Someone said always start a presentation with a little humor so I will attempt to summarize the last two centuries of European History as gently as possible:
"Heaven is when the Germans are the engineers, the British are the police, the French as the cooks and the Italians are the lovers.
Hell is when the Germans are the police, the English the cooks, the Italians the engineers, and the Swiss are the lovers."
The last couple of months have been a season of vindication for the "unpopular" opinions of Austrian Economics, individual liberty and free markets. Etatism and its failed doctrines have been paraded in all their human misery for the world to see. The disastrous policies of the Bush Administration, their "Conservative Republicans" (fascists) sycophants have finally been revealed for what they are. The complicit Federal Reserve Band, Alan (I should have known better) Greenspan, and the evils twins of fractional reserve banking and a fiat currency have sent world markets into inverted, flat, spin.
Spin-doctors and talking heads have been wagging their chins 24x7 trumpeting lies, folly, misunderstanding, bile, hate, and downright idiocy about the current predicament. Everyone has been blamed but the culprit: the United States Government and their Imperial President (buck stopping here for sure). As readers of LRC, Mises Institute, and Antiwar.com you already knew all this.
Bad housing loans, easy credit, derivatives, speculation, and human greed have all been blamed, but the truth is this mess is precisely because the market does work. The hot air had blown the balloon too big and it popped. Austrian Economics says what will happen (pop) not when (election 2008); it is after all, a qualitative theory. The illusion was the insane valuations the fact is the wealth never existed. (The old don’t count your winnings while you are sitting at the table thing.) The big pop was the inevitable restoration of sanity and responsibility. The truth is that the Federal Government is a deadbeat and should have a credit rating under 100. What is a surprise is that so many other countries bought into this folly and are now suffering the hangover of the big party as well.
Human Action being both inexorable and inevitable the market restoration is now in process. Lots of my mates have always thought I’m a little off kilter, but no matter, let’s look at some proof of the process at work. Along the way we will see the beauty of quantitative finance, the shrewdness and power of the solvent in time of a liquidity crunch, and how the market operates efficiently on a grand scale and how hubris always invites the reckoning of Nemesis. German engineering will be revealed in banking, derivatives, hedge funds, and corporate organization.
Last weekend brought fall color, the latest inane observation of the irrelevance of Sarah Palin, and an astute and bold move by Porsche to become the largest automobile manufacturer in the world. Porsche, using old-fashioned virtues of thrift by saving its money, knowledge by not compensating failure, and patience by biding its time rocked both the banking world and automotive. The European bankers were caught asleep at the wheel, pants around the ankles, and beaten like a government mule at their own game: quantitative finance, regulatory legerdemain, and cash reserves: a real thing of beauty.
Porsche is a manufacturer of fine automobiles, the epitome of German engineering acumen. They have always been a peripheral player on the world scale. Volkswagen manufactures for the benighted masses, the Chevy of Europe. Porsche has held a 34% share in VW for some time. They also have a lot of cash (German financial engineering) and over the weekend they quietly bought up large amounts of derivatives that when paid deliver VW shares at the end result of the transaction. Hedge funds: perennial media scapegoats, speculators, and market predators (necessary) have been running wild in this bear of bear markets (revaluation and write down) selling everything short. Derivatives are as pure capitalism as you can get in the modern world, the market is always open and you can buy so many ways as to go mad with the combinatorics and valuations.
Porsche on the other was not speculating, they were out hunting for a major score, a kill, not shaving fractions of a point in a quick transaction on an instantaneous perceived change in market momentum. They were buying while the hedges were selling VW short.
Dawn on Monday the Oct 27, 2008 saw the market surge with a price rally in VW stock. The Hedge Funds involved began to panic as they realized that they were moving in the wrong direction on a massive shift in VW valuation. By market close Porsche owned 74% of VW by boldly risking cash certain in the knowledge of their analysis of the situation. They moved on the weekend when the derivative markets are open (always like Denny’s) but redolent as the players are often living life in the fast lane, inattentive.
Tuesday morning (28Oct2008) and the hedges involved are selling other assets off to cover their positions. It is margin call time and when the bell rings you are out of the game for good unless you answer it unambiguously with cold hard cash or cash equivalents, payment in full. Some will fail, some will survive, many will be shattered. Billionaires became millionaires, millionaires became ordinary people, and in the Porsche organization new legends have been born. All because some engineers understood quantitative finance (applied differential equations), market timing, and valuation better than all the bankers, lawyers, regulators, and financial sycophants in a time of rapid change.
The Porsche team involved in this exploited a regulation they had no part in creating: that German regulations required disclosure of major stock purchases in publicly traded companies regardless if they were direct share purchase, through an intermediary, or derivatives when financed with credit. No disclosure is required when share acquisition is via derivatives when paid in cash. Classic regulatory legerdemain that benefits the regulated, after all who would want to buy derivatives with cash? Nemesis punishes the wicked for their arrogance and hubris.
As a libertarian, an Austrian devotee, and a connoisseur of edge work the Porsche move takes my breath away in its audacity, its timing and perfect execution. The market worked and it worked perfectly taking cash from the inattentive and arrogant and handing it to those with a better understanding of reality at this moment in time just what it is supposed to do!
Stockholders of Porsche and Volkswagen have certainly taken grateful notice of how the market works efficiently and impartially. The rest of a grateful world should too as Germans are engineering in this world and not trying to police it.
P.S. If you think that the Navier-Stokes equation is sexy, and nothing is more of a turn on than the plotted display of time evolution solution surface. If you can see the meaning in a system differential equations than Paul Wilmott may have a job for you. The market is always looking for a few good quants.
November 3, 2008
George Giles [send him mail] is an Independent writer in Nashville, TN.
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