Monday, August 13, 2012 | 11:18am
Humanity Doomed – Death by Electrons
How a generation who never went to the movies will destroy the world
 For in one hour so great riches is come to nought. And every shipmaster, and all the company in ships, and sailors, and as many as trade by sea, stood afar off,
 And cried when they saw the smoke of her burning, saying, What city is like unto this great city!
 And they cast dust on their heads, and cried, weeping and wailing, saying, Alas, alas, that great city, wherein were made rich all that had ships in the sea by reason of her costliness! for in one hour is she made desolate.
- Revelations (KJV) , Chapter 18
Humanity, as we know it, is living on borrowed time.
Our end will not come from an alien invasion, or by a rogue comet hitting the earth. It won’t be climate change, or the next new superbug. In the end, we will be undone by the movement of electrons.
The use of computers and automation in critical aspects of our lives is nothing new. Already, computers control the transmission of power across our country and the world. Computers determine who will and will not get home loans, and computers are now being used by terrorists and governments as the means of attacking nations and individuals.
But the greatest risk of all, in my opinion, is algorithmic stock trading. Currently responsible for over 60% of all trades on the stock exchange, computerized stock trading is a nightmare waiting to happen.
In computerized trading, programmers set a range of criteria for the machines to look for, and then these machines are put on auto-pilot, allowed to make millions of trades every hour. The profit off each trade might be at pennies apiece, but money can be made over time by making millions of transactions per day.
The profit potential of these trades (as well as the speed at which computers can make decisions relative to human traders) has made robo-trading very popular. So popular, in fact, that it is now impossible to stop the computers when things go wrong.
But… like the person who is so busy text messaging that they get into an accident, the short term gains (massive profits) has caused many to ignore the long-term disaster that will eventually effect us all.
To understand how the end will come, it is first necessary to understand how modern finance works:
Most major companies use borrowed money to fund their day to day operations. Whether it is your local grocery store buying the products they sell to you, or the major Wall Street firm buying out a competitor, short-term credit is the grease that keeps the wheels of finance moving.
The ability of these companies to borrow money is based on a number of things: the financial condition and stability of the company; the interest rate they are charged; and the willingness of those with money to loan to them.
In order to borrow money, most large companies (like individuals borrowing large amounts) must put up something as collateral. In the case of large public companies, this collateral is often in the forms of shares of stock in the company itself.
In normal times, things go smoothly and this system works just fine. But what happens when the share price of a company drops dramatically?
In this case, the value of the collateral (stock) has dropped, so the company must put up more money to guarantee their loans. If they are unable to do this, the loans automatically default, and the company must go bankrupt.
This also happens to people (and companies) who use borrowed money to buy shares of stock in this company (known as buying on ‘margin’). The stock is bought using the stock itself as collateral for the loan. When the price drops dramatically, the stock owner gets a ‘margin call’. And, if they are unable to come up with more money, the stock is sold to pay back the loan, even if that results in massive losses to both the stockholder and the company who loaned them the money.
Because of the inherent dangers of borrowed money, and especially because of the interconnected nature of the worlds’ financial systems, it is essential that traders have the ability to manage crisis, and to think outside of the traditional box when events create the potential for world disaster.
But computers know nothing about the human condition. To a computer, stocks are simply numbers that are manipulated based on a series of conditions. And worst of all: computers now have the ability to bring down the entire world system before humans could jump in to stop it.
On May 6, 2010, a computer error from a single trader produced an abnormal sell order in the S&P contracts market. This error immediately triggered the automated trading programs around the world, which instantly went into ‘sell mode’. Within 5 minutes, the market was down 1000 points.
On August 1, 2012, a series of computer errors caused a $200 million loss for Knight Capital, a major market maker. Over the course of the next few days, the price of Knight shares dropped 60%, causing ripples throughout the market.
The risk caused by computerized trading continues to grow. The Congress and Wall Street are unwilling to do anything about this problem since, in truth, everyone is making too much money.
In a repeat of the 2008 crisis, which was caused by a combination of greed and flawed assumptions, those with the power to prevent this disaster will not do so ever after it all comes crashing down.
So, as scary as it is to think about, here is what’s going to happen:
Some day in the (possibly near) future, there will be economic news that hits the airwaves. It may be about Greece, or Europe, or China, or even the middle east (for example, when things finally go crazy in Saudi Arabia).
The news will cause traders on the stock market to grow concerned about the short-term economic future. The price of 2 or 3 key stocks will drop as a result of this news.
Once that happens, the computers will see this drop, and automatically trigger its sell routines. Other computers in other offices will see these trades, and trigger their own sell routines.
The trading will not be limited to the directly concerned companies, it will carry over to the stocks in all industries.
Before the humans can jump in to stop it, the market will be down 2000 points in one day.
This will trigger margin calls and overnight bankruptcies; which will freeze credit markets, strangling other companies.
The cascade failure will happen too quickly for any government to get ahead of. By the time they finally muster the political will, the world financial collapse will be in ruins.
Once this happens, it’s all over but the slow death. The ATM’s will stop working. Gas stations and grocery stores will run out of product. The large cities, which rely on the smooth operation of the economy, will be unable to supply their populations with food or energy, and then the riots will begin.
All for the want of a few cents profit on some shares of stocks.
Don’t say you weren’t warned.