It’s Casino Royale out there in financial markets, and participants who just months ago were confident in what they do for clients are now tired and shaken. The idea of hedgeing one’s investment has morphed into a pure casino of placing bets throughout the day on every piece of investment paper one can imagine, from oil futures, to dollar futures, to inverse ETFs—on and on and on.
“The trend is your friend,” is the gambler’s siren cry. “We’ve called three successful tops and three bottoms the past month, for an average return of 75%” cry out the bookies. The only thing Beezer hasn’t heard yet are the radio ads urging “investors” to call a 1-800-whatever and get “two guaranteed wins for free!!!”
What the heck is going on? Gambling is going on. It’s that simple. The underlying investment world has been overlayed by a trillion upon trillion dollar gambling craze. Fundamentals are merely after-thoughts in this huge casino, and when fundamentals do assert themselves, the reactions in the real markets are magnified dramatically. “You in trouble?” asks the gambler, “Buy the inverse ETFs and make a fortune as the price declines.”
In the end, the vast majority of gamblers lose. As volatility increases, gamblers can’t keep up. It’s too fast. It’s only about price movement, up or down. They basically end up beating each other senseless.
Unfortunately the world is suffering immense collateral damage because all this gambling perverts price discovery in the underlying markets. Prices no longer correspond to any rational fundamentals and the productive industry relying on at least a modicum of price stability withdraw from the markets simply because no one can figure out how to actually get business done in this gambling whirlwind. Banks withdraw. Commodity buyers (and credit suppliers to commodity producers, including farmers) withdraw.
The idea was that all this stuff would provide liquidity to the markets. The risks that these “Non-Securities” could pose was not understood. What worked as an algorithm in the classroom turned out to be cyanide in the real world.
When the connection between the price of a real security is broken from the fundamentals, investors withdraw their money and put it where (it is fervently hoped) there is safety. At the moment, a favorite place to park this money is in US Treasuries. And that’s where it’s going to stay until regulations are put in place to inhibit gambling.
Something direct and easy to understand is needed. Eliminating all these non-securities by fiat would work. Taxing short term gains at 80% would probably have a serious calming effect.
A similar problem occured in the 1920s. Productive investments made previously in new industries that were manufacturing an explosion of goods like cars and washing machines, were bearing fruit and wealth was being created. But wealth created is not necessarily wealth re-invested in more productive activity. Especially if the previous investments need little additional capital to keep increasing profits. So the money gravitates to the stock market instead. In the 1920s regulation of these markets, as well as banking, was minimal. The stock market, or any financial market for that matter, is represented as a number. The number goes up, you win. The number goes down you lose–unless you can place a bet that rewards you if the number goes down. And of course, if you need to put down only a dime to bet a dollar, so much the better if you guess which way the number will go. It matters absolutely nothing what the fundamentals are. “The trend is your friend,” after all is said and done.
A side observation is that, under the scenario explained above, an early warning of coming disaster is that the disparity in incomes increases as the wealthy need not invest more in labor or machinery because previous investments in labor and machinery were so successful. No trickle down for a while, it seems.
Today it’s much the same. Only larger because there are simply more people on the planet, and way more money.
And it’s probably right to ask again, as Fred Schwed did years ago about Wall Street tycoons “Where are the Customers’ Yachts?” A lot of Manhatten executives have been paid hundreds of millions of dollars to pump up this gambling machine. So where are the customers’ yachts?