Fear, loathing and schadenfreude in the City

We have, of course, talked about the credit crunch and the oncoming recession before, and speculated on the possible effects on the engineering sector. But this week’s mind-boggling events centred on Volkswagen really do merit some discussion. If there was ever a demonstration of the money markets’ separation from reality, this is it.

Put simply, several hedge funds — those murky instruments of money-making who nobody, including it seems themselves, really understands — decided that Volkswagen was certain to suffer during the economic downturn, and therefore its share price would fall. They therefore took what’s known as a ‘short position’ on the stock, borrowing shares and selling them with the expectation of buying them back at a lower price to return to the lender, and pocketing the difference. Basically, it’s a bet that the price will fall.

But this time, the City Boys were hoist by their own petard. With immaculate timing, Porsche announced that it was going to increase its stake in VW to 75 per cent. This, of course, sent the share price soaring, and the hedge funds then had to scrabble to buy more VW shares to return to their owners. Unfortunately for them, the shares were in short supply — Porsche had most of them, and the state of Saxony another chunk, and they weren’t selling. When items are in demand, the price goes higher. Eventually, the hedge funds were forced to take a loss, amounting to some £13bn — an amount which I can’t even imagine in anything like real terms. And briefly, Volkswagen was the most valuable company on the planet.

And what has that to do with the actual business of Volkswagen, making a range of solid and reliable but fairly unexciting cars? Precisely nothing. Nothing at all. Despite Volkswagen’s history of innovation, its engineering excellence, and the fact that its cars are as durable as small tanks, its sudden rise to the top of the market was entirely driven by the machinations and obscure algebra of the finance world and — according to the BBC’s omniscient economics editor Robert Peston — the hedge funds’ software-driven buying and selling activities.

It’s appropriate that German companies should give us the biggest dose of schadenfreude of this recession, but it is a neat illustration of how finance works and how it regards the companies it depends upon. They seem to see them purely as abstract vehicles which provide them with mechanisms to profit, precisely how a punter sees Number Three in the 4.15 at Newmarket.

It’s been suggested that the dramatic rise and falls in the London stock exchange indices don’t actually have much relevance to the real world because, unlike the last recession, the FTSE 100 companies don’t really represent British industry. They are mostly conglomerates which don’t make anything in Britain. Indeed, despite the recession, you can see bright spots: Surrey Satellites, for example, is expecting massive growth in orders, driven in part for the need for more environmental information. BP’s growth in profits is truly stunning, both up and downstream. And the legendary motorbike marque Norton is finally back in British hands after 15 years of American ownership, with its new owner, Stuart Garner, planning to launch a new road bike and a rotary-engined model next year, and open a factory in Donington.

Small beer, perhaps, but not to be sniffed at. But perhaps it does show that we shouldn’t be spooked by the dire news from the City and Wall Street. Again, we’ve said it before, but it stands repeating: for the engineering sector, the future is in our hands.

Stuart Nathan

Special Projects Editor