And now for something completely different.
HFT has been a bugbear for several years now. The monster that would eat the equity markets, and then move onto derivatives for dessert. But HFT has apparently fallen on (relatively hard times). HFT volumes are down. HFT market shares are down. And most interestingly, HFT profits are down, by about 50 percent on a per share basis, more on a gross basis because volumes are down.
This should not really be a surprise. Basic economics predicts when profits in a particular activity are high that entry, the expansion of existing firms, and the development of competing technologies will dissipate those profits.
It’s interesting in this context to think about Schumpeter’s argument in Capitalism, Socialism, and Democracy. One motivation for the book was to examine whether there was, as Marx and earlier classical economists predicted, a tendency for profit to diminish to zero (where costs of capital are included in determining economic profit). That may be true in a totally static setting, but as Schumpeter noted the development of new, disruptive technologies overturns these results. The process of creative destruction can result in the introduction of a sequence of new technologies or products that displace the old, earn large profits for a while, but are then either displaced by new disruptive technologies, or see profits vanish due to classical/neoclassical competitive forces.
Whether it is by the entry of a new destructively creative technology, or the inexorable forces of entry and expansion in a technologically static setting, one expects profits earned by firms in one wave of creative destruction to decline. That’s what we’re seeing in HFT. It was definitely a disruptive technology that reaped substantial profits at the time of its introduction, but those profits are eroding.
That shouldn’t be a surprise. But it no doubt is to many of those who have made apocalyptic predictions about the machines taking over the earth. Or the markets, anyways.