My purpose of this post is not to exonerate Wall Street from its misdeeds, but rather to ask its accusers to be more introspective about their own role in Wall Street greed.
Let’s face it – everybody knows that the people on Wall Street are overpaid for what they do. Our problem with them is not that we begrudge them their money, but that we are envious and want to be able to make that kind of cash ourselves. It isn’t so much that we are mad at them for mis-spending our money, but rather we would like to be able to be overpaid for mismanaging the companies we ourselves work for. The problem is not that they are making the money or putting us into risky positions that they should know better about. The problem is that we are not making the money and when we put our employers in risky positions through our own ineptitude, we don’t get a similar payday on the way down.
The real reason everybody goes to Wall Street is because they are greedy bastards. There is a measure of safety in that realization. If you know that someone is completely amoral and only does things for money, you can be sure that if you pay them enough, their amorality is on your side. Similarly, this also puts somewhat of a cap on their own individual immorality, because, in real life, continual immorality sets a limit to the payday. Markets only function because of the general morality within business. If someone is amoral rather than immoral, they are more likely to behave morally in a generally moral society.
We actually have a sense of safety knowing that our money is tied up with greedy bastards who just want to know the bottom line.
If you actually did have a grudge against Wall Street that was based on true moral indignation and not simple envy at their ability to win bigger than you on every trade, there is a simple thing that you would be able to do to combat this.
Stop giving them money.
Instead, make money by offering loans to your friends and family to start businesses. Invest in local startups – people that you know have the strongest moral fiber. Invest in your local community.
What? That’s not liquid enough? There isn’t a big enough market? There’s too much risk and not enough reward? The people with character don’t make the deals that give the company the most profit? Local people don’t have the winner-take-all attitude needed to go to the top?
Well, then take Wall Street. But don’t act like you didn’t know what you were buying. And don’t act like you weren’t complicit when they do what they always do and leave you holding the bag. You went with them because you wanted to be the one holding the bag, right?
Most people think that the biggest problem with money printing by the Federal Reserve (either in the form of Quantitative Easing or in Zero-Interest (ZIRP) money-lending) is inflation. Inflation is a problem (if you doubt me, go to the grocery store), but it is not the worst.
The worst problem with money printing is the massive misallocation of resources that it causes. Money is supposed to be a measuring device. Provided I don’t do anything fraudulent, profit is essentially the added utility that a business adds to the economy. More profit = more economic benefit.
However, ZIRP heavily distorts the economic picture. As a case in point, look at Amazon.com. Its stock price is currently at $1,000, which is a P/E of 187. That means that it is essentially giving a return of 0.5%, which is less than treasury bonds at this point. So why all the investment here? There are a few reasons, but the biggest one is that when money is printed, it has to go somewhere. The easiest way to make a winning trade is to stick the printed money in the stock market.
Think of it this way – if I can get money for nothing, I don’t need a large return to be profitable. If I am getting money for 0%, then a 1% return is great – I just need to borrow a lot of it. Things don’t work quite that simply (the Fed rate is not actually zero, only a few people get to borrow at that rate, you don’t have unlimited borrowing, etc.), but the general effect is the same. What works right now is to massively leverage small gains. This generally turns into a pile-on in the stock market, where everybody buys stocks even though they are overvalued, and that in turn drives them still higher.
Now, let’s go back to Amazon. They have a market cap of HALF A TRILLION dollars. Under normal circumstances (i.e., a P/E of 15 instead of 180), Amazon would be worth about 50 billion. That means that almost all of that HALF A TRILLION is misinvested. Let that sink in – there is a half a trillion dollars that are misinvested in a single company! It isn’t quite that bad because not all of that is actual investment (not everyone paid $1,000 per share), but nonetheless, it is pretty bad.
Now, imagine this – let’s say that you couldn’t make money for free. Let’s say that companies actually had to show returns to get investment. What happens then? Well, the biggest returns are not in the stock market. The biggest returns are in building companies from scratch, or taking a small company and building it into a giant. Therefore, if I needed actual returns, I would build a company rather than just invest in an existing one. However, right now we have half a trillion dollars NOT DOING THAT. It is easier to simply leverage and buy rather than actually work for money. If I can just borrow extra and get the same result, that’s what I’ll do.
If you wondered what is sucking America dry, it is ZIRP! There is no reason to invest in building America. We just prop the existing companies in the stock market up and up and up, and America’s actual economy just languishes in the dust. The resources are all committed to the stock market. There’s hardly anything left for anyone else. Real businesses giving real jobs to real people isn’t where the big money is, because we can simply leverage ourselves to a financial benefit without any actual benefit.
Again, I should point out, this half a trillion dollars is the misinvestment in a single company. The focus on the stock market and the ZIRP policy that brings money to it are part of what is keeping main street America from succeeding.
Think of it this way. You are a millionaire. You have $1 million sitting around. What are you going to do with it? The stock bubble is heating up. You can invest it in the stock market, or you can risk it all and go invest in two guys in a garage starting a business. With the stock market, you have people printing money who will buy the stocks that you buy later on. With a business, you have to actually produce something in order to sell it. Which one will you do? And so the bubble grows bigger.
The other side of the coin is that this belief that the stock market can save us has made us all lazy. We want other people to make money for us. We have outsourced even the basics of making a living to other people. I hope we can find a way out of all of this. This is why in Microsecession I suggested we try to get away from the money economy. If we can, then the eventual disaster that is waiting to happen in the money economy will not affect us as strongly.
I am planning on starting stock trading, and I decided before I did, I would first layout my philosophical framework for understanding what I am undertaking. I get the feeling that many people engage in activities that they have not fully understood. They may get it right by chance, or even by skill, but disaster will also overtake them because they only understood the smaller forces, not the larger scale ones (for more information on this topic, see this post on seeing to infinity). Understanding something philosophically means that, while you will often get the smaller things wrong, you will usually get the larger ones right.
The stock market and MicroSecession
Now, you may think that stock trading is the opposite of the MicroSecession mindset. And, to an extent, you would be right. I am posting this here precisely because I recognize the dissonance in the approaches to the world, and wanted to explore them for myself and for others. In MicroSecession, we focus on our families and communities, and try to order our lives in such a way as to be able to be impacted much less by macroeconomic and political forces. It also aims to focus on the real over the artificial – preferring silver to dollars, land and chickens and personal capital to stocks and bonds.
So, before I go into further depth into stock trading and MicroSecession, I want to first review the MicroSecession approach to money and wealth. A lot of it is actually borrowed from the financial sector, but applied in such a way that any person on earth should be able to take advantage of it.
- Stop consuming, start producing – focus on hobbies and activities that are productive, not consumptive. Don’t watch TV, write a play instead.
- Purchase capital assets – a capital asset is one that allows you to be more productive. Whatever it is that you are doing, look for things that you can purchase to increase your productivity.
- Convert extra money into hard assets – if you have extra money, purchase things of real, lasting value. The simplest version of this is to buy real silver and gold, either as coins or jewelry.
This is not a get-rich-quick scheme. It is a way to make a tiny, stabilizing move in our modern society. Here are a few ways in which we have implemented this. First, our hobbies currently deal with learning and teaching. We learn (an activity that improves ourselves), and then teach (an activity which benefits others as well as earns us additional money). We produce teaching materials that do the same. We are not great at this yet, especially not great on the selling side, but most importantly, even though we are just eking out money, we are not consuming, but rather producing. Being above the zero line is the primary goal. As for capital assets, most of our purchases are for things related to improving our ability to teach and produce teaching products. Finally, we are indeed converting our extra money into hard assets. There isn’t a lot of extra money, so there aren’t a lot of hard assets. But, over the years, we have generated enough to the point that we have a hard asset savings with a modest value. Not large, not even nest-egg sized, but some. More than we would if we weren’t converting into hard assets. We have some silver and gold, we have some long-storage food, we each have a business bank account that is positive. So, we aren’t in a great place, but we are going forward.
So, if it is working, then why the stock market?
Well, there are a few things that are not working. Christa and I have been both trying to leverage our day job and our individual part-time jobs into larger growth areas. However, for my day job, despite the fact that we seem to be perfectly positioned for it, it just has never worked out. For our evening jobs, we have never had enough capital to really expand the business. All of our books are print-on-demand because we can’t afford a real print run. I can’t afford to take time off of work to write or otherwise develop the business. I can’t afford to hire a marketer to help me make sales. We need capital, but there is no source for friends-helping-friends investing. My hope is, if I wind up making it big, that I can help correct that. I would love to see a local stock exchange where people can easily contribute to the idea and easily take out the profits. But I’m getting ahead of myself. There is no such idea, and there isn’t anyone who believes in our ideas enough to help us move on to the next level, and we are unwilling to go into debt.
Therefore, I decided to take what I did have, and put it at risk in something. If I can’t get a break in my job, and I can’t get a break in my business, and there is no exchange for putting money into local businesses to help them out, I’ll simply go where there is a system and mechanism for putting money at risk to generate profits – the stock market.
However, before I begin, I need to know for myself what is the philosophy of the stock market. What is it that at least should be happening? What is it that people should be gaining? Where does this intersect and not intersect with reality?
Philosophy of Business and Stocks
So, the basics.
What is a profit? A profit, in theory, is the difference between the effort put into the company and the value placed on those efforts by the market. Hopefully, in order to benefit society, those efforts have a real value for society even above the value placed on it by the market.
What is a stock? A stock is a part ownership of a company.
What is the goal of owning a stock? The goal of owning a stock is to participate in the profits generated by the company.
What is the goal of issuing a stock? The goal of issuing a stock is to generate capital to enhance the productivity of the company.
What is productivity? Productivity is the ratio between the effort you put into the company and the total value the market provides.
The goal is that when a company issues a stock offering, it can become more productive, such that each unit of the company brings in even more profit than before. This way, the company benefits by increasing productivity, and the stock purchasers benefit by seeing a share of the productivity increase.
Note that simple expansion is not enough. Actual productivity must increase. If expansion introduces overhead rather than removing it, then the profit will go down, not up. Note that there are always new individual overhead items when scaling up, and also some implicit costs that were never recognized but always there, but, in the final analysis, the overall overhead should go down for increased productivity, or the unit cost should be sufficiently decreased to allow for the overhead.
I like to analyze things like this by looking at what it looks like on the smallest scales. Let’s say that Bill is an accountant. However, he is currently just using paper. He can’t afford a computer because he doesn’t make enough sales, but he doesn’t make enough sales because he can’t afford a computer. If Bill offers shares of stock in his company, then people can pool together money to buy Bill a computer in exchange for a piece of his company. That computer then dramatically increases Bill’s productivity. The increase in productivity is enough to both increase Bill’s income as well as provide a solid profit for the investors.
So, from this, we can deduce the following:
- The final expectation of owning a stock should be profits/dividends.
- The result of investment for the company should be sufficient increase in productivity to benefit both the business and the investors.
- The result of investment for the investor should be a higher return than the maximum of real inflation (about 6.25%) and the treasury bond rate (2.34%). Therefore, our return should be significantly greater than 6.25% if we are going to invest.
- The best way to anticipate future profit is from examining their effectiveness at generating internal productivity.
That last note probably requires some explaining. If inflation is 6.25%, then we can achieve this by just converting our money into hard assets, and then we have lower risk. We can also achieve the treasury bond rate by just investing in treasuries! Therefore, both of these represent a floor (really, a sub-floor – we all want to do much better than this) to what our gains should look like when investing.
Bad Strategies for Investing
Now, there are several strategies for investing that I have heard that I don’t like. I love value investing (it seems to make the most out of the above description) in principle, but the problem with value investing today is that most of the market is way overvalued. For instance, amazon.com is a mature company, but it is trading at a P/E ratio of 511. For a company as mature as Amazon is, this is ridiculous. If we look to the model described previously, this means that it is acting like a bond earning 0.2% per year. That is ridiculous. Apple, on the other hand, has a P/E around 16. That means that it acts like a bond that earns 6.25% per year. Much better! But still not where we want a stock to be at. Here, it is generating a return that is just at the inflation rate, so we might as well be buying hard assets. Plus, Apple lost its innovative touch a few years before Jobs died, and people are finally starting to notice, which doesn’t bode well for the future.
Anyway, having said this, many value investors will just say, “look for the best value.” That is ridiculous. If you are going to be a value investor, you should be looking for actual value. If the market isn’t giving you value, then you should not be investing in it.
Another common option is technical trading, where you trade based on market signals. I don’t doubt that someone can build a system that will spot market signals that no one else sees. However, these systems fall prey to a few systemic effects that few people bother to stop and think about.
The first one is that many systems are simply curve-fitting. That is, someone generated a system that fits old data really well, but it doesn’t actually capture any market knowledge. You see, anyone can fit data into a model. It’s really easy. However, to make a model that actually shows something real is a different animal. It’s also really easy to convince yourself that you made a model of something real when what you actually did was curve fit. I actually have a method to measure this effect, but it is still in development and will have to wait for another day.
The next two are what I call “recursive effects”. See this article for an introduction to recursive effects. The first recursive effect is in that models usually don’t take themselves into account. That is, models are “outside-looking-in” creatures. They tell you what is going on in the room. However, once the model itself is in the room, the room plays differently. A model that works on the outside looking in will often cease to work once it is on the inside, because the model didn’t account for itself. This is why models that are effective for individual investors often times lose effectiveness when it gets public. As long as it was with a single investor, the model itself had little impact on the market as a whole. Once everyone knows about it, there is now a new market which the model didn’t know about.
The other recursive effect is similar. Most models don’t take into account the effect of their own trades on the system. That is, if it looks like IBM is going up, and then I start buying IBM stock like a madman, I am going to trigger other price moves of IBM that might not have happened had I not made the trade. I might have to buy it at a higher price because I was buying! I might have to sell at a lower price because I was selling! Most models don’t take into account these recursive effects.
The final one is what I call “scale effects”. These are similar to the recursive effects just mentioned. That is, when you start doing something at scale, there winds up being problems that you didn’t have before. Perhaps you make a great trade and buy a million shares of stock XYZ at $1 and the price goes to $10. Did you make $9 million? Only if you can also sell it. All of a sudden, having $10 million and having access to $10 million are two different things. There might be interest rates, taxes, overhead, etc., that all come into account once you are at scale that may overwhelm a previously working system.
So, if not value or technical trading, how should you trade?
Here is what my strategy will be:
- Look for places where the market is mis-pricing things. In the current situation, I would look for places where the price is at least 15% off.
- For most plays, buy stocks where I legitimately can see value in holding them. That is, if the stock price went to zero, would there still be value? If so, then this is similar to holding other kinds of hard assets – the value is independent of the present price.
- Leverage using options, with the understanding that the price could go to zero. Options are great because they have a fixed downside risk. It is a way to exercise leverage without having to borrow. You can also short in this way.
The problem with #1 is that the market can continue to mis-price something for a long time. So, you have to be comfortable with that. However, as long as the price discrepancy is significant enough to warrant having your money there, it can work out.
Even shorter, (a) bet against the market, but only where the market is wrong by at least 15%, (b) buy things of underlying value, and (c) use options for leverage and shorting, not borrowing.
Anyway, I would prefer to invest in friends who need capital to enhance their productivity. I would also like for others to invest in me in a similar manner. However, there is not currently a means to do so. Therefore, I will attempt to use the existing mechanisms as best I can using my microsecession understandings to build enough of a base to fund my own way. Perhaps it will work, and perhaps I will lose it all. But I don’t want to be like the man who said, “I was afraid and went out and hid your gold in the ground. See, here is what belongs to you.” (Matthew 25:25).
I get upset whenever someone says they are going to “beat the market”. The market isn’t a video game. Outsmarting other people isn’t the goal.
Anyone who approaches the market with the intent of “beating” it has already lost. Sure, it’s possible to gain money on the stock market, and it is also possible to get more money than the next guy in the stock market. The same thing is true of gambling. Unless you view the market as merely a high-class casino, “beating the market” is one of the worst analogies.
If everyone lost all of their income, and you only lost half, would you be excited that you “beat the market”? What if you became rich by suckering everyone else out of their money? Is that something to be proud of? No, and those are two of the reasons why “beating the market” is a ridiculous goal.
The goal of investment in a market is to build value, period. If your goal is something else, you should get out, because you are not only likely to lose your shirt, you are likely to hurt others in the process.
The market is not a list of numbers, it is a list of companies. Buying a stock is not betting on a horse, it is investing in what a company does on a daily basis. The goal of an investment is to either (a) help capitalize an operation that you believe has future potential, or (b) provide early compensation for others who capitalized the operation earlier by purchasing for a fixed price a future revenue stream. If your goal is to just hang on until you find someone stupider than yourself to sell it to, then you are doing it wrong.
Now, by this notion, it might be that there are *no* companies worth investing in. That’s certainly a possibility. What then? I can see two clear choices: either (a) save your money (that’s what cash and precious metals are for), or (b) start your own company or help out someone who is not listed start theirs.
Your money has so much better uses than just to gamble it away. Instead, find a productive way to invest your money.
Our current economic debacle comes from having so many people focused on “playing the market” rather than actually creating value. Therefore, the gains are all fake. Because so many people “play the market” or “provide liquidity”, no one is “providing value”. This is what causes a market crash. Eventually, the market returns to the value. If no one is producing, then there is no value.
If value is being created, the actual numbers behind your wealth are much less important. Real capitalization is deflationary. Imagine this – let’s say you go to the store and buy 100 apples for $2 each. You now have $200 worth of apples, and you eat them all year. Now let’s say you buy an apple tree. Now you can, from now on, have $200 worth of apples without spending money. You might even wind up with enough to sell (which will lower the market price), or have such an abundance you give them away just to keep from having to clean them up!
All of these operations lower the value of your 100 apples. But do you care? Wouldn’t you rather have food in such abundance that you had to give it away rather than have to spend $200 each year? But for those who keep score with dollar signs, who want to do “better than you” rather than “well”, they would rather have apples become scarce, and their $200 worth of apples become worth $600. They would plow up an entire forest of apple trees to make their apples worth more. When they are starving in the street because they killed their own source of food, they will say, “I won – my assets are worth more dollars than anyone else’s”.
Which person in these stories was actually wealthier? The one with dollars, or the one with actual productive capital assets?
If you think you can successfully invest in the market, and in doing so improve the market itself, by all means be my guest. But if you want to play the market or beat the market, then for the good of yourself and others, please don’t.
Over the past few years, without anyone debating it or publicizing it, America’s national debt has been converted to an adjustable-rate mortgage. That’s right – the moment after ARM mortgages went belly-up, the treasury decided that they wanted to get in on the game. How does the national debt become financed with an adjustable-rate mortgage?
To answer this question, we have to ask, what is an adjustable rate mortgage and why is it a problem?
An adjustable-rate mortgage is one where the person receiving the loan gets a low interest rate, but the interest rate follows the market rate year-to-year. In a fixed rate loan, if your rate is 6%, it will be 6% until your loan is paid off. For an adjustable-rate mortgage, your rate might be 3%, but then next year it might be 8%, all depending on the interest rate in the markets. The problem with an ARM is that people get used to the low rates, and they forget to plan on what will happen if the rates go up. If the rates go up even a little bit, it catches them off guard and they can’t pay.
So how does the government do this with its debt?
Well, the government finances its debt on the open market. So, for instance, it might sell a treasury bond. The treasury decides whether that is going to be a 6-month, 1-year, 10-year, or 30-year bond. Traditionally, the treasury has financed the debt using primarily longer-term notes – 10 to 30 years. This means that if interest rates fluctuate, we have some time to deal with it before we need to refinance. It prevents a crisis from interest-rate swings.
Well, 10-year bonds yields are at about 2.5%/yr, but the 1-year bond is only 0.1%/yr. Therefore, to save money temporarily, the government over the last few years has rolled over half of its debt into short-term notes! This has helped the bottom line for the current years. The problem is that it means that we have $8 trillion in debt which has to be refinanced every year. Now, at the 1-year rate, $8 trillion costs $8 billion a year in interest payments. However, if the 1-year rate were to go up to any historically normal interest rate, the government deficit would shoot through the roof.
Let’s say the interest rate shot up to 4%. That is still considered low, historically. What would happen? It would cost the government $320 billion in new interest payments. That would increase the deficit by about 30%.
This is life on an adjustable rate mortgage.
If you have followed this site or my book for a while, you know that I am an advocate of returning to some semblance of commodity-backed currency. I mentioned that we actually could start trading in silver (and save a lot of money in taxes if we did).
Another idea is to create a standardized way to use gold and silver as collateral for loans. You see, many people own silver and gold, and (understandably) don’t want to spend any of it. However, it seems like a waste to spend so much time, effort, and money collecting silver and gold, but have it put to no purpose whatsoever.
One way that some people have found to put their gold and silver into use, without spending it, is to use it as collateral for a low-interest bank loan. That is, if you have $1,000 worth of silver, you can pledge it to the bank for an $800 loan at a very low interest rate. Then, as long as you pay back the money, you keep your silver, but if you fail to pay it back the bank keeps your silver. Thus, as long as you invest in a productive operation, you are able to use your silver and gold to increase your wealth, rather than have it sit doing nothing (which is Warren Buffet’s primary critique of precious metals).
So, what we could do is create a gold/silver depository. However, instead of just holding your money, you would also be issued a credit card that would be able to have ultra-low-interest credit up to 75% of your holdings. That works out well for the card holder, because they have a secure depository to hold their precious metals, and they can use them to make purchases. It works out well for the investors of the depository because they have guaranteed returns. If a creditor does not pay their monthly fee, you automatically get a payday in gold and silver. This creates two different vehicles for gold/silver investors. By using the facility, you can put your gold and silver into good use. By investing in the facility, you either get (a) a guaranteed small return if the borrower pays, or (b) discounted precious metals if they borrower does not pay – a win/win either way.
If the price of precious metals goes up, then you automatically get a larger credit line for borrowing, and deciding not to pay uses a smaller amount of silver or gold. Therefore, if you think the price of metals is going up, you can purchase something today, and pay for it with a lower value of silver tomorrow.
In addition, such a service could offer services for someone to audit their own silver lock box. It could have allocated vs unallocated accounts, and various other levels of service depending on your needs. Finally, the depository should exist within the state of the borrower, so that the borrower can come and view the holdings at any time.
This appears to have been tried once in 2010, but the site never got off the ground. I found several articles from March and April 2010 (all seem to be rewrites of the same press release), but nothing seemed to come of it. The website mentioned in those articles is now pointing to something else.
In the last few years, the only real buyer of government bonds has been the federal reserve. Historically, the federal reserve was not even allowed to purchase government bonds. In addition, it certainly wouldn’t have been able to become the primary purchaser without quantitative easing. However, the federal reserve is planning on backing off of quantitative easing, and that spells trouble for the government, and they know it.
Two policy changes this year indicate that the federal government knows that it is in trouble. The first is the myRA account announced at the State of the Union speech. This is a special retirement account being sold to lower-income Americans that can only contain *one* investment type. You guessed it – government bonds. The goal of this program is not to help poor people get retirement accounts. The goal is to sucker the poorest Americans into financing the government’s debts. Why? Because we can’t find anyone else to do it.
The second policy change is the increase in the Social Security Administration to pursue old debts, and take the money from relatives of the debtor. In some cases, they are withholding tax returns from people because the social security administration overpaid a relative of theirs 30 years ago. So, not your debts, but a relative’s debts. And not a recent debt, but one 30 years ago. This means that as quantitative easing starts to fade, the federal government is going to start doing increasingly panicked measures to increase their cash, because they have run out of people to finance their borrowing.
No, just to point out, I think that removing quantitative easing is a good thing. The problem is that it will reveal just how poorly managed our country and our economy have been, and it will hurt bad. It’s a necessary step for healing, but the transition is going to be a ride that no one will ever forget.
This article makes a stunning claim that globalization is the best thing society has going for us. I agree that free trade reduces poverty in general. I don’t mind some forms of globalism, but I’m not sure that it is unequivocally good. Free trade and globalization are both negative when done by immoral people, and I have trouble thinking that the present set of globalists are influencing societies for improved morality. Nonetheless, it is interesting information worth noting.