizant of this.

Economics and finance sound complex and boring, I admit, and it's made so by design. People in these disciplines count on you to think so and leave it to the 'experts'. But if you ask me, the kind of level that finance and economics has reached, over the last thousand years of commerce and trade, is NOTHING short of art and a testament to how imaginative humans can be. I'll show you how. Think of the most liquid asset (something that can be exchanged for money) in the history of the world - Gold.

The year is 800 AD. You have a sack-full of money (high chances are it may be in the form of gold itself, but let's neglect that possibility for now). Your friend comes along and tells you that there's this shiny metal which humans are obsessed with since centuries. You should buy it with your sack of money. You go to the king's treasury and buy it. You are a happy chap now. Few years down the line, your crops fail, but this shiny metal is still there with you, and you exchange it for a sack of money - probably a slightly larger sack than what you gave for it.

Some enterprising fellow saw this, and thought it's a nice way of making a few bucks - buy gold and sell later for a higher price. He becomes the world's first gold trader. But he's an ambitious guy and thinks that he has limited resources, so ONLY limited ways to make money. So he gets five other ambitious guys together, get them to pool their money and sign a piece of paper - making the world's first six shares and the first company. 

One year down the line, they became more ambitious, and gave an advertisement in the local newspaper, attracting more people to their "company", and make even more profits. This became the world's first IPO (initial public offering). After their IPO, a fellow came to them and said "I want money for my gold, but don't want to sell it to you." Now our guys are ambitious, they said, "Fine, I will give you the money, and keep the gold with me until you repay me. I will charge you a little bit more for this favour. Let's write this on a piece of paper." This piece of paper became the world's first loan.  

Cut to 2020. Our guys are long dead, but their generations down today are even more ambitious. They say, if you want to invest in this remarkable story of this shiny metal called gold, you no longer need to buy it, you can just buy give me money and I will promise to give you a little but more in 5 years, only if you don't ask for your money back or it's worth in gold during this time. Voila - we have gold bonds. Some guys got creative, and said, "we want to bet our money on this shiny metal, but don't want to own it, let's put our money in those guys who own it." Boom - you have gold-trading companies like Mannapuram and Muthoot. 

Some guys even got more creative, and said, "Sure, let's bet my money on gold companies, but I don't want to put all this money on one company, what if it goes bust!" There, you have gold ETFs (exchange traded funds) - investing not in a single company like a Mannapuram or Muthoot, but a little bit in all these companies at once. Some guys were quite fond of gambling, and said "I'll bet you 2:1 odds that gold's price one month down the line would be INR 500 more than what it's today." Hello, gold futures and options.  

Still with me? Is the above story not something that's extremely creative and ingenious? The next time when you read some complex economic jargon, think of this story. Chances are that just like we reached from buying solid gold in AD 800 to gold ETFs in 2020, there's a remarkable story of simple ideas behind something that sounds complex.

Now that you have had gone into two thousand years' worth of history of economics and finance in less than a thousand words, let me bring you to two recent brilliant stories I recently read and which led me to dedicate this newsletter to this subject - of how finance had reached a new pinnacle of creativity and innovation. One that may just save the world, and the other that may harm it in ways we might not be able to imagine.

Vaccine Bonds: I told you humans are imaginative right? Governments around the world have been pumping billions of money into vaccine research. But turns out that this COVID-19 is just one of the virus strains amongst the thousands yet to be identified which humans can be susceptible to and may be equally or even more dangerous. This requires years of future research and development, which demand serious economic resources and financial investment being directed towards these efforts. Hola!, vaccine bonds. Read this article from the New Yorker magazine (long read) on how these efforts require sovereign governments and private organisations to come together to literally save the world. And remember, here again the concept is quite simple - invest in a dozen companies researching on vaccines. Even if only one succeeds - the world is saved and you would still make a decent profit. 

 I had previously also written here on how coming up with a vaccine is one thing, distributing and marketing it is another unimaginable complex animal. 

Special Purpose Acquisition Companies: or SPACs as they are popularly known, are companies with no commercial operations that is formed strictly to raise capital through an IPO for the purpose of acquiring an existing company. In simple terms SPACs are generally formed by investors, or sponsors, with expertise in a particular industry or business sector, with the intention of pursuing deals in that area. In creating a SPAC, the founders sometimes have at least one acquisition target in mind, but they don't identify that target to avoid extensive disclosures during the IPO process. (This is why they are called "blank check companies." IPO investors have no idea what company they ultimately will be investing in.) 

2020 is the year of SPACs in the finance world. In the USA, 51 SPACs have raised funds though IPOs worth USD 25 billion. They hold immense potential as a golden parachute for startups and companies which cannot go the IPO route - which was an idea built to suit traditional companies which are required to show profitability, turnover etc. for a certain time period to be considered as safe to be presented on the open market. Startups, especially the disruptive kind or those involved in complex supply chain integrations and highly technological fields do not meet such criteria, and SPACs serve as a way for them to raise money.

While the idea is pretty neat, at the same time its extremely risky. IPOs in SPACs are akin to giving a "blank cheque" to these SPAC's managers. And while private equity and venture capital investors usually do the same thing using money from banks, other funds and institutional investors, SPAC's managers would do this with this and ordinary public's money obtained from an IPO. That's why the idea isn't exactly HARMLESS. Given the size of these SPAC IPOs and the attention they are getting, it's not far that you may start hearing these words in India in the coming year as well. Read this Forbes piece, and another article from the Verge, explaining SPACs - enough to make you sound as smart as any "expert" on CNBC. 

And before I bid adieu, remember I told you finance is extremely imaginative? While you never knew what SPACs were, some ambitious lads went out and launched a SPAC ETF last month - for passive investors who think a single SPAC is too risky and would rather put their bets on a whole bunch of them. 

Full marks for creativity. +5 for being cheeky. 

If you are getting scared by how dangerous all this financial creativity might be for the world, one sensible guy would agree with you. He once wrote a paper on how financial development made the world riskier, way back in 2005 when he was a university professor, which no one cared ABOUT until the world economy actually crashed in 2008. People then thought that this guy is smart, and later we made him the governor of India's central bank - Mr. Raghuram Rajan.