The science of finance/Introduction
« I strengthened you so that you might go and bear fruit, fruit that will last » (John 15,16)
What's the point of working? If it is true that our industries are destroying the Earth and everything that lives on it, wouldn't it be better to stop everything? Natural resources are fruits of the Earth. Work that destroys them is worse than work that bears no fruit. But if we no longer get up to work, how will we eat? Be treated ? How will we get what we need to live well?
Heaven on Earth: love one another. To love others is to live for their good: to perceive, to be moved, to imagine, to think, to want, to speak and to act for their good, therefore always to be of service to them. If we could not provide services, we could not truly love, effectively. Love one another, truly, means: provide services to one another.
Economic goods are wealth because they provide us with services. We can serve others by producing wealth that serves them.
We produce wealth with wealth. In a production project, revenues are always preceded by costs, because wealth must be brought forward to produce new wealth. This is why production projects always need to be financed. To finance is to advance wealth to carry out projects. In general, money must be advanced to purchase services, supplies and production goods.
Services require work and resources. To obtain all the services that we need, or that make life better, without exhausting workers, and without wasting natural resources, which are in limited quantity, we must be well trained and well equipped, because then we can fully develop our potential, be productive and provide services to everyone, without wasting our lives earning it, and without destroying the planet.
To train and equip workers, we just need to finance them. Our financing capacities are limited only by the resources available and the intelligence that gives us the means to use them. Finance give us the means to make the Earth a paradise, because resources are gigantic. So what are we waiting for? Why hasn't finance already made heaven on Earth?
Thanks to productivity gains, which are sometimes very large, an economy where everyone is at least modestly rich is a goal that seems attainable. We just need to invest so that everyone can be productive. We want good investments.
This short treatise on finance provides some answers, or rather beginnings of answers, to the following questions: What is a good investment?
Who should decide on investments and their financing methods?
Why are we not always encouraged to choose the good investments? Why are we sometimes encouraged to choose the bad ones?
To invest, we generally have to advance money. But where does the money come from? How do we have enough money to finance all the good projects?
To choose an investment carefully, we must anticipate the value of the projects. How to count the value of the projects in which we invest?
The science of finance is often astonishing. Here are some examples which will be explained in this treatise:
To be good producers of wealth, we have to be like Mozart.
Wealth equivalent to several billion dollars can disappear without anything tangible having disappeared and without anyone having been robbed.
When we drink a bottle of Champagne, we can save its value.
Wealth is sometimes created without work, without anyone having been robbed, and even without any tangible goods having been produced.
Some goods are almost eternal. They are like gooses that lay golden eggs, because they produce profit without being consumed.
Financial logic can encourage us to choose the most thieving projects, or the most destructive to the environment.
The most profitable project is not necessarily the most thieving project, it can be only the most intelligent project.
The circulation of money is like the multiplication of loaves.
Money creation can increase the production of wealth.
Central banks refused to pay the debts in gold that they had agreed to pay.
Central banks can create all the money they want, to lend it, to buy any asset, to pay any expense, to pay dividends to governments or to give it. They destroy the money they have created when their loans are repaid, when they sell assets, and when they receive interest on their loans.
Commercial banks create money when they lend, when they buy an asset, when they pay any expense, and when they pay dividends to their shareholders. They destroy money when their loans are repaid, when they sell assets and when they receive income.
We are no longer held back by the bridle of gold to finance all the good investments, because we can create all the money we need.
When agents restrict their spending, they collectively become poorer, rather than richer, and do not achieve the desired goal of increasing their monetary reserves.
Financial logic leads us to devalue wealth preserved for future generations.
A risk-free project that earns a regular profit has optimal value if and only if its net present value is zero.
Finance provides the means to make profits with a profit rate as high as one wants, even an infinite profit rate.
To be good financiers, we have to think like communists.
The surplus profits of optimal projects are all positive multiples of the same random magnitude.
Very risky projects or financial assets sometimes need to be valued as risk-free assets.
There is a risk price constant k which makes it possible to measure the cost of risk. kR is the cost of an irreducible risk R, measured by the standard deviation of the profit. 0 < k < 1. k seems to be approximately 1/2.
A one in two chance of winning 100 costs 50(1-k) = 25 if we play against an irreducible financial risk, and if k = 1/2.
It is possible to play against fate, without any other counterpart, at (1+k)/(1-k) against 1, with equal probabilities. (1+k)/(1-k) is strictly greater than 1 and could be quite large, 2 or 3, or more.
There are negative risks that have a positive value. If we increase a negative risk in absolute value without decreasing the average profit, we increase the value of the company.
The space of all projects with zero net present value is Euclidean. Its metric is the covariance between the surplus profits of the projects.
The irreducible risk of a project is equal to the covariance of its surplus profit with the optimal project whose risk is 1.
A general mathematical solution can be found to all problems of financial risk calculation.
Humans are buying and selling trillions of dollars of assets that have no value: cryptoassets.
Cryptoassets sellers are thieves and arsonists.
An optimal agent can predict her future decisions or their probabilities, because she knows that she will make optimal decisions. This method of anticipation leads to a general method of calculating the optimal value of all risky projects, and therefore the value of all wealth.