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This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrag

This is an excellent resource and a great read, but DAMN do money markets seem stupid as all get out to me. Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer?

novosel 3y ago
Great questions, but no reply will be coming at you. Except an apologetic nonsense-logic-it-is-obvious-it-works trope. Only product is the profit.
- scubbo 3y ago
  Quite. The general response I get from questions like this to financial folks is that these markets and vehicles and products are important "for liquidity", but they can never quite tell me who liquidity benefits other than the system itself.
  - NoboruWataya 3y ago
    It benefits people who need to raise cash, because they can do it more quickly and generally with lower financing costs than in an illiquid market. It benefits people who have cash that they want to invest, because they have more opportunities to do it and more visibility over which investments are safe and which ones are risky. Therefore it benefits society by transferring cash from people who have it now but need it later, to people who will have it later but need it now. Enabling and facilitating actual socially good activity, like manufacturing goods, providing services, etc. So there are definitely benefits to people outside the finance industry. However, in order to accept any of that you do ultimately need to believe, to some extent, in the market as a means of allocating resources. You don't need to think it's perfect, or that it shouldn't be regulated, or even that it is the fairest system, but you need to accept that it is the system we use. In a totally state-planned economy, finance wouldn't work or even make sense.
    - scubbo 3y ago
      Interesting - I'll definitely have to think on that one, thank you! I suppose another required assumption (implied but not explicitly stated) is that the activities undertaken by "people who need to raise cash" are, on balance, good things for actual people. Despite the fact that we overwhelmingly hear about the negative examples, I guess this is _probably_ true? Ugh, I suppose so. I wonder if there's a way to derive those same benefits (people doing useful work have access to funds) without the exploitable loopholes (sufficiently clever and evil people can shuffle numbers around and fabricate wealth without _actually_ affecting loan-availability)? I suspect that's probably a provable invariant - you can't have one without the other. Shame.
  - quickthrowman 3y ago
    If you own equities (individual stocks, ETFs, mutual funds) then you benefit. More liquidity means lower bid/ask spreads which means lower transaction costs and higher returns (since you are paying lower transaction costs, more of your money is invested and it adds up over time) for every investor. The NYSE minimum tick size used to be 12.5 cents, then 6.25 cents. Once HFT firms started becoming more widespread, the spread lowered significantly. SPY bid/ask spreads are 1 cent on a share that costs ~$450. Some assets even have sub-penny bid/ask spreads. The traders that create units of SPY get better spreads on the underlying stocks too, which benefits you as well by reducing asset fees and more accurately representing the NAV by lowering transaction costs. The S&P 500 is made up of 500 stocks, it is much more cost effective to assemble a basket of stocks with 1 cent spreads than 6.25 or 12.5 cent spreads. Liquidity does the same thing for every market, it increases the speed and accuracy of price discovery and lowers transaction costs.
    - scubbo 3y ago
      > If you own equities (individual stocks, ETFs, mutual funds) then you benefit. Right, yes - I as a relatively-wealthy individual certainly benefit from an effective market. But does _society_ benefit from the existence of a stock market in the first place? Does the increase in wealth for those at the top outweigh the comparative-loss (stagnation relative to inflation) to those who can't afford to buy-in? I find it hard to morally support a system whose justification boils down to "it redistributes wealth to the wealthier without providing any net-increase in quality of life".
rcme 3y ago
Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?
- tech_ken 3y ago
  Sure I’m pro-risk management. So by arbing lending-rates which risks are mitigated?
  - tylerhou 3y ago
    E.g. interest rate risk. Maybe I've sold a bunch of variable-rate bonds before. But now I am worried about interest rates rising. I can't call the bond for some reason (maybe not enough money, maybe some regulatory reason). So I buy an interest rate swap that pays out if interest rates rise.
  - deleted 3y ago
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- ineptech 3y ago
  This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who simply want to bet on the corn harvest, and from the scale of the finance sector it seems like we are pouring a lot more of our resources and brainpower in to designing exotic new ways to bet on the corn harvest than we are on growing corn.
  - marcosdumay 3y ago
    > as it allows them to use profits from good seasons to hedge against bad seasons It allows corn farmers to grow wheat instead, because he is selling it right now and wheat is more profitable right now. The main reason why it doesn't go astray and make people hungry is because people that isn't involved in any way can go, study the factors that make wheat more profitable to corn, do their predictions of what will be the case at the point of delivery, and if they predict correctly that the price is wrong they can go and adjust it making a lot of money on the process.
lordnacho 3y ago
The arbitrage game keeps the prices consistent with each other. It serves to create liquidity so that participants can get their business done without either waiting too long or paying too much.
- criddell 3y ago
  Maybe this is a dumb question, but who are the participants? What is the business they need to get done? What are they waiting on?
  - pwatsonwailes 3y ago
    Not dumb at all. The participants are basically everyone in the market. Everyone buying and selling and speculating on the thing in question. What they might be waiting on - imagine you have a business wanting to invest in something - new equipment maybe, or opening a new office. That requires capital expenditure. You might not have the free capital to be able to do that. However, if you can improve your cash position, that might be something which becomes available sooner, allowing you to grow more rapidly. That requires that you're able to secure finance, which means you need someone to either buy something from you now, or to buy the promise of something for the future. In either case, you now have increased cash at bank, which lets you invest to generate returns (hopefully). This is deeply rooted in the idea that money you have now is worth more than money you may have in the future.
  - NoboruWataya 3y ago
    Ultimately, they are governments, businesses and individuals. All of these actors regularly face situations where they need (or want) to expend money now that they will have eventually but do not have now. The financial markets are primarily about making it as efficient as possible to do that. (There is arguably another side of the financial markets that is about helping people manage risk, though they are somewhat related.) Most of the financial wizardry you read about in the linked article is related to that aim. It's not always obvious, because a lot of it is higher-order stuff: transactions between financial market participants where payouts are linked to other transactions (or aggregations of transactions) between financial market participants, etc. It can be hard to see the link to the participants I mentioned above. But a lot of it is a means to understanding, and spreading, the risks associated with financing those participants. It is a lot easier to lend people money to finance their wants and needs if you can (a) differentiate between people who will pay you back and people you won't; and (b) share the risk of not being paid back with others.
pwatsonwailes 3y ago
Whilst arbitrage is certainly something which exists in the financial markets, the vast majority of what's done isn't arbitrage. Arbitrage assumes differing views on valuation of an asset today. So I can buy something from person A, which they believe to be worth value x, and sell it to person B, who believes it to be worth y, where y > x. That's arbitrage in its simplest form - the market has priced something incorrectly, and I can buy it from willing sellers, and sell it to willing buyers at different values at the same time. The vast majority of financial transactions aren't this - they're speculative. They bank on the idea that money now is worth more than money in the future, and the future value of an asset (using the definition of an asset that it's a sequence of cashflows) is both variable and uncertain. So therefore the promise of future money is inherently tied to the concept of risk. The majority of financial markets trading is based around this concept of risk, and the management of it. There's vastly more complexity under the hood, but that's roughly speaking, accurate.
- tech_ken 3y ago
  Gotcha gotcha, that makes sense, thanks for the clear explanation! So I can see how the arbitrage (thusly defined) has the risk mitigation benefits other people talk about, can the same be said about speculation?
  - TuringTest 3y ago
    No, that's purely destructive greed. Ancient civilizations invented the jubilee (loans should be repaid in 7 years) to prevent speculation on them. But unfortunately, preventing extreme concentration of wealth has fallen out of favour
  - ls612 3y ago
    Speculation is fundamental to price discovery. Think about it this way, actors in financial markets all have various beliefs about the future, and all of these beliefs are on a scale of accurate to inaccurate. Speculation allows these beliefs to be aggregated into a single market price (which btw implies no arbitrage) for various types of contingencies and risks, and the price will rapidly update to reflect updates to reality and thus updates to everyone’s beliefs.
lolpython 3y ago
Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1]. [0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219.pdf https://www.ers.usda.gov/webdocs/publications/99518/eib-219.... [1] https://emp.lbl.gov/publications/primer-electricity-futures-and-other https://emp.lbl.gov/publications/primer-electricity-futures-...
- panarchy 3y ago
  Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples? What percentage of futures trading is on farmers crops? What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death? How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
  - rawgabbit 3y ago
    The website gives the gold mine example. Farmers and gold miners often have to weigh taking on a loan to get them through next season. They want a fixed rate of return to determine if the loan is worthwhile.
  - dmbche 3y ago
    Not sure why this person is getting downvoted, these seems like fair questions. Edit: Now get why it is downvoted, but it's fair to note that farmers represent a small (10% from what I gather here) portion of futures, so I don't know how reprensentative they are.
    - pwatsonwailes 3y ago
      They don't have anything to do with hedging. Good questions, just off-topic, which isn't something HN tends to like.
  - koolba 3y ago
    It’s not just farmers. It’s useful for anything that involves future delivery of a good that could have a variable price or production. A mining company would sell gold futures under the expectation that they will mine a known quantity of gold. They trade the risk of price fluctuations to match against their known liabilities (e.g. labor or depreciation of equipment costs). Now replace “gold” with lithium (for electric car batteries) and you can create the greenwashed story that you want to hear.
esotericimpl 3y ago
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deleted 3y ago
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ulfw 3y ago
Same with the majority of tech companies. All you do is endless meetings, plannings, reviews and extremely little actual human brain is used for productive output.
mhh__ 3y ago
Meaningful prices for the rest of us
deleted 3y ago
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yieldcrv 3y ago
> How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer? Interesting observation given that your own wealth is managed this way. Whether its the simple bank deposit in a checking account, if you've ever chased an interest rate for a savings account, or had your earnings managed in a retirement account from your employer, or if you attempted to make money faster because a debt was coming due. Its all tied together and a product of this system. The goal is to keep money moving within the economy, as people also race to hoard it.
tel 3y ago
Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. Markets exist as a global network of interactions and persistent imbalances anywhere in the system can have massive consequences. Generally, these consequences rhyme with "two counterparties which don't interact with one another directly all that often suddenly discover grave disagreements in the desired price and quantity of something they'd like to trade". Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase. So, markets work pretty hard to make sure that information from one area of the global economy can flow to all of the rest of the system with relative efficiency. This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Much like telephone, each pair of neighbors wants to do a good job sharing information without loss and, also, over long distances minor errors add up. Arbitrage is the glue which prevents this from happening. Arbitrage says that any time anyone discovers some level of disconnection occurring, they can make money at very low risk by voting to shift markets to better align with one another. Arbitrageurs are getting paid to provide a service to the market and subsequently the entire world. Their actions ensure that information flows throughout the global financial system quickly and without relying on centralized planning. Without them, markets could become disconnected and wander out of agreement.
- tech_ken 3y ago
  >Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. >This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Hell yeah I'm not sure where I fall on accepting this way of thinking about things, but the line of poetics/skeuomorphics/analogy is very cool to me. >Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase. This is kind of my sticking point because on direction of that risk is like an actual hazard to my biology and the other is the consequence of allocating food by market. Not saying it's 'wrong' per se, but it does stand out that we're resolving market problems with like market^2
nazka 3y ago
Without them we wouldn’t have McNuggets. McDonald’s is known to have almost invented and streamlined cooking to industrial level. But McNuggets were made possible only through financial engineering: https://tackletrading.com/tackle-today-the-rise-of-chicken-mcnuggets/ https://tackletrading.com/tackle-today-the-rise-of-chicken-m... I just finished some McNuggets so it’s even more funny to me right now.
- tech_ken 3y ago
  > Without them we wouldn’t have McNuggets. youtube.com/watch?v=uG3uea-Hvy4
alphanullmeric 3y ago
Sounds like you worry too much about what other people do with their own time and money.
- scubbo 3y ago
  When it results in a concentration of wealth in the hands of people who can abuse it for political ends, or results in market crashes that cause knock-on impact to real humans - then yes, worrying about it is reasonable and justified.
  - alphanullmeric 3y ago
    Feel free to not trade in this market then. “Mom they won’t share” is also not a particularly convincing way to justify the right to other people’s money.
    - diordiderot 3y ago
      Why is it their money? Your're starting at the wrong point in time friend. You need mommy just as much. E.g. Chad Ungabunga sees alphanumeric living on fertile soil with an attractive woman so he's going to bonk him over the head with a club and take his stuff because he's bigger and stronger.
      - alphanullmeric 3y ago
        It’s their money if you follow the “force is only justified in response to force” principle. They didn’t obtain their money by force, so you can’t take it by force from them. I believe that principle should be enforced by the government, that’s the only thing I need mommy for. Given that you also believe in police, military and courts, on top of a bunch of other shit (like stopping consenting individuals from trading their own money), no I don’t need mommy “just as much”.
  - scubbo 3y ago
    Belittling people pointing out selfishness as merely being jealous is not the slam-dunk you believe it to be. And, as diordiderot points out, I'm not trying to _take_ anything from anyone, but rather pointing out that they way they accrue more wealth (and power, with which to continue to accrue more...) is dishonest, arises from inequity, and is a net-negative to society. > if you follow the “force is only justified in response to force” principle Ooh, ooh, do the Paradox of Intolerance next!
JackFr 3y ago
Not sure if you meant “money market” as it’s understood to be the market lending/borrowing for terms of less than a year, or if you were referring to fixed income markets in general. Either way it’s hardly a waste of time or money, and banks make money not from “arbitrage shell games” but by matching buyers with sellers. Some people have money to lend and sone people have enterprises they need to fund.
zzbn00 3y ago
One example which is applicable to majority of the working population: in the UK at least the fixed-rate mortgages are priced off the Swap rates as that is how banks hedge them.
mo_42 3y ago
> Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer? If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. So companies that bring value to society should be able to expand their business. At the same time, regular people can invest in such companies at somewhat fair prices without doing much analysis. Basically, because the profits above the market average have been taken by smarter investors already. But it’s still good to always be able to put money somewhere and receive avg. market returns.
- H8crilA 3y ago
  Yeah, exactly. There is absolutely no way you could have ETFs if the "quick games" were forbidden. Not only because it's the HFTs that essentially run the fund on a day to day basis (see Authorized Participant for details). One famous example with a completely extinguished price discovery is the Soviet Union. I think this is what killed it more than any internal or international political problems.
- HWR_14 3y ago
  > If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. This only true of companies that were underpriced. Overpriced companies, either because of hype (Pets.com), fraud (Enron) or other reasons (maybe Jim Cramer issued a buy) do not benefit from a fairer price.
  - mo_42 3y ago
    I guess this could go in both directions. There are also underpriced companies. I know that some people knew that something was wrong with Wirecard and they short sold the stock.
  - chii 3y ago
    >> companies can raise more capital. > This only true of companies that were underpriced. You mean over-priced? because if a company is underpriced, they cannot raise capital as easily, since each share they raise would be underpriced, and thus the existing shareholders actually _lose_ value. An overpriced company is one where raising capital (via equity offering) is worth doing. If a company was under-priced, it would actually make more sense to do buybacks instead.
bell-cot 3y ago
These days - figure that it is 1% "honest & productive uses", and 99% society-undermining casino.
jdaw1 3y ago
I’m the author. Thank you for saying it is an excellent read — that was no small amount of work. You ask “Where is the productive output of all these arbitrage shell games?”, which is a very fair question. The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them. E.g., you are not the optimal person to hold the risk that, through no fault of your own, your house burns down. That risk exists, and you are not the optimal holder of it. Hence insurance. A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk. Of course, with markets come some ‘unproductive’ stuff. Likewise, democracy is good, but that is not necessarily praising the optimality of all parts of campaign finance legislation. Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages (and seemingly the board disallows a link).
- nostrademons 3y ago
  Note also that in some cases you might be the optimal person to hold the risk that your house burns down, if, for example, your liquid net worth is 100x the replacement cost of your home. And that's illustrative of the value of markets: you can choose to transact in them, depending on your personal circumstances. The insurance market exists because for the vast majority of people, rebuilding their home is not feasible with their current net worth. But for a small number of people it might be, and for a small number of firms it's probably worth it to insure many thousands of people, and then you can even slice up the shares of those insurance firms and sell them on the stock market so that the risk of your house burning down gets socialized across all the other shareholders but at the same time you have a stake in the profits.
  - nullindividual 3y ago
    It’s not a choice to be part of the insurance market for the vast majority of American homeowners. What you describe is choice in name only.
nostrademons 3y ago
Prices and financial markets in general exist solely for information transmission. The central problem of economics is "How do you produce the things that your population needs, in the quantity and at the time they need them, as efficiently as possible?" This is why every centrally-planned economy eventually fails, and why we were stuck in the feudal middle ages for a millennia. Information (and incentives) about what to produce and how to produce it efficiently weren't getting to the population at large, which caught us in a local subsistence minima. Financial markets give all the players an incentive (in the form of profit) to transmit information (in the form of prices) from people who want goods to people who can supply them. This is also behind the theory of why certain forms of financial transactions are legal and others are illegal. Arbitrage = legal, because it converges prices in two separate markets in a way that gives producers in both those markets better information about true demand. Futures markets = legal, because they smooth out temporal fluctuations in demand so that producers only have to worry about producing, while also incentivizing the construction of just enough storage & buffering to hold that product. Pump & dump schemes = illegal, because they distort price information in the market in an unsustainable way and then leave later participants to bear the cost of this. Same with Ponzi schemes. Equities markets = legal, because they transmit information about the overall cost of capital within the economy to firms, which can then use it to decide the profitability or unprofitability of various investments.
- panarky 3y ago
  > solely for information transmission Certainly one function of financial markets and prices is to convey information, but that's not "solely" their purpose. They also provide a mechanism for resource allocation, risk management, wealth generation and collective action, among other things. Your point about centrally planned economies, while historically corroborated in cases like the Soviet Union, might be an overgeneralization. The effectiveness of an economic system depends on numerous factors, including its degree of flexibility, the effectiveness of its institutions, and its ability to adapt to changing circumstances. Not all centrally planned economies are doomed to failure; some have been quite successful, notably in East Asia where countries like China and Vietnam have managed a mixed economy with elements of central planning and market mechanisms. Many capitalist corporations are centrally planned economies larger than many nation states. While everything fails eventually, these centrally planned organizations can last multiple human generations, and can be more durable than many markets and market-oriented economies. The assertion about the feudal Middle Ages also needs some nuance. The Middle Ages, and the feudal system in particular, had complexities beyond simple information and incentive problems. Numerous sociopolitical factors were at play, including a rigid class structure, the influence of the Church, and the lack of certain technological innovations. Ascribing the issues of a historical period mainly to its economic structure oversimplifies the multitude of factors that influenced societal development. Moreover, while financial markets do help in transmitting information from consumers to producers, they are not infallible. They can, and often do, suffer from issues like information asymmetry, where one party in a transaction has more or better information than the other. This can lead to problems like adverse selection and moral hazard. Financial markets can also be subject to speculation, which can distort the "signal" provided by prices. The focus on profit as the sole incentive in the market might be somewhat limited. People's decisions to buy, sell, and produce are influenced by a host of factors beyond profit, including societal and environmental concerns, personal values, and ethical considerations. Financial systems, to be truly effective, need to take into account this wide range of motivations.
lend000 3y ago
The output (generally speaking, not specific to money markets) is better prices. There are large scale examples of economies in which prices were mismanaged either due to lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union). While providing market information signals via prices is certainly an abstract concept that most people will never appreciate, it is important regardless. For complex instruments in money markets, the main effects are bridging mis-priced treasuries on different time frames and hedging against various outcomes for pensions, banks, and dealers in physical commodities. Most of the complex stuff either serves one of those purposes or becomes a zero sum game that doesn't affect non-participants. It's important to judge each instrument by its purpose and mechanism rather than bunch everything as a way to make bankers richer (e.g. a future vs. a CDO).
- mhh__ 3y ago
  CDOs aren't particularly crazy until you start pricing them using completely fictitious numbers and reasoning (IMO at least).
- consilient 3y ago
  > lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union) Venezuela has never had Soviet-style central planning. It's a market economy with a public sector only slightly larger than the OECD average. Their current situation is largely the result of excess social spending: first at the expense of investment and diversification away from oil prices were high, then at the expense of currency stability when oil prices crashed.
  - lend000 3y ago
    While you're correct that high social spending that relied on high oil revenue was probably the primary cause of Venezuela's economic collapse, they had price controls on food starting back in 2003 and they began nationalizing major industries in addition to oil by 2008. From 2008, it was a full on centrally planned disaster.
BillyTheMage 3y ago
I'm with you, but I apply the same logic to all rent-seekers and shareholders. We'd be a lot better off if we didn't have parasites and bottomless pits embedded in the economy by design.
quickthrower2 3y ago
While there are casinos, think: A farmer wants to get a fixed price for next years crop and insure against a bad harvest. Thats why you need these things. Ok the farmer example is a trope apparently. Any business where you need to hedge financial risk. Lending too many mortgages to self employed people? Sell that risk / revenue stream on to someone else and buy something different to diversify.
plandis 3y ago
The thing that I’ve always found wild is that the money people make on markets seems to be so much higher than the money people who actually make goods/services. Why has the global economy put such a high benefit from investment bankers compared to, for example, family doctors?
- thelamest 3y ago
  For one, finance is a macro force multiplier; it can make or break entire other industries. There’s also a bit of selection (global top) and survivorship (plenty of less visible non-success stories) in the wild money stories you can see out there.
- chii 3y ago
  > family doctors they can only scale at most linearly, with the number of hours they work. A financier can scale multiplicatively, because the amount of the monies they deal with can increase without "extra work". The multiplicative nature means the more capital you have access to, the more money you get to make, which approaches exponential at some point. And in the end, the financier speculating on the markets can affect many more people than the doctor ever can in their life.
cvalka 3y ago
Others have provided excellent answers. There's one thing I'd like to add. In order for the financial markets to provide more utility, a financial transaction tax needs to be introduced. It will indirectly kill unproductive or counterproductive financial activity such as high frequency trading.
rocho 3y ago
Futures and options were born from commercial needs. Suppose you produce oranges. It'll take a few months for the harvest, and while costs are generally well understood and stable, at what price will you sell those oranges? What if by then the price of oranges tanks and you find out you're not turning a profit? This is where futures come in. The producer can sell a number of futures contract to lock in a future selling price, making cash flows much clearer and predictable. Conversely, there's the case of a factory that needs to buy oranges for its products. They have the opposite problem and would like to make costs more predictable. Then they'd buy futures to lock in a future buying price.
e-master 3y ago
Generally speaking you can group large financial institutions into two groups: sell side and buy side. I’m no expert, but afaik, these firms either SELL liquidity (e.g. investment banks, market makers etc.) or BUY liquidity (for example pension funds, certain hedge funds). Liquidity is the key here - that is (if any) the benefit they bring to society. I can buy/sell pretty much any financial product/risk with reasonable spreads because there’s always someone on the other side of the trade ready to be my counterparty. Not that I want to defend some of these institutions, though some are better than others, but it’s important to keep in mind that they do take on risk in order to provide us liquidity, and most of them specialize in managing the risk, some of them are even good at it. Their infrastructure and connectivity and the price they charge you to provide liquidity allows them to make profits, but they do lose money sometimes. Also, compared to 20 years ago, there’s fierce competition now in pretty much every aaset class - if you work in one of the buy/sell side firms, you’ll very often hear terms such as spread compression etc (except the Covid years of course - people just wanted to trade, nobody cared about the price of liquidity (e.g. spreads or sales credit etc.) they had to pay)
pavlov 3y ago
Sibling comments have provided good explanations of why modern economies need finance: risk management, capital allocation, enabling ventures, and so forth. At the same time, it’s worth asking the question of why the financial sector just keeps growing and whether that’s desirable. Shouldn’t improved efficiency with digital systems make this intermediation layer thinner, less labor-intensive, more competitive? Instead it seems to be capturing an ever larger share of the economy’s output to itself. In my opinion regulators should try deploying some blunt tools like transaction taxes and hard salary caps, and see if we’d be any worse off with a smaller and poorer financial sector.
refurb 3y ago
The value add is offering financial products that consumers want. Businesses and people need to loan or borrow money, offering a wide variety of products that suit different needs supports economic growth. A good example of this are all the foreign companies that decide to go public on the NASDAQ. They aren't doing it in their home country because of a weak (or non-existant) equities market, or burdensome regulation.

novosel 3y ago

Great questions, but no reply will be coming at you. Except an apologetic nonsense-logic-it-is-obvious-it-works trope. Only product is the profit.

scubbo 3y ago
Quite. The general response I get from questions like this to financial folks is that these markets and vehicles and products are important "for liquidity", but they can never quite tell me who liquidity benefits other than the system itself.
- NoboruWataya 3y ago
  It benefits people who need to raise cash, because they can do it more quickly and generally with lower financing costs than in an illiquid market. It benefits people who have cash that they want to invest, because they have more opportunities to do it and more visibility over which investments are safe and which ones are risky. Therefore it benefits society by transferring cash from people who have it now but need it later, to people who will have it later but need it now. Enabling and facilitating actual socially good activity, like manufacturing goods, providing services, etc. So there are definitely benefits to people outside the finance industry. However, in order to accept any of that you do ultimately need to believe, to some extent, in the market as a means of allocating resources. You don't need to think it's perfect, or that it shouldn't be regulated, or even that it is the fairest system, but you need to accept that it is the system we use. In a totally state-planned economy, finance wouldn't work or even make sense.
  - scubbo 3y ago
    Interesting - I'll definitely have to think on that one, thank you! I suppose another required assumption (implied but not explicitly stated) is that the activities undertaken by "people who need to raise cash" are, on balance, good things for actual people. Despite the fact that we overwhelmingly hear about the negative examples, I guess this is _probably_ true? Ugh, I suppose so. I wonder if there's a way to derive those same benefits (people doing useful work have access to funds) without the exploitable loopholes (sufficiently clever and evil people can shuffle numbers around and fabricate wealth without _actually_ affecting loan-availability)? I suspect that's probably a provable invariant - you can't have one without the other. Shame.
- quickthrowman 3y ago
  If you own equities (individual stocks, ETFs, mutual funds) then you benefit. More liquidity means lower bid/ask spreads which means lower transaction costs and higher returns (since you are paying lower transaction costs, more of your money is invested and it adds up over time) for every investor. The NYSE minimum tick size used to be 12.5 cents, then 6.25 cents. Once HFT firms started becoming more widespread, the spread lowered significantly. SPY bid/ask spreads are 1 cent on a share that costs ~$450. Some assets even have sub-penny bid/ask spreads. The traders that create units of SPY get better spreads on the underlying stocks too, which benefits you as well by reducing asset fees and more accurately representing the NAV by lowering transaction costs. The S&P 500 is made up of 500 stocks, it is much more cost effective to assemble a basket of stocks with 1 cent spreads than 6.25 or 12.5 cent spreads. Liquidity does the same thing for every market, it increases the speed and accuracy of price discovery and lowers transaction costs.
  - scubbo 3y ago
    > If you own equities (individual stocks, ETFs, mutual funds) then you benefit. Right, yes - I as a relatively-wealthy individual certainly benefit from an effective market. But does _society_ benefit from the existence of a stock market in the first place? Does the increase in wealth for those at the top outweigh the comparative-loss (stagnation relative to inflation) to those who can't afford to buy-in? I find it hard to morally support a system whose justification boils down to "it redistributes wealth to the wealthier without providing any net-increase in quality of life".

rcme 3y ago

Risk management is the product. Surely you agree that a product that reduces risk is worth something, right?

tech_ken 3y ago
Sure I’m pro-risk management. So by arbing lending-rates which risks are mitigated?
- tylerhou 3y ago
  E.g. interest rate risk. Maybe I've sold a bunch of variable-rate bonds before. But now I am worried about interest rates rising. I can't call the bond for some reason (maybe not enough money, maybe some regulatory reason). So I buy an interest rate swap that pays out if interest rates rise.
- deleted 3y ago
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ineptech 3y ago
This isn't false but it feels reductive. A financial instrument that allows one to bet on the corn harvest is obviously valuable to the corn farmer, as it allows them to use profits from good seasons to hedge against bad seasons. They're also valuable to people whose business is affected by the corn harvest - cereal manufacturers, say. The problem is that they can also be used by people with no exposure at all who simply want to bet on the corn harvest, and from the scale of the finance sector it seems like we are pouring a lot more of our resources and brainpower in to designing exotic new ways to bet on the corn harvest than we are on growing corn.
- marcosdumay 3y ago
  > as it allows them to use profits from good seasons to hedge against bad seasons It allows corn farmers to grow wheat instead, because he is selling it right now and wheat is more profitable right now. The main reason why it doesn't go astray and make people hungry is because people that isn't involved in any way can go, study the factors that make wheat more profitable to corn, do their predictions of what will be the case at the point of delivery, and if they predict correctly that the price is wrong they can go and adjust it making a lot of money on the process.

lordnacho 3y ago

The arbitrage game keeps the prices consistent with each other. It serves to create liquidity so that participants can get their business done without either waiting too long or paying too much.

criddell 3y ago
Maybe this is a dumb question, but who are the participants? What is the business they need to get done? What are they waiting on?
- pwatsonwailes 3y ago
  Not dumb at all. The participants are basically everyone in the market. Everyone buying and selling and speculating on the thing in question. What they might be waiting on - imagine you have a business wanting to invest in something - new equipment maybe, or opening a new office. That requires capital expenditure. You might not have the free capital to be able to do that. However, if you can improve your cash position, that might be something which becomes available sooner, allowing you to grow more rapidly. That requires that you're able to secure finance, which means you need someone to either buy something from you now, or to buy the promise of something for the future. In either case, you now have increased cash at bank, which lets you invest to generate returns (hopefully). This is deeply rooted in the idea that money you have now is worth more than money you may have in the future.
- NoboruWataya 3y ago
  Ultimately, they are governments, businesses and individuals. All of these actors regularly face situations where they need (or want) to expend money now that they will have eventually but do not have now. The financial markets are primarily about making it as efficient as possible to do that. (There is arguably another side of the financial markets that is about helping people manage risk, though they are somewhat related.) Most of the financial wizardry you read about in the linked article is related to that aim. It's not always obvious, because a lot of it is higher-order stuff: transactions between financial market participants where payouts are linked to other transactions (or aggregations of transactions) between financial market participants, etc. It can be hard to see the link to the participants I mentioned above. But a lot of it is a means to understanding, and spreading, the risks associated with financing those participants. It is a lot easier to lend people money to finance their wants and needs if you can (a) differentiate between people who will pay you back and people you won't; and (b) share the risk of not being paid back with others.

pwatsonwailes 3y ago

Whilst arbitrage is certainly something which exists in the financial markets, the vast majority of what's done isn't arbitrage. Arbitrage assumes differing views on valuation of an asset today. So I can buy something from person A, which they believe to be worth value x, and sell it to person B, who believes it to be worth y, where y > x. That's arbitrage in its simplest form - the market has priced something incorrectly, and I can buy it from willing sellers, and sell it to willing buyers at different values at the same time. The vast majority of financial transactions aren't this - they're speculative. They bank on the idea that money now is worth more than money in the future, and the future value of an asset (using the definition of an asset that it's a sequence of cashflows) is both variable and uncertain. So therefore the promise of future money is inherently tied to the concept of risk. The majority of financial markets trading is based around this concept of risk, and the management of it. There's vastly more complexity under the hood, but that's roughly speaking, accurate.

tech_ken 3y ago
Gotcha gotcha, that makes sense, thanks for the clear explanation! So I can see how the arbitrage (thusly defined) has the risk mitigation benefits other people talk about, can the same be said about speculation?
- TuringTest 3y ago
  No, that's purely destructive greed. Ancient civilizations invented the jubilee (loans should be repaid in 7 years) to prevent speculation on them. But unfortunately, preventing extreme concentration of wealth has fallen out of favour
- ls612 3y ago
  Speculation is fundamental to price discovery. Think about it this way, actors in financial markets all have various beliefs about the future, and all of these beliefs are on a scale of accurate to inaccurate. Speculation allows these beliefs to be aggregated into a single market price (which btw implies no arbitrage) for various types of contingencies and risks, and the price will rapidly update to reflect updates to reality and thus updates to everyone’s beliefs.

lolpython 3y ago

Farmers use futures contracts to protect against price risks [0]. As do energy suppliers [1]. [0] https://www.ers.usda.gov/webdocs/publications/99518/eib-219.pdf https://www.ers.usda.gov/webdocs/publications/99518/eib-219.... [1] https://emp.lbl.gov/publications/primer-electricity-futures-and-other https://emp.lbl.gov/publications/primer-electricity-futures-...

panarchy 3y ago
Why is it that every time someone mentions futures trading someone comes along to drop the farmer's crops example, do y'all really have no other examples? What percentage of futures trading is on farmers crops? What about the crops they destroy because they would be less profitable? Does the protection against monetary risk outweigh starving people to death? How well will it work if we create unsustainable land that the farmers can no longer grow crops on?
- rawgabbit 3y ago
  The website gives the gold mine example. Farmers and gold miners often have to weigh taking on a loan to get them through next season. They want a fixed rate of return to determine if the loan is worthwhile.
- dmbche 3y ago
  Not sure why this person is getting downvoted, these seems like fair questions. Edit: Now get why it is downvoted, but it's fair to note that farmers represent a small (10% from what I gather here) portion of futures, so I don't know how reprensentative they are.
  - pwatsonwailes 3y ago
    They don't have anything to do with hedging. Good questions, just off-topic, which isn't something HN tends to like.
- koolba 3y ago
  It’s not just farmers. It’s useful for anything that involves future delivery of a good that could have a variable price or production. A mining company would sell gold futures under the expectation that they will mine a known quantity of gold. They trade the risk of price fluctuations to match against their known liabilities (e.g. labor or depreciation of equipment costs). Now replace “gold” with lithium (for electric car batteries) and you can create the greenwashed story that you want to hear.

esotericimpl 3y ago

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deleted 3y ago

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ulfw 3y ago

Same with the majority of tech companies. All you do is endless meetings, plannings, reviews and extremely little actual human brain is used for productive output.

mhh__ 3y ago

Meaningful prices for the rest of us

deleted 3y ago

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yieldcrv 3y ago

> How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer? Interesting observation given that your own wealth is managed this way. Whether its the simple bank deposit in a checking account, if you've ever chased an interest rate for a savings account, or had your earnings managed in a retirement account from your employer, or if you attempted to make money faster because a debt was coming due. Its all tied together and a product of this system. The goal is to keep money moving within the economy, as people also race to hoard it.

tel 3y ago

Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. Markets exist as a global network of interactions and persistent imbalances anywhere in the system can have massive consequences. Generally, these consequences rhyme with "two counterparties which don't interact with one another directly all that often suddenly discover grave disagreements in the desired price and quantity of something they'd like to trade". Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase. So, markets work pretty hard to make sure that information from one area of the global economy can flow to all of the rest of the system with relative efficiency. This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Much like telephone, each pair of neighbors wants to do a good job sharing information without loss and, also, over long distances minor errors add up. Arbitrage is the glue which prevents this from happening. Arbitrage says that any time anyone discovers some level of disconnection occurring, they can make money at very low risk by voting to shift markets to better align with one another. Arbitrageurs are getting paid to provide a service to the market and subsequently the entire world. Their actions ensure that information flows throughout the global financial system quickly and without relying on centralized planning. Without them, markets could become disconnected and wander out of agreement.

tech_ken 3y ago
>Arbitrage and it's various squishier more stochastic cousins are the vehicle by which information flows through markets. >This works a lot like a game of telephone where changes in one market venue propagate through related instruments to other venues crossing space, species, and even time. Hell yeah I'm not sure where I fall on accepting this way of thinking about things, but the line of poetics/skeuomorphics/analogy is very cool to me. >Economic wreckage is the result, at least, but also imagine what would happen if corn farmers produced only half the crop that their buyers would have liked to purchase. This is kind of my sticking point because on direction of that risk is like an actual hazard to my biology and the other is the consequence of allocating food by market. Not saying it's 'wrong' per se, but it does stand out that we're resolving market problems with like market^2

nazka 3y ago

Without them we wouldn’t have McNuggets. McDonald’s is known to have almost invented and streamlined cooking to industrial level. But McNuggets were made possible only through financial engineering: https://tackletrading.com/tackle-today-the-rise-of-chicken-mcnuggets/ https://tackletrading.com/tackle-today-the-rise-of-chicken-m... I just finished some McNuggets so it’s even more funny to me right now.

tech_ken 3y ago
> Without them we wouldn’t have McNuggets. youtube.com/watch?v=uG3uea-Hvy4

alphanullmeric 3y ago

Sounds like you worry too much about what other people do with their own time and money.

scubbo 3y ago
When it results in a concentration of wealth in the hands of people who can abuse it for political ends, or results in market crashes that cause knock-on impact to real humans - then yes, worrying about it is reasonable and justified.
- alphanullmeric 3y ago
  Feel free to not trade in this market then. “Mom they won’t share” is also not a particularly convincing way to justify the right to other people’s money.
  - diordiderot 3y ago
    Why is it their money? Your're starting at the wrong point in time friend. You need mommy just as much. E.g. Chad Ungabunga sees alphanumeric living on fertile soil with an attractive woman so he's going to bonk him over the head with a club and take his stuff because he's bigger and stronger.
    - alphanullmeric 3y ago
      It’s their money if you follow the “force is only justified in response to force” principle. They didn’t obtain their money by force, so you can’t take it by force from them. I believe that principle should be enforced by the government, that’s the only thing I need mommy for. Given that you also believe in police, military and courts, on top of a bunch of other shit (like stopping consenting individuals from trading their own money), no I don’t need mommy “just as much”.
- scubbo 3y ago
  Belittling people pointing out selfishness as merely being jealous is not the slam-dunk you believe it to be. And, as diordiderot points out, I'm not trying to _take_ anything from anyone, but rather pointing out that they way they accrue more wealth (and power, with which to continue to accrue more...) is dishonest, arises from inequity, and is a net-negative to society. > if you follow the “force is only justified in response to force” principle Ooh, ooh, do the Paradox of Intolerance next!

JackFr 3y ago

Not sure if you meant “money market” as it’s understood to be the market lending/borrowing for terms of less than a year, or if you were referring to fixed income markets in general. Either way it’s hardly a waste of time or money, and banks make money not from “arbitrage shell games” but by matching buyers with sellers. Some people have money to lend and sone people have enterprises they need to fund.

zzbn00 3y ago

One example which is applicable to majority of the working population: in the UK at least the fixed-rate mortgages are priced off the Swap rates as that is how banks hedge them.

mo_42 3y ago

> Where is the productive output of all these arbitrage shell games? How is this more than an abysmal waste of time and resources simply to make a small handful of bankers richer? If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. So companies that bring value to society should be able to expand their business. At the same time, regular people can invest in such companies at somewhat fair prices without doing much analysis. Basically, because the profits above the market average have been taken by smarter investors already. But it’s still good to always be able to put money somewhere and receive avg. market returns.

H8crilA 3y ago
Yeah, exactly. There is absolutely no way you could have ETFs if the "quick games" were forbidden. Not only because it's the HFTs that essentially run the fund on a day to day basis (see Authorized Participant for details). One famous example with a completely extinguished price discovery is the Soviet Union. I think this is what killed it more than any internal or international political problems.
HWR_14 3y ago
> If shares of companies are valued at fair prices it means that the finance departments for that companies can raise more capital. This only true of companies that were underpriced. Overpriced companies, either because of hype (Pets.com), fraud (Enron) or other reasons (maybe Jim Cramer issued a buy) do not benefit from a fairer price.
- mo_42 3y ago
  I guess this could go in both directions. There are also underpriced companies. I know that some people knew that something was wrong with Wirecard and they short sold the stock.
- chii 3y ago
  >> companies can raise more capital. > This only true of companies that were underpriced. You mean over-priced? because if a company is underpriced, they cannot raise capital as easily, since each share they raise would be underpriced, and thus the existing shareholders actually _lose_ value. An overpriced company is one where raising capital (via equity offering) is worth doing. If a company was under-priced, it would actually make more sense to do buybacks instead.

bell-cot 3y ago

These days - figure that it is 1% "honest & productive uses", and 99% society-undermining casino.

jdaw1 3y ago

I’m the author. Thank you for saying it is an excellent read — that was no small amount of work. You ask “Where is the productive output of all these arbitrage shell games?”, which is a very fair question. The purpose of financial markets, sometimes but not always wholly achieved, is to transfer risks to those best able to hold them. E.g., you are not the optimal person to hold the risk that, through no fault of your own, your house burns down. That risk exists, and you are not the optimal holder of it. Hence insurance. A Lincolnshire farmer — and yes, I like the non-abstract solidly of the example — is not the optimal holder of the ‘risk’ that the Australian and Kansas wheat harvests are super-bountiful. Markets allow that risk to be transferred to a non-farmer better able to hold the risk. Of course, with markets come some ‘unproductive’ stuff. Likewise, democracy is good, but that is not necessarily praising the optimality of all parts of campaign finance legislation. Let me also mention that I am the author of the definitive reference book on old Vintage Port: Port Vintages (and seemingly the board disallows a link).

nostrademons 3y ago
Note also that in some cases you might be the optimal person to hold the risk that your house burns down, if, for example, your liquid net worth is 100x the replacement cost of your home. And that's illustrative of the value of markets: you can choose to transact in them, depending on your personal circumstances. The insurance market exists because for the vast majority of people, rebuilding their home is not feasible with their current net worth. But for a small number of people it might be, and for a small number of firms it's probably worth it to insure many thousands of people, and then you can even slice up the shares of those insurance firms and sell them on the stock market so that the risk of your house burning down gets socialized across all the other shareholders but at the same time you have a stake in the profits.
- nullindividual 3y ago
  It’s not a choice to be part of the insurance market for the vast majority of American homeowners. What you describe is choice in name only.

nostrademons 3y ago

Prices and financial markets in general exist solely for information transmission. The central problem of economics is "How do you produce the things that your population needs, in the quantity and at the time they need them, as efficiently as possible?" This is why every centrally-planned economy eventually fails, and why we were stuck in the feudal middle ages for a millennia. Information (and incentives) about what to produce and how to produce it efficiently weren't getting to the population at large, which caught us in a local subsistence minima. Financial markets give all the players an incentive (in the form of profit) to transmit information (in the form of prices) from people who want goods to people who can supply them. This is also behind the theory of why certain forms of financial transactions are legal and others are illegal. Arbitrage = legal, because it converges prices in two separate markets in a way that gives producers in both those markets better information about true demand. Futures markets = legal, because they smooth out temporal fluctuations in demand so that producers only have to worry about producing, while also incentivizing the construction of just enough storage & buffering to hold that product. Pump & dump schemes = illegal, because they distort price information in the market in an unsustainable way and then leave later participants to bear the cost of this. Same with Ponzi schemes. Equities markets = legal, because they transmit information about the overall cost of capital within the economy to firms, which can then use it to decide the profitability or unprofitability of various investments.

panarky 3y ago
> solely for information transmission Certainly one function of financial markets and prices is to convey information, but that's not "solely" their purpose. They also provide a mechanism for resource allocation, risk management, wealth generation and collective action, among other things. Your point about centrally planned economies, while historically corroborated in cases like the Soviet Union, might be an overgeneralization. The effectiveness of an economic system depends on numerous factors, including its degree of flexibility, the effectiveness of its institutions, and its ability to adapt to changing circumstances. Not all centrally planned economies are doomed to failure; some have been quite successful, notably in East Asia where countries like China and Vietnam have managed a mixed economy with elements of central planning and market mechanisms. Many capitalist corporations are centrally planned economies larger than many nation states. While everything fails eventually, these centrally planned organizations can last multiple human generations, and can be more durable than many markets and market-oriented economies. The assertion about the feudal Middle Ages also needs some nuance. The Middle Ages, and the feudal system in particular, had complexities beyond simple information and incentive problems. Numerous sociopolitical factors were at play, including a rigid class structure, the influence of the Church, and the lack of certain technological innovations. Ascribing the issues of a historical period mainly to its economic structure oversimplifies the multitude of factors that influenced societal development. Moreover, while financial markets do help in transmitting information from consumers to producers, they are not infallible. They can, and often do, suffer from issues like information asymmetry, where one party in a transaction has more or better information than the other. This can lead to problems like adverse selection and moral hazard. Financial markets can also be subject to speculation, which can distort the "signal" provided by prices. The focus on profit as the sole incentive in the market might be somewhat limited. People's decisions to buy, sell, and produce are influenced by a host of factors beyond profit, including societal and environmental concerns, personal values, and ethical considerations. Financial systems, to be truly effective, need to take into account this wide range of motivations.

lend000 3y ago

The output (generally speaking, not specific to money markets) is better prices. There are large scale examples of economies in which prices were mismanaged either due to lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union). While providing market information signals via prices is certainly an abstract concept that most people will never appreciate, it is important regardless. For complex instruments in money markets, the main effects are bridging mis-priced treasuries on different time frames and hedging against various outcomes for pensions, banks, and dealers in physical commodities. Most of the complex stuff either serves one of those purposes or becomes a zero sum game that doesn't affect non-participants. It's important to judge each instrument by its purpose and mechanism rather than bunch everything as a way to make bankers richer (e.g. a future vs. a CDO).

mhh__ 3y ago
CDOs aren't particularly crazy until you start pricing them using completely fictitious numbers and reasoning (IMO at least).
consilient 3y ago
> lack of information/technology or centrally planned prices, some of which resulted in failed states (e.g. Venezuela and the Soviet Union) Venezuela has never had Soviet-style central planning. It's a market economy with a public sector only slightly larger than the OECD average. Their current situation is largely the result of excess social spending: first at the expense of investment and diversification away from oil prices were high, then at the expense of currency stability when oil prices crashed.
- lend000 3y ago
  While you're correct that high social spending that relied on high oil revenue was probably the primary cause of Venezuela's economic collapse, they had price controls on food starting back in 2003 and they began nationalizing major industries in addition to oil by 2008. From 2008, it was a full on centrally planned disaster.

BillyTheMage 3y ago

I'm with you, but I apply the same logic to all rent-seekers and shareholders. We'd be a lot better off if we didn't have parasites and bottomless pits embedded in the economy by design.

quickthrower2 3y ago

While there are casinos, think: A farmer wants to get a fixed price for next years crop and insure against a bad harvest. Thats why you need these things. Ok the farmer example is a trope apparently. Any business where you need to hedge financial risk. Lending too many mortgages to self employed people? Sell that risk / revenue stream on to someone else and buy something different to diversify.

plandis 3y ago

The thing that I’ve always found wild is that the money people make on markets seems to be so much higher than the money people who actually make goods/services. Why has the global economy put such a high benefit from investment bankers compared to, for example, family doctors?

thelamest 3y ago
For one, finance is a macro force multiplier; it can make or break entire other industries. There’s also a bit of selection (global top) and survivorship (plenty of less visible non-success stories) in the wild money stories you can see out there.
chii 3y ago
> family doctors they can only scale at most linearly, with the number of hours they work. A financier can scale multiplicatively, because the amount of the monies they deal with can increase without "extra work". The multiplicative nature means the more capital you have access to, the more money you get to make, which approaches exponential at some point. And in the end, the financier speculating on the markets can affect many more people than the doctor ever can in their life.

cvalka 3y ago

Others have provided excellent answers. There's one thing I'd like to add. In order for the financial markets to provide more utility, a financial transaction tax needs to be introduced. It will indirectly kill unproductive or counterproductive financial activity such as high frequency trading.

rocho 3y ago

Futures and options were born from commercial needs. Suppose you produce oranges. It'll take a few months for the harvest, and while costs are generally well understood and stable, at what price will you sell those oranges? What if by then the price of oranges tanks and you find out you're not turning a profit? This is where futures come in. The producer can sell a number of futures contract to lock in a future selling price, making cash flows much clearer and predictable. Conversely, there's the case of a factory that needs to buy oranges for its products. They have the opposite problem and would like to make costs more predictable. Then they'd buy futures to lock in a future buying price.

e-master 3y ago

Generally speaking you can group large financial institutions into two groups: sell side and buy side. I’m no expert, but afaik, these firms either SELL liquidity (e.g. investment banks, market makers etc.) or BUY liquidity (for example pension funds, certain hedge funds). Liquidity is the key here - that is (if any) the benefit they bring to society. I can buy/sell pretty much any financial product/risk with reasonable spreads because there’s always someone on the other side of the trade ready to be my counterparty. Not that I want to defend some of these institutions, though some are better than others, but it’s important to keep in mind that they do take on risk in order to provide us liquidity, and most of them specialize in managing the risk, some of them are even good at it. Their infrastructure and connectivity and the price they charge you to provide liquidity allows them to make profits, but they do lose money sometimes. Also, compared to 20 years ago, there’s fierce competition now in pretty much every aaset class - if you work in one of the buy/sell side firms, you’ll very often hear terms such as spread compression etc (except the Covid years of course - people just wanted to trade, nobody cared about the price of liquidity (e.g. spreads or sales credit etc.) they had to pay)

pavlov 3y ago

Sibling comments have provided good explanations of why modern economies need finance: risk management, capital allocation, enabling ventures, and so forth. At the same time, it’s worth asking the question of why the financial sector just keeps growing and whether that’s desirable. Shouldn’t improved efficiency with digital systems make this intermediation layer thinner, less labor-intensive, more competitive? Instead it seems to be capturing an ever larger share of the economy’s output to itself. In my opinion regulators should try deploying some blunt tools like transaction taxes and hard salary caps, and see if we’d be any worse off with a smaller and poorer financial sector.

refurb 3y ago

The value add is offering financial products that consumers want. Businesses and people need to loan or borrow money, offering a wide variety of products that suit different needs supports economic growth. A good example of this are all the foreign companies that decide to go public on the NASDAQ. They aren't doing it in their home country because of a weak (or non-existant) equities market, or burdensome regulation.