In 1815, the combined forces of Britain and Prussia defeated Napoleon’s army at the Battle of Waterloo. It was, said the Duke of Wellington, a damn close run thing. But even before the dust had settled on the battlefield, a carrier pigeon belonging to the House of Rothschild was on its way across the Channel to London. Nathan Rothschild, informed ahead of other traders that the country was not to be over-run by the French, consequently made a killing by buying British government bonds.
Little of this legend is true but there are elements that are accurate. There was a battle at Waterloo, which ended Napoleon’s career. Wellington did not say it was a damn close run thing but there is evidence he thought so. The Rothschilds used carrier pigeons but that was not how they learnt the battle’s outcome. Rothschild did have early knowledge of the outcome, and may have used it to advantage, but that knowledge was not the source of the house of Rothschild’s fabled wealth. It did, however, earn a great deal, helping governments of all complexions to fund the Napoleonic wars.
Financial markets have moved beyond carrier pigeons. The great financial centres of New York and Chicago are 700 miles apart. Fibreoptic cables transmit data between them in about seven milliseconds. But that is a long time in the life of a high-frequency trader, so Spread Networks has spent an estimated $300m building a fibreoptic link through the Appalachians. The shorter cable reduces the time taken to send data by about a millisecond.
The laws of physics suggest the speed of communication is – quite literally – limited by the speed of light, which takes four milliseconds to travel 700 miles. With appropriate technology, the news of Wellington’s victory would have been received in London, 200 miles away, about one thousandth of a second after the result was known. A close run thing takes on an entirely new meaning.
The true story of Spread Networks’ tunnel is even more improbable than the apocryphal saga of Rothschild’s coup. But the lessons of narratives in business and finance are often independent of the accuracy of their facts. The result of Waterloo defined the shape of 19th-century Europe. But the consequences would have been the same whether the result had been known one millisecond or 24 hours after it had occurred. Speed of communication of the news was of little general importance but a potential source of large profit. That difference between private and public value gives rise to much socially useless investment, such as the tunnel through the Appalachians.
The private benefit of such investment arises only if the knowledge remains selective, however. In another version of the tale, Rothschild was aware others knew of his superior telecommunications. So the wily financier was to be seen on the floor of the exchange selling bonds; the resulting consternation among English gentleman enabled his agents to buy cheaply from panicked sellers who believed Napoleon was on his way across the Strait of Dover. Today, as yesterday, it is differences in perceptions that give rise to trading opportunities.
The Rothschild of legend might have been guilty of both insider trading and market abuse. Today the UK’s Financial Conduct Authority might censure Wellington for disclosing his success to the banker’s agent before the British government, of which he was a curmudgeonly employee, had made the requisite formal announcement.
Yet there is something odd about this regulatory requirement, aside from its self-evident impracticality. Why should it be unacceptable to gain advantage from knowledge of the outcome of the battle but acceptable to gain advantage by getting faster to London with that news? Making profits from better-informed knowledge of business or government (where obtaining that might seem an activity of public value) is a criminal offence: making profits from marginally faster dissemination of that knowledge (where achieving that appears to have no public value at all) is a legitimate market practice.
That is why we devote more resources to training carrier pigeons and building fibreoptic links than to understanding military and business strategy, more brainpower to devising trading algorithms than to the analysis of competitive advantage. A damn rum thing, Wellington might have said.