In A Crisis? Cook The Books!

Fault lines

From an accounting and finance perspective, the COVID-19 pandemic could be as devastating as the financial crisis of 2008. This appears to be the view of Prem Sikka who says that the current crisis is affecting almost everyone. The emeritus professor highlights how the pandemic has exposed the fault lines of a system predicated on profit before people.

“Whilst millionaires are holed up in their mansions and travelling on their yachts, it is the poorest paid people who are in the front line”, says Sikka.

But this is not the whole story. The spread of epidemics disrupt the opportunity for the super rich to accumulate wealth through the continued exploitation of their workforce. Instead, they provide a cursory reminder to the elites that collective notions of society are the basic pillar of human existence and well-being. The emeritus professor advocates a concept of democracy and collective infrastructure forged at the point of production and regards the empowerment of people as crucial to the flourishing of society.

Corporate capture

His concept, however, is at odds with the current system which resembles an era where medieval barons limited rights to those who owned property. Such a system is geared up to rewarding those who operate within a speculative economy that Sikka likens to a Ponzi scheme. The professor argues that the key drivers of inequality – the big business and big accounting firms – have colonised a set of rigged accounting rules. Parliament, which supposedly has a democratic mandate to set these rules has abdicated its responsibility and given it to a private organisation who make them for the benefit of the corporations who fund it.

The corporate capture of the accounting discipline thus raises the broader issue relating to the financial capture of parliament and its undermining of the entire UK regulatory system. The said system, instead of serving the public interest, is configured to work against it. With many MPs making huge sums from consultancy fees, the glaring nature of a democratic system inherently compromised by elite interests has become exposed.

“At the moment, people say Britain has the best democracy that money can buy. That is true because money has bought it”, says Sikka.

The Ponzi Factor

That the functioning of ‘democracy’ is underpinned by a gigantic financial-based Ponzi scheme is a subject that the author of The Ponzi Factor, Tan Liu, focuses on in the context of the United States. What Liu realized whilst working in finance on Wall Street, was that hedge fund profits were not real but rather, from an accounting perspective, the result of non-legal pushes of a pen.

Liu explains how the system in the US works:

“We had this idea of you make money and finance by buying something for five and selling it for six. Except we don’t really have this aspect of what the price is today, tomorrow or the next day. So what you do is simply say, ‘I’m going to buy for five right now, I will sell for six in two years’. And during this time you can accrual this profit. The problem is, no one actually knows if you’ll be able to sell for six at the end of the two years.”

Liu continues:

“When the time comes and they actually have to pay back the loan, they have to get the six dollars they promised. But at the end of the two years they couldn’t sell it. What they did is simply bring in more investors and they bought their previous asset that they valued at six and they couldn’t sell it in the market for six. So they brought in more investors to buy the six to justify their valuation at the very beginning.”

It was at this point in his finance career that Liu understood the money-making system outside of the real cash economy was essentially about accounting tricks. The stock market is a massive system that shuffles money between investors. Ponzi schemes work on the basis that current investors’ profits are directly dependent on the inflow of money from new investors. It’s a principle that explains, more broadly, how capital markets currently function. Specifically, the system currently operating in the US is indicative of arguably the biggest Ponzi scheme ever created.

Disconnect

The disconnect that exists in the system amounts to the difference between investor perception and money supply reality. Within the US Ponzi scheme the gulf between the two is particularly huge. The reason these schemes grow is because earlier investors can’t cash out against a backdrop in which current investors continue to put money in. However, if everyone tried to cash out at the same point, the entire system would collapse.

Liu argues for a middle way – “how to prick a bubble slowly so it doesn’t pop as badly.” The author’s central thesis is based on the separating of dividend and non-dividend stocks. To this end, he says that companies should not be allowed to trade openly on the market until they become profitable thereby becoming a legitimate equity instrument.

One positive that’s emerged from the pandemic is that it has pushed people back to thinking about what they really need in their lives and to reassess some assumptions around economic growth that perhaps they’ve had wrong.

Maybe they will come to the realization, for example, that it’s unnecessary to buy stuff they don’t need with money they haven’t got and that they don’t need all these excess things to survive. “At the end of day”, says Liu, “real growth should not be measured in terms of how much money you spend or be based on the dollar amount a company sells.”