Capital allocation

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The more things change, the more they stay the same.

In his remarkable Debt: The First 5,000 Years David Graeber argues that, contrary to popular wisdom, money — capital — did not evolve out of a system of barter. It is a just-so story for which there is no anthropological evidence at all. money is more likely to have always represented indebtedness. A means of raising capital against assets without letting go of the assets.

When considering whether this time is different, it is well to look beyond substance and form to see whether the age old business of capital allocation is really changing. Financial services is, substantially, a very basic thing. That basic thing happens to be intrinsically very risky. All of the colossal complication that we know, love, and we rent-seeking agents secrete ourselves into the loving satin folds of, arises by way of mitigation of that fundamental risk. If you give existing pure value — abstract, disembodied worth, most commonly articulated in the form of money — to someone else in the hope they will generate more pure value, and thereby return some extra pure value to you, if things go wrong, you might not get your money back.

Call this the one law of finance:

If you stand to make money, you stand to lose money.

If a new invention comes along which falsifies this basic principle then things really are different.

The JC’s proposition is that an invention that did this would contravene the known laws of physics — real physics, not just lexophysics — and we should not expect one without accompanying plagues of locusts, lions lying with lambs, horsemen on the ridge and so on. Any such invention would be a perpetual motion machine.

From time to time new paradigms will emerge, and while undoubtedly they will disrupt the cosy cultured order of commerce, they won’t change that, but all the same people who should know better — and many who do know better — will believe, or at any rate profess, that this principle has been broken: Internet commerce. Renewable energy. AI. Cryptocurrency.

But none of these falsifies the one law.

To the extent they makes any sense at all, all aspects details of finance — all the incalculable variations and iterations, at every level of abstraction, however fractally recurring, comes down to this. This is banking ’s monomyth, the hero with a thousand faces.

(Some aspects of finance do make no sense at all — this is the madness of crowds, whose expectations can peak and froth over the stupidest of things — NFTs, SPACs, sustainability-linked derivatives — but they tend not to last long. Gravity, as the song has it, always wins. Good luck, brave but airheaded promulgators of SLDs: you will need it, finding your next job.

So the monomyth is a useful framework to contextualise whatever you happen to be doing. How close is it to the real allocation of capital? How adjacent are you to someone whose capital is at stake? Granting you a basic sense of proportion, the closer to that edge you are, the more secure your future is. Bullshitters can't survive there. You can’t delegate it to school-leavers from Bucharest. It can’t be done by AI.

So what are these core activities?

First order activities

Types of banking

• Intermediating: finding people who won’t or can’t contribute capital directly to a business and persuading them instead to contribute it indirectly, via you. This is the basic business of taking deposits i.e. being an actual bank, or running an investment fund; being a “shadow bank”. In either case, punter gives money to aggregator, and aggregator gives it to some other punter. The difference is one of return: the bank promises a fixed return, the fund promises you a slice of whatever comes back.
• Introducing: Connecting people for a fee: finding people to give contribute capital directly and taking a commission when they do (this may look like Intermediating, using words like “underwriting”, but (if done properly, isn’t).

Second order activities

• Monetising: raising money off thing

One thing

• Managing duration: a kind of non-arbitrage that works like an arbitrage 80% of the time

• Financing: raising money against capital and assets you already hold. This may be by borrowing against them,
• Spread management
• Form and substance the market will find a way of complicating the form by way of erecting barriers to entry.