To short a stock or currency has long been a part of the activity of the City of London – and every other financial centre in the world. It works like this:
- Shares in Bloggs Boaters are currently quoted at £1.25 each but you have a hunch (or maybe insider information – but that would be illegal) that the share values are going to fall.
- Without buying any shares you ‘open a position’ (meaning, agree a contract) to deliver one thousand Bloggs Boaters shares in a month’s time at their current price (£1.25).
- You are lucky and in the subsequent four-week period the price of Blogs falls to £1.00. Only at that point do you buy one thousand shares and deliver on your contract. You make a profit of 25p per share and so pocket £250 as a reward for following your hunch.
Financial engineering and shorting
Over the years, financiers with an appetite for risk have developed skills in ‘financial engineering’ and produced (allegedly) sophisticated financial instruments that have enabled them to make significant profits (and losses!) through financial wheeling and dealing. This has been tantamount to bringing a virtual roulette wheel into the markets.
We may note that this wheeling and dealing brought us the 2007–08 great financial crisis. That crisis prompted Lord Adair Turner (2009) chair of the Financial Services Authority to condemn much of the City’s activity as being ‘socially useless’ and to question whether the industry had grown too large.
Will Hutton, in his book, Them and Us (p103) gives an outstanding American example. ‘Fabulous’ Fab Tourre was a senior executive with Goldman Sachs and Hutton relates how he is credited with inventing a financial instrument at the instigation of the Paulson hedge fund to make a billion dollars by short selling.
Hutton goes on to describe how over the past generation, Britain has created the conditions for other Tourre-like investors to make fortunes by fair means or foul, while neglecting the innovation ecosystem that might have made it easier for genuine inventors to grow their companies. This is part cause of the UK’s lack of economic growth. The stock exchange has become too much of a casino and too little a source of patient capital.
Hedge funds, Brexit and shorting the pound
Hedge fund owners in the UK (think Jacob Rees-Mogg, Aaron Banks) railed against the restrictions imposed by the EU to contain irresponsible financial behaviour. Perhaps for this reason we get hedge fund owners being long-term supporters of Brexit.
This last point is illustrated by an example drawn from Peter Geoghan’s book Democracy for Sale. Crispin Odey has strong connections with the Conservative Party including being a big donor. He also owns a hedge fund. Geoghegan reports (p145) that Odey “made £220 million on referendum night betting that sterling would collapse if Leave won”. So here we have one of those union-flag-waving Tories selling sterling short when it suits his pocket.
Several of these hedge fund owners, including Odey (who once employed Kwarteng as an analysist at his hedge fund), backed Liz Truss for the premiership. Specifically, they contributed thousands of pounds to her leadership campaign against rival Rishi Sunak. They also ‘shorted the pound’, and/or ‘shorted UK government bonds’ – see my Bloggs shares example above – in the expectation that if she won, the value of the pound and the value of government securities would go down when she and her chancellor Kwasi Kwarteng introduced their financial package.
This is just what has happened. The hedge funds who followed this strategy will have made millions (tens of millions, perhaps hundreds of millions) in the last few days. A good profit on an investment of a few thousand in Truss’s leadership campaign.
As with so much the Conservatives have done recently, you could not make it up!