Newt Gingrich and Rick Perry have decided that it's politically expedient at the moment to attack their primary opponent, Mitt Romney on the grounds that he and the company he once ran, Bain Capital, engaged in "vulture capitalism". That is, they bought companies, closed them down, laid off their workers and sold off the assets for a profit. It's a shame they've decided to go down this road, and equally disturbing that Romney's defense is fairly tepid at best. It illustrates that the candidates either don't understand the principals of capitalism and free markets or they don't really believe in them. Neither one is a good scenario.
Let's first go to the fundamental issue. Companies are not created for the purpose of creating jobs. Successful, growing companies do tend to create jobs, but that's not their primary function. They're created to make money for their owners. That's not only a selfish pursuit on the part of the owners, it's essential for the survival of the company. Proponents of a government based economy don't relate to this because it doesn't apply in that realm. Our federal government takes in $2 trillion a year and spends $3.6 trillion. No problem in their minds. In fact, they'd like to spend even more. So far, no consequences, no worries. That's not the case in the private sector.
The "vulture capitalism" scenario stems from a company who's business model isn't working. The company does, however, have assets. If you can buy the company for less than the value of the liquidated assets, you can make money. To do this, you have to win a bidding war against others with either the same idea or who believe they can make the company work. In any case, it's up to the seller who's bid gets accepted, and up to the new owners what happens next. Kmart was purchased in bankruptcy by a group of investors who sought to profit from the company's real estate holdings. Shortly thereafter, the real estate market plummeted. The government did not step in to rescue the investors and the public did not clamor for such a rescue. There is only an outcry when such moves are successful.
The basic truth is that capitalism is based on selfishness. That's why it works. The net result of free market capitalism is that more people experience more benefit than from any other economic system ever tried. The reason is that people will pay you to help them, whether it's through the provision of a useful product or a service. To pursue ones selfish goals, one must figure out how to help people profitably, not because your aim is necessarily helping people, but because people aren't going to pay you for nothing (unless you're in government). The uncomfortable part about free market capitalism is that in some cases, bad things happen to good people. People make mistakes or just experience bad luck. Of course people can and do come to the aid of other people who are down on their luck. Problems arise when they try to get government to prevent bad luck and poor decisions from happening in the first place. They continue to believe the market can be controlled. If we just add the right mix of rules, regulations and limitations, we can have orderly prosperity. We can't and we wont.
Free markets are based on parallel processing dynamics. They express the cumulative result of billions and billions of individual decisions made by freely associating individuals in the absence of force. Central control destroys that dynamic. Out of the box ideas are not tried because they are not allowed. Big chances are not taken because the punishment for success exceeds any possible reward. Ideas are evaluated by a handful of pre-selected officials rather than by each individual according to their own judgement. Capital doesn't flow to innovation. It flows to the proverbial mattress, a.k.a. Treasury Securities.
If you believe in free markets you have to let them be free markets. If someone buys a company and decides to close it down and sell of the assets, for whatever reason, that's their prerogative. The trade-off in being an employee is steady paycheck, no liability. The downside is that the company you work for does not belong to you. If we continue down the road of holding up decisions about how to use private property, including companies, to government scrutiny and approval, "vulture capitalism" will be all we'll have left. Because the economy will be littered with the carcasses of ideas that had nowhere to grow.
Tuesday, January 17, 2012
Wednesday, December 14, 2011
The viscous cycle of international debt. How will it end?
Many have predicted in recent years, that the international debt bubble would lead to global inflation and sky high interest rates. So far, this has not happened. What's going on? Well, the debt has been propped up by more debt. How and when it ends is anybody's guess.
The European Union had yet another emergency summit and came up with yet another set of proposed solutions. Okay, not really solutions, but delays. One plan involves individual nations in the Euro group lending money to the International Monetary Fund (IMF), who would then make loans to troubled countries like Greece, Italy and Spain in return for assurances that they get their cash flow under control. This gets around an EU rule that does not permit European central banks to loan directly to member countries. It also takes the risk for such loans out of the hands of the EU central banks and places it instead with the IMF, which includes the U.S..
Another plan is to create new European Union rules that mandate certain budget constraints and has automatic penalties for violators. In exchange the European Central Bank would more aggressively buy member country bonds, keeping interest rates lower while they try to get their budgets under control. The details of the new rules and the automatic penalties have been conveniently delayed until at least March of 2012.
The reason for all this debt on top of debt is that the world's economies cannot support higher tax rates. Even if they imposed them, they'd actually lose revenue due to a further decrease in economic activity.
So why don't countries just print more money instead of borrowing? Well, the U.S. and the EU could certainly do that, and to some extent they have. In the U.S. we've had several rounds of what's called "Quantitative Easing" or QE. Essentially, the Federal Reserve creates new money and uses it to buy U.S. Treasuries (debt). So far, the demand for dollars has outpaced the production of new dollars and has not yet lead to inflation. So why has all this debt not caused massive inflation yet? Because the debt is still being primarily addressed with more debt.
Japan has a debt to Gross Domestic Product (total amount of goods and services produced in a year) of over 200%, yet their currency remains strong. This is because they continue to borrow and investors continue to lend. As long as Japan keeps issuing more debt, investors will seek Japanese currency to lend them. The same is true in the U.S.. The large banks and institutions continue to roll over profits and even proceeds from Treasury securities sales, back into Treasuries. They see few alternatives in the private sector, so they are even willing to loan the U.S. government money at zero percent interest for very short terms, and recently even at below zero which means they're willing to pay to keep their money safe until better days. Dollars flow from central banks to large organizations, corporations and countries, right back to the central banks. It's not showing up in the marketplace.
This only comes to an end when countries move from primarily borrowing to cover debt to printing instead. If the U.S. for example, suddenly decided to print their way out of debt, the institutions that had been investing in Treasuries would be forced to park their dollars elsewhere. If those trillions actually find their way to the private sector economy, inflation could pick up in a hurry and you could see "panic buying". That is, people would be desperate to exchange their currency for something, anything, that they can expect to hold it's value better. The value of the currency plummets and the price of everything skyrockets.
This obviously would be devastating for anyone on a fixed income. Additionally, the main tool used to counter inflation is higher interest rates, clobbering anyone with variable interest rate debt.
Another solution would be for countries to default, or not pay some or all of their outstanding debt. This is a no go, because most of that debt has been used as collateral for more debt. Hence a default on $100 could cause the elimination of many times that amount in capital. Economies would come to a complete standstill.
Of course governments could also drastically cut spending and embrace free market policies which would stimulate private sector earning and therefore tax revenues. This is not likely either because most of the powers that be don't believe in the free market. They cling to the belief that government can and must control the way resources are allocated and distributed. Leaving such important decisions in the hands of individuals is out of the question.
So at what point does it become necessary to stop borrowing and start printing with reckless abandon? I don't know. Maybe never. The central banks can continue with Quantitative Easing without causing inflation, as long as they do so at a pace that encourages investors to send that money right back to the Treasury markets. A sudden increase in private sector investment and economic activity would actually work against this plan, since it would take dollars away from Treasury investments, causing interest rates to spike, which might just prompt increased currency production. Absent some new innovation in the private sector that would cause such a thing, it's really up to the patience of the people. How long will the populace tolerate the continued downgrade of most of their standards of living while all the currency stays in the government/institution merry-go-round?
If hyper-inflation does come to pass, the good news is that it does eventually come to an end. It really is just another form of default, but the losses are spread out among the entire population rather than just among bondholders. It's nasty. It's tragic, and it can lead to lots more bad decisions if we're not careful, but it may just be the only real solution.
The European Union had yet another emergency summit and came up with yet another set of proposed solutions. Okay, not really solutions, but delays. One plan involves individual nations in the Euro group lending money to the International Monetary Fund (IMF), who would then make loans to troubled countries like Greece, Italy and Spain in return for assurances that they get their cash flow under control. This gets around an EU rule that does not permit European central banks to loan directly to member countries. It also takes the risk for such loans out of the hands of the EU central banks and places it instead with the IMF, which includes the U.S..
Another plan is to create new European Union rules that mandate certain budget constraints and has automatic penalties for violators. In exchange the European Central Bank would more aggressively buy member country bonds, keeping interest rates lower while they try to get their budgets under control. The details of the new rules and the automatic penalties have been conveniently delayed until at least March of 2012.
The reason for all this debt on top of debt is that the world's economies cannot support higher tax rates. Even if they imposed them, they'd actually lose revenue due to a further decrease in economic activity.
So why don't countries just print more money instead of borrowing? Well, the U.S. and the EU could certainly do that, and to some extent they have. In the U.S. we've had several rounds of what's called "Quantitative Easing" or QE. Essentially, the Federal Reserve creates new money and uses it to buy U.S. Treasuries (debt). So far, the demand for dollars has outpaced the production of new dollars and has not yet lead to inflation. So why has all this debt not caused massive inflation yet? Because the debt is still being primarily addressed with more debt.
Japan has a debt to Gross Domestic Product (total amount of goods and services produced in a year) of over 200%, yet their currency remains strong. This is because they continue to borrow and investors continue to lend. As long as Japan keeps issuing more debt, investors will seek Japanese currency to lend them. The same is true in the U.S.. The large banks and institutions continue to roll over profits and even proceeds from Treasury securities sales, back into Treasuries. They see few alternatives in the private sector, so they are even willing to loan the U.S. government money at zero percent interest for very short terms, and recently even at below zero which means they're willing to pay to keep their money safe until better days. Dollars flow from central banks to large organizations, corporations and countries, right back to the central banks. It's not showing up in the marketplace.
This only comes to an end when countries move from primarily borrowing to cover debt to printing instead. If the U.S. for example, suddenly decided to print their way out of debt, the institutions that had been investing in Treasuries would be forced to park their dollars elsewhere. If those trillions actually find their way to the private sector economy, inflation could pick up in a hurry and you could see "panic buying". That is, people would be desperate to exchange their currency for something, anything, that they can expect to hold it's value better. The value of the currency plummets and the price of everything skyrockets.
This obviously would be devastating for anyone on a fixed income. Additionally, the main tool used to counter inflation is higher interest rates, clobbering anyone with variable interest rate debt.
Another solution would be for countries to default, or not pay some or all of their outstanding debt. This is a no go, because most of that debt has been used as collateral for more debt. Hence a default on $100 could cause the elimination of many times that amount in capital. Economies would come to a complete standstill.
Of course governments could also drastically cut spending and embrace free market policies which would stimulate private sector earning and therefore tax revenues. This is not likely either because most of the powers that be don't believe in the free market. They cling to the belief that government can and must control the way resources are allocated and distributed. Leaving such important decisions in the hands of individuals is out of the question.
So at what point does it become necessary to stop borrowing and start printing with reckless abandon? I don't know. Maybe never. The central banks can continue with Quantitative Easing without causing inflation, as long as they do so at a pace that encourages investors to send that money right back to the Treasury markets. A sudden increase in private sector investment and economic activity would actually work against this plan, since it would take dollars away from Treasury investments, causing interest rates to spike, which might just prompt increased currency production. Absent some new innovation in the private sector that would cause such a thing, it's really up to the patience of the people. How long will the populace tolerate the continued downgrade of most of their standards of living while all the currency stays in the government/institution merry-go-round?
If hyper-inflation does come to pass, the good news is that it does eventually come to an end. It really is just another form of default, but the losses are spread out among the entire population rather than just among bondholders. It's nasty. It's tragic, and it can lead to lots more bad decisions if we're not careful, but it may just be the only real solution.
Monday, November 14, 2011
The Politics of Personal Destruction explained
This is not an opinion. It's a fact. Progressives or liberals or whatever you want to call collectivists this week, often employ the tactic of totally smearing an adversary in the media, regardless of any factual basis for the negativity. Free Market Capitalists almost never engage in this particular tactic, at least not without evidence.
Why is that? First you must understand that the philosophical tug-o-war going on in this country is not simply about different means to a common goal. The goals are very different. The Progressives would like to bring about a top-down society. One in which the government directs the flow of resources, human and material. They decide what kind of jobs people ought to have, what they should make, how they should spend their time, etc. It's all for the greater good of society as a whole. The individual is insignificant compared to the whole.
Free Market Capitalism is about free people engaging in free trade in the absence of force. The individual is the center of the free market universe. Society is the cumulative result of billions of individual decisions. It is not above the individual because it is not an entity unto itself. It would be meaningless without the individual.
The two models obviously cannot exist in the same place at the same time. They are polar opposites. We are nearing a point in history where one or the other is going to win out. People need to choose sides. The political arena has never been uglier and it's going to get worse.
But back to the smear campaign element. Herman Cain has been accused of sexual harrassment and essentially assualt, by women (at least the one's who's names have been revealed) with a history of making such claims against employers. The harrassment claims were investigated and found baseless. The ridiculous Gloria Allred stunt doesn't even merit analysis. Yet NBC, MSNBC, CNN and others can't stop repeating the charges and commenting on them as if they actually happened. Why? Because they are in the Progressive camp. Remember, the individual doesn't matter. They are working for the greater good. So what if Herman Cain and his family are destroyed? The important thing is that Progressives retain power, for the good of us all.
No doubt the Free Market Capitalist crowd will be fighting passionately as well, and they may very well employ some dirty tricks, but they generally will not destroy someone personally with information they know to be false. This is simply because it's a different mindset. The individual does matter. The individual is essential. The individual is not disposable.
Don't take my word for it. Watch and evaluate yourself. Keep in mind, the fact that a lie has been repeated a million times does not constitute proof (they will be repeated at least that many times. This is not a new tactic.) Use logic and objectivity. Evaluate facts, not emotions. Use common sense. Use a variety of information sources.
Why do I think it's important to point out the brutal tactics of the Progressives? Because they appear to be working and awareness is the only countermeasure.
Why is that? First you must understand that the philosophical tug-o-war going on in this country is not simply about different means to a common goal. The goals are very different. The Progressives would like to bring about a top-down society. One in which the government directs the flow of resources, human and material. They decide what kind of jobs people ought to have, what they should make, how they should spend their time, etc. It's all for the greater good of society as a whole. The individual is insignificant compared to the whole.
Free Market Capitalism is about free people engaging in free trade in the absence of force. The individual is the center of the free market universe. Society is the cumulative result of billions of individual decisions. It is not above the individual because it is not an entity unto itself. It would be meaningless without the individual.
The two models obviously cannot exist in the same place at the same time. They are polar opposites. We are nearing a point in history where one or the other is going to win out. People need to choose sides. The political arena has never been uglier and it's going to get worse.
But back to the smear campaign element. Herman Cain has been accused of sexual harrassment and essentially assualt, by women (at least the one's who's names have been revealed) with a history of making such claims against employers. The harrassment claims were investigated and found baseless. The ridiculous Gloria Allred stunt doesn't even merit analysis. Yet NBC, MSNBC, CNN and others can't stop repeating the charges and commenting on them as if they actually happened. Why? Because they are in the Progressive camp. Remember, the individual doesn't matter. They are working for the greater good. So what if Herman Cain and his family are destroyed? The important thing is that Progressives retain power, for the good of us all.
No doubt the Free Market Capitalist crowd will be fighting passionately as well, and they may very well employ some dirty tricks, but they generally will not destroy someone personally with information they know to be false. This is simply because it's a different mindset. The individual does matter. The individual is essential. The individual is not disposable.
Don't take my word for it. Watch and evaluate yourself. Keep in mind, the fact that a lie has been repeated a million times does not constitute proof (they will be repeated at least that many times. This is not a new tactic.) Use logic and objectivity. Evaluate facts, not emotions. Use common sense. Use a variety of information sources.
Why do I think it's important to point out the brutal tactics of the Progressives? Because they appear to be working and awareness is the only countermeasure.
Saturday, October 29, 2011
How bureaucracy poisons an economy
We all know government paperwork costs businesses money. But the government can print more money. It's not always the best yardstick by which to measure cost and value. As the government prints more, it becomes less valuable. A more consistent and meaningful approach is to use the measure that gives money its ultimate value. Time.
You may be familiar with the term "opportunity cost" as it's used in economics. If not, in a nutshell, it means that every dollar you spend on something is a dollar that is no longer available for something else. For example if a vendor is selling apples and pears for $1 each, and you only have $1, if you buy the apple, it cost you the opportunity to buy a pear.
It works the same for time. You only have 24 hours in a day. Less than that in a work day. Every hour you spend on one task is an hour that is no longer available for any other task.
According to the US Census Bureau, in 2007 there were 7.7 million firms with employees in the United States. Forcing one employee at each firm to spend 10 minutes on non-productive paperwork or procedures costs the economy 1.28 million man hours. That's 617 man-work years. Put another way, an unproductive 10 minute mandate on business costs the equivalent of hiring a crew of 617 people, full time, for a full year. What could you accomplish with that kind of manpower? And that's 10 minutes a year. Ten minutes a week and you've got a good sized army at your disposal. Ten minutes a day and you're rivaling economies of entire cities.
What is the average number of minutes spent at your business, filling out paperwork that you would not do if it were not mandated by some level of government? Multiply that by 7.7 million. We're already slowing ourselves down enough and some politicians want to add more dead-weight to the system.
When you hear of a new regulation or requirement and it's sold as something that only takes a few minutes, or the cost is negligible, think of it in terms of the cumulative waste of productive activity across the board. The free market is an expression of the cumulative effect of countless individual decisions and the productive moments of millions and millions of individuals. Taking man-hours out of the system removes value from the economy. Who do you think is a better judge of what an employee should be working on from 2pm to 3pm? The employer or the employee, or some a group of government bureaucrats?
You may be familiar with the term "opportunity cost" as it's used in economics. If not, in a nutshell, it means that every dollar you spend on something is a dollar that is no longer available for something else. For example if a vendor is selling apples and pears for $1 each, and you only have $1, if you buy the apple, it cost you the opportunity to buy a pear.
It works the same for time. You only have 24 hours in a day. Less than that in a work day. Every hour you spend on one task is an hour that is no longer available for any other task.
According to the US Census Bureau, in 2007 there were 7.7 million firms with employees in the United States. Forcing one employee at each firm to spend 10 minutes on non-productive paperwork or procedures costs the economy 1.28 million man hours. That's 617 man-work years. Put another way, an unproductive 10 minute mandate on business costs the equivalent of hiring a crew of 617 people, full time, for a full year. What could you accomplish with that kind of manpower? And that's 10 minutes a year. Ten minutes a week and you've got a good sized army at your disposal. Ten minutes a day and you're rivaling economies of entire cities.
What is the average number of minutes spent at your business, filling out paperwork that you would not do if it were not mandated by some level of government? Multiply that by 7.7 million. We're already slowing ourselves down enough and some politicians want to add more dead-weight to the system.
When you hear of a new regulation or requirement and it's sold as something that only takes a few minutes, or the cost is negligible, think of it in terms of the cumulative waste of productive activity across the board. The free market is an expression of the cumulative effect of countless individual decisions and the productive moments of millions and millions of individuals. Taking man-hours out of the system removes value from the economy. Who do you think is a better judge of what an employee should be working on from 2pm to 3pm? The employer or the employee, or some a group of government bureaucrats?
Tuesday, October 25, 2011
Catastrophe is vital to a free market system
Greece is broke and owes more than anyone believes it can ever pay back. They got there on sales of bonds to investors, which include nations, banks, businesses, organizations and individuals. These investors fear the consequences of having to actually realize the losses they've incurred. It's a very similar scenario to the pre-TARP days here in the United States. The investors argue that it would not just be a financial loss to them, but a shock to the whole system as a consequence of their failure. They hope the general fear will be equal to their own and everyone will work to cushion the blow. Cushioning the blow means transferring the loss to the general public to the largest extent possible.
This has worked in the sense that large businesses have been spared the calamity of letting nature run its course, and the system is in a long term funk rather than getting a short term wallup. The problem is that the bad ideas don't get the drubbing they deserve. The status quo, which failed, is kept alive. Nothing is learned. Innovation is not incentivized. Proven failures in policy are kept in place and even expanded upon. No pain, no gain.
Physical pain, is in one regard, a warning to the occupant of the body: "Don't do that." or "Don't do that again". It has a purpose. In fact a human, on it's own, without the capacity to feel pain would not likely live very long. Even mental pain and regret serve a purpose. The message is: "That course of action was a mistake. Don't do it again."
Fiscal pain serves a similar purpose in the market place. At the transaction level, if a consumer feels like he or she got less value than he or she anticipated, that's regret and will prevent the consumer from buying the product or service again. Bad value propositions die out over time. Now if the government stepped in and offered to pay half the purchase price for you, you might change your assessment of the value proposition, and the bad model is saved. Incompetence, deception, low quality, bad ideas are kept alive and well.
At the government level, the same dynamic is at work. Their ability to borrow is based on the market's confidence in their ability to make good on the bonds over time. If the bonds are backstopped, guaranteed or insured by a group of other governments, investors need not worry about whether or not the system of government can produce a viable, vibrant economy. Succeed or fail, they're going to get paid. Failed policies live on. Unsustainable governments are sustained. Bad ideas are reinforced.
The marketplace of ideas is directly connected to the actual marketplace. You have to acknowledge and remove the trash periodically or you will simply wallow in trash. Free market forces are very efficient at spotlighting the trash. Committees, elected or otherwise, are not. In fact, many governments prefer to deny the existence of trash to having to actually point it out or acknowledge it. Care free investors enable this approach. Investors are care free when taxpayers absorb their losses.
Imagine if investors actually had to consider whether or not a system of government would produce happy, productive citizens with a desire to excel. The only way to get that back into the equation is to take away the safety nets. Pain hurts. That's why it's effective. Making ourselves numb is not a path to a better future.
This has worked in the sense that large businesses have been spared the calamity of letting nature run its course, and the system is in a long term funk rather than getting a short term wallup. The problem is that the bad ideas don't get the drubbing they deserve. The status quo, which failed, is kept alive. Nothing is learned. Innovation is not incentivized. Proven failures in policy are kept in place and even expanded upon. No pain, no gain.
Physical pain, is in one regard, a warning to the occupant of the body: "Don't do that." or "Don't do that again". It has a purpose. In fact a human, on it's own, without the capacity to feel pain would not likely live very long. Even mental pain and regret serve a purpose. The message is: "That course of action was a mistake. Don't do it again."
Fiscal pain serves a similar purpose in the market place. At the transaction level, if a consumer feels like he or she got less value than he or she anticipated, that's regret and will prevent the consumer from buying the product or service again. Bad value propositions die out over time. Now if the government stepped in and offered to pay half the purchase price for you, you might change your assessment of the value proposition, and the bad model is saved. Incompetence, deception, low quality, bad ideas are kept alive and well.
At the government level, the same dynamic is at work. Their ability to borrow is based on the market's confidence in their ability to make good on the bonds over time. If the bonds are backstopped, guaranteed or insured by a group of other governments, investors need not worry about whether or not the system of government can produce a viable, vibrant economy. Succeed or fail, they're going to get paid. Failed policies live on. Unsustainable governments are sustained. Bad ideas are reinforced.
The marketplace of ideas is directly connected to the actual marketplace. You have to acknowledge and remove the trash periodically or you will simply wallow in trash. Free market forces are very efficient at spotlighting the trash. Committees, elected or otherwise, are not. In fact, many governments prefer to deny the existence of trash to having to actually point it out or acknowledge it. Care free investors enable this approach. Investors are care free when taxpayers absorb their losses.
Imagine if investors actually had to consider whether or not a system of government would produce happy, productive citizens with a desire to excel. The only way to get that back into the equation is to take away the safety nets. Pain hurts. That's why it's effective. Making ourselves numb is not a path to a better future.
Tuesday, October 4, 2011
How taxes regulations and madates kill an economy
You may know intuitively, that taxes and price controls and government mandates are bad for economic growth. But, do you know the mechanics of how they strangle an economy? It's really not that complicated, but experts like to use the lingo of the industry to make themselves sound much smarter than you. Here's an explanation in plain English.
Suppose you have a watchamacallit and I don't. You feel that watchamacallit is worth 20 cents. I believe it's worth 23 cents. There's a potential for a transaction there, created by our slight disagreement over the value of the watchamacallit. I could pay you anywhere from 20 to 23 cents and we'd both feel like it was a fair deal. Now suppose the government imposes a 5 cent tax on watchamacallits. To get the 20 cents you would need to feel good about parting ways with it, I'd have to pay you at least 25 cents. But I only think it's worth 23 cents. Transaction killed. Transactions that don't happen, don't show up in government statistics.
A tax of 1 or 2 cents may not have killed our transaction. There was still enough room in our margin of disagreement to make a deal. But when government gets too big, and demands too much, many transactions die and they get nothing.
Any third party mandate that adds cost to a transaction is a potential deal killer. Value is subjective. The point at which a transaction dies is totally up to the opinion of the buyer and the seller. You can't pass a law that makes me believe a whatchamacallit is worth more than I believe it's worth, and without putting a gun to your head, I can't make you accept less than you're willing to accept. Even if I put the gun to your head, how enthusiastic are you going to be about producing more whatchamacallits from that point forward?
Free markets means free people engaging in free trade in the absence of force. That last bit is why we need government. Yes, it has to be paid for, but the cost has to be low enough and the interference in the marketplace minimal enough that it doesn't kill the deal.
This is why companies go offshore. This is why small businesses don't expand. Third party add-ons make the risk/reward ratio too high. The government is trying to control too much, provide too much, take care of too much. It just costs too much. To add insult to injury, they aren't very good at it either.
Suppose you have a watchamacallit and I don't. You feel that watchamacallit is worth 20 cents. I believe it's worth 23 cents. There's a potential for a transaction there, created by our slight disagreement over the value of the watchamacallit. I could pay you anywhere from 20 to 23 cents and we'd both feel like it was a fair deal. Now suppose the government imposes a 5 cent tax on watchamacallits. To get the 20 cents you would need to feel good about parting ways with it, I'd have to pay you at least 25 cents. But I only think it's worth 23 cents. Transaction killed. Transactions that don't happen, don't show up in government statistics.
A tax of 1 or 2 cents may not have killed our transaction. There was still enough room in our margin of disagreement to make a deal. But when government gets too big, and demands too much, many transactions die and they get nothing.
Any third party mandate that adds cost to a transaction is a potential deal killer. Value is subjective. The point at which a transaction dies is totally up to the opinion of the buyer and the seller. You can't pass a law that makes me believe a whatchamacallit is worth more than I believe it's worth, and without putting a gun to your head, I can't make you accept less than you're willing to accept. Even if I put the gun to your head, how enthusiastic are you going to be about producing more whatchamacallits from that point forward?
Free markets means free people engaging in free trade in the absence of force. That last bit is why we need government. Yes, it has to be paid for, but the cost has to be low enough and the interference in the marketplace minimal enough that it doesn't kill the deal.
This is why companies go offshore. This is why small businesses don't expand. Third party add-ons make the risk/reward ratio too high. The government is trying to control too much, provide too much, take care of too much. It just costs too much. To add insult to injury, they aren't very good at it either.
Monday, August 22, 2011
Is the stock market going out of style?
With the economy in rough shape and uncertainty in the marketplace, it’s no wonder that individual investors are frustrated with the stock market these days. But if the stock market is going to be a reliable venue for growing and storing wealth over the long term, there are issues that go much deeper than the current economic climate that may need to be addressed.
Let’s look at the performance of the most widely known index, The DOW Industrials over the past 100 years. During that time the index has risen from around 100 points to around 10,000 points. That’s 100 times your money! Pretty good right? Actually, that’s just about a 4% annual rate of interest, before adjusting for inflation. If you could go back in time 100 years and invest $1,000, you might do just as well or better if you bought $1,000 worth of actual quality baskets rather than a basket of quality stocks.
Stocks had a momentus run between about 1985 and 1998. During that period, if you had bought at the lows and got out at the high, you’d have made a whopping 18% annual return. This was the advent of the internet age. All of a sudden information was cheap and easily obtainable. Commissions plummetted as internet trading houses like E-Trade and Ameritrade hit the scene. There was an explosion of individual investing. Prices soared, new companies took off like rockets. Then, of course, the bubble burst. It took a while for the individual investor to regain confidence and get back in the game, but back they came. Prices began to rise again. Then, of course, the housing bubble burst. Now, just three years later, the market is approaching 10,000 again. This time on the way down.
Not only are prices on the way down, but trading volume has actually been in a declining trend for the past two years. There’s good reason to be concerned. The very nature of the market has changed as much as the economy with the advancement of technology.
The vast majority of today’s trading volume is generated by computer programs called “quants” These programs make automatic, instantaneous transactions based on whatever data the programmers designed it to monitor. They look at trading data and try to find patterns. Some are even programmed to learn from their mistakes and make adjustments on the fly. Of course, much of that trading data is generated by other computer program trades. The result is that you have computer programs responding to the decisions of other computer programs. In the extreme you get situations like the “flash crash” of May 2010 when many large company’s stocks actually traded for $.01 (the exchanges later cancelled most of those trades). But how much does this type of trading effect stock prices when it’s not expressed in the extreme? The answer is nobody knows.
Stock prices are subjective. You can look at historical averages, but there is no price that any stock is “supposed to be” at on any given day or minute. These quant trades account for around 70% of daily volume. Most of the rest is day-trading, hedge funds and professional equities traders with outlooks of around 18 months. The traditional buy and hold investor, saving for retirement or school makes up just about 5% on any given day. The more computerized trading based on trading data takes place, the more divorced a company’s stock price becomes from any consideration of its business model or performance. Stocks go up because they go up and they go down because they go down. Moves in both directions are magnified as computerized triggers are set off. This is heaven for day traders, not so much for the passive investor.
I don’t believe the stock market is going to go away anymore than I believe lottery tickets or Las Vegas casinos are going to go away. But buying and holding equity in widely-held, publicly traded companies may not be a wise long-term investment strategy anymore. That’s not to say people wont make money. But predictability and connection to events on the ground is going out the window. Even a ban on computerized trading would only mean that you’d have to input the computer generated trade manually rather than automatically. You can’t put this genie back in the bottle.
Don’t take this as investment advice or a prediction of where the DOW is going to go in the future. But it is information you might want to consider and talk over with your investment advisor before deciding what to do with your hard earned savings.
Let’s look at the performance of the most widely known index, The DOW Industrials over the past 100 years. During that time the index has risen from around 100 points to around 10,000 points. That’s 100 times your money! Pretty good right? Actually, that’s just about a 4% annual rate of interest, before adjusting for inflation. If you could go back in time 100 years and invest $1,000, you might do just as well or better if you bought $1,000 worth of actual quality baskets rather than a basket of quality stocks.
Stocks had a momentus run between about 1985 and 1998. During that period, if you had bought at the lows and got out at the high, you’d have made a whopping 18% annual return. This was the advent of the internet age. All of a sudden information was cheap and easily obtainable. Commissions plummetted as internet trading houses like E-Trade and Ameritrade hit the scene. There was an explosion of individual investing. Prices soared, new companies took off like rockets. Then, of course, the bubble burst. It took a while for the individual investor to regain confidence and get back in the game, but back they came. Prices began to rise again. Then, of course, the housing bubble burst. Now, just three years later, the market is approaching 10,000 again. This time on the way down.
Not only are prices on the way down, but trading volume has actually been in a declining trend for the past two years. There’s good reason to be concerned. The very nature of the market has changed as much as the economy with the advancement of technology.
The vast majority of today’s trading volume is generated by computer programs called “quants” These programs make automatic, instantaneous transactions based on whatever data the programmers designed it to monitor. They look at trading data and try to find patterns. Some are even programmed to learn from their mistakes and make adjustments on the fly. Of course, much of that trading data is generated by other computer program trades. The result is that you have computer programs responding to the decisions of other computer programs. In the extreme you get situations like the “flash crash” of May 2010 when many large company’s stocks actually traded for $.01 (the exchanges later cancelled most of those trades). But how much does this type of trading effect stock prices when it’s not expressed in the extreme? The answer is nobody knows.
Stock prices are subjective. You can look at historical averages, but there is no price that any stock is “supposed to be” at on any given day or minute. These quant trades account for around 70% of daily volume. Most of the rest is day-trading, hedge funds and professional equities traders with outlooks of around 18 months. The traditional buy and hold investor, saving for retirement or school makes up just about 5% on any given day. The more computerized trading based on trading data takes place, the more divorced a company’s stock price becomes from any consideration of its business model or performance. Stocks go up because they go up and they go down because they go down. Moves in both directions are magnified as computerized triggers are set off. This is heaven for day traders, not so much for the passive investor.
I don’t believe the stock market is going to go away anymore than I believe lottery tickets or Las Vegas casinos are going to go away. But buying and holding equity in widely-held, publicly traded companies may not be a wise long-term investment strategy anymore. That’s not to say people wont make money. But predictability and connection to events on the ground is going out the window. Even a ban on computerized trading would only mean that you’d have to input the computer generated trade manually rather than automatically. You can’t put this genie back in the bottle.
Don’t take this as investment advice or a prediction of where the DOW is going to go in the future. But it is information you might want to consider and talk over with your investment advisor before deciding what to do with your hard earned savings.
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